Scott E. Mollen
Scott E. Mollen ()

Construction and Development Disputes—Atlantic Yards Project in Brooklyn—Lien Law §5—Private Developer on Public Land Must Post a Bond or Other Undertaking Guaranteeing Prompt Payment to Contractor—Piercing the Corporate Veil—Breach of Contract—Attorney Disqualification

This decision involved the Appellate Division, First Department’s interpretation of “the language of Lien Law §5, which provides that a private developer on public land must post a bond or other undertaking guaranteeing prompt payment to the contractor.” The decision also addressed issues involving “piercing the corporate veil,” breach of contract and disqualification of counsel.

The plaintiff and its affiliates are an “international construction conglomerate.” The defendants are development entities of the Atlantic Yards project in Brooklyn (project). The project is now called Pacific Park, Brooklyn. The project involved “the construction of a high-rise residential tower called ‘B2,’” utilizing “innovative prefabricated modular units developed by defendant…that would then be stacked together by plaintiff to form the high-rise.”

The court rejected the plaintiff contractor’s argument that Lien Law §5 could be satisfied only “by the posting of a bond” and “not a guarantee as was done here.” The court also held that the plaintiff “failed to plead a veil-piercing claim.” The “parties were very sophisticated, and negotiated in minute detail all aspects of their agreements to build B2 using innovative technology.” The court stated that the project’s failure cannot support a “veil-piercing” claim, if the plaintiff “failed to identify…fraud or other wrongdoing.” However, the court reinstated a claim, “based on inadequate factory and labor,” and denied the motion to disqualify defendants’ law firm, based on an alleged conflict of interest.

The Empire State Development Corporation (ESDC), had entered into a lease agreement with “A” LLC, an entity affiliated with defendant “B,” for construction of several buildings near the Barclays Center sports arena. The construction was to utilize “proprietary technology and design developed by” defendant “C,” also an affiliate of “B.”

“C” “had invited the plaintiff,…to participate in establishing a factory to construct and assemble the modules into the B2 Building.” The plaintiff and “D,” an affiliate of “C,” “entered into a ‘contract for module fabrication and testing services’ (the the testing agreement).” “The testing agreement contemplated a joint effort by plaintiff and [the 'C' related entities] to build and test the modular units…, with the goal of entering into a joint venture for construction of a full-blown modular factory facility.” Affiliates of the plaintiff and “C” had executed three agreements in furtherance of the B2 project. “D,” “E,” a company related to the plaintiff, “together with (as to certain portions) plaintiff and “B,” entered into an “LLC agreement” establishing “F,” “to build and operate the modular factory.”

The LLC agreement was essentially a joint venture, where “C” affiliates provided the modular unit intellectual property, plus additional capital and plaintiff’s affiliates provided capital and “construction know-how.” The LLC agreement made “E” (an affiliate of the plaintiff) “the managing member for…of day-to-day operations.” “D,” “E” and “F” thereafter entered into an “Intellectual Property Transfer and Development Agreement” (IP transfer agreement), which transferred “the modular IP and fruits of the testing agreement to “F.” The plaintiff and “B” entered into “a ‘Construction Management…Agreement’ (the CM agreement).” The CM agreement provided that plaintiff would enter into a subcontract with “F,” pursuant to which “F” would provide “the modular units and plaintiff would effect the assembly….”

The CM agreement provided, inter alia, that (a) the B2 project would “be substantially completed 416 business days after” being “issued a ‘Notice to Proceed,’”(b) plaintiff represented that “it had conducted due diligence and had no reason to believe that the modular design was inadequate . . .” (c) plaintiff had a right to “‘rely upon and use’ in its performance ‘information supplied to it by or on behalf of ['B'] Owner and its [a]ffiliates,’” (d) “plaintiff was ‘not responsible for defects and/or deficiencies in the Work attributable to [its] reliance upon any such information that is incorrect, inaccurate or incomplete,’” and e) “plaintiff would ‘notify ['B']…promptly of any inaccuracies in such information…so as to minimize potential delays.’”

The CM agreement permitted schedule changes “for ‘Force Majeure Event[s],’ ‘Owner-Caused Event[s],’ and ‘Contractor-Caused Delay[s].’” Extensions for Force Majeure and Owner-Caused Events, required “written notice within five days of [plaintiff's] actual knowledge of the event, followed by a second notice within 45 days after the end of the event (or the initial notice). [T]ime extensions were only available for events that ‘adversely impact[ed] activities on the critical path’ of the construction schedule.” “B” was permitted to “request or direct changes in the scope of work.” On Dec. 14, 2012, “B” issued a Notice to Proceed, effective Dec. 21, 2012. “The deadline for substantial completion was July 25, 2014.”

“By a 146-page letter dated August 8, 2014, plaintiff gave ['B'] notice of its intent to terminate the CM agreement on account of dozens of alleged Force Majeure and Owner-Caused Events and other breaches. The letter specified 12 alleged periods of delay…. Plaintiff attributed the delays to delays in the factory fit-out…defects in ['C''s] modular unit design technology; related negligence and failure to cooperate by ['B''s] design professionals; and improper changes to the scope of work made by ['B'] without the requisite change orders. Plaintiff also alleged that ['C'] had breached the CM agreement’s requirement that it provide evidence of satisfactory financing for the project by, among other things, failing to post a bond required by Lien Law §5.”

The plaintiff alleged that “C” had “breached the CM agreement’s requirement that it provide evidence of satisfactory financing for the project by, among other things, failing to post a bond required by Lien Law §5.” The plaintiff had stopped work on the project and notified “B” that the CM agreement was terminated.

The complaint alleged that the defendants had, inter alia, provided “a defective design for the project, including an inadequately designed…factory…with inadequate labor,” changed “the project scope without issuing change orders” and failed “to provide adequate security as required by the Lien Law.” The plaintiff also claimed that “B” was “a mere alter ego of ['C']” and plaintiff was entitled to pierce “ C”‘s “corporate veil.”

The defendants moved to dismiss, pursuant to CPLR 3211(a)(1) and (7), the “veil-piercing” claim, and “certain breach of contract claims, including the claims that defendants violated Lien Law §5, supplied a defectively designed factory and inadequate labor, and changed the project scope without appropriate change orders.” The plaintiff opposed the motion and cross-moved for partial summary judgment on the issue of defendants’ liability on the Lien Law §5 claim. The plaintiff also moved to disqualify defendants’ attorneys, on the grounds that the attorneys had “represented two of plaintiff’s affiliates in matters in Maryland and Florida” and the attorneys’ representation of “C” “was adverse to the interests of one of its affiliate’s directors….”

The trial court dismissed the claims that defendants failed “to post a bond required under Lien Law §5,” and had provided” an inadequate factory and inadequate labor.” The trial court denied the motion to dismiss the claims based on “design defects,” “improperly changing the scope of work,” “piercing the corporate veil claim” and denied the request to disqualify defense counsel.

The Appellate Division held that Lien Law §5 did not require the posting of a bond to guarantee “B”‘s performance under the CM agreement. The court opined that “the statute’s legislative history indicates that no bond—as opposed to some other sort of ‘undertaking,’ such as a guarantee—was required to be posted here.”

Lien Law §5, provides, in relevant part:

Where no public fund has been established for the financing of a public improvement with estimated cost in excess of two hundred fifty thousand dollars,…the public owner shall require the private entity for whom the public improvement is being made to post, or cause to be posted, a bond or other form of undertaking guaranteeing prompt payment of moneys due to the contractor,…subcontractors and to all persons furnishing labor or materials to the contractor or his or her subcontractors in the prosecution of the work on the public improvement.

The plaintiff argued that the guarantee provided by “C” was not the equivalent of “a bond ‘or other form of undertaking’ under the statute.” Citing the rule of statutory construction that meaning must be given to each word, Black’s Law Dictionary definition of an “undertaking,” as “[a] promise, pledge, or engagement” and the CPLR’s definition of “undertaking” as ” [a]ny obligation, whether or not the principal is a party thereto, which contains a covenant by a surety to pay the required amount, as specified therein, if any required condition…is not fulfilled,” the court explained that “an ‘undertaking,’…is simply a ‘formal promise [or] guarantee.’” The court also found that the legislative history of Lien Law §5 “strongly supported” the court’s interpretation.

Here, ESDC met its statutory obligation “by causing a ['C'] affiliate ['G']—to issue a formal ‘Guaranty’ that ['B'] would ’cause Substantial Completion of the Improvements and perform the Development Work,’ including ‘to fully and punctually pay and discharge any and all costs, expenses and liabilities incurred for or in connection with the Guaranteed Work, including, but not limited to, the costs of constructing, equipping and furnishing the Guaranteed Work.’” The court opined that such “guarantee follows the letter of the statute, namely ‘guaranteeing prompt payment’ to contractors.” The court reasoned that, because there are “better guarantees available, such as a letter of credit,…, is beside the point….” The court explained that “ESDC,…was satisfied with the guarantee issued by ['G']” and “ if the Legislature had wanted the guarantee to be on par with a letter of credit it could have said that or identified the…types of guarantees that would satisfy the statute.”

The court also held that “an inadequate factory and inadequate labor” claim stated a cause of action. The plaintiff had “plausibly” asserted that “the CM agreement, particularly when viewed together with the parties’ related…LLC and IP transfer agreements” required “B” “to ensure that an adequate modular factory and factory labor force were in place before it issued the Notice to Proceed.”

The trial court had upheld the claim that defendants provided “defectively designed modular unit technology.” The court agreed and held that the claim was not “refuted by documentary evidence.” The defendants had designed the modular units and “B” had “represented that…the modules and…were ‘sufficient for completion of the work.’”

The defendants also argued that the “plaintiff failed to provide timely notice…to assert a claim for design defect.” The defendants asserted that under the LLC agreement, the design defect claim had to be asserted by Dec. 7, 2012. However, “the parties appear[ed] to have contemplated that such flaws could be identified after Dec. 7, 2012.” Although “B” represented that “the design was sufficient,” it also agreed that “any design defects would be ‘Owner-Caused Events.’” The court noted that “there is tension between these provisions” and “with the disclaimers of warranties to which defendants point [and] such…conflicts present questions of facts” that should not be resolved on a pre-answer motion to dismiss.

The trial court had also upheld the claim that the defendants had changed “the scope of work without issuing appropriate change orders.” The defendants contended that the plaintiff waived such claim “by failing to comply with the CM agreement’s notice provisions governing change orders.” “[C]ompliance with the change order notice provision was a condition precedent to the assertion of a claim for unauthorized changes in the scope of work.” The court observed that the CPLR does not mandate that a party asserting a contract claim “plead compliance with a condition precedent.” Rather, a “party resisting a contract claim must plead the “failure to comply with the condition precedent.” Since the defendants failed to so plead, the trial court’s denial of the motion to dismiss the scope of work claims was affirmed.

The court then explained that “[v]eil-piercing”:

is a narrowly construed doctrine limiting “the accepted principles that a corporation exists independently of its owners…and that it is perfectly legal to incorporate for the express purpose of limiting the liability of the corporate owners”…. The party seeking to pierce the corporate veil bears the heavy burden of “showing that: (1) the owners exercised complete domination of the corporation in respect to the transaction attacked; and (2) that such domination was used to commit a fraud or wrong against the plaintiff which resulted in plaintiff’s injury”….

The plaintiff had alleged conclusory allegations “reciting typical veil piercing factors.” The plaintiff failed to allege “fraud or malfeasance.” “[A] simple breach of contract claim” against “B,” “without more, does not constitute a fraud or wrong warranting the piercing of the corporate veil.” Rather than alleging that “C” used “B” “to perpetrate a fraud, plaintiff, a sophisticated party, admit[ed] that it knowingly entered into the CM agreement with ['B'], an entity formed to construct the project.” The complaint did not allege that plaintiffs “believed it was contracting with or had rights vis-à-vis ['C'] or any entity other than ['B'].” The court noted that the “plaintiff could have negotiated for such rights.” “Having failed to do so, plaintiff cannot now claim that it was tricked into contracting with ['B'] only and thus should be allowed to assert claims against ['C'].”

The court also affirmed the trial court’s exercise of discretion in refusing to disqualify defendants’ counsel. The plaintiff’s out of state matters had no relationship with “any of the same adverse parties.” The plaintiff did not allege that any of defendants’ counsel’s “litigation team members possesses any of plaintiff’s confidential information, or that the ethical screen that [defendants' counsel] has set up between” its attorneys for defendants and its attorneys for plaintiff’s other entities “is in any other way inadequate.” Moreover, a movant seeking disqualification of an opponent’s counsel face “a heavy burden,” “[a] party has a right to be represented by counsel of its choice” and “any restrictions on that right ‘must be carefully scrutinized’” and must “examine whether a motion to disqualify, made in ongoing litigation, is made for tactical purposes, so as to delay litigation and deprive an opponent of quality representation….”

A dissenting opinion agreed with “most of the majority’s decision,” but disagreed that the “defendants’ completion guaranty is an appropriate undertaking that satisfies the requirements of Lien Law §5.”

The dissent agreed that Lien Law §5 applied to the project and noted, inter alia, that “the primary purpose of the Lien Law is to ensure that contractors, subcontractors, laborers and those who furnish materials in connection with the improvement of real property are promptly paid.”

The defendants argued that even if Lien Law §5 is applicable, ESDC has discretion to accept security other than a bond and “ESDC could have, had it wanted to, simply accepted the private developer’s representations of creditworthiness as a satisfactory undertaking.” Therefore, the defendants assert that the completion guaranty is “an acceptable and suitable ‘other form of undertaking,’ within ESDC’s exercise of discretion.”

The dissent opined that “[n]ot just any form of alternative security,…, will suffice.” The dissent believed that “to achieve the objective of the Lien Law, and consistent with the legislative history. . . any alternative undertaking must provide substantially equivalent protection to that provided by a bond. The alternative undertaking should be a financial arrangement that would afford an unpaid contractor, subcontractor,…, or provider of materials, a fund of money, or an asset, available for predictable and prompt payment. An identifiable fund of money, or a bond, or a lien against real property, are Lien Law remedies available in other contexts where services and materials are provided but not paid for, each having characteristics of ready availability.

The dissent further stated that “[a] letter of credit, the alternative undertaking contemplated by Governor Pataki when the 2004 amendment was passed, would also fulfill these requirements.” Governor Pataki had recommended that “any new proposal should allow the public owner to require the private entity to ‘post’ another form of undertaking, specifically suggesting a letter of credit as one possible alternative….” The dissent reasoned that “[a]lthough the completion guaranty generically states that the work will be kept ‘free…of liens,’ it is unclear how a mechanic’s lien could be filed against the property, given its public nature, because ‘real property owned by a public corporation is immune to mechanic’s liens’….” The dissent stated that “a completion guaranty such as has been posted in this case, “merely ‘guarantees the completion of a project …should the borrower be unable to do so.’…”

The dissent also reasoned that “[t]he completion guaranty is not the functional equivalent of a bond or other form of undertaking, because it is no more than [a] contractual promise to complete the project and pay its account, which, if not honored, requires a lawsuit to secure a judgment and a collection process to obtain satisfaction….” The dissent noted that “recovery is dependent upon a guarantor’s particular financial circumstances at the time a protected party is in need of the remedies that the Lien Law provides.” The dissent opined that “[t]his is hardly the streamlined and predictable process Lien Law §5 calls for in ‘guaranteeing prompt payment of the moneys due to the contractor…in the prosecution of the work on the public improvement’ where there are no public funds.” The dissent emphasized that the Completion Guarantee is not “an identifiable fund or asset on which a protected party can draw down payment.”

Thus, the dissent believed that “contractors and subcontractors on hybrid construction projects would be in a worse position in terms of a remedy than their private and public improvement counterparts, eviscerating the underlying purpose of the 2004 amendment.” The dissent agreed with the majority that “it is permissible under Lien Law §5″ for a party “to satisfy its obligations by means other than a bond.” However, it believed that the “Completion Guarantee…provided does not fulfill that obligation.” Thus, the dissent would not have dismissed of cause of action based on failure to comply with Lien Law §5.

Skanska USA Building Inc. v. Atlantic Yards B2 Owner, LLC, 652680/14, NYLJ 1202770649041, at *1 (App. Div., 1st, Decided Oct. 20, 2016). Opinion by Acosta, J.P. Saxe, Gische, Webber, Kahn, J.J. All concur except Gische and Kahn, JJ., who dissent in part in an Opinion by Gische, J.