Law Offices of Clinton D. Hubbard

2008

A Contractor May Recover Lost Profits Resulting From Impaired Bonding Capacity After Being Wrongfully Terminated From A California Public Works Job

If the owner wrongfully terminates a contractor from a job, the contractor is entitled to recover for lost profits from that job. Often, such termination also impairs the contractor’s bonding capacity. A contentious issue is whether a contractor can recover potential profits that it would have earned on other jobs in the future which it could not obtain because of the impaired bonding capacity. The answer appears to be a qualified “yes.”

After terminating the contractor the owner makes demand upon the contractor’s performance bond surety to complete the work. This creates an immediate conflict between the contractor and its surety regarding the contractor’s obligation to reimburse the surety for the costs of completion, the reasonableness of the costs, and other matters. As a practical matter this claim on the bond impairs and sometimes eliminates the contractor's ability to procure performance bonds from its current surety or another surety, until the dispute is resolved. In order for the owner, frequently a public agency, to become liable for this impairment of bonding capacity and subsequent loss of future jobs and the associated profits, such damages must be legally “foreseeable".

California Supreme Court: Lewis Jorge Construction

The California Supreme Court in 2004 expressed doubt that this kind of damage could, in general, be recovered by the contractor. Lewis Jorge Construction Management, Inc. v. Pomona Unified School Dist. (2004) 34 Cal. 4th 960. It held that a contractor's lost profits, based on prospective contracts it never won because of its impaired bonding capacity after a school district terminated its contract, were not recoverable as “general” damages. Although the contractor successfully sued the District for breach of contract and proved that it was wrongfully terminated, such damages on potential future contracts were deemed unrelated to the performance of the current contract and hence not recoverable. Furthermore, the contractor's lost profits did not qualify as special damages, because they were not actually foreseen or foreseeable as directly flowing from the District's breach. Following the Lewis Jorge decision some unpublished appellate decisions have taken a similarly skeptical view, and some have not. However, the only published decision (through late 2008) addressing these issues did award lost profits for jobs lost due to wrongful termination, expressly finding “foreseeability.” That decision provides a good roadmap for a contractor in this situation.

Court of Appeals: BEGL Construction

In BEGL Construction Co., Inc. v. Los Angeles Unified Sch. Dist. (2007) 154 Cal. App. 4th 970, the District terminated the contractor and filed a bond claim with the surety for completion of the project. The contractor argued at trial that the District's breach of contract impaired its bonding capacity, resulting in lost profits on jobs for a 2-year period up to the time of trial. The trial court admitted evidence of lost profits, which included expert testimony that there was an industry custom that where a dispute between a surety and a contractor occurred, the contractor would not be bonded as long as the dispute remained unresolved. The evidence also showed that the District was aware of that custom. The jury found the District in breach and awarded BEGL $954,000 in damages, $506,000 of which was attributable to lost profits on other potential jobs. The appellate court distinguished this fact situation from that in Lewis Jorge noting that "unlike the showing in Lewis Jorge, in this case there is sufficient evidence of foreseeability." There was expert witness testimony in the form of BEGL’s bonding agent that "whenever there is a dispute between a surety company, whether there is a lawsuit between—where the contractor is suing a bonding company or vice versa, no other surety company wants to do business with that contractor until that is resolved." There was also evidence from a District expert witness that “when the surety has a dispute with the contractor, they typically don't get bonded." And another District witness, a vice president of underwriting of a surety, testified that there was a general policy in "the bonding industry that as soon as a bond company learns of a dispute between a contractor and a bond company, they don't write further bonds for that contractor." There was also evidence of a statement by a District employee that he was aware that by terminating a contractor and making claim on the bond company, it might tend to “break" the contractor. The court held that this evidence of foreseeability exceeded the evidence before the Lewis Jorge court, and that therefore in this case lost profits were recoverable special damages. And it is noteworthy that the BEGL decision was not appealed.

“Foreseeability” is the main hurdle for a contractor under these circumstances. It is critical that the contractor develop through expert testimony a rich record of the custom and practice in the industry and the degree to which it is well-known that there are highly damaging consequences to wrongfully terminating a contractor via an impaired bonding capacity and loss of work on other jobs. It is not certain that the Supreme Court will accept this as adequate evidence of foreseeability sufficient to support special damages, but without such strong evidence the contractor has no plausible argument.

Loss of Profits Must Be Certain and Amount Must Not Be Speculative

In a case like this the contractor faces two other hurdles which are more routine, and common to any loss of profits claim: it must establish with sufficient certainty that there will be a loss of profits; and must establish beyond a mere "speculative" basis the quantity of those damages. Lewis Jorge addresses this issue as well, and it appears that in the construction industry the contractor will have a very difficult time satisfying these requirements for lost future jobs. There seems to be a concern that this industry is particularly turbulent and volatile, the jobs depend on competitive bidding, and it is difficult to show that the contractor will even be in business or in a position to take jobs on a profitable basis in the future. And the related concern is that it is difficult to predict or the profit those jobs will have in light of competitive bidding pressure and the inherent uncertainty in construction contracts.

In this area the BEGL court took a fairly forgiving view: it awarded lost profit damages even though BEGL did not present evidence regarding specific projects or specific sums lost as a result of its impaired bonding capacity. It showed that it had been in business for 17 years up to the time of trial; that it had been performing public works projects for 9 years up to the time of trial; that it had a 5-year track record of being able to regularly win jobs and to make a particular average annual income on them. This evidence was presented through an expert CPA who made inferences based on prior performance. Lost profits were claimed for only a 2-year period prior to the time of trial during which the company remained in business but was operating less profitably and at lower volume. Note that this is different from speculating as to how the company would have performed in future years (such as if it had been gone out of business due to the bonding impairment). It rejected the argument that BEGL needed to identify particular jobs and profit margins that it lost. It quoted from another case to the effect that requiring a contractor to prepare detailed bids it could never submit would be a waste of time and provide no surer safeguard against speculative damages. So BEGL did not need to present evidence in the form of a log of lost job opportunities that it missed and work up bids for each of those jobs. And again, BEGL reduced the speculative nature of these estimates by not seeking damages for future years but only for the years during which it had actual business performance data.

An unpublished appeals court decision following Lewis Jorge also awarded a wrongfully ejected contractor damages due to bonding impairment, such as increased bond rates, increase in borrowing costs, and reduction in revenues due to the inability to win as many jobs as it normally did. But it disallowed lost profits on potential jobs that it might have won after it had gone out of business (due to problems caused by the bonding difficulties). It deemed the evidence of profits on those future jobs to be too uncertain and speculative. M.A. Butters & Assocs. v. City of Lancaster (2005) Cal. App. Unpub. LEXIS 7195 (2005).