Lonergan Lives On—Fifth Circuit Affirms Contract Risk Allocation, Citing 110+ Year Old Texas Case

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The Fifth Circuit applying Texas law recently weighed in on whether a subcontractor could recover more than the contract balance from the general contractor when (1) the work proved more onerous than anticipated at contracting; and (2) the general contractor subsequently agreed to pay those unanticipated excess costs. See D2 Excavating, Inc. v. Thompson Thrift Construction, Inc., 973 F.3d 430 (5th Cir. 2020). The Fifth Circuit held that despite the general contractor’s oral agreement to pay the unanticipated costs, the subcontractor’s recovery was limited to the contract balance. The Fifth Circuit relied upon Lonergan and MasTec as controlling and concluded that the risk of excess costs had been allocated to the subcontractor under the parties’ contract and could not be re-allocated via a change order without valid consideration.

Contractors must be alert to the original contract’s risk allocation. Absent an express allocation otherwise, the contractor will bear the risk of cost overruns and will most likely be unable to shift unanticipated costs back to the counterparty after the work commences.

In D2 Excavating, Thompson Thrift Construction, Inc. (“Thompson”) was a general contractor who solicited a bid from D2 Excavating, Inc. (“D2 Excavating”) for site grading and excavation work. Thompson’s proposed contract represented that the project site was a “balanced site.” Yet, Thompson did not actually determine whether the site was balanced – i.e., that the work would not require importing or exporting dirt to achieve the planned elevations but required only transferring dirt within the site.

D2 Excavating did not investigate the site, but instead used a software program to determine the site was balanced, using the topographical survey Thompson provided. After performing simulations, D2 Excavating agreed to do the excavation pursuant to the proposed terms that Thompson originally provided with slight modifications. Notably, the contract provided:

Execution of this Agreement by the Subcontractor is a representation that the Subcontractor has visited the Project site, become familiar with local conditions under which the Work is to be performed and correlated personal observations with requirements of the Contract Documents. The Subcontractor shall evaluate and satisfy itself as to the conditions and limitations under which the Work is to be performed, including without limitation: (1) the location, condition, layout, and nature of the Project site and surrounding areas; (2) generally prevailing climactic conditions; (3) anticipated labor supply and costs; (4) availability and cost of materials, tools, and equipment; and (5) other similar issues. Accordingly, Subcontractor shall not be entitled to an adjustment in the Contract Price or an extension of time resulting from Subcontractor's failure to fully comply with this paragraph.

About a month into the project, it became clear that the site was not balanced. The parties disputed fault, but negotiated and decided that Thompson would cover D2 Excavating’s unanticipated excess soil costs. Thompson told D2 Excavating that it would issue a written change order. Relying on that promise, D2 Excavating continued its work under the contract.

Thompson, however, never issued the promised changed order. D2 Excavating stopped work once it became clear that Thompson was not going to pay the additional amounts to remove the dirt. At that point, 98.6% of the excavation was complete.

D2 Excavating sued Thompson for breach of contract, quantum meruit, violations of the Texas prompt pay statute, and to foreclose on a statutory and constitutional lien. Thompson counterclaimed for breach of contract. Notably, D2 Excavating did not pursue a fraud claim. The district court found for D2 Excavating, awarding D2 Excavating the unpaid contract balance, the unanticipated excess soil costs, interest, and attorneys’ fees. Thompson appealed, contending that D2 Excavating bore the risk that the site might be unbalanced and thus D2 Excavating could not recover beyond the contract price for any “excess” excavation work.

The Fifth Circuit agreed with Thompson. The Fifth Circuit recognized citing Lonergan v. San Antonio Loan & Tr. Co., 101 Tex. 63, 104 S.W. 1061, 1065–66 (1907): “The default rule in Texas, dating back to a case interpreting an 1899 contract to construct a building in San Antonio, is that the party doing the work bears the risk that it will end up being more difficult than anticipated unless the contract shifts that risk to the buyer of the services.” Further relying on El Paso Field Servs., L.P. v. MasTec N. Am., Inc., 389 S.W.3d 802, 811 (Tex. 2012), the Fifth Circuit provided: “This default rule flows from the basic contract principle that where one agrees to do, for a fixed sum, a thing possible to be performed, he will not be excused or become entitled to additional compensation, because unforeseen difficulties are encountered.” As noted by the Fifth Circuit, if “a factory agrees to manufacture 100 widgets for $500, it cannot later charge $600 if it ends up taking more labor or materials to produce the widgets than expected.” Because the contract did not expressly shift the risk to Thompson, D2 Excavating bore the risk of excess cost and could not recover more than the contract price from Thompson. The Fifth Circuit’s decision recognizes Lonergan and MasTec as controlling Texas authority.

The parties’ oral change order did not change the result. As held by the Fifth Circuit, the oral change order lacked consideration and was thus not enforceable. The purported consideration for the change order – exporting excess soil – was already required by the contract and thus could not form the basis of a valid contract modification. The Fifth Circuit therefore vacated the breach of contract award for the excess costs.

The Fifth Circuit further held that D2 Excavating could not recover under quantum meruit for the excess costs. The contract required the exporting of the excess soil. Under the general rule, quantum meruit is unavailable if a valid contract covers the services furnished. Too, the substantial performance exception could not apply as D2 Excavating sought the contract price plus quantum meruit, which is not allowed. Because the unanticipated excavation work was D2’s responsibility under the contract, quantum meruit was not a vehicle for recovering more than the contract price.

In sum, the time to allocate risk is at contracting as it will be unlikely that the parties can shift unanticipated costs post-contract absent valid consideration.

[View source.]

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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