The Virginia Supreme Court reaffirmed its position that punitive damages based in fraud will not be permitted against a contractor who makes knowing misrepresentations regarding the work performed on a project; in this case, correction of defective work. On September 18, 2009, the Virginia Supreme Court overturned a decision from the Circuit Court of Mecklenburg County in Dunn Construction Company, Inc., et al. v. Richard M. Clooney, and denied an owner’s action for fraud while acknowledging that the contractor’s representations to the owner regarding the compliance of its work were both deliberate and false.

Background

The case involved a $172,106 contract between Billy G. Dunn of Dunn Construction Company, Inc. (“Contractor”), and Richard M. Clooney (“Owner”) for the construction of a house. The Contractor was to perform all major construction, leaving certain interior finishing to be done by the Owner or another contractor. The contract stated that “[a]ll work[was] to be completed in a workmanlike manner according to standard practices.” During construction, the Contractor failed to construct the front foundation wall of the house properly, resulting in cracks in the wall and a portion of the wall to bow out several inches. To repair the wall, the Contractor agreed to install additional rebar in the cinderblock interior wall and to fill the cinderblocks’ cells with concrete. When seeking payment of the contract balance, the Contractor represented that the repairs were complete. After another hairline crack appeared in the “repaired” foundation, however, the Owner refused to provide final payment without further inspection of the wall. Inspection of the wall revealed that one-third to one-half of the cells actually contained no rebar and that the wall had not actually been filled with reinforced concrete. As a result, the house had the potential to collapse and the wall failed to meet Virginia building code requirements. The Owner filed a complaint in the Circuit Court of Mecklenburg County (“Circuit Court”)against the contractor alleging breach of contract, negligence, and fraud. The Owner claimed $34,038.27 for breach of contract and$100,000 in punitive damages under a theory of fraud. The Circuit Court’s jury instructions included one instruction that the jurors may only award punitive damages if there was clear and convincing evidence of “fraudulent misrepresentation regarding the repair to the foundation wall by” the Contractor. The jury returned a verdict for the Owner awarding$33,838.27 in compensatory damages (plus interest) and $25,000 in punitive damages. The Contractor filed a motion for reconsideration contending that the award of punitive damages was impermissible because any misrepresentation “arose out of contract, not tort.” The Circuit Court rejected the Contractor’s motion, affirmed the jury’s verdict and entered final judgment in favor of the Owner, including the award of punitive damages for fraud.

Virginia Supreme Court Decision

The Contractor appealed to the Virginia Supreme Court (“Court”), which reversed the Circuit Court’s decision. The Court stated the rule in Virginia, (and certain other jurisdictions as well), that “the duty tortiously or negligently breached must be a common law duty, not one existing between the parties solely by virtue of the contract.” In essence, the law in Virginia requires a project owner to show that the contractor committed an act of fraud that arose independently of the contractors’ contractual duties. To the extent that the Contractor made misrepresentations related to obligations it was required to perform under the contract only, the Court would not permit a finding of fraud for the Owner. In reaching its conclusion, the Court relied on its prior decision in Richmond Metropolitan Authority v. McDevitt Street Bovis, Inc., 256 Va. 553, 507 S.E.2d 344 (1998), a dispute arising from the contract for the construction of the Richmond, Virginia baseball stadium for the Atlanta Braves’ Triple A team. For the Richmond stadium, the design construction specified concrete bents with hollow conduits. In accordance with the design criteria, the contractor was required to inject grout into each hollow conduit containing steel tendons/bars. The grout was to be injected through grout tubes extending from the bents, which were to be cut off flush with the surface of the bents and sealed once the grout had set. The contractor certified in its pay applications that the work had been completed in accordance with the contract documents. Eleven years later, however, the Authority discovered that many of the conduits contained no grout or insufficient grout, and that the steel tendons/bars in the conduits had consequently eroded. According to the Authority, the contractor had sealed the empty tube openings with grout giving the false impression that the conduits were filled with grout. Three conduits contained no steel tendons/bars whatsoever. The Authority sued the contractor for constructive and actual fraud as well as for breach of contract. The Virginia Supreme Court held that the contractor’s breach of its duty to fill the conduits existed solely by reason of the contractual relationship between the parties; the duty did not exist without the contract. The allegations of constructive fraud were complaints of negligent performance of contractual duties, and the allegations of actual fraud were likewise found to arise out of misrepresentations related to an obligation that was specifically required by the contract. As a result, the Court found no basis for the Authority’s claim for fraud. This left the Authority without a remedy because the statute of limitations period for the Authority’s breach of contract claim had long since expired.

Notably, the Court in Richmond Metropolitan Authority distinguished the case before it from Flip Mortgage Corp. v. McElhone, 841 F.2d 531(4th Cir. 1988) in which the federal Fourth Circuit Court of Appeals (“Court of Appeals”)did make a finding of actionable fraud arising out of a contractual relationship. In Flip, allegations of fraud were based in part on the submission of false revenue reports. The false revenue reports were submitted almost from the beginning of the contractual relationship, which the Court said evidenced the party’s intent not to fulfill the contractual obligations at the time of entering into the contractual relationship. This conclusion led the federal Court of Appeals to find fraud in the inducement. The Court of Appeals based its finding on a Virginia Supreme Court case, Colonial Ford Truck Sales v. Schneider, 228 Va. 671, 325 S.E.2d 91 (1985), where the Court stated that “the promisor’s intention…[w]hen he makes the promise, intending not to perform…is a misrepresentation of present fact…[that] is actionable as an actual fraud.”

The Court in Dunn found it to be indistinguishable from Richmond Metropolitan Authority. The Court held that the contractor’s duty of repair arose out of the original contract. The Court further held that the fact that false representations were made in order to obtain payment from the owner did not take the fraud outside of the contract relationship because the payment requested was also part of the original terms of the contract. While the Court found that the Contractor’s actions were reprehensible, acknowledging that the contractor’s misrepresentations were both “deliberate and false,” the Court nonetheless concluded that it “cannot permit ‘turning every breach of contract into an actionable claim for fraud’ simply because of misrepresentations of the contractor entwined with a breach of the contract.”

Conclusion

The Virginia Supreme Court has established a rule in the preceding line of cases that a contractor is not liable for tortious conduct that arises out of contract obligations. An award of punitive damages for failure to properly execute the work is unlikely even in cases where a contractor knowingly and intentionally misrepresents the work completed; this is so regardless of how deceitful or contemptible the contractor’s actions appear to be. The only apparent exception appears to be cases of fraud in the inducement where an owner can prove a contractor’s intent not to fulfill its contractual obligations from the commencement of the contractual relationship between the parties.

Fortunately, in Dunn, unlike Richmond Metropolitan Authority, the Owner promptly inspected the Contractor’s work and was able to discover the defect timely and bring a breach of contract action to recover its losses. Owners should be mindful that the statute of limitations period in Virginia to bring a breach of contract action is five years from the time the cause of action begins to accrue. While an action for fraud does not begin to accrue until the fraud is discovered, a cause of action for breach of contract begins to accrue from the time the breach occurs. The fact that an owner has not yet discovered the breach before the five year period expires will provide no defense to an owner caught in this situation. Thus, an owner must be diligent in its efforts to ascertain a contractor’s compliance with the contract before the limitations period expires. Except for very limited circumstances, an owner cannot rely on fraud as a recovery fallback for its failure to discover sooner a contractor’s defective work.

The information or opinion provided in this article is the author's own and not necessarily that of Watt, Tieder, Hoffar & Fitzgerald, LLP. The author is solely responsible for the information and opinion that he or she has provided. The information contained herein does not replace seeking specific legal counsel to directly address individual client needs.