It is a given in the construction industry: owners and general contractors have superior bargaining positions when compared to subcontractors. This is justified by the fact owners generally fund projects and assume the risk a project may be, in one or more facets, unsuccessful. Likewise, general contractors typically assume a significant share of responsibility for the timely and efficient completion of a project. Of course, owners and general contractors stand to reap the greatest profits when a project succeeds. Because subcontractors typically compete for a limited number of jobs and submit competitive bids for the “privilege” of being awarded a subcontract, they usually have little or no leverage to exercise when negotiating subcontract terms. They either are told or intuit the message accompanying a subcontract is, “If you do not sign our subcontract as is, we will award this job to the next highest bidder, and you will lose out on the work.”
The parties’ unequal bargaining positions virtually always results in subcontracts, which may substantially benefit the owner and/or general contractor at the expense of the subcontractor. Depending on the size of the project, the value of the subcontract, and the sophistication of the owner or general contractor, subcontractors are compelled to agree to onerous terms. Such terms can include a strict project schedule, naming owners and general contractors as additional insureds under their liability insurance policies, indemnifying owners and general contractors for any liability arising out of their work, and immediately contributing to the defense of the owner or general contractor upon commencement of a claim. When subcontractors make legal inroads and chip away at the power and control of owners and general contractors, it is worthwhile for insurers and attorneys to take note.
RAI Industrial – Officially, Unofficial
Rai Indus. Fabricators, LLC v. Fed. Ins. Co.[i] is a U.S. District Court decision in which the court applied California law. The RAI decision itself was not published in the 2018 Federal Supplement; however, the California decisions cited within it are valid and may be relied upon and referenced to a California court. Furthermore, the court’s analysis and rationale provide a roadmap for subcontractors who wish to argue a subcontract provision, which states no damage can be recovered for delay of the project, may be challenged and potentially set aside.
In the Rai case, general contractor Sauer, Inc. agreed to design and build an Operational Readiness Training Complex at Fort Hunter Liggett, California. Sauer subcontracted with Agate Steel, Inc. for Agate to supply and assemble structural and other steel components at the project. Agate’s subcontract included a lengthy “no damage for delay” clause which stated, in essence, Sauer would not be liable to Agate for “any delay, disruption or interference” to Agate’s work. The list of potential project delays and interruptions for which Sauer would not be responsible was extensive and included delays related to: acts, omissions, or negligence of the project owner, contractors, subcontractors, and consultants; fire, earthquake, and other natural disaster; riots, strikes, and other labor actions; severe weather; changes to the work; Agate’s late access to the job site; defects in the plans or specifications; unexpected soil or other conditions; and generally, all conditions beyond Sauer’s control. In short, this was a one-sided agreement benefitting Sauer and placing the burden of delay on subcontractor Agate. Under the agreement, delays occasioned by the acts or omissions of Sauer could give rise to additional time for Agate to complete its work, but Agate was under no circumstances to collect damages for delay, regardless of cause.
The project was substantially delayed. Agate alleged Sauer’s acts and omissions were a primary cause of the delay. It alleged Sauer failed to direct and coordinate work among subcontractors, failed to follow change order procedures, significantly altered plans and specifications, revised Agate’s scope of work during construction, and arbitrarily altered project sequencing, all of which resulted in significant damages for Agate.
Sauer’s Motion to Dismiss
Agate and Sauer filed claims against each other in the Federal District Court for the Northern District of California. Among Sauer’s challenges to Agate’s lawsuit, it filed a motion to dismiss Agate’s First Amended Counter-Claim. In the motion to dismiss, Sauer asserted Agate contractually waived its right to any delay damages. They asserted Agate could not maintain a cause of action for “unjust enrichment,” and Agate’s cause of action for breach of the implied covenant of good faith and fair dealing was subject to dismissal, because no duty was alleged independent of the parties’ subcontract. Sauer contended Agate could not pursue delay damages based on a theory the project’s delay exceeded the “expectations of the parties” at the time the contract was signed. Sauer argued Agate was precluded from making the argument because the subcontract was an integrated agreement for which oral evidence was inadmissible.
Analysis: “No” Delay Damages Means “Only Mostly No”
The Federal District Court first confirmed “general, clear and explicit no damages for delay clauses are valid and enforceable.”[ii] It also characterized as “sound,” Sauer’s argument the subcontract constituted an integrated document for which supplemental oral evidence was inadmissible. However, the court relied with approval on a prior decision in ultimately allowing Agate to proceed with its claim for damages arising out of delay of the project.
In Hawley v. Orange County Flood Control[iii], plaintiff established defendant breached their contract by unreasonably delaying transmittal of revised construction plans and written authority to proceed with the work. Despite plaintiff’s evidence supporting these allegations, the Hawley trial court granted defendant’s motion for nonsuit, relying on a “no damages for delay” provision in the contract. On appeal, plaintiff in Hawley argued it made a preliminary evidentiary showing its damages were not within the contemplation of the parties when negotiating the contract. Plaintiff prevailed, with the appellate court agreeing whether or not the “no damages for delay” clause in the parties’ contract intended to preclude an award damages to the Hawley plaintiff constituted a question of fact, which required further hearing and was not appropriate for rejection as a matter of law.
The Rai judge likened Agate’s allegations regarding the significant scope of Sauer’s deviation from the terms of their subcontract to the proof offered by plaintiff in Hawley. The judge concluded Agate was entitled to continue its case and to present related evidence, rather than have the claim rejected on a motion to dismiss.
The Federal District Court provided a second basis for permitting Agate’s claim of delay damages to proceed, and it is an important one. The court summarized Agate’s argument as follows: “Agate argues the no damages for delay clause is unenforceable because the parties ‘abandoned’ the Subcontract.” The court continued, quoting a prior decision which held: “[P]rivate parties may impliedly abandon a contract when they fail to follow change order procedures and when the final product differs substantially from the original.”[iv] The Rai court continued:
In Opdyke, a contractor sued the owner for services performed in remodeling a building. The contractor alleged that the parties abandoned the written construction contract that included a maximum limit for cost and entered into a new oral contract under which the contractor was to be paid the cost of construction plus ten percent. The appellate court affirmed judgment in favor of the contractor on a cost plus basis, finding that the trial court was well justified in determining that ‘by the course of conduct which the parties adopted, they abandoned the price limitation and proceeded upon a straight cost plus basis.’[v]
The Rai court then reviewed the lengthy list of Agate’s allegations, which, if proved, supported a finding Saurer’s conduct materially changed the nature and scope of the subcontract such that both parties had effectively abandoned it. The Rai court then concluded Agate was permitted to proceed with its claim. The court wrote it did not intend to render any opinion regarding Agate’s entitlement to damages or the measure of those damages. Instead, it held only that Agate was allowed to proceed with its claim for delay damages, rather than to have the claim summarily dismissed at the pleading stage of the case.
If an insured or client is a subcontractor who signed an agreement with a “no damages for delay” provision, the subcontractor is not immediately out of luck – if there is evidence the owner or general contractor, through their acts or omissions, substantially changed the conditions under which work was performed and accepted the client’s performance of work under the new terms. Under such circumstances, the subcontractor is not automatically precluded from seeking delay damages, despite the “no damages for delay” provision in the parties’ agreement. Further, if both parties effectively changed the subcontract’s terms by ignoring them, and instead observed alternative procedures, the contract could be considered “abandoned,” and evidence of the terms of the parties’ revised agreement should be admitted.
A question raised but not answered by the Rai decision and cases cited within it is whether, under similar circumstances involving an apparent mutual abandonment of a written subcontract, a subcontractor may be excused from other onerous terms. Such an argument is potentially viable, but the parties’ conduct would presumably have to affect the ability of the subcontractor to comply with the disputed terms, such as to complete the project without material delay. Arguing a revised agreement eliminates a subcontractor’s obligation to secure additional insurance coverage. To indemnify the owner or general contractor for liability arising out of the subcontractor’s work would probably not succeed, absent evidence the parties intended to remove those obligations from their agreement.
A trial judge will probably have to be educated about the relevant authorities and an appeal may ultimately be necessary. There is sound and longstanding legal precedent, which allows a subcontractor to present evidence courts should not prevent it from seeking delay damages where the circumstances of work on a given project were significantly different from what the parties originally contemplated. If a case involves egregious conduct by the owner or general contractor, or if there is evidence the parties effectively abandoned their written agreement and performed under the terms of an alternative one, there may be a viable legal challenge to unfavorable subcontract terms on behalf of the insured or client.
Robert G. Bernstein has been in practice in California for 31 years and is Senior Counsel with Tyson & Mendes. He specializes in construction defect and construction-related claims.
[i] Rai Indus. Fabricators, LLC v. Fed. Ins. Co., 2018 U.S. Dist. LEXIS 74612 (N.D. Cal., May 2, 2018)
[ii] See, e.g., Hansel v. Covell (1933) 218 Cal.622, 627-628.
[iii] Hawley v. Orange County Flood Control (1963) 211 Cal.App.2d 708.
[iv] Amelco Electric v. City of Thousand Oaks (2002) 27 Cal.App.4th 228, 235 (citing Opdyke & Butler v. Silver (1952) 111 Cal.App.2d 912, 913–14, 916, 918–19)).
[v] Opdyke, supra at p. 919.