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Inside This Issue:

* Absent Contractual Allocation of Risk of Delay, Subcontractor Cannot Recover Delay Damages from General Contractor Who was not Responsible for their Occurrence

* Punitive Damage Award Against Insurance Company Reversed by Supreme Court as Excessive

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ARTICLE # 1
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Absent Contractual Allocation of Delay Risk, Subcontractor Cannot Recover Damages from General Contractor who was not Responsible for their Occurrence
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By: Gerald Katz, Esq.
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In In Re: Regional Building Sys., Inc. v. The Plan Comm., 320 F.3d 482 (4th Cir. 2003), a federal court held that under New York law, absent a contract term to the contrary, a subcontractor cannot recover delay damages from its general contractor when the general contractor is not responsible for the delay.

In the underlying dispute, a contractor entered into a contract with the owner of a tract of real property in Staten Island, New York to manufacture, deliver, and install modular housing units on the property. Shortly thereafter, the contractor subcontracted a portion of its work. Under the terms of the subcontract, the subcontractor was required to pick-up the contractor-built housing units from the contractor, transport the units to the project site, and then erect and complete the structures.

Several months into construction, however, the owner experienced financial difficulties and defaulted on a number of payments. Without these payments, the contractor experienced severe cash flow problems. As a result, the contractor could not meet its subcontract obligation to deliver the requisite number of housing units to the subcontractor.

The contractor suspended work under the subcontract, forcing the subcontractor to bear the expense of supporting idle labor and equipment. Almost a year and a half into the project, the owner ceased paying the contractor altogether. Finally, after the owner defaulted on two consecutive payments, the contractor suspended deliveries and thereafter terminated both its prime contract with the owner and its subcontract with the subcontractor.

The contractor then filed for bankruptcy, and the subcontractor brought claims before the bankruptcy court, seeking to recover not only payment for the work it had performed but also to recover certain other expenses, additional damages, delay damages, and interest. In the middle of the trial the contractor’s bankruptcy trustee agreed to pay the subcontractor $718,128.23, which reflected the undisputed portion of the subcontractor’s claim for work actually performed. As no agreement could be reached as to the remaining claims, however, the parties went to trial. In the end, the bankruptcy court held that the general contractor acted reasonably in suspending the work and ultimately terminating its contracts and that, while the subcontractor could recover a relatively nominal amount for its reimbursable expenses and additional damages, there would be no recovery of delay damages and interest.

The subcontractor appealed the bankruptcy court’s holding that it could not recover delay damages from the general contractor, arguing that the contractor’s financial difficulty did not excuse performance of the subcontract. The United States Court of Appeals for the Fourth Circuit disagreed, finding that under New York law, absent a contractual commitment to the contrary, a contractor cannot be held responsible for delay damages incurred by its subcontractors unless it caused or controlled the delay at issue. In short, unless there is a specific allocation of the risk of delay, a general contractor does not impliedly guarantee that its subcontractors will not be delayed by factors outside its control. Turning to the specific facts at issue, the court noted that the contractor’s suspension of work was caused by the owner’s failure to pay the contractor. As a result, the contractor was not responsible for the delays its subcontractor experienced and was not liable for the subcontractor’s delay damages.

Although the court in Regional Building Systems, Inc. applied principles of New York law, its holding reflects the general tendency of courts to leave the cost of a realized commercial risk where it lies in the absence of an express, agreed-upon allocation of that risk.
About the Author: Gerald I. Katz, Esq., KATZ & STONE, L.L.P., 8230 Leesburg Pike, Suite 600; Vienna, Virginia 22182; phone: 703.761.3000; e-mail: gkatz@katzandstone.com

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ARTICLE # 2
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Punitive Damage Award Against Insurance Company Reversed by Supreme Court as Excessive

When State Farm Insurance refused a proposed settlement for the amount of its policy limit for a law suit arising out of an automobile accident, the matter went to trial and a jury returned a verdict against State Farm’s insured in the amount of three times the policy limit. State Farm paid the entire judgment but the Insured (Mr. and Ms. Campbell) then sued the insurance company for bad faith, fraud, and intentional infliction of emotional distress. A jury in that trial awarded the Campbells compensatory damages of $2.6 million and punitive damages of $145 million.

The compensatory damages were eventually reduced by the state courts to $1 million but the $145 million punitive damages survived the appeals through the state courts. On appeal to the Supreme Court, State Farm argued that the punitive damage award was excessive and violated the Due Process Clause of the Fourteenth Amendment. The Supreme Court agreed and reversed the judgment, holding that under the circumstances of this case, it was more likely that the punitive damages that could be justified would be “at or near the compensatory damages amount.”

The explanation by the Court is instructive. The court relied principally upon guide posts for reviewing punitive damages that it had established in the recent case of BMW of North America, Inc. v. Gore, 517 U.S. 559. “It should be presumed that a plaintiff has been made whole by compensatory damages, so punitive damages should be awarded only if the defendant’s culpability is so reprehensible to warrant the imposition of further sanctions to achieve punishment or deterrence.” The Supreme Court stated, “In this case, State Farm’s handling of the claims against the Campbell’s merits no praise, but a more modest punishment could have satisfied the State’s legitimate objectives.” Instead the trial was used improperly as a platform to expose, and punish, the perceived deficiencies of State Farm’s operations throughout the country. This resulted in the Utah courts awarding punitive damages to punish and deter conduct that bore no relation to the Campbell’s harm.

The second guidepost considered by the court was the disparity between the actual harm suffered by the plaintiff and the punitive damages award. The Court stated that few awards exceeding a single-digit ratio between punitive and compensatory damages will satisfy due process. “Single-digit multipliers are more likely to comport with due process,” said the Court. In this case, the Court found a presumption against an award with a 145 to 1 ratio. Applying The Gore case guideposts, the Court concluded that in light of the substantial compensatory damages award, it was likely that only punitive damages in about the same amount as the compensatory damages could be justified. State Farm Mutual Automobile Insurance Co. v. Campbell, (No. 01-1289, April 7, 2003).

Comment by Kent Holland:

The question of who gets to decide whether to settle a case has been a matter of concern for design professionals under their professional liability policies, and it has been a matter of concern for contractors under their various liability policies. Language from a typical professional liability policy states: “If YOU refuse to consent to any settlement or compromise recommended by US involving any part of OUR limits of liability and acceptable ot the claimant, and YOU elect to contest the CLAIM, suit or proceeding, then OUR liability shall not exceed the amount which WE would have paid for DAMAGES and CLAIM EXPENSES at the time the CLAIM or suit or proceeding could have been settled or compromised.”

What is interesting is that professional liability carriers sometimes find themselves in the situation where they believe it is appropriate to settle a case but their insured design professional feels strongly that they did nothing wrong, and they don’t want to settle for fear that this will be a black mark against them. This policy language is sometimes called a “hammer clause” and it says in essence to the insured design professional, “OK, you can exercise a right under the policy to refuse to settle the matter, but if the amount that is awarded at trial is greater than what we could have settled the case for, you (the design professional) will be responsible for the excess amount, and we (the insurance company) will pay only that part of the judgment that is within the amount for which the case could have been settled with the plaintiff.

The flip side of the settlement decision is what happened in the State Farm case. In the event that the carrier refuses to settle for an amount proposed by a plaintiff within the policy limit, as was apparently the situation in the underlying automobile claim that gave rise to the State Farm case, the carrier may be on the hook for the full judgment, including that part which exceeds the policy limit. But there is still the question of additional hardship, time, costs, and emotional distress incurred by the Insured as a result of the insurance company’s refusal to settle the case when it could have been settled. In an effort to encourage the carrier to settle (and for the purpose of laying a foundation for an en eventual bad faith claim against the carrier), the insured’s attorney will often write to the carrier at the time that the carrier is refusing to settle the underlying case. That letter will typically state that the Insured desires to settle the matter for the amount proposed by the plaintiff and that the insurance company’s failure to do so is deemed by the insured to be bad faith and is subjecting the insured to damages such as those claimed by the plaintiff in the State Farm case. This may be considered by the court in determining whether the insurance company acted in bad faith, with intentional disregard of the best interests of its Insured under the policy.

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ABOUT THIS NEWSLETTER & A DISCLAIMER

This newsletter Report is published and edited by J. Kent Holland, Jr., J.D., a construction lawyer and risk management consultant for environmental and design professional liability.  The Report is independent of any insurance company, law firm, or other entity, and is distributed with the understanding that ConstructionRisk.com, LLC, and the editor and writers, are not hereby engaged in rendering legal services or the practice of law.  Further, the content and comments in this newsletter are provided for educational purposes and for general distribution only, and cannot apply to any single set of specific circumstances. If you have a legal issue to which you believe this newsletter relates, we urge you to consult your own legal counsel. ConstructionRisk.com, LLC, and its writers and editors, expressly disclaim any responsibility for damages arising from the use, application, or reliance upon the information contained herein.

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