Mechanics’ Lien Claim Defeated Where Contractor Fails to Provide Proper Contractor Affidavit

Pyramid Development, LLC v. DuKane Precast, 2014 IL App (2d) 131131, vividly illustrates the importance of diligent record-keeping practices on construction projects and the dire financial consequences that can flow from a failure to do so.  It emphasizes how crucial it is for a contractor to comply with Section 5 of the mechanic’s lien act – 770 ILCS 60/5 (the “Act”) – the section that requires a contractor to give the owner a sworn statement that lists all persons providing labor and materials on a project.

The plaintiff contractor sued to foreclose a mechanics lien on several townhomes it was hired to build and also sued a subcontractor for defective concrete work supplied to the project.  After a bench trial, the court nullified the lien because it was negated by damage to the property.  Plaintiff appealed.

Result: Plaintiff’s lien is defeated because it didn’t comply with Section  5.

Reasons:

– The purpose of the Section 5 affidavit is to put the owner on notice of subcontractor claims;

– An owner has the right to rely and act upon a contractor’s section 5 affidavit unless the owner has reason to suspect the notice is false or knows that it’s false;

– An owner is protected from subcontractor claims where they’re not listed on the contractor’s affidavit unless the owner knows of the subcontractor omissions or has colluded with the contractor to exclude the subcontractors;

– Section 5 provides that it’s the owner’s duty to ask for and the contractor’s obligation to supply a sworn statement listing all parties furnishing lienable work on the property and the amounts owed to them;

– Where an owner doesn’t request a Section 5 affidavit, the contractor isn’t required to provide one;

– An owner’s previous acceptance of a flawed Section 5 affidavit doesn’t waive the contractor’s compliance with that section. (i.e., Just because an owner has accepted deficient affidavits in the past, doesn’t mean the contractor doesn’t have to comply with Section 5, e.g.)

(¶¶ 26-29).

Here, the property owner had a pattern of accepting faulty Section 5 affidavits. The plaintiff’s principal admitted that the names and amounts on the affidavits were often wrong and the amounts inflated.  Plaintiff also conceded that it routinely named itself as a subcontractor when it didn’t actually do any of the work on the townhomes.

The court held that since the plaintiff’s section 5 affidavits were facially erroneous, the lien claim was properly defeated.

The court also affirmed judgment against the plaintiff on its breach of contract claim. In a breach of contract suit involving construction services, a contractor is held to the “substantial performance” standard: he must perform in a workmanlike manner and a failure to do so is a breach of contract. (¶ 35).

A breach of contract plaintiff must also prove money damages.  And while he doesn’t have to do so with mathematical certainty, he still must offer some basis from which the court can compute the damage with reasonable probability. (¶ 37).

Here, the plaintiff didn’t meet his burden of proving damages.  Its record-keeping was scatter-shot and rife with discrepancies.  The plaintiff’s numbers didn’t match up and it couldn’t explain myriad invoice errors at trial.  This failure to carry its burden of proving damages doomed the plaintiff’s breach of contract claim.

Take-aways:

Accurate record-keeping is essential; especially on high dollar projects with multiple contractors;

Where an owner requests a section 5 affidavit, the contractor must supply one;

An Owner’s past acceptance of a faulty affidavit won’t excuse contractors duty to strictly adhere to section 5.

Two-Year Continuous Employment Rule to Support Non-Compete Validated by Illinois Appeals Court

Fifield v. Premier, 2013 IL App (1st) 120327 is rightly regarded as a watershed case in Illinois employment and non-compete law circles for squarely stating that two years of continuous employment is the required consideration to support a non-compete agreement in an at-will setting.

Prairie Rheumatology Associates, SC v. Francis, 2014 IL App (3d) 140338 represents an appeals court’s recent validation of the two-year rule in the context of a medical practice suing to prevent one of its former physician employees from competing against it.

The plaintiff medical company and the doctor defendant entered into an at-will employment contract (it could be terminated by either side at any time) that contained a 2-year and 14-mile non-compete term. The defendant agreed not to perform competing medical services for 2 years and within 14 miles of the plaintiff’s office measured from the date defendant’s employment ceased and the physical office location.

19 months into her tenure, defendant quit and went to work for a medical services firm located nine miles from plaintiff’s office. Plaintiff sought a preliminary injunction to enforce the non-compete. The trial court entered an injunction that prevented the defendant from treating plaintiff’s current patients but allowed defendant to treat patients that belonged to her before she started working for the plaintiff. The defendant appealed.

Held: reversed. Non-compete lacks consideration and is not enforceable.

Reasons:

In Illinois, a post-employment restrictive covenant (like a non-compete agreement) is enforceable only where it is reasonable in geographic and temporal scope (“space and time”) and necessary to protect a legitimate employer interest.  A restrictive covenant is reasonable where (1) it’s no greater than necessary to protect the employer’s legitimate business interest, (2) it doesn’t impose an undue hardship on the employee, and (3) isn’t injurious to the public. (¶ 12).  But before the court analyzes these three factors, it must first determine whether the restrictive covenant is supported by consideration.

The reason for the consideration rule is because an employer’s promise of continued employment is often illusory in an at-will relationship since the employer can fire the employee at any time without warning.  Two years or more of continued employment constitutes adequate consideration in the non-compete setting and the two-year rule applies even where the employee resigns on his own instead of where he is fired.  (¶¶ 14-15).

Here, the defendant resigned 19 months after her employment commenced – five months short of the required two-year consideration period. As a result, the court declined to enforce the non-compete.

The court rejected plaintiff’s argument that it gave the defendant “additional consideration” in the form of marketing support and facilitating defendant’s hospital privileges. Looking at the evidence, the court found plaintiff gave defendant minimal assistance in obtaining hospital privileges and failed to introduce defendant to any referral sources as was promised. At the injunction hearing, plaintiff’s principal couldn’t name a single doctor to whom she introduced defendant during defendant’s time practicing at plaintiff’s office.  (¶¶ 18-19).

Afterwords:

This case cements rule that two years of continuous employment is required for there to be adequate consideration to enforce a post-employment non-compete term.  An employer can possibly get around this by offering additional consideration (i.e., something the employee is otherwise not entitled to).  But where the employer cannot offer evidence of the additional consideration, the two-year rule controls and will bar enforcement of the non-compete.

Bank Customer’s Suit Versus Bank For Unauthorized On-Line Transfer Defeated by Economic Loss Rule

After a hacker accessed its on-line banking system and wired about $125,000 from its account, a healthcare firm sued its former (and now defunct) bank for breach of contract, negligence and breach of the implied duty of good faith and fair dealing.

The FDIC substituted in as defendant after it was appointed receiver of the closed bank and moved for summary judgment on all complaint counts.  The Northern District of Illinois in Envision Healthcare, Inc. v. FDIC, 2014 WL 6819991 (N.D.Ill. 2014) granted summary judgment in favor of the bank on all claims.

Reasons:

Two contracts governed the parties relationship, both of which required the bank to permit withdrawals based on recognized user ID and password credentials and allowed plaintiff’s authorized agents to initiate wire transfers from its account.  Other than verifying that the person requesting a withdrawal or wire transfer entered valid log-in data, the bank had no other obligations in either written agreement.

Rejecting the plaintiff’s breach of contract claim, the court noted that banks generally owe a duty of reasonable care to depositors. This duty arises from the position of trust banks occupy vis-a-vis their customers.  But in the context of lawsuits lodged by bank customers for unauthorized transfers, UCC Article 4A’s “Funds Transfers” section governs and sets out a detailed scheme of customer rights and remedies. 810 ILCS 5/4A.  In cases involving unauthorized withdrawals or funds transfers, this statute takes precedence over any common law obligations owed by a bank to its customer.

The court held that the plaintiff couldn’t show a breach of contract since all the bank was obligated to do was honor any request by someone who supplied recognized log-in data. Since the person requesting the funds transfer had a valid ID and password, and the contract terms didn’t saddle the bank with any additional duties, the plaintiff failed to establish the bank’s breach of contract.

Economic Loss Rule

The plaintiff’s negligence suit was defeated by the economic loss doctrine.  This rule posits that where a contract governs the relationship between the parties, the contract defines each side’s rights and responsibilities.  A plaintiff cannot recover in tort (i.e., in negligence) where a contract defines the parties’ relationship and the defendant fails to perform his contractual obligations. *6.

Here, the bank-customer relationship was controlled by the two written agreements.  In Illinois, the general rule is that a service provider is only responsible for physical harm (and not economic harm ) resulting from a breach of duty.

Since the bank defendant was a service provider, and the plaintiff’s damages were purely economic (the $125K unauthorized wire transfer), the economic loss rule barred plaintiff’s negligence claim. *6.

Another reason the court ruled for the bank on the negligence count was because UCC Article 4A (810 ILCS 5/4A) pre-empted or displaced plaintiff’s negligence count.  This Section sets forth in detail a bank’s obligations and a customer’s remedies for honoring an unauthorized payment order. Since the plaintiff didn’t premise its claims under this UCC section, its negligence claim was pre-empted.

Duty of Good Faith and Fair Dealing

The bank also defeated plaintiff’s ‘good faith and fair dealing count. The duty of good faith and fair dealing is implied in every Illinois contract and requires a party who has “contractual discretion” to exercise that discretion reasonably, and not arbitrarily.

The duty does not give rise to a stand-alone cause of action, though. Instead, it’s an interpretive tool employed by the court when assessing the validity of a breach of contract clam.  Any reference to the duty of good faith and fair dealing should be alleged as part of a broader breach of contract claim – not a separate cause of action.

In this case, since the plaintiff failed to incorporate its good faith and fair dealing claims into its breach of contract count, the claim failed as a matter of law.

The Court also noted that the bank didn’t have broad “discretion” in deciding whether to honor a funds transfer.  The bank had to honor a transfer request so long as it was made by someone with a valid log-in and password.

Since the bank didn’t have the option of refusing a bank customer’s payment request, it lacked contractual discretion and the good faith and fair dealing duty claim failed. **8-9.

Take-aways:

– The bank-customer contract will govern the parties’ relationship;

– A service provider (like a bank) owes no extra-contractual duty (a duty that’s not spelled out in the document) to its customer absent physical damage to a customer or his property;

– A plaintiff suing his bank for unauthorized wire transfers should couch his complaint in the language of UCC Section 4A to have the best prospects for recovery.