Public-Private Partnership (P3) and design-build project delivery methods get much press and are in frequent use by public agencies across the country. Still, the vast majority of public projects in the United States are awarded under the traditional design-bid-build approach. Under this traditional delivery system, the public owner hires an architect/engineer to design a project and to prepare detailed drawings and specifications for its bid and construction. These design documents are incorporated into the contract documents and the project is advertised for competitive bid to the construction community. The contract is then awarded to the lowest, responsive bidder.
While the competitively bid public works contracting process may seem simple, the simplicity of the process results in certain implied representations that are essential for this method of contracting to make economic sense for the construction community. No implied representation is more important in the hard-bid scenario than the implied warranty of the correctness of the plans and specifications. This is the warranty that says the project is constructible as designed by the owner and as set forth in the bid documents. This implied warranty is critical to competitively bid public works contracts because it sets forth the most basic premise of the agreement between the parties: the contractor is submitting a price to build the project based upon the construction documents provided; if there are components missing from the owner’s design or the project is not constructible as set forth in the bid documents, the contractor did not price this risk into its bid and the owner has not purchased the right to shift this risk to the contractor. This simple concept is a critical component of the construction community’s ability to assess the contractual risk it is undertaking when submitting bids for traditional public works projects and it likewise protects public agencies from paying a premium for contingent risks.
In California, the traditional rules applicable to hard-bid public contracts have been reinforced through a series of published legal decisions and statutes and are adopted in the official California “CACI” Model Jury Instructions. This article reviews some of these basic rules and the policies applicable to public contracts.
The Terms Of Hard-Bid Public Contracts Are Non-Negotiable
When a public agency expends funds on a public works project it must, with limited exceptions, comply with competitive bidding laws. See, e.g., City of Los Angeles Charter, section 386 (12/13/90 version);Ghilotti Construction Company v. City of Richmond, 45 Cal. App. 4th 897, 904, n. 2, (1996); Public Contract Code section 20162, et seq. The public agency prepares the contract documents, and the bidding contractor has no right to modify or negotiate the contract’s terms – it is a take it or leave it scenario. See City of Los Angeles Charter at section 386(f) (12/13/90 version). In fact, a public works contractor must submit a bid bond or other guarantee with its bid that provides, if it is the lowest responsible bidder, it will execute the public agency’s contract or forfeit its bid bond/guarantee. See, e.g.,id.
The Implied Warranty To Prepare Complete And Accurate Construction Documents: A Review Of California Law
Consistent with the non-negotiable nature of public contracts, the public agency, in turn, must act in good faith and prepare complete and accurate construction documents prior to soliciting bids. In California, this requirement can be seen in California Public Contract Code section 1104 (applicable to local public agencies) and Public Contract Code section 10120 (applicable to state agencies). Public Contract Code section 1104 provides:
No local public entity, charter city, or charter county shall require a bidder to assume responsibility for the completeness and accuracy of architectural or engineering plans and specifications on public works projects, except on clearly designated design build projects.
Public Contract Code section 10120 (applicable to state agencies) mandates:
Before entering into any contract for a project, the department shall prepare full, complete, and accurate plans and specifications and estimates of cost, giving such directions as will enable any competent mechanic or other builder to carry them out.
The implied warranty of the correctness of plans and specifications is derivative of a public agency’s responsibility to prepare complete and accurate plans and specifications from which contractors may prepare a bid. See, e.g., Souza & McCue Constr. Co. v. Superior Court of San Benito County, 57 Cal. 2d 508 (1962); Warner Constr. Corp. v. L.A. 2 Ca1. 3d 285 (1970). This rule of law has been referred to in federal cases as the “Spearin Doctrine,” named after a seminal United States Supreme Court case in which the Court held that government contracts contain an implied warranty that plans and specifications issued by the government for bidding are complete and accurate for the construction of the project. United States v. Spearin 248 U.S. 132, 136-37 (1911). In Spearin, the United States Supreme Court held:
[I]f the contractor is bound to build according to plans and specifications prepared by the owner, the contractor will not be responsible for the consequences of defects in the plans and specifications. Id.
In two key California decisions, Souza and Warner, the California Supreme Court effectively adopted the principles underlying the Spearin doctrine. Souza, 57 Cal. 2d at 510-11; Warner, 2 Cal. 3d at 294. InWarner, the City of Los Angeles entered into a competitively bid public works project. The general contractor bid the project based on the plans and specifications issued by the City. During construction, the general contractor encountered unforeseen difficulties not disclosed in the design documents supplied by the City. The City refused to execute a change order, and the contractor performed the extra work associated with the unforeseen conditions. The contractor subsequently sued the City for misrepresentation and breach of the implied warranty of the correctness of the plans and specifications. As to the breach of contract action, the City raised numerous contractual defenses, including that any modification to the contract could only be effectuated through the competitive bidding process or through the change order procedures contained within the contract. The California Supreme Court rejected the City’s arguments and found that the general contractor was entitled to damages based on the City’s breach of the implied warranty.
In Souza, the California Supreme Court had earlier stated the rule as follows:
A contractor of public works who, acting reasonably, is misled by incorrect plans and specifications issued by the public authorities as the basis for bids and who, as a result, submits a bid which is lower than he would have otherwise made may recover in a contract action for extra work or expenses necessitated by the conditions being other than as represented. This rule is mainly based on the theory that the furnishing of misleading plans and specifications by the public body constitutes a breach of an implied warranty of their correctness. The fact that a breach is fraudulent does not make the rule inapplicable.
The Souza and Warner decisions are not stand-alone California cases, and are in accordance with long standing California law upholding the right of a contractor to recover damages from a public entity for breach of the implied warranty of correctness of its plans and specifications. See, e.g., E.H. Morrill Company v. State, 65 Cal. 2d 787 (1967) (breach of implied warranty action against the State of California); Tonkin Construction Co. v. County of Humboldt, 188 Cal. App. 3d 828 (1987) (breach of implied warranty action against Humbolt County); Gogo v. Los Angeles Flood Control Dist. 45 Cal. App. 2d 334 (1941) (breach of implied warranty action against the Los Angeles County Flood Control District).
Morerecently, in Dillingham-Ray Wilson v. City of Los Angeles, 182 Cal. App. 4th 1396 (2010), the California Court of Appeal reaffirmed the implied warranty and the contractor’s right to seek modified total cost damages for contract breach, provided certain elements are met. As to the implied warranty, theDillingham-Ray Wilson Court stated:
If a contractor makes a misinformed bid because a public entity issued incorrect plans and specifications, precedent establishes that the contractor can sue for breach of the implied warranty that the plans and specifications are correct. The contractor may recover for extra work or expenses necessitated by the conditions being other than as represented
In California, the implied warranty of the correctness of the plans and specifications has been expanded somewhat to include a public agency’s failure to disclose material information. California courts had struggled with the situation where the plans and specifications were correct but the contractor was misled as a result of material information being unintentionally withheld by the public agency. Until recently, however, there was not agreement among California appellate court decisions as to whether a contractor had to establish a fraudulent intent to conceal material information to recover from a public owner or whether the mere failure to furnish material information was enough to establish public owner liability.
In the recent California Supreme Court decision Los Angeles Unified School Dist. v. Great American Ins. Co. 49 Ca1. 4th 739 (2010), the Supreme Court resolved the split among California appellate courts and expanded the implied warranty of the correctness of the plans and specifications to include a public agency’s failure to disclose material information. The Court essentially adopted the “superior knowledge” rationale recognized in federal procurement contracts. In its written opinion, the Supreme Court stated a four-part rule:
[A] contractor need not prove an affirmative fraudulent intent to conceal. Rather . . . a public entity may be required to provide extra compensation if it knew, but failed to disclose, material facts that would affect the contractor’s bid or performance. Because public entities do not insure contractors against their own negligence, relief for nondisclosure is appropriate only when (1) the contractor submitted its bid or undertook to perform without material information that affected performance costs; (2) the public entity was in possession of the information and was aware the contractor had no knowledge of, nor any reason to obtain, such information; (3) any contract specifications or other information furnished by the public entity to the contractor misled the contractor or did not put it on notice to inquire; and (4) the public entity failed to provide the relevant information.” Id. at 745.
California: Damages Recoverable For A Public Agency’s Breach Of The Implied Warranty
The method used to calculate the damages that flow from a public owner’s breach of a construction contract is frequently a source of dispute between the contractor and the public agency, particularly when the impacts of the breach are wide-spread and pervasive. As a starting point, the following underlying principles in contract damages are important to the analysis.
First, the goal under the law with respect to breach of contract damages is to place the injured party in as good a position as he would have occupied if the contract had not been breached. Lewis Jorge Constr. Mgmt., Inc. v. Pomona Unified School Dist., 34 Cal. 4th 960, 967-968 (2004). The California Supreme Court adopted the English rule of Hadley v. Baxendale over 120 years ago in Mitchell v. Clark, 71 Cal. 163 (1886), and more recently reaffirmed its general principle in holding that when one party breaches a contract the other party is entitled to damages sufficient to make that party “whole,” which means to place the non-breaching party in the same position as if the breach had not occurred. Applied Equipment Corp. v. Litton Saudi Arabia Ltd., 7 Cal. 4th 503, 515 (1994). Pursuant to California Civil Code section 3300, the proper measure of damages for breach of a contract is “the amount which will compensate the party aggrieved for all the detriment proximately caused thereby, or which, in the ordinary course of things, would be likely to result therefrom.” Civ. Code § 3300. Damages can be recovered for breach of contract if the damages are the direct and natural consequence of the breach, and the amount can be shown with sufficient certainty. Mann v. Jackson, 141 Cal. App. 2d 6, 12 (1956). The damages sought must be “clearly ascertainable in both their nature and origin.” Civ. Code § 3301.
Next, the California Supreme Court has also consistently applied the rule that once liability is shown, “it is not necessary for the injured party to plead his damages with arithmetical exactness.” California Lettuce Growers, Inc. v. Union Sugar Co., 45 Cal. 2d 474, 486-87 (1955). “[W]hen it clearly appears that a party has suffered damage a liberal rule should be applied in allowing a court or a jury to determine the amount,” even if that amount is “uncertain, contingent or difficult of ascertainment.” Id. Thus, contract damages for the breach of public and private contracts are traditionally calculated by any reasonable method of approximation of the harm caused and need not be susceptible to exact proof. See Allen v. Gardner, 126 Cal. App.2d 335, 340-341 (1954); Hensler v City of Los Angeles, 124 Cal. App. 2d 71 (1954). This is especially true when the breaching party renders it impractical to determine damages with absolute accuracy. See Pacific Scientific Co. v. Glassey, 245 Cal. App. 2d 831, 842-43 (1966);Clemente v. State of California, 40 Cal. 3d 202, 219 (1985). For example, California courts have allowed a construction contractor to approximate damages caused by a public entity’s breach of contract based on the contractor’s past experience with regard to the costs of doing the same type of work involved in the case. See Hensler, 124 Cal. App. 2d at 87. A defendant’s protection is the requirement that there be a causal link between the wrongful conduct and the damages awarded. See Postal Instant Press, Inc. v. Sealy, 43 Cal. App. 4th 1704, 1709 (1996).
Furthermore, an important public policy consideration in determining the appropriate method to measure breach of contract damages is the need for predictability in commercial transactions and the financial risks being undertaken. See Amelco Electric v. City of Thousand Oaks, 27 Ca1. 4th 228 (2002). The California Supreme Court in Amelco summarized basic contract law, stating:
Under a breach of contract theory, the plaintiff must demonstrate a contract, the plaintiff’s performance or excuse for non-performance, the defendant’s breach, and damage to the plaintiff. ‘Contract damages are generally limited to those within the contemplation of the parties when the contract was entered into or at least reasonably foreseeable by them at that time; consequential damages beyond the expectation of the parties are not recoverable. This limitation on available damages serves to encourage contractual relations and commercial activity by enabling parties to estimate in advance the financial risk of their enterprise.’ ‘Predictability about the cost of contractual relationships plays an important role in our commercial system.’ Id. (citations omitted).
In claims arising out of the breach of the implied warranty of the correctness of the plans and specifications, public agencies know that at the time of contract award that there is potential financial exposure for the damages caused by the issuance of incorrect plans and specifications. Placing this risk on public agencies is reasonable, as they alone are in the position to remove the risk by completing the plans and specifications prior to soliciting bids. Conversely, contractors, in assessing the risk of bidding public projects, are entitled to assume that the public agency prepared complete plans and specifications, and that the public agency has disclosed all material information concerning the project, as required.
While the preferred method to calculate contract damages is under the pricing mechanism of the contract, as discussed above, general California contract law does not foreclose other methods of calculating damages, particularly when the difficulty in quantifying damages is caused by the breaching party. For example, the Amelco Supreme Court decision affirmed the use of reasonable estimates in calculating breach of contract damages against a public entity. The Amelco decision cites with approval the case ofCity of Salinas v. Souza & McCue Construction Co., Inc., 66 Cal. 2d 217 (1967) (“Souza II”). Amelco,supra, 27 Cal. 4th at 247. The Souza II case involved the public entity’s breach of the implied warranty of the completeness and accuracy of its design documents, and the court allowed damages based on the difference between the fair and reasonable cost of actual performance and what the costs “would have been” in the absence of the breach. Souza II, 66 Cal. 2d at 225-26. Determining what the costs “would have been” necessarily requires reasonable estimating of damages. Far from prohibiting the use of reasonable estimates in proving damages against a public entity, the Supreme Court affirmed this practice in Amelco.
Following this line of reasoning, more recently in Dillingham-Ray Wilson v. City of Los Angeles, 182 Cal. App. 4th 1396 (2010), the California Court of Appeal affirmed the contractor’s right to use a modified total cost approach, provided certain requirements were met. The contractor’s main theory of recovery in theDillingham-Ray Wilson case was based on the public agency’s breach of the implied warranty of the correctness of the plans and specifications. In discussing the modified total cost method to calculate damages, the Court of Appeal stated:
This [total-cost recovery] method may be used only after the trial court determines the following can be shown: (1) it is impractical for the contractor to prove actual losses directly; (2) the contractor’s bid was reasonable; (3) its actual costs were reasonable; and (4) it was not responsible for the added costs. If some of the contractor’s costs were unreasonable or caused by its own errors or omissions, then those costs are subtracted from the damages to arrive at a modified total cost. `If prima facie evidence under this test is established, the trier of fact then applies the same test to determine the amount of total cost or modified total cost damages to which the plaintiff is entitled.’ Id. at 1408 (internal citations omitted).
Regardless of the method used to calculate damages arising from a public agency’s breach of the implied warranty of the correctness of the plans and specifications, the California Supreme Court has firmly established that the contractor is entitled to recover for the “extra work” caused by the conditions being different than represented in the construction documents:
A contractor of public works who, acting reasonably, is misled by incorrect plans and specifications issued by the public authorities as the basis for bids and who, as a result, submits a bid which is lower than he would have otherwise made may recover in a contract action for extra work or expenses necessitated by the conditions being other than as represented. Souza, supra, 57 Cal. 2d at 510-11 (emphasis added.)
As always, the specific circumstances of a project, the contract terms, and the nature of the damages suffered as a result of a breach of the implied warranty will dictate the approach for calculating contract damages. Nonetheless, California law is clear that an essential premise of public works contracting is the implied warranty, and California law is equally clear that difficulty in quantifying contract breach damages, particularly when the difficulty is caused by the breaching party, is not a bar to recovery.