Ordinarily, a direct contractual relationship is required for there to be contractual liability between two parties. The Supreme Court of South Dakota has recently expanded this liability by ruling that an owner is liable for breach of contract to a subcontractor with whom it had no direct contractual relationship. The city of Sioux Falls entered into a general contract for the construction of an overpass and ramp in an area known for drainage problems. The general contractor subcontracted the sewer and water main work. Both the original contract and the subcontract were subject to the agreement and approval of the city.
The terms of the subcontract required the subcontractor to complete the sewer and water main project in accordance with the terms of the general contract, including general conditions and detailed specifications, all drafted by the city.
The sewer pipe was to be supported by type-A bedding material. However, because conditions were particularly wet and unstable, a larger bedding material — type-B — was required. The contract provided that the city engineer would be authorized to specify type-B material if it were needed to stabilize the trench base.
After the situation deteriorated to the point that the steel casing around the water pipe bent, causing the bridge above to crack, the city demanded that the subcontractor correct the problem and rebury the pipe at its own expense. The subcontractor complied, then turned around and sued the city for $180,000 for breach of contract. Remarkably, the subcontractor was awarded $270,000 by the jury. (The trial judge later reduced the verdict to $180,000.)
The law in South Dakota is that a subcontractor may proceed in a breach of contract action against an owner where the parties are "in privity" with one another. Privity is not limited to direct contractual relationship.
In South Dakota, privity of contract occurs when: (1) the subcontractor is specifically approved by the owner and (2) the parties owe reciprocal duties to one another under the terms of the contract. Both of these conditions were met during this construction project. First, the city expressly approved the subcontractor for the sewer and water main work. Second, the subcontractor was obliged to complete the work in compliance with the city's specifications and was subject to daily inspections by the city's inspector. Furthermore, the contract specifications recite application to subcontractors as well as general contractors.
In broad language, the South Dakota Supreme Court commented, "When the city enters into a contract with a general contractor, who in turn subcontracts with another party under the express approval of the city, it would defy logic to allow the city or the subcontractor to be immune from liability to one another, particularly when the contracts give rise to reciprocal duties between them."
The court's decision implies that the city's problems were self-inflicted by drafting the contract language in the manner it did. First, the contract indicates the city's recognition that there is privity of contract with its subcontractors. There is also a strong inference from the court's decision that the contract did not contain standard language expressly negating any contractual obligations to subcontractors and others except for the general contractor. The court also noted that the city demanded that the subcontractor correct the problem at its own expense, an order that should have been given to the general contractor who could then pass it on to the subcontractor. (C & W Enterprises Inc. vs. City of Sioux Falls, 635 N.W. 2d 752, 2001 SD)