Lack of Standing vs Lack of Capacity to Sue for Breach of Contract
“[A]s a general rule, it is only the private parties to contracts – as opposed to third parties or public authorities – who have the legal standing to sue for breach of contract.” See, generally, “Contract as Empowerment,” 83 U. Chi. L. Rev. 759, at note 120 (Spring 2016). But, “[e]very year, more than 100 reported court opinions consider the question whether an outsider can sue for damages under a contract made by others – in part because the law is so ambiguous.” See, discussion in “An ‘App’ for Third Party Beneficiaries,” 91 Wash. L. Rev. 1663 (Dec. 2016).
Both Kansas and Missouri follow the general rule that one must be a party or intended beneficiary of a contract to have standing to sue for breach of that contract. See, Verni v. Cleveland Chiropractic College, 212 S.W.3d 150, 153 (Mo. en banc 2007); compare, Cornwell v. Jesperson, 238 Kan. 110 at 115, 118, 708 P.2d 515 (1985), and Noller v. GMC Truck & Coach Div., General Motors Corp., 244 Kan. 612 at 617, 772 P.2d 271 (1989).
Neither Kansas nor Missouri treats the issue as one of capacity. The cases in both jurisdictions find that a plaintiff not a party to a contract lacks standing, not capacity. See, Midwestern Health Mgmt. v. Walker, 208 S.W.3d 295, 297 (Mo. App. 2006) (denial of assignment of account raised issue of standing, not capacity); Byers v. Snyder, 44 Kan. App.2d 380 at 385, 237 P.3d 1258 (Kan. App. 2010) (defense that plaintiffs not intended beneficiaries of contract raised issue of standing, implicating court’s jurisdiction).
This distinction has a difference. The rules of civil procedure lead to different methods of addressing lack of capacity vs. lack of standing.
Under the Federal and Kansas rules a plaintiff need not allege capacity to sue (except to establish jurisdiction in the federal court). F.R.Civ.P. 9(a)(1)(A), K.S.A. 60-209(a)(A). Under Missouri’s fact pleading rules a plaintiff need only plead the “ultimate fact” of capacity. Mo.R.Civ.P. 55.13. But, all of these rules require a party raising an issue of capacity to do so by specific denial supported by facts. F.R.Civ.P. 9(a)(2), K.S.A. 60-209(a)(2), Mo.R.Civ.P. 55.13.
On the other hand, the waiver provision of the rules does not apply to the defense of lack of subject matter. See, F.R.Civ.P. 12(h)(1), K.S.A. 60-212(h)(1), and Mo.R.Civ.P. 55.27(g).
In other words, the defense of lack of jurisdiction due to lack of standing cannot be waived. But, lack of capacity is waivable if not presented by specific denial. See, City of Wellston v. SBC Communs., Inc., 203 S.W.3d 189, 192 (Mo. en banc 2006); Douglas Landscape & Design, L.L.C. v. Miles, 51 Kan. App.2d 779 at Syl. ¶2, 355 P.3d 700 (Kan. App. 2015).
Since the cases in Missouri and Kansas treat the right to sue on a contract as providing standing for purposes of subject matter jurisdiction, a party can raise the issue at any time, even on appeal. See, Verni, supra, at 153; Byers, supra, at 385.
Texas courts handle this issue differently. In Texas, the right to sue as a party, intended beneficiary, or assignee of a contract provides capacity to sue. If a defendant establishes that a plaintiff has no right to sue on a contract, the court must dismiss the plaintiff’s case on the merits, not for lack of subject matter jurisdiction. See, e.g., John C. Flood of DC, Inc. v. Supermedia, L.L.C., 408 S.W.3d 645, 650 (Tex.App.-Dallas 2013, pet. denied).
This difference means that in Texas a party must address the plaintiff’s right to sue on a contract immediately by a verified denial or waive the defense. Tex. R.Civ.P.93. But, in Kansas, Missouri, or federal courts not applying Texas law, a party can theoretically wait.
 Under Texas law a plaintiff must have standing and capacity. Coastal Liquids Transportation, L.P. v. Harris County Appraisal District, 46 S.W.3d 880,884 (Tex. 2001).
Standing of Beneficiaries under Trust or Will to Assert Claims Against the Lawyer that Represented the Settlor
The normal rule is that a non-client may state a claim for legal malpractice against a lawyer only if the client intended the lawyer’s services to benefit the non-client. Donahue v. Shughart, Thomson & Kilroy, 900 S.W.2d 624, 628-629 (Mo. 1995) (establishing a balancing test for determining whether a lawyer owes a duty to a non-client). This is consistent with hornbook third party beneficiary law.
What if the client retained a lawyer to prepare or modify a trust or will naming beneficiaries but died without expressly stating (or including in the instrument) that he intended the lawyer’s services to benefit those beneficiaries? The Missouri Court of Appeals has applied Donahue to imply such an intent from the settlor’s designation of the beneficiaries in the trust. Johnson v. Sandler, Balkin, Hellman, & Weinstein, P.C., 958 S.W.2d 42, 50 (Mo. App. 1997).
In Johnson, the beneficiaries under a trust established by their deceased father with the assistance of the father’s first lawyer sued the father’s second law firm for negligence in modifying the trusts to allow the father’s second wife to elect against the trust and deprive them of some of the proceeds. The Court of Appeals addressed the law firm’s contention that it had not performed services to benefit the plaintiffs, claiming that the decedent had not even instructed them to consider the plaintiffs:
“To satisfy Donahue, it is not necessary that the client advise the attorney drafting a will or a trust that he ‘intends to benefit’ the beneficiaries. The main purpose of retaining an attorney to prepare a testamentary trust is to ensure the future transfer of the settlor’s estate to the beneficiaries designated by the settlor…Therefore, an intent to benefit is inherent in designating persons as beneficiaries of a trust or will.” 958 S.W.2d at 50.
A few jurisdictions continue to hold that, absent fraud or collusion or malice, an attorney is not liable to a non-client for harm caused by the attorney’s negligence in drafting a will or trust. But, the majority of jurisdictions, like Missouri, recognize that intended beneficiaries harmed by a lawyer’s malpractice may maintain a cause of action against the lawyer even absent an attorney client relationship. See, Leak-Gilbert v. Fahle, 55 P.3d 1054, 1060 (Ok. 2002) (collecting cases at footnotes 15 and 16 and citing Johnson v. Sandler).
Lawyer’s Attempt to Limit Scope of Representation
Syndicated legal cartoonist, Stu, in 2002 showed the first line of a “discount” lawyer’s opening statement to the jury: “My client is totally innocent of a few of the charges.” The client may have wondered who was representing him on the rest of the charges.
Whether or not intended by Stu, the cartoon illustrates the problem for clients when their lawyer limits the scope of his representation. Clients want their lawyer to represent them and generally have little appreciation for the impact of any limitation.
ABA Model Rule 1.2(c) requires any limitation to be “reasonable” and the client to give “informed consent.” Whether that requirement actually protects the client depends on the conscientiousness of the lawyer. A few examples illustrate.
May a law firm preclude acting adversely to another client?
This limitation can arise when a law firm already represents two clients who could become adverse to each other in a matter. To avoid the potential future conflict, the law firm agrees to represent one of the clients on the matter but limits the scope so that it cannot act adversely to the other client.
ABA Model Rule 1.2(c) contemplates that any such limitation does not exempt the law firm from the obligations of “competent” and “diligent” representation. These obligations, in turn, require the law firm to meet the standard of care and to do whatever is required to represent the client. If suing the other client would ordinarily be what was required under the standard of care, the limitation is improper. Yet, the rule also contemplates that the limitation itself is a factor to consider in determining competence and diligence!
May a law firm limit an established scope of representation?
This limitation can occur when a law firm already represents a client but then attempts to narrow the scope (eg., as in the above example to preclude suing another client). While the ABA Model Rules do not expressly address the situation, in combination with a lawyer’s common law fiduciary duty to a client, Model Rule 1.8 provides an analogy.
Model Rule 1.8 requires a lawyer seeking to enter into a “business transaction” with a client to advise the client in writing to seek other legal counsel. The rule focuses on the need to protect a client in an established fiduciary relationship in which the client is otherwise likely to rely on the lawyer’s recommendation. By analogy, any effort by a law firm to change the scope of an established relationship in a material way should require the law firm to advise the client in writing to seek other counsel before giving an informed consent.
May a law firm limit the information it must disclose to a client?
This limitation typically arises when the law firm represents two or more clients that have competing business or legal interests. The limitation directly involves the interaction among the law firm’s duties relating to confidentiality, communication, and ethical conflicts.
Every lawyer is obligated under ABA Model Rule 1.6(a) to maintain confidential all information related to the representation. Every lawyer is also obligated under Rule 1.4(b) “to explain a matter to the extent reasonably necessary to permit the client to make informed decisions regarding the representation.” The problem occurs when the law firm has information arising out of the representation of one client “reasonably necessary” to representing another client. That problem can lead to a conflict of interest requiring the lawyer to withdraw from representing one or both clients.
This problem becomes acute when the law firm tries to preempt it by expressly limiting its obligation to disclose information to one client. The law firm’s fiduciary duty and the ABA in a formal opinion make clear that a law firm cannot avoid a conflict of interest in this way.
May a law firm exclude specific tasks from a representation?
ABA Model Rule 1.2(c) aimed at permitting law firms to “unbundle” their services to clients. Instead of automatically representing clients in all matters law firms could specify by reasonable agreement and informed consent what they would do for their clients.
So, the general answer to this question is yes. But, a specific answer still requires consideration of what a reasonably prudent and competent lawyer would need to do to meet the standard of care. And, of course, the rules expressly require the client’s informed consent, which the lawyer “may not assume from a client’s or other person’s silence.”
There are multiple relationships that “informed consent” can theoretically permit but which it would be imprudent for a law firm to undertake. Any attempt to limit scope that also involves representation of multiple clients on the same matter, waiver of conflict, or a material change in the fiduciary relationship falls into this category. And, the attempt may create a basis for liability to a client with damage claims.
Joint Representation of Multiple Parties on a Construction Project
Typical contractual relationships on a construction project
A construction project typically involves several contractual relationships. The Owner may contract with a Lender as well as a Contractor; the Contractor with Sub-contractors and maybe even a Surety.
Opportunities for joint representation of these parties on the same construction project do occur. The Contractor may have joined with the Owner or with its Sub-contractors in a joint venture to do the project. The same economics underlying the joint venture may lead the parties to use the services of the same law firm on the project. But, even then, the parties have probably used different counsel to negotiate the joint venture.
Given the need to negotiate contracts and the probability of at least routine disputes and litigation during the project, joint representation of the typical contracting parties seems unlikely to work ethically or practically.
What about the contractor and the lender? Unlike the owner and the lender, the contractor and the lender do not necessarily have a direct contractual relationship.
But, the contractor may have to look to the lender to fund pay applications – especially in a project owned by a single purpose entity with limited liability and resources. The principals behind the owning entity may have resources, but they have set up the LLC for the specific purpose of limiting their liability. This fact makes the contractor dependent on the loan disbursements for payment on the construction contract.
Unfortunately, the lender may refuse to fund a pay application for reasons related to the owner’s performance on the loan, not the contractor’s performance on his contract with the owner. The contractor may not get paid even if he has performed. Not surprisingly, the AGC advises: “The lender may (or may not) be your ally.” (AGC Guide to Construction Financing, 2d ed. 2007, p. 15)
This prospect probably means that the lender and the contractor are not typically going to seek out the same counsel. Nor would a construction law firm reasonably seek to represent both on the same project. But, what if the same law firm already represents both the lender and the contractor?
The law firm probably has a strong incentive to represent at least one or the other of its clients on the project. The problem is that either client might not like its law firm representing the other client on the project. The law firm may face the choice of representing neither – a very distasteful decision – or trying to represent both despite the possibility of funding issues.
In this situation the law firm has the ethical and fiduciary obligation to consider whether it can represent both and, if so, how.
The ethical rule
ABA Model Rule 1.7(a) establishes a prohibition “if the representation involves a concurrent conflict of interest.” Under the rule a “concurrent conflict of interest” exists if the clients are “directly adverse” or if there is a “significant risk” that the representation of either client will be materially limited by the law firm’s responsibilities to the other client. Comments 7 and 26 to the rule make clear that both types of conflict can occur in transactional matters, not just litigation. And, Comment 2 makes it the lawyer’s responsibility to determine whether a conflict exists.
“Concurrent conflict of interest”
Certainly, a direct contractual relationship can involve a “concurrent conflict of interest” when the parties are negotiating the contract or if a dispute develops over contract performance. The law firm in our situation may conclude that no concurrent conflict exists because its client the lender will not have an immediate, direct contract with its client the contractor.
But, this conclusion overlooks the reality of the construction project. The lender may require the owner, with which it has a direct contract (the loan), to obtain the contractor’s consent to an assignment of the owner’s interest in the construction contract. The lender may even require the contractor to obtain a completion guaranty from the contractor. Both of these requirements benefit the lender and effectively create a potential obligation by the contractor to the lender. Even though the lender and the contractor may not have an immediate, direct contractual relationship, they may become “directly adverse.”
The loan agreement may also attempt to provide the lender with a priority over any contractor lien on the project. While the validity of the priority may depend on state law, the lien interests of the lender could interfere with the lien interests of the contractor. As noted before, the lender may refuse to fund a pay application. The reality is that there may be a “significant risk” that the law firm’s ability to represent both clients could be materially limited.
“Consentable concurrent conflict of interest”
If a concurrent conflict of interest exists, ABA Model Rule 1.7(b) requires the law firm to determine whether the conflict is “consentable,” meaning can the clients consent to (waive) the conflict. The law firm can only ask the clients to consent to the conflict if it “reasonably believes that the lawyer will be able to provide competent and diligent representation to each affected client.”
Presumably, the law firm would have objective difficulty making this determination if the clients were already “directly adverse” or if the law firm’s ability to represent either client were already materially limited by one or the other client. For example, one client insists that the law firm favor its interests over the other client. In other words, the law firm should only be able to make a reasonable determination that a conflict is “consentable” if the conflict is merely potential and even unlikely.
If the conflict is consentable, the law firm must then obtain the clients’ “informed consent, confirmed in writing.” This requires the law firm to consult with the clients, disclose the various ways and risks of adverse effects on the clients from the joint representation and the alternatives and then confirm their consent in writing. The clients’ sophistication is important, but the burden is absolutely on the law firm.
Since most consentable conflicts will be potential, can the client actually provide an informed consent to something in the future? While the rule does not provide a bright line test, it does suggest that a general, open-ended consent to future conflicts is not effective and that the answer depends even more on the sophistication and experience of the client.
The law firm in our example may attempt to avoid the conflict by assigning different lawyers to represent its two clients on the project. It cannot. If Rule 1.7 would prohibit one lawyer from representing both clients, it also prohibits two lawyers in the same firm.
Representing two clients on the same construction project or, more generally, on the same transaction runs other risks. One client may require the law firm to keep information confidential from the other client. If that information is potentially prejudicial to the other client, the law firm gets into an untenable position. It cannot disclose the information; yet, it has an ethical responsibility to disclose any information to its clients necessary to represent them.
Independent of the ethical requirements imposed by the rules, a law firm also has fiduciary responsibilities to its clients. In the broadest sense this responsibility means that the law firm must put its clients’ interests ahead of its own and act only in the clients’ interests. In this respect the law firm in our example probably has to tell both of its clients that it cannot represent either on the same project.
If the law firm does not and attempts to obtain consent to the joint representation, it runs the risk that if something goes wrong on the project and one or the other of its clients incurs loss, the client may feel and may even be able to show that the lawyer failed to protect the client’s interest due to the joint representation. This result exposes the law firm to liability for damages.
Management of Dissenters’ Rights Case
This post discusses the management of dissenters’ rights cases involving privately held corporations. These may be S corps, C corps, or LLC’s. They may be family owned or simply closely held. The common characteristic is a dispute between the majority in management and the minority.
Typically, the dispute arises because the minority shareholders consider that the majority in control of management of the company has in some way acted to prejudice the minority. The minority shareholders may claim breach of fiduciary duty, self-dealing, or fraud by the directors and sue for remedies under the common law. Or, the majority may use statutory procedures that enable them to “squeeze-out” the minority but obligate the company to pay “fair value” for the minority’s shares. The ensuing litigation may therefore involve both common law and statutory claims.
The term, “dissenters’ rights,” actually derives from the minority’s right to dissent from the majority’s statutory proceeding (typically a merger of the original corporation into a new corporation owned by the majority shareholders only). This right includes the entitlement to “fair value” for the dissenter.
1. Principal legal and factual issues
Some dissenters’ rights statutes expressly state that their fair value remedy is exclusive, typically with exceptions for fraud in the process. Most states, following either the Model Business Corporation Code or Delaware law, have incorporated some degree of exclusivity with exceptions into their case law. So, the first principal issue is whether the minority shareholder’s lawsuit is limited to a statutory fair value claim. Usually, a plaintiff can assert both common law claims and the statutory remedy if fraud or some form of self-dealing by the directors is present.
The legal and factual issues associated with common law claims are routine in the sense that they are similar to such claims outside of the dissenters’ rights context. They obviously may overlap with the issues in the statutory claims.
The issues in a statutory proceeding are different because (a) the judge is usually the trier of fact and (b) the statute, case law, or standards usually provide that “fair value” is measured at a date just before the statutory transaction, generally independent of the effects of the transaction. These two characteristics of a dissenters’ rights case lead to significant evidentiary issues, such as what facts are relevant to a valuation just before the transaction date.
The accepted standard is what was “known or knowable” at the valuation date, but that standard can provoke controversy as the judge decides what he may consider in valuing the plaintiff’s shares. So, there is considerable motivation by the party controlling the information (usually the majority in management) to limit or somehow modify the disclosure of information that might tend to increase the value of the dissenter’s shares. This motivation obviously leads to discovery issues and subsequently credibility issues.
2. What is the real source of the dispute?
On the surface, the answer to this question is easy. The dispute is about the value of the dissenting shareholder’s shares. The majority in management wants the amount to be low, and the dissenter wants the value to be high.
But, a disagreement about value usually has its roots in something more fundamental. Identifying that fundamental problem can assist not only in managing the case but also in resolving it. At worst, the fundamental problem may be that the shareholders have simply had a personal falling out (always potential in a closely held, even family, corporations), now have personal animosity, and cannot act rationally with respect to each other. At best, they have simply disagreed about the value. Understanding real source of the dispute is necessary to dealing with discovery issues and managing expectations.
3. How to maximize (or minimize) the “fair value?”
Developing the best strategy in a dissenters’ rights case means addressing several factors:
a. The party in control of the information (usually the majority in management) probably has a motivation and the ability to control and modify the information.
b. The dissenting shareholder may have had no involvement in management and may have little or no understanding of the business, its operation, or its records.
c. The judge as trier of fact may have insufficient time or inclination to understand the sometimes complex accounting issues required to value a business.
Each of these factors leads to challenges in discovery and proof of facts. The managing majority may resist any discovery, even alter records, and misstate the facts to suit its position on value. This potential increases when the plaintiff has no experience and so limited ability to recognize what is wrong. The plaintiff may have difficulty finding and presenting a “fact” witness, forcing reliance on expert testimony and cross-examination. Finally, a trial to the court may take an exceedingly long time, during which the presentation of evidence can become repetitive, the process expensive, and the judge can lose the ability to make difficult factual determinations. All of these factors can combine to make the whole experience emotionally difficult for the parties.
4. What are the challenges to the strategy?
Put differently, what are the unexpected pitfalls that can disrupt any well-planned strategy with mistakes? There are many, but they fall into a few categories:
a. Given the risk that a court may find the dissenters’ rights statutory remedy exclusive, the initial pleadings – even those premised on “notice” – are important. If the dissenting minority shareholder has a common law right of action, he must plead it carefully to come within the statutory or case law exceptions to exclusivity for fraud, breach of fiduciary duty etc knowing that the defendant will argue that the claim is simply about the price of the shares.
b. Given the control over the facts that the majority in management has, discovery must assume and counter efforts to limit and modify the truth. While good practice may assume this in any case, it is paramount in representing the minority, non-management shareholder. So, discovery can become more time consuming and expensive to achieve the necessary level of information.
c. If, as the plaintiff, the minority shareholder lacks personal information about the business and its operation, then the plaintiff needs to substitute another credible source of facts to preempt and counter the “story” from the defendant. The documents can help; cross-examination can help, and an expert can help. Whatever the approach, it is best to get the facts pinned down in deposition testimony ahead of trial to avoid time consuming, costly adjustments during trial. While trial lawyers often like to opt against detailed depositions before trial (for good reasons of cost, disclosure of approach etc), preemption of factual surprises may argue against that option in the dissenters’ rights case.
d. More than most cases, dissenters’ rights cases probably should be settled to save costs, avoid delays, and minimize the risk that the parties’ dislike for each other will color the proceeding. This means more attention to planning a settlement and working with counsel for the other side to carry it out.
Shareholders Sometimes Owe a Fiduciary Duty to Other Shareholders
Do shareholders have a fiduciary duty to one another? That is, in the context of being shareholders of the same corporation, can they act entirely for their own benefit or do they have a duty to act for the benefit of one another?
The default answer to this question is ‘no’. Shareholders are owners of the corporation and not the managers. Shareholders typically do not act in a management capacity and generally are free to vote or act in ways that benefit themselves, even if to the detriment of other shareholders.
This default can break apart in the context of a close or closely held corporation. A closely held corporation has few shareholders and usually those shareholders also serve as the directors and officers of the company. In that role, those shareholders also act in a management capacity. This relationship can be even more blurred when a shareholder holding the majority of the shares serves as a director or officer.
In these circumstances, it can be difficult to determine when shareholder should be acting for the benefit all the shareholders rather than for only themselves .
A “Close Corporation” or “Closely Held Corporation”? Or Does it Matter?
Think of a “corporation,” and you probably think of a large company with hundreds or thousands of shareholders with a separate board of directors. But a second kind of corporation exists alongside the large, public corporation. Known as the closely held corporation, close corporation, or even family corporation, this business structure differs in many ways.
The closely held corporation shares many of the characteristics of a public corporation in that it is formed by the filing of articles of incorporation, has shareholders, has bylaws (sometimes), and has a board of directors (sometimes). An important difference exists in how the organization is managed. The entity has few shareholders and some or all of those shareholders also serve as the directors and officers of the corporation.
Business entities are primarily created by statute, but courts have long recognized the existence of the closely held corporation at common law. That is, courts have been willing to recognize that a corporation is “closely held” if it had certain characteristics. For example, Missouri courts sometimes consider a corporation to be “closely held” if it has a small number of shareholders, does not have a public market for its stock, and its shareholders substantially participate in the business operations.
The purely common law existence of closely held corporations is now (mostly) an artifact of the past. Both Kansas and Missouri have enacted statutes creating the “close corporation.” In both states, a corporation must elect in its articles of incorporation to be a close corporation, and there is a limit to the number of shareholders of the corporation. Election to close corporation status means that the company falls under a different subset of statutory rules than the traditional corporation.
Nevertheless, the enactment of the statutory “close corporation” has not driven the common law “closely held corporation” extinct. Courts in both Kansas and Missouri continue to recognize its existence when the entity has not made the statutory election in its articles of incorporation but displays the characteristics of a closely held corporation.
Why does it matter? Because the duties owed to shareholders in a close (or closely held) corporation often are higher than in the typical public corporation. Meaning that directors (and sometimes shareholders) may owe a higher duty to the shareholder of a corporation displaying the qualities of a close corporation, even if it has not expressly elected such a status. Therefore, a shareholder in the “close corporation” or “closely held” corporation may be entitled to a higher duty of care than in a large, public company.
If There Is a Payment Bond on the Project, Keep Your Eye on the Correct Deadline for Filing a Claim
Payment bonds are a part of many (if not most) construction projects. Payment bonds often are required under state (or federal) law for public projects. But these bonds also are commonly required on private projects when the owner demands it.
A payment bond is an agreement between a general contractor and surety for the surety to guarantee the payment of labor and material costs on the project. The existence of a payment bond provides a measure of security for subcontractors and suppliers. Even if the general contractor cannot or does not pay, a subcontractor or supplier can file a claim for payment from the bond.
But subcontractors and suppliers should understand the deadline they face if they try to collect against the payment bond.
Subcontractors and suppliers may be most accustomed to filing mechanics’ liens against the project to remedy nonpayment. Depending on the state where the project is located, an unpaid sub could have several months to file a lien or notice of lien. But a filed mechanics’ lien is not a claim against the payment bond. More importantly, a mechanics’ lien will not stop the clock from running on the deadline to file a claim against the bond. It is common for payment bonds to require that claims against the bond be filed within 90 days after the last day of providing service or materials.
So while it might be a good idea to also file a mechanics’ lien, keep your eye on what the payment bond requires. Courts will uphold the 90-day claim period, and if you miss this deadline then you miss your opportunity for payment under the bond.
“Substantial Compliance” with the Missouri Mechanics’ Lien notice requirement may be sufficient, but “strict compliance” will help you sleep at night.
Missouri law imposes an unusual prerequisite on general contractors before they can file a mechanics’ lien. Early in a project a general contractor must issue a notice to the property owner that mechanics’ liens could be filed in the event of nonpayment. According to the statute, the following notice must be given in ten-point bold type:
NOTICE TO OWNER
FAILURE OF THIS CONTRACTOR TO PAY THOSE PERSONS SUPPLYING MATERIAL OR SERVICES TO COMPLETE THIS CONTRACT CAN RESULT IN THE FILING OF A MECHANIC’S LIEN ON THE PROPERTY WHICH IS THE SUBJECT OF THIS CONTRACT PURSUANT TO CHAPTER 429, RSMO. TO AVOID THIS RESULT YOU MAY ASK THIS CONTRACTOR FOR “LIEN WAIVERS” FROM ALL PERSONS SUPPLYING MATERIAL OR SERVICES FOR THE WORK DESCRIBED IN THIS CONTRACT. FAILURE TO SECURE LIEN WAIVERS MAY RESULT IN YOUR PAYING FOR LABOR AND MATERIAL TWICE.
The law is unusual because the general contractor must issue the notice early in the project before any issue of nonpayment even arises. If the general contractor forgets to issue the notice either when the contract is signed, materials are delivered, work is started, or the first invoice is issued, any later-filed mechanics’ liens could be invalid. It can be a steep price to pay for a failure to supply a notice.
Missouri courts have struggled to determine when a mechanics’ lien should be invalidated for failure to comply with the statutory notice requirements. The relatively easy cases are those where a general contractor does not provide any notice at all. In these instances, the general contractor can expect that a court will invalidate mechanics’ liens, even where work has been completed to the satisfaction of the owner.
The trickier cases are those where the general contractor provides written notice to the owner but without using the exact statutory language. The question here is whether “strict” compliance with the statute is required or whether “substantial” compliance satisfies the law’s requirements. At least one Missouri state appellate court and a federal bankruptcy court applying Missouri law have held that substantial compliance is sufficient. In those cases, the general contractor provided written notice in the parties’ contracts, although without using the exact language from the statute.
Given the remedial purpose of mechanics’ liens, it could be that the Missouri Supreme Court would agree with substantial compliance. But the better path is to copy and paste the statutory text, keep your mechanics’ lien out of court, and sleep better at night.
Does a CGL Policy Cover Construction Defects? It Depends On Where You Are.
General contractors obtain commercial general liability (“CGL”) policies to cover their liability for property damage or personal injury. A general contractor might assume that their CGL policy also covers liability for construction defects. In some instances, that assumption is correct. But in others, they might be surprised to find themselves exposed.
The heart of the issue is the interpretation of the term “occurrence” in a CGL policy. These policies cover personal injury and property damage caused by an “occurrence.” An occurrence in turn is defined as an “accident.” But courts in different states do not agree on whether damage due to a construction defect should be considered an accident and therefore a covered occurrence under a CGL policy.
In Kansas, an “occurrence” under a CGL policy includes damage caused by defective work so long as it was not intended or foreseeable. Therefore, a general contractor operating in Kansas generally can expect that its CGL policy will provide coverage for construction defects.
In Missouri, the answer might be very different, depending on what is alleged in the petition. The rule in Missouri has been that a CGL policy will cover tort claims resulting from construction defects but not contract claims. The distinction is odd because it puts the focus on what the plaintiff pleads rather than on what actually caused the defect. However, a recent Missouri Supreme Court case indicates that Missouri courts might begin following a rule similar to Kansas courts and instead focusing on whether the damage was foreseeable, regardless of the claim alleged in the petition.
In Colorado, the state legislature recently decided to reverse the rule followed by Colorado courts. Due to disagreement with the then-current court doctrine, the legislature enacted statutory law that defines damage resulting from construction defects to be an “accident,” in order to cause this type of damage to be covered under CGL policies.
The uncertainty from state to state is troubling for general contractors. But as the recent changes above demonstrate, state courts and legislatures are moving to the view that CGL policies cover construction defects.