Using Litigation as a Life Boat in a Perfect Legal Storm

Oct 22, 2015
Shai Harary

perfect legal storm
All business people are like sailors: we set out with our sights set on the horizon where success and prosperity lie, doing our best to navigate our way with integrity, intelligence, and impunity (we hope!).

But what happens when we unwittingly steer into a perfect storm of untenable issues?

Last week I blogged about the top eight reasons you MUST litigate. It’s tough enough when there are just one or two good reasons to take legal action… but what about when all eight are in the mix?

Recently I had a big kahuna of a case where a successful Southern California real estate entrepreneur ran into a boatload of problems with a general contractor he’d hired to build a 40-unit apartment complex. Unbeknownst to him, the general contractor was addled with several heavy-duty personal problems (drug addiction, contentious divorce, and related financial issues). In his desperate state, the contractor pushed my client for more payments, more frequently, and not just for what he’d completed, but also for work that he asserted couldn’t be started without an advance. Because the real estate developer was essentially over a barrel, he did what was asked… over and over again, hoping that something would change and the project would get back on track.

Eventually the real estate entrepreneur realized that the money he’d paid had gone everywhere BUT to the project; subcontractors were rumbling about encumbering the property with mechanics’ liens because they hadn’t been paid, and this situation in particular threatened to embroil the project in a plethora of lawsuits within weeks. Litigating from above (e.g. against the general contractor) and from below (the subs) would surely and swiftly drain the project of resources thanks to extensive legal fees. Funds from the original construction loan and from private investors (many of whom were family members and close friends) had already begun to dwindle. The real estate entrepreneur had spent 80% of his funds and only 50% of the work was complete, and worse, the contractor was so busy robbing Peter to pay Paul by juggling three or four other projects that he wasn’t even responding to (my now) client anymore. (Additional abuses included: co-mingling funds, fabricating invoices from imaginary subcontractors, expensing charges unrelated to the project, using the job to extort side work from subcontractors, asking “preferred” vendors to set up new companies that would bill my client for services that were never provided… for which no funds were expended… that never purchased any materials or performed any work . . . in short, a scam of epic proportions.)

Once I heard the details of the situation, it was clear to me that a perfect storm had brewed and somebody had to make a decisive move first or risk being destroyed when the dark cloud of grievances burst:

  • There was enough at stake: The value of the project was over $11,000,000.00, and the construction contract was worth $2,100,000.00 — again, 80% of which had been paid to the contractor by my client — but only 50% of the project was completed, leaving an amount in controversy of $630,000.00. Add to that the monthly cost of the money (the “hard money” loan), and the decision to litigate more than made sense, economically speaking.
  • The other side was non-responsive: The general contractor wasn’t taking my client’s calls, responding to emails, or otherwise communicating.
  • The contractor’s expectations were wildly out of whack: When I reached out to the contractor’s attorney (which he finally retained) he actually stated that my client owed him money, and not the other way around. Unfortunately for opposing counsel, he took the case on a contingent fee based upon false representations by the client and didn’t realize that the contractor had a lot of complicating issues that could destroy his credibility in the courtroom. (The aforementioned addiction, ugly divorce, and… OH YEAH… a kick back scheme.)
  • My client needed immediate relief: Every day that his development wasn’t completed he was losing money. He was servicing the debt on that “hard money” loan, and each month that passed cost my client $26,500.00 in interest. And of course my client had future tenants waiting for their new apartments, as the market was “hot.” The project completion was within view, but the contractor had created a toxic mix of conflict, which was now poisoning the entire investment.
  • My client was out of time: Between the dwindling construction loan and the looming lawsuits from burned subcontractors, the clock was ticking.
  • New disputes were starting to appear: The original issue — getting the contractor to make good on what he’d been paid for — was just the tip of the iceberg. Subcontractors, vendors, and suppliers were beginning to sniff around for financial relief. When a contractor fails to pay the subs they come to the owner (my client) for payment, bringing a bevy of mechanics’ liens with them.
  • We needed to get the attention of the decision maker: With the contractor not responding to our overtures to address the problem or our attempts to create a resolution prior to litigation, there was only one sure way to get things to shift.
  • We needed to nip in the bud the possibility that the contractor would sue my client: Although there was a contract, the contractor repeatedly told my client that he would happily sue him to get the funds he needed to “finish the job.” While it sounded like crazy backward talk, when someone threatens a lawsuit, it’s always a good idea to take him or her seriously.

In situations like this it’s important to focus on the big picture. As I explained to my client, the small picture was this: My contractor is screwing me. I am losing money every day that this conflict persists. I am so angry that he did this to me. I am worried about my friends and family who have put their faith in me and their fortunes into the project.

But of course the big picture was simple: How do I keep this project afloat now that it’s in serious danger of sinking?

While the contractor thought a suitable response to dealing with conflict was to stick his head in the sand, it was clear to me that we had to devise a new tack and get on course to the outcome my client wanted, needed, and deserved: to save the development, to hopefully make some money on his hard work, and most importantly to prevent the project from turning into an anchor that could drag his investors and him down to the depths of financial ruin. For my client, the only thing worse than losing all of his money would have been to also lose his relationships with his friends and family in the process.

This is when litigation became the lifeboat – it literally saved my client from doom and kept his real estate dreams from smashing on the rocks of his failed working relationship with his key construction partner. The goal was a contractual separation of the general contractor from my client and specifically from the property. By our making the first move toward legal action, it forced the contractor to hire an attorney and thus opened up an avenue for discourse and ultimately, recourse. It also helped position my client for a significantly improved shot at success; no doubt there would have been (and probably were) many other parties considering the same action. Because we filed the lawsuit decisively, we were now first at the table.

Next, my client and I met with each of the subcontractors and negotiated new agreements that required lien releases before they would become effective while preserving any potential claims against each of the subcontractors. Finally, we made some strategic compromises that helped diffuse the high emotions and bring the situation back down to Earth.

In the end we did get the contractor to leave the project, cover legal fees, release the liens, and overall not interfere any further in any other possible way. In other words, we used decisive legal action as a lever to settle the case as quickly as possible without protracted litigation.

Stepping away from the nautical analogy for a minute and jumping back to last week’s post — sometimes the best way to end a fight is to throw the first punch!

And now back to facing that perfect legal storm… just know that it takes a lot of hard work to turn the tide and sail on without being washed up by the enormous expense of a long drawn-out lawsuit. Sure, the debacle cost my client time and money, but in the end, we not only kept the project afloat, we repaid the loan, investors got their return, and my client was ultimately able to reset his course to a profitable venture.

Have you ever faced down a perfect legal storm? Tell us about it in the comments!