The Third Circuit Court of Appeals Decides Contracts Mean What They Say and the No Harm No Foul Rule Still Applies

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Construction Group Newsletter

July 2009

The United States Court of Appeals for the Third Circuit starts its decision Great American Insurance Co. v. Norwin School District, etc., 544 F.3d 229 (2008) this way:

“Our trek through the factual morass from which this case arose begins in 2001, when Norwin undertook two public school construction projects.”

In its conclusion the court said:

“The facts in this case are singular, the case history bizarre.”

There are lessons to be learned from this bizarre morass.

The case involved the construction of two schools for the Norwin School District in Pennsylvania. Shoff Construction was the contractor for both projects, under separate contracts. Great American Insurance Company or GAIC was Shoff’s surety. Foreman Program and Construction Managers, Inc., acted as the construction manager.

The dispute arose several months after Shoff had received its final payment on both projects when GAIC told the School District that it had received payment bond claims from Shoff’s subcontractors and suppliers totaling $800,000.00. When it learned final payment had been made to Shoff, GAIC sued contending the School District should have obtained GAIC’s consent before making a final payment. GAIC also contended that the final payment under each of the contracts should have been equal to 5% of the contract price, the amount of retainage GAIC contended Norwin was required to hold under the terms of the contracts. GAIC calculated that amount to be $467,342.06, considerably more than the actual final payment to Shoff of $103,323.82. The School District in turn sued Shoff and Foreman, the claim against Foreman being that it had breached its construction management contract by approving the final payment to Shoff without obtaining the consent of GAIC.

After a series of motions, a “secret settlement” and a trial, the end result was a judgment in the School District’s favor against Foreman for $467,347.05 or 5% of the amount of each contract.

Foreman appealed and one of the central issues was whether GAIC’s consent was required before Shoff was paid more than 95% of the contract amount. Both contracts provided that GAIC consent was required before “final payment”. GAIC contended that the contracts required a full 5% be retained until the time of final payment and that GAIC’s consent was required for payments in excess of 95%. What created the issue was less than clear contract language. The contracts were based upon the AIA A201/cm General Conditions, but those general conditions had been amended and in certain cases superseded by separate “Supplementary Conditions”. The Supplementary Conditions provided that after the project was 50% complete, the 10% retainage. could be reduced but “shall not exceed 5%” The court said that left room for a range of retainage values capped at 5% and that GAIC’s consent was not required before retainage was reduced below 5%. The Court did find that Foreman had approved a final payment of $103,323.82 on both projects without obtaining GAIC’s consent and that this failure was a breach of Foreman’s contract with the school district. That however did not end the matter.

Under the secret settlement agreement between GAIC and the School District, the School District allowed GAIC to obtain a judgment against it and agreed GAIC’s lawyer paid represent the School District in pursing Foreman. The agreement provided that in the event the School District did not recover anything from Foreman it would not have to satisfy GAIC’s judgment. According to the Court what that meant was that the School District was not damaged by Foreman’s breach of contract. The School District got exactly what it bargained for, two schools at the contract price.

This case emphasizes the need for clear, concise and consistent contract language throughout all portions of the contract documents. This is especially important when it comes to contract clauses dealing with things like payments. The parties will be using the payment clause on a regular basis. Contract language which is overly complex and does not lend itself to practical application will lead to disputes. If it takes a lawyer to explain the payment application process the language needs a lot of work. The case also makes clear that not every breach of contract will result in a financial recovery. If there is to be a recovery the party claiming the breach must also prove the breach actually caused them to suffer damages.