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.

GARDEN VARIETY PAYMENT DISPUTE BETWEEN OWNER AND CONTRACTOR

Posted on May 8, 2014May 8, 2014 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, 2012February 18, 2012 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.