Increased Workforce Is Not "Delay" - Massachusetts Appeals Court affirms subcontractor award despite no-damage-for-delay clause

In Central Ceilings, Inc. v. Suffolk Construction Company, Inc., et al., - N.E.3d - 91 Mass.App.Ct. 231 (Mar. 29, 2017), the Massachusetts Appellate Court affirmed a $321,315 damages award against a general contractor in favor of a subcontractor.  The subcontractor claimed that as a result of the general contractor's mismanagement of the dormitory construction project (at Westfield State University) it was less productive and therefore incurred costs. 

Indeed the subcontractor, who installed exterior and interior wall systems, illustrated that properly sequencing its work "floor by floor, exterior to interior, building by building" was key to meeting its cost and time bid. The evidence presented showed that general contractor "struggled" coordinate the other trades who needed to complete their work before the subcontractor could begin, failed to timely survey the locations for the subcontractor to line up its panels, delayed making the building weather tight, among other delays.  The delays caused the subcontractor to perform costly extra work mobilizing and demobilizing and to incur project administration costs.  In addition, the subcontractor was not given extra time to do this work due to the looming liquidated damages that the general contractor would owe if the project was not completed on time (though the general contractor later attempted to dispute that the subcontractor had ever asked for extra time).  Instead the subcontractor was "compressed" and forced to assign, and pay for, extra personnel on the project. To support its claim, the subcontractor introduced an expert who opined, using the total cost method, that the loss was "best quantified through the impact it had on [the subcontractor's] manpower." After confirming the subcontractor's bid was "reasonable," he examined what the subcontractor actually spent to complete the project, what change orders were already paid, and concluded that the difference, $321,315, was the subcontractor's lost productivity.

In response, the general contractor pointed to the contract's no-damages-for-delay clause and asserted that the demanded recovery was wholly precluded. In pertinent part, the clause stated:

The Subcontractor agrees that it shall have no claim for money damages or additional compensation for delay no matter how caused, but for any delay or increase in the time required for performance of this Subcontract not due to the fault of the Subcontractor, the Subcontractor shall be entitled only to an extension of time for performance of its Work. Written notice of all claims for any extension of time shall be submitted to Contractor within ten (10) days of the date when Subcontractor knows (or should know) of the event which causes such delay, or such claim shall be considered waived by Subcontractor

The trial judge held, and the appellate court affirmed, that the unambiguous provision was inapplicable to the subcontractor's claim for two reasons.

First, the only remedy under the no-damages-for-delay clause was the extension of time but, here, no extensions were allowed in contravention to the agreement. The general contractor protested on appeal that no extension requests from the subcontractor were ever received, but the general contractor did not raise that issue at the trial court and the record belied that position anyway.  

Second, the trial court held and the appellate court affirmed that in strictly construing the draconian language of the clause, the subcontractor's damages claimed, lost productivity, were not "for delay" (precluded by the clause) but rather "it had been forced to increase its workforce due to the compression of the schedule occasioned by [the general contractor's] breaches" (not precluded by the clause). The trial court observed that the general contractor's "breaches did not affect [the subcontractor's] ability to complete its work on time . . . but, rather, with its ability to complete its work on budget."

Accordingly the award, and the total cost method for calculating the award, were affirmed.

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The author, Katharine Kohm, is a committee member for The Dispute Resolver. Katharine practices construction law and commercial litigation in Rhode Island and Massachusetts. She is an associate at Pierce Atwood, LLP in Providence, Rhode Island. She may be contacted at 401-490-3407 or kkohm@PierceAtwood.com.

US Supreme Court False Claims Act Decision in Escobar Has Significant Implications for Contractors

Marion T. Hack, Partner, Pepper Hamilton LLP
John H. Conrad, Associate, Pepper Hamilton LLP

On June 16, 2016, the U.S. Supreme Court ruled in the matter of Universal Health Services, Inc. v. United States ex rel. Escobar, 136 S. Ct. 1989 (2016), changing the legal landscape for False Claims Act qui tam claims concerning the implied false certification theory of liability. This article will discuss the Escobar holding and examine relevant considerations for contractors in light of this ruling.

In Escobar, a teenage patient received counseling under Massachusetts’ Medicare program at a mental health facility, Arbour Counseling Services, which is owned and operated by a subsidiary of Universal Health Services, Inc. As part of the counseling process, the staff at Universal diagnosed the patient and prescribed medication. The patient had an adverse reaction to the mediation and subsequently died of a seizure. It was later determined that four out of the five Universal employees that treated the patient were not properly licensed to provide mental health counseling, prescribe medications or offer counseling services without supervision. Specifically, the person who diagnosed the patient had her psychologist license application rejected by Massachusetts, and the person who prescribed the medication was actually a nurse who lacked authority to prescribe medication without supervision, in violation of 130 Code Mass. Regs. § 429.22, et seq. Escobar, 136 S. Ct. at 1997-98.

During this time frame, Universal submitted requests for payment to the government for its personnel under Massachusetts’ Medicare program. Universal submitted these payment requests despite its knowledge that its personnel was improperly classified under the billing codes used by Universal.

The False Claims Act Claim

In 31 U.S.C. § 3730(b)(1) it states, “A person may bring a civil action for a violation of section 3729 for the person and for the United States Government. The action shall be brought in the name of the Government.” These suits are referred to as “qui tam” suits. Further, 31 U.S.C. § 3729(a) provides, “any person who knowingly presents, or causes to be presented, a false or fraudulent claim for payment or approval . . . is liable to the United States Government for a civil penalty of not less than $5,000 and not more than $10,000,[1] . . . plus 3 times the amount of damages which the Government sustains because of the act of that person.”

Under the above provisions, the respondents in Escobar brought a qui tam suit, alleging that Universal had violated the False Claims Act and defrauded the government in billing for services that were not properly rendered as described in the billings, while failing to disclose serious breaches related to Massachusetts’ Medicare program. The respondents asserted that the government would not have reimbursed the claims had it known that it was billed for mental health services that were performed by unlicensed and unsupervised staff. Escobar, 136 S. Ct. at 1997-98.

Universal filed a motion for summary judgment to dismiss the respondents’ claims. The district court granted Universal’s motion “because none of the regulations violated by Universal was a condition of payment.” The U.S. Court of Appeals for the First Circuit reversed, holding that “every submission of a claim implicitly represents compliance with relevant regulations, and that any undisclosed violation of a precondition of payment (whether or not expressly identified as such) renders a claim ‘false or fraudulent.’” The First Circuit also held that the “regulations themselves provided conclusive evidence that compliance was a material consideration of payment.” Id. at 1998.

The U.S. Supreme Court rejected both the holding of the district court and the holding of the First Circuit and remanded to the district court for further determination of the matter utilizing the new standard for implied certification claims under the False Claims Act. Id. at 2004.

New Standard for Implied False Certification Claims

The Court in Escobar held:

[T]he implied false certification theory can, at least in some circumstances, provide a basis for liability. By punishing defendants who submit “false or fraudulent claims,” the False Claims Act encompasses claims that make fraudulent misrepresentations, which include certain misleading omissions. When, as here, a defendant makes representations in submitting a claim but omits its violations of statutory, regulatory, or contractual requirements, those omissions can be a basis for liability if they render the defendant’s representations misleading with respect to the goods or services provided.

Id. at 1999 (emphasis added).

In Escobar, Universal knowingly submitted payment applications that listed specific billing codes corresponding to certified and licensed personnel, where those individuals were not certified or licensed, thus misleading the government into paying the invoices. Id. at 1997. The Escobar Court clarified that the claims in the matter related to more than just demands for payment and that “representations that state the truth only so far as its goes, while omitting critical qualifying information[,] can be actionable misrepresentations.” Id. at 2000.

A critical determination in the new Escobar standard is whether the statements made qualify as actionable misrepresentations. The Court in Escobar provided examples of some statements that create actionable misrepresentations to guide future litigation. When a seller of property reveals that there are two new roads near a property for sale, but fails to disclose that a third potential road might bisect the property, the seller has omitted key information that would “materially affect the value of the purchase.” Id. (citing Junius Const. Co. v. Cohen, 257 N.Y. 393, 400 (1931)). An applicant for a position at a college makes actionable misrepresentations when his résumé lists prior jobs and then retirement, but fails to disclose that his “retirement” involved time in prison for a $12 million bank fraud. Id. (citing Sarvis v. Vermont State Coll., 172 Vt. 76, 78, 80-82 (2001)). Both of these examples point to the need for the misrepresentation to affect the basic value of the goods or services to be provided in order to be an actionable misrepresentation.

The Escobar Court also held a critical factor was that the “misrepresentation about compliance with a statutory, regulatory, or contractual requirement must be material to the Government’s payment decision in order to be actionable under the False Claims Act.” Id. at 1996 (emphasis added). The Court also held that liability is not limited to cases where the requirements involved were expressly designated as conditions of payment. Id. at 2001. To assist in interpreting this standard, the Court provided an example of a material misrepresentation. When a contract involves the supply of guns, and the contract does not state that the guns must actually shoot, but the supplier knows that the government routinely rescinds contracts if the guns do not shoot, the supplier has “actual knowledge” of the materiality of that requirement. Further, the seller’s failure to appreciate the materiality of that condition would amount to “deliberate ignorance” or “reckless disregard” of the falsity of the information. Id. at 2001-02. The Court also cited to United States ex. rel. Marcus v. Hess, where two contractors violated a non-collusion bidding requirement and withheld that information. This was implicit false certification because the government would not have funded the subsequent payments had it known of the violation. Id. at 2003 (citing Marcus, 317 U.S. 5379, 543 (1943)).

In the construction context, misstatements concerning the types of materials supplied or the qualifications of the individuals whose labor is billed could implicate this implied false certification theory of the False Claims Act. For example, consider a construction contract that calls for a specific material or equipment that is required to meet specified quality or regulatory requirements. If the contractor knowingly supplies a different and lesser quality item and then bills for the government per the schedule of values including the originally specified item, then the contractor may be liable for implicitly submitting a false claim. Where a design/build contract calls for engineering or oversight services to be performed by a licensed engineer, or where a construction management contract calls for licensed or certified personnel to perform services, and where the contractor supplies unlicensed or uncertified personnel for the positions involved, an implied false certification claim is possible. Another example is a time and material construction contract that specifies categories of workers, depending on specific worker classifications and training levels. If the contractor provides labor that does not meet those specified classifications within the contract (e.g., supplying apprentice labor and billing for journeymen), and the contractor submits billing for personnel based on the classifications that do not match the personnel qualifications, the contractor is potentially liable for an implied false certification claim.

In all of these possible scenarios posed above, contractors need to be vigilant in verifying that the labor or materials supplied by the contractor or its subcontractors do in fact meet the specifications and/or regulatory requirements for any project. Otherwise, the contractor could be exposed to significant per act penalties and treble damages under the False Claims Act. Should any of these issues arise, a contractor should seek assistance in resolving the matter at the earliest time to avoid or minimize the potential penalties.

[1] The government revised the penalties in 2015 via 28 C.F.R § 85.3(a)(9) to a minimum of $10,781 and a maximum of $21,563 per occurrence.

Article originally posted August 26, 2016 on Constructlaw, an update and discussion of recent trends in construction law and construction, maintained and edited by Pepper Hamilton's Construction Law Practice Group. 

Texas Supreme Court Denies General Contractor’s Negligent-Misrepresentation Claim Against Architect for Increased Construction Costs Caused By Deficient Plans

The Texas Supreme Court recently held that the economic-loss rule bars claims of negligence and negligent misrepresentation from a general contractor against an architect because there was no contract between the parties. Instead, the contractor was limited to its claims for breach of contract against the project’s owner. LAN/STV v. Martin K. Eby Constr. Co., 435 S.W. 3d 234 (Tex. Jun. 20, 2014).

The Dallas Area Rapid Transportation Authority (the “Owner”) contracted with the architect, LAN/STV (the “Architect”), to prepare plans, drawing, and specifications for the construction of a rail line within downtown Dallas. The Architect agreed to be responsible for the professional quality, technical accuracy, and coordination of all designs, drawings, specification, and to be liable to the Owner for all damages caused by the Architect’s negligent performance of any of the services furnished. The Owner incorporated the Architect’s plans into its solicitation for competitive bids to construct the rail line. The project was awarded to Martin K. Eby Construction Company (the “Contractor”). The construction contract contained administrative procedures for the Contractor to follow if asserting disputes against the Owner, including any design problems. There was no contact or contractual privity between the Contractor and the Architect.

Just after starting construction, the Contractor discovered that the Architect’s plans were replete with errors. While the Contractor expected that only 10% of the plans would be changed, eventually 80% of the Architect’s plans had to be changed. This greatly disrupted the construction schedule and required additional labor and materials. In total, the Contractor calculated that it lost nearly $14 million on the Project.

After settling with the Owner, the Contractor filed this tort action against the Architect alleging claims for negligent misrepresentation. The jury apportioned some responsibility to the Owner and the Contractor, but found that the Architect was 45% responsible. Judgment was subsequently rendered in favor of the Contractor for about $2.25 million. The Court of Appeals affirmed the judgment.

The Texas Supreme Court analyzed whether the economic-loss rule barred the Contractor’s recovery for negligent misrepresentation. Under the economic-loss rule in Texas, a plaintiff suffering purely economic loss cannot recover under negligence theories against a defendant if the duties allegedly breached arose solely from the defendant’s contract with a third-party. Put another way, the economic-loss rule means that there is “no general duty to avoid the unintentional infliction of economic loss.” Restatement (Third) of Torts: Liability for Economic Harm, § 1.

The economic-loss rule does not create a bright-line standard, and has caused some confusion among courts as to its application. In the construction context, the Court recently explained that the economic-loss rule does not bar an owner’s negligence claims directly against a subcontractor for damage to the owner’s property caused by defective work. Though the owner had no contract directly with the subcontractor, the subcontractor owes all persons (including the owner) the duty to perform its work with reasonable care to avoid causing damage to other persons’ property. In that case, the property damage was to the owner’s property and fell outside the scope of work in the subcontractor’s construction contract with the general contractor. Thus, the owner’s negligence claims were permitted to proceed. Chapman Custom Homes, Inc. v. Dallas Plumbing Co., 445 S.W. 3d  716 (Tex. 2014). The case is analyzed in further detail here.

In the LAN/STV case, in contrast, the Contractor sought to recover only for its increased costs of construction resulting from the Architect’s failure to comply with the standards of performance required under its design contract with the Owner. The Court explained that participants in construction projects typically cannot recover their economic losses from parties with whom they did not contract. A roofing subcontractor, for example, could not recover its economic losses through negligence claims against a foundation subcontractor that caused construction delays by failing to perform its work in a timely manner. Rather, the roofing subcontractor’s recovery, if any, would lie in claims for breach of contract against the general contractor, the only party with whom the roofing subcontractor had an agreement.

With respect to the Contractor’s negligent-misrepresentation claims against the Architect, the Court felt that the same reasoning barred any recovery. This is a divergence from the recent Restatement on the issue, which suggests that an architect’s duty to a contractor arises from the expectation that plans are prepared for contractors to rely upon to carry out the construction. Restatement (Third) of Torts: Liability for Economic Harm, § 6, cmt. b. While the Court agreed with this concept, it held that the contractor’s “principal reliance must be on the presentation of the plans by the owner, with whom the contract is to reach an agreement, not the architect, a contractual stranger.” The Court felt that contractors were sophisticated parties who could protect their interests adequately through allocating risk in their construction contracts with the owners.

As the Court noted, there are significant differences of opinion among various states as to whether contractors may assert negligent-misrepresentation claims against architects absent contractual privity. Indeed, prior to this case, several Texas courts of appeals permitted such claims. However, this case clarifies that, in Texas, contractors may not recover purely economic losses through negligent-misrepresentation claims against architects with whom they lack contractual privity.

Thanks to Ian Fullington at Griffith Davison& Shurtleff, P.C. for assistance with preparing this post.