CONTRACTUAL SETOFF AND APPLICATION WHEN PERFORMANCE BOND BUYS OUT OF ITS EXPOSURE

Posted on June 9, 2024June 9, 2024 by David Adelstein

The theory of “setoff” is an important theory in construction disputes. Florida’s Fourth District Court of Appeal recently provided worthy discussion on contractual setoffs:

Setoffs in contract claims are governed by [Florida Statute] section 46.015(2), which provides that if a plaintiff has released “any person in partial satisfaction of the damages sued for, the court shall [setoff] this amount from the amount of any judgment to which the plaintiff would be otherwise entitled at the time of rendering judgment.” The setoff statute intends to prohibit plaintiffs from getting double recoveries.

A setoff requires that settling and non-settling parties be jointly and severally liable. The settled damages must also be the same damages for which the setoff is sought; stated differently, a setoff is not proper where the trial damages to be setoff are separate and distinct from the settled damages.

Close Construction, LLC v. City of Riviera Beach Utility Special District, 49 Fla.L.Weekly D1184d (Fla. 4^th DCA 2024) (internal citations omitted).

Here is how setoff became the driving issue in this appeal.

A public body terminated a contractor and made a claim against the contractor’s performance bond surety. The surety, prior to any lawsuit, settled the performance bond claim for $1 Million (presumably, based on its own risk management). The public contractor and contractor ended up in a lawsuit that proceeded to a jury trial. After the trial, the trial court entered a final judgment to the public body for about $1.9 Million. The contractor moved to setoff the $1M from the judgment that its surety previously paid, which the trial court denied. The appellate court, thankfully, reversed this component of the judgment because setoff should undeniably apply.

Whether the trial court properly awarded setoff is a question of law. Close Construction, supra (internal citations omitted).

The appellate court found that the contractor’s performance bond surety’s settlement payment should be setoff from the judgment the public body received against the contractor:

The District argues that Surety’s payment does not fall within section 46.015(2)’s “sued for” language because the District did not sue Surety on the [performance] bond and Surety never became a defendant in the breach of contract action. We find this argument meritless. The “damages sued for,” i.e., the damages which the District sought in its litigation against [contractor], are the same damages covered by the District’s settlement with Surety. Those damages are the same regardless of whether the District sued Surety.

Contrary to the District’s argument, the setoff statute applies where a plaintiff releases “any person” — the statute is not limited to only litigants. Requiring a lawsuit to be filed as a prerequisite to a setoff would allow a suing party to recover twice by electing not to sue every party or by simply obtaining pre-litigation settlements. Here, the damages sought are the same whether the District brought a bond action against Surety or a breach of contract suit against [contractor]. The District recovers from Surety only because it stands in [contractor’s] shoes under the bond’s terms as a payment source for any damage caused by [contractor’s] breach of contract. In other words, Surety is liable only if [contractor] is liable too.

In sum, the District’s settlement with Surety for the amount of the performance bond resulted from [contractor’s] breach of the contract. Surety and [contractor] were jointly and severally liable for the damages caused by [contractor’s] breach under the bond’s terms. When the District obtained a verdict for damages caused by [contractor’s] breach, the District was recovering for the same damages already covered by the settlement with Surety. The District cannot recover from both [contractor] and Surety for the exact same damages for which the two were jointly and severally liable.

Close Construction, supra (internal citations omitted).

There are times a performance bond may buy-out of an exposure. However, under no circumstances should this allow the beneficiary of the performance bond (known as the obligee) to receive a windfall or double recovery!

Please contact David Adelstein at dadelstein@gmail.com or (954) 361-4720 if you have questions or would like more information regarding this article. You can follow David Adelstein on Twitter @DavidAdelstein1.

APPLICATION OF SET-OFF WHEN A DEFENDANT SETTLES IN MULTIPARTY CONSTRUCTION DISPUTE

Posted on December 23, 2016November 8, 2024 by Edward Garber

The defense of set-off is an important defense in construction disputes, particularly multiparty disputes. For more information on this defense, please check out this article as it explains the application of set-off in civil disputes in detail.

The issue of set-off will come up in a multiparty dispute when a plaintiff settles with one or more of the defendants. The remaining defendant(s) wants the benefit of that settlement to set-off and reduce any judgment against it. An example of this scenario can be found in Escadote I Corp. v. Ocean Three Limited Partnership, 42 Fla. L. Weekly D23a (Fla. 3d DCA 2016).

In this case, an owner of a condominium unit sued the condominium association, the developer, and the general contractor for water intrusion and mold infestation. The claim against the condominium association was the only claim that entitled the owner to attorney’s fees pursuant to its lawsuit (thus, attorney’s fees were isolated to only that claim against the association). During trial, the owner settled with the association. In entering a settlement, the owner smartly allocated the settlement amount such that $500 was allocated to its principal damages and $374,500 was allocated to its attorney’s fees. The owner then obtained a jury verdict against the contractor and developer for approximately $2M, jointly and severally, and the contractor and developer wanted the entire $375,000 settlement amount with the association to be set-off from the $2M verdict. The trial court set-off the entire $375,000 from the jury verdict when entering judgment. The appellate court reversed.

Because $374,500 in the settlement agreement was smartly allocated to attorney’s fees, even if self-serving, this was not a proper set-off that the contractor or developer could benefit from. The reason being was that attorney’s fees were only sought against the association, not the developer or contractor, so they could not benefit from these separately allocable damages. They could only benefit from the $500 allocated in principal damages since that was a principal damages component that applied to all of the defendants. See Escadote I Corp., supra (“If the settlement funds are applicable to a claim asserted only against the settling co-defendant, the non-settling co-defendants are not eligible for a set-off in the amount of the settlement. Expressed another way, the [set-off] statutes presuppose the existence of multiple defendants jointly and severally liable for the same damages.”) (internal quotations and citations omitted).

The apportionment / allocation in the settlement between the owner and association was very smart and the correct thing to do, again, even if the allocation was self-serving to the plaintiff. If the owner did not include this allocation, then the developer and contractor would have reaped the benefit of the entire $375,000 as a set-off against the jury’s verdict. See Escadote I Corp., supra (“[I]n a case in which a settlement recovery is not apportioned between (a) claims for which co-defendants are jointly and severally liable with the settling co-defendant, and (b) claims which were only asserted against the settling co-defendant, the entire amount of the undifferentiated recovery is allowable as a set-off.”).

LIQUIDATED DAMAGES PROVISIONS IN SUBCONTRACTS (PARTICULARLY SUBCONTRACTS FOR PUBLIC PROJECTS)

Posted on May 18, 2014November 8, 2024 by Edward Garber

The assessment of liquidated damages should be a consideration to contractors on all projects, specifically public (federal and state) projects where the prime contract routinely contains a liquidated damages provision for delays to the completion of the project. Many times, the subcontract will contain a provision that will allow the prime contractor to pass-through liquidated damages assessed by the government (owner) to the responsible subcontractor. Well, what if the government did not assess liquidated damages? Can the prime contractor still assess liquidated damages against a responsible subcontractor in accordance with the subcontract? The opinion in U.S. f/u/b/o James B. Donahey, Inc. v. Dick Corp., 2010 WL 4666747 (N.D.Fla. 2010), would allow a prime contractor to assess liquidated damages against a subcontractor even if the government did not assess liquidated damages against the prime contractor.

In this case, a prime contractor entered into a contract to design and build four buildings at the Pensacola Navy Station and provided a Miller Act payment bond. The prime contractor hired a subcontractor to perform the plumbing and mechanical work. Due to delays the general contractor believed were caused by the subcontractor, it withheld substantial payment from the subcontractor. The prime contractor contended that the subcontractor caused 63 days of delay to the occupancy of the Visitors Quarters building and 32 days of delay to the Aviation Rescue Swimmers School building. The subcontract provided that in the event of delays, liquidated damages would be assessed in the amount of $5,400 per day for delay to the Aviation Rescue Swimmers School and $24,898 per day for delay to the Visitors Quarters.

The subcontractor filed a Miller Act lawsuit against the prime contractor and its surety (amongst other causes of actions). The prime contractor filed a counterclaim based on the liquidated damages that it assessed against the subcontractor, an amount in excess of what it was withholding. The subcontractor moved for summary judgment arguing that the liquidated damages provision was unenforceable (and the prime contractor could not assess liquidated damages) because the provision was a pass-through provision; thus, because the government did not assess liquidated damages against the prime contractor, the prime contractor could not assess liquidated damages against the subcontractor. The subcontractor further argued that the liquidated damages provision is unenforceable because it is being treated as a penalty because the subcontractor is not being provided the benefit of extensions of time granted by the government to the prime contractor that would negate delays. The prime contractor countered that nothing in the subcontract stated that liquidated damages could only operate as a pass-through claim, that being that the government had to assess liquidated damages before the prime contractor could assess liquidated damages against the subcontractor. The prime contractor further countered that the extensions of time granted by the government were irrelevant since they did not pertain to the subcontractor’s scope of work or affect the subcontractor’s milestone completion dates.

The Northern District of Florida agreed with the prime contractor and denied the subcontractor’s motion for summary judgment because it found the liquidated damages provision enforceable. The Northern District explained as it pertained to the subcontractor’s Miller Act payment bond claim:

“In considering a Miller Act claim, the trier of fact must thus look to the subcontract to determine the amount due. ‘[I]f the subcontract provides for a condition precedent to payment, or a part thereof, which is not fulfilled, the subcontractor cannot recover labor and material expenditures against the surety on the payment bond.’ In other words, if there has been a default by the subcontractor, the general contractor may assert recoupment or setoff as a defense. Because there is a genuine issue of material fact regarding the timeliness of Donaghey’s [subcontractor] performance and, therefore, Donaghey’s entitlement to the amounts withheld by Dick [prime contractor], summary judgment is inappropriate as to Donaghey’s Miller Act claim.”

Dick Corporation, 2010 WL at *3 quoting U.S. f/u/b/o Harrington v. Trione, 97 F.Supp. 522, 527 (D.C.Colo. 1951).

Stated differently, the Miller Act payment bond surety was entitled to rely on the prime contractor’s assessment of liquidated damages as a set-off / recoupment defense to the subcontractor’s Miller Act claim. Also, if there were other conditions precedent that the subcontractor failed to comply with, the Miller Act surety would be entitled to many of these defenses as well.

The Northern District further maintained that a liquidated damages provision under Florida law will be enforceable if the provision does not operate as a penalty, meaning damages upon a breach must not be readily ascertainable at the time of the contract and must not be grossly disproportionate to any damages reasonably expected to follow from the breach. Dick Corporation, 2010 WL at *4 quoting Mineo v. Lakeside Village of Davie, LLC, 983 So.2d 20, 21 (Fla. 4^th DCA 2008). The Court held that the liquidated damages provision did not operate as a penalty and it was not intended to operate only as a pass-through mechanism. See, e.g., U.S. f/u/b/o Sunbeam Equip. Corp. v. Commercial Constr. Corp., 741 F.2d 326, 328 (11^th Cir. 1984) (“The fact that the Navy did not assess liquidated damages as such against Commercial [prime contractor], would not foreclose recovery of delay damages, if Commercial could demonstrate that damages arising out of the subcontract with Sunbeam [subcontractor] were not otherwise compensated.”)

There are three important take-aways from this opinion:

Liquidated damages provisions in subcontracts can operate as more than a pass-through provision for liquidated damages assessed by the government (owner). These provisions can operate as a mechanism to assess liquidated damages against the subcontractor even if the government / owner has not assessed liquidated damages against the prime contractor. Prime contractors and subcontractors need to keep this in mind when drafting and negotiating liquidated damages provisions. If the intent is for the provision to only operate as a pass-through provision, this intent should be clearly stated in the subcontract. If the intent is for it to operate more than as a pass-through provision, then this risk needs to be considered by the subcontractor.

Liquidated damages are typically going to be deemed enforceable if they are not intended to operate as a penalty.

A Miller Act payment bond surety will be entitled to rely on set-off / recoupment affirmative defenses contained within the subcontract including, without limitation, the prime contractor’s assessment of liquidated damages or other delay damages against the subcontractor pursuant to the subcontract.

GARDEN VARIETY PAYMENT DISPUTE BETWEEN OWNER AND CONTRACTOR

Posted on May 8, 2014November 8, 2024 by Edward Garber

Payment disputes between owners and contractors are common. The recent case of Hibachi Grill, Inc. v. Arki Construction, Inc., 39 Fla. L. Weekly D954a (Fla. 3d DCA 2014), illustrates two common scenarios that exist in the payment dispute: (1) the contractor claims it is owed the full contract price for substantially performing the work and (2) the owner wants to setoff amounts that it paid directly to subcontractors.

This case turned on the contractor’s approximate $32,000 breach of contract claim against the owner for unpaid contract balance for building out leased space. Both the owner and contractor agreed that the owner paid approximately $14,000 directly to subcontractors. The owner argued that this amount should reduce the contractor’s $32,000 claim; however, the trial court entered a judgment for the contract balance that did not include this set-off. The Third District agreed that the owner’s direct payment to subcontractors should reduce the contractor’s claim; otherwise, the contractor would receive a windfall since it no longer has to pay those subcontractors.

The owner further argued that the contractor’s unpaid contract balance claim should be further reduced by “lost profit” that was included in the contractor’s unpaid contract balance claim. To support this argument, the owner relied on inapplicable cases where contracts were breached BEFORE substantial performance of the contract was achieved. However, when the contractor substantially performs, it is entitled the full contract price subject to appropriate deductions. In the instance case, the deduction was the payment the owner made directly to subcontractors. In other situations, the owner could deduct deficient work from the contract price. See, e.g., Wm. Dejon Developers, Inc. v. Panhandle Grading & Paving, Inc., 538 So.2d 88 (Fla. 1^st DCA 1989) (deducting from full contract price of roadwork the amount of the contractor’s deficient work); Oven Development Corp. v. Molisky, 278 So.2d 299 (Fla. 1^st DCA 1973) (discussing that contractor that substantially performs is entitled to full contract price subject to proper deductions from the owner supported by competent evidence of the contractor’s breaches).

This case would support an owner’s position that it can pay subcontractors directly to reduce the amount owed to the contractor. In many situations, this is totally acceptable. The contractor may agree to the payment owed to the subcontractors either through a direct payment or joint check. In other situations, such as when the subcontractor properly preserved lien rights, the owner may want to preserve its right to pay those subcontractors in consideration of releases of lien to ensure its property does not get liened by the subcontractor. However, what about the situation where the owner pays a subcontractor that otherwise has no lien rights? According to this case, the owner could do so to reduce its payment to the contractor since the contractor would owe that money to the subcontractor. Yet, by the owner doing so, especially if it does so unilaterally, it prevents the contractor from potentially resolving a dispute with the subcontractor that the owner is not fully informed about (and which could include work that formed a basis as to the owner’s dispute with the contractor). And, it prevents the contractor from negotiating a final payment amount with the subcontractor so that it can, in turn, negotiate a final payment amount with the owner that is less than its contract balance. So, while this case explains the windfall to the contractor without the deduction for the owner’s direct payment to subcontractors, that windfall may not always be the case.

And, this case demonstrates the importance of how a contractor that substantially performed should present its damages. A contractor that substantially performs is entitled to the contract price subject to applicable deductions that the owner proves with competent evidence (e.g., deficient work, payment to subcontractors, etc.).

A CONTRACTOR’S RIGHT TO SET-OFF AMOUNTS FROM A SUBCONTRACTOR

Posted on February 18, 2012November 8, 2024 by Edward Garber

Oftentimes, subcontractors perform trade work for the same contractor on multiple projects. Because of this, it is practical for contractors to include in the subcontract a provision that authorizes them to set-off the subcontract amount due to any defects, breaches, etc. by the subcontractor that occur on another project. On the other hand, subcontractors that understand the ramifications of this provision, want to delete this provision from any subcontract in order to keep their receivables from one project completely separate from another project.

In Carolina Consulting Corp. d/b/a Barrier Wall of South Florida v. Ajax Paving Industries, Inc. of Florida, 2012 WL 163927 (2nd DCA 2012), a roadway contractor subcontracted the paving work on two separate projects (in two different counties).

After the subcontractor completed its work for the first project (“Project One”), a payment dispute arose whereby the subcontractor asserted it was owed more money than it was paid. At this time, the second project (“Project Two”) had not begun and was severely delayed.

When Project Two was ready to commence, the paving subcontractor advised the contractor that it would not perform until it was paid in full for Project One and was issued a change order for the increase in material price due to the severe delay to the start date. The subcontractor later stated that it would not perform until it received adequate assurances from the contractor of the contractor’s ability and willingness to pay for Project Two. The contractor then terminated the subcontractor and hired another subcontractor to perform the paving work for Project Two at an increased rate and lawsuits between the contractor and paving subcontractor were initiated.

The trial court held the subcontractor was entitled to suspend its performance on Project Two until it received adequate assurance that it would be paid for the work. The trial court further found that the subcontractor should be awarded approximately $119,000 for unpaid work for Project One and approximately $105,000 for the contractor wrongfully terminating the subcontractor on Project Two.

The contractor appealed to the Second District Court of Appeal maintaining that the subcontractor breached the subcontract for Project Two when it decided to condition its performance on the receipt of adequate assurances of the contractor’s ability to pay. The Second District agreed and reversed the trial court.

In examining this issue, the Second District looked at Florida’s Uniform Commercial Code, particularly Florida Statute s. 672.609(1), dealing with the sale of goods. This statute, in short, provides that “a merchant has the right to demand adequate assurance of performance ‘[w]hen reasonable grounds for insecurity arise with respect to the performance of’ the other party.” Carolina Consulting, 2012 WL at *2.

The Second District, however, noted that it previously declined to address whether this right under the Uniform Commercial Code applies in the context of construction contracts. The Court further declined to address this issue in this case. Rather, it stated that under the facts of the case, the subcontractor did NOT have a reasonable basis to demand adequate assurances from the contractor because the contractor had a payment bond (which is designed to guarantee payment to subcontractors and suppliers, etc.). For this reason, the Court maintained that the subcontractor breached the subcontract for Project Two and the contractor had the right to set-off amounts for the breach for Project Two for any amounts the contractor may have owed the subcontractor for Project One.

On this point, the Second District stated:

“Under the terms of both subcontracts, upon Ajax’s [subcontractor] breach of subcontract, the contractor had the right to hire another subcontractor to perform the work and then deduct the cost from any amount owed to Ajax in connection with the Pasco County subcontract [Project One].”

This bolded language seems to suggest that the contractor’s subcontract included a provision that allowed it to deduct or set-off amounts owed on one project due to defects or breaches on another project. However, even without this contractual language, it would seem that any amounts owed to the subcontractor for Project One would be offset by any amounts owed to the contractor for Project Two (due to the subcontractor’s breach of that subcontract). In this scenario, the outcome could be the same irrespective of the contractual language. Although, without the contractual set-off language, and assuming the contracts permitted prevailing party attorneys’ fees, it would seem that the subcontractor would be entitled to its fees for the contractor’s breach of the subcontract for Project One and the contractor would likewise be entitled to its fees for the subcontractor breaching the subcontract for Project Two. With the contractual set-off language, it is highly possible that the subcontractor would not be entitled to recover its fees for the contractor’s breach of the subcontract for Project One because the contractor had the contractual right to set-off such amounts due to any breaches associated with Project Two. This is a confusing but important distinction.

As it relates to the subcontractor demanding adequate assurances, this case is important because it illustrates that if the contractor has a payment bond, it will be very difficult for a subcontractor to ever condition its performance on demanding adequate assurance of the contractor’s ability to pay (i.e., its creditworthiness). While, irrespective of the payment bond, such an argument seems extremely challenging if made under the Uniform Commercial Code–many times contracts (particularly prime contracts) will include language that allows a contractor to demand adequate assurance of the paying party’s creditworthiness. Even with this contractual language, it will still be a difficult argument to make if there is a payment bond in place. Also, expanding this rationale, because of lien rights, a court may find that because a contractor/subcontractor has the right to lien the project (a subcontractor can lien the project if there is not a payment bond), it is really never in the situation to reasonably condition its performance on adequate assurances because it could preserve or try to collateralize its payment claim by recording a lien on real property as well as pursue a breach of contract claim against the nonpaying party.