Including Non-Signatory Subcontractors in Arbitration Clauses in Construction Contracts

Jaime Dewees | Framing Issues

Arbitration is an increasingly popular forum for the resolution of construction disputes.  It often provides a more predictable procedural process specially designed for the industry in light of construction-specific rules and mediation procedures enacted by alternative dispute resolution providers, such as the American Arbitration Association (AAA). Of course, there are pros and cons to private arbitration proceedings administered by AAA and other organizations, including, among other things, those discussed in last week’s post about the increased up-front costs incurred to initiate an arbitration proceeding and paying the fees and expenses associated with a single arbitrator or multiple arbitrator panel. On the other hand, construction arbitrators are generally highly-qualified and experienced construction attorneys and industry professionals capable of resolving complex and highly-technical disputes  Given the complexity of construction disputes this is often advantageous and preferable to a state court judge or jury of laypersons with little or no construction experience.

When planning a construction project, construction professionals should anticipate claims or controversies and make an informed decision up front about the ideal forum for resolving these disputes when they inevitably arise.  Whether arbitration or litigation is preferred depends on a number of time and expense factors, as discussed above.  However, if arbitration is preferred, then “consistency is key” in order to bring all claims and controversies into an arbitration involving many contractors and subcontractors (and their subcontractors and vendors) and to avoid piecemeal dispute resolution outside of arbitration.

The arbitration clause in construction contracts defines the scope of the claims, controversies, and disputes arising from construction projects and directly influences the parties that are bound by an agreement to arbitrate.  The contracting parties should express a clear intent to arbitrate, and must also consider other parties who do not actually sign the construction contract but are nevertheless contemplated by the terms of the operative agreement. In Texas, a non-signatory to an agreement to arbitrate within a construction contract—including a subcontractor, for example—may be compelled to arbitration under legal theories establishing the non-signing subcontractor’s agency with and for another contractor, or as an alter ego of a general contractor that is in essence the same entity as between the general contractor and subcontractor (which is, generally, difficult to prove absent fraud).

At the outset of beginning a construction project, contracting parties can contemplate and capture non-signatories to the main construction contract through incorporating by reference the respective party’s signed subcontract agreements or even reference to the subcontractors themselves. Generally, contracting parties seeking to arbitrate their disputes must establish both a valid agreement to arbitrate and that their claims fall within that agreement’s scope. See Jody James Farms, JV v. Altman Grp., Inc., 547 S.W.3d 624, 629 (Tex. 2018) (citing In re Kellogg Brown & Root, Inc., 166 S.W.3d 732, 739 (Tex. 2005)). If the goal is to keep construction disputes wholly confined in the arbitration forum, the arbitration clause must be given special focus.  That is, the owner/developer and its general contractor, and all subcontractors and second-tier or below subcontractors, should be expressly contemplated by and accounted for in the arbitration clause.  The parties to the prime construction contract should endeavor to reference all of their respective signed subcontract agreements, to the extent they exist, as well as develop the arbitration clause to capture all disputes arising from the construction project and include joinder or consolidation with the arbitration proceeding of any other person or entity that is necessary to resolve the claim, controversy, or dispute, or that is substantially involved in or affected by the same. In doing so, the contracting parties can better avoid bringing piecemeal, fact-intensive litigation against subcontractors.

It is often penny-wise and pound-foolish not to consult with an experienced attorney when drafting a construction contract on any project of significance.  A well-drafted arbitration provision can later save significant time and expense in an effort to avoid costly multi-party (and potentially multi-forum) litigation.  The KRCL Construction Team has significant experience guiding clients through the contract formation process.  The cost of preparing an enforceable arbitration provision costs pennies on the dollar as compared to potential extensive discovery and prolonged litigation in state or federal court.

Reasonableness of Liquidated Damages Determined at Time of Contract (or, You Can’t Look Back Again)

Christopher G. Hill | Construction Law Musings

I’ve discussed the continuing litigation between White Oak Power Constructors v. Mitsubishi Hitachi Power Systems Americas, Inc. previously here at Construction Law Musings because the case was another reminder that your construction contract terms matter and will be interpreted strictly here in the Commonwealth of Virginia.  The prior opinion in this case from the Eastern District of Virginia court the Court considered the applicability of a liquidated damages provision.  In the latest opinion from the Court (PDF) the Court looked at when and how any liquidated damages would be calculated.  In its June 22, 2020 opinion, the Court put the issue as follows:

White Oak’s motion for partial summary judgment presents a narrow issue: whether courts may consider the damages actually sustained by a party as a result of a contract breach when deciding if liquidated damages required by a contract “grossly exceed” a party’s actual damages.

Mitsubishi argued that White Oak could not enforce the liquidated damages provisions of the contract (all of which are laid out in the opinion linked above) because the liquidated damages were not reasonable and “grossly exceeded” the actual damages incurred by White Oak because of project delays allegedly caused by Mitsubishi.  Mitsubishi argued that the Court must look retroactively at the actual damages incurred when determining whether the liquidated damages constituted a penalty.  White Oak argued that the Court should look proactively at what the parties thought damages could be at the time of contracting.  After a thorough review of Virginia law, the Court agreed with White Oak and stated:

[c]ourts applying Virginia law must consider the actual damages contemplated at the time of contract when determining the reasonableness of a liquidated damages provision. Moreover, the fact that courts must focus on the intent of the parties based on the circumstances at the time of contract formation further supports applying the prospective approach. Accordingly, Mitsubishi may not challenge the liquidated damages provision based on the damages White Oak suffered after the alleged delays occurred.

In short, when drafting or reviewing liquidated damages provisions for your construction contracts with the assistance of an experienced Virginia construction lawyer, be sure to have them be “indexed” to the prospective damages the parties reasonably consider to be possible when the contract is made.  You are not likely to win an argument after the fact-based upon the actual damages incurred.

As always, I recommend that you read the entire opinion for yourself and draw your own conclusions.  Also, please let me know with a comment if you have any thoughts on my analysis.

California Court Allows Subcontractor To Pursue Project Owner For Tortious Interference

Scott R. Murphy and Anthony C. Sallah | Barnes & Thornburg

In a case of first impression in the district, California’s Fourth District Court of Appeal found in Caliber Paving Co., Inc. v. Rexford Industrial Realty & Management, Inc. that an owner on a construction project could be liable to a subcontractor for the tort of intentional interference with the subcontractor’s contract with the general contractor. The court held that even though the owner may have had an “economic interest” in the subcontractor’s contract with the general contractor, the owner was still a “stranger” to the contract and could be liable for intentional interference.

In Caliber Paving Co., the defendant-owner entered into a contract with a general contractor to make improvements on the owner’s property. The general contractor, in turn, contracted with the plaintiff-subcontractor to perform paving work at the project. A dispute arose during construction regarding payment and, shortly thereafter, the subcontractor was terminated from the project. The subcontractor subsequently sued alleging that a representative from the owner had directed the general contractor to “kick [the subcontractor] off the job or hire somebody else,” and that the owner “wanted [the subcontractor] off the job.”

The trial court dismissed the subcontractor’s intentional interference with contract claim against the owner, relying on the California Supreme Court’s prior decision in Applied Equipment Corp. v. Litton Saudi Arabia Ltd. There, the California Supreme Court held that only strangers to a contract – “outsiders who have no legitimate social or economic interest in the contractual relationship” – can be liable for intentional interference with contract.  The trial court in Caliber Paving Co. reasoned that because the contract involved improvements to the owner’s property, the owner had a “direct economic interest” in the contract and was not a stranger. The trial court emphasized that “[i]t is hard to envision a situation where the alleged interfering party does not have a more direct economic interest in a contract than one between its general contractor and a subcontractor over how the property is improved.”

The appeals court reversed the trial court’s decision. The appeals court analyzed the California Supreme Court’s language in Applied Equipment, specifically the Supreme Court’s statement that “outsiders” to a contract are those “who have no legitimate social or economic interest in the contractual relationship,” and found that they were not dispositive. The appeals court reasoned:

The Supreme Court’s comments about the liability of noncontracting parties were unnecessary to the holding of Applied Equipment, which was limited to whether a party can be liable for conspiracy to interfere with its own contract. The Supreme Court never addressed whether a tort claim for interference with contract could be made against a noncontracting party claiming to have a social or economic interest in the contractual relationship. Cases are not authority for propositions not considered … The context of Applied Equipment leaves no doubt the Supreme Court did not intend to restrict tort liability for interfering with contractual relations to noncontracting parties with no social or economic interest in the contract.

The appeals court also looked to the reasoning and purpose for imposing liability for intentional interference with contract and determined that there is no immunity for noncontracting parties with a social or economic interest in the contract. Instead, where a noncontracting party engages in conduct that is “socially opprobrious” and induces a party’s breach, they may be liable for intentional interference regardless of any social or economic interest in the contract. In addition, the appeals court expressed concern over insulating noncontracting parties from their own tortious conduct. The appeals court reasoned that a party with an economic interest could intentionally interfere with a contract without facing either tort or contract liability, given their status as a stranger. “This result is particularly perverse as it is those parties with some type of economic interest in a contract who[ ] would have the greatest incentive to interfere with it.”

The appeals court declined to follow California federal court decisions to the contrary. Instead, it favorably cited other California state court decisions that similarly declined to follow the “social or economic interest” language from Applied Equipment.

While this decision is not limited to the construction context, it nonetheless has broad implications for owners and contractors on construction projects in California. It is likely that owners can no longer rely on the Supreme Court’s “social or economic interest” language in Applied Equipment to immunize themselves from tortious interference claims brought by downstream subcontractors. The same applies for contractors defending tortious interference claims from sub-subcontractors or suppliers. 

Notably, the appeals court’s decision may not be limited to situations where a subcontractor is removed from the project and could arguably apply where a subcontractor alleges that an owner improperly interferes with a subcontractor’s scope of work or means and methods.

The “Negligent Negotiations” Theory of Recovery – Is it a Go or No Go at the Boards of Contract Appeal? Part 1

Maria L. Panichellie and Michael A. Richard | GovCon Examiner

Attention contractors – there is a new theory of recovery to consider! …Or, is there?  Truth is, it might depend on what agency you are doing business with, and where you bring your case.

A trio of interesting – and arguably contradictory – Board of Contract Appeals decisions addressing the “negligent negotiations” theory of recovery opens up potential new avenues of relief for contractors…but leave many open questions.  This theory predicates contractor recovery on the Government’s failure to engage in meaningful discussions during competitive procurements under FAR Part 15.  More specifically, on the Government’s failure to identify for the contractor any significant weaknesses and deficiencies in the contractor’s proposal.  But, is the theory really viable?   In this two-part series, we will take a look at recent case law from the Armed Services Board of Contract Appeals, and recent case law from the Civilian Board of Contract Appeals, and explore what these cases say about contractor’s rights to recover under this new theory.  

This week, we’re taking a look at the 2019-2020 Chugach decisions from the Armed Services Board of Contract Appeals (“ASBCA”).  Let’s dive in!

ASBCA – THE CHUGACH CASES

We will start with a little background on the Chugach cases.  There, NAVFAC (“the Agency”) had released a Request for Proposals (“RFP”) for a fixed-price, indefinite-delivery, indefinite-quantity (“IDIQ”) contract relating to base operations support services at Agency installations throughout the Northwest.  A competitive FAR Part 15 procurement, the RFP provided that offerors would be evaluated on the basis of price and six non-price factors.  The “Basis of Evaluation” included an Agency evaluation concerning the adequacy of offerors’ proposed staffing levels.

In its initial evaluation, the Agency determined that CFSI’s proposed staffing levels were “significantly low” in some areas, and that this constituted a “significant weakness” in CFSI’s proposal.  However, when the Agency later opened discussions with offerors (after establishing a competitive range pursuant to FAR 15.306), it failed to advise CFSI of these perceived inadequacies.  Subsequently, based on Agency revisions to the solicitation, CFSI actually decreased proposed staffing levels.  Still, the Agency said nothing about the inadequate staffing levels; rather, the Agency told CFSI that its “overall recurring work FTEs are within an acceptable range.”  Meanwhile, internally, the Agency had determined that CFSI’s revised proposal “did not adequately address the government’s concern and the significant weakness remained.”  Despite this significant weakness, the Agency ultimately issued an award to CFSI.

After award, as the ABCA explained it, CFSI “struggled to satisfy the Navy’s demands under the contract … the Navy’s actions [had] caused [CFSI] to negotiate staffing levels (and, as a direct result, firm-fixed pricing) for this contract that were materially inadequate and that caused significant losses.”  Accordingly, CFSI thereafter filed a certified claim for roughly thirty-six million dollars, the denial of which CFSI then appealed to the ASBCA. 

Before the ASBCA, CFSI argued that it was entitled to compensation for the significant loss it incurred because of the Agency’s actions during contract formation.  Count I of CFSI’s complaint was premised on what it called a “negligent negotiations” theory.  CFSI argued that, pursuant to FAR 15.306, the Government had an obligation, if it chose to enter into discussions with offerors, to enter into meaningful discussions – i.e. discussions that would advise offerors of the deficiencies and significant weaknesses in their proposals.  CFSI asserted that the Government’s failure to do so was negligent, and resulted in CFSI incurring substantial costs.  This, according to CFSI, entitled CFSI to recover its losses from the Agency. 

The Government moved to dismiss CFSI’s claim for lack of jurisdiction, arguing that CFSI’s negligent negotiations “claim” was, in reality, nothing more than a bid protest, challenging the Agency’s evaluation of CFSI’s bid, not a claim, relating to the performance of a contract.  The Board, in a May 2019 decision, disagreed. The Board reasoned that CFSI was not a disappointed bidder, but rather, an awardee of a contract. The Board further found that the negligent negotiations claim absolutely “related” to the contract.   Reasoning that the regulatory requirements that govern exchanges with offerors under FAR 15.306(d) exist for the benefit of the contractor (and drawing an analogy to previous Federal Circuit precedent) the ABSCA held that an Agency’s violation of FAR 15.306(d) could properly form the basis of a CDA claim.  The Board also noted that CFSI’s Count I “negligent negotiations” claim was in some ways related to its Count II “superior knowledge” claim, which the Board had, in an earlier April 2019 summary judgment decision, declined to dismiss.  (The doctrine of superior knowledge is premised upon the notion that where “the government has knowledge of vital information that will affect a contractor’s performance, the government is obligated to share that information.”) 

This first Chugach decision made it clear that the ASBCA is willing to entertain, and believes it has jurisdiction to hear, claims brought on the “negligent negotiations” theory.   The Board subsequently doubled down on this thinking in a May 2020 decision, when it refused to grant the Government the summary judgment that it sought.  In its summary judgement motion, the Agency argued that CFSI’s negligent negotiations claim must be dismissed because CFSI could not prove that it would have significantly increased its staffing had the Navy alerted CFSI to the “significant weaknesses” relating to inadequate staffing.  The Agency further argued that, while it admittedly had found significant weaknesses in earlier versions of CFSI’s proposal, it did not internally note any significant weaknesses on the later versions of CFSI’s proposal, and therefore had no obligation to tell CFSI of such alleged significant weaknesses.  The Board was not at all persuaded by these arguments.  Reasoning that there was a material factual issue as to whether the Navy properly informed CFSI of the significant weakness, it denied the Government’s motion for summary judgment with respect to Count I.   Though the language of the decision is not entirely clear, this could be interpreted to imply that the Government may be held responsible for its failure to alert contractors, during FAR Part 15 discussions, to any significant weakness or deficiency, whether or not the Government had actually identified such weakness internally. In other words, so long as the weakness/deficiency should have been identified, the contractor should have been alerted.

Taken together, these decisions demonstrate that the ASBCA is willing to hear contractor claims premised on negligent negotiations.  So, what does that mean for you?  Well, if you incur damages during performance of a contract as a result of a significant weakness in your proposal, which the government was aware of, but failed to address with you during FAR Part 15 Competitive Range Discussions, you may very well be able to recover those damages from the Government by asserting a negligent negotiations claim before ASBCA.  It is something you should definitely explore with counsel.

That said, there are still a fair number of open questions relating to this theory of recovery.  Most notably, what, exactly, a contractor must establish to show that the Government “failed to properly inform” the contractor of the significant weaknesses and deficiencies in its proposal?  It is also unclear to what extent this “negligent negotiation” theory might overlap or dovetail with superior knowledge claims.  Finally, it is not yet clear how other forums will react to this theory of recovery, or the underlying rationale espoused by the ASBCA.  Well, at least, we will have to wait and see how the Court of Federal Claims and the Federal Circuit view the issue.  A recent Civilian Board of Contract Appeals (“CBCA”) case, Hamstra Chico LLC, might provide some insight on that Board’s opinion.  But more on that case next time, in part two of our series…

The “Negligent Negotiations” Theory of Recovery – Is it a Go or No Go at the Boards of Contract Appeal? Part 2

Maria L. Panichelli and Michael A. Richard | GovCon Examiner

Attention contractors – have you heard about “negligent negotiations”?  A trio of interesting – but arguably contradictory – Board of Contract Appeals decisions addressing this theory of recovery have opened up potential new avenues of relief for contractors…but left a number of unanswered questions.  In this two-part series, we are taking a look at recent case law and exploring what these cases say about a contractor’s right to recover.  

In our last post, we discussed the 2019-2020 Chugach decisions from the Armed Services Board of Contract Appeals (“ASBCA”).  Today, we are tackling a recent Civilian Board of Contract Appeals (“CBCA”) case, Hamstra Chico LLC.  If you are ready, let’s jump back in. 

CBCA – HAMSTRA CHICO LLC

You may remember the Chugach decisions (found here and here) from our last post.  These decisions demonstrate that the ASBCA is willing to hear contractor claims premised on the arguably novel theory of “negligent negotiations.”  So, what exactly is this theory?   It allows a  contractor to recover when it can show that the Government was aware of significant weaknesses or deficiencies in the contractors’ proposal, but failed to address those weaknesses or deficiencies during FAR Part 15 negotiations.  In other words, if you were to incur damages during performance of a contract as a result of a significant weakness or deficiency in your proposal, and the Government had been aware of that weakness/deficiency but failed to address it with you during discussions, you may very well be able to recover those damages by asserting a negligent negotiations claim before ASBCA.  That is great news.  Even so, there are a number of questions left open by the Chugach decisions, not the least of which was how other forums -such as the Court of Federal Claims (“COFC”), Federal Circuit, and Civilian Board of Contract Appeals – might view this novel theory of recovery.  Well, while we might need to wait to hear what COFC or the Federal Circuit think, a recent CBCA case, Hamstra Chico LLC, provides some insight on that Board’s opinion. 

In Hamstra, the United States Department of Veterans Affairs (“the VA” or “the Agency”) issued a solicitation to obtain proposals for the construction and subsequent lease of a building for a fifteen-year term. The solicitation originally provided that “the cost of electricity, gas, and water will be paid directly by the VA” but this was later revised.  Under the revised solicitation, the costs of electricity were to be borne directly by the contractor. The contractor, Hamstra Chico LLC (“HC”), expressly acknowledged receipt of the amendment, accepting all terms and conditions. 

However, it would appear that HC did not entirely understand that it should include ongoing electrical costs in its total proposed contract cost.  As the contractor later explained, its proposal was based on the understanding that the Agency would pay for the overwhelming majority of the electrical utilities associated with the building.  Though, according to HC, the Agency must have realized HC’s error when reviewing the contractor’s proposal, the Agency never brought this pricing error to HC’s attention, despite engaging in four rounds of discussions with HC.  During these discussions, HC asserted, the VA never “brought up its contrary understanding of the terms of the lease,” which HC later argued the Agency was required to do.

After the building was constructed, HC attempted to have the Agency take over the utility costs.  HC filed a claim, arguing that the Agency had engaged in “defective negotiations” when it failed to identify the electricity costs as a deficiency or a significant weakness during the multiple rounds of negotiations with HC.  HC argued that, in failing to inform HC of its pricing error, the Agency violated FAR 15.306(d)(1) and (3).  In making this argument, HC relied on the May 2019 Chugach decision discussed in our last post.

On appeal, the CBCA did not find the reasoning in Chugach applicable to the case before it.  As a threshold matter, the CBCA noted that an ASBCA decision was not binding on CBCA.  It went on to distinguish the Chugach case from the situation facing HC.  In Chugach, the CBCA said, the contractor contended that it won an award with staffing levels that the Agency expressly found, internally, to be inadequate and a “significant weakness”.  The Agency did not inform the contractor of this weakness during discussions.  The contractor asserted that it would have increased staffing had it been informed of the weakness.  Based on all of this, the ASBCA found it had jurisdiction to hear the claim.  Here, in contrast, the CBCA reasoned, jurisdiction was not at issue.  HC sought to reform the contract to correct a mistake it made regarding pricing.  Moreover, unlike in Chugach, where the agency had expressly identified a weakness, but failed to convey that weakness to the contractor, here, there was no proof that the Agency had ever expressly identified – even internally – any problem with HC’s proposal pricing.  The Board explained:

“The contractor faults the [A]gency which, according to the contractor, ‘never brought up its contrary understanding of the terms of the lease as it was required to do.’ With this basic premise, the contractor errs. The contractor never expressed its understanding until after award. The contractor recognizes that the amendment made it clear that the agency would not directly pay for electricity. The contractor priced the contract as it deemed appropriate under the solicitation language.”

In other words, there was no evidence to show that the Agency ever knew that HC had misunderstood the pricing requirements.  The CBCA further reasoned that the parties had presumably reached agreement on a fair and reasonable price for the overall contract, not just a single line item or subcomponent.  Accordingly, the CBCA concluded that it would “not adopt or extend the analysis in Chugach to permit this contractor to pursue further the relief sought.”   

So, what does this mean for the applicability of Chugach, and the “negligent negotiations” doctrine at the CBCA going forward?  To be honest, it is a little unclear.  The CBCA did not reject the applicability of a “negligent negotiations” theory outright – it simply found it inapplicable to HC’s situation.  Certainly, the CBCA appears reluctant to allow contractors to reform contracts to correct proposal pricing mistakes if those mistakes were not expressly identified as a weaknesses or deficiencies by the Government, and where those mistakes may not have even been evident to the Agency reviewing the proposals.  But what about a situation more like Chugach, where the Agency was not only aware of the contractor’s errors, but internally noted them as “significant weaknesses” or deficiencies, yet still failed to alert the contractor to the issues during negotiations?  What if the Agency was aware that something in a contractor’s proposal likely constituted a mistake, but did not specifically determine it to be “significant weaknesses or “deficiency?”  The Hamstra Chico LLC decision leaves these questions unanswered.

It will be interesting to see how the case law regarding negligent negotiation continues to develop at the Boards of Contract Appeals, and it will also be interesting to see – if and when the COFC and Federal Circuit weigh in – how the Courts address the issue.  In the meantime, if you are pursing claims before the CBCA, it would be wise not to put too many eggs in the “negligent negotiations” basket.  It is likely best to rely on the more standard theories of recovery.