An Object Lesson In Defense Strategy And The Principals Of Caveat Emptor, DD 03/07

Defense Digest

An Object Lesson In Defense Strategy And The Principles Of Caveat Emptor

The case of Donald M. Durkin Contracting, Inc. v. City of Newark, D. Del., Civ. A. No. 04-163-GMS, began in the summer of 2000 when the City of Newark, Delaware, retained URS Corporation to engineer the design of a reservoir. In April 2002, the City contracted with Durkin to perform the construction. The contract awarded to Durkin was approximately $9 million, based upon a bid which was $2 million less than the next-lowest bid.

In late 2003, after more than 60 percent of the construction work was complete, Durkin raised questions about what it believed were defects in URS's design affecting both the constructability and ultimate safety of the reservoir. Not receiving satisfactory responses to its concerns from the City or URS, Durkin refused to perform any further construction.

By letter dated February 3, 2004, Newark declared Durkin in default of the contract and that it was terminating Durkin "for cause." On March 16, 2004, Durkin filed a Complaint in the United States District Court naming the City, its Mayor and Council members individually, as well as URS, alleging Newark breached the contract and violated Durkin's due process rights. Newark filed an answer with a counterclaim for contract damages, and Newark also filed a third-party complaint to add Durkin's performance bond surety, Federal Insurance Company.

Initially, Newark and Durkin attempted to resolve the dispute through negotiations. Durkin sought an agreement that its termination would be "for convenience" under the contract and payment by Newark of some $500,000(+/-) for Durkin's unpaid work. The City maintained that URS's design was safe and could be built and, absent Durkin's consent to return to work and complete the reservoir under the terms of its contract, would not agree to any further payments while holding firm to its "for cause" termination, allowing recovery against Durkin and its bond for increased construction costs. Unable to reach agreement, by late 2004, after initial motion practice gained no advantage for any of the parties, the litigation proceeded to the discovery phase. Newark contracted with a different entity to complete construction under URS's design. By the summer of 2006, the reservoir was completed and operational.

In the interim, Durkin received no new construction contracts from any source, being required to disclose that it had been terminated "for cause" by Newark, and found itself potentially facing bankruptcy. Newark, meanwhile, spent approximately $14 million to complete the reservoir, some $5 million more than Durkin's contract, which it sought to recover through the litigation.

After trial was conducted over seven days from September 27th through October 5th, the jury returned a verdict against Newark awarding Durkin $11.6 million in contract damages; $25 million in civil rights damages; and $1.8 million in attorneys' fees. URS, on its cross-claim against Newark, was awarded $560,000 in its attorneys' fees and costs.

When Durkin's complaint was originally received by the City in March 2004, Newark's public entity general liability carrier assessed it as primarily a civil rights claim, for which coverage existed, and assigned Newark's defense to a professional liability attorney skilled in civil rights law. The City Solicitor and retained outside counsel convinced the insurance carrier that the claims were primarily construction and contract related. At the City's urging, the insurance carrier re-assigned the defense of the claims to the City's retained outside counsel, an attorney skilled in construction law, but with minimal experience in civil rights litigation.

With the benefit of the District Court's published decisions on pre-trial motions, the significance of the insurance carrier's reliance on the City's representations becomes apparent.

Public works contracts, such as Newark's with Durkin, are subject to Constitutional Due Process protections, which, once granted, cannot be withdrawn without notice and an opportunity to be heard. For that reason, most public works contracts contain both a "termination for cause" provision requiring due process prior to termination – but which also provides the public entity a mechanism to recoup from the contractor its additional or increased costs occasioned by the contractor's default – as well as a "termination for convenience" clause by which the public entity can terminate the contract, but requiring that it compensate the contractor for its unpaid work and demobilization costs. "For convenience" clauses are constitutionally sound as they are a negotiated term in which the contractor has agreed to waive its due process rights. Durkin's contract with Newark contained both "for cause" and "for convenience" provisions.

Durkin's contract was also subject to a construction performance bond issued by Federal Insurance Company. Separate from the contract, the Bond contained its own notice requirements. In order to recover against the Bond to recoup its additional costs under the contract's "termination for cause" provision, the City needed to provide Federal with the notice and opportunity to respond required by the Bond.

The contract required seven days written notice to both Durkin and Federal of Newark's intention to terminate for default and an opportunity for Durkin to cure. The Bond required notice to Federal "that the Owner is considering declaring a Contractor Default" and a "conference with the Contractor and the Surety to be held not later than fifteen days after receipt of such notice to discuss methods of performing the Construction Contract." If unsuccessful in resolving the dispute, the Bond required a subsequent declaration by Newark of "a Contractor Default and formally terminat[ing] the Contractor's right to complete the contract" that "shall not be declared earlier than twenty days after the Contractor and Surety have received" the notice of "intention to declare" a Contractor Default.

Compliance with the Bond's notice and hearing requirements would also fulfill the Contract's "for cause" notice and hearing/opportunity to cure requirements, as well as its Constitutional Due Process requirements.

On November 21, 2003, after Durkin raised its concerns about the reservoir's design, the City sent a letter to Durkin and Federal stating in pertinent part that "we [the City] are now considering declaring Donald M. Durkin Contracting, Inc. in default of Newark Municipal Contract No. 02-02 . . . . This precautionary letter has become necessary following DMD's failure to present a response to a means and methods for continuation of the project in accordance with our contract." That fulfilled the first requirement of the Bond, as well as the notice requirements of the Contract and Due Process clause.

After that November 21, 2003, letter, Durkin, Federal and the City had a series of meetings and exchanges of correspondence, which failed to resolve Durkin's concerns or result in Durkin returning to work. Although the reported decisions provide few details, it appears that the post-November 21st meetings and correspondence fulfilled the Bond, Contract and Due Process requirements for an opportunity to be heard.

By letter dated February 3, 2004, the City informed Durkin and Federal that "pursuant to the terms of the Contract and the Construction Performance Bond, the City of Newark declares a Contractor default and hereby formally terminates Donald M. Durkin Contracting, Inc.'s right to complete the contract for Construction of the City of Newark Water Supply Reservoir. The termination is for cause due to Durkin's refusal to complete the Work." Neither Durkin nor Federal were afforded any subsequent opportunities for hearing or opportunity to cure after the February 3, 2004, notice.

Newark's position in its Answer and Counterclaim to Durkin's complaint and throughout the litigation was that the November 21, 2003, letter was, itself, effective to terminate Durkin's contract "for cause," fulfilling all of the Contract, Bond and Due Process notice, hearing and opportunity to cure requirements.

On September 22, in response to several motions in limine filed by Durkin and a motion for summary judgment filed by Federal, the court issued an order "precluding the City from arguing or presenting evidence at trial that any other writing [than the November 21, 2003, letter] constituted the seven-day notice required by the Construction Contract" and Bond. That order further granted summary judgment dismissing Federal and Newark's bond claim, finding that the November 21, 2003, letter did not fulfill the notice requirements of the Performance Bond. The court concluded that "there is no evidentiary basis upon which a reasonable jury could find in favor of the City" that Newark's advisory that it was "considering declaring" a default in a self-described "precautionary letter" was sufficient to (a) provide Durkin and Federal notice that a "Contractor Default" was, in fact, declared and (b) give Durkin and Federal the opportunity for a hearing and response required by the Bond.

In its pleadings, the City consistently represented to the court that "on November 21, 2003, Newark advised Durkin and its surety of the default." Although Newark's remedy against the Bond was removed, it still held its contract remedies against Durkin directly.

However, on September 25, 2006, the day trial was scheduled to begin, the City provided Durkin with additional documents responsive to discovery requests that the City claimed to have only "discovered" the Friday before. Among those documents was a January 20, 2004, letter from the City's outside counsel (who was thereafter retained by the insurance carrier to handle the litigation defense) to the City and URS (negating any claim of privilege) addressing whether Durkin's contract could be terminated for cause. The relevant portion of the attorney's analysis stated: "The Surety's [Federal] obligation arises after (1) the Surety is notified regarding a default and (2) after meeting with the Surety, declaring a default and terminating the contract. You satisfied step 1 in November. We have not formally taken step 2 . . . ."

The eleventh hour disclosure of the City's attorney's pre-litigation assessment, which stood in stark contradistinction from its pleadings and representations to the court, prompted the judge to observe that the conduct "brings the City dangerously close to a Rule 11 violation" and resulted in the court striking Newark's counterclaim and affirmative defenses to Durkin's breach of contract claim as a sanction for discovery abuse and bad faith litigation conduct.

The City's strategic approach to the litigation was premised on completion of the reservoir being dispositive proof that URS's design was safe and constructible. The theory appears to have been that since the completion contractor finished the reservoir as designed by URS, Durkin's concerns were unfounded and its refusal to perform the work gave Newark cause to terminate and a basis for recovery against Durkin directly or its Bond. The court's September 22nd order removed the Bond claim, and its September 28th order foreclosed the City from pursuing its contract remedies. As a result, Newark was left defending a civil rights action for which it was unprepared.

By logical and necessary extension, the combination of the court's pre-trial orders was to convert the trial into a lengthy damages inquisition on issues of notice, hearing and opportunity to respond – in other words, on the Constitutional Due Process issues only, but for which Durkin retained a contract claim for damages – to which too little attention had been paid at a time when the course of the litigation could have been affected.

As a result, a case that the insurance carrier could have, and probably would have, settled for $500,000 became one with a verdict of $38.5 million, of which $25 million was for covered civil rights damages.

* Scott Shannon is an associate in our Wilmington, Delaware, office. He can be reached at jsshannon@mdwcg.com or (302) 552-4329