102 Substantial Performance

• Jurisdiction: Arizona

(a) Introduction

The courts have used five concepts to determine how much, if any, compensation a contractor is entitled to receive where there is less than complete performance.

Litigation involving contractors frequently arises where the contractor has performed some, but not all, of the work under a contract with the owner. The contractor seeks to be paid the contract price or some portion of it. The owner normally responds that the contractor has not fully performed the work required under the contract and, therefore, denies that the contractor is entitled to payment.

The Arizona courts have relied on one or more of the following theories to determine how much, if any, compensation the contractor is entitled to:

1. Covenant preferred to condition;

2. Waiver of express condition;

3. Severability;

4. Failure to render substantial performance; and

5. Nonmaterial breach.

(b) Covenants Preferred to Conditions

Where the work is attached to the land of the buyer and cannot be returned, and the buyer has derived benefit from it, the courts will generally treat the nonperformed portion as a promise. Nonperformance of a promise gives rise to damages but does not totally defeat the right to payment. In such a case, the contractor is entitled to a partial payment.

Under generally accepted principles of contract law, a contractor who fails to perform a condition is not entitled to performance (i.e., payment) by the owner. On the other hand, if the contractor fails to perform a promise (also referred to as a covenant), the contractor nevertheless is entitled to the owner’s performance; the owner, however, must be compensated for damages resulting from the breach of the covenant. In the latter case, there is usually a reduction in the contract price to reflect the reduced value resulting from the breach.

Since failure to satisfy a condition would prevent the contractor from recovering for work that it did perform under the contract, the courts generally prefer to treat contractual obligations as covenants rather than conditions. This is particularly true where a benefit has been conferred on the owner.

A classic textbook case in this area is Jacob & Youngs, Inc. v. Kent, 230 N.Y. 239, 129 N.E. 889 (1921), which involved a contract to construct a country residence. The contract required pipe to be purchased from a specified manufacturer. After the work had been completed, it was discovered that, through an oversight of one of the subcontractors, some of the pipe used was purchased from a different manufacturer. The owner demanded that the nonconforming pipe be replaced and withheld payment of the balance of the contract price.

Replacement of the nonconforming pipe would have required substantial demolition and reconstruction of the residence. There was no evidence that the nonconforming pipe was inferior in quality to the pipe specified in the contract. Justice Cardozo, who authored the majority opinion of the court, discussed the distinction between covenants and conditions (sometimes referring to covenants as “dependent promises”) and stated:

There will be harshness sometimes and oppression in the implication of a condition when the thing upon which labor has been expended is incapable of surrender because united to the land, and equity and reason in the implication of a like condition when the subject matter, if defective, is in shape to be returned. From the conclusion that promises may not be treated as dependent to the extent of their uttermost minutiae without a sacrifice of justice, the progress is a short one to the conclusion that they may not be so treated without a perversion of intention. . . . There will be no assumption of a purpose to visit venial faults with oppressive retribution.

Id. at 890-91.

The court held that the failure to use the specified pipe was the breach of a covenant rather than a condition. The owner was not excused from paying for the work, but the payment could be reduced to reflect any reduction in value because of the use of the nonspecified pipe.

In Cracchiolo v. Carlucci, 62 Ariz. 284, 157 P.2d 352 (1945), the Arizona Supreme Court adopted Justice Cardozo’s rationale. The contractor in the case completed a motel, except for a difficult repaving of a driveway. The contractor demanded payment of the balance of the contract price minus the cost of repaving. The owner withheld payment, contending that performance of the repaving was a condition to the contractor’s right to collect the contract balance. In affirming judgment for the contractor, the court stated:

Where a contract has been partly performed by one party and the other has derived a substantial benefit therefrom, the latter cannot refuse to comply with its terms simply because the former fails to complete performance. Where there has been part performance and there is a breach of a promise which goes to only a part of the consideration and the breach may be compensated for in damages, the breach does not relieve the other party from his obligation to perform his promise.

Id. at 292 (citations omitted).

This principle was followed in Caldwell v. Tilford, 90 Ariz. 202, 367 P.2d 239 (1961). Here, work was to be performed by the seller on certain real property prior to close of escrow. The buyer attempted to rescind the contract for the seller’s failure to install a gas meter. The court held that such a breach was insufficient to justify a rescission and required the buyer to close escrow.

However, a condition rather than a covenant was found in American Continental Life Ins. Co. v. Ranier Constr. Co., 125 Ariz. 53, 607 P.2d 372 (1980), which imposed a major forfeiture.

The contractor was paid $457,000 on a $517,000 contract, but was not paid retention. The jury returned a verdict for the contractor in the amount of $130,000. It returned a separate verdict for the owner in the amount of $10,000, apparently to deal with items not completed or needing correction.

The supreme court reversed the verdict and ordered entry of judgment in favor of the owner. The contractor had not applied for or obtained a certificate for payment from the architect as required under the contract.

The contract provided for the issuance of a certificate of substantial completion, at which time the owner took possession of the building. The architect would then issue a punch list that had to be performed for final completion. Upon completion of the punch list, the contractor would obtain from the architect a certificate for payment, and retention would then be paid.

The owner disagreed with the architect’s punch list, requiring more items to be completed. The architect sided with the contractor on the question of additional punch list items. The contractor demanded payment from the owner, which was refused. The contractor then sued, without applying for or obtaining a certificate for payment from the architect.

The supreme court treated applying for and obtaining the certificate for payment as a condition precedent to obtaining payment of the retention, regardless of any resulting benefits the owner might have received for which the contractor was not compensated.

The dissent contains an interesting discussion of the doctrine that strict performance is not a condition precedent to payment. Substantial performance should support a recovery either on the contract or on a quantum meruit basis. It is noted that American courts generally have departed from the common-law rule requiring literal performance of building contracts in favor of permitting recovery where there has been substantial performance.

Authority is quoted citing three reasons for the rule. First, materials and labor upon a building are such that even if rejected by the owner of the land, the owner receives benefit. It is therefore equitable to require the owner to pay for...