Choice Deprives Public Entity Of Attorneys’ Fees On Stop Notice

Jeffrey A. Sykes – March 23, 2012

The California Court of Appeal clarified the law on a public entity’s right to recover attorneys’ fees in connection with its withholding of funds from a general contractor because of a stop notice filed by a subcontractor. In doing so, the Court of Appeal compared the Civil Code provisions regarding public and private works of improvement and addressed the statutory options available to a public owner. There are two ways for the public entity to proceed in response to a subcontractor stop notice. Depending on the choice made, a public entity may, or may not, have a right to recover attorneys’ fees. If the recovery of attorneys’ fees is sought, the choice should be carefully made.

In Tri-State, Inc. v. Long Beach Community College District, No. B231848, 2012 WL 764416, (Cal. Ct. App. Mar. 12, 2012) the public entity did not choose carefully. As a result, the Second Appellate District reversed a trial court’s award of attorneys’ fees to the public entity. The public entity withheld funds from the general contractor because a subcontractor filed a stop notice. The public entity agreed to accept a stop notice release bond from the general contractor in exchange for the subcontractor dismissing its action to enforce the stop notice. The parties stipulated to this and the court entered an order on the stipulation. In the words of the Court of Appeal, because the public entity made no claim on the funds, it was “merely a disinterested stakeholder in an action to enforce a stop notice, acting as a custodian of the disputed funds.”

The public entity then moved for an award of attorneys’ fees under Civil Code Section 3186. The judgment entered on the stipulated order included an award of attorneys’ fees to the public entity. The subcontractor appealed the award of attorneys’ fees, contending that Civil Code Section 3186 does not authorize the award of attorneys’ fees. The Court of Appeal agreed, distinguishing Civil Code Section 3186, regarding stop notices on public works projects, and Civil Code Sections 3161, 3162 and 3176, regarding stop notices on private works of improvement.

Jeffrey A. Sykes – March 23, 2012

Civil Code Section 3186, regarding stop notices on public works projects, requires a public owner to withhold an amount “sufficient to answer the claim stated in the stop notice and to provide for the public entity’s reasonable cost of any litigation thereunder.” Examining the legislative history of Section 3186, the Court of Appeal in Tri-State, Inc. concluded that the “reasonable cost of any litigation” was limited to the cost of verifying and recording the stop notice, exclusive of attorneys’ fees. In contrast, the Court of Appeal observed that Civil Code Section 3176, regarding stop notices on private works of improvement, expressly entitles the prevailing party in an action against an owner or construction lender on a bonded stop notice to recover attorneys’ fees.

Had the public owner chosen carefully, it would have pursued an interpleader action by which a stakeholder with no interest in disputed funds may deposit them with the court, obtain a discharge of liability and compel the competing claimants to litigate their claims without involving the stakeholder. The Court of Appeal in Tri-State, Inc. recognized that Code of Civil Procedure Section 386.6 provides for the award of attorneys’ fees to the interpleading party.

Subcontractors Take Note – Appellate Division Confirms that Construction Lender has no Duty to Subcontractor Absent Express Promise to Pay – Lexology

Peter James Herrigel – March 21, 2012

The New Jersey Appellate Division recently ruled in Vollers Excavating and Construction, Inc. v. Citizens Bank of Pennsylvania, Docket No. A-3844-10T1 (March 5, 2012), that a construction lender has no obligation to pay an unpaid subcontractor on a project when the general contractor files for bankruptcy protection.  In Vollers, Vollers was a subcontractor to Opus East LLC (“Opus East”), the general contractor on a project known as Mercer Corporate Center (the “Project”).  Opus East was the sole shareholder of Mercer Corporate Center, LLC (“MCC”), the owner of the Project.  In 2007, MCC entered into a construction loan agreement with Citizens Bank of Pennsylvania (“Citizens”) for $23.3 million to finance the Project.  Also in 2007, Vollers entered into a subcontract agreement with Opus East for excavation, grading and other related services for the Project for approximately $3.3 million.  Vollers had no agreement with Citizens.

Construction on the Project commenced and, in the fall of 2008, Opus East began to experience cost overruns, which were jeopardizing the Project’s viability.  In May 2009, Opus East warned Vollers that Opus East and MCC may discontinue paying subcontractors.  In June 2009, Vollers filed a construction lien against the Project for $505,754.32.  In July 2009, Opus East and MCC filed bankruptcy petitions for relief under Chapter 7.

With Opus East and MCC both in bankruptcy, Vollers attempted to collect directly from Citizens.  The trial court granted summary judgment to Citizens and dismissed the matter with prejudice.  The trial court concluded that Vollers’ contract was with Opus East (the general contractor), not with Citizens, and there was no evidence that Citizens knew that Opus East and MCC were in default and going into bankruptcy, but wanted Vollers to continue working without pay.   The trial court found no evidence that Citizens had a duty to pay Vollers for services that were rendered to Opus East and/or the Project.

The Appellate Division affirmed substantially for the reasons expressed in the trial court’s oral opinion.  The Appellate Division did expressly note that a lender providing a construction loan owes no duty to an unpaid subcontractor absent the lender’s express promise or assurance of payment.  Here, Vollers had no communications with Citizens, there was no evidence that Citizens made an express promise or assurance to pay Vollers and Citizens did not direct Vollers to continue working on the Project.

The Appellate Division made clear that Vollers was not a party to any of the loan documents between Citizens and MCC and had no rights thereunder.  There was no privity of contract nor any evidence that Vollers was an intended third-party beneficiary of the agreement between MCC and Citizens.  As a result, Citizens had no obligation to pay Vollers pursuant to Vollers’ contract with Opus East, and Vollers was unable to collect from Citizens.

The Vollers case makes clear that subcontractors have no rights to collect against the construction lender in the event the general contractor or owner files for bankruptcy or otherwise leaves the project, absent some express promise by the lender to pay for the subcontractors’ work on the project. Absent that express undertaking, the subcontractor is limited to the general contractor (or others in privity, if any), owner (through its construction lien rights) and possibly a surety under a payment bond, if applicable, for recovery for its work at a project.  This is important because the subcontractor’s construction lien rights may be of no benefit if the construction lender forecloses on the Project property based on a defaulted construction loan.

via Subcontractors take note – Appellate Division confirms that construction lender has no duty to subcontractor absent express promise to pay – Lexology.

Insurance Claims and Bad Faith Law Blog: Bad Faith Attorney’s Fees Awarded for Dishonoring Florida Mediation Agreement.

The Florida Appellate Court upheld the imposition of Attorney’s Fees as sanctions for failure to keep an agreement made by a party at Mediation in this case, under a doctrine that Attorney’s Fees can be imposed as sanctions where a Court can determine that a party has engaged in “inequitable conduct”.  As described in the Appellate Court’s opinion, the inequitable conduct doctrine permits the assessment of Attorney’s Fees where one party has engaged in “‘egregious conduct or acted in bad faith.’”  Id. at *1.

Alternative Dispute Resolution: Providing New Solutions to Burdens of Dealing With Electronic Discovery in Construction Disputes

Gregory R. “Greg” Meeder

From bidding to design to construction management, the use of computer-driven technology and tools have exploded in the construction industry. Historically, construction disputes have always been document intensive because they involve multiple parties, facts developing over one or more construction seasons and thousands of documents spread amongst developers, architects, engineers, general contractors, subcontractors and suppliers. Construction firms are now turning to tablet devices and related applications to develop and manage construction projects. See Erin Joyce, Make Way for App Builders, Engineering News-Record, Dec. 5, 2011, at 30. Rapid communication among remote industry segments now takes place over PDA devices and web conferences rather than in person. See Luke Abaffy, Millennials Bring New Attitudes, Engineering News-Record, Feb. 28, 2011, at 22. Advanced design modeling systems, such as building information modeling, is now widely used to identify construction challenges before the project hits the ground. See The Case for Investing in 3-D Modeling, Illuminations, Fall 2011. All of these technological advances, which lead to stored electronic media, create a vast amount of electronically stored information (ESI) that may be discoverable during dispute resolution – whether in court or arbitration.

Most parties about to embark on litigation are not entirely aware of nor are they equipped with the personnel to manage the expanse of ESI that may be related to the underlying dispute. If the parties choose to litigate their dispute in court, it may be necessary to hire an outside consultant to locate, gather, store and produce the ESI in order to comply with the Federal Rules of Civil Procedure (FRCP) or, alternately, state rules of civil procedure. The parties must also engage attorneys to conduct a lengthy and costly privilege review of all ESI to ensure that attorney-client and work product privileges are not waived during production. Although “claw back” agreements, which require parties to return privileged information produced through inadvertent disclosure may alleviate the fear of waiver, it is imperative, nonetheless, that all material be reviewed to avoid providing an opposing party with even a glimpse of protected information. Furthermore, depending on the format of the ESI produced by the opposing party, a party may incur further expenses to convert the ESI into a useable format so that it can be reviewed by attorneys and parties.

This alert discusses the current ESI law, the impending ESI crisis in arbitration, and how resolving claims through alternative dispute resolution helps to corral the burdens of ESI discovery by managing ESI with specific agreements, guidelines and rules.

ESI Standards Under Rules of Civil Procedure

FRCP and most state rules of civil procedure allow for the discovery of ESI that is “reasonably accessible” to the parties. See FRCP 26(a)(1)(A)(ii); FRCP 26(b)(2)(B). Litigants are therefore required to produce all relevant, non-privileged ESI pursuant to a discovery request. See FRCP 34. Moreover, to avoid destruction of potential evidence, litigants must preserve ESI when they have notice that ESI is relevant to litigation or may be relevant to potential future litigation. See, e.g., Zubulake v. UBS Warburg, LLC, 220 F.R.D. 212, 216 (S.D.N.Y. 2003). Therefore, given the time and effort it may take to locate, preserve and produce all discoverable ESI, parties may ask the court to limit the scope of discoverable ESI through a showing of undue burden or cost.

Notably, failure to produce all discoverable ESI could result in sanctions ranging from attorneys’ fees and costs to adverse inference jury instructions or a default judgment. See FRCP 37; U.S. v. Philip Morris USA, Inc. 327 F. Supp.2d 21 (D.D.C. 2004) (fining defendant $2.5 million for destroying potentially discoverable emails two years after the entry of a preservation order and barred from presenting witnesses at trial who had failed to retain and preserve relevant records); Danis v. USN Commc’ns, 2000 WL 1694325, 53 Fed.R.Serv.3d 828 (N.D. Ill. Oct. 20, 2000)(levying personal fine against the defendant’s CEO for failure to take reasonable steps to preserve data at the outset of discovery); Metro. Opera Ass’n, Inc. v. Local 100 Hotel Emps. & Rest. Emps. Int’l Union, 212 F.R.D. 178 (S.D.N.Y. 2003), motion for reconsideration denied, 2004 WL 1923760 (S.D.N.Y. Aug. 27, 2004) (entering default judgment against the defendant when it failed to implement a systematic procedure for the retention of documents, knowing that the client had no document retention plan in place and delegated the document production tasks to a lay person who lacked an understanding of how broadly the term “document” was defined by the document request).

Alternative Dispute Resolution Tribunals Provide Guidelines and Rules to Answer the ESI Crisis Has Impacted Disputes in Arbitration

Alternative dispute resolution proceedings (ADR), such as arbitration and mediation, have become popular forums in which to resolve construction disputes because ADR is considered less expensive, faster, and more efficient than court litigation. In recent years, however, ADR – specifically arbitration – has been criticized as becoming no different than court litigation due greatly in part to extensive and costly discovery. See ADR Systems of America LLC, Commercial Arbitration Rules at 3 (Aug. 30, 2011). Much of the escalated expense associated with discovery is attributable to the growing use, management and discoverability of ESI. ESI is generally considered email, web pages, word processing files, databases, codes and algorithms, metadata, computer programs, or any other kind of data that can be stored on a computer, blackberry or other PDA.

The three main ADR tribunals, ADR Systems of America LLC (ADR Systems), JAMS, and the American Arbitration Association (AAA), have therefore developed electronic discovery guidelines and rules to assist the parties, advocates and neutrals to deal with requests for electronic discovery, while also maintaining the goals and processes associated with arbitration.

ADR Systems Commercial Arbitration Rules

On August 30, 2011, ADR Systems issued revised commercial arbitration rules to “implement many of the ideas advocated by business and academic commentators to reverse” the trend of arbitration “becoming almost indistinguishable from court litigation.” ADR Systems of America LLC, Commercial Arbitration Rules at 3. These revised rules contain defined limits on the disclosure of ESI during arbitrations. Included in the rules are provisions defining the various types of ESI and related data, as well as “modes” by which parties may agree to disclose ESI. See ADR Systems of America LLC, Commercial Arbitration Rules, Rule 8.4.

JAMS Comprehensive Arbitration Rules and Procedure

Recognizing that ESI “has substantially increased the volume of available document discovery” and “has also substantially increased the cost of the discovery process,” JAMS released the “Recommended Arbitration Discovery Protocol for Domestic, Commercial Cases” on January 6, 2010. In that document, JAMS recommended that the arbitrator issue “an early order” containing language expressly limiting the scope of electronic discovery permitted in the arbitration. Additionally, JAMS provides expedited arbitration procedures that may be incorporated into the parties’ agreement to arbitrate or requested in the claimant’s post-dispute demand for arbitration. The expedited procedures, found at Rule 16.2, provide specific limits on the discovery of ESI.

AAA Arbitration Rules

Neither the AAA Commercial Arbitration Rules nor the AAA Construction Industry Arbitration Rules contain specific procedures regarding discovery of ESI. However, the AAA Rules provide the parties and the arbitrator with the ability to manage discovery to best suit the needs of the specific matter. Furthermore, the AAA’s International Centre for Dispute Resolution (IDCR) developed “ICDR Guidelines for Arbitrators Concerning Exchanges of Information” that can be adopted by parties to other AAA arbitrations by agreement.


It is advantageous to establish ADR agreements before there is a controversy. Limiting the scope of electronic discovery through arbitration agreements, and the rules and guidelines provided by the various ADR tribunals, fosters the following:

  • lower cost dispute resolution
  • decreased burdens in providing ESI during discovery
  • comprehensive and focused discovery results
  • efficient use of a parties’ time
  • less barriers to document review
  • ESI produced in a useable format
  • quicker resolution of disputes
  • avoiding costs that surpass the goals and value of the dispute
  • simplifying the steps to help keep ESI confidential

Pursuing a claim through ADR with well defined limits on the scope of ESI enables parties, attorneys and neutrals to better manage the exchange of information during arbitration, and reach a resolution in a more efficient and less costly manner.

New Jersey’s Bad Faith Bill Remains Pending in Senate

March 12, 2012

On January 20, 2012, the New Jersey Senate introduced S766, which provides a cause of action for bad faith – an insurance carrier’s breach of the covenant of good faith and fair dealing – in the investigation, evaluation, processing, payment or settlement of insurance claims.  The bill is intended to codify certain common law rights and to ensure that this new cause of action is decided before a judge without a jury.  The bill remains pending in the Senate Commerce Committee.

New Jersey common law on bad faith is shaped almost entirely by two New Jersey Supreme Court rulings.  In Rova Farms Resort, Inc. v. Investors Ins. Co. of Am., 65 N.J. 474 (1974), the Supreme Court held that a carrier owes its insured an “inherent fiduciary obligation,” and it “can justly serve its interests and those of its insured only by treating the claim as if it alone might be liable for any verdict which may be recovered.”  Id. at 492-493.  Applying this logic, the Court ruled that when an insurer controls the defense and refuses to settle within policy limits, the carrier has breached the covenant of good faith and fair dealing and, therefore, is responsible for paying the full judgment even if that judgment is in excess of the policy limits.  Id. at 496.

Nearly twenty years later, the Supreme Court expanded the factual bases of bad faith set forth in Rova Farms in its opinion in Pickett v. Lloyd’s, 131 N.J. 457 (1993), holding that bad faith claims are not limited to third-party policies but extend to first-party policies as well.  It further found that an insurer is liable for bad faith where it denies or delays paying a claim when aware of an absence of a reasonable basis to deny or delay processing the claim or where the insurer shows a reckless indifference to facts or to proofs submitted by the insured.  Id. at 473, 481.  The Court established the level of proof necessary to maintain this cause of action, adopting the “fairly debatable” standard by which the plaintiff must show that the bad faith could be determined on summary judgment as a matter of law.  Id. at 473.

Against this backdrop, the legislature introduced S766.  The bill has two stated goals: (1) to codify existing case law recognizing a cause of action for bad faith in the processing and denial of first- and third-party claims by insurance carriers; and (2) to reverse the recent Supreme Court ruling in Wood v. New Jersey Manufacturers Ins. Co., Docket A 44 066643, June 14, 2011, (2011 N.J. Lexis 679), where the Court held that a bad faith claim for failure to settle a claim within limits gave rise to the right to a jury trial.

In its current iteration, with the obvious exception of the right to a jury, the proposed legislation preserves much of the common law.  The essence of Rova Farms is captured in the bill where it provides, in pertinent part, that the cause of action for the breach of the duty of good faith and fair dealing includes “the insurer’s failure to attempt in good faith to effectuate a prompt, fair and equitable settlement of a claim in which [the insured’s] liability becomes clear.”  The inclusion in this proposed legislation of first-party claims is clear in the definitions and the accompanying statement.  That the legislature also intended to incorporate aspects of Pickett is also evident.  The bill, in its current form, unambiguously includes acts of bad faith connected to processing of a claim (“investigation, evaluation, processing, payment”) as well as the settlement issue set forth in Rova Farms.  What is somewhat less clear is the applicable standard of proof.  The bill simply states that an insurer that “acts[s] unreasonably” in the processing of a claim settlement or without a “reasonable basis in denying the coverage” will have committed bad faith.  Whether that translates to the “fairly debatable” standard articulated by the Supreme Court in Pickett or to standards set forth in other New Jersey statutes and regulations will undoubtedly be the subject of future court rulings if the legislation is passed.  See N.J.S.A. 17:29(B)-4(9) et seq. and N.J.S.A. 17B:30-13.1 et seq. (and associated regulations at N.J.A.C. 11:2-17.1 et seq.) which prohibit insurers from engaging in unfair claims settlement practices.

The bill also provides for the recovery of attorneys’ fees.  What is not as clear is how this provision interacts, if at all, withN.J. Court Rule 4:42-9(6) which allows, at the discretion of the Court, for the recovery of attorneys’ fees for successful claimants in actions involving liability and indemnity policies.  The proposed legislation does provide, however, that a claimant that meets the established burdens of proof shall be entitled to “the full amount of damages as determined by the judge, regardless of the coverage limits of the policy.”  Whether that provision is sufficient to cover all attorneys’ fees, as well as other damages incurred by the policyholder, remains to be seen.  The proposed legislation also provides, consistent with the Pickett ruling, that punitive damages are available but only “by clear and convincing evidence” of “actual malice or wanton and willful disregard of any person who foreseeably might be harmed by the insurer’s acts or omissions.”

Even if this legislation does not pass, it still is instructive to the policyholder tendering a claim to its insurer.  The term “tendering a claim” is merely putting the insurer on notice of the circumstances that give rise to coverage and requesting that the insurer provide coverage.  However, given the applicable case law and the proposed legislation, it is in the policyholder’s interest to gather as much factual information as possible, including documentary evidence, of the circumstances giving rise to the claim and to forward that information to the carrier as soon as possible.  It is also important for the policyholder to keep all policy information, particularly when dealing with older occurrence-based policies, so factual issues over the extent of policy coverage will not give carriers a reason to delay.  Additionally, it is important for policyholders to comply with insurers’ inevitable requests for information to the extent possible.  Finally, policyholders should keep good records of all interactions with carriers following tendering of a claim so that, if necessary, proofs for a bad faith claim will be available to it.