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March 2011 >>
Contract Litigtaion: Why You Need to Gear Up for a Battle
Today’s contractors are under siege. Multiple issues threaten to reduce profitability: high materials costs, terminated or delayed projects and less financing. Sometimes, owners with dwindling funds simply fail to pay as agreed.
When the economy is at a low, contractors cannot easily look the other way or take pennies on the dollar when they are not fully compensated for their work.
Contractors are facing liabilities in the course of contract litigation that pose bigger risks than ever before. And, because litigation can prove devastating for all but those with the deepest of pockets, contractors need to prepare for battle to ensure the most favorable outcome.
Never Assume
As any great general will attest, one should never go into battle without understanding the risks. Too often contractors think they are exempt from certain liabilities. For example, consider the case Martel v. Loverbirds Café & Bakery, Inc. (2010). Fran Martel, a general contractor, was hired to construct two eateries. To control costs and prevent delays, the project owner hired a project manager, who required Martel to submit all work orders and only go forward with those that received approval. But, as is often the case, Martel’s final construction costs far exceeded the original budget.
The owner made the mistake of assuming he was only responsible for paying the work orders approved by his project manager. In fact, many of the work orders Martel completed were not approved by the owner, but rather requested by city inspectors—making the owner’s approval irrelevant. Furthermore, the owner provided no documentation for why some orders were approved and others were not.
As a result, the court ruled against the owner, who had to pay more than $80,000 in expenses to Martel on top of the $200,000 of approved work orders. This added a 40 percent cost increase to the project, something small developers can ill afford.
Manage Labor Issues
Another common area that requires a different risk management approach is labor. With national unemployment continuing to hover around 9 percent, many municipalities are being pressed to review all development deals to ensure they support job growth, a very subjective term.
In one example, the Lansing Michigan City Council tried to go back on a deal with a developer because his plan did not include union labor. The developer was forced to sue and received a favorable ruling, but he incurred significant legal expenses and project delays as a result.
Understand ‘Loser Pays’ Provisions
Another legal reality that can significantly alter the risk landscape for a contractor is the growth of predominately “loser pays” jurisdictions and prevailing party provisions in contracts. As the name suggests, loser pays provisions in contracts or certain statutes require one to pay the adversary’s legal fees in the case of an adverse ruling.
Numerous mini loser pays systems are emerging in Alaska, California and Texas. As a result, a company with a regional footprint needs to be aware of the full extent of its liabilities if it loses a lawsuit.
Toll Brothers recently learned this lesson the hard way when it had to pay $1.4 million in legal fees to another developer. Toll’s purchase sales agreement for a 147-acre development property in California included a loser pays provision in the event of any legal proceedings.
Being exposed to millions of dollars in legal liabilities, particularly after the sting of an adverse ruling, is a level of risk exposure few, if any, business owners can afford in today’s economy.
Hedge with the Latest Risk Management Tools
In the past few years, a wave of new risk management tools emerged to help companies and individuals better manage litigation liability. One popular innovation is third-party funding. Insurance companies, banks and hedge funds now provide litigation funding to plaintiffs in exchange for a percentage of the potential settlement. This can help companies better manage cash flow and invest in growing the business rather than paying legal fees—giving them an edge over the competition.
Another rapidly emerging risk management tool is an insurance policy that covers attorneys’ fees awarded pursuant to loser pays provisions in contracts. This contract litigation insurance can be purchased at various stages throughout the litigation process. It covers all adversary attorneys’ fees per the prevailing party provision in the underlying contract in the event of an adverse ruling at trial or a summary judgment.
Because the legal fees often far exceed the damages, contract litigation can be an invaluable tool in managing risk. Furthermore, it allows companies or individuals to pursue meritorious claims without fear of financial ruin—creating a level playing field for all.
Incorporate Risk Management in the Legal Strategy
The longer a lawsuit takes, the greater the contractor’s liability and, most likely, the less cash it will have on hand.
Contractors and their attorneys must adjust their legal strategy to elevate the importance of risk management. Understanding the legal landscape can make all the difference. For example, if bringing a suit, is there a choice of where to file the case? Which courts are congested? What is a reasonable time estimate for proceeding to trial? When staffing a case, how many attorneys are necessary?
Any opportunity that allows for an expedited and efficient prosecution and resolution greatly reduces risk exposure.
Taking into account all the factors involved in contract litigation, from the strengths of the claim to the potential liability, and from the legal strategies to the unpredictability of various courts, it becomes clear that choosing to go forward is an enormous commitment. By drawing on best practices, new innovations and core principles, a contractor stands the greatest chance of success.