Appearances Can Be Deceiving
Contractor Entitled to Payment on a Cost-Plus Basis Despite Executing Lump Sum Contract with Owner
This case concerns a clash between the words of a contract and the parties’ course of performance.
In 2017, an owner contracted for the design and construction of a hotel in Durango, Colorado. When the estimated cost of constructing the hotel was too high, the owner turned to a contractor with whom the owner’s principals had worked on prior projects in an effort to reduce the project’s cost. The owner and contractor executed a lump sum contract to provide to the owner’s lender. At the time the contract was signed, the project design was still incomplete.
The project was plagued by permit, design, change, and COVID-related delays. Although the contract reflected a lump sum arrangement, the contractor submitted pay applications based on the cost of the work. The pay applications were approved and paid by the owner. When the contractor’s pay applications exceeded its schedule of values, the owner’s lender balked and required future pay applications to be calculated on a percentage complete basis so as not to exceed any line item in the schedule of values.
When construction commenced, the owner was continually concerned about the project budget and directed the contractor to value engineer various items in an effort to reduce project cost. When the contractor submitted several large change orders late in the project, the owner refused to approve or pay them. The owner asserted that, because the written contract was for a lump sum, the contractor was not entitled to payment based on the actual cost of the work. Despite not being paid, the contractor obtained a certificate of occupancy so the owner could operate the hotel.
Because of the owner’s refusal to pay the contractor in full, the contractor recorded a mechanic’s lien for over $3M against the project and foreclosed on the lien. The foreclosure action was stayed pending arbitration under the written contract. A two-week arbitration administered by the American Arbitration Association took place in late January 2023. The contractor was represented in the proceedings by Karl A. Berg, Jr., and Erin M. Leach of Mulliken Weiner Berg & Jolivet P.C., Colorado Springs, Colorado.
The contractor contended that, even though the parties had signed a lump sum contract, they agreed through their course of performance that the contractor could instead expect to be paid on a cost-plus basis. The contractor sought more than $3.1M in damages. The owner defended on the basis of the parties’ lump sum contract terms, and further asserted numerous counterclaims in excess of $8.1M, including for alleged construction defects.
The arbitration panel agreed with the contractor that it was to be paid the actual cost of the work plus a fee. The panel observed that if the parties’ agreement had been for a lump sum, the owner would not have been concerned about the project budget, the owner would not have directed that the contractor value-engineer the project, and the contractor would have had to complete the project regardless of the actual costs incurred. The contractor was awarded over $2.3M in damages plus interest, attorneys’ fees, and costs, resulting in a final award in favor of the contractor totaling over $3.4M.
The fact that the contractor signed a lump sum contract when it intended to be paid cost-plus made it considerably more difficult for the contractor to prevail in this action. The contractor had to overcome a strong presumption that the parties’ agreement was reflected in the document they signed. However, the contractor carried the day based on the parties’ substantial – and well-documented – course of performance in support of the contractor’s position.
This case offers at least three important lessons. First, to mitigate the risk of litigation, contracting parties should negotiate and sign a written agreement that accurately reflects their desired business outcomes. Second, even with a written agreement firmly in place, the parties’ course of performance (and possibly their prior course of dealing) can result in a modification or waiver of key terms. Third, during the course of a project, a party to a contract should carefully document any course of performance that supports its intended business outcomes, especially if the conduct is contrary to the express terms of the parties’ signed agreement.
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Karl A. Berg, Jr.: firstname.lastname@example.org
Erin M. Leach: email@example.com