C & A.S.E. v. RIO MAR NORTH ZONE DEVELOPMENT CORP

IN THE UNITED STATES BANKRUPTCY COURT
FOR THE DISTRICT OF PUERTO RICO
In re: :
:
C & A, S.E., : Case No. 05-5297 (GAC)
:
Debtor : Chapter 11
___________________________________:
:
C & A, S.E., :
:
Plaintiff :
:
v. : Adv. No. 05-00234
:
RIO MAR NORTH ZONE :
DEVELOPMENT CORP., :
:
Defendants :
___________________________________:
DECISION AND ORDER
The debtor filed this adversary proceeding against Rio Mar
North Zone Development Corporation (“North Zone”) seeking damages
for breach of a construction contract. The debtor claims the
amount of $920,000.00 for monies retained under the contract,
$950,000.00 for claims made against the debtor by service and
material suppliers as a consequence of change orders and
unspecified damages in the amount of $1,000,000.00, for a total of
$2,870,000.00. North Zone filed a counterclaim alleging that the
debtor breached the contract, by failing to complete the project
and that the debtor’s abandonment caused North Zone damages in the
amount of $2,849,541.44, including direct costs, liquidated
damages, construction taxes and additional inspection costs. North
Zone subsequently received the sum of $1,250,000.00 from the surety
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company and thus limits the damages claim to $1,599,541.44.
Three witnesses testified on behalf of the debtor, including
the operation’s manager for the project, the project engineer and
the President of the debtor corporation, related to the extensive
change orders and the delays in the project and as to North Zone’s
unwillingness to release retainage funds to allow the debtor to
complete the project. Two witnesses, the developer and the project
inspector, testified on behalf of North Zone regarding the nature
and extent of the project, the debtor’s obligations and
performance, the debtor’s alleged default and abandonment of the
project and the expenses incurred by North Zone to complete the
project.
After hearing the extensive testimony and after reviewing more
than 700 pages of transcripts and exhibits of an even more
voluminous nature, the Court concludes that both the debtor and
North Zone suffered damages under the contract. However, based on
the evidence submitted, the Court cannot conclude that either party
caused the damages suffered by the other. The Court cannot
conclude that it is more likely than not that either side is
responsible for the financial loss suffered by the other.
Accordingly, for the reasons set forth below, the Court will enter
judgment in favor of North Zone on the debtor’s complaint and
judgment in favor of the debtor on North Zone’s counterclaim.
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BACKGROUND
On January 24, 2000, the debtor entered into a lump sum
contract, in the amount of $20,373,490.00, with North Zone to
construct two apartment complexes or “clusters” and a parking lot
in Rio Grande, Puerto Rico. The contract term was 547 days, with
an expected completion date of July 24, 2001. Pursuant to the
terms of the contract, North Zone was responsible for the adequacy
of the construction documents, while the debtor had the obligation
to furnish all labor, equipment, material and services for the
total construction of the project. Subsequent to the commencement
of the work, the construction plans were modified and changed
through numerous change orders. In total, there were seventy-three
change orders, with some being additive and causing additional work
and others being deductive and decreasing the required work. The
project completion date was extended from 547 days to 1,710 days
and the cost of the project increased.
On August 31, 2004, the debtor sent a letter to North Zone
informing it of the debtor’s interest in finishing the project, but
indicating that the extension of the contract and the change orders
resulted in an additional cost to debtor of $2,600,000.00. In the
letter, the debtor contended that North Zone had abandoned the
original contract. The debtor sought an advance of $496,925.00 to
conclude the project. Notwithstanding that North Zone advanced
monies to the debtor on two previous occasions in order to finish
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the construction, on September 1, 2004, North Zone sent a letter to
the debtor declining the proposal and ordering the debtor to leave
the project on September 7, 2004, indicating that North Zone would
take over the project on September 8, 2004. North Zone ultimately
completed the project in December of 2005 at an approximate cost of
$25,000,000.00.
DISCUSSION
The leading case in Puerto Rico on the contractual rights of
parties pursuant to a construction contract is Levy, Hijo, Inc. v.
Public Buildings Authority, 1994 JTS 32, 135 D.P.R. 382, 1996 WL
724959 (P.R.), 1996 P.R.-Eng. 724,959 (publication page references
are not available for the English translation of this document).
In Levy, the Supreme Court of Puerto Rico attempted to harmonize
the authority of the owner of a construction project to issue
change orders, granted by a contractual clause, with the rights of
the contractor. The Court determined that delays in the time
originally agreed upon in these types of projects are common and
that they should be anticipated. Yet, the Court also determined
that a general contractor is entitled to delay damages when the
owner orders excessive or an unreasonable number of change orders,
beyond those contemplated in the contract. The Court opined that
a contractor should be compensated for industrial overhead and
profit for unforeseeable work and for the unforseen major costs of
planned works. Likewise, damages can be awarded to a contractor if
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the delay in the project caused by the owner exceed normal
construction industry practices.
A contractor’s right to indemnification results from
obstruction of the contractor’s performance with extraordinary
delays, which disrupt the contractor’s work, constituting a breach
of contract. The Court also indicated that a construction contract
can be annulled or revised by the Court. The Court concluded that
the intention of the parties must be considered taking into account
the contract, the parties actions, their expertise and industry
practices.
In Levy, an expert witness testified as to the normal length
of construction delay in the building of regional hospitals and
opined that a 45% delay was foreseeable based on change orders and
work stoppage orders. The Court considered this testimony and
concluded that each case has its own peculiarities and must be
resolved individually. Nonetheless, the Court concluded that
nothing bars the parties from contractually stipulating to avoid
judicial adjudication.
In summary, the Court in Levy held that a contractor is
entitled to recover from the owner, the additional costs associated
with change orders, that exceed the completion date beyond a
reasonable period of time. The contractor is also entitled to have
the delivery date extended for a reasonable period of time, in
spite of a contractual clause providing that “time is of the
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essence.” The owner is not liable for the indirect costs incurred
by the contractor for the reasonable time delay in delivery
resulting from change orders. The reasonableness of the time
delay and the forseeability of the delay depends on the nature and
complexity of the work and the prevailing practice in the
construction industry.
In the present case, the debtor alleges that the change orders
and time delays were due to design errors and/or delay in the
decision making process and that the change orders interrupted the
sequence of construction. And while the debtor argued that the
completion date was unreasonably extended based on excessive change
orders, the debtor failed to produce evidence as to the
reasonableness of the time delay, except testimony that it was
unreasonable. The project engineer testified that he had never
participated in a project in which the completion date was tripled
and that generally the contract would be in default before the
project completion date was tripled. While the parties agree that
the completion date was extended from 547 days to 1,710, the debtor
failed to present expert testimony to address the forseeability of
the delay, as it related to the nature and complexity of the work
and the prevailing practice in the construction industry.
North Zone, on the other hand, offered testimony demonstrating
that many of the change orders were anticipated by the debtor
before it began work on the project. The Court concludes that the
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debtor was aware of errors and omissions in the construction
documents before it began construction. Prior to commencing work,
the debtor was also aware that a cluster had to be relocated. One
of the initial problems encountered in relocating the cluster ten
to twelve feet back, with an elevation forty-two feet above that of
the initial plans, was that of encountering rock. This was not
foreseeable by either party based on the geological survey and soil
samples and it served to paralyze the construction. This concealed
condition was covered by Article 13.1.7 of the General Conditions
of the Contract for the Construction of Public Works, accepted by
the parties, which provided that:
[s]hould concealed conditions encountered in the
performance of the Work below the surface of the ground
be at variance with the conditions indicated by the
Contract Documents or should unknown physical conditions
below the surface of the ground of an unusual nature,
differing materially from those ordinary encountered and
generally recognized as inherent in work of the character
provided for in this Contract, be encountered, the
Contract Sum shall be equitably adjusted by Change Order
upon claim by either party made within twenty days after
the first observance of the conditions.
Thirty-one of the change orders related to the differing site
conditions in the new location. There were also significant
problems with a concrete subcontractor, which cannot be attributed
to North Zone. Thus, the Court concludes that numerous change
orders were anticipated and foreseeable before construction began
and others do not make North Zone liable to the debtor.
In spite of the extensive change orders and time delays, the
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parties continued under the contract, rather than renegotiate. The
parties had worked together on previous occasions, the principals
of the two corporations were childhood friends, and both had
expertise in the construction industry. The course of dealing
between the parties was to continue operating under the contract
and to execute the change orders as provided for under the
contract.
Article 13 of the General Conditions of the Contract for the
Construction of Public Works, provided for change orders, which
add, delete, alter or revise the contract. The financial
agreements pertaining to the change orders were agreed to in
accordance with Article 13. Pursuant to Article 13.2, claims for
additional costs were not valid unless made in writing within
twenty days after the occurrence of the event giving rise to such
claim. And while the parties did not always follow the process
established for change orders, since sometimes work was performed
and approved later, all the change orders were negotiated and
accepted.
Pursuant to the General Conditions of the Construction
Agreement itself, change orders were computed in strict accordance
to direct construction costs, exclusive of all indirect costs; plus
a 10% addition for overhead and profit. All terms were approved by
both parties. And the Supplementary General Conditions of the
Contract for the Construction of Public Works provided that the
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acceptance of a change order by the contractor, relieved North Zone
from all claims related to or as a consequence of the change order.
Therefore, because the debtor was compensated for all of the change
orders, pursuant to their terms, the debtor is unable to make
further claims against North Zone for the change orders.
While the debtor contends that the numerous change orders
constituted a breach of the construction contract and that it
suffered damages as a result of the change orders, it appears that
numerous change orders were produced and approved at the request of
the debtor and the debtor was paid for the change orders that
caused additional work to be performed. Other change orders were
deductive and required less work to be performed, or simplified the
job. If the debtor suffered damages as a result of the change
orders, it was because the amounts agreed to in the change orders
were not sufficient to compensate the debtor for what it agreed to
undertake.
The Court concludes that the intention of the parties, based
on the contract, their actions and their expertise, was to treat
the contract as if it were in full force, until the debtor
indicated that it would be unable to continue without further draws
from the retainage.
The Court notes that while North Zone had previously allowed
the debtor to draw from the retainage with the approval of the
surety, pursuant to the Supplementary General Conditions of the
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Contract, North Zone was not obligated to release retainage. The
supplementary conditions provide that the owner “may” release
retainage, which the Court concludes is permissive. With respect
to the retainage held by North Zone, Article 10 of the General
Conditions of the Contract for the Construction of Public Works, in
dealing both with progress payments (Article 10.3) and substantial
completion (Article 10.7), permitted North Zone to withhold the
retainage until all payrolls, bills for materials and equipment and
other indebtedness connected with the project were paid and the
consent of the surety was obtained. North Zone ultimately used the
retainage toward the completion of the project; a right that it
reserved in the contract.
North Zone also maintained the right to stop the work.
Pursuant to Section 4.3 of the General Conditions of the Contract
for the Construction of Public Works, accepted by the parties, the
owner retained the right to stop the work for any reason deemed
necessary to insure the proper execution of the contract. Clearly,
the debtor was having financial difficulties and while it expressed
the desire to continue, it was unable to perform without additional
payment from the retainage.
The Court was not placed in a position to determine the point
at which the number of change orders and the time delay became
unreasonable or the point at which they became unforeseeable. Yet,
it appears to the Court, based on the recognized inadequacy of the
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initial construction documents, that the debtor was justified in
leaving the project. Pursuant to Article 9.4 of the General
Conditions of the Contract for the Construction of Public Works,
the owner could seek to collect liquidated damages from the
contractor if it neglected to carry out the work, after notice to
the contractor and the surety. While the debtor continued under
the contract, the Court concludes that it was not obligated to
continue. North Zone appeared to have recognized this when it
failed to request damages or give notice to the debtor that it
would seek to collect from it for failing to complete the project.
Based on the sheer number of change orders and the extreme delay in
the project, the Court concludes that the debtor was justified in
stopping the work. Accordingly, no damages will be awarded to
North Zone.
ORDER
WHEREFORE IT IS ORDERED that judgment be entered in favor of
Rio Mar North Zone Development Corp. on C & A, S.E.’s complaint and
that judgment be entered in favor of C & A, S.E. on Rio Mar North
Zone Development Corp.’s counterclaim.
SO ORDERED.
San Juan, Puerto Rico, this 8th day of October, 2008.
s/ Gerardo A. Carlo
________________________________
GERARDO A. CARLO
Chief, U.S. Bankruptcy Judge
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