Court Rules Improperly Terminated Contractor Without Recourse In Light Of Converter Clause

As this column has noted on many occasions, the contract between the parties is the ultimate definition of their relationship. While that document should provide guidance in the “good times”, it will certainly be relied on when a party is looking to terminate the contract. However, in the absence of something in the contract justifying termination, a party may attempt to manufacture the circumstances it ultimately uses to do so. While such a termination would be improper, an appellate court, in the recent case of Tycoon Construction Corp. v New York City Housing Authority, reminds us that where the contract contains a “converter clause” converting an improper termination for cause into one for convenience, the contractor will have no recourse for the improper termination—no matter how ugly the circumstances of the termination were.

Background

In October of 2014, Tycoon Construction Corp. was awarded a contract by the New York City Housing Authority to perform certain “building entrance improvements”, which primarily focused on the installation of alarmed, ballistic security doors. The contract contained a “converter clause” which provided that “[i]f, after termination of the Contractor’s right to proceed, it is determined that the Contractor was not in default, or that the delay was excusable, the rights and obligations of the parties will be the same as if the termination had been for the convenience of [NYCHA]”. The contract also required that Tycoon provide NYCHA with notice of any claims within 20 days of their accrual.

In order to perform its work under the contract (specifically, the access control system), Tycoon needed for NYCHA to coordinate with Verizon to provide working telephone jacks and lines. For whatever reason, NYCHA could not provide the required working telephone service, thus precluding Tycoon from having the entrances tested and signed off. At around the same time (in October of 2016), NYCHA undertook to change the design of the entryways, and directed Tycoon to perform the extra work required to undertake the new design (which involved ripping out some of its newly installed entrances to install the ones with the updated design). On December 27, 2016, Tycoon submitted a change order of nearly $3 million to NYCHA for this work, and on January 11, 2017, it submitted a formal Notice of Claim under the contract.

Within a few weeks of this change order, NYCHA ordered Tycoon’s workers off of the site, and on March 27, 2017, it declared Tycoon in default (and placed a claim under Tycoon’s performance bond). None of the reasons cited in the March 27^th letter were enumerated in the contract as bases to default the contractor. Because NYCHA is a public entity, Tycoon commenced an administrative review proceeding under Article 78 of the Civil Practice Law and Rules to annul the decision to terminate the contract, arguing that it was unsupported by the terms of the contract and, therefore, was arbitrary and capricious. Based on the language of the contract the court agreed, and the default was annulled (which annulment was subsequently affirmed on appeal).

Subsequently, Tycoon commenced a lawsuit against NYCHA to recover for the improper termination and unpaid extra work. NYCHA moved to dismiss, arguing that the converter clause insulated it from the effects of its judicially determined improper termination, and that the late Notice of Claim precluded Tycoon from recovering its extra costs pursuant to the change order. Tycoon opposed, offering a novel argument conceding that while the contract contained a converter clause giving NYCHA the right to terminate for any reason, such did not insulate it from having to pay financial damages resulting from such an improper termination. As to the late Notice of Claim, Tycoon argued that its damages were only ascertainable upon the issuance of the change order on December 27, 2016, and that its Notice of Claim, filed 15 days later, was timely.

Decision

The court granted NYCHA’s motion, finding that as NYCHA had the unilateral right to terminate the contract, it could not be made to pay costs related to an improper termination. As to the extra work claim, the court found that Tycoon’s claims accrued upon the change of the design in October of 2016—and not the issuance of the change order in December—and, therefore, the Notice of Claim filed in January of 2017 was untimely. The appellate court affirmed, citing well settled case law on both propositions, holding that where there is an unqualified right to terminate the contractor (here, by the converter clause deeming an improper termination as one for convenience), NYCHA had the right to do so “without court inquiry as to whether the termination was driven by an ulterior motive”. Similarly, as the service of a timely Notice of Claim was a condition precedent to the recovery on the extra work claim, the failure to do so amounted to a complete waiver of the claim.

Comment

On a construction project, the contract is the document by which claims live or die. A converter clause is a dangerous one for a contractor (or for a subcontractor) because it insulates the upstream party from the consequences of taking improper actions (which, here, were judicially determined to be improper, and included the making of an improper demand upon Tycoon’s performance bond). Similarly, a short Notice of Claim provision can serve to insulate an owner or an upstream contractor from having to pay for services rendered in good faith.

Holdings such as the one here serve as warnings to contractors to be familiar with all of the terms of their contract, and to be diligent about sending out correspondence, such as a Notice of Claim, so as to preserve their right to collect later on. Likewise, familiarity with all of the terms of the contract could have enlightened the decision as to whether to pursue a separate special proceeding to determine whether the termination was improper. Given the converter clause, that determination served only as a pyrrhic victory.

While a contract on a publicly bid job cannot be negotiated, contractors would nevertheless be well advised to have experienced construction counsel review the contract pre-bid and advise of both its “highlights” and “lowlights” so as to enlighten the contractor’s decision as to whether to bid or not. (To borrow a late-July baseball analogy, sometimes the best trade you make is the trade you don’t make.) Post-bid, the contractor should have counsel prepare “claim books”, which set forth the rights that the contractor has (and does not have) under the contract. These claim books also tailor notice and other documents to the terms of that contract, and include specific timelines clearly setting forth what notices have to be given, and when, so as to best preserve the contractor’s right to payment.

If you would like more information regarding this topic please contact Thomas H. Welby at twelby@wbgllp.com or call (914) 428-2100