Suppliers oftentimes rent or furnish supplies or equipment on credit to a customer (such as a subcontractor) on an ongoing or open account. Under this scenario, the supplier typically has its customer enter into a credit application (ideally, where there is a personal guarantor) and then there may be a sales or rental agreement (or purchase order) documenting the costs of the supplies bought or rented in accordance with the account.
The case of Romona Equipment Rental, Inc. ex rel. U.S. v. Carolina Casualty Ins. Co., 2014 WL 2782200 (9th Cir. 2014), illustrates an argument raised against a supplier of rental equipment in a federal Miller Act payment bond action when the supplier rented equipment to a subcontractor on an open account. In this case, the subcontractor entered into a credit application with the supplier that established the open account for the subcontractor to rent equipment on a federal construction project. The rental equipment that the subcontractor would utilize would be documented by rental agreements and corresponding invoices. The subcontractor entered into 89 rental agreements with the supplier where the supplier furnished the rental equipment on credit. Around this time, the prime contractor terminated the subcontractor from the project leaving the subcontractor owing the supplier substantial sums of money for the rental equipment.
The supplier served the prime contractor with its notice of nonpayment within 90 days of the last day it furnished rental equipment (as it was required to do under the Miller Act since the supplier was not in privity of contract with the prime contractor). The supplier then filed suit against the prime contractor’s Miller Act payment bond for the unpaid rental charges. The prime contractor and surety argued that the supplier’s notice of nonpayment was untimely as to ALL the rental equipment furnished to the construction project more than 90 days before service of the notice. The prime contractor and surety further argued that the supplier failed to mitigate its damages by continuing to supply equipment despite nonpayment. At trial, the district court held that the supplier’s notice of nonpayment covered ALL rental equipment the supplier furnished to the subcontractor for the project in light of the open book account. The district court further held that the supplier’s duty to mitigate damages occurred 4 days after the subcontractor was terminated and, therefore, the supplier was not entitled to recover for rental equipment after this date.
The main issue on appeal to the Ninth Circuit Court of Appeals was whether the supplier’s notice of nonpayment was timely as to ALL rental equipment furnished on an open book account more than 90 days before the notice. Stated differently, the issue was whether each rental agreement created, in essence, a separate contract with a separate requirement to serve a notice of nonpayment within 90 days from the last date the specific equipment was furnished pursuant to each rental agreement. The Ninth Circuit, relying on precedent from the First, Fourth, and Fifth Circuits, affirmed that: “if all the goods in a series of deliveries by a supplier on an open book account are used on the same government project, the ninety-day notice is timely as to all of the deliveries if it is given within ninety days from the last delivery.” Romona Equipment Rental, supra, at *3. This is a good ruling for suppliers!
Interestingly, while the Ninth Circuit agreed with the district court as to the date when the supplier’s duty to mitigate occurred (4 days after the subcontractor was terminated), there was discussion on this issue. It turned out that the subcontractor originally paid its supplier the first 9 invoices for rental equipment, but then only paid 2 of the remaining invoices. The supplier ceased renting equipment to the subcontractor when it learned that the subcontractor was terminated from the project. Yet, before the subcontractor was actually terminated, the subcontractor and prime contractor were trying to resolve the issues that led to the subcontractor’s termination (not uncommon). Thus, the supplier had a good faith belief that the issues would get resolved and it would get paid. Also, the subcontractor and supplier had a longstanding relationship and the supplier was currently furnishing equipment on another federal project and was being paid by the subcontractor. For these reasons, the Ninth Circuit explained that, “Although Ramona [supplier] failed to alert Candelaria [prime contractor] to Otay’s [subcontractor] delinquency until the seventy-eight invoices from Otay were overdue, this does not render the district court’s conclusion-that Romona had commercially reasonable justifications for choosing not to mitigate its damages prior to June 10, 2008 [4 days after the termination]—illogical.” Romona Equipment Rental, supra, at *4.
This dialogue raises an interesting issue regarding the mitigation of damages defense (or duty to mitigate losses/damages) raised by a prime contractor or surety when a supplier goes unpaid for an extended period of time but continues to furnish supplies or equipment. The point of termination raised an easy line of demarcation as to when the credit for rental equipment needed to be cut off. But, what if the subcontractor was not terminated and the supplier continued to rent equipment despite nonpayment? Even though the supplier typically expects payment net 30 days and does not have a pay-when-paid provision in its rental agreements or purchase orders, it still many times will give its customer (e.g., subcontractor) the appropriate slack while its customer is awaiting payment, especially a longstanding customer, a good customer, or when it has a good faith belief that it will ultimately get paid. Also, as it relates to rental equipment, while the supplier can stop furnishing new rental equipment, it is not that easy simply showing up to a project (let alone a federal project) unannounced and removing equipment being rented on a monthly or daily rate. So, there are definitely commercially reasonable justifications where a supplier will continue to let an account grow when it is not getting timely paid. The key for the supplier to establish that it tried to mitigate its losses is to lay the foundation that it sent communications to its customer and its customer’s customer (such as the prime contractor) regarding the delinquent account and its expectation that the equipment be returned when it becomes apparent (or the supplier is concerned) that it may not get paid (or when it no longer has the good faith belief that it will get paid). In Romona Equipment Rental, although the prime contractor likely knew the subcontractor was renting construction equipment (and was not in a position to pay unless the subcontractor received payment), the prime contractor still argued that the supplier should have notified the prime contractor of the subcontractor’s delinquent account as a means to mitigate damages.
For more information on a supplier’s burden of proof in a Miller Act action, please see: http://www.floridaconstructionlegalupdates.com/suppliers-burden-of-proof-in-a-miller-act-payment-bond-claim/.
Please contact David Adelstein at email@example.com or (954) 361-4720 if you have questions or would like more information regarding this article. You can follow David Adelstein on Twitter @DavidAdelstein1.