On certification to the Superior Court, Appellate Division.
O'hern, Clifford, Keefe, Wilentz, Stein, Handler
The judgment of the Court was delivered by
This appeal concerns the extent to which a court may invalidate an arbitration panel's award that was allegedly based on a mistaken determination of law. The issue arises in the context of a construction-management contract for an Atlantic City hotel and casino. The principal errors of law asserted are that the arbitrators (1) failed to observe settled principles of contract law by awarding damages that were not in the contemplation of the parties at the date of the contract and (2) awarded damages for lost profits after the date on which the project was substantially completed. We find that the asserted errors of law were not so gross, unmistakable, or in manifest disregard of the applicable law as to warrant judicial invalidation of the award.
The matter arises out of a 1983 construction-management contract entered into by plaintiff, Perini Corporation (Perini), and defendant, Greate Bay Hotel & Casino, Inc., trading as Sands Hotel & Casino (Sands). For purposes of this appeal, we adopt generally the version of the facts set forth in Perini's supplemental brief to this Court.
In 1981, Sands's parent company purchased the Brighton Hotel. The Brighton had experienced steadily-declining revenues for several years before Sands purchased it. Sands, however, was able to reverse that trend, making an $8,000,000 profit during its first year of operation. The Brighton's financial troubles had stemmed from several factors: (1) the hotel was a full block from the boardwalk; (2) there was no entrance visible from the boardwalk; and (3) the company had a poor marketing strategy. Sands realized that in order to increase its revenues, it had to draw a significant number of patrons from the boardwalk.
To achieve that goal, Sands decided to undertake major renovations. On July 21, 1983, it entered into a construction-management agreement with Perini for a partial renovation of the hotel and casino. Under the terms of the agreement, Perini's responsibilities as construction manager were to coordinate with the owner and the owner's architect, supervise the trade contractors, and set a guaranteed maximum price for the project (originally $16,800,000) in exchange for a $600,000 fee plus reimbursement for actual expenses. If the cost of the project exceeded $20,000,000, Perini would be entitled to four percent of the project costs over $20,000,000 in addition to the agreed upon fee. The hotel and casino were continuously open and operating throughout the partial-renovation project.
The project had several component parts: (1) expansion of the existing casino gaming area; (2) creation of a new food court; (3) renovation of the nineteenth and twentieth floors and the addition of a new twenty-first floor to house an executive plaza club and seven luxury "high-roller" suites; (4) creation of an additional entrance at the southeast corner of the building (the new park entrance); and (5) the creation of a $400,000 ornamental, non-functional glass facade located outside of the east wall, which faces the boardwalk. Sands described the latter as a "new glitzy glass facade on the east side of the building which might act as a magnet to lure a new category of customers - strollers who might leave the boardwalk and walk the long block from the beach to the Sands."
The contract contained no completion date and no "time-of-the-essence" clause. At the time the parties entered into the contract, the owner's architect had not completed the plans, drawings, and specifications. Sands concedes that it would have been impossible to fix a completion date at the date of contracting; thus, the contract provided that "at the time a guaranteed maximum price is established, * * * a date of substantial completion of the project shall also be established."
The contract defines "substantial completion" as "the date when construction is sufficiently complete * * * so the owner can occupy or utilize the project or designated portion thereof for the use for which it is intended." Perini asserts that "substantial completion" is a term of art in the construction industry with uniformly-understood significance related to performance, warranties, payment, and damages. Most significantly, it asserts that under prevailing law no damages for delay may be awarded after substantial completion.
As noted previously, the contract did not contain a completion date because that date was to be fixed at the time that a guaranteed maximum price was established. However, when the guaranteed maximum price was set (originally at $16,800,000 and later increased to $24,000,000), a substantial completion date had not been placed in the contract.
Sands contends that the parties did agree ultimately to May 31, 1984, as the substantial completion date for the project. The record before the Court shows that the contractual completion dates submitted to the New Jersey Casino Control Commission required substantial completion of the project's three main components (the expansion of the casino, the construction of seven "high-roller" suites, and the new park entrance) on or before June 1, 1984. Significantly, Sands informed Perini that it would postpone the project until 1985 were Perini unable to complete the project before the start of the summer season.
Perini argues that the entire project and various portions thereof reached substantial completion, as defined in the contract, as follows: casino and food court, April 17, 1984; new park entrance and facade, August 31, 1984; suites, September 14, 1984; and the entire project, September 14, 1984. Perini contends that no one disputes that the revenue-producing portions of the work -- the expanded casino gaming area and the food courts -- were open and operational before Memorial Day and that Perini was entitled to an excusable extension of the completion date for the "high-roller" suites until August 22, 1984. Therefore, for all practical purposes, Perini argues that Sands's only delay claim related to an alleged four-month delay, from May through August 31, 1984, in the substantial completion of the glass facade. After the entire project had reached substantial completion on September 14, 1984, Perini claims that in keeping with the term-of-art meaning of substantial completion, only "punch list" and warranty work remained to be completed at the site. However, Sands sought to terminate the contract by letter dated December 21, 1984, despite an asserted contractual provision that it could not terminate the contract after substantial completion.
After Sands's purported termination of the contract, Perini brought suit in the Superior Court, Atlantic County, Chancery Division. Perini sought a declaratory judgment that Sands could not terminate the contract after the renovation project had reached substantial completion. On Sands's cross-action, the court determined that the termination issue, as well as any other disputed matters, were subject to arbitration under the contract.
Perini and Sands submitted three issues to the arbitrators: (1) lost profit damages alleged by Sands; (2) contract balances due Perini; and (3) wrongful termination of the contract by Sands. By a two-to-one vote, with the attorney-arbitrator Dissenting, the panel awarded Sands over $14,500,000 in damages for lost profits. The arbitrators failed to decide explicitly the issue of whether Sands had the power to terminate Perini's contract after substantial completion. During the arbitration proceedings the parties stipulated that Perini would receive $300,000 plus interest as its contract balance.
Sands sought judicial confirmation of the award in the Chancery Division, while Perini sought to vacate the award. Perini presented a variety of issues to the Chancery Division, not all of which have been made the subject of this appeal. Because we limited our grant of certification primarily to the question of mistake of law, we advert but briefly to the Chancery Division proceeding. Perini argued that there had been no competent evidence before the arbitrators to sustain the award. However, the court found that with respect to the damage award, there was competent evidence before the arbitrators from "which they could have reasonably concluded as they did."
Next, the Chancery Division addressed the issue of lost profits. Although expressing concern about the damages awarded from September 1 through the end of December 1984, the Chancery Judge concluded that the arbitrators had not committed "the kind of gross mistake or clear disregard of applicable law that is required to overturn an award."
In an unreported decision, the Appellate Division affirmed. It held that the arbitrators had not been clearly mistaken as a matter of law and thus refused to vacate the award. The court found that enough evidence had been presented to the arbitrators to allow them to conclude that lost profits were a reasonably-foreseeable event of the breach of the contract. Furthermore, the evidence presented was sufficient to ensure that the lost profit damages were not speculative in nature.
The Appellate Division looked at a number of factors in reaching a decision on the substantial completion issue. First, it reviewed evidence of construction conditions around the casino entrance during the fall of 1984 that precluded access to the casino and prevented "beneficial use" of the entrance. Second, it noted that the concrete steps leading to the new entrance had to be repoured during the fall. Based on those factors the court found that "there is evidence from which the arbitrators could conclude Perini did not complete the job as required by the contract until December 1984, well beyond the projected completion time of the end of May 1984."
The court found also that the award was not manifestly unjust, noting that the actual contract price was $24,000,000, and thus the $14,500,000 in lost profits was not disproportionate to the actual contract price.
We granted certification, 127 N.J. 533 (1991), limited to the following issues: (1) whether the asserted mistake of law was reviewable by the courts; (2) the continued validity of the principle that mistakes of law are the equivalent of undue means; and (3) the disproportionality of the arbitration award. We now affirm the judgment of the Appellate Division.
Judicial attitudes about arbitration have changed significantly. Although originally there was mistrust of the arbitral process, that attitude has been replaced by a strong judicial commitment to arbitration. In Southland Corp. v. Keating, 465 U.S. 1, 13-14, 104 S. Ct. 852, 859-60, 79 L. Ed. 2d 1, 13-14 (1984), Chief Justice Burger traced the historic reluctance of the courts to support arbitration to the ancient antipathy between equity and specific performance of arbitration agreements. That reluctance has been all but swept away by judicial recognition that the mindless jealousy of the English courts for their own jurisdiction must yield to the needs of a modern society to develop desirable alternatives to litigation. Our guiding principles should strengthen the systems that encourage those alternatives to litigation, not weaken them. See Sanford M. Jaffe & Linda Stamato, Dispute Resolution: Complementary Programs and the Courts 13 (Jan. 1983) (unpublished paper available from the Administrative Office of the Courts).
The New Jersey courts realized that adoption of the hostile attitude displayed by the English courts could have been detrimental to our judicial system. Thus, our courts have long encouraged the use of arbitration proceedings as an alternative forum. See James B. Boskey, A History of Commercial Arbitration in New Jersey Part I, 8 Rut.-Cam. L.J. 1, 2 (1976). As early as 1794, New Jersey enacted a statute that codified the English common law. Id. at 8. That arbitration statute was reformed in 1923 and is still in existence today. See N.J.S.A. 2A:24-1 to -11.
Arbitration has been defined as follows: "'(1) It is the voluntary reference of a dispute by the parties to (2) an arbitrator or arbitrators chosen by the parties who (3) agree the decision will be final and binding.'" Levine v. Wiss & Co., 97 N.J. 242, 257 (1984) (O'Hern, J., Dissenting) (quoting Arthur J. Simpson, Jr., Whither Judicial Arbitration in New Jersey 12 (Mar. 9, 1982) (unpublished manuscript available from the State Library)).
In Barcon Associates, Inc. v. Tri-County Asphalt Corp., 86 N.J. 179 (1981), we explained that "arbitration is 'a substitution, by consent of the parties, of another tribunal for the tribunal provided by the ordinary processes of law,' and its object is 'the final Disposition, in a speedy, inexpensive, expeditious and perhaps less formal manner, of the controversial differences between the parties.'" Id. at 187 (quoting Eastern Eng'g Co. v. City of Ocean City, 11 N.J. Misc. 508, 510-11 (Sup. Ct. 1933)).
Any party can submit a matter to arbitration. Our Arbitration Act provides: "Two or more persons by their agreement in writing may submit to arbitration a controversy existing between them at the time of the agreement * * *." N.J.S.A. 2A:24-2. Parties can agree to follow the procedures established by the American Arbitration Association (AAA), which contain the usual trial-type format, or they can agree to any other type of procedure to resolve the dispute. In this case, the parties agreed to follow the Construction Industry Arbitration rules of the AAA. Under those rules, a national panel of construction arbitrators is established and maintained. Also, those rules allow a pre-hearing conference and a preliminary hearing, prescribe the qualifications of the arbitrators and the number thereof, and establish the order and tenor of the proceedings. The rules do not require a specific format for the award. They state only that "the award shall be in writing and shall be signed either by the sole arbitrator or by at least a majority if there be more than one." Most significantly, the rules provide that "the arbitrator may grant any remedy or relief which is just and equitable within the terms of the agreement of the parties."
Once an arbitration award has been entered, any party to the arbitration may seek confirmation of the award with the court within three months of the arbitrators' decision. N.J.S.A. 2A:24-7. The award will be confirmed unless "the award is vacated, modified or corrected." Ibid. As at common law, the statute narrowly defines the circumstances permitting an arbitration award to be vacated. Those reasons are as follows:
a. Where the award was procured by corruption, fraud or undue means;
b. Where there was either evident partiality or corruption in the arbitrators, or any thereof;
c. Where the arbitrators were guilty of misconduct in refusing to postpone the hearing, upon sufficient cause being shown therefor, or in refusing to hear evidence, pertinent and material to the controversy, or of any other misbehaviors prejudicial to the rights of any party;
d. Where the arbitrators exceeded or so imperfectly executed their powers that a mutual, final and definite award upon the subject matter submitted was not made.
Sections a and d are relevant here and we shall refer to them as the "undue means" and the "exceeded their powers" provisions, respectively.
Obviously a mistake of law is not one of the stated grounds for vacating an award. Nor, indeed, is sufficiency of the evidence. But some content must be given to those statutory-review provisions. Thus, arbitrators may not make an award that is wholly bereft of evidential support. McHugh Inc. v. Soldo Constr. Co., 238 N.J. Super. 141, 147-48 (App. Div. 1990).
Our case law has been less than precise about the scope of judicial review of arbitral errors of law. In Barcon Associates, the Court said that "'arbitrators decide both the facts and the law,'" 86 N.J. at 187 (quoting Daly v. Komline-Sanderson Eng'g Corp., 40 N.J. 175, 178 (1963)). However, in In re Arbitration Between Grover and Universal Underwriters Insurance Co., 80 N.J. 221, 230-31 (1979), the Court set aside an arbitration award because the arbitrator had mistakenly found coverage under an insurance policy without the corroboration required by the terms of the policy. Such an award was viewed as both exceeding the powers of the arbitrator and having been procured by undue means. The Grover Court cited Held v. Comfort Bus Line, 136 N.J.L. 640 (Sup. Ct. 1948). In that case, the term "undue means" was first interpreted under the present statute to embrace a mistake of law. Justice Heher, sitting at the Passaic Circuit, explained that undue means is found in two situations:
(1) where the arbitrator meant to decide according to law, and clearly had mistaken the legal rule, and the mistake appears on the face of the award or by the statement of the arbitrator; and (2) where the arbitrator has mistaken a fact, and the mistake is apparent on the face of the award itself, or it is admitted by the arbitrator himself.
Justice Heher explained further that "ordinarily, a mistake or error of law or fact is not fatal unless there is a resulting failure of intent or the error is so gross as to suggest fraud or misconduct." Id. at 642.
Although lower court decisions have used the phrase "undue means" to connote a mistake of law, the only New Jersey Supreme Court case equating a mistake of law with undue means is Perez v. American Bankers Insurance Co., 81 N.J. 415 (1979). That opinion, in citing Grover, suggested that a mistake of law is the equivalent of undue means. Id. at 420.
Later, in Faherty v. Faherty, 97 N.J. 99 (1984), the Court vacated a portion of an arbitration award based on a mistake of law under N.J.S.A. 2A:24-8d, the "exceeded their powers" provision. There, the parties' separation agreement provided for arbitration of any later disputes and contained a provision that New Jersey law would govern the resolution of such disputes. Based on that provision, the Court vacated an arbitral award under the "exceeded their powers" section because the arbitrator had failed to follow New Jersey law in granting alimony to the wife after she had remarried. See also Selected Risks Ins. Co. v. Allstate Ins. Co., 179 N.J. Super. 444 (App. Div.) (vacating arbitrators' award under both the "undue means" and "exceeds their powers" provisions for failure to follow the law), certif. denied, 88 N.J. 489 (1981).
There is little profit in seeking to pigeonhole a mistake of law under either of those statutory sections. Suffice it to observe that "when the parties intend that their contract be interpreted in accordance with the law, [the arbitrator's] authority is circumscribed by being limited to carrying out that intent." Kearny PBA Local # 21 v. Town of Kearny, 81 N.J. 208, 217 (1979). In this case, Sands does not disagree that the arbitrators intended to interpret the contract and remedy the breach in accordance with law. Specifically, Sands stated that "the arbitrators did intend to apply the law and * * * their award is firmly supported by the applicable legal principles." We do not intend, however, that the arbitrators be Judges or that their decisions be subject to the same appellate supervision as those of Judges.
The real question is the scope of judicial review. Even in the public sector, arbitrators have broad latitude to resolve questions of law when interpreting contracts. In public-sector arbitration the scope of judicial review "is limited to determining whether or not the interpretation of the contractual language is reasonably debatable." Kearny PBA Local # 21, supra, 81 N.J. at 221. Surely, in the private sector similar latitude should be allowed at the very least. Thus, in private-sector arbitration an arbitrator's determination of a legal issue should be sustained as long as the determination is reasonably debatable. See Department of Law & Pub. Safety v. State Troopers Fraternal Ass'n, 91 N.J. 464, 469 (1982) ("Arbitrators in the private sector have broad discretion in determining legal issues."); Communications Workers of Am., Local 1087 v. Monmouth County Bd. of Social Servs., 96 N.J. 442, 450 (1984) ("parties in the private sector may explicitly authorize the arbitrator to decide legal issues").
Whether the arbitrators are viewed as having acted with "undue means," or having "exceeded their powers," the judicial inquiry must go beyond a search for mere mistakes of law. Were we to decide otherwise, arbitration would simply become another form of private, non-jury trial. A scope of review that allows an arbitration decision to stand when the interpretation of law is reasonably debatable is consistent with the earlier formulation set forth in Held, supra, 136 N.J.L. 640. That formulation requires that the arbitrators must have clearly intended to decide according to law, must have clearly mistaken the legal rule, and that mistake must appear on the face of the award. In addition, the error, to be fatal, must result in a failure of intent or be so gross as to suggest fraud or misconduct.
That scope of review is consistent with formulations found in other jurisdictions.*fn1 For example, under New York law an arbitration award "will not be vacated even though the court concludes that [the arbitrator's] interpretation of the agreement * * * misapplies substantive rules of law, unless it is violative of strong public policy, or is totally irrational, or exceeds a specifically enumerated limitation on [the arbitrator's] power." In re Arbitration Between Silverman and Benmor Coats, Inc., 461 N.E.2d 1261, 1266 (1984). In Illinois, even "gross errors of judgment in law or a gross mistake of fact are not grounds for vacating an award unless the mistakes or errors are apparent upon the face of the award." Rauh v. Rockford Prods. Corp., 574 N.E.2d 636, 644 (1991).
In California, where an arbitrator's award is "made binding by the contract * * * and the legal issue concerns its construction, only a mistake of law egregious enough to amount to an arbitrary remaking of that contract is judicially cognizable." Pacific Gas and Elec. Co. v. Superior Court of Sutter County, 277 Cal. Rptr. 694, 701, cert. granted, 810 P.2d 997 (1991). See also Celtech, Inc. v. Broumand, 584 A.2d 1257, 1258 (D.C. App. 1991) ("To persuade a court to interfere with an arbitration award, a party must show corruption or 'gross mistake'; an error of judgment will not do."); Jackson Trak Group, Inc. v. Mid States Port Auth., 751 P.2d 122, 127 (Kan. 1988) (errors of law are not sufficient to vacate award fairly made in absence of "fraud, misconduct, or other valid objections"); Fischer v. Guaranteed Concrete Co., 151 N.W.2d 266, 270 (Minn. 1967) (arbitrators award will not be set aside for mistake of law absent "fraud, mistake in applying his own theory, misconduct, or any other disregard of duty"); Bailey and Williams v. Westfall, 727 S.W.2d 86, 90 (Tex. Ct. App. 1987) ("Not every error of * * * law warrants setting aside an arbitration award, but only those errors which result in a fraud or some great and manifest wrong and inJustice."); Racine Unified School Dist. v. Service Employees' International Union, Local 152, 462 N.W.2d 214, 216 (Wis. Ct. App. 1990) (only "manifest disregard of the law" would justify setting aside an arbitrator's decision).
Finally, federal precedent offers a concise formulation of a set of principles for judicial review of arbitral mistakes of law;
"Manifest disregard of the law" by arbitrators is a judicially-created ground for vacating their arbitration award, which was introduced by the Supreme Court in Wilko v. Swan, 346 U.S. 427, 436-37, 74 S. Ct. 182, 187-88, 98 L. Ed. 168 (1953). It is not to be found in the federal arbitration law. 9 U.S.C. § 10. Although the bounds of this ground have never been defined, it clearly means more than error or misunderstanding with respect to the law. Siegel v. Titan Indus. Corp., 779 F.2d 891, 892-93 (2d Cir. 1985); Drayer v. Krasner, 572 F.2d 348, 352 (2d Cir.), cert. denied, 436 U.S. 948, 98 S. Ct. 2855, 56 L. Ed. 2d 791 (1978); I/S Stavborg v. National Metal Converters, Inc., 500 F.2d 424, 432 (2d Cir.1974). The error must have been obvious and capable of being readily and instantly perceived by the average person qualified to serve as an arbitrator. Moreover, the term "disregard" implies that the arbitrator appreciates the existence of a clearly governing legal principle but decides to ignore or pay no attention to it. Bell Aerospace Company Division of Textron, Inc. v. Local 516, 356 F. Supp. 354, 356 (W.D.N.Y. 1973), rev'd on other grounds, 500 F.2d 921 (2d Cir.1974). To adopt a less strict standard of judicial review would be to undermine our well established deference to arbitration as a favored method of settling disputes when agreed to by the parties. United Steelworkers v. American Manufacturing Co., 363 U.S. 564, 80 S. Ct. 1343, 4 L. Ed. 2d 1403 (1960); United Steelworkers v. Warrior & Gulf Navigation Co., 363 U.S. 574, 80 S. Ct. 1347, 4 L. Ed. 2d 1409 (1960); United Steelworkers v. Enterprise Wheel & Car Corp., 363 U.S. 593, 80 S. Ct. 1358, 4 L. Ed. 2d 1424 (1960); Saxis Steamship Co. v. Multifacs International Traders, Inc., 375 F.2d 577 (2d Cir.1967). Judicial inquiry under the "manifest disregard" standard is therefore extremely limited. The governing law alleged to have been ignored by the arbitrators must be well defined, explicit, and clearly applicable. We are not at liberty to set aside an arbitration panel's award because of an arguable difference regarding the meaning or applicability of laws urged upon it.
[Merrill Lynch, Pierce, Fenner & Smith, Inc. v. Bobker, 808 F.2d 930, 933-34 (2d Cir. 1986).]
In short, "the role of the courts in reviewing arbitration awards is extremely limited." Local 153, Office & Professional Employees Int'l Union v. Trust Co. of New Jersey, 105 N.J. 442, 448 (1987). We sit not as an appellate court to review arbitral decisions of law but only to safeguard against interpretive error that may be characterized on its face as gross, unmistakable, undebatable, or in manifest disregard of the applicable law and leading to an unjust result.
We note that the Chief Justice has forcefully marshaled the reasons to overrule our prior precedent with respect to judicial review of arbitration awards. He points to the Appellate Division decision in Brooks v. Pennsylvania Manufacturers' Ass'n Insurance Co., 121 N.J. Super. 51 (1972), modified on other grounds, 62 N.J. 583 (1973), as the point at which the lower courts began expanding the otherwise narrow "mistake of law" exception. Post at (slip op. at 8-10). However, the Brooks mistake of law exception has never been approved by this Court. We do not believe that prior precedent precludes the result that we reach and see no need to revisit the issues. Nor do we envision a threat to arbitration processes or an "anti-arbitration bias" in our decision. Appeals of this nature are almost non-existent. In the eleven years since the Barcon decision, we can find no meritorious review in our Court of a commercial-arbitration award.
Rather, we believe that the arbitration process is strengthened by having a limited reservoir of judicial review. Faherty, supra, 97 N.J. 99, is a good example. To let stand an award of alimony that would, on its face, violate New Jersey's statutory law and policy would undermine public confidence in arbitration as a credible system of complementary dispute resolution. We are confident that the limited judicial review that we contemplate will strengthen, rather than weaken, such alternatives to litigation. It is not surprising, in view of the very large sums of money involved in this case and the unusual theory of damages accepted by this arbitration panel, that the arbitral party would seek judicial review.
We turn now to the application of those principles to the facts of this case. Perini alleges that several mistakes of law in this arbitration were clear, substantial, and highly prejudicial. We shall address each.
1. Was it a mistake to award damages for lost profits that were not in the contemplation of the parties at the date of contract?
Since Hadley v. Baxendale, 9 Ex. 341, 156 Eng. Rep. 145 (1854), lawyers and Judges have pondered the difficult issue of harnessing the concept of expectation damages. Should the delay in transit of a crankshaft needed to drive a grist mill have caused a common carrier to be liable for the lost profits of the mill? The rule of consequential damages is said to have been devised to meet the demands of a rapidly-expanding market society. Whatever the doctrine's origins, it is a settled part of our legal landscape.
"Compensatory damages are designed 'to put the injured party in as good a position as he would have had if performance had been rendered as promised.' 5 Corbin, Contracts § 992, p. 5 (1951)." What that position is depends upon what the parties reasonably expected. It follows that the defendant is not chargeable for loss that he did not have reason to foresee as a probable result of the breach when the contract was made. Hadley v. Baxendale, 9 Ex. 341, 156 Eng. Rep. 145 (1854); accord Crater v. Binninger, 33 N.J.L. 513 (E. & A. 1869). The oft-quoted language in Hadley for this proposition is:
Where two parties have made a contract, which one of them has broken, the damages which the other party ought to receive, in respect of such breach, should be such as may fairly be considered either arising naturally, i.e., according to the usual course of things, from such breach of contract itself, or such as may reasonably be supposed to have been in the contemplation of both parties at the time they made the contract, as the probable result of the breach of it. [9 Ex. at 354, 156 Eng. Rep. at 151]
(Donovan v. Bachstadt, 91 N.J. 434, 444-45 (1982) (footnote omitted) (citations omitted).]
Lost profits fall under the category of consequential damages. Seaman v. United States Steel Corp., 166 N.J. Super. 467, 471 (App. Div.), certif. denied, 81 N.J. 282 (1979); E. Allan Farnsworth, Contracts § 12.14 (1982).
Perini argues that lost profits were not contemplated by the parties at the time of contract most significantly because the parties "specified in their contract the precise remedies available in the event of a breach by the other side." Perini points to contract clauses 12.1.1 (construction manager agrees to indemnify owner), 12.4 (owner required to purchase property insurance), 13.2.1 (owner may make good on obligations construction manager fails to perform), and 13.2.2 (where construction manager fails to perform duties under the circumstances described, owner may terminate employment of construction manager) in support of its argument. Had either party contemplated damages for lost profits, Perini argues, a provision would have been included in the contract. For example, Sands would have placed a liquidated damages clause in the contract or it would have included a "time-of-the-essence" clause. As one commentator has noted, liquidated damages clauses are included in construction contracts as a "predetermined assessment of compensatory damages for failure to substantially complete the construction project within the contract time." Steven M. Siegfried, Introduction to Construction Law § 8.03(d) (1987) (hereinafter Siegfried).
Furthermore, Perini argues that it would not have accepted such a great risk for the minimal fee of $600,000. Thus, Perini argues that because the parties did not mention lost profits as a remedy in the case of late completion, lost profits cannot be awarded, and therefore the award of lost profits was not in accordance with the terms of the contract. Also, Perini contends that the parties could not have anticipated that the failure to complete a non-functional, ornamental facade could lead to damages of millions of dollars. Finally, even if lost profits were contemplated by the parties, they did not intend to allocate the risk of loss to Perini.
However, the testimony of Sands's personnel clearly established that Sands intended to increase its profits by attracting more patrons from the boardwalk. Certainly, Perini had to be aware of Sands's motive at the time it entered into the contract. Also, Sands stressed the importance of timely completion of the project. On numerous occasions Sands informed Perini that it wished to have the project completed prior to the beginning of the summer season, the casino industry's busiest season. Perini was well aware of the projected completion date. In an inter-office memorandum, dated September 26, 1983, Perini's project manager wrote: "The projected completion date is June 15, 1984, which is 12 work days beyond the required completion date on May 31, 1984." Furthermore, Perini knew that Sands would delay construction if the project could not be completed by May 1984. Thus, it appears that the arbitrators had more than enough evidence to conclude that Perini was aware that its failure to complete the project in a timely fashion could lead to a significant loss of income. In fact, a letter written on June 12, 1984, by William Weidner, Sands's president, specifically informed Perini that Sands intended to seek damages. Certainly, based on the evidence submitted to them, the arbitrators could have concluded that the damages were reasonably foreseeable. Thus, Perini's first alleged mistake of law must fail.
2. Was it a mistake to award damages for lost profits after the date when the project was substantially completed?
Perini argues that if the award of lost profits from September through December 1984 is allowed to stand, the well-established rule that limits damages after substantial completion will be violated because the parties agreed that substantial completion of the project occurred on September 15, 1984.
Substantial completion has a definite meaning in the construction industry. Amicus, Associated General Contractors of America (AGCA), tells us that the contract entered into by Perini and Sands is substantially the same as AGCA Document No. 500, which in turn is modeled on forms distributed by the American Institute of Architects (AIA). Those AIA forms are widely used in the construction industry. Justin Sweet, Sweet on Construction Industry Contracts: Major AIA Documents § 1.1 (1987) (hereinafter Sweet). The definition of substantial completion that appears in the contract reads as follows: "The date of substantial completion of the project or a designated portion thereof is the date when construction is significantly complete in accordance with the drawings and specifications so the owner can occupy or utilize the project or designated portion thereof for the use for which it is intended." According to Professor Sweet, the AIA defines substantial completion as "what the owner bargains for, a mostly completed project within the required time." Sweet, supra, § 16.15. Professor Sweet also notes that generally AIA contracts contain a clause that requires a contractor, on substantial completion, to submit "a comprehensive list of items to be completed or corrected." That is generally known as a "punch list." Ibid. Although the specific clause described by Professor Sweet was not included in the contract here, the definition of punch list and its link to substantial completion will be helpful to our analysis. Generally, the punch list includes those items that restrict the final completion of the project. 2 Steven G.M. Stein, Construction Law P7.09 at 7-78 (1991) (hereinafter Stein).
Another factor that is indicative of substantial completion is the issuance of a certificate of occupancy by the municipality, normally by its building department. Id. at 7-77. When an owner attempts to assess liquidated damages, a "certificate of occupancy should arguably determine the date of substantial completion." Ibid.
In its amicus brief, AGCA argues that substantial completion in construction law and the common-law doctrine of substantial performance are different, without clearly stating the consequence of that purported difference. It appears that substantial completion is a term used in the construction industry to measure the time commitment portion of the contract. Sweet, supra, § 17.4. In any case, the definition of substantial completion used by the parties is similar to the definition of substantial performance used by the courts. See Jardine Estates, Inc. v. Donna Brook Corp., 42 N.J. Super. 332, 337 (App. Div. 1956). Perini in its papers and the case law use the terms interchangeably. Construction-industry authorities agree that the courts use the terms interchangeably. Stein, supra, P6.07 & n.13 at 6-18.
As noted previously, Perini contends that it substantially completed the project by mid-September 1984, and therefore should not be liable for lost profits from that date to the date of termination in December 1984. According to Perini, the award of lost profits for that period amounted to approximately $4,000,000.*fn2 Construction industry treatises agree with Perini. Siegfried states:
The doctrine of substantial performance can be used as a defense to a breach of contract action for failure to complete a project within the contract time. In fact, unless otherwise specifically agreed, a liquidated damages provision is not enforceable for the period beyond the point of substantial completion.
[Siegfried, supra, § 8.05.]
As Williston points out, most commonly, the courts have applied the doctrine of substantial performance to cases that involve building contracts. The doctrine has been interpreted to allow a builder who has substantially performed a contract to recover the full price under the contract less any damages suffered by the owner due to the builder's breach. 6 Williston on Contracts § 842 (3d ed. 1962). That rule generally is followed in most American jurisdictions. 3A Corbin on Contracts § 701 (1960).
The case law is in accord. In Jardine Estates, supra, the court stated that there is substantial performance of a contract "'where all the essentials necessary to the full accomplishment of the purposes for which the thing contracted for has been constructed are performed with such an approximation to complete performance that the owner obtains substantially what is called for by the contract.'" 42 N.J. Super. at 337 (quoting 9 Am. Jur., Building and Construction Contracts § 42).
In Feeney v. Bardsley, 66 N.J.L. 239 (E. & A. 1901), the Court found no error in the lower court's charge to the jury where it stated:
If the contractor has substantially performed his contract, even though he has failed to do so in some minor particulars, he is entitled to recover the contract price, less what will be a fair allowance to the owner to make good the defects in performance of the contract.
In Van Dusen Aircraft Supplies, Inc. v. Terminal Construction Corp., 3 N.J. 321 (1949), this Court, citing Feeney approvingly, stated in dicta that the "rule of damages where a building is substantially completed, but is defective in some particulars, is the cost of making good the omitted or defective work." Id. at 329. Accord Power-Matics, Inc. v. Ligotti, 79 N.J. Super. 294 (App. Div. 1963); Winfield Mut. Hous. Corp. v. Middlesex Concrete Prods. and ...