The Creative-But-High Standard of “Alternative” Claims in Construction Disputes

Sometimes construction claimants and their attorneys need to think outside the box in their efforts to recover payment for work.  There are many situations in which claimants adequately prove they are entitled to recover, but for one reason or another they are not made whole.  For instance, the counterparty may become insolvent or dissolved, or a mere breach-of-contract action is inadequate to recover for all losses.  In these situations, claimants must find alternative claims for recovery and other pockets from which to recover. 

In the case of Sun Nurseries, Inc. v. Lake Erma, LLC, a landscape contractor (Contractor) provided services to a developer (Developer) but was not paid in full for such services.  Because Developer became insolvent, Contractor needed to find alternative and additional sources for recovery.  As a result, it brought a fraud claim and a fraudulent-transfer claim against Developer, and sought to recover from Developer’s owners.  This case illustrates that, while these claims are great alternatives to traditional claims, courts will impose a high bar to pursue them.

Background

Developer hired Contractor to perform landscaping services from late 2003 through mid-2005.  Contractor submitted invoices for its work but was shorted approximately $30,000 in payment.  Testimony from Developer indicated that a check payable to Contractor was written but never mailed to Contractor.

When Contractor threatened to file a lien on development property, Contractor promised that it would pay the contract balance.  In addition, Developer requested a meeting to discuss its concern that Contractor was overcharging for its work. At the meeting, Developer also indicated that it was over budget and unable to pay Contractor.  Of course, Contractor did not believe Developer’s claim of insolvency and ultimately filed a lawsuit.

During the discovery phase of the lawsuit, Contractor discovered that Developer made an $8 million distribution to its owners.  Developer contended that the distribution was primarily a distribution of property in furtherance of its attempt to obtain additional funding.  Developer did so by distributing property, which its owners pledged to secure loans from a bank.  But its owners transferred the loan proceeds and the pledged property back to the Developer.

Alternative Bases for Recovery

After Contractor lost its lien rights — allegedly as a result of Developer’s fraudulent representations — it sought to rely on alternative bases for recovery.  Moreover, it needed to identify additional parties to pay the unpaid invoices.  Accordingly, in addition to the traditional breach-of-contract claim and quantum meruit claim, Contractor asserted claims based on fraud, conversion, and Georgia’s fraudulent conveyance law.  And it argued the court should pierce the corporate veil of Developer and permit Contractor to recover against the owners of Developer.

At trial, the court granted directed verdicts in favor of Developer’s owners on all claims, and in favor of the Developer on the fraud-based claims and conversion.  With regard to the traditional claims, the jury rendered a verdict in favor of Contractor.  While accepting its verdict against Developer, Contractor nevertheless appealed the directed verdicts granted by the trial court.

Fraud and Fraudulent Transfers

As fraud-based claims, Contractor asserted that Developer (1) fraudulently dissuaded it from filing a lien and (2) fraudulently transferred assets to its owners in an attempt to defeat the rights of creditors such as Contractor.

In Georgia, a fraud claim has five elements: (1) a false representation, (2) scienter, or an intent to deceive, (3) an intent to induce another’s reliance, (4) justifiable reliance by the other party, and (5) damage to the other party.  Contractor argued that Developer’s representative knew that Developer could not pay Contractor at the time he promised to do so.  And Contractor relied on this statement to forgo filing its liens.

The court sided with Developer on these claims.  It reasoned that Contractor presented no evidence that Developer’s representative was aware or should have been aware at the time of the statement that Developer would not ultimately pay Contractor the amount owed.  Contractor also failed to present evidence that such statement was made with fraudulent intent to prevent Contractor from asserting its lien rights.  In fact, the statement was made at a time when, arguably, Contractor’s lien rights had already expired.  In any event, there was no evidence that Developer believed that Contractor had active lien rights at the time of the statement.

For similar reasons, the court held that Contractor’s fraudulent-transfer claim failed.  An actionable fraudulent transfer occurs when a transfer is made with “actual intent to hinder, delay, or defraud any creditor of the debtor.”  Contractor pointed to Developer’s transfer of property to its owners as evidence of a fraudulent transfer.

The court again ruled against Contractor because it failed to present any evidence of “actual intent,” such as attempts to conceal the transfers, retention of rights in property transferred, distribution of all assets, and other “badges of fraud.”  Accordingly, an essential element of a fraudulent-transfer claim was lacking, and the claim was properly dismissed.

No LLC Member Liability

Contractor also tried to “pierce the corporate veil” of Developer by suing Developer’s owners.  It again relied on the transfer of property to Developer’s owners as evidence that Developer disregarded its corporate formalities, which is one factor courts consider in such claims.

Yet again the court sided with Developer.  Though Developer transferred property to its owners, the transfer was made to facilitate a loan, the proceeds of which were immediately returned to Developer.  Thus, the owners did not make personal use of the loan proceeds and did not disregard the corporate formality of Developer.

Conclusion

The case demonstrates the difficulty of recovering on alternative claims.  Courts impose a higher standard to recover on claims based on fraud.  The essential element of scienter, or fraudulent intent, typically is difficult to prove.  Furthermore, courts are more familiar with the legal separateness of corporations and LLCs and are reluctant to “pierce the corporate veil” except in limited circumstances.  Thus, in connection with construction disputes, recovery against persons other than the contract counterparty is typically more difficult.

Nevertheless, an experienced construction litigator should assert these alternative claims when the facts warrant.  Among other benefits, they can increase the claimant’s bargaining power in settlement negotiations.  In addition, an experienced and pensive judge, or a considerate jury, just might side with the claimant in appropriate circumstances.

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