Court Holds That Public Entity Can Unilaterally Replace Subcontractor Under California’s Subletting and Subcontracting Fair Practices Act

Garret Murai | California Construction Law Blog | June 10, 2019

The Subletting and Subcontracting Fair Practices Act (Public Contract Code section 4100 et seq.), also known as the Listing Law, is intended to prevent direct contractors on public works projects from “bid shopping” and “bid peddling.”

Bid Shopping: Bid shopping is when a direct contractor discloses a subcontractor’s bid to other subcontractors in an attempt to obtain a lower bid than the one in which it based its bid to the owner.

Bid Peddling: Bid peddling is the other side of the equation. It is when a subcontractor whose bid was not selected, lowers its bid in an attempt to induce the direct contractor to substitute it for another subcontractor after the prime contractor’s bid has been awarded.

The Listing Law advances these goals by prohibiting a direct contractor from replacing a subcontractor listed in the direct contractor’s bid unless:

  1. Consent is given by the public owner; and
  2. That consent is based on one of several specifically enumerated situations, including a subcontractor’s failure to perform its work, failure to pay prevailing wages, failure to carry the proper contractor’s license for the work, etc.

As set forth in statute, the Listing Law allows a direct contractor to request a “substitution” from a public owner. However, it says nothing about a public entity’s ability to require a direct contractor to make a “substitution.” That is, unless you read between the lines, as courts are sometimes apt to  do.

Synergy Public Management, Inc. v. City and County of San Francisco 

In Synergy Public Management, Inc. v. City and County of San Francisco, Case No. A151199 (March 14, 2019), the City and County of San Francisco awarded a bid submitted by Ghilotti Bros. for street repairs in the historic Haight-Ashbury area of San Francisco. Ghilotti had listed Synergy Public Management, Inc. in its bid to perform excavation and utilities work.

Ghilotti’s contract with the City also included a provision providing:

When a Subcontractor fails to prosecute a portion of the Work in a manner satisfactory to the City, Contractor shall remove such Subcontractor immediately upon written request of the City, and shall request approval of a replacement Subcontractor to perform the work in accordance with Administrative Code section 6.21(A)(9) and the [Act], at no added cost to the City.

Work on the project began in April 2015. During performance of the work, Synergy broke five gas lines, improperly shored trenches on multiple occasions which could have led to a street collapse, and “dangled” one of its foremen “by his ankles” into an open manhole with no safety equipment. It reminds me of those hilarious, at least to me, construction fails you read about on occasion.

Following the fifth gas line break, the City had had enough and issued a stop-work order. In a letter to Ghilotti, the City directed Ghilotti, pursuant to the contract, “to remove [Synergy] immediately” and “immediately . . . request approval of a replacement subcontractor to perform the work.”

In response, Ghilotti informed the City that it “substantively and procedurally dispute[d] the validity of the City’s replacement demand” but had “solicited proposals for the completion of Synergy’s remaining scope of work.” Synergy submitted its own response stating that it “strongly object[ed] to the [the City’s] unilateral decision of subcontractor substitution.” And we’re off to the races.

The City, in turn, scheduled a hearing under the Listing Law. At the hearing, Ghilotti and Synergy argued that the hearing officer did not have jurisdiction to hold a hearing under the Listing Law because it was the City, not Ghilotti, who was seeking to replace Synergy. The hearing officer basically called Ghilotti and Synergy’s arguments hogwash (more specifically, “absurd”) and upheld Synergy’s removal from the project.

Synergy and Ghilotti each filed a petition for writ of  mandate to have the Superior Court review the decision by the hearing officer. At the hearing on the writ, the trial court found that because Ghilotti had not requested the replacement of Synergy that the hearing officer had acted outside of his jurisdiction.

The City appealed.

The Court of Appeal Decision

On appeal, the First District Court of Appeals acknowledged that “case law reflects ‘a consistent fact pattern’ of the prime contractor, not the awarding authority, seeking substitution, and [the Listing Law’s] references to a ‘request’ by a the prime contractor contemplates this will be the normal situation.”

But, explained the Court, “this does not establish that the prime contractor must always request a substitution for there to be jurisdiction for a hearing under the [the Listing Law]. ‘Rather, the failure to literally comply with an obligatory statutory procedure, such [as those contained in the Listing Law], is valid if the procedure used complies in substance with all reasonable objectives of the statutory scheme.’”

And here, held the Court of Appeals:

There is no dispute for purposes of this appeal that Synergy performed substandard and unsafe work, yet for reasons that are unclear Ghilotti wanted to retain Synergy. Thus, no risk existed of bid shopping by Ghilotti, much less bid peddling by Synergy or another subcontractor. And once the City elected under its contract with Ghilotti to force Ghilotti to remove Synergy for unsatisfactory work, another party’s work on Synergy’s portion of the project could not lawfully proceed without the City’s consent. The City’s decision to hold a hearing on its own initiative instead of waiting for Ghilotti to “request” substitution furthered the statutory objective of protecting public safety by giving the awarding authority control over which subcontractors work on a project.

Conclusion

So, there you have it. A public entity can unilaterally replace a subcontractor on a public works project under the Listing Law without waiting for a direct contractor to make a request for a “substitution,” so long as the public entity contractually reserves its right to replace a subcontractor. What’s less clear is if a public entity can reserve its right to replace a subcontractor for any reason or whether the reason must be based on one of the enumerated situations identified under the Listing Law.

Illinois Considers Following Trend Toward Making General Contractors Liable for Wages of Subcontractors

James Rohlfing | Construction Industry Counselor | April 23, 2019

A bill pending in the Illinois legislature (HB2838) exemplifies a nationwide trend in the construction industry to hold a contractor who has a direct contract with an owner (“Direct Contractor”) liable for the unpaid wage and fringe benefit obligations of its subcontractors on a private project. Direct Contractors already have liability for employee wages owed by their subcontractors on public projects covered by the Davis Bacon Act, and the same responsibility is owed under the prevailing wage acts of many states. Direct Contractors may also have liability for subcontractors’ wages on private projects pursuant to some states mechanics lien acts, as well as obligations contained in union collective bargaining agreements to which a Direct Contractor may be signatory.

The effort to expand the obligation of Direct Contractors to guarantee payment of subcontractor employees on private projects received a kick start last year when California and Maryland enacted laws making Direct Contractors responsible for the unpaid wages and fringe benefits of all workers in the construction chain. A review of the California and Maryland laws, as well as the bill pending in Illinois, suggests states should be cautious in enacting such laws while they weigh the benefits against the difficulties that might result.   

In California, a Direct Contractor contracting for the construction of a private building project as of January 1, 2018 is liable for any debt owed to a wage claimant, or a third party on the wage claimant’s behalf, incurred by a subcontractor at any tier acting in furtherance of the Direct Contractor’s contract with the owner. The Direct Contractor’s liability includes unpaid wages, and fringe benefits, such as health and welfare contributions, plus interest and attorneys’ fees, but not penalties. Interestingly, under the California law, employees may not bring an action to enforce the law. Instead, a complaint may be brought by: 1) the California Labor Commissioner; 2) a labor-management cooperation committee; or 3) a labor union to collect unpaid fringe contributions. The property of a Direct Contractor may be attached to satisfy a judgment entered against it. Direct Contractors have the right to request payroll records from their subcontractors and to withhold payment if the request is not fulfilled.

A Maryland law which became effective October 1, 2018 also provides that Direct Contractors are liable for the wage obligations of subcontractors at any tier. The Maryland law permits an action to be brought at any time within three years after wages are due, while the limitations period in California is one year. In addition to liability for interest and attorneys’ fees, as provided by the California law, a Maryland Direct Contractor must pay a penalty of three times the unpaid wage. Though Maryland’s law requires a subcontractor to indemnify a Direct Contractor for liability under the law, that is little conciliation for the Maryland Direct Contractor. The subcontractor has already failed to pay its own workers, and in any event, a right to indemnification likely is available under common law. Finally, Maryland’s law does not expressly require a subcontractor to furnish payroll records to a Direct Contractor, though that right could be established by contract.

The bill pending in the Illinois legislature closely resembles the California law. It would impose liability on Direct Contractors for wage claimants of subcontractors at any level on private projects, and a claim could not be brought directly by a wage claimant. Also, as in California, Illinois would charge a Direct Contractor interest and attorneys’ fees but not penalties, and an action would have to be brought within one year from when payment was due.   

Illinois might be well served to first study the effect of recent enactments in other states before launching a similar law. Specifically, the Illinois proposal leaves the following questions unanswered:

  • Would Direct Contractors require all subcontractors to furnish payment bonds to guarantee wages are paid?
  • Would smaller and newer subcontractors who cannot provide bonds be unable to compete on most private commercial projects?
  • How much additional administrative work would be required to track whether subcontractors were paying all employees?
  • Would the payment process be slowed for all subcontractors, while proof of payment by lower tiers is gathered, putting further pressure on cash flow?
  • What role would politics play in whether a labor management cooperation committee would bring suit against one of its large contractor members?
  • Does the word “subcontractors” include material suppliers, as it does under the Illinois Mechanics Lien Act, or does it only include subcontractors covered by the prevailing wage act?
  • Are jobs paid for by public funds on private property or projects on public property using private funds included as “private” projects?
  • If attorneys’ fees are awarded to a prevailing wage claimant, should they also be available to a successful Direct Contractor?
  • Does the provision permitting the attachment of a Direct Contractor’s property to collect a judgment differ from existing law and if so, in what way? 

For hundreds of years, American jurisprudence has recognized the distinction between independent contractor and agency law. Illinois and other states interested in following the examples of California and Maryland should examine the experiences in other states with such laws to help grapple with those questions.

Virginia Supreme Court Puts Contractor Teaming Agreements on Life Support

Paul R. Hurst, Kendall R. Enyard and Thomas P. Barletta | Steptoe & Johnson LLP | July 17, 2018

Although teaming is not officially dead under Virginia law, teaming agreements typically used by contractors may well be on life support after a recent Virginia Supreme Court decision holding that the post-award provisions of a teaming agreement relating to the award of a subcontract were unenforceable.

In CGI Fed. Inc., v FCi Fed., Inc., Record No. 170617 (Va. S. Ct. June 7, 2018), the Virginia Supreme Court (the Court) affirmed a lower court’s decision to set aside a jury verdict for $12 million in damages arising out of breach of contract and fraudulent inducement claims. The Court determined that the teaming agreement at issue did not create an enforceable obligation to enter into a subcontract with specific terms, but rather included language that expressly conditioned the formation of a subcontract on future events and negotiations and included other terms indicating that the relationship might terminate without the formation of a subcontract. Further, the Court found that CGI Federal, Inc. (CGI) could not recover damages on its fraudulent inducement claim because CGI was not entitled to lost profits under a subcontract in which the final terms were uncertain and unenforceable. The Court also affirmed the lower court’s ruling granting summary judgment in favor of FCi Federal, Inc. (FCi) on CGI’s alternative claim of unjust enrichment.

Background

In 2012, CGI and FCi entered into a teaming agreement to prepare a proposal for a US State Department contract for visa processing that was set aside for small businesses. The decision to form a team arrangement provided benefits to each party – CGI, as a large business, was not eligible to bid on the contract and FCi, although it was small, did not have the capabilities to perform the contract alone. The teaming agreement provided that FCi would submit the proposal as the prime contractor and CGI would be included in the proposal as a subcontractor.

Under the teaming agreement, CGI agreed: (a) that it would not team with or assist any other contractor competing for the visa contract; (b) to furnish personnel, materials, and information necessary to assist FCi in preparing the proposal; and (c) to reasonably cooperate with FCi to ensure the success of the proposal. CGI’s and FCi’s teaming agreement also included provisions relating to a subcontract for CGI if FCi won the prime contract. Those provisions included:

  • A Statement of Work which provided that CGI would receive a workshare of 45% the total contract value, but which also made CGI’s workshare “subject to the final solicitation requirements” for the visa processing contract;
  • An agreement to engage in good faith negotiations to enter into a subcontract subject to applicable laws, regulations, terms of the prime contract and CGI’s best and final proposal to FCi;
  • A provision subjecting the subcontract to various additional conditions, including the “‘[m]utual agreement of the parties to the statement of work, financial terms and reasonable subcontract provisions;’” and
  • A clause providing for the expiration of the teaming agreement if the parties could not agree on terms and conditions for a subcontract within 90 days of the contract award to FCi;

The teaming agreement also provided that each party would bear its own costs, expenses, risks and liabilities arising out of the performance of the teaming agreement, and precluded the recovery of lost profits for a breach of the teaming agreement.

FCi submitted the jointly prepared bid to the State Department on December 6, 2012; however, FCi did not share the proposal with CGI and failed to inform CGI that the proposal allocated only 38% of the workshare to CGI. The State Department identified certain deficiencies in FCi’s proposal and directed FCi to submit a revised proposal. In response, FCi informed CGI additional subcontractors were needed and that CGI’s workshare therefore could not exceed 41%. In exchange for accepting a 41% workshare, CGI requested and FCi agreed to allocate 10 management positions for CGI employees for work on the contract. The parties executed an amended teaming agreement that reflected the agreed upon changes to the workshare percentage and the allocation of 10 management positions to CGI, but did not amend or alter any of the other provisions of the original teaming agreement. However, the day after the parties executed the amended teaming agreement, FCi submitted a revised proposal to the State Department that reflected only a 35% workshare for CGI and reserved all management positions for FCi employees.

On August 2, 2013, the State Department awarded FCi the visa processing contract, but the performance of the contract was delayed due to multiple protests related to FCi’s small business status. To resolve the protests, FCi agreed to give the protester work under the contract which, in turn, reduced CGI’s workshare even more. After FCi’s settlement with the protester, the State Department requested a revised proposal. In its second revised proposal, FCi increased its workshare to 75% and it lowered CGI’s workshare to 18% without CGI’s knowledge.

On March 31, 2014, the State Department finalized FCi’s contract award for a base year contract with four annual renewal options for a total value of $145 million, and FCi and CGI then began negotiations of a subcontract. Initially, FCi offered CGI 18% workshare and subsequently increased the offer to 22% workshare. The parties agreed to a temporary agreement that allowed CGI to perform work on the visa contract under which CGI was paid $2 million. On November 10, 2014, FCi terminated CGI for cause related to a staffing dispute.

The Trial Court’s Decision

On March 25, 2015, CGI initiated a lawsuit against FCi for breach of contract for FCi’s failure to extend a subcontract to CGI with a 41% workshare and 10 management positions for CGI employees, unjust enrichment (which was plead in the alternative to the breach of contract claim) and fraudulent inducement relating to the amended teaming agreement under which CGI sought to recover the lost profits it expected to earn under the subcontract. At the close of evidence, FCi moved to strike on the basis that the post-award provisions of the teaming agreement were unenforceable and that CGI failed to prove its damages on the fraudulent inducement claim. The trial court found that the provision in the teaming agreement that required the parties to enter into a subcontract within 90 days of contract award, limited damages. The court also took FCi’s motion to strike under advisement, but submitted the case to a jury. The jury awarded CGI $11,998,000 for the breach of contract and fraudulent inducement claims.

After holding a hearing on FCi’s motion to strike, the court vacated the jury verdict on CGI’s breach of contract claim and the $12 million award to CGI. On the breach of contract claim, the court found that the teaming agreement was unenforceable because the post-award terms were “aspirational only” as neither party agreed to be bound by the teaming agreement’s post-award provisions related to workshare and management positions until a formal subcontract was negotiated and executed.

The court upheld the jury’s finding that FCi fraudulently induced CGI to enter into the amended teaming agreement. However, it vacated the jury’s award of lost profits because the parties had not agreed to a subcontract within 90 days of contract award to FCi; it went on to hold that CGI therefore was precluded from recovering lost profits beyond the 90 day period and that CGI had failed to prove lost profits during that limited period. The court also granted FCi’s motion for summary judgment on the unjust enrichment claim and entered final judgment for FCi on all claims.

Virginia Supreme Court’s Analysis

On appeal, the Virginia Supreme Court affirmed the trial court’s ruling vacating the jury’s verdict on the breach of contract claim. The Court found that the “amended teaming agreement did not create any enforceable obligation for FCi to extend a subcontract with a 41% workshare and 10 management positions to CGI.” Relying on Navar, Inc. v. Fed. Bus. Couns., 291 Va. 338, 347 (2016) (Steptoe’s Navaradvisory can be found here), the Court found that the amended teaming agreement, read as a whole, did not create any enforceable post-award obligations for FCi to extend work to CGI as a subcontractor and that, at most, the amended teaming agreement imposed a framework for good faith negotiations of a final subcontract.[1]

Specifically, the Court determined that the amended teaming agreement contained several provisions that expressly conditioned the formation of a subcontract on future events and negotiations which, the Court concluded “make clear the parties never agreed to the final terms of a subcontract.” For example, the Court found that the Statement of Work’s provision regarding CGI’s post-award workshare was subject to the final solicitation requirements of the visa processing contract. Similarly, it pointed to the amended teaming agreement’s requirement that parties enter into “good faith negotiations for a subcontract . . . subject to applicable laws, regulations, terms of the prime contract and . . . [CGI’s] best and final proposal to FCi;” and the provision for termination of the teaming agreement if the parties could not reach an agreement on the terms and conditions of a subcontract within 90 days of award of a prime contract as evidence that the parties’ “contemplated [that] a subcontract may not materialize after the prime contract award to FCi and [had] created a mechanism for ending their relationship.” Finally, the Court also stated that just as CGI could not rely on the teaming agreement to get a subcontract from FCi, “FCi could not have relied on the agreement to require CGI to perform work as a subcontractor.”

The Court also found that the trial court correctly vacated the jury’s damages award, but the Court did not concur with the lower court’s ruling that CGI’s fraud damages were limited by the 90-day termination provision in the amended teaming agreement. Instead, the Court held that “lost profits are not recoverable for a fraudulent inducement claim when they are premised on the unenforceable provisions of a contract;” here, the unenforceable post-award provisions of the amended teaming agreement. The Court also noted that CGI proved the existence of its lost profits based on the amounts it would have earned under the subcontract. The Court, however, concluded that because the final terms of the subcontract, including CGI’s workshare, were uncertain (subject to negotiations and contingencies), any damages based on lost profits under the prospective subcontract were therefore also uncertain and not recoverable.

Finally, the Court affirmed the lower court’s entry of summary judgment in favor of FCi on CGI’s unjust enrichment claim under which CGI sought to recover the expenses it incurred in helping FCi prepare the proposal and any profits that FCi realized from performing the work it had promised to CGI. The Court rejected CGI’s claim on the basis that the amended teaming agreement created an enforceable express contract that governed the parties’ relationship in preparing the proposal for the State Department contract. For example, the amended teaming agreement set forth reciprocal obligations related to proposal preparation and negotiation of a subcontract and included provisions that required the parties to bear their own costs of performance and precluded them from recovering lost profits for a breach of the amended teaming agreement. As a result, the Court determined that CGI, as a victim of fraudulent inducement, was entitled to either rescind the contract or affirm the contract and sue for damages. Here, the Court held that CGI was not entitled to recover on its quasi-contract claim because CGI sued for contract and tort damages and therefore, it affirmed the amended teaming agreement and agreed to be bound by its provisions, which expressly barred the recovery of lost profits or expenses incurred to prepare the proposals.

Takeaways and Conclusion

CGI involved a fairly typical contractor teaming agreement – e.g., one that did not expressly provide for the award of a subcontract upon the award of a prime contract, made the award of a subcontract contingent on various future events, and provided for good faith negotiations of a subcontract and for termination of the teaming agreement if the parties failed to successfully negotiate a subcontract.

The Court’s decision essentially holds that such an agreement is unenforceable under Virginia law insofar as a prospective subcontractor seeks breach of contract damages for failure to award a subcontract pursuant to the teaming agreement. Likewise, the prime contractor under a teaming agreement cannot rely on that agreement to compel its teammate to perform as a subcontractor. The Court’s opinion also appears to foreclose recovery of lost profits under a fraudulent inducement claim insofar that claim is based on an unenforceable contract.

On the other hand, the Court’s opinion recognizes that the typical contractor teaming agreement can create an enforceable express contract relating to the preparation a proposal and negotiation of a subcontract. The opinion also leaves open the possibility of a breach of contract action for failure to conduct good faith negotiations for a subcontract. However, the damages potentially recoverable in such an action are uncertain, although B&P costs could be one potential measure. Moreover, assertion of a contract (or tort) claim might preclude recovery under an unjust enrichment theory for failure to engage in good faith negotiations for the award of a subcontract.

CGI was not well served by the teaming agreement with FCi: A jury found that CGI was fraudulently induced to execute the amended teaming agreement; and although CGI continued to assist FCi in proposal preparation, it was then “left at the altar” without a subcontract or a remedy. However, government contractors will continue to use teaming agreements because joining complementary capabilities improves the ability of the team members to obtain contract awards and because many procurements are now “team versus team.”

A typical teaming agreement may be entered into well before the RFP has been issued and at the time of formation issues such as whether the teammate improves the ability to win the award and whether the teammates can work together will predominate over considerations of enforceability. However, the Court’s decisions in CGI and Navar demonstrate that enforceability can be a significant issue if one party seeks to require its teammate to meet certain of its obligations under the teaming agreement or to recover damages for its failure to do so. Given this uncertainty, the companies entering teaming agreements should consider exploring alternative choice of law provisions that are more hospitable to the enforcement of teaming agreements.

They should also consider drafting teaming agreements that are as specific as possible regarding the terms of the anticipated subcontract and that limit or avoid provisions that condition the formation of a subcontract on future events and negotiations. However, accomplishing this can be difficult if the program’s requirements are not known or finalized at the time the parties negotiate the teaming agreement so that it may be difficult to negotiating a teaming agreement early in the pursuit of a contract opportunity that will be fully enforceable in Virginia.

That said, the decision of the US District Court for Eastern District of Virginia in Cyberlock Consulting, Inc. v. Info. Experts, Inc., 939 F. Supp. 2d 572, 578 (E.D. Va. 2013), aff’d, 549 Fed. Appx. 211 (4th Cir. 2014), may provide some guidance for developing a potentially enforceable teaming agreement. There, the District Court, applying Virginia law, struck down a teaming agreement as an unenforceable agreement to agree where, looking at the agreement as a whole, the Court concluded that the parties did not manifest an intent to be bound by the agreement. In reaching that result the Court cited the several elements of the teaming agreement (similar to those in the FCi/CGI teaming agreement) as evidence that the parties contemplated that a formal subcontract would have to be negotiated and executed and that the future transaction “might not ever come to fruition.” See 939 F. Supp. 2d at 575-75, 581-82. In that regard, the District Court’s interpretation of Virginia law as applied to the teaming agreement at issue was consistent with the Virginia Supreme Court’s decision in CGI. However, in setting out the facts of the case, the District Court noted the teaming agreement at issue was the second of two teaming agreements between the parties relating to contract opportunities with the Office of Personnel Management. Although the first teaming agreement was not at issue in the case and the Court did not otherwise discuss its enforceability, its discussion of that agreement provides an interesting contrast with the second, unenforceable, agreement. In particular, the Court observed that the first teaming agreement:

  • Had several attachments, including (i) a Statement of Work, which “specifically covered provisions including the period of performance, place of performance, the requirement for key personnel, the format of the contract [IDIQ], and project management requirements for the work that Cyberlock would be performing for [the prime contractor],” (see id. at 574), and (ii) “the specific subcontract” that parties intended to enter following award of a prime contract, id. at 574-75;
  • Provided that the prime contractor “‘will . . . enter into the subcontract attached to this Agreement as Exhibit D” within five business days of award of the task order to the prime contractor. id.; and
  • Identified a number of events that would result in its termination, but “none of [them] was the failure of the parties to successfully negotiate a subcontract.” Id.[2]

While provisions such as these do not ensure enforceability, they do address some of the shortcomings in teaming agreements like those in CGINavar and Cyberlock that have been found to be unenforceable under Virginia law.

New Louisiana Law Requires Public Entities to Pay Interest on Late Payments to Contractors

Mark W. Mercante and Nicholas R. Pitre | Baker Donelson | June 20, 2018

On May 30, 2018, Louisiana Governor John Bell Edwards signed into law Act No. 566 of the 2018 Regular Session, amending Louisiana Revised Statute Section 38:2191(B) effective August 1, 2018, to provide for interest on late payments by public entities. Under the amendment, a payment is considered late and interest begins to accrue 45 days following the public entity’s receipt of a proper request for payment. Interest is set at 0.5 percent daily, not to exceed 15 percent. The amended statute will require contractors to distribute late interest payments among the contractor and subcontractors in proportion to the principal amount due within ten days of the contractor’s receipt of an interest payment.

The text of the amendment is set forth below (bold and underlined words are additions to prior law; no words were deleted):

B. (1) Any public entity failing to make any progressive stage payment within forty-five days following receipt of a certified request for payment by the public entity without reasonable cause shall be liable for reasonable attorney fees and interest charged at one-half percent accumulated daily, not to exceed fifteen percent. Any public entity failing to make any final payments after formal final acceptance and within forty-five days following receipt of a clear lien certificate by the public entity shall be liable for reasonable attorney fees and interest charged at one-half percent accumulated daily, not to exceed fifteen percent.

(2) Any interest received by the contractor pursuant to Paragraph (1) of this Subsection shall be disbursed on a prorated basis among the contractor and subcontractors, each receiving a prorated portion based on the principal amount due within ten business days of receipt of the interest.

Does the Miller Act Trump Subcontract Dispute Provisions?

Christopher Horton | Smith Currie & Hancock | May 9, 2018

The Miller Act

All general contractors performing public building or public works contracts with the federal government must be familiar with the Miller Act. It is a requirement for doing business with the federal government. Pursuant to the Miller Act, a general contractor entering into a public building or public works contract with the federal government must furnish a payment bond in an amount equal to the contract price, unless the contracting officer determines that it is impractical to obtain a bond in that amount and specifies an alternative bond amount.

Miller Act payment bonds guarantee payment to certain subcontractors and suppliers supplying labor and materials to contractors or subcontractors engaged in the construction. As a result, subcontractors have an avenue of relief should they not get paid for work done on the project. Specifically, subcontractors have a right to bring an action against the surety within 90-days after the date on which the person did or performed the last labor or furnished or supplied the last of material for which the claim is made. Any such action must be brought no later than one year after the date on which the person did or performed the last labor or furnished or supplied the last of material. 40 United States Code § 3133.

Limiting Subcontractor Claims

General contractors handling federal work routinely include provisions in their subcontracts that require their subcontractors to exhaust certain dispute procedures prior to filing suit for non-payment or for additional compensation and damages based on alleged extra work, changed conditions, or other grounds. By employing these provisions, general contractors attempt to control the process by which their subcontractors seek recovery for additional compensation or damages. Generally, these provisions require subcontractors to submit their claims through the general contractor against the government, in accordance with the Contract Disputes Act, rather than bringing suit directly against the general contractor under the Miller Act.

For general contractors, these provisions offer a way to avoid costly litigation that may have only arisen because of the government’s denial of a change order or other government action affecting the cost of the project. For subcontractors, however, these provisions limit their rights to recovery and may increase costs associated with recovery. Most importantly, participation in a contract mandated dispute resolution procedure will not toll or extend the Miller Act’s one-year deadline for filing. The one-year deadline is, for the most part, absolute.

Are Miller Act Limitations Enforceable?

General contractors cannot avoid Miller Act lawsuits unless their subcontractors have executed waivers expressly releasing their rights under the Miller Act after the subcontractors have furnished labor or material for use in the performance of the contract. This provision of the Miller Act was added in 1999 to prevent general contractors from requiring that their subcontractors waive Miller Act rights as a precondition to obtaining work on federal projects. It is also directly relevant to the validity of contract provisions requiring exhaustion of dispute procedures prior to initiating Miller Act lawsuits. While some courts interpret these provisions as a de facto waiver of rights under the Miller Act, other courts differ on whether these provisions are enforceable.

Court Decisions Concerning Dispute Remedy Exhaustion Provisions

A number of federal courts have determined that subcontract terms conflicting with the provisions of the Miller Act are unenforceable. Based on this determination, courts have considered whether subcontract provisions requiring exhaustion of dispute procedures prior to initiating a Miller Act suit conflicts with the waiver provisions of the Miller Act. Only a few federal courts have addressed this issue. The majority of courts that have (D.C., Maryland, Nebraska, New Jersey, Pennsylvania, Virginia), have found that such provisions are unenforceable and do not require dismissal or stay of a Miller Action lawsuit. These courts have focused on the language of the provisions at issue. In these cases, the provisions set forth in the subcontract have conditioned the subcontractor’s right to recovery under the payment bond on the completion of the dispute procedures. By requiring that a subcontractor exhaust other procedures first, the courts have determined that the provision conflicts with the waiver requirements set forth in the Miller Act. The provisions at issue in these decisions also fail to expressly cite to the Miller Act.

A minority of courts (Louisiana, California, and Hawaii) have upheld dispute exhaustion provisions and entered dismissals or stays of Miller Act. Contrary to the decisions referenced above, the courts rendering these decisions based their rulings upon the fact that the provisions at issue included express language that required a stay for Miller Act claims pending exhaustion of the dispute procedures. The courts also found that the provisions were not so extreme as to constitute a waiver. The subcontractor’s Miller Act remedies remained intact pending exhaustion of the contractual dispute procedures.

“Best Practices” for General Contractors and Subcontractors

As is discussed above, only a few states have considered whether dispute provisions requiring exhaustion of remedies are enforceable. The majority of states that have considered the issue have refused to enforce the stays or dismissals required by such provisions. But it is fair to say that the law is still evolving on this issue. General contractors and their counsel should consider the following when drafting these types of provisions: (1) whether the Miller Act is expressly referenced; (2) whether the provision includes a disclaimer that the provision does not serve as a waiver of any Miller Act rights; and (3) whether enforcement of the provision is in furtherance of ongoing dispute procedures contemplated by the provision. The last item is great import because it will always be difficult to convince a court to dismiss or stay a claim if the parties are not in the process of moving forward with the dispute procedures referenced within the applicable provision.

On the other hand, subcontractors should consider whether such provisions should be stricken from their subcontracts when negotiating the terms. If not, subcontractors and their counsel should fully consider whether it is better to proceed with the dispute procedures prior to filing a Miller Act lawsuit or whether filing and later challenging the provision in court is a better option. If the one-year deadline is approaching, subcontractors must either file a Miller Act suit or lose their Miller Act rights.