17.2 Contractor Remedies Upon Owner Default

• Library: Virginia Construction Law Deskbook (Virginia CLE) (2019 Ed.)

17.2 CONTRACTOR REMEDIES UPON OWNER DEFAULT

17.201 Common Law Rights and Remedies.

A. Right to Payment for Completed Work. When an owner breaches the contract, the contractor is generally entitled to recover its reasonable expenses, including amounts owed to subcontractors, as well as profits that would have been realized had the contractor been permitted to complete the contract according to its terms. ¹¹⁸ The contractor has the burden of proving (i) the breach by the owner; (ii) that the breach resulted in damages; and (iii) the amount of the damages. ¹¹⁹ Of course, the contractor is not entitled to recover speculative or conjectural profit, but only damages that are the direct result of the breach. The damages must be proved with reasonable certainty, though not exactness.

A contractor may also rely upon implied contractual remedies to the extent that no express written agreement exists or if, for various reasons, the contractor's performance is beyond the terms of the express agreement between the parties. In such cases, the contractor may base its claim upon quantum meruit—the value of the labor or services actually provided to the owner. ¹²⁰ A quantum meruit claim can include damages for the contractor's costs, plus overhead and a reasonable profit on the work performed. ¹²¹ Even if the contractor has failed to entirely complete the contract work, it may be able to assert substantial performance of the contract if it has achieved the essential purposes of the contract so that the owner has received the benefits of its bargain. ¹²²

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If the contractor faces claims from its subcontractors or suppliers because the owner has failed to make payment for completed work, the contractor is entitled to rely on express provisions in its contract with the subcontractors or suppliers that limit the contractor's obligation to pay only when it receives payment from the owner, or "pay when paid." If it can be shown that the language of the contract in question is clear on its face that the parties mutually intended the contract to include such a clause and therefore shift the risk of nonpayment to the subcontractor or supplier, then the clause will be enforced. ¹²³

B. Right to Stop Work. The contractor need not continue performance if the owner has materially breached the contract. ¹²⁴ Depending on the scope and duration of the breach, work stoppage alone might not afford the contractor a sufficient remedy, in which case termination of the contract may be warranted. The contractor's right to stop work for nonpayment must be determined by reviewing the contract. Many contracts require the contractor to give notice to a nonpaying party and an opportunity to cure before exercising a right of termination. Changes in the work do not usually provide the contractor with the right to stop work. Rather, the contractor is usually required to continue working, under protest, and reserve negotiation rights or the right to pursue litigation or arbitration at the conclusion of the contract. ¹²⁵ The contractor may be entitled to recover the reasonable costs of demobilization if it terminates work for nonpayment, plus loss of profits that can be proven. If the contractor is subsequently paid and returns to work, it may be entitled to recover for any delays and remobilization costs. ¹²⁶

Obviously, there are risks associated with choosing to terminate work. If a court determines that the owner's failure to make payment did not constitute a material breach of the contract, the non-performing contractor may be found in breach and liable to the owner for resulting damages. ¹²⁷

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Even if sufficient grounds exist to justify termination by the contractor, there are numerous practical objections to doing so. For example, terminating a contract might impair the contractor's bonding capacity, especially if termination causes the owner to assert a breach of contract claim. The contractor must also consider its outstanding obligations to subcontractors, laborers, and suppliers and the possibility that they will assert claims against the contractor's payment bond. Finally, termination by the contractor may affect its cash flow, especially to the extent that there are outstanding payment applications for the terminated project.

C. Stop Notice to Construction Lender.

1. Statutes Governing Stop Notices. Some states have statutes that permit a contractor to whom payment is owed for labor or materials to give notice to a construction lender advising the lender to stop disbursing funds on the loan for the project. ¹²⁸ These statutes often require the notice to contain such information as the contractor's name and address, the amount owed, the nature of the labor or materials for which amounts are owed, and the dates on which the amounts were due. Under these statutes, a lender who disburses funding under a construction loan after receiving such a notice may be liable to the contractor for the amounts of the loan disbursed after the notice is received, up to the amount owed to the contractor. ¹²⁹

Some statutes provide for interest, costs, and attorney fees as part of the claim. The contractor may also be entitled to seek more than the amount claimed as a penalty. These statutes may provide a termination date for the notice if the contractor has not initiated legal action to enforce its claim in the interim. Should the contractor otherwise receive payment, it must provide the lender notification that the stop-lending notice is revoked.

2. Draws After Stop-Lending Notice. Some statutes permit construction draws after a stop-lending notice is received if the owner of the project certifies to the lender the progress of the project to date, including the percentage of completion of the project, the identity of contractors providing labor and materials, the amount owed to each prime contractor, and the portion of draws that will be paid by the owner to the listed prime contractors. ¹³⁰ An owner failing to apply draws in the manner

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indicated in the foregoing certificate can be found criminally liable and subject to penalties. The lender must provide a copy of the owner's certificate to the claiming contractor.

3. Application to Virginia Contractors. Virginia does not have a stop-lending statute, but contractors should be mindful of whether the jurisdiction in which work is being performed does have such legislation.

D. Right to Damages. ¹³¹

1. Direct Versus Consequential Damages. The law recognizes two broad categories of damages for breach of contract: direct or "general damages" and consequential or "special damages." ¹³² Damages that arise naturally or ordinarily from a breach of contract are considered direct. Such damages, which arise in the ordinary course of human experience, are compensable. However, damages resulting from the intervention of "special circumstances" that are not ordinarily predictable are deemed consequential. Consequential damages are only recoverable if they were within the contemplation of the parties at the time of the execution of the contract. ¹³³

Determining whether damages are direct or consequential is a question of law; determining whether the parties contemplated such damages at the time of contract execution is a question of fact for resolution by the trier of fact. ¹³⁴ For example, in a case involving construction of a hospital, the owner sued the contractor to recover added financial costs incurred because of delays in construction as well as the difference in the market rate of interest between the date of delay and the time the project was finally completed. The court determined that extended financing costs were direct damages since those costs were normally encountered in delay cases. On the other hand, increases in market rates for interest on construction loans are not naturally related to the construction delays but rather from countervailing pressures within the money market. As such, they were not direct damages but consequential damages, and since they were not contemplated by the

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parties at the time of contract execution, the owner could not recover for the interest rate differentials that occurred. ¹³⁵

2. Delay Damages.

a. In General. Damages incurred by the contractor for excusable delays in completing the scheduled work are compensable, ¹³⁶ or the contractor may be entitled to an extension of time to complete the work. ¹³⁷ In fact, the contractor can even recover on the basis of an implied right to finish the work ahead of schedule. ¹³⁸ If there are multiple causes of delay and the owner is not responsible for all of them, the contractor must apportion its delay damages. The contractor must present evidence that will show with a reasonable degree of certainty the share of damages for which the owner is responsible. ¹³⁹

b. Measurement Methods. Recoverable delay damages are to be measured by the direct cost of all labor and material, plus fair and reasonable overhead expenses properly chargeable during the reasonable time required to complete performance. ¹⁴⁰ In such cases, the plaintiff must prove its damages with reasonable certainty but not with exactness. As long as "an intelligent and probable estimate" can be made, evidence of delay damages will be allowable. ¹⁴¹

c. Compensable Excusable Delay Damages. Excusable delays can be either compensable or non-compensable. Excusable delays that are non-compensable may be remedied by a time extension for completing the project. ¹⁴² The types of compensable delay damages recoverable by the contractor include (i) added equipment rental costs and the value of

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contractor-owned equipment; ¹⁴³ (ii) escalation in material costs; ¹⁴⁴ (iii) increased labor costs; ¹⁴⁵ (iv) extended insurance and bond premiums; ¹⁴⁶ and (v) extended home office overhead costs. ¹⁴⁷

d. Extended Home Office Overhead Costs.

(1) The Eichleay Formula for Measuring Costs. The standard method for measuring extended home...