Opinion ID: 2616073
Heading Depth: 3
Heading Rank: 1

Heading: Excess expenditure for gravel

Text: Judge Cranston found that furnishing gravel was Holly's responsibility under the subcontract. He held, however, that the circumstances did not warrant withholding the progress payment. He concluded that Lease wrongfully withheld $25,000 of the $35,000 progress payment billed by Holly in May 1979, causing Holly's inability to pay S & B Gravel. He therefore allowed Lease to recover only an amount based on the 75¢ per cubic yard price. On appeal, Lease contends that the trial court's finding that it owed Holly $25,000 on the due date for the May progress billing was erroneous and that in fact it paid Holly all that was owed at the time. Lease reasons that each party's valid backcharges owed at the time the progress payment was due should have been included by the trial court in calculating the amount of the progress payment that was due and owing. We agree and hold that Lease did not wrongfully cause Holly's inability to pay S & B Gravel. On remand Lease should be awarded an amount representing the additional expenditure for gravel made necessary by Holly's failure to pay its bill. Judge Cranston relied on our decision in Arctic Contractors, Inc. v. State, 564 P.2d 30 (Alaska 1977), stating that there the court recognized that the right to withhold progress payments is limited to circumstances clearly warranting it. The circumstance found by the court in Arctic to warrant withholding of a progress payment was that it be for the purpose of protecting itself from liability from the subcontractor's suppliers and not for some other reason, citing U.S. v. Heyward-Robinson Co., 430 F.2d 1077 (Second Circuit 1970). Here no such ground was stated by Lease. Accordingly, the court concludes that Lease wrongfully withheld payment of the progress amount billed by Holly at the end of May, 1978. While we did state in Arctic Contractors that [t]he right to withhold progress payments is limited to circumstances which clearly warrant it, 564 P.2d at 43 (footnote omitted), Judge Cranston otherwise misinterpreted our decision there. We did not hold that the state was justified in withholding a progress payment in order to protect itself from liability from the subcontractor's creditors; rather, we held that the withholding was warranted to induce the contractor to obtain proper bonding as it was contractually obligated to do. 564 P.2d at 43-44. More importantly, we did not purport to limit the court's consideration of when circumstances clearly warrant withholding the progress payment. A general contractor may be justified in refusing to make a progress payment to the subcontractor when the latter has failed to substantially perform his contractual obligations entitling him to the payment. See 3A Corbin on Contracts § 708 (1960); see also id. § 692 at 273; Restatement (Second) of Contracts § 237, comment d (1981). It follows that the general contractor is entitled to withhold from a progress payment a valid backcharge for work within the scope of the subcontract which the general contractor has had to perform itself. Of course, the contractor runs the risk of guessing wrong as to whether the subcontractor has not substantially performed in the first instance and whether the backcharge is valid in the second. Here, Judge Cranston found that Holly had the contractual obligation to finegrade. Of the total backcharge of $52,844.89 for finegrading, Judge Cranston found $44,440.60 to be valid. Lease was entitled to withhold this amount from progress payments due July 1, 1979. Our analysis does not end here, however. On October 17, 1978, Holly had backcharged Lease for various items of work performed not covered by bid and not within his contractual obligations. This was not paid by Lease. Judge Cranston allowed $26,342 of this backcharge. The contract provided that [b]ackcharges ... shall be promptly paid by the indebted party. We conclude that Holly was entitled to payment of this backcharge by the time the May progress payment was due. Adding this amount to the $35,000 May progress payment billing, the validity of which is not in dispute, gives a total of $61,342 due to Holly. It is undisputed that under the contract Lease was entitled to retain 10% of this amount. [2] Thus, $55,207.80 was actually due and owing to Holly. Subtracting the $44,440.69 justifiably withheld and the $10,000 Lease paid Holly on June 28, 1979, leaves only $767.11 owed to Holly as of the due date for the May progress payment. We conclude that Lease's improper withholding of this relatively insignificant amount did not cause Holly's inability to pay its $9,500 bill with S & B Gravel which in turn resulted in the increased cost of gravel. Holly argues that Lease could not withhold a portion of the May progress payment because Holly had provided the services for which payment was due prior to receiving notice of intent to withhold. Holly cites this court's statement in Arctic Contractors that [p]ayments due for services performed before notice has been served may not be withheld, although they may be recoverable in whole or in part as damages for breach of the contract. 564 P.2d at 43. We disagree and take this opportunity to clarify the requirement of notice in Arctic Contractors. In Arctic Contractors we held that Arctic had a continuing obligation under its contract with the state to furnish adequate bonds. 564 P.2d at 40. We rejected Arctic's argument that by permitting work to proceed after discovering defects in the bonds the state waived its right to require, or was estopped from requiring, Arctic to obtain new bonds. Id. at 40-41. We said that in order to compel adherence to the contract's bonding provisions, the State, upon furnishing notice of its intent to do so, could properly have withheld payments for work and material furnished after notice was given. Id. at 42. After discussing federal Court of Claims decisions interpreting similar contractual progress payment provisions, we stated: Progress payments due after notice of intent to withhold has been served on the contractor may be withheld as a source of leverage to assure the contractor's compliance with the terms of the contract. Payments due for services performed before notice has been served may not be withheld... . Id. at 42-43. No authority was cited for the apparent bright-line rule requiring notice, [3] nor was the underlying legal theory explained. We decline to require notice prior to withholding progress payments in every case. For example, there appears to be no general requirement of notice prior to withholding a progress payment where the subcontractor has materially breached his promise to perform upon which the prime contractor's promise to make progress payments depends. Thus, in K & G Construction Company v. Harris, 164 A.2d 451 (Md. 1960), the Maryland Court of Appeals held that the contractor was justified in withholding a progress payment for work which had been performed before the subcontractor damaged the structure with a bulldozer. See also 6 Williston on Contractors § 870, at 317-21 (3d ed. 1962) (quoting extensively and with approval K & G Construction ); Restatement (Second) of Contracts § 241, illustration 1 (1981) (based on K & G Construction ). Notice is necessary for reinstatement of a condition of the obligor's duty to perform which has been excused by his acceptance of partial performance despite non-occurrence of the condition. [4] In Arctic Contractors, proper bonding was an express condition of the state's duty to perform. See 564 P.2d at 40-41. The state made progress payments after the bond defect was discovered. When it notified the contractor of the defect, the state said nothing about withholding progress payments even though it knew that work was progressing and that the contractor was continuing to incur debts which it expected to cover with the progress payments. Id. at 44. After noting these facts, we concluded, Under the circumstances withholding the progress payment without notice was improper, and it constituted a breach of the contractual agreement between Arctic and the State of Alaska. Id. We interpret Arctic Contractors as holding that the state's acceptance of Arctic's performance by continuing to make progress payments after it discovered the bonding defects justified Arctic in believing that its continued performance would be accepted and paid for despite the bonding defect. See Restatement (Second) of Contracts § 247, supra n. 4. Therefore, the condition of proper bonding was excused unless and until the state gave proper notice of its reinstatement. In this case, Holly's performance of his contractual obligations, including finegrading, was a condition of Lease's duty to perform. See K & G Construction, 164 A.2d at 455. In contrast to Arctic Contractors, Lease did not accept Holly's partial performance despite the non-occurrence of the condition. Although Lease continued to make progress payments, it billed Holly for the finegrading. It withheld the applicable portion of the progress payment immediately after completing the finegrading. Holly could not reasonably have believed that his subsequent work would be accepted as fulfillment of his contractual obligations despite his failure to finegrade. Notice was not required prior to withholding a portion of the progress payment for finegrading because the condition had not been excused.