By Michael C. Loulakis and Lauren P. McLaughlin
Whether on private or public projects, general contractors are frequently in positions of having to present subcontractor claims for payment to their owner clients. The myriad of disputes concerning what are termed “pass-through” claims typically center on the viability of the downstream claim itself (i.e., whether it is permitted by statute or time-barred, whether it contains substantial backup documentation, and/or whether it comports with other exculpatory provisions, such as notice or a no-damages-for-delay clause).
Savvy contractors include in their subcontracts the very limited means by which prime contractors are required to present pass-through claims. Almost all sophisticated subcontracts ensure that there is no daylight between the prime contract and the subcontract concerning pass-through claims. In other words, the subcontractor’s rights against the prime are typically limited to whatever the owner will pay on the claim, if presented. Rarely are disputes litigated concerning the prime contractor’s duties concerning the presentment itself. This month, we highlight the case of Helix Electric of Nevada LLC v. APCO Construction Inc. where an appeals court was asked to weigh in on the propriety of the prime contractor’s actions with respect to the pass-through submission.
The disputes in the case began when the city of North Las Vegas contracted with APCO Construction Inc. to build a phase of the Craig Ranch Regional Park. At the time of bid, the anticipated project duration was approximately 550 calendar days. Helix Electric of Nevada LLC submitted a bid of approximately $4.6 million to APCO for the electrical scope of work required on the project. Helix’s estimate assumed a project duration of 550 days. The city canceled the original solicitation and reissued the request for bids, changing the project duration from 18 months to 12 months. APCO submitted its second bid to the city with a 12-month schedule and was awarded the contract.
The project encountered significant delays and was not substantially completed until nine months following the original substantial completion date. Helix notified APCO of its intent to submit a delay claim. In response, APCO indicated that Helix must timely pursue reimbursement for those costs and provide all related documentation to APCO, so that APCO could then submit Helix’s claim to the city. Helix submitted a claim for $102,000 based on a calculation of $640 per day for 32 weeks. APCO created a change order request for Helix’s $102,000 delay claim and submitted it separately to the city. APCO also told Helix it was in the process of preparing its own time impact analysis, which would “open the door for Helix” to present its case.
The city rejected the Helix change order request on the grounds that the city did not have a contract with Helix. The city expected APCO to include its subcontractors’ claims in its own claim, rather than submit subcontractors’ claims separately.
APCO informed Helix it needed backup documentation to reverse the city’s rejection but did not tell Helix that the city rejected the claim on the basis that the city did not have a contract with Helix. APCO later submitted its own $1,090,066 delay claim with the city and settled for $560,724. APCO’s claim did not include any of Helix’s delay claim. As part of the settlement, APCO agreed to forgo any claim, present or future, that may occur on the project.
The record shows APCO did not notify Helix that it had settled with the city or that the city had paid APCO’s delay claim.
Helix ultimately billed APCO for its retention and included a conditional waiver and release upon final payment that indicated a disputed claim amount of “zero.” Helix submitted another claim to APCO in the amount of $26,304, accounting for the extended overhead costs for the months of September and October. APCO submitted Helix’s claim to the city, which the city again rejected on grounds that the city did not have a contract with Helix and, moreover, the city had already settled with APCO.
APCO then sent a copy of a check in the amount of Helix’s retention and an updated unconditional waiver for Helix to sign upon final payment. The waiver included the retention amount. Helix added the delay claim amount to the payment line next to the retention amount but did not list the delay claim as a disputed claim on the waiver. Helix’s president emailed APCO’s contract manager expressing concern about Helix’s delay claim. Helix’s senior vice president also wrote to APCO, explaining that Helix reserved its rights to its delay claim. Helix’s president also emailed a proposed promissory note to APCO’s contract manager laying out a payment plan for Helix’s delay costs. Ultimately, Helix claimed APCO owed $134,724.68 for Helix’s delay costs.
APCO did not pay Helix’s delay costs, and Helix filed suit. The district court ruled in favor of Helix after a three-day bench trial, finding that APCO breached the covenant of good faith and fair dealing by not including Helix’s delay damages claim as part of APCO’s own claim to the city and thereafter settling its own claim with the city without notifying Helix. Notably, the district court found that the city rejected Helix’s claims because APCO did not include Helix’s claim under its own claim and that APCO waived and released Helix's claim by settling with the city. The court further found that the waiver Helix signed applied to retention only and not to Helix’s claim for delay damages. The district court awarded Helix $43,992.39 in delay damages and $1,960.85 in interest along with attorney fees. APCO appealed.
On appeal, APCO argued that the district court erred by applying the covenant of good faith and fair dealing because APCO and Helix’s subcontract limited Helix’s remedy to an extension of time (and not delay damages). APCO further argued that by applying the covenant of good faith and fair dealing, the district court had effectively modified or superseded the subcontract’s provisions and frustrated the parties’ reasonable expectations under the contract for monetary damages.
The appellate court was not persuaded. The court began its analysis by noting that the implied covenant of good faith and fair dealing exists in all contracts. Regarding the essence of the duty, the court described that it “prohibits arbitrary or unfair acts by one party that work to the disadvantage of the other.” When one party performs a contract in a manner that is unfaithful to the purpose of the contract — and the justified expectations of the other party are thus denied, damages may be awarded against the party who does not act in good faith.
The appellate court found that APCO breached the covenant of good faith and fair dealing. When APCO settled with the city of North Las Vegas, the court found APCO’s actions contrary to the spirit and purpose of its subcontract with Helix. By submitting Helix’s claim to the owner separately from its own, APCO failed to preserve Helix’s claim because it knew the city would only accept claims from APCO and not from Helix. Further, the court was troubled that APCO entered into a settlement agreement with the city without Helix’s knowledge and waived all claims arising from the project delay, including Helix’s delay costs. The court noted that the subcontract required APCO to make available to Helix all information that affected Helix’s ability to meet its obligations under the subcontract, including information relating to delays and modifications to APCO’s agreement with the city.
Finally, the court found that APCO misrepresented to Helix the reasons for the city’s rejection of Helix’s claim, telling Helix the rejection was due to a lack of backup information when the city rejected the claim because it was a standalone pass through. APCO also resubmitted Helix’s delay claim after Helix provided APCO with more backup information despite already knowing the city rejected Helix’s claim for a different reason. The appeals court found that APCO had misled Helix into believing the owner’s denial was based on the lack of detail in Helix’s claims stating, “APCO performed the subcontract in a manner that was unfaithful to its purpose.”
The court also addressed whether the conditional waiver and release form barred Helix’s claims. In Nevada, a state statute prevents subcontractors from waiving their rights to disputed claims when signing partial release forms. The statute says: “Any release or waiver required to be provided by a … subcontractor or supplier to receive a progress payment or retainage payment must be … limited to claims related to the invoiced amount.” In this case, APCO argued on appeal that Helix’s claim should also fail because it signed a partial waiver and release form that covered “final payment to the undersigned for all work” on the project. APCO argued the waiver and release form should preclude its delay claims. The court, as a matter of first impression, enforced the statute and held that the release Helix signed only applied to its retention amount and Helix could therefore pursue a claim for delay costs not contemplated by the waiver.
The case is instructive in demonstrating that a prime contractor or subcontractor’s actions in pursuing pass-through claims for downstream contractors is fraught with risk. On the one hand, contractors face false claims exposure to public owners if they certify or pass through a claim that has egregious errors. On the other hand, contractors face exposure to subcontractors for settling with owners without including subcontractors’ claims. In the latter scenario, a contractor will be found to have “frustrated” the purpose of the subcontract if it shuts the subcontractor out of a delay claim.
This case is different, however. The contractor’s actions in not being forthright about the reasons for the rejection and not disclosing that it had settled with the city and released all claims on the project were considered to have breached not a specific contract obligation but a duty implied in all contracts — the duty of good faith and fair dealing. This duty requires that neither party will do anything that will destroy or injure the right of the other party to receive the benefits of the contract.
There is no specific definition of this duty, and courts have discretion to determine its scope. “Good faith” has generally been defined as honesty in a person’s conduct during the agreement. The obligation to perform in good faith exists even in a contract that expressly allows either party to terminate the contract for any reason (i.e., a contractor cannot use a convenience termination to “bid shop”). “Fair dealing” usually requires more than just honesty. It generally requires that a party cannot act contrary to the “spirit” of the contract, even if it gives the opposing party notice that it intends to do so.
It is important for construction professionals to keep in mind that the duty of good faith and fair dealing means that parties cannot evade the spirit of the bargain, perform incorrectly on purpose, or interfere with or fail to cooperate with the other party’s performance.
This article first appeared in Civil Engineering Online.