Claim of Fraudulent Inducement of a Construction Contract Does Not Invalidate Arbitration Clause in That Same Contract

Emily D. Anderson | Pepper Hamilton | February 8, 2018

Koudela v. Johnson & Johnson Custom Builders, LLC, 2017 Ohio App. Lexis 5800 (December 29, 2017)

In this case, Nicolas and Monica Koudela (the “Koudelas”) entered into a construction contract with “Johnson & Johnson Builders” (the “Agreement”), whereby Johnson & Johnson Builders agreed to construct a single family home for the Koudelas in Ohio.  However, Johnson & Johnson Builders was a fictitious name for Johnson & Johnson Custom Builders, LLC (“J&J”), and was not an entity registered with the Ohio Secretary of State.

In the Agreement, the parties agreed to submit all disputes to binding arbitration in Cleveland, Ohio.  The arbitration clause further provided that the cost of the arbitration would be borne by the party initiating the claim.

After disputes arose on the project regarding the work performed by J&J, the Koudelas filed suit in the State Court of Ohio against J&J and its principals, alleging claims for fraud in the inducement, breach of contract, negligence, conversion, unjust enrichment/detrimental reliance, and a declaratory judgment that the arbitration clause in the Agreement was unenforceable.  J&J moved for an order dismissing the complaint, or, in the alternative, staying the litigation pending binding arbitration.  The trial court granted J&J’s motion and stayed the litigation pending binding arbitration. 

On appeal, the Koudelas argued that the arbitration provision in the Agreement was void because J&J did not properly register the trade name (“Johnson & Johnson Builders”) with the Ohio Secretary of State, and that the effect of fraud and the fictitious nature of the contracting party negated the arbitration clause.  The Koudelas further argued that section 1329.10 (B) of the Revised Code prohibited J&J from relying upon the arbitration clause in the Agreement.  Section 1329.10 (B) of the Revised Code provides:

No person doing business under a trade name or fictitious name shall commence or maintain an action in the trade name or fictitious name in any court in this state or on account of any contracts made or transactions had in the trade name or fictitious name until it has first complied with section 1329.01 of the Revised Code and, if the person is a partnership, it has complied with section 1777.02 of the Revised Code, but upon compliance, such an action may be commenced or maintained on any contracts and transactions entered into prior to compliance.”

The Court of Appeals disagreed and affirmed the trial court’s decision to stay the litigation pending arbitration.  The Court observed that the Koudelas’  reliance on section 1329.10 (B) of the Revised Code was misplaced because J&J did not initiate the action, but was merely defending it.  Instead, the relevant section of the Revised Code was section 1329.10 (C), which provides:

An action may be commenced or maintained against the user of a trade name or fictitious name whether or not the name has been registered or reported in compliance with section 1329.01 of the Revised Code.

The Court further reasoned that the arbitration clause in the Agreement should be enforced because J&J remained liable for any obligations incurred while doing business under its trade name, the Koudelas did not allege that the arbitration clause itself was fraudulently induced in either its complaint or in its briefs in opposition to J&J’s motion, and the Koudelas clearly knew who to sue since they named the correct entity in the litigation.  The Court also noted that the Koudelas did not perform any searches beforehand to see if any lawsuits had been filed against J&J’s trade name nor did they perform a routine search of the Ohio Secretary of State website, which, in the Court’s opinion, was further proof that the Koudelas were not fraudulently induced to enter into the Agreement.

Protecting Contractors Subject to Chief Engineer Decision Clauses

Jonathan M. Preziosi and Stephanie L. Jonaitis | Pepper Hamilton LLP | January 2018

Most contractors have encountered a prime contract provision with a governmental agency or public authority owner where the contract states that all claims for extra costs, delay damages or the like must be presented to the owner’s Chief Engineer for a decision, and that the Chief Engineer’s decision shall be conclusive, final and binding on the parties. This is a much different animal than a clause that merely requires presentation of all claims to the Chief Engineer as a prerequisite to filing a lawsuit. Under the first type of clause, the Chief Engineer becomes the sole judge and jury for the claim, and his or her decision can only be modified or reversed by the courts if the decision was based on fraud, bad faith or mistake about a fact over which no rational person could possibly disagree (such as a mathematical calculation). The right to appeal from a Chief Engineer’s decision under one of these clauses is therefore very limited.

The authors have encountered circumstances when contractors have felt that being bound by such a “Chief Engineer decision” clause is not a bad thing. The Chief Engineer for a particular agency or authority may have a well-earned reputation for dealing with contractors and their claims in an open-minded, fair and neutral manner. Other contractors are skeptical about the chances of getting a fair decision from a person who is the head of the very same organization that is being “sued” for a large amount of money, especially when the claim may involve criticism of project personnel who interact with the Chief Engineer at the office every day. This article will briefly explore key points to keep in mind for the contractor who may have doubts about having its claim decided by the Chief Engineer in the unwelcome event that a claim has to be made.

The first point to keep in mind is that the enforceability of Chief Engineer decision clauses varies from state to state. The courts of some states hold that these clauses are enforceable, and that their judges should not interfere with dispute resolution clauses that are voluntarily signed.1 The courts of other states disfavor these clauses as contracts of adhesion, and prohibit them on the assumption that the relationship between a Chief Engineer and his or her agency is just “too close” to ensure an impartial decision on a claim against the agency.2

Sometimes, Chief Engineer decision clauses will appear in contracts with bi-state agencies that are, by nature, congressional “compacts” between the governments of two states. It is quite possible that the courts of one of those states would enforce such clauses, while the courts of the other state would prohibit them. In such a situation, the contractor’s attorney should evaluate which state’s law should govern the contract, an evaluation that takes into account factors such as the location of the project, where the contract was signed, and where the important witnesses are likely to live.

Assuming that the Chief Engineer decision clause in a given contract is enforceable in the state whose law controls the contract, and that the Chief Engineer will therefore have the final, binding and conclusive say over how a claim gets decided, the contractor and its attorney should be proactive in suggesting — or demanding — that appropriate procedures are in place to ensure as fair a hearing as possible. Counsel should work cooperatively with the “claim officer” or other agency representative responsible for the administration of the hearings to ensure that there will be a right to inspect the agency’s project records and possibly take the depositions of key witnesses as a means of discovery before the hearings start. The hearings themselves should give the contractor a full and fair opportunity to cross-examine the owner’s witnesses and present rebuttal testimony after the owner has presented its defenses. Counsel should also request that the claim officer implement appropriate procedures to ensure that the Chief Engineer does not have any “off the record” communications about the claim with the agency employees or consultants involved in defending it.

Ultimately, and as the U.S. Supreme Court made clear in a case decided a half century ago, the hearing procedures must be “conducted in such a way as to require each party to present openly its side of the controversy and afford an opportunity of rebuttal.”3 Hearing procedures that do not meet this minimum standard of fairness and due process may expose the Chief Engineer’s decision to reversal by a reviewing court, even in states where Chief Engineer decision clauses are enforceable. Most agency claim officers are keenly aware of these standards and understand that it would be in the best interests of all parties to have a hearing process that incorporates procedural safeguards like those discussed above. Counsel for the contractor should proactively work with the claims officer to ensure such a process is formally established in writing before any hearings begin.

Endnotes

1 See, e.g.Laquila Constr., Inc. v. New York City Transit Auth., 282 A.D.2d 331, 331 (N.Y. App. Div. 2001) (holding that a dispute resolution provision making the Chief Engineer the decision maker was enforceable).

2 See, e.g.Gauntt Constr. Co. v. Del. River & Bay Auth., 575 A.2d 13 (N.J. App. Div. 1990) (“Relationship between Director and DRBA . . . is obviously too close to assure the dispassionate and impartial resolution of disputes” between the DRBA and its contractors).

3 United States v. Carlo Bianchi & Co., 373 U.S. 709 (1963).

The Contract Disputes Act: What Every Federal Government Contractor Should Know

Sarah K. Carpenter | Smith Currie | January 29, 2018

Claims on construction projects are unpleasant, but sometimes unavoidable. Contract with the federal government and you are by statute and by contract required to resolve any and all disputes under the Contract Disputes Act. So what is the Contract Disputes Act? This article sets forth basic information all federal government contractors should know when faced with the necessity of making or defending a claim on a federal project.

What Is the Contract Disputes Act?

The Contract Disputes Act of 1978 (CDA or Act) was enacted by Congress to implement a comprehensive statutory scheme for the resolution of government contract claims. The CDA provides a framework for asserting and handling claims by either the government or a contractor. All disputes under the CDA must be submitted to either the U.S Court of Federal Claims or to an administrative board of contract appeals. The vast majority of board cases are handled by either the Armed Services Board of Contract Appeals or the Civilian Board of Contract Appeals. The ASBCA is generally responsible for deciding appeals from decisions of contracting officers in the Department of Defense, the Department of the Army, the Department of the Navy, NASA, and when specified, the CIA. The CBCA hears disputes from all other executive agencies except the United States Postal Service (USPS), the Postal Rate Commission, and the Tennessee Valley Authority.

The USPS is served by the Postal Service BCA. In addition, the Government Accountability Office Contract Appeals Board handles contract disputes arising in the legislative branch, and the Office of Dispute Resolution for Acquisition handles contract disputes and bid protests arising out of Federal Aviation Administration procurements.

What Types of Claims Are Subject to the CDA?

The CDA governs post-award monetary claims, such as breach of contract, non-monetary claims, such as a claim for time or interpretation issues regarding a specification, and claims arising out of an implied-in-fact contract between the federal government and a contractor.

What Types of Claims Are NOT Subject to the CDA?

There are a few categories of claims that may arise between the government and a federal contractor that are not subject to the CDA. For instance, a prevailing wage claim arising under the Davis Bacon Act is not subject to the CDA because claims or disputes which another federal agency is specifically authorized to handle are not subject to the disputes process under the CDA. Additionally, any tort claim that does not arise under or relate to a contract or implied-in-fact contract between the government and a contractor is not subject to the CDA. Lastly, it should be noted that the CDA governs only post-award disputes; therefore, pre-award claims, such as bid protest actions, are not subject to the Act.

Who Can Assert a Claim under the CDA?

The federal government and government contractors may bring claims under the CDA. Claims by the government, such as claims for liquidated damages or claims for default termination, are subject to the CDA and may be brought by the government against a contractor after a contracting officer has issued a final decision on each claim. Generally, a final decision by the contracting officer is a prerequisite to the government’s assertion of any claim or counterclaim against a contractor. However, an important exception to this rule is that a contracting officer’s final decision is not a prerequisite to the government’s assertion of a counterclaim against a contractor under the False Claims Act.

Generally, only the parties to the contract—the government and the prime contractor—can bring a claim under the CDA. A subcontractor cannot bring a claim against the government under the CDA. However, a prime contractor may assert a pass-through claim against the government on behalf of a subcontractor. A prime contractor may only sponsor a claim on behalf of a subcontractor if the prime contractor has paid the subcontractor’s claim or, more commonly, the prime contractor otherwise remains potentially liable to the subcontractor pursuant to a claims cooperation or liquidating agreement. Most liquidating agreements limit the prime contractor’s liability to the amount the government agrees to pay or is required to pay.

When Can a CDA Claim Be Asserted?

Claims by both the government and federal contractors are subject to a six year statute of limitations which means that claims under the CDA must be submitted within six years of the time when all events establishing alleged liability for an injury were known or should have been known. Additional time limitations under the Federal Acquisition Regulation may apply to claims related to changes, differing site conditions, or suspension of work. For instance, a contractor is required to give “prompt” written notice to the contracting officer of a differing site condition before it is disturbed.

How to Make a Claim under the CDA?

A contractor is not required to submit its claim under the CDA in a particular format. However, a contractor’s claim must strictly satisfy the criteria set forth below to constitute a claim under the CDA.

First, a contractor must make a written demand or assertion. A mere notification by a contractor notifying a contracting officer of an issue or an amount the contractor believes it is entitled to does constitute a claim under the CDA.

Second, the contractor’s written demand or assertion must seek the payment of money in a sum certain, the adjustment or interpretation of contract terms, or other relief arising under or relating to a contract between the government and the contractor. The contractor’s claim must be sum certain or capable of determination by a simple mathematical formula. A contractor’s assertion for payment “approximately” or “in excess of” an amount will not constitute a claim under the CDA.

Third, all contractor claims exceeding $100,000.00 must be certified by the contractor. Claims asserted by the government are not required to be certified under the CDA. For claims exceeding $100,000.00, a contractor must certify that (i) the claim is being asserted in good faith, (ii) the supporting data is accurate and complete to the best of the contractor’s knowledge, (iii) the amount requested is accurate, and (iv) the person asserting the claim is duly authorized to certify the claim.

Fourth, the claim must be submitted within the six year statute of limitations.

Fifth, the claim must be submitted to a contracting officer, not a field officer or other administrative official.

Sixth, the claim must include a specific request for a final decision or otherwise set forth a clear indication that the contractor would like the contracting officer to issue a final decision.

If a contractor’s claim satisfies the six requirements set forth above, then the claim may be properly asserted under the CDA.  A claim does not initially need to include supporting data, such as a detailed cost breakdown, if it otherwise satisfies the criteria of a CDA claim. However, a contractor’s claim should contain sufficient information to show the basis for the contractor’s entitlement to the relief requested.

What Is the Difference Between a Request for Equitable Adjustment and a Claim under the CDA?

As is discussed below, once a CDA claim is made, the contracting officer is obligated to issue a final decision that, if unfavorable, must be appealed within ninety (90) days to a BCA or one year to the Court of Federal Claims. Rather than start the running of this clock, a contractor may ask for a change order or submit an uncertified request for an equitable adjustment or REA. Such requests give the contractor and the government an opportunity to discuss and negotiate the contractor’s request outside the time limits imposed by the CDA. If, as often happens, the contracting officer agrees to issue a change order, both sides are spared from the formal dispute resolution process. On the other hand, contractors should avoid falling into endless letter writing and negotiations. If it becomes apparent that the contracting officer has no intention of issuing a change order, the contractor should proceed to the formal CDA claims process described above.

What Happens Once a Claim Under the CDA Is Asserted?

Once a contractor submits a claim to a contracting officer meeting all of the criteria of a CDA claim, the contracting officer must issue a final decision on the claim. If the contractor’s claim is for an amount less than $100,000.00, the contracting officer must issue a final decision within sixty (60) days of receipt of the claim. However, if the contractor’s claim is for an amount exceeding $100,000.00, the contracting officer may issue a final decision within sixty (60) days or provide to the contractor a firm date within a “reasonable time” by which the contracting officer will issue a final decision. If the contracting officer fails to issue a final decision within a reasonable time, such failure may constitute a deemed denial, and the contractor may proceed with an appeal to the appropriate BCA or the Court of Federal Claims. Frequently, deemed denial appeals result in an order directing the contracting officer to issue a final decision.

How to Appeal a Final Decision?

After a contractor receives a final decision by a contracting officer regarding its claim, the contractor may choose to appeal the final decision to the Court of Federal Claims or the BCA that has jurisdiction over its contract. A contractor may appeal the entirety of the contracting officer’s final decision or some portion thereof.

Timing may be dispositive for a contractor in determining which forum to file its appeal of the contracting officer’s decision. A contractor must file its appeal with the BCA within ninety (90) days of receipt of the contracting officer’s final decision. Or, a contractor may file an appeal with the Court of Federal Claims within twelve (12) months of receipt of the contracting officer’s final decision. Timing may play a crucial role in a contractor’s decision, but many factors, such as preference for a more—Court of Federal Claims—or less—BCA—formal set of procedural rules or the ability of the government to bring a False Claims Act counterclaim, should be weighed by a contractor in making its forum selection for its appeal. Generally, once a contractor chooses its forum, its decision is binding, and the contractor cannot pursue its claim in the other forum.

A formal complaint is not required to file an appeal of a contracting officer’s final decision to a BCA. An appeal to the BCA must be in writing, express dissatisfaction with the final decision, manifest intent to appeal the final decision, and be sent to the contracting officer and the BCA. To appeal a contracting officer’s decision before the Court of Federal Claims, the contractor must file a complaint setting forth the factual and legal basis for its claims.

Are Attorneys’ Fees Recoverable for a Claim under the CDA?

Generally, a contractor may not recover its attorneys’ fees incurred pursuing a claim under the CDA. The Equal Access to Justice Act allows some individuals and small businesses to recover attorneys’ fees up to $125 per hour if it is determined that the claimant is the prevailing party and the government’s position was not substantially justified. The claimant must also comply with the size standards set forth in the Act.

Louisiana First Circuit Holds that Private Works Act Surety Cannot Raise Pay-if-Paid Defense

Mark W. Frilot, Mark W. Mercante | Baker Donelson | January 25, 2018

The Louisiana First Circuit recently held that a Private Works Act payment bond surety cannot raise a pay-if-paid provision in its principal’s contract as a defense to a claim against the bond.

Bear Industries, Inc. v. Hanover Insurance Co. involved the construction of a Wal-Mart Supercenter in New Roads, Louisiana. The plaintiff, Bear Industries, Inc. (Bear), supplied materials for the project to a subcontractor, Amtek of Louisiana, Inc. (Amtek). Bear, Amtek, and Hudson Construction Company of Tennessee (Hudson), the prime contractor, entered into a joint check agreement under which Hudson issued all payments to Bear by joint check to Amtek and Bear.

Because of a dispute between Amtek and Hudson, Hudson stopped making payments, and Bear filed a Louisiana Private Works Act statement of claim and privilege. Bear later filed suit against Amtek and Hanover Insurance Company (Hanover), the surety that furnished the payment bond for the project on behalf of its principal, Hudson.

The trial court ruled in favor of Bear and against Hanover and Amtek and held that Hanover could not rely on a pay-if-paid clause in Hudson’s contract with Amtek as a defense to Bear’s claims. The trial court reasoned that “Hanover’s liability under the Private Works Act differs from conventional surety principles.” Specifically, the trial court found that a Private Works Act bond is statutory, and, “[a]s such, safeguards required for the bond by the Act would be read into the bond, and provisions in the bond, not required by the Act, would be read out of the bond.” In support of its conclusion, the trial court cited Glencoe Education Foundation, Inc. v. Clerk of Court & Recorder of Mortgages for the Parish of St. Mary, a Public Works Act case holding that “because the [pay-if-paid] contractual provision on which the surety relied was contrary to the purpose of the Public Works Act, the surety, which had issued a statutory bond, could not assert a ‘pay-if-paid’ clause in a principal’s subcontract as a defense to payment of sums owed to subcontractors who have performed work and supplied materials on a public construction project.”

On appeal, the First Circuit affirmed the trial court’s ruling and held “that the ‘pay-if-paid’ defense is not available to Hanover under the Private Works Act.” The court reasoned that “[a]llowing a surety to assert a ‘pay-if-paid’ clause to defeat payment to a subcontractor on the basis that the contractor has not received full payment from the owner, where the owner has escaped liability to the subcontractors by relying on the payment bond, would render the protections afforded to laborers and suppliers on private works projects set forth in the Private Works Act meaningless.”

Kentucky Supreme Court Holds “Pay-if-Paid” Provision in Subcontract Is Valid and Enforceable, Shifting Risk to Subcontractor

Michelle Beth Rosenberg | Pepper Hamilton LLP | January 25, 2018

Superior Steel, Inv. v. Ascent at Roebling’s Bridge, LLC, 2017 Ky. LEXIS 511 (December 14, 2017)

Corporex Development and Construction Management, LLC (“Corporex”), a design builder, contracted with Dugan & Meyers Construction Company (“D&M”), a construction manager and general contractor on the Ascent at Roebling’s Bridge (the “Project”), a 21-floor luxury condominium in Covington, Kentucky.

As a cost saving measure, D&M asked Superior Steel, Inc. (“Superior”) to fabricate the steel and to have Ben Hur Construction Company (“Ben Hur”) complete the erection and installation work. Superior and D&M entered into a fixed price contract for $1,814,000. In turn, Superior subcontracted with Ben Hur to erect the steel and metal decking for $444,000. As structured, the payments would flow from Corporex to D&M to Superior. Superior would then pay Ben Hur.

During the course of the Project, D&M instructed both Superior and Ben Hur to perform extra work. Ben Hur and Superior submitted work orders to D&M who in turn submitted work orders to Corporex. Ultimately, Corporex refused to pay for Superior and Ben Hur’s additional work and refused to pay Superior’s retainage.

Superior and Ben Hur filed a complaint against Corporex and D&M for breach of contract, among other claims, in order to recover monies owed. The trial court held that a contract existed between Superior and D&M and that an implied contract existed between Ben Hur and D&M, as a matter of law. The trial court entered judgment in favor of Superior for $124,017.26 for extra work performed and $195,143.40 for unpaid retainage. Additionally, the trial court entered judgment in favor of Ben Hur for $284,295.53 for extra work performed.

The Court of Appeals vacated the trial court judgment, reasoning that the jury should have been explicitly instructed as to the “pay-if-paid” provisions in the Superior/D&M contract. Such provisions essentially mandated that Superior was entitled to payment from D&M only if D&M received payment from Corporex. The Kentucky Supreme Court agreed with the Court of Appeals on this issue.

At the center of Superior and Ben Hur’s breach of contract claims, was the “pay-if-paid” provisions which condition D&M’s payment of Superior on D&M having first been paid by Corporex. “Pay-if-paid” conditions shift the risk of nonpayment from the contractor to the subcontractor. The Superior/D&M contract contains two sections with pay-if-paid language. First, Article 7.11 “Claims Payment,” states:

[n]o additional compensation shall be paid by the Contractor to the Subcontractor for any claim arising out of the performance of this Subcontract, unless the Contractor has collected corresponding additional compensation from the owner, or other party involved, or unless by written agreement from the Contractor to the Subcontractor prior to the execution of the Work performed under said claim, which agreement and work order must be signed by an officer of the Contractor.

Second, Article 8.2.4, “Time of Payment” states:

[r]eceipt of payment by the Contractor from the Owner for the Subcontractor Work is a condition precedent to payment by the Contractor to Subcontractor. The subcontractor hereby acknowledges that it relied on the credit of the Owner, not the Contractor for payment of the Subcontract Work.

The Supreme Court held that these provisions unambiguously created a condition precedent that D&M must receive payment prior to its obligation to pay Superior. Therefore, the provisions unequivocally allocated the risk of nonpayment by Corporex to Superior and relieved D&M of its obligation to pay Superior unless and until it received payment from Corporex. As it was undisputed that Corporex never paid D&M, D&M was not obligated to pay Superior under the contract terms. The Supreme Court held the “pay-if-paid” provisions were consistent with public policy because Kentucky has long respected freedom of contract and allowed the parties to allocate foreseeable risk among themselves. Furthermore, the Supreme Court refused to invalidate such a policy without clear direction from the Legislature.

Thus, because the Supreme Court held that the “pay-if-paid” provisions were valid and enforceable, those provisions precluded judgment in favor of Superior against D&M. Nevertheless, the Supreme Court also held that Superior and Ben Hur, which had obtained a judgment for unjust enrichment against Corporex for the extra work claims, could sustain that judgment.