Phillip L. Parham III | ConsensusDocs
Flow-down clauses in construction subcontracts—blanket clauses providing that some or all of the terms and conditions in the prime contract between the general contractor and the property owner apply equally between the subcontractor and general contractor—are an important component to managing risk for a general contractor and reducing the likelihood of disputes with either/both the owner and subcontractor. Put simply, flow-down provisions can provide continuity between the general contractor’s obligations to the owner and the subcontractor’s obligations to the general contractor. Properly drafted, flow-down clauses reduce the general contractor’s risk by ensuring that the subcontractor is legally bound to meet the owner’s objectives for the project in the same way as the general contractor. But relying on blanket flow-down clauses, alone, to protect the general contractor is like a soldier going into battle with nothing but a helmet, leaving significant other areas exposed and unprotected. In other words, a general contractor should look beyond just a singular, blanket flow down of terms to ensure its bases are properly covered.
Accordingly, this article goes beyond the blanket flow-down clause and highlights several key subcontract provisions where inconsistent obligations among the subcontractor, general contractor, and owner expose the general contractor to increased liability and inconsistent outcomes. Specifically, this article will examine disputes resolution clauses, liquidating provisions, notice provisions, and termination provisions. However, this article will not provide a deep examination of these clauses, nor does it highlight every potentially relevant clause. Rather, it focuses on these select clauses to highlight important issues associated with flow-down provisions.
Dispute Resolution Clauses
To begin, a subcontract’s dispute resolution clause is an important clause outside of the flow-down provision to protect the general contractor. This is especially important when claims by a subcontractor involve the owner. All too often, dispute resolution procedures in a subcontract conflict with those in the prime contract, and in these cases simply flowing down the prime contract’s procedures for resolving disputes does little to protect the general contractor against multi-front battles and inconsistent outcomes.
Imagine a scenario where a subcontractor makes a claim for additional compensation for work that it alleges is outside the scope of work stated in the subcontract agreement. In turn, the general contractor may seek this additional compensation from the owner, who may not agree with the subcontractor’s claim for additional compensation. If the owner, general contractor, and subcontractor are unable to reach an agreement on the claim, the general contractor is caught in the middle. In these cases, it is important that the subcontract obligates the subcontractor to the same dispute resolution procedures that apply to disputes with the owner, including both the jurisdiction and venue for disputes, as well as terms stating that the subcontractor may be joined as a party to the general contractor-owner proceeding. If the subcontract fails to do so, the general contractor may be forced to prosecute the subcontractor’s claims in one proceeding while defending against the claims in a separate proceeding, which could result in inconsistent results, such as the general contractor being held liable for the subcontractor’s claims while not obtaining equal recovery from the owner. Such a scenario also results in increased legal costs and time lost for the general contractor, as it prosecutes/defends multiple, separate legal proceedings.
Liquidating Provisions
A related provision with similar importance in subcontractor claims involving the owner is the so-called “liquidating” provision, which can serve to limit the general contractor’s liability to the subcontractor to the amount that the general contractor recovers from the owner. In other words, the subcontractor’s ability to recover damages from the general contractor is contingent on and expressly limited to the owner’s liability to the general contractor. This assumes that the owner is, or could be, ultimately liable for the damages (and not the general contractor). Without including this limitation on the general contractor’s liability to the subcontractor, the general contractor risks being liable for the subcontractor’s claims without any contribution from the owner.
Inconsistent Notice Provisions
Another area of exposure for the general contractor is when there are inconsistencies between the notice provisions in subcontracts and prime contracts. For example, imagine that the prime contract obligates the general contractor to notify the owner of any claims for additional compensation within seven days of the event giving rise to the claim. But the subcontract requires that the subcontractor notify the general contractor of such claims within ten days of the event. In this scenario, a timely noticed claim for additional compensation from the subcontractor may come after the general contractor’s deadline to notify the owner of the same claim. As a result, the general contractor may still be liable for the subcontractor’s claim even though it has waived its right to recovery from the owner by failing to provide timely notice. Moreover, even if the subcontractor is held to the same notice deadline as the general contractor through the flow-down provision, the general contractor risks inadvertently missing its notice deadline to the owner if the subcontractor submits its claim to the general contractor at the deadline. To avoid this risk, a general contractor should ensure that the subcontractor’s notice deadline provides the general contractor with enough runway to timely notify the owner of the subcontractor’s claim.
Termination Provisions
Finally, general contractors should ensure that their termination rights against the subcontractor mirror the owner’s termination rights against the general contractor. Failure to do so exposes the general contractor to significant risk if the owner terminates the prime contract. This risk arises frequently when the subcontract fails to provide the general contractor with the right to terminate a subcontractor for convenience. In this scenario, if the general contractor is terminated—either for cause or for convenience—the general contractor should have the ability to terminate its subcontractors regardless of whether their performance contributed to the general contractor’s termination. Specifically, if the general contractor is only able to terminate the subcontractor for cause but has no legitimate reason for doing so, the terminated subcontractor has a strong argument that the general contractor breached the subcontract through wrongful termination. And if the subcontractor prevails on its claim, the general could face significant liability exposure, including potential liability for the subcontractor’s expected profits on the entire subcontract agreement, including work that the subcontractor has not yet performed.
In sum, flow-down provisions can protect the general contractor by ensuring that the subcontractor’s obligations to the general contractor are consistent with the general contractor’s obligations to the owner. But as demonstrated from the above examples, flow-down clauses are only one part of the general contractor’s armor against being caught in a multi-front battle. Consequently, general contractors should pay careful attention to how their contractual relationship with subcontractors both compliments and conflicts with the general contractor’s relationship with the owner. A general contractor who relies on a flow-down provision, alone, for continuity of obligations does so with an increased potential for risk.
When one of your cases is in need of a construction expert, estimates, insurance appraisal or umpire services in defect or insurance disputes – please call Advise & Consult, Inc. at 888.684.8305, or email experts@adviseandconsult.net.