Contractors often include in their subcontracts provisions that allow them to set off amounts otherwise due a subcontractor to compensate for damages it has incurred or anticipates will incur due to the subcontractor’s breach of its obligations.
These provisions are generally enforceable, and in many states the common law allows such set-offs—even absent express set-off provisions. When the contractor’s damages are significant, set-offs are typically imposed early on before the remaining subcontract balance becomes insufficient to fund the full sum of the damages. But, as a recent case illustrates, a contractor might not be permitted to set off funds that were due and owing to the subcontractor before the incident.
U.S. Composite Pipe South, LLC v. Frank Coluccio Constr. Co. et al., No. 12-00538 JMS-KSC, 2014 WL 5023489 (D. Haw. Oct. 7, 2014) involved a contract between a contractor and the city of Waikiki for the replacement of a sewer force main. The contractor initially bid the project using the particular brand of pipe cited by the city in its specifications. After execution of the contract, however, the city issued a change order to the contractor changing the pipe to another type, which was manufactured by a now-defunct German company. The contractor, in turn, issued a purchase order for the pipe to the pipe supplier, which had a value of approximately $3.5 million.
The payment terms contained in the purchase order specified that the contractor’s payments to the pipe supplier would be made in three installments: 50% upon signing of the purchase order, 25% upon delivery of the pipe to the jobsite and 25% after installation and pressure testing.
After installing the pipe, the contractor conducted hydrostatic pressure testing, which failed to maintain the specified 50 psi for one hour. The contractor eventually convinced the city to relax the hydrostatic pressure requirement and accept the pipe, but not before incurring additional costs and experiencing delays. The contractor also claims to have incurred additional costs and equipment damage due to allegedly defective piping that experienced a catastrophic failure. As a result of the foregoing, the contractor, which had paid the pipe supplier the first installment of 50% of the purchase price, refused to make further payments and asserted its right to set-off its damages. The pipe supplier sued for $1.8 million, plus interest, and the contractor filed a counterclaim in which it set out its allegations concerning the catastrophic failure and the pipe’s inability to pass hydrostatic testing.
The court was confronted with several motions for summary judgment—one of which was filed by the pipe supplier, which claimed that the contractor could not properly set-off the second installment because it was due upon shipment of the pipe to the project.
As you might imagine, the facts asserted by the pipe supplier and contractor were very much in dispute, especially on the issue of the cause of the catastrophic failure and whether the hydrostatic testing failure was a result of pipe quality or the contractor’s faulty installation. The parties also could not agree whether the 50-psi hydrostatic requirement was a part of the purchase order. These and other factual disputes could not be resolved by the court and would have to play out at trial when witnesses could be heard and their credibility determined. Consequently, the court chose to rule on only one issue—whether the contractor could set-off the second installment that was due and owing to the pipe supplier once the pipe was received at the project site.
The court ruled for the pipe supplier and noted that even if the pipe turns out to be defective and the pipe supplier is liable for the contractor’s losses, the contractor has no right in the meantime to set-off the second installment. It thus ordered the contractor to pay the 25% installment, plus interest. The court reasoned that because all conditions for payment of the second installment had been met, payment was due even before problems arose. It allowed the contractor to retain the third installment, however. This particular issue is a rare one, but the rule appears to be (at least in Hawaii) that only payments becoming due and owing to subcontractors after the discovery of a breach may be the subject of a proper set-off. R&B
Larry Caudle is a principal in Kraftson Caudle LLC, a law firm in McLean, Va., specializing in heavy-highway and transportation construction.