Subcontract Should Flow Down Delay Caused by Subcontractors

David Adelstein | Florida Construction Legal Updates

A general contractor’s subcontract with its subcontractor should include a provision that entitles it to flow down liquidated damages assessed by the owner stemming from delays caused by the subcontractor.  Such a provision does not mean the general contractor does not have to prove delays caused by the subcontractor or can arbitrarily allocate the amount or days it claims the subcontractor is liable.  The general contractor still will need to reasonably establish the delays the subcontractor caused the critical path of the schedule, i.e., delayed the job.   In addition to the right to flow down liquidated damages, the subcontract should also entitle the general contractor to recover its actual extended general conditions caused by the subcontractor’s delays (regardless of whether the owner assesses liquidated damages).  The objective is that if the subcontractor delays the job, the subcontractor is liable for liquidated damages the general contractor is liable to the owner for in addition to the general contractor’s own delay damages. This is an important subcontractual provision so that the risk of delay caused by subcontractors is clearly flowed down to them in the subcontract.

In a 1987 case, Hall Construction Co., Inc. v. Beynon, 507 So.2d 1225 (Fla. 5th DCA 1987), the subcontract at-issue contained language that stated, “The parties hereto agree that a supplier who delays performance beyond the time agreed upon in this Purchase Order shall have caused [general contractor] liquidated damages in the amount required of [general contractor] by their contract per day for each day such delay continues which sum the supplier hereby agrees to pay.”

The general contractor was liable to the owner for liquidated damages in the amount of $1,000/day and settled the liquidated damages assessment with the owner for the amount of $20,000 (which was a reduction from a $60,000+ exposure for 60+ days of delay).  The general contractor looked to apportion the liquidated damages to subcontractors it claimed was liable for the delay.  The subcontractor at-issue disputed its apportionment; therefore, the general contractor sought ALL of its delay damages caused by the subcontractor for the full amount of the 60+ day delay period.   The appellate court held that while the subcontract could be clearer, it was still unambiguous that the general contractor could ONLY recover liquidated damages because that is all that contract afforded:

Liquidated damages is a fictitious contractual amount which the parties agree will be paid for breach if damages are not readily ascertainable at the time the contract is drawn.  Although the [general contractor] maintains that it is entitled to liquidated damages as well as actual damages suffered as a result of the delay, we find that the parol evidence rule precludes such a finding.

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Had the general contractor been aware of the parol evidence rule, a different contract may have been provided.  For example, a contract with one paragraph for indemnification of all liquidated, or other, damages paid by the general to the owner and another paragraph for payment of other actual, consequential damages suffered by the general as a result of the delay caused by the sub.

Hall Construction Co., 507 So.2d at 1226-27.

When a Flow Down Provision Doesn’t Flow Up: Oregon Appellate Court Holds That a Flow Down Provision From a Prime Contract With an Arbitration Clause Does Not Grant Subcontractors a Right to Compel Arbitration With Owner

R. Zachary Torres-Fowler | Pepper Hamilton LLP | September 27, 2018

Eugene Water & Elec. Bd. v. MWH Americas, Inc., 2018 Ore. App. LEXIS 879 (July 25, 2018)

On July 25, 2018, an Oregon appellate court concluded that a pair of subcontractors could not compel an owner to arbitrate its claims against them by virtue of a “flow-down” provision in a prime construction contract which also contained an arbitration clause. The case is a reminder that principles of contract interpretation govern the enforcement of arbitration agreements and that courts will not compel arbitration where both parties have not expressly consented to arbitrate their disputes.

As part of an improvement project for the Leaburg Dam near Eugene, Oregon, the Eugene Water and Electric Board (“EWEB”) entered into a prime contract with Advanced American Construction (“AAC”) as the general contractor for the project. AAC subsequently entered into subcontracts with MacTaggart, Scott & Company Limited (“MacTaggart”) and Olsson Industrial Electric, Inc. (“Olsson”). When the improvements to the Leaburg Dam failed, EWEB filed a complaint in Oregon state court against AAC and, shortly thereafter, asserted claims against the two subcontractors in an amended complaint.

During the proceedings, AAC sought to compel arbitration of EWEB’s claims against AAC because the prime contract contained an arbitration clause. As litigation proceeded, both MacTaggart and Olsson also sought to compel arbitration of EWEB’s claims against them. Problematically, however, because MacTaggart and Olson, as subcontractors, were only in direct privity with AAC, and not EWEB, no express agreement to arbitrate existed between EWEB and the two subcontractors.

Nevertheless, the subcontractors argued they were entitled to compel arbitration by virtue of a “flow-down” provision in the prime contract between EWEB and AAC. The prime contract’s “flow down” provision stated:

Contractor shall require each Subcontractor, to the extent of the Work to be performed by Subcontractor, to be bound by the terms and conditions of these General Conditions and all other Contract Documents, and to assume toward the Contractor all the obligations and responsibilities which the Contractor assumes toward the Owner thereunder, unless (1) the same are clearly inapplicable to the subcontract at issue because legal requirements or industry practices, or (2) specific exceptions are requested by Contractor and approved in writing by Owner. Where appropriate, Contractor shall require each Subcontractor to enter into similar agreements with Sub-subcontractors at any level.

According to MacTaggart and Olsson, the “flow-down” provision incorporated the terms of the prime contract, including the arbitration provision, into AAC’s subcontracts and, therefore, bound EWEB to arbitration with the two subcontractors.

The trial court rejected the subcontractors’ arguments. On appeal, the Oregon appellate court agreed and held that, as a matter of contract interpretation, the “flow-down” provision did not entitle the subcontractors to compel arbitration.

According to the court of appeals, although “some ‘flow-down’ or ‘conduit’ provisions in construction contracts have the effect that [MacTaggart and Olsson] assert of binding an owner to arbitrate with subcontractors down the chain of contracts,” the text of the “flow-down” provision in this instance did not give the subcontractors the right to request arbitration. As the court explained, the prime contract’s “flow-down” provision “states that the contractor must require subcontractors, as to the work to be performed by the subcontractors, to be bound by the terms and conditions of all contract documents, and to assume toward the contractor all the obligations and responsibilities which the contractor assumes toward the owner.” As a result, the “flow-down” provision imposed requirements on AAC—as the contractor—with respect to its subcontracts, but did not create an agreement between EWEB and the subcontractors or, otherwise, impose reciprocal obligations and responsibilities directly toward EWEB. In other words, the rights and obligations of the prime contract flowed-down, not up.

Moreover, as the court pointed out, the “flow-down” provision only applied “to the extent of the Work to be performed by Subcontractor.” According to the court, this language meant that the “flow-down” provision only addressed the subcontractors’ performance obligations and responsibilities to AAC, and did not reflect an intention to afford the subcontractors additional rights and remedies directly toward EWEB.

As a result, the court of appeals affirmed the lower court’s ruling and dismissed the subcontractor’s appeal.