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Every Word Counts: Critical Lessons in Contract Language

Disputes are an unfortunate part of construction. Complex projects invite disagreement, and while most disputes are resolved by the project participants, a very few end up in court or arbitration. To that end, anyone who has gone through the painful process of allowing third parties such as arbitrators, judges or juries who were not involved in the project, to decide a dispute will tell you that contract language takes on a whole new meaning when disputes are decided by people who were not involved in the project.

Contracting parties often pay little attention to contract clauses - until disputes arise. A recent decision of the North Carolina Court of Appeals, Cleveland Construction, Inc. v. Ellis-Don Construction, Inc. et al, ____ S.E.2d ____ , 2011 WL 1238364 (N.C. App. 2011), focused on several issues that arose between the general contractor, Ellis-Don ("ED") and one of its subcontractors ("CCI") on a hospital construction project ("Project"). At the completion of the Project, ED had submitted a claim for extras, delay and inefficiency to the Project's owner and architect, and had eventually settled the claim. Prior to submitting the claim, ED had solicited claims from many of its subcontractors, including CCI, and those subcontractor claims were included in what ED presented to (and ultimately settled with) the owner and architect. The issue in the ED/CCI lawsuit was how much, if any, of the settlement proceeds should be paid to CCI.

As any experienced construction professional knows, "pass-through" claims, in which the general contractor essentially "sponsors" a subcontractor's claim to the owner, are common on construction projects. The handling of such claims (who controls the processing, how money obtained by settlement or judgment is distributed among the participants in the claim, payment of attorney and expert witness fees and more) is often addressed in the subcontract. If not addressed in detail there, these issues are almost always addressed in a liquidating agreement, a document signed by the parties once claims are imminent containing the specifics on the handling of claims. The goal is to make sure that once the claim is resolved between the general contractor and the owner, the general and the subcontractor do not end up in their own fight over who gets how much of the proceeds. The CCI v. ED case illustrates what happens when the parties are unable to reach an agreement on these issues.

The subcontract between ED and CCI stated that CCI could only recover on account of delay and inefficiency if ED decided to pursue such claims from the owner and/or architect and actually recovered money. As noted above, ED did recover from the owner and architect, but the settlement proceeds were not allocated, the subcontract did not specifically address how much of the settlement funds belonged to CCI, and the parties never entered into a liquidating agreement. When the parties were unable to settle on an amount, they went to court.

After a 16 day trial, a significant judgment was entered in favor of CCI. However, the judgment was reduced by an amount that the Court felt was "fair" to compensate ED for having pursued the claim in the first place. In other words, the Court concluded that CCI should contribute to ED's costs of having pursued the claim since, absent that pursuit, there would not have been any recovery in which CCI could share.

When ED appealed the underlying judgment in CCI's favor, CCI cross-appealed on this single issue, arguing that since the subcontract did not require CCI to share in the costs of pursuing the claim and there was no liquidating agreement, the trial court erred in reducing the judgment to require CCI to pay its "fair share" of the claim pursuit costs. The North Carolina Court of Appeals agreed with CCI and reversed the trial court on this issue.

On first blush, this seems terribly unfair. The subcontract did not require ED to pursue claims; in fact, it left that decision totally to the discretion of ED. Further, the subcontract said that CCI would only be paid for delay and inefficiency if ED submitted claims and recovered. The evidence at trial was that ED spent in excess of $1.5 million pursuing the claim. Wouldn't it be "fair" for CCI to shoulder some portion of that burden?

Not so fast, according to the Court. The subcontract was ED's standard form subcontract. The language regarding the pursuit of claims was written by ED, and it was not modified by the parties. While the language addressed the handling of claims, it said nothing about any obligation for CCI to contribute to the pursuit costs. Additionally, the subcontract included an "integration clause," meaning that the entire agreement of the parties was contained in the subcontract -- there were no verbal side agreements regarding the payment of costs, etc.

To that end, the subcontract, drafted by ED and signed by CCI, did not help ED in this case. The Court held that because the subcontract did not obligate CCI to share in the claim pursuit costs, the trial court erred when it required CCI to do so. Also, because the parties did not have a liquidating agreement in place to address the issue, the Court found that there was no written obligation for CCI to pay any portion of ED's costs of pursuing the claim. These were two sophisticated parties, and the Court held them to the terms of their written agreement.

There are several take-aways that can be learned from this case. First and foremost, the words that are in contracts mean something. Alternatively, the omission of words is also significant. While it may have been "fair" for CCI to pay a portion of the cost incurred by ED in pursuing recovery from the owner and architect, "fairness" took a backseat once ED and CCI ended up in litigation. Second, whether addressed by way of the subcontract or a later liquidating agreement, it is best if the parties agree in advance on how claims are to be processed (i.e. who takes the lead in pursuing them, how funds obtained via settlement or judgment are distributed, how the costs of pursuing claims are to be borne, etc.). Had that occurred here, ED and CCI would likely have not ended up in their own lawsuit, itself an expensive and lengthy process that began in 2004 and was not finally resolved by the North Carolina Court of Appeals until 2011.

Every word in a contract means something, and the omission of words in a contract is of equal importance. The failure to adequately address issues in a contract is often a cause of later frustration, disagreement and even legal actions between the contracting parties.

Seth R. Price, shareholder in the Atlanta office of national law firm Chamberlain Hrdlicka, possesses significant experience in the field of construction law. For nearly 30 years, his practice has emphasized the resolution of large, complex construction contract disputes in state and federal courts and through arbitration. He assists owners, contractors and subcontractors in resolving potential and actual construction disputes.

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