Owner Defenses to Contractor Claims for Nonpayment
 

by James R. Keller

This article appeared in The St. Louis Bar Journal, p. 16-20, Fall, 2001.

I.                   Introduction

Ultimately, owners become the targets in most construction disputes over the nonpayment of money. After all, by definition and default owners control the cash flow, deciding who gets paid and when.

This article examines how owners can defend successfully in a Missouri courtroom their decision not to pay the original contract price. While emphasizing the owner's perspective, in a breach of contract case, it also points out to those pursuing payment avenues to consider when evaluating the legal merit of an owner's decision not to pay. The focus is limited to disputes between owners and contractors, and between contractors and subcontractors, but the general principles apply to others, as well.^[1]

II.                Missouri's Approved Jury Instruction

Juries more than judges decide the significant construction lawsuits and the appellate courts continue to issue dozens of decisions each year on these trials. This article relies on those cases. (Binding arbitration is beyond the scope of this article.)^[2]

Missouri has an approved jury instruction for breach of contract construction disputes.^[3] To recover, a contractor must show what the contractor and the owner agreed to do, that the contractor "substantially performed" the work in a "workmanlike manner", that the owner did not perform (which usually means did not pay), and that the contractor was thereby damaged.

An owner should concentrate on defeating one or more of these elements, for they offer an owner's best chance at success, as more fully discussed below. (Affirmative defenses are not covered.)

A.                Substantial Performance

1. Defined by case law

Missouri has several approved jury instructions in non-construction breach of contract disputes, all of which require proof of full performance to recover.^[4] By contrast, a contractor in a construction dispute only has to prove substantial performance to recover.^[5] Complete performance is not necessary. This difference obviously benefits contractors.

Owners still have hope, however, as Missouri also has a separate mandatory jury instruction defining "substantially performed" to mean "performance of all important parts of the contract with only slight variations".^[6] This instruction practically invites an owner to argue that the contractor did not perform "all important parts" and to argue that the contractor's deviations were more than slight. (To an owner, every deviation seems important.) Either argument could defeat entirely a contractor's claim for more money. Thus, proof of "substantial performance" could be do or die for a contractor.

The Missouri courts define substantial performance to be when the owner can use the building for its intended purpose.^[7] This is a fact question to be decided at trial.^[8] However, once an owner occupies the building, and begins its business operations, it is difficult to argue against substantial performance.

2. Defined by Agreement

The American Institute of Architects (AIA), the industry standard for construction contracts, defines substantial performance^[9], much like Missouri case law, as occurring when the "owner can occupy or utilize the work for its intended use"^.[10] Likewise, many non-AIA contracts define substantial performance in a similar manner.

Typically, final payment is tied to the contractor reaching substantial performance. Thus, anyone involved in a payment dispute over substantial performance should carefully consider when the owner really could use the construction project, leaving aside aggravation and a job that is less than perfect. The answer may determine if the contractor can recover at all, and if so, how much.

3. Slight Deviations

Substantial performance occurs despite contractor deviations from the contract, or imperfections in the work, provided they are "slight" or "trivial".^[11] Contractor effort is important, especially if the question of substantial performance is close. At least one court looked for a contractor's "honest endeavor to comply"^[12]. Another observed that it is "highly unusual" for a project to be in exact accordance with the plans and specifications.^[13] This means that an owner needs a real reason, a substantial complaint, to viably justify nonpayment, due to a contractor's alleged failure to achieve substantial performance.

4. Owner Damages or Offset from Payment

Defective work does not always offer the owner a complete defense, but it does provide at least a partial defense for nonpayment in full under the contract. Substantial performance entitles the contractor to recover the contract price, but only after deducting the money necessary to finish the work and to correct any defects.^[14] Thus, an owner should always look at these costs when considering its defense, with an eye toward developing enough in repair costs to completely offset or at least reduce the amount of money otherwise owed.

In rare cases, the measure of damage to repair or complete work is the diminution in value to the property.^[15] This method applies when the cost to repair or complete the project involves unreasonable economic waste. The offset or damage then is the difference between the value of the property as built and as it should have been built.

B. The Agreement

To recover, the contractor must prove to a jury the terms of the agreement between the owner and the contractor.^[16] Since the original written agreement often changes as the work progresses, it may be difficult to determine by the end of the project what the parties had agreed to do. An owner often can defend a decision to stop payment based on a dispute about the terms of the agreement, or because the contractor was not complying with them. A construction project is a moving target, a fact that at least initially allows owners latitude in refusing to pay.

1. The Jury Instruction

When appropriate, owners should require that the contractor set forth in the verdict directing instruction as much detail about the agreement as possible, particularly what the contractor agreed to do. The instruction must submit "every essential element" necessary to recovery.^[17] Jury instructions require a finding on "every contested, material issue" or there is reversible error.^[18] Because construction projects are complex and ever changing, owners should "load-up" this instruction with all important, disputed aspects of the agreement.

In one case where a subcontractor sued a contractor, it was not enough that the subcontractor had sufficient evidence at trial to support its claim of substantial performance, by showing that it supplied glass that was merchantable, of good workmanship, free from defects, and suited for the intended purpose.^[19] Nothing in the verdict directing instruction required the jury to make these findings, which the contractor contended were a critical part of the parties' modified agreement. The appellate court agreed and reversed a judgment, due to instruction error, even though there was no objection to the instruction until a motion for new trial.

In another case, the Western District Court of Appeals reversed a judgment for a contractor of $561,200 on a breach of contract claim, because the verdict directing instruction did not require the jury to decide whether the contractor had to perform extra work due to changed conditions.^[20] While the evidence at trial supported this conclusion, without an express finding by the jury, the owner could have another trial.

2. Scope of Work

All contracts, whether written or oral, should set out what the contractor is to do, and thus define the "scope of work". Detail and clarity are important, and scope of work provisions need to include the contract's general conditions, as well as the more technical drawings, plans and specifications.

A contractor who follows the owner's plans and specifications will not be responsible for defects.^[21] However, an owner certainly can defend a nonpayment claim when the contractor does not follow the contract, or deviates from the scope of work. In fact, an experienced builder has a duty to a layperson owner, given a contract provision calling for workmanlike construction, not to build pursuant to an owner's documents or "sketch" if doing so would produce "substantial defects."^[22]

The scope of work often changes, even on small projects. The accepted practice, when this occurs, is for the owner and general contractor to execute a written change order, an amendment to the original contract, outlining this new and different work, and how much money will be paid for it. Larger construction projects typically call for many formal change orders covering such topics as additional time to complete the project, redesign of the project, extra work, change in product, and the like.

Change orders can impact a contractor's costs to do the work in ways far beyond the dollar amount agreed upon in the change order. For example, if the contract time is extended by one month, the contactor may incur additional third-party and delay costs for this period, which were not included initially in the change order. An owner can defend a claim for such additional costs if the change orders to not contain a provision to later-request such costs.^[23] Many contractors fail to reserve their rights to additional money, and they regret it later.

3. Retainage
Construction contracts are unique when it comes to payment. Typically, they allow an owner to withhold a percentage, often ten percent, from the amount otherwise due with each cash payment to a contractor. This withheld amount is called "retainage". Upon substantial completion, the owner usually releases the retainage^[24]. An owner's greatest leverage is to withhold any payment, especially the retainage. Even if otherwise owed, an owner may decide to withhold payment of retainage to offset money it claims from the contractor, such as for defective work.^[25] Again, he who controls the money, at least for awhile, controls everything.

Courts will enforce a contract provision between a contractor and its subcontractor calling for payment of retainage when the owner pays the contractor.^[26] However, Missouri courts also will support an owners' decision not to release retainage without proper documentation, such as evidence of final payments to subcontractors, final mechanics' lien waivers, certificates of completion, a contractor's affidavit, invoices for labor, equipment and materials, project construction records, and an affidavit of prevailing wage compliance.^[27]

A contractor for the Kansas City Zoo lost a $454,572 judgment in 2000 because it did not properly document its claim.^[28] The Zoo, as owner, prevailed under Missouri's Prompt Payment Act because of what many would consider to be technical requirements for a contractor to provide invoices and other information.

4. Extra v. Additional Work

Quite often a contractor does work that it feels exceeds the scope of the original agreement, work requiring more time, money, materials or all three. The question becomes whether this is extra or additional work.

Extra work is work not originally contemplated by the parties. Additional work is work required to complete the contract, which arose from conditions the contractor did not initially anticipate.^[29]

An owner can defeat a claim to increase the contract price if it is additional work, while a properly documented claim for extra work, to an owner, translates into more money. The fact finder must decide which it is.^[30] The scope of work provision often breaks the tie in close calls.

5. Delay in Completion

Time is money, for the contractor and for the owner. Thus, no construction article would be complete without some consideration of a delay-in-completion claim, which often is made by both the contractor and the owner on the same project. A contractor who promises to complete the job by a date certain is bound by this promise.^[31] His "unexcused" delay entitles the owner to damages, another reason an owner can withhold payment.^[32] When no time limit is fixed, the law implies a reasonable time to perform.^[33]

There are many reasons for delay that are not a contractor's fault, but most contracts require that the contractor, regardless of the reason, notify the owner of a contractor's request for more time. Failure to do so can defeat a contractor's claim for more money. In fact, if required in the contract, written notification becomes a condition precedent to recovery by the contractor, ^[34] and thus a "technical" defense that has teeth.

C. Workmanlike

Most contracts contain a provision that the contractor perform the work in a workmanlike manner.^[35] Even if the contract is silent on this requirement, there is an implied warranty, by case law, that every contractor's and subcontractor's work must be workmanlike.^[36] Workmanlike means "work which is completed in a skillful manner and is non-defective."^[37] Bad work, at any stage, can be reason enough to stop payment, and a defense that owners should automatically consider in every case.

Proof that work was not workmanlike may require expert testimony. For example, homeowners could not recover against their contractor when a large retaining wall collapsed, as "the question of whether concrete retaining walls are constructed in accordance with sound engineering principles should be answered by expert opinion testimony".^[38] This was beyond the common knowledge of a judge or jury.

On the contrary, a trial court could decide, without expert testimony, if the plaintiff, in a workmanlike manner, filled a lagoon with dirt and then compressed it with a tractor.^[39] Such evidence does not involve interpretation of technical or engineering principles.

III.             Conclusion

This article merely scratches the surface. The casebooks offer a bounty of fertile ground for those pursuing and those defending owners over the nonpayment of money.