United States District Court, S.D. New York
OPINION & ORDER
ALISON J. NATHAN, District Judge.
This is a breach of contract case arising out of a payment bond issued by Defendant Arch Insurance Company ("Arch"), as surety, and General Contractor J.K. Scanlan ("JKS"), as principal, in connection with the Orchard Hills Project. Plaintiff Innovative Design and Building Services, LLC ("IDBS"), a modular construction manufacturer and subcontractor on the Project, alleges that it is owed $4, 748, 191.00, plus prejudgment interest, under the terms of the payment bond. A nonjury trial was held in this action in - on February 3, February 4, February 5, February 6, and February 7.
Pursuant to this Court's procedures for nonjury trials, the parties submitted the direct testimony of witnesses under their control by affidavit. The Court received direct examination declarations from Plaintiff witnesses Steven Scheinkman and Jolene Myers; and Defendant witnesses, Gordon Paterson, Stuart Markowitz, Ray Scuola, and Bruce Bergstrom. Each of these witnesses was cross-examined at trial. In addition, Defendant took direct testimony from Mr. Scheinkman and Ms. Myers in support of its affirmative defenses at trial, and read into the record certain excerpts from the deposition testimony of Ray Cudwadie. This opinion represents the Court's findings of fact and conclusions of law for purposes of Federal Rule of Civil Procedure 52. The Court's findings appear primarily in the "Findings of Fact" section, but some additional findings appear in the remaining sections of the opinion.
Briefly, the parties' dispute relates to the Orchard Hills Project ("Project"), a multifamily housing construction project in Newburgh, New York. Plaintiff IDBS entered into a series of seven subcontracts with general contractor JKS to manufacture and install modular units for the Project. Defendant Arch executed a surety bond to insure the payment of subcontractors on the Project. IDBS performed its subcontracts in full, but JKS was unable to pay in full, and IDBS sought to recover the unpaid balance from Arch as JKS's surety. Arch has asserted a number of defenses against liability; principal among them is its contention that IDBS is equitably barred from seeking recovery based on representations made during the course of the Project. The Court rejects these defenses, and judgment will accordingly be entered in favor of Plaintiff.
I. Findings of Fact
A. Parties and Jurisdiction
Plaintiff IDBS is a limited liability company organized and existing under Delaware law. The sole member of IDBS is Innovative Building Systems, Inc. ("IBS"), a corporation organized and existing under Delaware law, with its principal place of business in Mechanicsburg, Pennsylvania. Joint Pretrial Order ("JPTO") § III. IDBS is related to two predecessor entities: (1) Excel Holmes, LLC ("Old Excel"); and (2) Excel Homes Group, LLC ("New Excel"). In short, the assets of Old Excel were acquired by New Excel, New Excel changed its name to IBS, and IBS is the sole member of IDBS. See Pl. Findings of Facts ("Pl. Facts") ¶¶ 67-74.
Defendant Arch is a corporation organized and existing under Missouri law, with its principal place of business in New York, New York. JPTO §Ill.
The Court has jurisdiction over this matter under 28 U.S.C. § 1332 because there is diversity of citizenship and the amount in controversy exceeds the statutory amount.
B. Orchard Hills Project
The Orchard Hills Project ("Project") involved the financing and construction of 260 multifamily apartments in Newburgh, New York. The initial owner of the Project was Orchard Hills of Newburgh, LLC ("Owner" or "Orchard Hills"), and the General Contractor was J.K. Scanlan Company, Inc. ("JKS"). Pl. Facts ¶ 1.
The multifamily homes comprising the Project were built using modular construction: sections of the buildings called "modes" or "units" were manufactured offsite in indoor factories, transported to the construction site, and finally assembled to form the complete structures.
The Project was financed in large part by an approximately $50 million mortgage issued in May 2010 under the HUD Multifamily Accelerated Processing Program, pursuant to § 221(d)(4) of the National Housing Act, 12 U.S.C. § 1715 l . Under that program, a private lender provides a mortgage for a housing project's construction, and HUD insures the mortgage and agrees to buy it out in the event of default. See 12 U.S.C. § 1715 l In this case, private lender Metropolitan Funding Corporation ("MFC") applied for and obtained a HUD-insured mortgage of approximately $50 million on behalf of Orchard Hills. See Def. Findings of Facts ("Def. Facts") ¶¶ 2, 21-23.
C. Negotiations with Old Excel
In September 2009, JKS met with employees of Old Excel to discuss their potential nvolvement as modular subcontractors on the Project and negotiate an estimate. Def. Facts ¶ 3. On October 6, 2009, Old Excel, JKS, and Orchard Hills entered into a Letter oflntent ("LOI") providing that all three parties would "work diligently toward executing a Sales Agreement and a Partnership Agreement on or before March 1, 2010." Ex. 1. Pursuant to those agreements, JKS and Orchard Hills would purchase the required modular units solely from Old Excel in exchange for: (1) a $16, 665, 027.00 from JKS; (2) a separate $3 million contract from Orchard Hills; and (3) an additional 5% ownership interest in the project, also coming from Orchard Hills. See Def. Facts ¶ 7; Ex. 1.
D. Cost Review Analysis and Application to HUD
Meanwhile, MFC, Orchard Hills, and JKS worked towards satisfying the requirements for HUD approval of the Project. In October 2009, lender MFC retained Stuart Markowitz to conduct the Cost Review Analysis required by HUD. Def. Facts ¶ 10. In the course of conducting that review, Mr. Markowitz received documents indicating that the cost of the modular construction on the Project would be $16, 643, 027. Def. Facts ¶ ¶ 11-12.
Among the documents submitted to Mr. Markowitz was a November 20, 2009, Memorandum of Understanding ("MOU") generated by Old Excel, which stated that it was the intent of JKS and Orchard Hills to purchase "solely from [Old Excel]" the modular units necessary for completion of the Project for a total of $16, 665, 027. Def. Facts ¶ 12. The MOU omitted any reference to the separate $3 million in cash or 5% ownership interest provided for by the LOI. See Ex. 38. After Mr. Markowitz noted the $22, 000 discrepancy between the $16, 643, 027 figure he had initially received and the $16, 665, 027 figure in the November 20, 2009, MOU, he received a revised MOU, dated December 7, 2009, stating that the contract price was $16, 643, 027. See Ex. 227 ¶ 13. The revised MOU also omitted any reference to the separate $3 million contract with Orchard Hills or contemplated 5% ownership interest. Mr. Markowitz relied on the revised December 7, 2009, MOU in concluding that the Project was acceptable for the HUD program. Ex. 227 ¶¶ 6, 14.
MFC submitted the Project to HUD on January 15, 2010, seeking approval of a $48 million loan. Def. Facts. ¶ 21. The submission stated that "[Old Excel] will provide the modular units" at a price of $16.6 million, reflecting the contract price set forth in the MOU submitted to Mr. Markowitz. Id. ¶ 22.
E. Change in Ownership
On April 30, 2010, New Excel acquired certain assets and liabilities of Old Excel under an asset purchase agreement ("APA"). Def. Facts ¶ 24. Pursuant to the APA, New Excel expressly assumed liability for "the contracts and agreements... described on Schedule 4 hereto." Ex. 102, at 3. The October 9, 2009, LOI was listed on Schedule 4; the November 20, 2009, and December 7, 2009, versions the MOU were not. See id sch. 4, p.2.
F. Issuance of Bond and HUD Closing
Orchard Hills and JKS approached Arch to obtain the necessary payment and performance bonds for the Project in April 2010. Def. Facts ¶ 36. Arch considered the Project's status as a HUD-insured project very attractive from an underwriting perspective. Def. Facts ¶ 37.
As part of its underwriting process, Arch requested that New Excel obtain payment and performance bonds for its subcontract. Def. Facts ¶ 38. In order to comply with this request, New Excel employee Jay Kedia provided Arch with a "Sunshine Letter" stating that New Excel had been a client of Travelers Casualty and Surety Company "for over 10 years, " during which time New Excel had "completed and [Travelers had] bonded projects in the $5, 000, 000. [sic] range for a wide variety of owners." Ex. 56. The letter further stated that it was Travelers' opinion that New Excel "[was] qualified to perform [the Project], which [it] underst[ood] [to] ha[ve] an estimated contract price to be [sic] approximately $20, 000, 000." Id. At the time of the letter, New Excel had been in existence for less than a month. See Def. Facts ¶ 24.
The HUD-insured loan closed on May 25, 2010. At that time, the Prime Contract between Orchard Hills as owner and JKS as general contractor was executed, as were the payment and performance bonds naming JKS as principal and Arch as surety. Def. Facts ¶ 41; Pl. Facts ¶ 1.
G. Modular Subcontracts
At some point following the formation of New Excel, New Excel determined that the terms of the original deal, outlined in the LOI, were unacceptable and sought to renegotiate. See Tr. 145:24-146:15; Ex. 14. Ultimately, JKS and IDBS entered into a series of seven subcontracts for the completion of the modular construction. Pl. Facts ¶¶ 3-5. In contrast with the deal contemplated by the LOI, the seven subcontracts dealt exclusively with JKS, and were exclusively for cash. See id.
JKS and IDBS entered into the first subcontract on October 21, 2010, for the supply and installation of modular units at the Project site for $3, 786, 000. Pl. Facts ¶ 3. JKS and IDBS entered into subcontracts two through five on December 17, 2010, for a total sum of $12, 712, 248. Def. Opp. Facts ¶ 4. JKS and IDBS entered into the two final subcontracts on April 25, 2011, for $3, 177, 000 and $3, 885, 400 each. Pl. Facts ¶ 5. Thus, under the terms of the seven subcontracts, JKS was itself liable to IDBS for the entire contract price, which totaled $23, 560, 648, subject to certain surcharges and credits. This amount far exceeded the approximately $16 million of the HUD-insured mortgage allocated to modular construction. See Def. Facts ¶ 11.
H. Performance Bond Claim and Investigation
On June 9, 2011, John Scanlan of JKS wrote a letter to IDBS indicating that JKS was experiencing financial distress and could not perform the subcontracts as written. Ex. EEE. The letter began, "[a]s you are aware, we started the [Project] with a significant financial whole [sic] because of the deal with [Old Excel] not coming to fruition, " and continued, "[t]o date, I have not been able to [close the financial gap]." Id. In light of these issues, Mr. Scanlan wrote that he would "have to cancel the orders [buildings 4, 13, and 11 under subcontract 7]." Id.
The letter also disclosed that JKS was "having difficulty" with Orchard Hills-the original owner of the Project. Ex. EEE. These issues reached a head when, on June 22, 2011, an attorney for Orchard Hills made a claim on JKS's performance bond, alleging, that JKS had "committed a material anticipatory breach of its agreement by... seeking a contract price increase of $6, 111, 149 for work that falls squarely within its contractual scope." Pl. Facts ¶ 8; Ex. CCCC. The claim letter further asserted that JKS had "only contracted for 20 of the required 29 buildings, " despite exhausting the available funds. Pl. Facts ¶ 10; Ex. CCCC. At the request of Mr. Scanlan, Ex. 97, IDBS provided Arch with a letter confirming that all of the modular units required for the Project were under contract, see Ex. GGG.
Meanwhile, Arch conducted its own investigation of the claim. Over the course of that investigation, Arch discovered that Orchard Hills in fact had no standing to make a claim on the payment bond, as JKS had acquired its ownership interest in the Project. Pl. Facts ¶ 18. Arch was, furthermore, informed of the circumstances surrounding the financing gap alluded to in Scanlan's letter to IDBS. As Arch claims specialist Gordon Patterson explained in a June 23, 2011, email, "[JKS's] position... reflects a change in the form of compensation to be received by the modular unit manufacturer [IDBS]." Ex. HHH. "Due to a change in ownership, [IDBS] chose to forego the equity interest for an additional $6 million to the subcontract." Id. Arch understood that this gap in funding was the cause of the instant performance bond claim. Id. However, Arch apparently accepted Mr. Scanlan's assurances that "the remaining equity partners [were] providing the extra funding" and that the gap was "a dead issue." Id.
Arch ultimately denied Orchard Hills' performance bond claim. See Pl. Facts. ¶ 22; Ex. III. In the letter explaining its decision, Arch cited: (1) the fact that Orchard Hills no longer had standing to make the claim-as JKS now held the controlling interest in the Project; (2) the fact that "anticipatory breach" did not "rise to the level of either a contract default or a justification for termination of the contract"; and (3) the letter from IDBS stating that all of the modular units were under contract. Id.
I. Breach of Subcontracts and Payment Bond Claim
Despite Mr. Scanlan's assurances to IDBS and Arch, JKS continued falling behind on its payments. By November 30, 2011, JKS owed IDBS $2, 409, 717, along with retainage of $188, 288. Pl. Facts ¶ 34.
On January 20, 2012, as a condition of completing construction on the final three buildings (which had previously been cancelled because of JKS's financial difficulty), IDBS and JKS entered into an Amendment to Subcontract Agreements One Through Seven ("January 20 Amendment"). Pl. Facts ¶ 40; Ex. M. Among other things, the Amendment gave IDBS the right to accelerate all balances, including retainage, due ...