California Case That Reads Like Russian Novel Results in Less Than Satisfying Result for Both Project Owner and Contractors

Garret Murai | California Construction Law Blog | April 3, 2019

Sometimes you can see a train wreck coming a mile away. The next case, Design Built Systems v. Sorokine, Court of Appeal for the First District, Case Nos. A151264 and A152059 (February 26, 2019), is one of those cases. It also happens to read like a Tolstoy novel.

The Beginning of the Train Wreck

Alexei Sorokine and Elena Koudriavtseva, husband and wife, owned a single family home in San Rafael, California. Sorokine had acquired the house prior to his marriage to Koudriavtseva.  In 2010, he traveled to Russia and, for reasons unexplained, has not been able to return.

Following a landslide on the property in 2006, Sorokine entered into a construction contract with Design Built Systems to design and build a series of retaining walls.  DBS was also retained to remedy a stop work notice issued by the City of San Rafael following work performed by others.

In 2011, DBS entered into another contract, this time with Koudriavtseva, for installation of concrete retaining walls and a driveway. The contract price was $175,000. However, after DBS had completed most of its work, Koudriavtseva fired DBS and hired PA Builders, Inc. to complete the project and, according to Koudriavtseva, to remedy defects caused by DBS. PA Builders, however, was unlicensed. More on that later.

During this same time, a gentleman named Dmitriy Kornach and his company Kornach Construction Company (collectively “Kornach”), performed significant remodeling work at the property, much of it himself, but at times with his sons Alexi and Oleg. Kornach, a longtime friend of Sorokine, agreed to purchase materials for the project because he was able to obtain wholesale prices by virtue of his general contractor’s license.  However, Kornach too was later fired by Koudriavtseva who fired him in the fall of 2011.

This Tolstoyesque saga, of course, ended in litigation.

The Train Wreck

In 2012, DBS sued Sorokine and Koudriavtseva alleging claims for breach of contract, foreclosure of mechanics’ lien, common counts and account stated.

Sorokine and Koudriavtseva in turn filed a cross complaint against DBS, as well as Kornach, and Kornach’s license bond surety, American Contractors Indemnity Company. The cross-complaint alleged 11 causes of action for: (1) breach of written contract; (2) breach of oral contract; (3) breach of implied warranty; (4) negligence; (5) disgorgement; (6) intentional misrepresentation; (7) negligent misrepresentation; (8) rescission and restitution; (9) violation of the Unfair Business Practices Act; (10) breach of the covenant of good faith and fair dealing; and (11) recovery under contractor’s license bond.

Kornach in turn filed a cross-complaint against Sorokine and Koudriavtseva alleging claims for indemnity, contribution, declaratory relief, and an unusual one entitled “fraudulent filing,” based on Kornach’s claim that Sorokine and Koudriavtseva violated Internal Revenue Code section 7434 by inter alia borrowing money from Kornach but failing to repay it, filing fraudulent IRS 1099 forms indicating that they hadrepaid Kornach, and that the fraudulent 1099 forms caused Kornach to have his tax returns audited resulting in additional tax liability.

And, with that, this mess of a case went to trial. A jury trial five years later.

At the beginning of trial, Kornach’s counsel filed several motions in limine seeking to exclude evidence and testimony. One of them, Motion in Limine No. 17, sought to preclude Sorokine and Koudriavtseva’s counsel from introducing evidence and testimony regarding work performed by unlicensed contractors, namely PA Builders, on the ground that Business and Professions Code section 7031 bars all actions that seek compensation for work performed by unlicensed contractors. The trial court granted the motion.

On the twelfth day of trial, the trial court heard and ruled on several motions for directed verdict filed by the parties, two of which were appealed:

  1. The trial court granted a motion for directed verdict filed by Kornach arguing that Sorokine and Koudriavtseva’s claims for breach of written contract, breach of oral contract, breach of implied warranty, and breach of the covenant of good faith and fair dealing failed because Sorokine and Koudriavtseva could not show proof of damages as a result of the trial court’s earlier granting of Kornach’s Motion in Limine No. 17 pertaining to work performed by PA Builders. The trial court granted  Kornach’s motion for directed verdict.
  2. The trial court also granted a motion for directed verdict filed by Kornach on his Internal Revenue Code section 7434 fraudulent filing claim. This was unusual, because it is typically defendants, rather than claimants, who file motions for directed verdict. In any event, Kornach’s counsel argued that Sorokine and Koudriavtseva had failed to introduce evidence controverting Kornach’s “fraudulent filing” claim. The trial court granted this motion as well.

Following the results of the directed verdicts, the only claim remaining was DBS’ claim against Sorokine and Koudriavtseva, upon which the jury rendered a verdict in favor of DBS in the less than impressive amount of $32,190.

Following trial, the trial court awarded Kornach $20,000 in penalties under Internal Revenue Code section 7434, $122,956.50 in attorney’s fees and costs, and $113,196.50 in costs of proof based on previously served requests for admissions. In addition, the trial court awarded DBS $120,749.50 in costs of proof also based on previously served requests for admissions. Grand total: $376,902.50 on what amounted to a $32,190 claim.

But, of course, it wasn’t over.  Sorokine and Koudriavtseva appealed.

The Appeal

On appeal, Sorokine and Koudriavtseva asserted three claims of error by the trial court: (1) granting Kornach’s motion for directed verdict on its IRS “fraudulent filing” claim; (2) granting Kornach’s motion for directed verdict on Sorokine and Koudriavtseva’s inability to prove damages; and (3) awarding $113,196.50 to Kornach for costs of proof.

Kornach’s Fraudulent Filing Claim

For some reason, unusual claims often accompany unusual facts. As discussed above, Kornach’s “fraudulent filing” claim alleged that Sorokine and Koudriavtseva issued false or “fraudulent” 1099s, when in fact they never paid Kornach, which was a violation of Internal Revenue Code section 7434. Internal Revenue Code section 7434 permits a private cause of action against anyone who “willfully files a fraudulent information return with respect to payments purported to be made to any other person.” The section provides for a civil penalty of $5,000 per violation, plus costs, and an award of reasonable attorney’s fees. However, the section also provides, that if a court determines that there is a violation, its decision must identify the correct amount that should have been reported.

Kornach prevailed on this claim by filing a motion for directed verdict, which, as also discussed above, is unusual in that such motions are typically brought by defendants arguing that the claimant failed to prove one or more elements of its claim.  Here, however, Kornach successfully argued to the trial court that Sorokine and Koudriavtseva had failed to introduce evidence controverting Kornach’s claim under Internal Revenue Code section 7434 thereby flipping the burden of proof.

The Court of Appeals, while acknowledging that there are “a few cases” addressing motions for directed verdict filed by a party that has the burden proof, and while noting that it is possible to do so, held that the directed verdict rendered in favor of Kornach was in error because: (1) the evidence showed that the 1099s were not completely wrong, and importantly not “fraudulent,” because Kornach testified that he made three loans to Sorokine for $200,000, $100,000 and $100,000 and that Sorokine paid back $280,000 of these amounts; (2) Koudriavtseva testified that she was unaware at the time the 1099s were issued by her accountant that any were in error and Sorokine was unavailable at trial to testify whether he knew that any of the 1099s were issued in error; and (3) issues of a witnesses’ knowledge and belief are characteristically questions for the fact finder, which, in this case, was the jury.

Sorokine and Koudriavtseva’s Inability to Prove Damages

We’ve written before about Business and Professions Code section 7031. For contractors it’s like the Death of Ivan Ilyich(I’m a fan of Russian literature as you can tell). Everything is going fine when something seemingly inconsequential occurs (e.g., a short lapse in your contractor’s license). You think nothing about it at first, then suddenly you’re in a world of hurt, questioning the fairness of it all. In short, under Business and Professions Code section 7031, if you’re a contractor performing work requiring a valid contractor’s license, and you don’t have one: (1) you cannot make a claim for compensation for work performed; and (2) the property owner can sue you to disgorge all compensation paid to you. In short, to use a Cold War analogy, it’s the nuclear option of remedies.

The manner in which Kornach used Section 7031, however, was unusual. Rather than use the section as a shield against a payment claim by PA Builders (who was unlicensed) or as a sword to recover compensation paid to PA Builders, Kornach used it as a shield against Sorokine and Koudriavtseva’s construction defect claim, arguing that because PA Builders was unlicensed, Sorokine and Koudriavtseva could not use the amounts they paid to PA Builders to correct the work performed by Kornach to show the value of their damages.

The Court of Appeals didn’t buy it. “There is no authority for the proposition that a person who unwittingly hires an unlicensed contractor to repair work not properly performed by someone else is precluded from introducing evidence of the cost of repair,” explained the Court. “The purpose of the licensing law is to protect the public from incompetence and dishonesty in those who provide building and construction services,” further explained the Court, “not to punish the innocent people who hire them.”

The Award of $113,196.50 for Costs of Proof

In civil cases, parties are permitted to conduct “discovery” to learn more about an opposing party’s claims or defenses in a case. This includes serving written questions that must be answered by opposing parties. One form of discovery is the use of Requests for Admissions, which asks an opposing party to “admit” or “deny” under penalty of perjury leading questions posed by the other side, such as “Admit that contractor XYZ performed work on the project that was not paid for.”

Code of Civil Procedure section 2033.420 provides:

If a party fails to admit the genuineness of any document of the truth of any matter when requested to do so under this chapter, and if party requesting that admission thereafter proves the genuineness of that document or the truth of that matter, the party requesting the admission may move the court for an order requiring the party them the request was directed to pay the reasonable expenses incurred in making that proof, including reasonable attorney’s fees.

Section 2033.420 provides that a Court is required to make such an order unless if finds any of the following:

  1. An objection to the request was sustained or a response to it was waived;
  2. The admission sought was of no substantial importance;
  3. The party failing to make the admission had reasonable ground to believe that that party would prevail on the matter; or
  4. There was other good reason for the failure to admit.

The decision doesn’t provide, let alone describe, the specific request for admission. However, what apparently occurred, is that Sorokine and Koudriavtseva denied a request for admission that was later shown at trial to be true. But here’s the kicker. Kornach was awarded $113,196.50 in costs of proof expenses under Civil Code section 2033.420 for proving the truth of a request for admission, not of requests for admission that Kornach had sent to Sorokine and Koudriavtseva, but based on requests for admissions that another party had sent to Sorokine and Koudriavtseva, namely Kornach’s license bond surety ACIC.

The Court of Appeals made quick work Kornach’s argument, citing Section 2033.420’s language that “the party requesting the admission,” not a different party, may thereafter seek cost of proof of expenses in proving the truth of a request for admission. “Kornach offers no authority for the proposition that a party may recover cost of proof expenses based upon requests for admission propounded by someone else,” explained the Court, “[a]nd the authority he does cite . . . says nothing of the sort.”

Conclusion

Design Built Systems is an interesting case if only for the twists and turns of the facts and the unusual claims and arguments made by counsel at trial. For parties and their counsel, however, the case  stands for at least two propositions: (1) While Business and Professions Code section 7031 is a powerful remedy, it can’t be used as a shield against proof of repair costs, even if the repairs are made by an unlicensed contractor; and (2) You can’t seek proof of expenses under Code of Civil Procedure section 2033.420 for proving the truth of a request for admission unless the request for admission was one that you yourself served on the opposing party.


Insured’s Complaint for Breach of Contract and Bad Faith Adequately Pleads Consequential Damages

Tred R. Eyerly | Insurance Law Hawaii | March 4, 2019

    The appellate court overturned the trial court’s dismissal of the insured’s complaint seeking consequential damages. D.K. Prop. Inc. v. Nat’l Union Fire Ins. Co. of Pittsburgh v, Pa., 2019 N.Y. App. Div. LEXIS 329 (N.Y. App. Div. Jan. 17, 2019). 

    The insured’s building began to shift and exhibit structural damage, including cracks, after construction began in an adjoining building. The insured submitted a claim under its commercial insurance policy. The insurer did not pay the claim, nor did it disclaim coverage. 

    The insured sued, alleging breach of contract for failure to pay covered losses under the policy. The second cause of action was for breach of the implied covenant of good faith and fair dealing. The complaint also requested consequential damages in connection with each cause of action. The trial court granted the insurer’s motion to dismiss the claim for consequential damages.

    The issue was whether, at the pleading stage, a claim for consequential damages arising from the insurer’s processing of the claim, required a detailed factual description or explanation for why such damages, which did not directly flow from the breach, were also recoverable. The complaint alleged that rather than pay the claim, the insurer made unreasonable and increasingly burdensome demands for three years. The insured alleged that this was a tactic to make the claim so expensive to pursue that the insured would abandon it. The investigatory process had taken so long that the structural damage to the building worsened. Among the consequential damages alleged were engineering costs, painting, repairs, monitoring equipment and moisture abatement to address water intrusion, loss of rents, and other expenses attributable to mitigating further damage to the property. 

    An insured could sue for consequential damages resulting from an insurer’s failure to provide coverage if such damages were foreseen or should have been foreseen when the contract was made. At the pleading stage, the question was whether the plaintiff had stated a claim, not whether the plaintiff was able to establish its claim. Here, the insured met the pleading requirements with respect to consequential damages. Despite the insurer’s call for a heightened pleading standard, an insured’s obligation to “take all reasonable steps to protect the covered property from further damage by a covered cause of loss” supported plaintiff’s allegation that some or all of the alleged damages were foreseeable. 

Court Denies Recovery of Public Adjuster Fees in Breach of Contract Action

Ashley Harris | Property Insurance Coverage Law Blog | December 16, 2018

In Kingshill Hospitality, Inc. v. American Economy Insurance Company,1 the policyholder’s hotel was damaged by a fire. Three days later the policyholder hired a public adjuster to assist in submitting its insurance claim. A dispute arose regarding the amount of loss and the policyholder filed suit for breach of contract.

As part of the damages claimed, the policyholder sought recovery of the public adjuster fee as consequential damages. The insurance carrier moved the court to strike the claim for consequential damages, which the court granted.

The policyholder argued that “it had to retain the services of an insurance claims professional (Public Adjuster) to pursue its claim.” The court disagreed, reasoning that consequential damages are “[l]osses that do not flow directly and immediately from an injurious act but that result indirectly from the act,” and here, the policyholder hired the public adjuster only three days after the fire occurred and before the insurance carrier made a coverage determination. The court concluded:

Because these costs were incurred in May – before the alleged breach occurred when American Economy partially denied coverage on June 1 – Kingshill’s public adjuster expenses cannot be categorized as consequential damages.

While not relevant under the facts of this case, the court noted:

If an insured believes that its insurer is not attempting to settle a claim in good faith and hires a public adjuster to refute the damage estimate or coverage determination proferred by an insurer, such expenses could be considered consequential damages. And under those facts, the consequential damages would be extracontractual damages that could only be recovered in a bad faith action, pursuant to QBE Ins. Corp. v. Chalfonte Condominium Apartment Ass’n, Inc., 94 So.3d 541 (Fla. 2012).

It should be noted that courts in Florida have found that consequential damages can be recovered in a breach of contract action.2 Here, however, where the public adjuster was hired before a dispute arose regarding the loss or coverage, the public adjuster fees were not recoverable.
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1 Kingshill Hospitality, Inc. v. American Economy Ins. Co., No: 5:18-cv-520, 2018 WL 6427681 (M.D. Fla. Dec. 5, 2018).
2 See e.g.Trident Hospitality Florida, Inc. v. American Economy Ins. Co., No.: 6:08-cv-289, 2008 WL 11334515 *2 (M.D. Fla. May 30, 2008) (“Plaintiff is entitled to consequential damages if it can prove that damages ‘were within contemplation of the parties when the contract was formed.’” Citing Martin v. Monarch Life Ins. Co., No. 94-1182, 1995 WL 127157, at *1 (M.D. Fla. Mar. 21, 1995)).

Bad Faith May Arise Out Of Wrongful Misrepresentation in Application Denial

Chip Merlin | Property Insurance Coverage Law Blog | November 28, 2018

Suspicion runs rampant with some insurance companies when it comes to alleged arson. Even if they cannot prove the policyholder had anything to do with a fire, some adjusters cannot help to look for other ways to deny an insurance claim. In Hayes vs. Metropolitan Property and Casualty Insurance Company,1 an insurer was held liable for bad faith denial of an insurance claim even though the policyholder did not win the breach of contract action because the policyholder failed to file his lawsuit within the one-year statute of limitations.

Since it is a misrepresentation in the application case, let’s start with the application facts:

Hayes’s home at 480 South 6 Street, Springfield, Nebraska, was insured…under a homeowner’s insurance policy. Hayes used the detached garage of the residence as part of a home base for his plumbing business, and in addition to living there himself with his children, he also rented out the second and third levels of the residence to a tenant and her two children.

When Hayes insured the residence in 2007, Met argues that he indicated on his application that the premises were not used to conduct business, and were not used as rental property. However, the application, a five-page document, was not a model of clarity on either of these two points. It was apparent that the form was not filled out by hand because pre-printed “x’s” were used in the checked boxes. Hayes testified that he did not recall personally completing the application in 2007; that he worked with an independent insurance agent when it was filled out, and it was also likely filled out with information from his sister, because his signature “stamp” was used in the signature line instead of his actual handwritten signature, and she had his authorization to use the stamp.

With regard to tenants, the form asked whether “the residence [was] held exclusively for rental?” and a pre- printed “x” was marked next to the letter “N” in answer to that question. The form also asked for number of “families” and the number “1” was printed in that box. With regard to the business, the form asked whether “[a]ny farming or other business [was] conducted on premises?” and again, a box indicating “no” was marked with a preprinted x. Hayes testified at trial that while he did maintain some plumbing supplies at the property, very little of the plumbing equipment was located in the detached garage due to limited space. He also testified that he definitely did not “run” the plumbing business out of the premises, although customers would on occasion contact him there about doing a plumbing job. Further, Hayes had a separate commercial business insurance policy to cover the plumbing business in the detached garage, (although the address for this business was inadvertently and incorrectly listed on the insurance form as 680 South 6 Street, Springfield, Nebraska, rather than 480), and Hayes testified that he believed the commercial policy adequately covered his business. Hayes did not make a claim with regard to the shop or business as a result of the fire.

(Emphasis added).

Of course, there was no problem with Metropolitan accepting the premiums for six years until a fire happened in January 2013. The insurance company kept rejecting the policyholder’s proofs of loss, made numerous requests for documents and information and took numerous examinations so that by the time the insurance company got around to deny the claim for a misrepresentation in the application, approximately 18 months had passed.

The problem for the policyholder was that he did not file his lawsuit until after the denial and long after the 12-month suit limitation under the policy. The problem for Metropolitan was that the judge who dismissed the contract action because it was late-filed also found that Metropolitan had no reasonable basis to deny the claim and found bad faith on the part of Metropolitan.

The Circuit Court of Appeals noted:

While Met is correct that there must have been a contract at some point in time in order for there to be a bad faith claim, Met cannot insulate itself from a bad faith claim by creating the fiction that a contract never existed by voiding or rescinding it “ab initio.” The cases Met cites do not stand for the proposition that an insurer can do what it did here–discover there is liability after eighteen months of “investigating” and rescind based upon misrepresentation evidence that was within its knowledge five days after the fire….

There are a number of lessons from this case. Insurance companies must investigate claims promptly. Second, when insurance companies deny claims, they must have a reasonable basis to do so, and a reasonable basis cannot be based on an ambiguous application with ambiguous answers which do not indicate an intent to deceive the insurance company.

Insurance Joke For The Day

What’s the difference between an actuary and an accountant?

An actuary looks at his shoes when he talks to you. An accountant looks at your shoes.
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1 Hayes v. Metropolitan Prop. & Cas. Ins. Co., No. 17-3005, 2018 WL 5852740 (8th Cir. (Neb.) Nov. 9, 2018).

Timely Paying Appraisal Award Exempted Insurer from Breach of Contract and Bad Faith Claim

Marle Laur | Property Insurance Coverage Law Blog | November 3, 2018

In the case Biasatti v. GuideOne National Ins. Co., No. 07-17-00044-CV (Tex. Ct.App. Aug. 16, 2018), Steven Biasatti and Paul Gross, d/b/a TopDog Properties, brought suit against its insurance company, GuideOne National Insurance Company for breach of contract.

TopDog Properties (“TopDog”) was insured through a commercial insurance policy issued by GuideOne National Insurance Company (“GuideOne”). The property suffered a loss as a result of wind and hail damage, and TopDog put GuideOne on notice of the loss. The insurer inspected the property and determined that the damage totaled $1,896.88. GuideOne did not issue payment to the insured since the damage was less than the $5,000.00 deductible. When GuideOne did not change its coverage determination after a second inspection, TopDog requested appraisal of the claim. GuideOne responded that under the policy, only the insurer could invoke appraisal, and it declined to do so. The insured filed suit.

Months after TopDog filed suit, GuideOne invoked appraisal. The insured resisted, and the trial court refused to compel the appraisal. On appeal, the trial court was directed to grant GuideOne’s motion to compel appraisal.

The appraisers and umpire set the amount of loss at $168,808.00. GuideOne sent TopDog a check for $146,927.30, which reflected the amount awarded less the deductible and depreciation.

TopDog then filed a motion for partial summary judgment against the insurer for breach of contract and failure to timely pay the insured’s claim. The insurer argued, in its own motion for summary judgment, that since it had promptly paid the appraisal award, the insured’s claims against GuideOne could no longer stand. The trial court ruled in favor of GuideOne’s motion. TopDog appealed.

The appellate court affirmed the trial court’s ruling, holding that since GuideOne invoked the appraisal clause following the benefits dispute, as permitted by the policy, then timely tendered the appraisal award, TopDog received the benefits it was entitled to under the policy and did not demonstrate that any policy benefits were withheld.

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