Are Contractors' Claims for Lost Profits Based on Impaired Bonding Capacity Dead in California? California Supreme Court Limits the Potential for Contractors to Recover Lost Profits for Impairment Of Bonding Capacity

Lewis Jorge Const. Management v. Pomona Unified School District (2004) 34 Cal. 4th 960.

By James E. Sell

What was once a difficult claim (at best) for contractors to prosecute and to prove was arguably made that much more so by the California Supreme Court in the recent case of Lewis Jorge Const. Management v. Pomona Unified School District.

In Lewis Jorge, the Pomona Unified School District terminated its construction contract when the contractor, Lewis Jorge Construction Management, still had not finished the project four and a half months after the promised due date. Lewis Jorge's bonding company, CNA, then hired another firm to complete the project. CNA next suspended and then later reduced the amount of bonding for Lewis Jorge. Lewis Jorge eventually stopped bidding work altogether and went out of business. Lewis Jorge sued the District and was awarded some $500,000 on the breach of contract claim. Lewis Jorge also recovered some $3 million for lost profits that Lewis Jorge claimed it would have earned on prospective construction contracts it never won because of its impaired bonding capacity. The Court of Appeal concluded that those potential profits were a proper item of general damages in a breach of contract action. The Supreme Court disagreed.

The issue before the Supreme Court was whether generaldamages for breach of a construction contract included potential profits lost on future contracts that a contractor does not win when, as a consequence of the owner's breach, the contractor's surety reduces the contractor's bonding capacity. The Supreme Court held that such general damages were not recoverable:

"General damages for breach of a contract 'are based on the value of the performance itself, not on the value of some consequence that performance may produce.' (citation omitted.) Profits 'which are the direct and immediate fruits of the contract' are 'part and parcel of the contract itself, entering into and constituting a portion of its very elements; something stipulated for, the right to the enjoyment of which is just as clear and plain as to the fulfillment of any other stipulation.' ( citation omitted.)"

The Supreme Court noted that Arntz Contracting Co. v. St. Paul Fire & Marine Ins. Co. was the only California decision upholding damages for a contractor's lost profits on future contracts that it did not win because its impaired bonding capacity. However, the court was quick to distinguish the contractor's claim in the Arntz case which arose not from an owner's breach of a construction contract, but from a surety's contract to provide future bonding. "Because the contract was one for future bonding, it was entirely within the contemplation of the surety that its breach of the contract - resulting in the contractor's loss of actual bonding - would preclude the contractor from bidding on and being awarded major projects."

In contrast, the Supreme Court did not believe that the District and Lewis Jorge's bargain included potential profits on future construction projects that Lewis Jorge had not bid on and been awarded. At best, Lewis Jorge was entitled to recover from the District its anticipated net profit on the Pomona project. The Supreme Court went on to note that the District's decision to terminate Lewis Jorge from the project did not "directly or necessarily" cause Lewis Jorge's loss of potential profits on future contracts. Rather, the loss was caused by the decision made by Lewis Jorge's bonding company, CNA, to stop bonding Lewis Jorge.

Having concluded that profits Lewis Jorge might have earned on future construction projects were improperly awarded as general damages, the Supreme Court then decided that Lewis Jorge's lost potential profits were also not recoverable as special damages. The Court noted, "Lewis Jorge did not establish that when the contract was formed the District could have reasonably contemplated that its breach of contract would probably lead to a reduction of Lewis Jorge's ability to obtain future contracts." Among other things, the District established that, at the time it signed its contract with Lewis Jorge, it did not know what Lewis Jorge's balance sheet showed and what criteria its bonding company used to evaluate a contractor's bonding limits. "Absent such knowledge, the profits Lewis Jorge claimed it would have made on future, unawarded contracts were not actually foreseen nor reasonably foreseeable. Hence they are unavailable as special damages for the breach of this contract."

While the Supreme Court did not specifically eliminate a contractor's claim against an owner to recover lost profits on future contracts due to reduced bonding capacity, the Supreme Court made clear why it disfavors such a claim and why it may be difficult to prove. The contractor asserting such a claim will be required specifically to plead the claim in its complaint and will carry a heavy burden of proof before the trier of fact. Some attorneys have commented that the Lewis Jorgecarte blancheto be more aggressive and will give them more freedom to terminate contracts with little regard for the contractor. However, well before the Lewis Jorge opinion, others recognized the difficultly of pleading and proving this type of claim. A contractor seeking to recover such damages should be prepared to show that: (1) its bonding capacity was impaired as a result of its losses on the job in question; (2) it was precluded from bidding on a specific project as a result; (3) if it had bid that project, it would have been the low bidder; (4) it had the knowledge, experience, and ability to perform the project on which it was precluded from bidding; (5) its bid was accurate; (6) it could have performed the project for the cost anticipated in its bid; and (7) the amount of its likely net profit. decision will give project owners

In summary, the Lewis Jorge decision confirms and further explains why a contractor's claim for lost profits due to impaired or reduced bonding capacity is difficult to prove.