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).

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.

Does Arbitration Apply to Contemporaneously Executed Contracts (When One of the Contracts does Not Have an Arbitration Provision)?

David Adelstein | Florida Construction Legal Updates | January 6, 2018

Binding arbitration is an alternative to litigation.  Instead of having your dispute decided by a judge and/or jury, it is decided by an arbitrator through an arbitration process.  Arbitration, however, is a creature of contract, meaning there needs to be a contractual arbitration provision requiring the parties to arbitrate, and not litigate, their dispute.  Just like litigation, there are pros and cons to the arbitration process, oftentimes dictated by the specific facts and legal issues in the case.

 

What happens when a person executes two (or more) contemporaneous contracts, one with an arbitration provision and one without?  Are the parties required to arbitrate the dispute arising out of the contract that does not contain the arbitration provision?

 

The reality is that this has become an unnecessary over-complicated situation that should be avoided by specifically incorporating all of the contracts into an operative contract or, conversely, expressing the intent in each contract whether arbitration applies.  Being specific will avoid the over-compilation of this issue.

 

In an example of what really amounts to an over-complicated opinion regarding an arbitration provision, the case of Lowe v. Nissan of Brandon, Inc., 43 Fla. L. Weekly D103b (Fla. 2d DCA 2017) dealt with a consumer automobile transaction where a consumer challenged the sale price of an automobile.  The consumer purchased a car and signed three contemporaneous contracts: a purchase agreement, an installment sale contract (i.e., the purchase was subject to the condition that the installment contract would be accepted by a financing institution), and an arbitration agreement.  The purchase agreement incorporated the arbitration agreement.   The arbitration agreement incorporated the installment contract.  The installment contract (quite confusingly, in my opinion), however, did not incorporate the arbitration agreement or the purchase contract.

 

The consumer claimed that because the installment contract did NOT incorporate the arbitration agreement, arbitration did not apply to disputes involving the installment contract.  Notwithstanding, the trial court compelled arbitration. The appellate court affirmed.

 

The general contract principle regarding construing contemporaneously executed documents together has been reiterated in many casesSee, e.g.Dodge City, 693 So. 2d at 1035; Phoenix Motor Co., 144 So. 3d at 696 (quoting Collins, 641 So. 2d at 459). “But if the parties execute ‘two separate contracts and only one contract contains an arbitration clause, the parties cannot be compelled to arbitrate disputes arising from the contract that does not call for arbitration.’ ” Phoenix Motor Co., 144 So. 3d at 696 (quoting Lee v. All Fla. Constr. Co., 662 So. 2d 365, 366 (Fla. 3d DCA 1995)). The exception is where the contract with the arbitration clause incorporates by reference the contract which does not contain an arbitration clause, such that the latter could be “interpreted as part of the [former] contract.” Id. at 697 (citing Affinity Internet, Inc. v. Consol. Credit Counseling Servs., Inc., 920 So. 2d 1286, 1288-89 (Fla. 4th DCA 2006)).

To incorporate by reference a collateral document, the incorporating document must (1) specifically provide “ ‘that it is subject to the incorporated [collateral] document’ ” and (2) the collateral document to be incorporated must be “ ‘sufficiently described or referred to in the incorporating agreement’ ” so that the intent of the parties may be ascertained. Kantner v. Boutin, 624 So. 2d 779, 781 (Fla. 4th DCA 1993) (quoting Hurwitz v. C.G.J. Corp., 168 So. 2d 84, 87 (Fla. 3d DCA 1964)). The [s]upreme [c]ourt set forth the second requirement for incorporation by reference in OBS Co. v. Pace Construction Corp., 558 So. 2d 404, 406 (Fla. 1990): “It is a generally accepted rule of contract law that, where a writing expressly refers to and sufficiently describes another document, that other document, or so much of it as is referred to, is to be interpreted as part of the writing.”

Lowe, supra.

 

Here, there was no dispute regarding the contemporaneous execution of the contracts.  The appellate court found that while the installment contract did not incorporate the arbitration provision, this contract was a condition precedent to the purchase agreement.  Thus, once the installment contract was accepted by a financing institution, the purchase agreement with the arbitration provision became the operative contract without any conditions precedent. (The case actually has a more complicated legal analysis to affirm the trial court’s ruling that the parties should be compelled to arbitration).

 

In my opinion, this is nothing more than a basis to compel the parties to arbitrate when the installment contract that was sued upon did not contain an arbitration provision or incorporate the arbitration agreement or purchase agreement.  All of this could have been avoided had specificity occurred in the installment contract or had the purchase agreement specifically incorporated the installment contract.  But, if arbitration is a creature of contract, and the dealership prepared (which it did) the contracts it wanted the consumer to contemporaneously execute, compelling the parties to arbitrate based on what is perceived to be the “operative contract” seems to go against the grain that parties cannot be compelled to arbitrate disputes arising from a contract that does not contain an arbitration provision.