Chapter 14 - Payment Remedies

Assessing Damages

Summary:

This chapter sets forth the legal criteria used to establish a breach of contract and the available damages or remedies. Determination of the time of the breach and application of the appropriate Statute of Limitations (Code of Civil Procedure § 337) is explained. Also included is the importance of documentation in order to establish the breach (See Chapter 17 Claims Analysis.) The question of whether there is fraud or bad faith sufficient to establish a tort and claim exemplary damages is explored. Waiver of consequential damages — AIA approach and Eichleay Formula are discussed. Finally, the California False Claims Act (Government Code §§ 12650-12655) and its applications are discussed.

§ 14.1 Breach of Contract

Many construction claims arise out of a disagreement concerning the interpretation of a written agreement. The California Civil Code, the Business and Professions Code and other relevant statutes contain a wide variety of provisions relating to the drafting, interpretation and enforcement of contracts. Although most construction contracts in this day and age are relatively sophisticated, the manner in which they are interpreted, and the diverse set of circumstances they ostensibly must address, are diverse and the results in court are often unpredictable.

The authors of construction contracts are forever attempting to produce a contract which will meet the needs of the contracting parties while addressing, or at least setting forth, a procedure by which unforeseen events can be handled in a manner which will be expeditious and economical. However, when this fails, a claim ensues and the most prevalent theory under which claims are presented is breach of contract.

A breach of contract is generally defined as the unjustified, or unexcused, failure to perform a contract. Although ordinarily the breach of contract is the result of an intentional act, the negligent performance of a contract may also constitute a breach, giving rise to alternative contract and tort actions. We will address further in this chapter tort damages, but for the time being let us direct our attention to purely contractual damages resulting from a breach.

The building industry generally involves contracts that provide for a payment by the owner to the contractor in installments based upon objective criteria specifically delineated within the contract itself, e.g., percentage of work completed. When one installment is not paid when it becomes due, the question arises whether or not this is a breach of contract. One view has been that the delay is only a temporary excuse for non-performance; (i.e., the contractor may stop work until the progress payment is received, but he must resume work when paid, unless the delay is so unreasonably long as to amount to a material breach or failure of consideration, in which case it gives rise to the usual remedies of rescission or damages.)

California courts have taken the approach that although a failure to pay an installment is not such a breach as to justify a suit for damages, the contractor may rescind (in effect, take back the contract) and recover the reasonable value of the work already done. There has been some discussion in the California courts regarding the somewhat inconsistent analysis of this rule, because if the delay is not serious, it should not justify termination of the contract. However, if it is serious and wrongful, it is a breach and damages are proper.

The courts eventually found a reasonable approach, and have stated that there must be a “substantial” failure to comply with the terms of the contract for there to be a breach. Thus, an action for damages will lie for breach of contract if: (1) there was some act of prevention or hindrance by the owner; (2) there is repudiation of the contract by the owner; or (3) the contract makes the timely payment of each installment an expressed condition precedent to the further duty of the performance of the remainder of the contract.

Thus, if the contract itself makes timely payment of each installment an express condition precedent to the further duty of performance by the contractor, then the contractor need not work when an installment is not made. However, the best rule of thumb is that barring an express condition in the contract, there must be a substantial deviation for a breach of contract to occur.

We can see from the outset that the most important area of assessing damages (or claims analysis) is to have a detailed review and understanding of the terms of the contract itself, because those are the terms which will eventually “make or break” any claim.

While researching the terms of the contract itself, it is essential to keep a checklist of time limitations upon which actions may be brought. (See Chapter 18, Deadlines and Limitations.)

The remedies for a breach of contract are numerous. Some of the remedies are: rescission and restitution; damages; specific performance; injunction; declaratory relief; and ejectment for quiet title. Furthermore, the plaintiff may bring an action in tort, which would result from a negligent breach or other wrongful conduct, which may or may not be added as an alternative remedy to those found in contract.

Further, the contract itself may or may not specify the particular remedies that are available in the event of a breach, which may be in addition to, or in substitution of, those previously mentioned. However, keep in mind that a contract, or a provision in a contract, may attempt to limit the non-breaching party’s remedies. There are instances in which such a limitation has been upheld to limit the non-breaching party’s damages to those specifically enunciated.

It has also been held by the courts in California that a party may waive a breach of contract and elect to treat the contract as still alive, remain ready, willing and able to perform on his own part, and limit his remedy to compensation for the breach. Also, a party may elect to treat a breach of contract as partial or total, and his damages would thus necessarily be affected.

Generally speaking, the damages to which one is entitled for a breach of contract are those damages that reasonably flow from the breach by the other party. As indicated earlier, any claim or breach of contract consists of two major parts. There is the entitlement section, which relies upon the specific provisions in the contract upon which the breach applies, as well as the damages section, which sets forth the calculations in support of the compensation claimed. Some of the items of damage that have been awarded by the courts in construction claims dealing with a breach of contract are labor costs, equipment costs, material costs, bond and insurance costs, home office overhead, jobsite overhead, profit, interest and, if allowed within the contract document itself, attorney fees.

As one can see, the basic object of damages is to compensate the party injured by allowing him, as nearly as possible, the equivalent of the benefits of performance. All legally cognizable damages must be proximately caused by the breach of the contract. This is a rule that has long been the law in England and the United States, and flows from the 1854 English case of Hadley v. Baxendale (1854) 9 Ex.Ch. 341. That case dealt with general damages which naturally arise from the breach, or which might have been reasonably contemplated or foreseen by both parties, as well as special damages which arise from special circumstances and cause an unusual injury.

Civil Code § 3359 also provides: “Damages must, in all cases, be reasonable, and where an obligation of any kind appears to create a right to unconscionable and grossly oppressive damages, contrary to substantial justice, no more than reasonable damages can be recovered.”

Special damages are generally not recoverable unless the circumstances were known, or should have been known, by the guilty party at the time he entered into the contract. The California Supreme Court ruled that a contractor’s large claim of prospective economic damages after an alleged wrongful termination by a public entity was not foreseeable by the public agency at the time of contract award. Lewis Jorge Construction Management. v. Pomona Unified School Dist. (2004) 34 Cal.4th. 960. This case is widely viewed as making it more difficult for contractors to recover consequential damages against public entities.

While attorney fees are normally borne by each party, the contract may shift that responsibility. For example, in Sears v. Baccaglio (1998) 60 Cal.App.4th 1136, the Court addressed the question of who is the prevailing party in terms of collecting attorney fees on an action for breach of contract. The Court found (pursuant to Civil Code § 1717 and Code of Civil Procedure § 1032) that the important question was which party prevailed on the contract. The fact that one party might have “netted” more than another does not necessarily mean that the party who gets the most is the “prevailing” party.

It should be noted that the validity of Sears v. Baccaglio decision under Civil Code § 1717 has since been called into question. See David S. Karton, A Law Corp. v. Dougherty (2014) 231 Cal.App.4th 600, 612-613; de la Cuesta v. Benham (2011) 193 Cal.App.4th 1287, 1294-1299.

There are numerous cases splitting the fine hairs of attorney fees issues.

§ 14.2 Material Breach & Abandonment

Over the past twenty-five years, a trilogy of California decisions has provided guidance for assessing damages where the contractor claimed it was overwhelmed by changes, disruptions and delays on construction projects.300

The first case, Huber, Hunt & Nichols, Inc. v. Moore (1977) 67 Cal.App.3d 278, a Fresno County convention center case, held that a contractor’s proffered proof of computer cost printouts failed to meet its burden of proof and set forth a requirement of “cause and effect” proof for monetary claims.

The next case was C. Norman Peterson Co. v. Container Corp. of Am. (1985) 172 Cal.App.3d 628, a fast track, private pulp mill case, where a sympathetic court allowed the overwhelmed contractor to proceed on the basis of both abandonment and breach of contract.

Next, in Cal. ex rel. Dep’t of Transp. v. Guy F. Atkinson Co. (1986) 187 Cal.App.3d 25, a state hearing officer used the modified total cost method, where the overall project costs were estimated, and then certain deductions were taken for costs incurred and the contractor’s admitted errors. This approach was permitted “where accurate assessments of costs ‘as planned’ are difficult, if not impossible, to ascertain.”

Each of the trilogy cases were decided by California Courts of Appeal. The California Supreme Court upset the apple cart in Amelco Electric v. City of Thousand Oaks (2002) 27 Cal.4th 228. Although it leaves many questions unanswered, the Amelco decision is probably the most important public works case decided over the last twenty-five years. As stated earlier in this book, the Supreme Court found that the “abandonment” theory of construction contracts did not apply to public entities. Furthermore, it surveyed federal and state cases involving situations where public entities had committed material breach of the agreement, as well as discussing various standards for determining the breach of contract damages. The case drew praise from public agencies, but a leading legal scholar called it a “crushing blow to … post-completion, inefficiency claims.”301

As the Amelco decision is both significant and subject to wide interpretations, the following key excerpts from the majority opinion are reported verbatim:

In 1992, defendant City of Thousand Oaks (City) solicited bids for electrical work to be performed in the construction of the Civic Arts Plaza, a project including a civic center or office building, a dual purpose 400-seat council chamber and forum theater, an 1,800-seat civic auditorium or performing arts theater, and an outside area (the project). Instead of a general contractor, the project was managed by Lehrer McGovern Bovis, Inc. (LMB), and the City solicited bids for the various prime contracts. City received five electrical work bids. Amelco Electric (Amelco), one of the largest electrical contractors in the United States, bid $ 6,158,378, and was awarded the contract. All five bids came within 10 percent of each other and the three lowest bids were within 3 percent of each other.

During the two-year construction process, City furnished 1,018 sequentially numbered sketches to the various contractors to clarify or change the original contract drawings, or to respond to requests for information. The vast majority of the changes were to one building, the civic center or office building, and to the outside lighting. Of the sketches issued, 248 affected the electrical cost. Amelco requested 221 change orders, and City and Amelco agreed upon 32 change orders encompassing these change order requests. As a result of these change orders, City paid Amelco $ 1,009,728 above the contract price, an increase of nearly 17 percent.

Amelco claimed at trial that the project involved an unusually high number of sketches that were difficult to work with. Amelco further claimed that scheduling the various contractors’ work became more difficult as a result of the changes. Amelco testified it was at times required to delay or accelerate particular tasks and to shift workers among tasks to accommodate work by other trades. While Amelco maintained daily records of its work activities, it was unable to produce documentation of instances in which its performance of a work directive or change order was delayed or interfered with by LMB’s actions, and for which it was not compensated. The general foreman, the person responsible for actually recording the information, was given a hypothetical regarding recordkeeping practices: “[I]f you came to this courtroom to work today, . . . and the wall was moved, that would be something you would put in your daily log?” “No.” “You wouldn’t note that?” “I wouldn’t put it down on my daily log.”

Amelco’s vice-president asserted the sheer number of changes made it “impossible” to keep track of the impact any one change had on the project or on Amelco, likening the effect to “death by 1,000 cuts.” Amelco conceded it was inefficient in performing the work, but assigned responsibility for virtually all of that inefficiency to LMB.

In May 1993, Amelco wrote to LMB concerning “Work Directive 48, addendum No. 1,” which Amelco asserted improperly shifted engineering documentation responsibilities to Amelco. Amelco also expressed concern that the electrical drawings being issued did not identify all revisions, or contain all prior revisions, and gave examples of how these omissions interfered with its performance. Amelco requested a change order and $ 203,759 in additional funds to hire a drafter to update the drawings, a foreperson, and a project engineer. LMB refused additional funds on the ground that these tasks were included in the original contract price. Amelco claimed at trial that it accepted this decision, did not hire any additional personnel to do the work, and signed a change order for zero dollars and zero additional time, because LMB verbally promised that “things are going to get better.”

On July 29, 1994, over a year later, and approximately two months before the project was completed, Amelco sent a letter requesting a second change order be issued for Work Directive No. 48. Amelco asserted the executed change order did “not include any field productive labor impact or related problems,” and that “[t]he price for this work will follow in the near future.”

In January 1995, Amelco submitted a $ 1.7 million total cost claim for costs allegedly resulting from the noncaptured costs of the change orders. The testimony was in conflict whether LMB had requested that Amelco submit such a claim; in any event, the claim was rejected. Amelco filed this action, ultimately alleging abandonment and breach of the construction contract. By the time of trial, Amelco’s claim had increased to $ 2,224,842 because of the discovery of additional costs.

The City asserted Amelco lost money on the project because it failed to start work promptly on the project, did not coordinate its work with other trades, such as by regularly attending mandatory coordination meetings, reduced its workforce so that it did not have enough workers to install the major electrical system components efficiently, did not have an organized manner of incorporating changes into the drawings (unlike other contractors on the project), performed work on the project under at least one subcontract for a different subcontractor during this period, and generally mismanaged its work.

After a five-week trial, the jury found the City had both breached and abandoned the contract, and awarded Amelco $ 2,134,586 respectively (but not cumulatively) for each claim

. . .

We granted the City’s petition for review.

Does the Abandonment Theory of Liability Apply Against a Public Entity?

. . .

We now consider whether the abandonment theory of liability applies against a public entity. We conclude it does not, since such a theory is fundamentally inconsistent with the purpose of the competitive bidding statutes.

Under the abandonment doctrine, once the parties cease to follow the contract’s change order process, and the final project has become materially different from the project contracted for, the entire contract--including its notice, documentation, changes, and cost provisions--is deemed inapplicable or abandoned, and the plaintiff may recover the reasonable value for all of its work. Were we to conclude such a theory applied in the public works context, the notion of competitive bidding would become meaningless.

. . .

We next consider whether Amelco adduced sufficient evidence to warrant instructing the jury on the total cost method of measuring damages. The City does not argue total cost recovery is never appropriate against a public agency, only that such a damages theory is inappropriate here. For this reason, we do not determine whether total cost damages are ever appropriate in a breach of public contract case, but rather whether the theory for such damages was in this case properly submitted to the jury.

. . .

We conclude Amelco failed to adduce substantial evidence to warrant instructing the jury on the four-part total cost theory of damages. In particular, Amelco failed to adduce evidence to satisfy at least the fourth element of the four-part test, i.e., that it was not responsible for the added expenses. A corollary of this element of the test is that the contractor must demonstrate the defendant, and not any one else, is responsible for the additional cost.

. . .

Under these circumstances, the jury should not have been instructed to calculate Amelco’s loss from any breach of contract under a total cost measure of damages.”

The Supreme Court of California expressly reserved judgment on whether the total cost method could ever be used against a public agency in California. However, it quoted federal law at length regarding where cardinal change and total cost method could be used, as well as the various California cases where the total cost method had been applied to private projects.

The California Supreme Court found that there was no evidence in the Amelco case to support a jury being given an instruction on the total cost method of recovery. There are multiple legal and practical lessons that can be drawn from the Amelco case. Whenever humanly possible, the public works contractor must take special care to keep exceptional daily records of events, delays and costs. Next, the contractor must segregate the impacts of its scope of work changes, its disruption and delay costs and the specific times of critical path elements of delay and inefficiency into discrete claims.

The critical path method schedule impacts and monetary claims must be archived, verified and placed into evidence using a high degree of presentation skill, contract clarity, accounting accuracy and graphical consistency, including photographs of specific events and conditions. The contractor must be ready to take the judge or jury on a journey through the project, if possible, on a day-by-day basis. At this point, few contractors have been prepared to invest the time or energy that is necessary to accumulate this information on a daily basis. However, the advent of new technology for tracking materials, people and activities on projects, as well as real-time jobsite photography, may eventually allow extremely accurate traces of project progress, meeting the stringent criteria of the Amelco court.

Of course, the saga of battle continues, with cases like Dillingham-Ray Wilson v. City of Los Angeles (2010) 182 Cal.App.4th 1396. A modified total cost claim was allowed after the contractor deducted from the overall costs several admitted costs that were the City’s responsibility. (Note, the Author represented CBI in that case.)

§ 14.3 Tort Damages

There are a number of situations, in addition to contractual obligations, in which there may be further tort causes of action where punitive damages may apply. These situations generally involve fraud or bad faith, and we find them most particularly in an insurance setting. Whether or not tort damages would apply to any construction dispute will rise and fall upon the facts surrounding the dispute itself.

In Erlich v. Menezes (1999) 21 Cal.4th 543, the California Supreme Court acknowledged that there was considerable blurring of the distinction between contract law and tort law, and that there was considerable pressure to expand the areas of tort law into something that had been termed “contorts.” The court held that despite this pressure the purposes of the two areas were well established and that the purpose of contract law was to enable the parties to estimate in advance the financial risks of their enterprise. While an action may be both a violation of a contract and a tort, a breach of the contract only becomes tortious when it violates a duty that is independent of the contract.

Since in Erlich, supra, the damages were only, according to the court, “economic injury and property damage” of the sort anticipated by the contract, there could be no recovery in tort. The Court affirmed the principles of tort liability in cases when principles of social policy had been breached, but took special pains to clarify that mere property damage would not support a claim for emotional distress damages, stating: “[p]ublic policy supports a similar limit [on emotional distress damages] where the negligence concerns the construction of a home.” The Court explains, Erlich, supra at 557: “The Erlichs may have hoped to build their dream home and live happily ever after, but there is a reason that tag line belongs only in fairy tales. Building a house may turn out to be a stress-free project; it is much more likely to be the stuff of urban legends--the cause of bankruptcy, marital dissolution, hypertension and fleeting fantasies ranging from homicide to suicide.” The Supreme Court concluded that as a result of this analysis, emotional distress damages in connection with property damage should not be compensable.

The Supreme Court ruled in Aas v. Superior Court (2000) 24 Cal.4th 627 that homeowners’ associations and individual homeowners do not have a private right of action in negligence against developers, general contractors and subcontractors for recovery of economic losses they sustain as a proximate result of construction defects in mass produced housing, including, but not limited to, those involving violations of governing building codes, which have not yet caused personal injury or physical damage to property, other than the defectively constructed portions of the residential structures themselves.

The Aas court further opined that the plaintiff may well have a negligence claim in the future, but only if the alleged latent construction defects result in physical harm to persons or other property within the 10-year limitation period. The court also disallowed a claim of residual loss of market value of the homes following repairs.

In residential construction, the Aas case has been superseded by statute in Civil Code § 895 et seq. (Right to Repair Act or the Act). The Act establishes a set of building standards pertaining to new residential construction, and provides homeowners with a cause of action against, among others, builders and individual product manufacturers for violation of the standards (Civil Code §§ 896, 936). (This is also discussed in Section 7.2(f).)

The Act makes clear that upon a showing of violation of an applicable standard, a homeowner may recover economic losses from a builder without having to show that the violation caused property damage or personal injury.

§ 14.4 Waiver of Consequential Damages

A waiver of consequential damages is contained in many construction agreements. Others simply state a liquidated amount for project delay. As far as innovative approaches go, the AIA calls for the owner and the contractor to each waive what would otherwise be, in reality, consequential damages which would normally flow from the breach by either party.

In the AIA approach, the contractor waives his home office overhead, which is often characterized as an indirect cost in the construction. It is not a direct cost, such as labor, materials and/or equipment, but typically includes the cost of accounting and payroll services, general insurance, the salaries of upper level management and marketing costs. The home office overhead is the actual dollar amount that is an essential part of the contractor’s cost of doing business. Thus, he is giving up something in return for that which the owner waives. When dealing with the home office overhead, the standard, or formula, which is generally accepted in calculating this loss, is the Eichleay Formula.

The owner, under the AIA approach, waives claims for all potential economic loss associated with project delay. This would include extended construction interest and fees for extending the construction, increased interest on both the construction and permanent financing, extra licensing costs, lost revenues and others.

In discussing damages, one must take into consideration that the non-breaching party is only entitled to that which he bargained for in the first instance. The non-breaching party is not entitled to be compensated in a manner which would put him in a better position had the breach not occurred. In this particular instance, this would be known as “betterment” and is not permitted.

§ 14.5 Economic Loss Rule

The economic loss rule is an active defense in many California construction defects cases. In essence, it states that there must be physical damage for a property owner to obtain recovery — not just economic loss. The defense is hotly contested in most construction disputes.

The more recent cases on this rule include, Aas v. Superior Court, 24 Cal. 4th 627 (2000), see note above — superseded by statute, Ratcliff Architects v. Vanir Construction Management, Inc. (2001) 88 Cal.App.4th 595; Weseloh Family Ltd. Partnership v. K.L. Wessel Construction Co., Inc. (2004) 125 Cal.App.4th 152; Seely v. White Motor Co. (1965) 63 Cal.2d 9; and Stearman v. Centex Homes (2000) 78 Cal.App.4th 611; and see California Civil Code § 1708.

§ 14.6 Limitations of Liability

The use of limitations of liability is widespread in the construction industry. They include specific limitations for professional negligence, limits on indemnity obligations, disclaimers of consequential damages (noted above), and global limits of liability. In fact, the setting of liquidated damages for late completion operates as a limitation on liability for late performance, especially where there is a “stop loss” or “global limit” of such damages.

The leading California case on construction limitations of liability is Markborough v. Superior Court (1991) 227 Cal.App.3d 705. It states a variety of factors to be considered in enforcing such clauses that are typical for commercial contracts and UCC disputes where limitation clauses are asserted by a party. The factors include the reasonableness of the limits under the circumstances, the relative sophistication and negotiating power of the parties, as well as whether the parties had an opportunity to negotiate the clause. It does not seem as important whether the parties actually did negotiate the clause, but such situations certainly are more likely to result in a finding the clause was considered and adopted by the parties after due deliberation.

A party may also attempt to claim an indemnity clause in its favor also operates as a limitation of liability. In Queen Villas Homeowners Assn v. TCB Property Management (2007) 149 Cal.App.4th 1, a homeowners association (Queen Villas) sued their property management company (TCB), asserting negligence in supervising association funds that had been embezzled. The property management agreement contained an indemnity clause that shifted liability from the property management firm to the homeowners association.

The Queen Villas decision acknowledges the legal chestnut, “Indemnification agreements ordinarily relate to third party claims.” (citing Myers Building Industries, Ltd. v. Interface Technology, Inc. (1993) 13 Cal.App.4th 949, 969.) It then cites Rooz v. Kimmel (1997) 55 Cal.App.4th 573 as a case where the parties clearly intended the indemnity clause to also serve as a shield of liability. However, it held the TCB clause was not intended to serve as a broad, unequivocal release of any two-party breach of contract claims against the property management firm.

Practice Pointer: When drafting enforceable limitation of liability clauses, use a “belt and suspenders” approach. This array of armament might include a disclaimer of consequential damages, a limitation of indemnity rights to the amounts recoverable from stated insurance policies, an explicit and time limited warranty clause, an exclusive remedies clause that excludes other common law and statutory remedies and a statement that the limitations clauses have been negotiated by the parties who are sophisticated and incorporate the clause as part of an integrated commercial transaction and allocation of project risks.

§ 14.7 Fraudulent Claims

In 1987, the legislature enacted the California False Claims Act, which is codified in Government Code §§ 12650-12655. It provides a comprehensive statutory regulation of false and fraudulent claims “knowingly” submitted to state agencies or local public entities. It provides for civil penalties, as well as criminal penalties. A general understanding of these specific code sections is essential before presenting any claim to a public entity.

The statute has the following definitions:

(2) `Knowing’ and `knowingly’ mean that a person, with respect to information, does any of the following:

(a) Has actual knowledge of the information.

(b) Acts in deliberate ignorance of the truth or falsity of the information.

(c) Acts in reckless disregard of the truth or falsity of the information.

Proof of specific intent to defraud is not required.”

Thus, we see that specific intent to defraud is not necessary and the conscious disregard of truth and utilization of false information can be actionable.

Note: False claims are discussed in more detail at Section 17.2.