In today’s tough economic environment, many contractors are just one missed pay cycle away from financial ruin. Because many suppliers, subcontractors and contractors are teetering on the verge of insolvency, the seldom invoked legal doctrine of “economic duress” can play a critical role in your company’s success. This article explains what the “economic duress” doctrine is and why it is important both when you are negotiating the amount you intend to pay your creditors, and when you determine what to accept from a third party that owes you money.
In Rich & Whillock, Inc. v. Ashton Development, Inc. (1984) 157 Cal.App.3d 1154, the California appellate court specifically addressed a contractor’s ability to utilize the economic duress doctrine in the context of undisputed contract funds. Rich & Willock was an underground contractor that agreed to perform excavation work for Ashton Development. The contract expressly excluded blasting. When Rich & Whillock encountered rock, the owner directed the contractor to blast the unforeseen materials and bill the owner for the extra costs incurred. Rich & Whillock invoiced the owner as the project progressed and accounted for the extra costs with daily time sheets. Once the work was completed, Rich & Whillock submitted a final billing in the amount of $72,286.45 for the undisputed extra work. The owner refused to pay.
When the contractor asked the owner why he was not being paid, the owner said he had run out of money and could not pay the amount claimed. The subcontractor informed the owner that he would “go broke” if he was not paid because they were a new company, the project was a big job for them, they had rented most of their equipment and they had subcontractors waiting to be paid.
Against these facts, the owner offered to pay Rich & Whillock $50,000 or nothing, and told the contractor that if it did not accept this amount as a “compromise” he would get nothing, and could sue for the full amount.
Not surprisingly, Rich & Whillock accepted the $50,000 compromise – but only after again complaining that the deal was “blackmail” and that they were only signing it to survive.
Four months after receiving its final payment, Rich & Whillock filed a lawsuit to recover the balance. After a bench trial, the court found that Rich & Whillock were due the additional $22,286.45 because the settlement and release was unenforceable under the economic duress doctrine. The owner appealed.
The Court of Appeal affirmed the trial court’s ruling and held that “[t]he underlying concern of the economic duress doctrine is the enforceability in the marketplace of certain minimal standards of business ethics.” After acknowledging that reasonable settlements of good faith disputes are desirable, the Court made clear that the rules are entirely different when dealing with a debt that is due (not reasonably disputed) and a contractor that is experiencing financial difficulty.
The Court of Appeal affirmed the trial court’s ruling and held that “[t]he underlying concern of the economic duress doctrine is the enforceability in the marketplace of certain minimal standards of business ethics.” After acknowledging that reasonable settlements of good faith disputes are desirable, the Court made clear that the rules are entirely different when dealing with a debt that is due (not reasonably disputed) and a contractor that is experiencing financial difficulty.
The Court went on to explain why the doctrine is necessary: “The necessity for the doctrine in cases such as this has been graphically described: ‘Nowadays, a wait of even a few weeks in collecting on a contract claim is sometimes serious or fatal for an enterprise at a crisis in its history. The business of a creditor in financial straits is at the mercy of an unscrupulous debtor, who need only suggest that if the creditor does not care to settle on the debtor’s own hard terms, he can sue. This situation, in which promptness in payment is vastly more important than even approximate justice in the settlement terms, is too common in modern business relations to be ignored by society and the courts.”
It is not surprising that Rich & Whillock was decided in 1981, which was also a time of great economic turmoil in California. Because many in the construction industry are again one payment cycle away from shutting their doors, the economic duress doctrine should be considered whenever resolving a claim for undisputed monies due and owing.
If you are the party looking to pay less than the principal amount due, consider these pointers. First, do not threaten your subcontractor and avoid “take it or leave it” negotiation tactics. Second, expressly include a waiver of any claims based on economic duress in your release document.
If you are the party being offered less than the principal amount due you, or nothing, and are facing financial ruin, consider accepting what is being offered then bringing an action to recover the balance. If you decide to take this route, be certain to communicate and document your position to the payor that you are only accepting the proposed settlement because refusing to accept the amount would ruin your company.
Either way, be aware that the current economic climate threatens the enforceability of settlement agreements and releases in California.
If you have any questions regarding this article, feel free to email the author at as@salamiradmorrow.com.