California Supreme Court Holds Public Entity May Be Liable to Contractor for Nondisclosure of Material Information Under Superior Knowledge Doctrine – Proof of Affirmative Concealment or Intentional Misrepresentation Not Required

Los Angeles Unified School District v. Great American Insurance Company
49 Cal. 4th 739 (July 12, 2010)

On July 12, 2010, the California Supreme Court filed a ruling significant to public entities entering into contracts for public works projects. In Los Angeles Unified School District v. Great American Insurance Company, the Court held that 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,” even when the failure to disclose information was not fraudulent. Articulating a test modeled after the federal courts’ superior knowledge doctrine, the high court articulated four conditions that must be met for such liability to attach.

Facts

The case involved the construction of an elementary school in the Los Angeles Unified School District (the “District”). During construction, the District terminated its initial contractor for default and then solicited proposals from replacement contractors to correct the terminated contractor’s deficient work and complete the project. The District provided the prospective bidders with “pre-punch lists”, identifying the work its inspectors had found to be defective, incomplete or missing. The pre-punch lists referred only to defects visible by inspection, but included language indicating the District’s intent that the replacement contractor would also be responsible for unlisted defects in the existing work.

The District awarded a contract to Hayward Construction Company (“Hayward”) based on its proposal to perform the work on a time and materials basis and for a guaranteed maximum price of $4.5 million. Under its contract, Hayward agreed to “correct deficiencies in the work performed by the former contractor, without limitation,” as noted on the pre-punch lists. Furthermore, the contract provided that Hayward assumed responsibility for “patent (evident) defective work done by the former contractor that [Hayward] is required to correct to complete the Project.”

After work began, Hayward encountered deficiencies in the existing work that were not noted on the pre-punch lists, and requested almost $3 million from the District to perform the corrective work for those deficiencies, which it characterized as latent defects. Although the District disputed Hayward’s entitlement to any additional compensation, it paid Hayward an extra $1 million under a reservation of rights, and then subsequently instituted an action against Hayward and its surety to recover that amount. Hayward cross-claimed, asserting that it was entitled to additional compensation for the latent defects, because the District had failed to disclose certain pertinent information regarding the defective conditions during the bidding process. For example, Hayward asserted that the District failed to disclose a consultant’s report which would have alerted it to the need for more extensive repairs to stucco work than would be assumed from the pre-punch lists. Similarly, Hayward asserted that that the District was aware that some of its intended methods of repair would be ineffective.

The trial court decided in favor of the District, holding that a breach of contract action based on nondisclosure required a showing of active concealment or intentional omission of material information. An intermediate Court of Appeals disagreed, and reversed the trial court’s ruling. An appeal was taken to the Supreme Court, which affirmed the judgment of the Court of Appeals, but imposed conditions, consistent with the federal doctrine of superior knowledge, on the circumstances under which nondisclosure by a public entity would result in liability.

Discussion

The Court agreed with the appeals court that a contractor need not prove an affirmative fraudulent intent to conceal to maintain a breach of contract action based on nondisclosure against a public entity. Instead, the Court continued, under certain circumstances, “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.”

Recognizing that public entities do not insure contractors against their own negligence, the Court clarified that recovery was not available for all failures to disclose. Rather, the Court articulated four criteria that must be met for a contractor to recover against a public entity for nondisclosure: (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.

The Court further explained that a “public entity may not be held liable for failing to disclose information a reasonable contractor in like circumstances would or should have discovered on its own, but may be found liable when the totality of the circumstances is such that the public entity knows, or has reason to know, a responsible contractor acting diligently would be unlikely to discover the condition that materially increased the cost of performance.” According to the Court, “the circumstances affecting recovery may include, but are not limited to, positive warranties or disclaimers made by either party, the information provided by the plans and specifications and related documents, the difficulty of detecting the condition in question, any time constraints the public entity imposed on proposed bidders, and unwarranted assumptions made by the contractor.

Click here to view full text of decision courtesy of LexisNexis.

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