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Uncooperative Sub's Side Deal with Owner Costs It $500,000 in Punitive Damages
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March 17, 2008
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By Peter Zweighaft
Howrey LLP
A general contractor agreed to install an energy management system at a hospital. The contractor engaged a subcontractor to perform HVAC work, which comprised about 40 percent of the projects. The owner was to make 10 installment payments of $148,475 each to the contractor for a total of $1,484,750. The HVAC subcontract provided that payments were due under it only when the owner had paid the general contractor. It provided for liquidated damages of $250 a day for late completion. The completion date was based on a schedule provided by the subcontractor.
The owner made 9 of the 10 installment payments but withheld the last payment because the HVAC subcontractor's work was not completed on time. The subcontractor recorded a mechanic's lien, sued the owner to enforce the mechanic's lien and sued the contractor for breach of contract. The contractor sued the owner for breach of contract. While the litigation was pending, the subcontractor continued working on the project, finishing 617 days late.
On the eve of trial, the subcontractor and owner reached a settlement: The owner agreed to make the last installment payment directly to subcontractor, bypassing the contractor, in exchange of a mechanics' lien release and a dismissal from the lawsuit. The contractor learned about the settlement on the first day of trial. The trial court permitted contractor to add a claim against the subcontractor for tortious interference with contract on grounds that the final installment payment was owed to the contractor.
At trial, the subcontractor prevailed on its breach of contract claim against the contractor. However, because of the subcontractor finished late, the liquidated damages exceeded the breach of contract damages, and the subcontractor recovered nothing against the contractor. In contrast, the contractor prevailed on its tortious interference claim against the subcontractor and was awarded $26,100 in actual damages and $500,000 in punitive damages. The contractor also prevailed against the owner for breach of contract, receiving $101,546 in compensatory damages.
The subcontractor appealed to the Missouri Court of Appeals and argued that its interference with the payment provisions of the prime contract was justified because it was protecting a valid economic interest. The appellate court affirmed. Environmental Energy Partners, Inc. v. Siemens Building Technologies, Inc., 178 S.W.3d 692 (Mo.App. 2005).
The Court of Appeals held that justification can be established only if there is a legal right to interfere. Justification exists when one seeks to protect a valid economic interest, has a legal right to do so and does not employ improper means. But, one "is not justified in interfering with another's business affairs if the action taken was legally improper. Actions are improper if they 'are independently wrongful notwithstanding injury caused by the interference.' " Contractual provisions can determine legal rights and, therefore, whether or not justification exists.
Here, the court held, the subcontractor had no contractual right to demand payment directly from the owner. The prime contract and the subcontract required payments to go from the owner to the contractor and then from the contractor to the subcontractor. Because the subcontractor's actions were contrary to the terms of the parties' contracts, it had no legal right to interfere in the owner's obligation to pay contractor, and its efforts to divert payment were not justified.
The subcontractor also appealed the $500,000 punitive damages award, arguing that the punitive damages award was excessive and violated due process. Relying on U.S. Supreme Court precedent, the Court of Appeals focused its analysis of due process on three elements: 1) the degree of reprehensibility of the subcontractor's conduct; 2) the ratio of punitive damages to compensatory damages; and 3) a comparison of the punitive damages assessed to other penalties imposed for comparable misconduct.
As the first element, the court denounced the subcontractor's conduct, finding that its "actions were egregious, unwarranted, overbearing, reprehensible, and without justification." The court specifically noted that the subcontractor failed to complete its work on time, stopped communicating with contractor, refused to meet with the contractor, failed to submit reports that were required for the contractor to receive payment from the owner, erroneously represented that its work was complete and secretly negotiated with the owner to divert the final installment payment from the contractor. The court concluded that the first element was satisfied because the subcontractor's conduct was "reprehensible and unconscionable."
As to the second element, the court recognized U.S. Supreme Court precedent holding that "few awards exceeding single-digit ratio between punitive and compensatory damages, to a significant degree, will satisfy due process." With compensatory damages of $26,100 and punitive damages of $500,000 resulting in the ratio of 19:1, the punitive damages appeared vulnerable to the subcontractor's due process challenge. However, the Court of Appeals also looked to the $101,546 in compensatory damages awarded against the owner. When added to the $26,1000 compensatory damages awarded against the subcontractor, this brought the ratio down to 4:1, well within the due process boundaries.
Finally, the court refused to undertake an analysis of the third element, which required a comparison of the punitive damages assessed with penalties that might otherwise be imposed for comparable misconduct. Because the subcontractor's misconduct did not involve fraud, the Court of Appeals distinguished the U.S. Supreme Court cases that examined this issue. "Tortious interference with contract involves acts that are ethically and morally reprehensible and are, in a civil sense, legally wrongful, whereas fraud claims... are akin to criminal conduct for which sanctions might be identified and compared." Without having any criminal conduct to compare with the subcontractor's conduct, the court found the factor of comparative penalties to be of no assistance in evaluating the punitive damages. The court concluded that the punitive damages awarded were not so high as to be arbitrary and a denial of due process.
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For more information about the issues covered in this report, please contact Peter K. Zweighaft in our Los Angeles office at 213-892-1996 or at zweighaftp@howrey.com or contact your Howrey attorney. For more information about Howrey's Construction Practice Group, click here.
©2008 Howrey LLP
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