This article first appeared in Thompson Reuters Construction Accounting & Taxation, July/August 2009 – Vol.19, No. 4, and is reprinted with permission.
Is it worth pursuing your construction claim?
The decision to proceed may not be clear-cut. This post analyzes some factors potential claimants should consider when determining whether to file a lawsuit or demand for arbitration.
I wrote the article below (published article available here) during the last major downturn, around 2009, but many of the same thoughts and principles apply in 2020.
The recent economic downturn has left many in the construction industry wondering whether it is worth pursuing their construction claims. Several factors go into that decision, some of which are quantifiable and tangible, others of which are personal and emotional.
Assuming the intangible factors do not win out, one should decide whether to pursue the claim in the same manner one would determine whether to make any investment: if the likely gain exceeds the likely loss, then an investment in the claim may be economically worthwhile.
Unfortunately, calculating the likely gains and losses is as much an art as it is a science.
One evaluation method is to multiply the amount the potential claimant is likely to win by the likelihood of winning, and then subtract the cost of prosecuting the claim, which is generally measured in attorneys’ fees and court costs. For instance, if a claimant has a 65% chance of winning a claim worth $100,000, and the average cost to prosecute this type of claim is $25,000, the claim may be an economically worthwhile asset since $65,000 is more than double the likely collection costs.
Of course, accurately predicting the likelihood of winning is a tricky business, even for construction attorneys.
The value of a potential claim must also be evaluated in light of variables that are less readily quantifiable, such as the likelihood of collecting damages from one’s opponent, who may be insolvent by the time of judgment, and the costs of the interruption to the claimant’s business, including loss of reputation and loss of productivity.
Potential claimants should try to consider all possible outcomes to their claims and the likelihood of those outcomes, including any counterclaims one’s opponent may have, and the various tracks the dispute may proceed upon when deciding whether to initiate a lawsuit or arbitration… when deciding whether it is worth pursuing your construction claim.
Mediation Before Litigation or Arbitration?
Statistics indicate that only around 3% of civil lawsuits result in a trial.[1] This is in part because trials are complicated and expensive, and in part because of the widespread use of nonbinding mediation before arbitration or litigation.
I wrote an article entitled Non-Binding Alternatives to Court Litigation for Resolving Construction Disputes, which is available for free download at that link, to explore alternatives to litigation and arbitration for the design and construction industry.
Mediation is an inexpensive process in which a neutral third party attempts to facilitate a negotiated settlement between two or more parties. Mediation tends to succeed if the parties proceed in good faith with a realistic understanding of the consequences of not settling.
Mediation is a valuable tool for assessing whether an investment in a lawsuit or demand for arbitration would be economically worthwhile. Even mediations that fail to result in a settlement are seldom failures, as the process of exchanging information with one’s opponent tends to provide valuable insight into the defenses or counterclaims one may face in court or arbitration proceedings.
If mediation is not required by contract, it is worthwhile to inquire whether the other party will agree to participate in a voluntary mediation. The parties can always agree to submit their dispute to mediation even if it is not contractually required.
Have You Complied With The Construction Contract?
One considering whether it is worth pursuing your construction claim should first ask itself whether it and the parties for whom it is legally responsible, such as his subcontractors, complied with the terms of the contract. Parties who fail to fulfill their contractual obligations risk counterclaims and adverse outcomes, and should think twice before proceeding with a construction claim.
Sometimes one’s failure to perform his obligations under a contract can be justified by the other party’s breach of contract. A subcontractor not paid may, for example, be justified in demobilizing before completing its contractual scope of work. However, this may not be justified if the subcontract contains a pay-when-paid provision or a clause that requires work to continue through pending disputes. There, it may be the subcontractor who has breached the contract. Potential claimants should carefully read their contracts to understand their rights and duties when analyzing a potential claim.
Even if there is no written contract, a potential claimant should still ask itself whether it lived up to its end of the bargain on the project.
Contracts can be made in writing, but oral contracts and implied contracts are equally enforceable if their existence and terms can be established.
Unwritten contracts may be held to exist if the parties act or perform as if an agreement between them does exist. If money changed hands and some work was performed, an enforceable contract will probably be held to exist. The terms of such unwritten contracts are often extrapolated from documents exchanged between the parties, such as requests for proposals, unexecuted proposed contracts and standard terms and conditions. It is important to read these documents when analyzing a potential claim, particularly if there is no written, signed contract.
Taking a realistic view of the variety and validity of potential counterclaims that may be filed by one’s opponent is critical to determining whether an investment in a potential claim would be worthwhile. Part of this is understanding all of the parties’ contractual rights and obligations.
Have You Suffered Legally Recoverable Damages?
The law does not automatically award damages to the innocent party if another party breaches a contract, even if the breach is intentional. The aim of construction contract law is not to punish the breaching party, but to place the innocent party in the same position it would have been in had the contract not been breached. One should think about the kind of damages it would need to recover to be made whole when evaluating the upside of a potential construction claim.
In simple cases, such as collection claims in construction contracts on unpaid accounts receivable, the nonbreaching party can be made whole with an award of monetary damages that is easy to quantify. In more complicated disputes, such as claims involving economic losses on projects delayed or never completed, the nonbreaching party may be awarded the costs or losses it incurred due to the project plus appropriate compensation for any benefits that accrued to the breaching party because of its efforts.
Since it can be difficult to quantify the amount necessary to make a nonbreaching party whole, some contracts specify a dollar amount of liquidated damages that one may recover if the other party breaches the contract. Courts usually enforce liquidated damages provisions, provided the specified sum is a reasonable estimate of the damages that the non-breaching party may actually sustain and not a penalty or fine to incentivize a party to comply with the contract.
Can You Collect If You Win?
Owners frequently develop property using a single-purpose limited liability company or land trust with no assets other than title to the property. With few exceptions, the law treats (properly formed and registered) single-purpose entities as distinct legal entities that shield their principals and affiliated companies from liability. Just because the owner has substantial assets does not mean the single-purpose LLC listed on the contract will have assets sufficient to satisfy a claim. Potential claimants who contracted directly with an owner or developer must be wary of winning a judgment or arbitration award against a single-purpose entity with no assets.
Subcontractors should also be wary of pursuing claims against contractors without funds to satisfy claims. Many projects are funded through a construction lender that disburses payments at the end of the month for services performed during that month.
As a result, contractors routinely advance credit to owners and developers, subcontractors advance credit to contractors, and so on. It is not uncommon for a general contractor to owe sums well in excess of the cash it has on hand to its subcontractors for the past month’s work. Often, the contractor may be unable to pay the claims of its subcontractors if the owner or lender stops making the monthly disbursements.
Yet few in the construction industry view themselves as the credit managers they are, and even fewer take the time to investigate their client’s creditworthiness, feeling they are fortunate to have won the project in the first place.
This makes it all the more important for potential claimants to investigate whether the adverse party can satisfy a judgment or arbitration award if one is entered on the potential claim. This is a key aspect of whether it is worth pursuing your construction claim. A judgment against an insolvent party is worthless.
My video entitled Can Architects and Contractors Better the Odds of Being Paid by Owners, which is available at that link, discusses these kind of issues.
Other Options Besides Litigation or Arbitration?
Lawsuits or arbitration proceedings should be initiated only as a last resort, if you have decided that it is worth pursuing your construction claim, as they are expensive and can lead to unsatisfactory results.
Before filing a complaint or demand for arbitration, one should consider whether anyone is out there who may have an interest in seeing the claim resolved and whether everything possible has been done to get that person’s attention.
For example, one owed money from a contractor claims management should consider whether it can motivate the project owner or surety to pressure the contractor into paying it by recording a mechanics’ lien or giving notice under a payment bond. Although every project is different, most involve investors, lenders, guarantors, title companies, sureties, insurers or others who would prefer to see a potential claim settled rather than litigated or arbitrated.
Potential claimants should use parties like these to bring pressure to bear on whoever is ultimately responsible to settle the claim before resorting to litigation or arbitration.
One should also consider creative settlement and cost-saving options before initiating a lawsuit or arbitration, if you decided that it is worth pursuing your construction claim.
An owner whose prime contractor and its subcontractors recorded mechanics’ liens against its property may be able to avoid a protracted dispute with the contractor by settling the subcontractors’ claims at a discount to undercut the amount of the contractor’s claim.
An architect at an impasse over the dollar value of a claim for fees brought by its consulting engineer should consider whether the engineer would reduce its claim in exchange for the promise of more work.
And parties who may otherwise be adverse to one another, such as contractors and subcontractors, should consider entering into liquating agreements to jointly prosecute their claims against a third party who has assets sufficient to satisfy both claims, such as a property owner or developer.
My article on such liquidating agreements a/k/a pass through agreements, Pass-Through Claims in Construction Litigation, is available for free download at that link.
Is the Construction Claim Subject to Arbitration or Litigation?
Parenthetically, I believe that people who seek early, cost-efficient dispute resolution should participate in mediation before resort to litigation or arbitration. Almost no exceptions.
Litigation is the default method of binding dispute resolution. This means one must sue in court unless the dispute arises from a contract containing an arbitration clause.
Arbitration is a streamlined process that dispenses with the rules and formalities of litigation. It is a consensual form of alternative dispute resolution, and parties who have not agreed to arbitrate a dispute cannot be forced to do so.
This creates problems in multi-party disputes where some parties are required to arbitrate and others are not. Claimants who resolve related claims in different forums risk inconsistent outcomes, an increased risk of being assessed with liabilities that could have been borne by others, and a diminished ability to shift liability to others through contribution or indemnity claims.
For example, a developer with an arbitration clause in the architect’s contract but not in the contractor’s contract could not only wind up simultaneously prosecuting the same claim in different forums, it could lose in both if the arbitrator finds that the absent contractor is responsible for the defects and the jury determines that the absent architect is liable.
An investment in a potential claim may not be worthwhile in a situation like this. If the dispute is likely to involve finger-pointing among multiple parties, it is important to determine whether all of them can be joined in the same lawsuit or arbitration.
A good practice is to keep one’s contracts consistent on a project-by-project basis; if there is an arbitration clause in one contract, there should be similar clauses in every other contract one enters into for a project.
Check out my post entitled Negotiating Dispute Resolution Clauses In Contracts, available at that link, for more information on dispute resolution considerations in design and construction contracting.
There is little consensus on whether arbitration or litigation is the better form of binding dispute resolution. Many attorneys prefer arbitration for some claims and litigation for others.
Although arbitrations are typically resolved more quickly and inexpensively than lawsuits, arbitrations can be just as expensive if the attorneys approach it with a litigation mentality. In response, I co-authored an article entitled Arbitrator-Directed Arbitration: A Proposal to Improve Construction Arbitration, which is available for free at that link.
The main advantage of arbitrating construction disputes may be that arbitrators tend to be professionals or business people from the construction industry, such as architects, contractors or construction attorneys, who are better suited than a jury of laypeople to analyze technical construction-related evidence and testimony and to reach the right conclusion.
I wrote co-authored a 50-page treatise on Arbitration for the design and construction industry, which is available for download at that link.
However many attorneys would prefer to be before a judge in a court of law in cases involving complex legal issues. My post about The Advantages of Litigation, as an alternative to arbitration, is available at that link.
Although the decision of whether to include an arbitration clause in a contract is generally made well before claims arise, one should still consider whether it is bound to bring its potential claim in a forum that is favorable or unfavorable for that type of claim when deciding whether or not to pursue the claim.
Do You Have the Evidence to Prove Your Claim?
In litigation and arbitration, claimants do not get what they deserve, they get whatever relief they can prove they are entitled to. Whether you can prove your claim is a key aspect of deciding whether it is worth pursuing your construction claim.
To the extent possible, potential claimants should gather the documentation and evidence they may need to prevail on a claim before filing it. If relevant evidence is not in one’s possession or control, it should determine how it will gather it before the trial or arbitration hearing starts. This may entail issuing subpoenas or document requests, propounding interrogatories on the adverse parties, taking depositions to preserve verbal testimony and issuing requests under the Freedom of Information Act to governmental agencies.
Provided one has a reasonable belief that whatever additional documents or evidence it may need to prove its claim do exist and can be later obtained, it is okay to file a complaint or demand for arbitration without them, provided it has sufficient facts to give it a good faith basis to proceed with the claim. Preserving evidence, including electronically stored information (ESI), is important even if the ESI is not collected before the claim is filed.
However, potential claims involving sudden or calamitous events pose unique concerns.
If the claim arises from a crane collapse or structural failure, the evidence one needs to prevail on a claim may have been lost or destroyed in the immediate aftermath of the event. Potential claimants who lack photographs or physical evidence necessary to prove their claims should make sure they have a reasonable chance of obtaining what they need from someone else once the lawsuit or arbitration is underway. Regardless of how damaged or injured one may be, a claim is worthless if the claimant lacks the evidence to entitle it to a recovery.
An often overlooked aspect of pre-claim due diligence is the documentation of one’s claim for damages.
Most potential claimants think more about why they are entitled to recover damages than about the testimony and documentation they will need to prove how much they should be awarded. Those deciding whether it is worth pursuing your construction claim should quantify and document their damages.
This can be complicated both in claims that involve speculative losses and claims that involve more commonly sought damages, such as extended home office overhead, which can be calculated in different ways depending on the data one is looking at (and whether it is trying to minimize or maximize the claim amount).
Assumptions about the amount of damages that may be recoverable are central to whether it will be is worthwhile to pursue a claim, so potential claimants should think critically about how to prove and document their claim for damages before filing a complaint or demand for arbitration.
Can You Recover Your Attorneys’ Fees?
Attorneys’ fees are generally the largest expense claimants incur in prosecuting claims, but few claims result in an award of attorneys’ fees to the prevailing party.
Most construction claims are settled or dismissed before the end of the trial or arbitration hearing when one’s right to recover attorneys’ fees is decided.
Even cases that go to trial or an arbitration hearing seldom result in an award of attorneys’ fees unless (I) an applicable statute provides for recovery of attorneys’ fees; (2) the contract contains a clause that awards attorneys’ fees to the prevailing party; or (3) attorneys’ fees are awarded to sanction the unsuccessful party for a claim or defense prosecuted in bad faith. This high hurdle is intentional and the result of a policy intended to discourage litigation.
This assumption is so basic, it is referred to as the “American Rule” in United States jurisprudence.
Since attorneys’ fees are seldom awarded, one should never count on recovering them (even if the contract provides for recovery of attorneys’ fees) when deciding whether it will be economically worthwhile to pursue a claim.
An attorneys’ fee clause in a contract is, as a rule, more useful to increase a nonbreaching party’s bargaining power in settlement negotiations than it is to actually recover attorneys’ fees.
Are There “Hidden” Legal Impediments to Recovery?
Construction claims are often defeated by legal principles that may seem counterintuitive and even unfair to non-attorneys.
Here are a few examples:
- Under the betterment doctrine, property owners may be forced to pay for most of the cost of items accidentally omitted from the design of an architect even if the owner is not at fault.
- Economic losses (not involving damage to property) typically cannot be recovered through tort causes of action (such as negligence) by someone who did not contract with (and thus cannot assert a breach-of-contract claim against) the party at fault for its damages, even if the innocent party is forced to bear the loss.
- Governmental agencies’ immunity generally prevents them from being sued in tort, and they can sometimes escape contractual liability if the funds appropriated to finance this specific project have been spent.
- Many states’ statutes prevent the enforcement of clearly written contractual provisions, including clauses that provide for indemnity and the recovery of interest on past due sums.
- Statutes of limitation can limit the time one has to pursue a claim and statues of repose can, at times, bar claims before one sustains damages or realizes it has a claim.
Identifying hidden legal impediment and defenses to construction claims requires the special knowledge and experience of a construction attorney. Consult one if you need a realistic assessment of the possible gains and losses associated with a potential claim.
Conclusion
In tough times, many people hesitate to pursue construction claims without greater than usual assurances of a net gain. Although the likely outcome of litigation and arbitration can be difficult to predict, the factors listed above can help you determine whether an investment in your potential claim – whether it is worth pursuing your construction claim – may be economically worthwhile.
[1] 1 “Civil Justice Survey of State Courts, 2005, Special Report, Bureau of Justice Statistics (Oct. 2008, rev. April 9, 2009).
This publication is prepared for the general information of friends of Baker Law Group LLC in Illinois. It is not legal advice for you, or legal advice regarding any specific matter. Jeremy S. Baker is licensed to practice law only in Illinois. Under rules applicable to the professional conduct of attorneys in various jurisdictions, it may be considered attorney advertising material. Prior results do not guarantee a similar outcome.
Is It Worth Pursuing Your Construction Claim? It is not always easy to decide!
