Right to Payment: Substantial Performance and Satisfaction

A recent opinion from the Court of Appeals of Texas provides clarification regarding a contractor’s right to payment where the adequacy of the work performed is challenged and an owner attempts to rely on a satisfaction clause to withhold payment.  It also sheds light, in the context of complex construction contracts, on the common contract requirement that the contractor must “strictly comply” with the Contract requirements. In Turner v. Ewing, the court first recognized a widely applied contract principle: a property owner cannot rely upon a contractor’s technical but immaterial breach as an excuse for its own non-performance in the form of non-payment. Stated differently, a contractor who has substantially performed can sue for payment on the contract despite failing to strictly comply with each and every obligation thereunder.

Turner highlights several key considerations with respect to the question of whether a contractor has substantially performed: “To constitute substantial compliance, the contractor must have in good faith intended to comply with the contract, and shall have substantially done so in the sense that the defects are not pervasive, do not constitute a deviation from the general plan contemplated for the work, and are not so essential that the object of the parties in making the contract and its purposes cannot without difficulty be accomplished by remedying them.”

These considerations closely track those set forth in O.W. Grun Roofing & Construction Co. v. Cope, an earlier opinion from the Texas Court of Appeals. There, the court explained that the question of substantial performance is determined “by weighing the purpose to be served, the desire to be gratified, the excuse for deviating from the letter of the contract and the cruelty of enforcing strict adherence or of compelling the promissee to receive something less than for which he bargained.”

The Turner court also considered the owner’s argument that the satisfaction clause in the contract gave the owner the right to withhold payment for work that allegedly failed to meet the owner’s satisfaction. While the plain language of the satisfaction clause at issue conditioned payment upon owner’s satisfaction, the court explained that such a clause “requires the owner to make his judgment in good faith.” The court further noted that “[t]his standard does not consider the actual mental satisfaction of the party making the determination; rather it examines whether the performance would satisfy a reasonable person.” In other words, a satisfaction clause does not give owners a right to withhold payment for work that was reasonably performed, regardless of whether the owner is subjectively satisfied with the performance. Applying this rule, the Turner court found sufficient evidence to support the conclusion that the owner was not acting in good faith by claiming dissatisfaction with the contractor’s work as a basis to withhold payment.

Although Turner was decided under Texas law, the case offers helpful reminders to owners and contractors in various jurisdictions.  For an owner to withhold payment due to a breach, the contractor’s breach needs to be material.  And if a “satisfaction” clause is being relied upon to withhold payment when the work has otherwise been substantially performed, owners should be aware that an “objective” standard of “reasonableness” will likely be implied as governing the Owner’s discretion.