Under Construction - December 2017

Snell & Wilmer

Letter from the Editor

Welcome to the final 2017 edition of our Under Construction newsletter. It is hard to believe that 2018 is right around the corner!

In this issue, we highlight several topics affecting the construction industry not just today, but as we move into the new year. Our first article addresses that things are looking good overall for construction in 2018. This article points out that as the U.S. economy continues to improve, corporate tax liability and regulation are expected to decline and private and public projects are anticipated to thrive nationwide. Therefore, it will be important to monitor and understand some of the most prevalent issues that will impact the construction industry next year. Our first article provides some thoughts on legal topics that will probably dominate construction in 2018 based on the author’s consultations with our clients, colleagues and industry experts.

As you know, construction contracts almost always include deadlines. One way to emphasize and ensure compliance with contractual deadlines is to include a “time is of the essence” clause, but that may not always be enough. Our next article provides analysis to those who rely solely on this clause and how they may want to protect themselves by having key deadlines enforced.

Another article describes a recent case where the Arizona Court of Appeals declined to enforce Arizona’s prompt pay protections to a subcontractor on a federal project. Since payment is the cornerstone of the construction industry, this article is essential reading.

Other interesting cases covered in this edition include a California Appellate Court case that clarified prevailing wage law for public works projects, another run-of-the-mill insurance coverage case in the California Appellate Court that turned out to not be so run-of-the-mill and provides additional arrows for obtaining insurance coverage in a construction defect case, and a recent Colorado liquidated damages case that just made the issue more complicated.

We hope you will find these articles informative and enlightening. Please let us know if you want us to address a specific construction issue in a future newsletter. We hope your year has been good to your family, your company and you as we wrap up these remaining few weeks of 2017. Hoping that 2018 is your best year yet!

Jim Sienicki

Anticipated Hot Topics for Construction in 2018

by Richard G. Erickson

Things are looking good for construction in 2018. As the U.S. economy continues to improve, corporate tax liability and regulation is expected to decline and private and public projects are anticipated to thrive nationwide, it will be important to monitor and understand some of the most prevalent issues that will impact the construction industry next year. Based on consultations with our clients, colleagues and industry experts, here are some of my thoughts on legal topics that will probably dominate construction in 2018.

Project Documentation

Construction litigation will continue to rely predominantly on how well you document your project at the time the dispute arises. Far gone are the days of competing “he said, she said” verbal disputes over scope changes, critical path delays and prompt payment. Individual and company smart phones, portable laptop computers and Wi-Fi connectivity on site have provided more immediate means of documenting project conditions and claims. All of this technology generates emails, text messages and phone calls that often combine as compelling evidence of swift notice and that something is wrong on the project.

While some of this information may pose hearsay and other challenges of admissibility at trial or arbitration, collaborative testimony and records custodians can always help establish trustworthiness and help overcome evidentiary objections to electronic communications. Some courts have recently analyzed facts in which electronic communications sufficed to create a binding agreement under the Statute of Frauds. In addition, judges, juries and arbitrators are more familiar now with documenting project conditions by electronic communications, and litigation decision makers tend to appreciate the credibility of messages sent more immediately on site than from an offsite office much later.

When issues arise on the project, for example, a project manager has the ability to send a text message or email from their smart phone in order to make an immediate record of the problem. Contemporaneous documentation of the problem is far more reliable than the same messages sent by the project manager at the end of each week or verbally at the morning or weekly construction meetings. If a dispute arises, the project manager can produce evidence they sent the message and that the intended party received it. As a result, a key aspect of claims litigation has become the “hold” letter that demands all parties preserve their electronically stored information (ESI) and data on company and personal phones, computers and other devices. This “hold” would and should include preservation of any social media messages or postings about the project, since there may be material evidence regarding what has been communicated or stated in cyberspace. If ESI and data are destroyed or lost after this “hold” letter is received, a party may have other remedies in addition to damages on the actual claim.

Insurance and Indemnity

Insurance will continue to be a gamble in the construction industry. Some insurers and sureties appear to be determined to try and force their upper hand over owners and contractors by utilizing what are, in many cases, incomprehensible endorsements, waivers and insurance policy riders. Often, these endorsements and waivers are expressly prohibited by the governing contract documents on the project but are forced by the insurers as addenda anyway. Litigation over this inconsistency becomes inevitable because insurers are not parties to the construction contracts but are after players in resolving construction disputes. Thus, the actual parties on the project are often left disputing the enforceability of the insurance documents, and insurers respond by threatening to deny coverage for legitimate claims. Resolving any insurance inconsistencies in the project documents, therefore, becomes paramount before contracts are signed.

To be sure, risk transfer is still the most obvious objective of obtaining insurance to cover losses on a construction project. However, indemnity has become perhaps the most confusing aspect of risk transfer on the project. In some cases, for example, clients have asked for review of indemnity clauses consisting of more than 1,000 words. Some of the clauses appear to commit a contractor to broad indemnity obligations but then become confusing by identifying more specific obligations in following paragraphs. Other clauses bind the contracting parties to upstream or downstream indemnity provisions that are entirely inconsistent. Indemnity obligations become irreconcilable and confusing, and contract negotiations are consequently bogged down while the parties try to decipher the indemnity language and agree on a reasonable and applicable provision.

In addition, as provided below, the tendency to favor form agreements many times fails to account for state-specific legal restrictions of indemnity, assuming the project is governed by the law of the state where the project is located. Most jurisdictions, for example, prohibit indemnity of another party’s negligence on public projects, but many contracts still include broad indemnity that violates the anti-indemnity statute.

Since getting indemnity rights can literally free a contracting party of significant legal expense and damages exposure, parties should especially take the time to strike wordy language that confuses the parties’ obligations. Taking time to refine or revise indemnity clauses can also shift risk elsewhere and make indemnity more of a zero-sum game. If, in picking apart an indemnity clause a contractor realizes it is taking on more liabilities than it is willing or able to take on, the contractor should demand a higher price, consult with its own insurers to try and cover the increased risk or move on to projects with less exposure.

Form Contracts

I anticipate form contracts will continue being the preferred starting point for project documents. This year, the American Institute of Architects (AIA) completed a comprehensive vetting of their form agreements by introducing updates to its 10-year-old contracts. The AIA forms are very familiar and popular since the AIA has more than a 100 years of experience producing all types of written agreements for all means of project delivery. Although revisions in 2017 were not substantial, expect the AIA’s prime contracts, general conditions, design agreements and subcontracts to be preferred form contracts in 2018. The updated AIA forms are also a good comparison tool when negotiating and drafting construction agreements from scratch.

The AIA tailored its 2017 revisions to match advances in technology by eliminating obsolete means of communication like faxes and by anticipating paperless payment administration on projects certified for Leadership in Energy and Environmental Design (LEED). In addition, the most common form of General Conditions, the AIA A201, changed slightly to address some of the complicated insurance risks that were discussed above. The A201 now includes more options and an exhibit for detailing insurance coverage to mirror what contracting parties were already doing with endorsements and addenda to their construction agreements. Payment and performance bonds can also be more specifically identified for clarity through the new and improved A201. For a more direct view of the 2017 updates, you can access the revised documents at https://www.aiacontracts.org/.

The choice of contractual dispute resolution continues to favor private arbitration, even though form contracts expressly provide a litigation option. This is despite the perception that private arbitration has become more expensive than it used to be. Experiencing steep filing fees and high hourly rates for the best arbitrators has discouraged some contracting parties from choosing mediation and arbitration. The stigma of public litigation, and the fear of overwhelming a jury with a complicated construction dispute, however, may be enough to keep many disputes in a private dispute resolution forum. Current editions of AIA and ConsensusDocs form contracts provide enough options to match dispute resolution with the parties’ contractual intentions. Contracting parties will, nevertheless, need to pay close attention to edited form contracts and should fight harder for what is reasonable and consistent with governing law.

Getting Paid

Getting paid will continue to evolve into a more accountable and timely process due to construction management software like Textura and because electronic transfer of funds has become the preferable and prevailing means of receiving payment. Many owners and contractors seem to finally agree on the cost savings of paperless projects. Faster administration of payment also creates higher morale on the project. Owners and contractors disagree, on the other hand, about the legal grounds for withholding and delaying payment, even when there is a Prompt Payment Act and there has been no timely written objection to work on the project.

While many jurisdictions have fashioned prompt payment laws to deter owners and contractors that delay or withhold payment without a timely written objection first, some have argued these laws only served to create another legal cause of action for payment to be litigated (along with the unwelcome and unanticipated cost and time of litigation). General contractors have continued to insist upon pay-if-paid/pay-when-paid conditions as a buffer against prompt payment laws. Contracts have also become littered with tedious payment application details that wind up delaying submissions for weeks. Some subcontractors have complained about non-negotiable provisions that purport to delay their statutory lien rights until the subcontractor engages in an expensive dispute resolution procedure first.

In 2018, anticipate that payment disputes will continue to be the disputes that require inordinate litigation to resolve. For one, payment disputes tend to become personal and immediately heated because of their impact on the schedule and on established relationships on the project. Slow pay and no pay almost always triggers fear that something more serious is coming. No matter what the contract says, contractors will more promptly evaluate the risk of terminating the contract compared to the consequences of proceeding with doubts about getting paid. Secondly, litigation over payment tends to take more time than anticipated to resolve. The parties are at odds to begin with over a major disparity in what is owed, if anything. Final-hour additions and back charges enter into the negotiations and destine settlement for failure. Litigation experts hypothesize about damages that may be expressly waived under the parties’ written agreement, or by prior lien waivers. Finally, once attorneys’ fees and expert costs are added to the payment problem, parties become more determined to be made whole by an outcome that includes their litigations costs. Construction mediators and arbitrators, however, often ask the parties to leave fees and costs out of the negotiations. Contractors will also hold on to their liens for dear life even though foreclosure on the lien is often of little value compared to the lender’s priority position on the property.

Thus, while payment administration has become more sophisticated, disputes over payment will remain an unavoidably costly problem in the industry. There is no contractual provision or statutory scheme that appears to discourage payment disputes. Even when parties clearly agree to be bound by payment terms in their written agreements, nonpayment sometimes causes parties to forget some of the harsh prerequisites to getting paid. In the end, the trend is for judges and arbitrators to strictly enforce the parties’ written agreements because they reflect negotiated terms and mutual obligations of sophisticated commercial parties.

In my opinion, these are just a few of the topics to watch in the coming year based on what weighs heavy on the minds of owners, developers, contractors, subcontractors, suppliers, and design professionals.


Even When Your Contract Says So, Time May Not Always Be “Of the Essence”

by Justin L. Carley and Michael Paretti

Construction contracts almost always include deadlines. One way to emphasize and ensure compliance with contractual deadlines is to include a “time is of the essence” clause, but that may not always be enough.

The rules of contract interpretation generally provide that, if possible, each provision of a contract should be given meaning and purpose. This does not mean, however, that all contract provisions are created equal – some are material and some are not. That distinction becomes important in litigation that concerns a deadline in a contract that contains a general “time is of the essence” clause. In Nevada, a material contract provision is a matter of such importance that one party would not have entered into the contract if it foresaw the other party’s failure to perform that provision. Thus, breach of a material provision would defeat the purpose of the contract and therefore relieve or discharge the non-breaching party from its remaining performance obligations. On the other hand, an immaterial contract provision is not absolutely critical to the purpose of the underlying contract, so a breach is not as serious, and does not relieve the non-breaching party from its remaining performance obligations.

In terms of timeliness, “a delay in performance is material only if the time of performance was made of the essence by the express language of the contract or by its importance under the circumstances.” Nevada’s Civil Pattern Jury Instructions, CONTRACTS INSTRUCTION 13CN.42. Regardless, just having a general ‘time is of the essence’ clause in the contract may not be enough to make timely performance of every contractual deadline a material requirement.

For example, a Nevada trial court recently ruled that a general “time is of the essence” clause was insufficient for a landlord to rely upon when attempting to enforce a tenant improvement reimbursement request deadline, in part because the provision containing the reimbursement request deadline did not emphasize that time was of the essence of its performance specifically. Then, the court looked outside of the four corners of the contract and considered the parties’ conduct, which also failed to evidence that they treated time as of the essence regarding the reimbursement request deadline specifically. In turn, the court found that despite the existence of a general “time is of the essence” clause, tenant’s failure to timely request reimbursement was immaterial, thus it did not excuse the landlord’s material obligation to reimburse the tenant.

So, beware. If you want to enforce a deadline, the belt and suspenders approach would be to include a general “time is of the essence” clause in the contract, and then, specifically also say so in any provision that contains an important deadline. Additionally, the parties’ actions need to reflect that time is of vital importance. Silence or inactivity surrounding key deadlines could lead to a determination that the deadline was not material, which might unintentionally excuse untimely performance.


Arizona Court of Appeals Declines to Enforce Subcontractor Prompt Pay Protections on Federal Project

by Jason Ebe

On November 16, 2017, the Arizona Court of Appeals issued its opinion in Zumar Industries, Inc. v. Caymus Corporation, in which it reversed the trial court’s granting of summary judgment in favor of the subcontractor, Zumar, on its breach of contract claim against the general contractor, Caymus, for the contractor’s failure to promptly pay the subcontractor amounts the contractor had received from the owner on behalf of that subcontractor.

For background, this case arose from a project for the National Park Service to furnish and install new motorist guidance signs at the Grand Canyon National Park. The contractor purchased the sign panels from the subcontractor, received the sign panels from the subcontractor, and invoiced the federal government, representing that the sign panels line item work was 100 percent complete. Based on that representation, the federal government paid the contractor in full for this line item. However, the contractor did not make payment to the subcontractor. Rather, the contractor concealed from the subcontractor that it had applied for and received payment, and otherwise mislead the subcontractor into believing payment had not been received. After attempts to resolve the dispute through settlement were unsuccessful, the subcontractor filed suit for the balance owed, and, during discovery, learned of the contractor’s conduct in receiving payment from the federal government but refusing to pass those payments received to the subcontractor.

The federal prompt pay act, 31 U.S.C. 3905(b)(1), and the Arizona prompt pay act, A.R.S. 32-1129.02(B), require that a contractor pay a subcontractor within seven days of receipt of payment from the owner for that subcontractor’s work. Based on these laws and the contractor’s conduct, the subcontractor prevailed first at arbitration and second at the trial court on the basis that the contractor materially breached the subcontract by wrongfully withholding payment in violation of these prompt pay laws.

On appeal, the Arizona Court of Appeals held, first, that the Arizona prompt pay act did not apply to the subcontract for the work on the federal project and, second, that the subcontractor did not establish that the contract to furnish and install signage was a construction contract subject to the federal prompt pay act requirements. The appeals court remanded the case back to the trial court to determine, absent the statutory violations, whether the contractor materially breached the contract by failing to pay the subcontractor.

What’s the take away here, in particular for subcontractors and suppliers seeking prompt payment for their work and materials? While the prompt pay statutes are very helpful, they may not always apply, so, best practice is to include as an express term in the subcontract or purchase order a requirement that the contractor pay the subcontractor or supplier the amounts received by the contractor on behalf of the subcontractor or supplier within seven days of receipt of that payment. Then, the subcontractor or supplier can more easily establish a material breach of that agreement without reliance on the prompt payment statute. Moreover, the subcontractor or supplier should seek information, where feasible, from the owner as to the status of owner payments to the contractor, to verify the contractor’s representations as to whether it has billed for and been paid for the subcontractor’s work or supplier’s materials. The Arizona prompt pay act specifically authorized a subcontractor to do so. A.R.S. § 32-1129.01 (R).


California Appellate Court Clarifies Prevailing Wage Law for Public Works Projects

by Cary D. Jones *

On June 30, 2017, in Cinema West, LLC v. Christine Baker et. al., No. A144265 (Cal.App. 2017), the California First Appellate District Court of Appeal decided that the construction of a movie theater by Cinema West, LLC (Cinema West) in Hesperia, California qualified as a “public work” within the meaning of California’s Prevailing Wage Law because Cinema West had accepted public funds for the construction of an adjacent parking lot and various off-site improvements. The question presented in this case was whether part or all of the construction work undertaken by Cinema West and the City of Hesperia (City) should be considered as an integrated project in assessing whether public funds were deployed.

As background, California’s Prevailing Wage Law requires workers employed on public works projects to be paid the local prevailing wage for work of a similar character (Cal. Lab. Code § 1720-1784). The Cinema West Court noted that public works is broadly defined as a project that involves construction, alteration, demolition, installation, or repair work done under contract and paid for in whole or in part out of public funds. Furthermore, the Court explained that the phrase “paid for in whole or in part out of public funds” has been broadly interpreted to encompass both direct and indirect subsidies, including the performance of construction work by the state or political subdivision in execution of the project or money loaned by the state or political subdivision that is to be repaid on a contingent basis.

Cinema West contracted to develop a movie theater in the City. The City sold Cinema West a plot of land at fair market value of $102,529 under the Disposition and Development Agreement (DDA) that required Cinema West to build the theater. Under the DDA, Cinema West agreed to a 10-year operating covenant in exchange for forgivable loans from the City and a one-time payment from the City of $102,529. The DDA obligated the City to develop an adjacent parking lot that provided Cinema West with reciprocal access, as well as various off-site improvements for the theater, including a water retention system.

In administrative proceedings initiated by a local electrical workers union with the California Department of Industrial Relations, the Director of Industrial Relations (Director) found that the theater, parking improvements and related facilities were part of a single integrated project and were subject to prevailing wage requirements. The Director identified three separate sources of public funds utilized on the project: the City’s one-time payment of $102,529 to Cinema West upon the filing of a notice of completion for the theater; the two forgivable loans made by the City to Cinema West of $1,546,363 and $250,000 in connection with the operating covenants; and the City’s construction of the adjacent parking lot and installation of off-site improvements.

Cinema West then filed an administrative appeal of the Director’s determination and claimed that it would not be receiving any funds from the City, but failed to provide any evidence contesting the public works determination. Cinema West then filed a petition for writ of mandate challenging the Director’s decision, which the Superior Court denied. Cinema West subsequently appealed the Superior Court ruling and argued a private construction project should not be subject to prevailing wage requirements merely because other related construction was publicly funded, and that the mere coordination of two related construction projects did not create a complete integrated object. Cinema West finally argued that the theater project did not involve public funds because the forgivable loans and one-time payment were never accepted.

The Court heavily relied on an analysis in Oxbow Carbon & Minerals, LLC v. Department of Industrial Relations (2011) 194 Cal.App.4th 538, where the Second District Court of Appeal set forth the concept that construction is the creation of the whole—the “complete integrated object”–which is composed of individual parts. This approach led the Court to determine that the Cinema West theater construction was completely integrated with the parking lot improvements and the related off-site improvements and therefore subject to prevailing wage requirements. The DDA also indicated that the parking lot was necessary to serve the theater and Cinema West was obligated to maintain improvements and utilities on the parking lot pursuant to the covenants, conditions and restrictions as well as the reciprocal access and parking easement. Beyond this, Cinema West and the City agreed to coordinate the design and construction of both the theater and the parking lot which were built at the same time on the same vacant lot.

Finally, although Cinema West claimed it would no longer be receiving any funds from the City, the Court of Appeal found that refusing public funds post-construction would undermine the Prevailing Wage Law by denying workers the minimum prevailing wage for work already performed and found the argument irrelevant in determining that the project qualified as a public work.

Importantly, the Cinema West decision makes it clear that the coverage of the Prevailing Wage Law is broad, and developers should be aware of this decision.

* Cary Jones would like to thank Jenna Le who contibuted to this article.


California Appellate Court Finds Contractor’s Delay Damages Covered Under a CGL Policy

by Michael J. Baker

In what would normally be considered a run-of-the-mill insurance coverage case, a California Appellate Court has found that a Commercial General Liability (CGL) insurance policy covered losses for delay damages arising from “property damage” under the insuring clause of the policy. The court noted that the policy did not define damages to exclude delay costs. The court interpreted damages to be payments made to compensate a party for direct or consequential injuries caused by the acts of another and found that delay costs were a consequential loss and as such, were part of the damages the insurance company must pay because of “property damage”. Global Modular, Inc. v. Kadena Pacific, Inc. California Fourth Appellate District, Case No. E063551.

The Global Modular case arose out of an insurance dispute between a general contractor, subcontractor, and the subcontractor’s general liability carrier over water damage to a building construction project caused by heavy rains. The United States Department of Veterans Affairs (VA) hired Kadena Pacific, Inc. as the general contractor to oversee construction of a building that was to house the Center for Blind Rehabilitation in Menlo Park, California. Kadena hired Global Modular, Inc. to build, deliver, and install the 53 modular units that would comprise the building. Because Kadena had hired a different subcontractor for the roofing, Global Modular agreed to deliver the units covered only by roof deck substrate. Kadena initially scheduled delivery in the summer months, but delivery was delayed until October and November, the rainy season. Despite Global’s positive efforts to protect units by covering them with plastic tarps, the interior suffered water damage from the rain. Ultimately, Kadena and Global mutually agreed to terminate the contract and Kadena oversaw the remediation of the water damage to repair and complete the project. Global sued Kadena for failure to pay and Kadena countersued, alleging Global breached the contract in various ways, including failing to repair the water damaged interiors. The parties partially settled their case before trial. They reserved for trial claims potentially covered by Global's insurance policy with North American Capacity Insurance Company (NAC). The trial court ruled in favor of Kadena, finding the damage award was covered under NAC’s policy as a matter of law. The Court of Appeal concluded the trial court properly determined NAC’s policy covered the water damages and that Kadena was entitled to attorney fees.

On appeal, NAC argued that the delay damages awarded for the 131 days Kadena spent repairing the water damage was not covered under its policy because it did not constitute “property damage” under the policy terms. The Court of Appeal disagreed stating, “contrary to NAC’s contention, delay damages arising from ‘property damage’ fall under the insuring clause, which obligates NAC to pay those sums that the insured becomes legally obligated to pay as damages of…. “property damage” to which the insurance applies” (emphasis in original). The Court noted the policy did not define damages, but courts generally interpret the term to include payments made to compensate the party for direct or consequential injuries caused by the acts of another. The Court noted that policy language interpreting “damages” in the CGL insuring clause is to be interpreted broadly to include all of the “expenses” attributed to actual cleanup, mitigation of damage or investigation or monitoring.

NAC also argued that: 1) water damage was not covered under its insurance policy; 2) damages concerning property damage arising out of the insured’s operations were excluded; and 3) the water damage was excluded because the insured’s work was incorrectly performed on the property that was damaged, i.e., the insureds’ work product. The Court of Appeal acknowledged NAC’s argument that commercial general liability insurance policies are not designed to provide contractors and developers insurance to cover claims that their work is inferior or defective, but the court noted “the problem with NAC’s argument is that is based on its view of the underlying policy of commercial general liability insurance and not on an application of the policy language to the facts of the case.” The court found that the work, even if performed correctly or inadequately here was not part of Global’s “work” and therefore was covered because Global was not physically working on the units at the time of the water damage. The exclusion did not apply. The court also noted it was important that there was no allegation the items for which Kadena sought repair or replacement costs – the drywall, insulation, framing, and ducting – were defective. Global prevailed against NAC on the coverage of the water damage.

The Court also addressed whether attorney fees were recoverable under the contract in light of the fact that parties’ settlement agreement released the right to attorney’s fees. The court noted that settlement agreement reserved rights to assert claims covered by insurance which were not covered by the release of the attorney's fees claim. The court likewise found that the settlement amount paid by Global should not be offset by the damage award covered by NAC’s policy of the payment because the settlement amount represented payment exchanged for Kadena’s release of claims other than its water damage claim.

The take away here is to carefully read the insurance policy. Reliance on broad statements of coverage and exclusions do not substitute for the application of specific policy language to the facts of the case. Global Modular underscores the point that delay damages may be recoverable depending on the language of the insurance policy.


Liquidated Damages in Colorado Just Got More Complicated

by Kevin Walton and Daniel R. Frost

Liquidated damages can be one of the most important considerations in any construction contract, not only when the owner and the contractor find themselves in dispute, but also when the contract is initially negotiated. A recent Colorado case emphasizes just how careful the parties need to be in negotiating and drafting liquidated damage provisions.

Generally speaking, the essential purpose of a liquidated damages clause is to provide a simple and efficient measure of damages for various breaches. It has been said that liquidated damages clause is an “advanced settlement” of the damages that might flow from nonperformance. To that end, many parties when drafting a liquidated damages provision, simply recite that: (1) the parties intended to liquidate damages; (2) the amount of liquidated damages was a reasonable estimate of the presumed actual damages caused by a breach; and (3) at the time of contracting, it was difficult to ascertain the amount of actual damages that would result from a breach. That approach may no longer be sufficient in Colorado, however. In Ravenstar, LLC v. One Ski Hill Place, LLC, 401 P.3d 552 (Colo. 2017), the Colorado Supreme Court addressed what happens when a contract gives a party the right to choose between liquidated damages or actual damages.

In Ravenstar, plaintiffs contracted to buy condominiums from a developer. As part of their contracts, plaintiffs deposited earnest money and construction deposits equal to 15 percent of each unit’s purchase price. Plaintiffs breached their contract by failing to obtain financing and failing to close by the closing date. Each contract’s damages provision provided that if a purchaser defaulted, the developer had the option to retain all or some of the deposits as liquidated damages or, alternatively, to pursue actual damages and apply the deposits to that award. After plaintiffs defaulted, the developer chose to keep plaintiffs’ deposits as liquidated damages. Plaintiffs sued for return of their deposits.

Plaintiffs argued that the liquidated damages provision was unenforceable because it gave the developer the option to choose between liquidated damages and actual damages. From this, they argued that there was no mutual intent to liquidate damages because there wasn’t an agreed sum of damages. The trial court and the appellate court disagreed with plaintiff, both ruling in favor of the developer. The Colorado Supreme Court concluded that, as a matter of freedom of contract, a liquidated damages clause is enforceable when the contract allows the injured party to choose between liquidated damages and actual damages. But the Court provided one limitation—the option must be exclusive, meaning that a party can’t seek liquidated damages and actual damages.

Under Ravenstar, Colorado owners may include optional liquidated damages provisions in their contracts without invalidating the liquidated damages provision. If the relationship results in litigation, the court may allow the party to choose between the liquidated damages or actual damages. Even if the actual damages exceed the liquidated amount, compelling reasons may still exist to choose the liquidated damages. Which in turn leads to the following questions:

  • Which state’s law will apply?
  • To what breaches will the provision apply?
  • How does the clause relate to the other provisions of the contract?

The Ravenstar case underscores the importance of thinking carefully and drafting precisely inputting liquidated damages provisions into contracts.

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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