Fifth Circuit Holds Contractor May Not Assert Set-Off for Defective Work Because It Failed to Comply with Subcontract Provisions for Notice and Opportunity to Cure

United States ex rel JEMS Fabrication, Inc. v. Fidelity & Deposit Co. of Maryland, 2014 U.S. App. Lexis 8175 (5th Cir., April 30, 2014)

This dispute arises out of a construction project to renovate and redevelop pumping stations located at various sites along the Mississippi River.  The U.S. Corp of Engineers entered into a contract with Benetech, LLC for the project.  Benetech then entered into a subcontract with plaintiff JEMS, whereby JEMS agreed to supply custom-fabricated structural steel for use on the project.  The contract amount, including approved change orders, was $2.38 million and required JEMS to provide shop drawings, materials and on-site labor.

JEMS delivered all of the shop drawings and most of the materials required by the subcontract.  However, JEMS did not supply most of the on-site labor, as Benetech and JEMS agreed that Benetech would supply the labor to satisfy its self-performance obligations in its contract with the Corp of Engineers.  JEMS and Benetech also agreed to a subcontract modification such that Benetech would purchase a custom building directly from JEMS’ subcontractor for $54,000.  However, because of changes made by the Corp of Engineers, which were not incorporated into the subcontract, Benetech’s cost for the custom building was $147,000.  Ultimately, Benetech paid JEMS just under $1 million for its work on the project and alleged that JEMS was not entitled to any additional payment.  Benetech claimed that it was entitled to a set-off against any amount due under the subcontract because it had to purchase materials that JEMS should have supplied for the project.

JEMS filed suit in the United States District Court for the Eastern District of Louisiana against Benetech and its sureties alleging Miller Act claims, and against Benetech for breach of contract and a Louisiana state law claim.  After a two-day trial, the district court entered final judgment in favor of JEMS, ordering that Benetech and its sureties were jointly and severally liable to JEMS for $497,873, plus interest, for materials that JEMS supplied to the project.  The district court rejected the defendant’s arguments that Benetech was entitled to a set-off of $408,759 against payments due under the subcontract, as the court concluded that Benetech “failed to provide JEMS with notice of any deficiency and an opportunity to cure” as required by the subcontract.  The sureties, but not Benetech, timely filed an appeal.

On appeal to the Fifth Circuit, the sureties made three arguments: (1) that JEMS supplied the materials at issue for another Benetech project, (2) that the payments for shop drawings are not compensable labor under the Miller Act, and (3) that the sureties were entitled to a set-off of $408,759 against payments due under the subcontract.  The Fifth Circuit declined to consider the first two arguments, as the sureties failed to raise these arguments in the district court.

Regarding the $408,759 set-off, the district court concluded that the sureties were entitled to only a $54,000 set-off, being the agreed cost of the custom-building that Benetech purchased directly from JEMS subcontractor.  The Fifth Circuit agreed with the district court and concluded that any set-offs above this amount were impermissible because Benetech failed to provide JEMS with notice and an opportunity to cure any alleged deficiencies.  The Fifth Circuit rejected the sureties argument that they were not bound by the notice and cure subcontract provisions.  The court stated that while the sureties were not parties to subcontract, they “nonetheless stand[] in the shoes of the contractor and [are] bound by its dealings for these purposes.”  The Fifth Circuit concluded that Benetech’s failure to abide by the subcontract and provide JEMS with notice and an opportunity to cure precluded the sureties from reducing subcontract payments by Benetech’s costs of alleged deficiencies in the materials provided or any increased costs for the custom building.

To view the full text of this decision, courtesy of Lexis ®, click here .

Jason C. Spang

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