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Louisville and Jefferson County Metropolitan Sewer District v. T Contracting, Inc.

Supreme Court of Kentucky

December 13, 2018

LOUISVILLE AND JEFFERSON COUNTY METROPOLITAN SEWER DISTRICT APPELLANT
v.
T CONTRACTING, INC. APPELLEE

          ON REVIEW FROM COURT OF APPEALS CASE NOS. 2015-CA-000333, 2015-CA-000374 JEFFERSON CIRCUIT COURT NO. 12-CI-006235

          COUNSEL FOR APPELLANT: Kenneth Allen Bohnert Jennifer Fust-Rutherford Richard M. Sullivan Conliffe, Sandman, & Sullivan PLLC

          COUNSEL FOR APPELLEE: Gerald Lee Stovall The Stovall Firm, PLLC

          OPINION OF THE COURT BY CHIEF JUSTICE MINTON

         The Kentucky Fairness in Construction Act ("KFCA"), [1] which became effective over a decade ago, made dramatic changes in our existing law by voiding, as a matter of public policy, a host of what were then customary provisions in construction contracts. On discretionary review of this case, we hold that the Court of Appeals erred when it applied provisions of the KFCA to void the entire dispute-resolution process contained in the parties' sewer-construction contract. The KFCA nullifies contract provisions that prohibit the parties from asserting preserved claims to a neutral third-party adjudicator, but it does not nullify claim-preservation requirements in a contract. And the Court of Appeals further erred by failing to apply the applicable severability provisions of the KFCA that nullify only the nonconforming contract provisions, leaving the remaining provisions intact. Accordingly, we reverse the decision of the Court of Appeals on this point and reinstate the summary judgment entered in the trial court. We affirm the Court of Appeals on all remaining issues.

         I. BACKGROUND.

         The Louisville and Jefferson County Metropolitan Sewer District ("MSD") hired T Contracting, Inc. ("T") for its Board Run Interceptor, a sewer project in southeast Louisville, for approximately $2.3 million. The contract governing the parties' relationship consists of 20 pages of detailed terms, including the timeframe for performance, the process for dispute resolution (referred to as "Article 13"), and liquidated damages for delayed completion. As provided in the contract, T began work on February 1, 2011. T was supposed to substantially complete the project by January 31, 2012, but that did not happen.

         II. ANALYSIS.

         Before this Court for resolution are three issues: (1) whether the trial court correctly awarded summary judgment to MSD on one of T's claims for extra work, (2) whether the trial court properly handled MSD's liquidated damages claim, and (3) whether the trial court properly denied MSD's motions for directed verdict and judgment notwithstanding the verdict (\JNOV) on one of MSD's breach of contract claims against T. We address each issue and their subparts in turn.

         A. The trial court properly granted summary judgment in favor of MSD on T's claim for extra work undertaken to repair and replace damaged pipes associated with the project.

         MSD first challenges the Court of Appeals' reversal of the trial court's grant of summary judgment in favor of MSD, clearing MSD of any liability on T's claim for costs incurred in repairing and replacing piping used in the construction of the project. A trial court may grant summary judgment only if the evidence before it "show[s] that there is no genuine issue as to any material fact and that the moving party is entitled to a judgment as a matter of law.*[2]"Appellate review of a summary judgment involves only legal questions and a determination of whether a disputed material issue of fact exists. So we operate under a de novo standard of review with no need to defer to the trial court's decision."[3]

         1. Factual and Procedural Background.

         Under the contract, T agreed to install more than 9, 400 linear feet of sewer pipe. In early 2012, T advised MSD that it had completed work on the project and requested that MSD declare the project substantially complete. On March 5, 2012, MSD notified T that it had inspected the pipe system and had discovered leaks. Because of the leaks, MSD refused to declare the project substantially complete. On March 16, T notified MSD that the known leaks had been repaired and again requested that MSD declare the project to be substantially complete. On March 22, an MSD representative removed a manhole cover and saw water in the pipe invert. On April 2, MSD responded to the March 16 letter, stating that it had not accepted the piping and refused to declare the project substantially complete.

         Before T began further repairs, T notified MSD in a letter dated June 6, 2012: "If MSD continues to require that T Contracting perform work outside the scope of its contract, T Contracting will require that a change order be issued for an equitable adjustment to the contract." MSD responded to T's notification in a letter dated June 14, 2012, by inquiring, in part, about whether T would perform further work on the project. T responded in a letter dated June 15, 2012: "T is not refusing to perform any further work . . . . If the work you identify is beyond the scope of our contract, we will submit a proper change order request for that work."

         Beginning on June 27, 2012, T conducted exfiltration testing to locate the remaining leaks. On July 11, 2012, T sent the following email to MSD, claiming that the failure of the pipes was due to a design defect in the pipes that MSD mandated T use:

We again state that this exfiltration testing and repairs are being done under protest since the line had previously passed air testing as required by the specifications. T will submit a change order request for an equitable adjustment to the contract price and the contract time as the result of the duplicative testing and the work required as the result of the design deficiency.[4] However, we are proceeding in good faith in an attempt to get this line open for accepting sewer flow.

         The testing revealed cracks, which allowed groundwater to infiltrate the pipes under four creek crossings. T repaired the pipe at three of the four locations, having to replace the pipe at the fourth location because it was beyond repair, incurring additional costs for labor, materials, and equipment.

         Before replacing the pipe at the fourth location, T retained independent consultants to observe its work and inspect the cracked pipe and concrete encasement as they were removed. The consultants could not determine what generated the large lateral forces that would have caused the cracks in the concrete pipe and encasement, but they indicated that they were not caused by an installation failure on the part of T.

         On August 24, 2012, MSD certified in writing that substantial completion was achieved on August 17, 2012. On September 7, 2012, T reaffirmed that it intended to file a claim for the costs of the repairs and replacement of the pipes, pending a determination of those costs. On October 16, 2012, T submitted a claim for $108, 542.41 incurred because of additional testing and the repair and replacement of the cracked concrete pipe and encasements that failed for reasons beyond its control. MSD denied this claim, citing T's alleged failure to comply with the contract's dispute-resolution process, Article 13. T then requested submission of its claim to MSD senior representatives for executive negotiations under Article 13, but MSD did not respond.

         T to filed suit against MSD. Among other claims, T alleged breach of contract for MSD's failure to pay the $108, 542.41 for the work it performed to test, repair, and replace the concrete pipes. MSD responded and disputed T's claims and specifically alleged as a defense that T failed to comply timely and completely with Article 13, purportedly leading to the waiver of T's $108, 542.41 claim against MSD.

         MSD moved for partial summary judgment on this claim. It asserted that T's claim for costs related to repairs or replacement of the creek-crossing pipes was barred by Article 13. Specifically, MSD pointed to T's failure to comply with the contract's timeframe and procedures for bringing claims for additional compensation. Because T did not comply with Article 13, specifically because T did not timely file a formal claim, MSD argued, under the explicit language of the contract, that T's $108, 542.41 claim was waived. T responded by asserting that Article 13 was unconscionable and impossible to comply with, in addition to violating the recently enacted KFCA.

         The trial court granted summary judgment in favor of MSD on T's claim. The trial court found that T's claim was barred because the company failed to comply with Article 13, which required T to give written notice of the creek-crossing problem within ten days of discovering it and a formal claim within 30 days of the written notice. The trial court observed that T gave MSD timely written notice but failed to file its formal claim within the 30-day period. Instead, T tried to file its claim 95 days after its written notice and 60 days after the last pipe was placed. Because Article 13 prescribed strict timeframes, the trial court concluded that T's claim was barred. In reaching that conclusion, the trial court rejected T's argument that Article 13 was void and unenforceable. The trial court reasoned that T and MSD were sophisticated, experienced entities; therefore, the contract was not unconscionable. The trial court also rejected T's KFCA argument, finding Article 13 to be a form of alternative dispute resolution allowed under the KFCA.

         The Court of Appeals reversed the trial court's summary judgment, holding instead that the KFCA rendered the entirety of Article 13 null and void. The Court of Appeals quoted KRS 371.405(2)(a), which makes void and unenforceable:

A provision that purports to waive, release, or extinguish the right to resolve disputes through litigation in court or substantive or procedural rights in connection with such litigation, except that a contract may require binding arbitration as a substitute for litigation or require nonbinding alternative dispute resolution as a prerequisite to litigation[.]

         Applying this statutory language to the contract, the Court of Appeals declared the entirety of Article 13 void and unenforceable. The Court of Appeals reasoned that the portion of Article 13 that declared appeals to the Chief Engineer to be final and binding ran afoul of the statute. The Court of Appeals also found that the provision declaring unappealed MSD decisions final and binding violated the KFCA. Based on these contract terms, the Court of Appeals deemed the whole of Article 13 void and unenforceable.

         2. The KFCA and Article 13.

         The KFCA "legislates several areas of the contractor-owner relationship including: timing of progress payments, limits on retainage, no-damages-for-delay clauses, dispute resolution, mechanic's liens, and attorneys' fees."[5] Signed into law in 2007, the KFCA "was intended to help level the playing field between contractors and owners."[6]

         KRS 371.405 provides, in relevant part, the following:

(2) The following provisions in a contract for construction shall be against the public policy of this Commonwealth and shall be void and unenforceable:
(a) A provision that purports to waive, release, or extinguish the right to resolve disputes through litigation in court or substantive or procedural rights in connection with such litigation, except that a contract may require binding arbitration as a substitute for litigation or require nonbinding alternative dispute resolution as a prerequisite to litigation;
. . .
(c) A provision that purports to waive, release, or extinguish the right of a contractor or subcontractor to recover costs, additional time, or damages, or obtain an equitable adjustment of the contract, for delays in performing the contract that are, in whole or part, within the control of the contracting entity. . . .
(3) Subsection (2)(c) of this section shall not render null, void, and unenforceable a contract provision that:
. . .
(b) Requires notice of any delay by the party affected by the delay; or
. . .
(d) Provides for arbitration or any other procedure designed to resolve contract disputes[.]
. . .
(4) If a provision of a construction contract is found to be null and unenforceable, that provision shall not affect other provisions of the contract that are in compliance with this section and, to this end, the provisions of the contract are severable.

         The Court of Appeals applied certain portions of the KFCA to render null and void the entirety of Article 13. And the Court of Appeals appears to have overlooked KRS 371.405(4), which, as outlined above, provides for the severability of contract provisions that are not in conformance with the KFCA. Specifically, the Court of Appeals found Subsections (O) and (S) of Article 13 to be in violation of KRS 371.405(2)(a). But, as MSD correctly points out, the Court of Appeals improperly struck all of Article 13 based on the nonconformance of Subsections (O) and (S) with the KFCA, failing to apply the severability requirement outlined by KRS 371.405(4).

         "It was early decided that when some covenants of an indenture are legal and others illegal, the legal covenants may be enforced. A court may sever the illegal portion of the agreement and enforce the remainder."[7] "The general and well-established rule of the law of contracts [is] that where an agreement is illegal in part, the part which is good may be enforced, provided it can be separate, or severable, from the part which is bad[.]"[8] Kentucky law recognizes this rule: "Where a contract. . . consists of several covenants and agreements with regard to different subjects, and one of the covenants is illegal and vicious, the general rule which prevails is that, if the illegal covenant of the contract can be eliminated from it without impairing its symmetry as a whole, the courts will adopt that view and eliminate the obnoxious feature and enforce the remainder of the contract. . . ."[9] "We, of course, recognize that terms of a contract may be severable in particular items."[10]

         Undoubtedly, our rule of severability can be applied, if at all necessary, to invalidate portions of Article 13 that appear to violate the KFCA. We must now determine whether the provisions of Article 13 at issue truly do violate the KFCA. If we find only certain portions to be in violation of the KFCA, we must sever only those portions and not the entirety of Article 13.

         Article 13, entitled "Claims by the Contractor and Dispute Resolution," has 22 provisions that outline the terms and conditions to which all claims by T against MSD are subject. We provide a brief overview of each of the relevant provisions at issue.[11]

         Subsection (A) mandates written notice on the part of T for any of its "claims, disputes and other matters in question against MSD." The written notice "shall be received by MSD no later than ten (10) days after the event, or the first appearance of the circumstances [] causing the claim" and must be set forth in detail. Finally, "[T] agrees and acknowledges that its failure to provide written notice of a claim as set forth herein shall constitute a waiver of any claim for additional compensation or time extension related thereto[.]"

         Subsection (F) mandates, "[If T] seeks to make a claim for an increase in the Contract Price, as a condition precedent to any liability of MSD therefor, [T] shall strictly comply with . . . Article 13." Any claim by T must be made "before proceeding to execute any additional or changed Work." Finally, "Failure of the condition precedent to occur shall constitute a waiver by [T] of any claim for additional compensation."

         Subsection (J) mandates that within 30 days after the date of T's written notice of claim against MSD, T must file a formal written claim against MSD, outlining, in detail, the facts and circumstances of the claim. T must also provide MSD with "[o]ther information and documents . . . within ten (10) days after written request by MSD." Finally, "The failure to provide a claim as set forth herein, or the failure to provide such other documents or information requested by MSD within ten (10) days after the written request shall constitute a waiver of any claim for additional compensation or time extension related thereto[.]"

         Subsection (K) mandates that MSD "issue a formal written decision on a claim" within 30 days "after receipt of a formal written claim as provided in Paragraph l3(J), or thirty (30) days after [T's] response to the request by MSD under said Paragraph for other documents or information, whichever is later[.]" Subsection (L) states that "[t]he issuance of a formal written decision by MSD pursuant to Paragraph l3(K) . . . with respect to any such claim, dispute, or other matter will be a condition precedent to any exercise by [T] of such rights and remedies it may otherwise have under the Contract or applicable law in respect of any such claim, dispute, or other matter[.]" If MSD fails to render a formal written decision, T may submit to MSD a separate written demand for decision. If MSD later fails to issue a formal written decision within ten days of that separate demand, "the parties shall proceed as if a written decision adverse to [T] had been issued."

         Subsection (M) mandates, "The formal written decision of MSD on such claim, dispute, or other matter will be final and binding upon [T] unless, within ten (10) days after issuance of the decision, [T] appeals the decision by delivering to MSD a written request for executive negotiation." Most importantly, if T does not appeal the decision by executive negotiation, MSD's decision shall be rendered final and binding. Ten days after the receipt of a request for executive negotiation, the parties must meet and attempt to resolve the dispute. Subsection (N) provides that if executive negotiation fails, T may appeal, subject to Subsections (O) through (V).

         Subsection (O) mandates that the appeal must be submitted to the Chief Engineer of MSD no later than ten days after the date the executive negotiation has been declared unsuccessful by MSD or T. Most importantly, failure to do so within ten days results in the decision of MSD becoming final and binding. The Chief Engineer must issue a decision within 60 days after submission of the request for such decision. If the Chief Engineer fails to issue a written decision within 60 days, "the parties shall proceed as if a written decision adverse to [T] had been issued. The decision shall be final, conclusive and binding, absent intentional misconduct, fraud or bad faith[.]"

         Subsection (S) importantly provides, "MSD and [T] agree that all decisions of MSD that are not appealed to the fullest extent provided herein are final, conclusive and binding, and cannot be appealed to or challenged in any forum or court." Furthermore, "MSD and [T] further agree that all decisions of the Chief Engineer are final, conclusive and binding . . . and cannot be appealed to or challenged in any forum or court. . . ." Finally, Subsection (V) provides, "[t]he resolution of any claim under Article 13 shall be reflected by a Change Order executed by MSD and [T]. Under no circumstances shall MSD or T be required to participate in or be bound by any arbitration proceedings."

         A careful reading of KRS 371.405 evidences that some, but not all, of the above-highlighted Article 13 provisions run afoul of the KFCA.

         The parties appear to be in agreement that Subsection (O) and (S) are rendered null and void under KRS 371.405(2)(a).[12] What the parties disagree on is the effect of this statute on provisions in Article 13, like Subsection (A), which completely bars T from asserting a claim against MSD if T fails to provide notice of that claim within a certain time period of the occurrence of the events giving rise to that claim. T reads KRS 371.405(2)(a) broadly to render null and void Article 13 provisions like Subsection (A). On the other hand, MSD reads KRS 371.405(2)(a) narrowly to preserve Article 13 provisions like Subsection (A). Careful statutory interpretation supports MSD's argument.

         To understand why MSD is correct, we must examine KRS 371.405(2)(a), (c), and (3). KRS 371.405(2)(a) renders null and void "[a] provision that purports to waive, release, or extinguish the right to resolve disputes through litigation in court or substantive or procedural rights in connection with such litigation," except the contract may allow for binding arbitration or nonbinding alternative dispute resolution. KRS 371.405(2)(c) renders null and void B[a] provision that purports to waive, release, or extinguish the right of a contractor or subcontractor to recover costs, additional time, or damages, or obtain an equitable adjustment of the contract, for delays in performing the contract that are, in whole or part, within the control of the contracting entity." Finally, KRS 371.405(3) prevents (2)(c) from rendering null and void a contract provision that, in relevant part: 1) requires notice of any delay by the party affected by the delay; or 2) provides for arbitration or any other procedure designed to resolve contract disputes.

         There are seemingly two types of provisions in Article 13 at issue: 1) provisions that require the contractor, i.e. T, to comply with certain requirements, like providing notice, in order to preserve its claim; and 2) provisions that prohibit claims, even those that are preserved, from eventually being resolved by a third-party adjudicator. A careful reading of KRS 371.405 proves that the KFCA establishes and treats differently these two categories of contract provisions as well. Simply put, KRS 371.405(2)(a) renders null and void those provisions in the second category identified above but not the first.

         If, as T argues, KRS 371.405(2)(a) is meant to be read so broadly so as to render null and void any provision that requires T to act in some way to preserve its claim against MSD, then KRS 371.405(2)(c) is rendered completely superfluous[13] because this is exactly what (2)(c) does in the context of damages and contractual modifications related to "delays in performing the contract. . . within the control of the contracting entity[.]" Rather, (2)(a) only renders null and void those provisions that prohibit a contractor from asserting preserved claims before a neutral adjudicator. Adopting T's reading would also render KRS 371.405(3) meaningless because that statute provides for acceptable contractual provisions that are not rendered null and void by (2)(c) and that deal with preservation of the contractor's claim. In other words, T's reading of subsection (2)(a) would also render subsection (3) meaningless because, while (3) saves some types of provisions prohibited by (2)(c), (3) would still leave unsaved those same types of prohibited provisions under (2)(a).

         KRS 371.405(2)(a) does not render null and void provisions that force the contractor to undertake some action to preserve its claim. For example, Subsection (A), which mandates notice by the contractor of a claim it seeks to assert against the project owner on penalty of waiving that claim, would not be rendered null and void by (2)(a) because that contractual provision deals with preservation of a claim. In other words, the contractor can assert a claim against whomever he or she wants but must provide notice to that entity to do so. But Subsections (O) and (S) do not provide a way for the contractor to continue the dispute through a neutral adjudicator; rather, the only function of Subsections (O) and (S) is to take the dispute resolution process out of the hands of a neutral adjudicator altogether. Contractual provisions, like Subsection (A), that afford the contractor the opportunity to continue asserting a dispute before a neutral adjudicator, so long as certain preservation requirements are complied with, do not run afoul of KRS 371.405(2)(a).

         Such provisions do, on the other hand, run afoul of KRS 371.405(2)(c). A careful reading of KRS 371.405(2)(a) reveals that (2)(a) does not strike down provisions that simply require the contractor to act to preserve the right to continue the claim. KRS 371.405(2)(c), on the other hand, is much clearer in the extent of its reach, rendering null and void "[a] provision that purports to waive, release, or extinguish the right of a contractor ... to recover costs, additional time, or damages, or obtain an equitable adjustment of the contract, for delays in performing the contract that are . . . within the control of the contracting entity." Under this provision, contractual provisions like Subsection (A) would be rendered null and void because the failure to comply with them completely forecloses the contractor from asserting a claim against the project owner "to recover costs, additional time, or damages, or obtain an equitable adjustment of the contract, for delays in performing the contract that are . . . within the control of the contracting entity." Under T's reading of (2)(a), however, (2)(c) is unnecessary because (2)(a) already has this preclusive effect.

          KRS 371.405(2)(a) must have a different effect than KRS 371.405(2)(c); otherwise, KRS 371.405(2)(c) is rendered completely superfluous. Simply put, KRS 371.405(2)(c) prohibits contractual provisions that completely foreclose a contractor's ability "to recover costs, additional time, or damages, or obtain an equitable adjustment of the contract, for delays in performing the contract that are . . . within the control of the contracting entity," while KRS 371.405(2)(a) prohibits contractual provisions that foreclose the contractor from bringing a claim against the project owner to a neutral, third-party adjudicator as long as a preserved "dispute" exists, i.e. the contractor complied with all contractual provisions to ensure that the claim was not waived.

         Finally, we cannot forget the effect of KRS 371.405(3). KRS 371.405(3) prevents KRS 371.405(2)(c) from rendering null and void certain contractual provisions that require compliance on penalty of foreclosing the ability of the contractor to recover damages for delays in performing the contract for which the project owner is responsible. Coincidentally, although KRS 371.405(2)(c) would initially render null and void a provision like Subsection (A) of Article 13, KRS 371.405(3) acts as an exception to (2)(c). Subsection (3) specifically affords enforceability of "a contract provision that[] [r]equires notice of any delay by the party affected by the delay[, ]" exactly the function of Subsection (A).

         KRS 371.405(3) tempers the broad preclusive effect of KRS 371.405(2)(c). Of additional note is KRS 371.405(3)(d), which upholds the enforceability of provisions subject to (2)(c) that "[p]rovide[] for arbitration or any other procedure designed to resolve contract disputes." One could argue that the process outlined in the contract at issue in this case, where the ultimate adjudicator is an MSD official whose decision cannot be appealed, constitutes "any other procedure designed to resolve contract disputes."

         But to prevent an absurd result, [14] in conjunction with the statutory canon ejusdem generis, we must interpret this provision as providing for "any other procedure designed to resolve contract disputes" where ultimately a neutral, third-party adjudicator decides the propriety of the claim. It would be absurd to read (3)(d) as allowing for a contract provision that forecloses ultimate adjudication of a preserved claim by a neutral adjudicator when (2) (a) does exactly the opposite, i.e. negates such provisions. Moreover, the statutory canon ejusdem generis, counsels: "Where general words follow specific words in a statutory enumeration, the general words are [usually] construed to embrace only objects similar in nature to those objects enumerated by the preceding specific words."[15] In (3)(d), the word "arbitration" precedes "any other procedure designed to resolve contract disputes." Using the canon ejusdem generis, it would appear that "any other procedure designed to resolve contract disputes" was meant to encompass neutral, third-party adjudication, not simply a unilateral adjudication by one of the interested parties. It would be an untenable reading of (3)(d) to afford enforceability of the dispute-resolution process outlined in Article 13, which allows MSD ultimately to dictate the resolution of T's preserved claims without ultimate resolution by a third-party neutral adjudicator.

         Furthermore, recall that (3) upholds the validity of provisions that run afoul of (2)(c). Provisions that run afoul of (2)(c) are those that prevent a contractor from asserting claims against the project owner for delays in performing the contract "within the control of the contracting entity," i.e. project owner. So essentially, if we read (3)(d) as allowing the project owner to create a dispute-resolution system whereby the project owner is the judge, jury, and executioner, then we would be allowing project owners to insulate themselves from damages created by their own actions. This could not have been the intention of the General Assembly in enacting this statute.

         In sum, KRS 371.405 works like this. Subsection (2)(a) nullifies contract provisions that prohibit parties from asserting preserved claims before a neutral, third-party adjudicator. Subsection (2)(c) nullifies contract provisions that prohibit parties from asserting unpreserved claims, subject to Subsection (3)'s exceptions allowing for certain provisions that do that very thing.

         Further support for our interpretation of the inner workings of KRS 371.405 can be found in Bruner and O'Connor's seminal treatise on Construction Law.[16] Bruner and O'Connor recognize that "[t]imely notice of claims is a matter of fundamental fairness, and the notice requirements imposed by contracts . . . often reinforce the importance of timely notice by making it a 'condition precedent' to claim recovery or to commencement of litigation."[17] More importantly, "[e]xpress 'condition precedent' provisions . . . routinely are enforced, absent evidence of bad faith, fraud or gross negligence."[18] Moreover, "[i]n addition to claim notice requirements, changes and claims clauses frequently impose time limits for submission of ...


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