By: Thomas S. Tripodianos Published: September 2011

Dispute resolution procedure making contractor the sole arbiter of all claims and disputes under the subcontract was void for illegality under the law of trusteeship and was unenforceable

The facts of the case start out in a fairly common fashion. General Contractor, entered into a prime contract with the Dormitory Authority of the State of New York (DASNY) with respect to a public improvement construction project. General Contractor, then entered into a written subcontract agreement (the subcontract), with Subcontractor for the project.

The subcontract contained a not so uncommon "Dispute Resolution Procedure," which made the General Contractor "the sole arbiter of all claims, disputes, and questions of any nature" subject only to limited judicial review if "the determination by the sole arbiter was made in bad faith or fraudulently."

Subcontractor began its performance of the subcontract, and timely completed its installations. During the course of the project, General Contractor requested and directed Subcontractor to perform additional work, which was beyond the scope of the subcontract. Subcontractor alleges that despite due demand, General Contractor has failed and refused to pay it this outstanding subcontract balance in breach of the subcontract. Subcontractor also asserts a delay claim against the General Contractor. Subcontractor sued the General Contractor for breach of contract, to foreclose its mechanics' lien, to enforce the Lien Law Article 3A Statutory Trust, and the General Contractor's surety as a beneficiary of the statutory payment and performance bond.

The Subcontractor was able to overcome the General Contractor's and Surety's motion to dismiss by arguing that the Dispute Resolution Procedure in the subcontract is void for illegality under the law of trusteeship and is unenforceable as a matter of law. Under Lien Law §3-A, General Contractor, as a general contractor on a public improvement construction project, is a statutory trustee with respect to all funds it received from the owner, DASNY, for work performed on the project and that, as a subcontractor to General Contractor, Subcontractor is a statutory beneficiary of that trust. The Subcontractor noted and the Court agreed that the Dispute Resolution Procedure runs afoul of the General Contractor's obligations to Subcontractor as a statutory trustee because it creates a conflict of interest in permitting General Contractor to determine whether to retain public trust funds for itself or compensate Subcontractor for work performed.

The Dispute Resolution Procedure was also found to run afoul of the Subcontractor's mechanics' lien rights. The Dispute Resolution Procedure creates three conditions precedent to the subcontractor's right to recover compensation to which it would be entitled under the Lien Law: exhaustion of the described alternative dispute resolution procedure before an arbitrator controlled by defendant contractor; the filing of a notice of claim with the contractor; and the pleading of compliance with the preceding procedural requirements, without which the subcontractor is deemed to have waived the right to recover, all of which violate the public policy reflected in the Lien Law by providing for a waiver by the subcontractor of "all rights and remedies against the Contractor which are not expressly provided for by the said [Dispute Resolution Procedure]", including "any claims of breach of contract or other alleged bases for damages or relief against the Contractor".

Subcontractor's claims against the surety bond also survived the motion to dismiss as the General Contractor's attempt to apply the notice and alternative dispute resolution procedures contained in the subcontract to defeat Subcontractor's rights under State Finance Law §137 is clearly in contravention of the public policy reflected in the statute and repeatedly recognized in the caselaw.

Subcontractor's breach of contract claims were dismissed as the Court found the Dispute Resolution Procedure to be enforceable as it pertains to those specific causes of action. That portion of damages asserted for delay, as contained in the payment bond claim was also reduced on similar grounds.

It is important to note that the Court specifically found that the Subcontractor in this case had substantially complied with the Notice of Claim provisions in the agreement.

This case like others before it serves to highlight a contracting party's need to consult experienced construction attorneys in negotiating and understanding their agreements and to then be vigilant in following the provisions of the contract. If those prerequisites are met you will have provided your construction litigation attorney with the ammunition needed to fight for your rights.

If you would like more information on this issue or any other construction issue, please contact Welby, Brady & Greenblatt, LLP at (914) 428-2100. 

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