Lots of construction cases filled the advance sheets this month, and we chose six you should know about. We begin with a Federal decision from the Sixth Circuit Court of Appeals (covering cases arising in Michigan, Ohio, Kentucky, and Tennessee) on an appeal of an OSHA violation based on imputing a foreman’s constructive knowledge of a risk to the company itself. Next we look at what the Supreme Court of Indiana had to say about the scope of a performance bond for highway construction under Indiana law. Our third case turns to an Ohio Court of Claims opinion on whether a public owner could backcharge a contractor without first giving notice of defects in the work. Then we move to an Ohio Court of Appeals (Franklin County) and a case that deals with whether taking an unreasonable amount of time to complete a project is a material breach of contract when the contract contains no date for completion. For our fifth case, we look at what another Ohio appellate court, this one for Cuyahoga County, had to say about reforming a contract based on both parties’ mistake about the quantities required. Finally, case number six comes to us from the U.S. District Court for the Northern District of Ohio and deals with what happens when a contractor defaults and the surety must pay claims against the surety bond. How does the surety recoup the money it has had to pay out?
Court Upholds OSHA Citation Because Foreman Should Have Recognized Violation
To establish a ‘serious’ violation of industry safety standards under OSHA, the government must prove several facts:
- the employer was not in compliance,
- the employee was exposed to the hazard,
- there was a substantial likelihood that the employee could suffer death or a serious injury, and
- the employer knew, or with reasonable diligence could have known, of the violation.
What does it mean for the employer to know of the violation? Is a corporation’s imputed knowledge of a safety violation sufficient to charge it with a ‘serious’ violation of OSHA safety standards? This was the question taken up by the United States Court of Appeals for the Sixth Circuit in Kokosing Construction Company, Inc v. Occupational Safety and Hazard Review Commission (May 25, 2007), 2007 U.S. App. LEXIS 12835.
The case arose from an accident during the construction of an underground sewer line in Cincinnati. The project required deep excavations, which in turn required the use of de-watering pumps. In order to provide power for the de-watering pumps, Kokosing used construction-grade electrical cords connected to portable generators.
The workers on the site also used wire chokers to move equipment on the site. A wire choker is a device that uses a multi-strand wire to form a loop on each end.
Just prior to the incident, a Kokosing foreman discovered two electrical cords and two water discharge hoses lying on top of a choker. The foreman asked another employee to assist him in pulling the choker out from under the cords and hoses. When they attempted to pull the choker out, a wire protruding from the midsection of the choker pierced one of the electrical cords. Both employees suffered electrical shocks.
OSHA conducted an investigation and issued a citation for a serious violation. The administrative law judge who heard the case determined that the citation was properly issued. After the Occupational Safety and Hazard Review Commission upheld the decision, Kokosing appealed to the Sixth Circuit.
Kokosing argued that it had no knowledge of the violation and that the knowledge of its foreman was, at best, constructive knowledge. According to Kokosing, the Commission should not have imputed the foreman’s knowledge of the violation to the company. The court stepped through two different earlier cases to reach an answer.
In Carlisle Equip. Co. v. United States Sec’y of Labor, 24 F.3d 790 (6th Cir. 1994), the court found that as long as the government can prove that knowledge of a risk could have been obtained “with the exercise of reasonable diligence,” a supervisor is considered to have constructive knowledge. In an earlier case, Donovan v. Capital City Excavating, 712 F.2d 1008 (6th Cir. 1983), the court found that the actual or constructive knowledge of the employer’s foreman or supervisor can be imputed to the employer. Putting these two cases together, the court found that if the foreman could have found the hazard through reasonable diligence, that constructive knowledge would be imputed to Kokosing. Determining reasonable diligence requires the court to look at several factors, “including an employer’s obligation to inspect the work area, to anticipate hazards to which employees might be exposed, and to take measures to prevent the occurrence.”
In this case, the foreman knew of the possibility of a hazardous situation. He admitted that he knew the choker was old, but still did not check it for abrasions before he moved it. He testified that he had been taught to protect electrical cords from sharp metal. The court found that the Commission drew the logical conclusion that the foreman knew an old choker could have abrasions that could pierce the electrical cord, thereby presenting a hazard. “By failing to check for such abrasion . . . [he] failed to take incredibly simple actions to prevent the hazard.”
The court found that the foreman’s constructive knowledge could be imputed to Kokosing. Such knowledge was sufficient to uphold a serious violation and a fine of $1,875. This case serves to remind employers that what a foreman doesn’t know but should can hurt both the employees and the company.
Remote Subcontractor Gets No Protection from Performance Bond
Highway construction in Indiana requires a performance and payment bond “conditioned upon the faithful performance of the work . . . and also upon payment by the contractor and by all subcontractors for all labor performed or materials furnished or other services rendered in the construction of the highway.” Does that requirement, in Ind. Code § 8-23-9-9, mean that the bond protects all subcontractors at all levels, no matter how remote?
The Indiana Supreme Court answered that question last month in Alberici Constructors, Inc. v. Ohio Farmers Insurance Company, 866 N.E.2d 740 (Ind. May 22, 2007), and the answer is likely to please sureties more than it will subcontractors. Bluffton, Indiana, was the site of the project that led to this dispute. The Indiana Department of Transportation contracted with Primco, Inc. to reconstruct a bridge and build a pedestrian bridge near Bluffton. Primco purchased the bond in question to comply with § 8-23-9-9. The chain of subcontractors went three deep: Primco, the general contractor, subcontracted with Harmon who subcontracted with Gateway who subcontracted with Alberici.
Payment made its way to all but the last subcontractor. According to the Court, Gateway failed to pay Alberici. When Alberici filed a claim on the bond, Ohio Farmers denied the claim, responding that Alberici was “too remote” to benefit from the bond. So Alberici sued in Federal court—apparently because it was from outside Indiana. The Federal court needed to understand Indiana law on surety bonds so, in the absence of any past cases on the issue, it certified a question to the Indiana Supreme Court: “Does a performance bond required by and issued in accordance with Ind. Code § 8-23-9-9 afford coverage to a third-tier claimant?”
The Court’s answer—that it did not— hinged on its preferred definition of “subcontractor.” The Court admitted that a broad definition could encompass “any person or organization that has contracted at any level, to provide any part of the labor or materials for the project, no matter how insignificant.” That was obviously the definition Alberici preferred. The surety preferred a narrower definition of “subcontractor,” limiting it to entities “within one or a few degrees of contractual separation from the contractor,” and thus excluding Alberici.
To choose between the two definitions, the Court looked first at other sections of the Indiana Code (since § 8-23-9-9 failed to define “subcontractor”). One provision, on state public works projects in Title 4, said a “subcontractor” was “any person entering into a contract with a contractor to furnish labor or labor and materials used in the actual construction of a public works project.” If the Court had chosen that definition, Harmon (who subcontracted with Primco) would be the only subcontractor involved here, as only first-tier subs would qualify.
Other sections of the Code proved less helpful, as they specifically limited their definitions to a narrow context or provided no definition at all. So the Court turned next to the Department of Transportation Regulations.
These likewise made subcontractor status depend on a direct relationship with the contractor. The Court’s next source of guidance was Federal and Indiana case law, and it supported both sides in the argument. None of the cases was decided after the enactment of § 8-23-9-9, unfortunately, so the Court had no clear mandate from other courts. Alberici favored a 1915 case from an Indiana Court of Appeals, as that court had determined that the bond should cover all debts intimately related to the road construction. But the Court thought that outcome resulted from the specific bond language and did not lay down a general principle of bond law. Finally, the Court looked at public policy in an attempt to determine the impact of its decision “on policy and judicial economy.” This concern convinced the Court that extending bond protection to subs of every tier “seems to be the worst possible administrative outcome.”
Why? “Without a bright line defining where surety coverage extends,” the Court said, “contractors would face an incalculable risk of liability for claims made by distantly remote suppliers or laborers on contracts made without contractor approval.” So the Court decided to limit bond coverage to “at most, second-tier laborers and suppliers” because that decision fostered “relative certainty for all those involved in public construction projects.”
Where did that leave Alberici? The Court explained what a remote subcontractor could do: “demand advance payment or some form of financial undertaking before delivering the bridge pieces.” We need to point out that this decision depended on Indiana case law and statutes. In other states where the definition of “subcontractor” might be different, the outcome could also be different.
Failure To Give Notice, Provide Time To Cure Dooms Backcharge Try
Contractors and owners must be aware of their duties and obligations as they are set forth in their construction contracts. One of these duties/obligations may be a requirement to give notice if a certain event occurs, if a claim is made, or if there are defects in the completed work.
When notice is required but is not given, the party who should have given the notice may have waived its rights to recover on an otherwise valid claim or to recover for defects in workmanship. Notice provisions effectively allow the party who is to receive the notice the opportunity to take some remedial actions to minimize its costs.
In Certek, Inc. v. The Ohio State University (Ct. of Cl. May 2, 2007), 2007-Ohio-2750, the owner, OSU, failed to give proper notice of alleged defects in construction. OSU, as a result of the lack of notice, was not permitted to backcharge Certek for its alleged construction defects.
OSU contracted to have Certek manufacture and install “an airborne contamination BL+ laboratory module.” OSU approved the plans, and Certek installed the lab module and completed its work in December of 2004.
OSU first alleged that there were problems with the lab module by letter dated April 29, 2005. According to OSU, the defects included the following: the module wiring was incompatible with OSU’s security system, the door locking mechanism needed to be adapted to allow electronic proximity cards to be used to access the lab, the sterilizer unit needed an altered exhaust hood to release exhaust fumes away from electrical components, and the exhaust stack needed to be lengthened.
Certek argued that the modifications were not “part of the original approved design” and that the modifications were actually improvements. It also argued that it had no chance to modify the lab, as any “notice” came after others had already made the modifications.
In a hurry to open the lab, OSU had hired other contractors who were already on site to complete the modifications. OSU provided the April 29th notice to Certek after the modifications were completed but still attempted to backcharge Certek for the costs incurred in modifying the lab module.
Certek sued in the Court of Claims, where claims for damages against the State must be filed. The Referee’s decision came down May 2. Not surprisingly, the Referee’s focus was on the contract between the parties, which determined the rights and obligations of each party.
The court reviewed the contract and determined that the parties intended that notice be given, that notice was not given in a timely manner, and that Certek was not allowed a reasonable time to cure any defects. The contract also provided for Certek and OSU to negotiate “a written equitable adjustment” to the cost if changes were demanded.
The court concluded that OSU could not backcharge Certek if OSU failed to follow the contractual notice provisions and the provisions related to changes in the work. “Timely notice was not given to plaintiff of the alleged defects,” the Referee said. “Reasonable time to cure was not allowed to plaintiff. The contract terms did not allow OSU to undertake changes, enhancements, and alterations to the building and then to present a bill without negotiation.”
This time it was the owner who lost out by not giving notice. But the principle cuts both ways. When a contractor fails to give notice that it is incurring additional costs, courts will enforce the notice provision against the contractor, as the Ohio Supreme Court did recently in Dugan & Meyers Construction Co., Inc. v. Ohio Dept. of Administrative Services (April 25, 2007), 113 Ohio St.3d 226, 2007-Ohio-1687. As the current case shows, understanding the terms of the contract and abiding by them in a timely fashion is the only way to avoid regrets.
Unreasonably Late Finish Means Builder Can’t Collect Full Contract Amount
If a contract contains no completion date and no “time is of the essence” clause, then a contractor can take whatever time it needs to finish the job, right? Not according to the Ohio Court of Appeals that looked at the issue earlier this month. In Morton Buildings, Inc. v. Correct Custom Drywall, Inc. (Franklin App. June 7, 2007), 2007-Ohio-2788, the court found an implied duty to perform in a reasonable time and laid down some guidelines for determining what was reasonable.
The case began with plans to construct a garage. But not just any garage—it was 36,000 square feet, cost $126,438, and was designed to hold a motor home and a collection of automobiles. Correct Custom Drywall wanted it built within 90 days and requested proposals in April 2002 with that in mind. Morton submitted two different proposals, each with a time frame of just over three months. The contract the parties signed, however, did not contain a completion date.
Morton submitted the initial plans to the City of Reynoldsburg on July 15, 2002. The City returned the plans about two weeks later, requesting that the ceiling trusses be strengthened. But the contractor waited another seven weeks (until September 21) to resubmit the plans. The City took only two days to approve them, but again there was a delay: It was October 15 before the building materials arrived. Inspection of the interior plumbing caused the next delay, in December, and it was January 8, 2003, before work on the garage resumed. Then the owner, Correct Custom Drywall, learned that connecting to the City sewer was going to cost another $20,000, and construction was not likely to finish before April 15, 2003—a whole year after the first proposals were submitted.
The frustrated owner terminated the contract, having paid only $50,571.00—about 40% of the original contract price. (The court opinion says nothing about what it cost to finish the job, or even if the job was ever finished.)
The contractor sued for breach of contract and unjust enrichment (a non-contractual claim that the owner had received a benefit and ought to pay a reasonable price for it). Correct Custom Drywall filed a counterclaim for breach of contract. A judge heard the case (in a “bench trial”), and everybody lost—or at least, nobody had to pay anyone else on any of the claims. So the contractor appealed.
The Court of Appeals began by deciding whether the contractor had breached the contract by taking nearly a year for what was planned to be a three-month job. The contract failed to specify a completion date, the court noted, so “the law implies that performance must take place within a reasonable time.” If performance took an unreasonable time, then a material breach of contract had occurred. This was all black-letter law, based on standard treatises about contract law.
“Consequently,” the court said, “if one party to a contract unreasonably delays its performance, the other party is excused from its contractual obligations.” But how to judge whether taking a year to build this super garage constituted an unreasonable time? The court said it had to look first at what the parties in-tended and then consider any uncontrollable delays. There was no “exact calculus” to apply, but it was clear that the parties had intended a three-month construction period, and the actual construction stretched over a year. Although some delays were caused by the City, the court found the contractor more responsible:
Indisputably, Morton was responsible for drafting the plans so that they met the City’s standards and for submitting (and resubmitting) those plans to the City in a timely manner. Moreover, the time lag in Morton’s redesign, not the City’s period of consideration, caused the majority of the delay.
The court’s conclusion was that the unreasonable delay excused the owner from its payment obligation. Morton disagreed, arguing that the owner had told him to go forward with construction, even after the initial three-month period. Wasn’t this a waiver of the owner’s right to terminate the contract for unreasonable delay?
The court said it was not. Because there was no definite date on which the job was to finish, the owner could continue to demand that the contractor finish the garage without waiving any right to timely performance.
Morton’s next argument was that the trial court had erred by reading a “time is of the essence” clause into a contract that lacked such a provision. Again, the court disagreed. The trial court had not even addressed this issue, deciding instead on the basis of an implied obligation to finish within a reasonable time.
Finally, the court looked at the unjust enrichment claim. Could the contractor recover on this noncontractual claim what it was unable to recover for breach of contract? The court noted that such a tactic will work only if there is proof that the other party acted in bad faith. According to the court, “Morton had to prove that Wade [the owner of Correct Custom Drywall] lured Morton into building a garage that Wade did not intend to pay for.” The evidence did not support that argument, so again the contractor lost. It should be noted that such a claim is unavailable on public contracts in Ohio.
Although most contracts for large projects contain completion dates, this decision is likely to be useful in disputes where no such date is specified. It provides some guidance for determining what is a reasonable time to finish when there is no date, and it makes it clear that—in Franklin County, at least—an owner does not have to pay for work that is unreasonably late.
Court Reforms Contract To Pay Subcontractor More Based on Mutual Mistake
What happens if a subcontractor’s bid is only about 65% of the actual cost of the labor and materials necessary to complete the subcontractor’s portion of work on a private project? Who pays the additional cost? As shown last month in an Ohio Court of Appeals decision, it depends on the circumstances surrounding the construction project and the terms of the contract that the parties signed.
In City Life Development, Inc. v. The Praxus Group, Inc. (Cuyahoga App. May 3, 2007), 2007-Ohio-2114, the contractor, City Life, requested a bid from Praxus to install siding and trim. Praxus submitted a bid of $80,000, which City Life rejected as too high. Praxus asked for additional information to help revise its bid, and City Life responded by providing Praxus with the bid of another contractor, Bedrock Construction. Based on the quantities in the Bedrock bid, Praxus revised its bid to $56,341.44. Praxus warned City Life, however, that the quantities used in the Bedrock bid were insufficient to complete the project. In fact, the contract that the parties eventually signed failed to list the quantities of siding needed.
The court noted in passing, without further comment, that in signing the contract Praxus was stating that it had reviewed the architectural drawings in calculating its bid. Clearly, it had not.
Praxus submitted an invoice for an additional $40,000 because of cost overruns. City Life refused to pay the invoice and “insisted that Praxus adhere to the original terms of the contract.” Sure enough, there were cost overruns and a material supplier filed a mechanic’s lien in the amount of $39,966.71. City Life sued Praxus for failing to pay the supplier, and Praxus filed a counterclaim for breach of contract.
According to both the trial and appellate courts, there was a mutual mistake made by the parties, as they both underestimated the amount of materials needed to complete the project. “The mistake was mutual rather than unilateral since [City Life] believed that the amounts as outlined in the Bedrock bid were accurate and Praxus accepted this assumption in revising its bid.”
Because the mistake was mutual, the court could reform the contract, giving the parties a contract that would “embody the true intent of the parties.” In this case, that meant Praxus could receive payment in full.
This case highlights the importance of having a solid set of contract documents that define what is and what is not included as part of the contract documents. Typically, construction contracts include a list of the contract documents. The plans, specifications, addenda, and other documents that make up the “Contract Documents” are usually defined somewhere in the agreement. In this case, the contract contained the following language: “When discrepancies to cost arise, this document and any subsequent documents and verbal agreements that become part of this project take precedence.” A sentence like that allows a verbal conversation or a diagram on a cocktail napkin to become a part of the contract documents. When City Life provided the Bedrock bid to Praxus, it allowed the bid to become a basis for the contract. The bid was used as an estimate of the quantities for bidding purposes, and it should not have been.
Finally, it should be recalled that this was a private project, and not a public contract.
Surety Pays Claims, Recoups Losses Through Indemnity Agreement
This column often discusses cases that involve sureties, but usually the dispute is between the surety and the owner. However, that represents just one of the relationships involved. When a surety issues a construction bond, there is also an agreement between the surety and the contractor. Often the principals of the contractor are a party to the agreement with the surety, too. The surety/contractor/contractor’s principal relationship was the focus in Developers Surety & Indemnity Company v. Skyway Industrial Painting & Contracting (June 22, 2007), 2007 U.S. Dist. LEXIS 45517 & 2007 U.S.Dist. LEXIS 45521, two opinions issued the same day from the U.S. District Court for the Northern District of Ohio.
In exchange for Developers’ issuing surety bonds, Skyway and its owners executed an Agreement of Indemnity. The Agreement required them to indemnify Developers and hold it harmless for “any and all liability, loss, claims, demands, costs, damages, attorneys’ fees and expenses of whatever kind or nature, together with interest thereon at the maximum rate allowed by law, which [Developers] may sustain or incur by reason of or in consequence of the execution and delivery by [Developers] of any Bond on behalf of [Skyway].”
Developers issued two Subcontractor Performance Bonds in favor of Skyway as principal and Becdir Construction Company as obligee for bridge painting projects in Lucas and Harrison counties. Becdir declared Skyway in default on the Lucas county project. Developers investigated the claim and determined that it was obligated to pay the entire penal sum of the bond to Becdir. On the Harrison county project, Becdir made claims against Skyway for unpaid labor and/or materials. Developers again investigated the claim and determined that it was obligated to make the payments on Skyway’s behalf.
Having paid the claims, Developers filed suit to enforce the Indemnity Agreement. Eventually, Developers moved for judgment in its favor based solely on legal principles (called “summary judgment,” in legalese). The court explained the requirements to grant summary judgment this way: “Proper summary judgment analysis entails ‘the threshold inquiry of determining whether there is a need for a trial—whether, in other words, there are any genuine factual issues that properly can be resolved by a finder of fact because they may reasonably be resolved in favor of either party.’”
Developers offered evidence that Skyway had defaulted under the terms of the bonds, which were issued in reliance on the Indemnity Agreement. Developers also offered evidence that they incurred losses and expenses as a result of Skyway’s default. On the other side, the defendants “offered absolutely no evidence or argument to contradict these claims,” the court said.
Therefore, there were no genuine factual issues that required a trial.
Looking directly at the language of the agreement, the court found it to be “clear and unambiguous; the Indemnitors are contractually bound to indemnify and hold Developers harmless for all losses and expenses incurred by reason of the execution or procurement of any Bond issued by Developers on behalf of Skyway.” The court awarded the surety $100,934.16 and found the defendants to be jointly and severally liable. This means that in addition to the corporation, Skyway, each individual defendant who signed the agreement is also personally liable to satisfy the judgment. Anyone procuring a performance bond—especially one that requires indemnification by the company’s individual owners—must be aware of the consequences of nonperformance