August 11, 2020 |

Construction Disputes and the Substantial Performance Doctrine

What happens when a contractor performs work that a homeowner later alleges is defective? Is the contractor entitled to payment for this work and if so, how much? Like most legal answers, the answer is: It depends. There is a common defense afforded to contractors called the Substantial Performance Doctrine that, when successful, requires a homeowner to pay the contractor in full. To understand the Doctrine, we must first examine the context in which it is used.

Your typical construction dispute begins when a homeowner hires a contractor to perform work on his property. If the homeowner is not satisfied with the contractor’s quality of work, he may feel the contractor has breached the contract, relieving the homeowner of his obligation to pay what is due. While sometimes this is true, it is not always the case.

In Kentucky, when one party breaches a contract the other party may abandon the contract, depart from any performance on his own part and demand damages. See Dalton v. Mullins, 293 S.W.2d 470 (Ky. 1956). To prove breach of contract, there must be 1) existence of a contract; 2) breach of that contract; and 3) damages flowing from the breach of contract. Metro Louisville/Jefferson Cty. Gov’t v. Abma, 326 S.W.3d 1, 8 (Ky. Ct. App. 2009).

The first element seems fairly simple; Either there is a contract or there isn’t one. While this may be true, a “contract” in Kentucky does not necessarily have to be a formal, written agreement. In reality, any agreement can be a contract as long there is offer and acceptance, full and complete terms, and consideration. Collins v. Kentucky Lottery Corp., 399 S.W.3d 449, 455 (Ky. Ct. App. 2012). The only exceptions to this rule are codified in KRS §371.010, otherwise known as Kentucky’s Statute of Frauds, and include the sale of real estate and agreements that extend beyond one year.

For the terms of any contract to be full and complete, they must be definite and certain, and must set forth the promises of performance to be rendered by each party. Energy Home, Div. of S. Energy Homes, Inc. v. Peay, 406 S.W.3d 828, 834 (Ky. 2013). While the agreement need not cover every conceivable term of the relationship, it must set forth the “essential terms” of the deal. Quadrille Bus. Sys. v. Kentucky Cattlemen’s Ass’n, Inc., 242 S.W.3d 359, 364 (Ky. Ct. App. 2007).

Different contracts require different terms depending on the subject matter. For example, a contract to build a fence might include the type of material to be used, while a contract to purchase a car might include the vehicle’s make and model. The terms required of a construction contract will likewise depend on the project’s complexity. Moreover, the more terms that are definite and certain, the more ways there are to breach the contract by failing to comply with those terms.

Even without a contract, a homeowner may still have a cause of action against a contractor who produces a defective product. One example is when a contractor’s work does not meet “code.” New construction must comply with state and national building codes pursuant to Chapter 198B of the Kentucky Revised Statutes. Failure to build according to code is unlawful. Like a claim for breach of contract, KRS §198B.130 permits a homeowner to recover from the builder when damages flow from the violation. Damages are a very important part of any construction dispute and will be discussed in detail below.

There may be several alternative claims available to a homeowner without a contract. If you find yourself in this situation, seek legal advice from an attorney who can walk you through your options.

The Substantial Performance Doctrine

Just because there has been a breach of contract doesn’t mean the homeowner is relieved of his obligation to pay under the contract. While this may seem counterintuitive, the reasoning is rooted in traditional principles of equity, or fairness.

Whether the contractor is entitled to payment depends on how much work the contractor actually performed. This concept is called the Substantial Performance Doctrine. Under the Substantial Performance Doctrine, a builder can recover the contract price as long as his work is substantially complete, even if it is defective. Meador v. Robinson, 263 S.W.2d 118, 118 (Ky. 1953). The purpose of the Doctrine is to protect contractors who cannot possibly comply with every minute specification of a building contract. Cassinelli v. Stacy, 238 Ky. 827, 38 S.W.2d 980, 985 (1931). The Doctrine also attempts to provide equitable relief to a contractor who furnishes labor and material to a homeowner who retains the benefit of the labor and materials. Id. In other words, it would be unfair to allow a homeowner to keep a house without paying for the house, even if the house is imperfect.

However, a contractor’s right to relief under the Substantial Performance Doctrine is not absolute; “[T]he project’s defects must not be so serious as to deprive the property of its value for its intended use or to so pervade the whole work that the deduction of damages will not be fair compensation.” 13 Am.Jur.2d Building, Etc. Contracts § 48 (2d ed 2015). A contractor is likewise foreclosed from relying on the Doctrine where the defects in the construction or the omissions from the requirements set forth in the building contract are intentional, and not the result of an attempt in good faith to perform the contract. Cassinelli, 238 Ky. At 38.

So, at what point is a project “substantially complete” under the Doctrine? Unfortunately, “no mathematical rule relating to the percentage of the price, of the cost of completion, or of completeness can be laid down to determine substantial performance of a building contract.” 5 Bruner & O’Connor Construction Law §18:12 (2015). This means it is ultimately up to a judge or a jury to decide. Some construction contracts provide their own definition of substantial completion to create more certainty. For example, a contract for the construction of a house may include the following provision:

The house will be deemed to have reached “Substantial Completion” upon the earliest of: (1) the issuance of a final or temporary certificate of occupancy; (2) the lender’s determination that the house is substantially complete; or (3) customer’s occupation of any part of the house.

In 2007 the Kentucky Fairness in Construction Act was passed, and while it does not apply to residential construction, it provides a helpful definition of “Substantial Completion.” Substantial Completion is defined under § KRS 371.410(2) as:

The point at which, as certified in writing by the contracting entity, a project is at the level of completion, in strict compliance with the contract, where:

(a)  Necessary approval by public regulatory authorities has been given;

(b)  The owner has received all required warranties and documentation; and

(c)  The owner may enjoy beneficial use or occupancy and may use, operate, and maintain the project in all respects, for its intended purpose.

If a contractor is successful under the Substantial Performance doctrine, the homeowner must pay what is due under the contract and bring a separate claim to recover damages as an offset of the contract price. Meador, 263 S.W.2d at 118.

            While the substantial performance doctrine serves to protect the contractor, “of equal importance is the contractee’s right to recover damages. Without the second half of this rule “substantial performance” would simply amount to a windfall for the breaching contractor.” Shreve v. Biggerstaff, 777 S.W.2d 616, 618 (Ky. Ct. App. 1989).

So, how does a homeowner know the amount of damages he is entitled to? If the project is too far gone, “the measure of damages in such a case is the difference between the fair market value of the building as constructed, and its value if constructed according to the contract”. Ward v. Qualls, 229 Ky. 662, 17 S.W.2d 739, 740 (1929). If the defects can be remedied at a reasonable cost, however, the measure of damages is “the reasonable cost of correcting the trouble”. Id.

Unless the contract provides for the recovery of attorney’s fees, it is unlikely a homeowner can recover this expense under a breach of contract claim. This is because Kentucky follows the “American rule” with regard to attorney’s fees, meaning such fees are only recoverable when permitted by statute or contract. See O’Rourke v. Lexington Real Estate Co. L.L.C., 365 S.W.3d 584 (Ky. Ct. App. 2011).

You may be wondering about the statutes discussed earlier in this article relating to building and housing codes. Indeed, KRS §198B.130 permits the recovery of attorney’s fees when building codes have been violated. This statute, as recently amended, reads in pertinent part;

(1) Notwithstanding any other remedies available, any person or party, in an individual capacity or on behalf of a class of persons or parties, damaged as a result of a violation of this chapter or the Uniform State Building Code, has a cause of action in any court of competent jurisdiction against the person or party who committed the violation. An award may include damages and the cost of litigation. If a certificate of occupancy was not issued, then an award may also include reasonable attorney’s fees.

KRS §198B.130 , KY LEGIS 62 (2020), 2020 Kentucky Laws Ch. 62 (HB 98).

Note the use of the word “may” in the above statute. Like Kentucky’s breach of contract claim, damages must be proven before they will be awarded. An unpublished Kentucky case called Crouch v. Bilbrey is a good example of when an award for damages was withheld despite the obvious presence of building code violations.

In this 2013 case, a homeowner and a contractor entered into an oral contract for the construction of a new residence. In the final stage of construction, the homeowner refused to pay his contractor the final draw due, claiming the work was incomplete, substandard and in violation of Kentucky Building Code. 24 different building code violations were found at the property, and the contractor did not dispute their existence. Some of the building code violations included lack of handrails on the steps to the basement and improper insulation in one wall of the attic.

Notwithstanding the uncontested violations, a jury chose not to award the homeowner any damages, finding the cost to remedy the infractions was de minimis, or too minor to merit an award. On appeal, the court affirmed the award, holding that “per statute, an award of damages does not automatically flow from a violation of the building code. KRS §198B.130’s permissive use of “may” recognizes the longstanding principle that damages must be proven.” Crouch v. Bilbrey, No. 2011-CA-002098-MR, 2013 WL 1003444, at *3 (Ky. Ct. App. Mar. 15, 2013).

In sum, a homeowner who feels he has paid for defective work should procure an appraisal or estimates for the cost to remedy any defects or building code violations, as well as a professional opinion as to the potential long-term effects of the defects or violations. Seek legal advice from an attorney who can help turn this information into a successful claim for damages. Without damages, a homeowner’s claim for code violations or breach of contract, however strong, is all for naught.

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