Walking the Tightrope: Liquidation Agreement “Traps for the Unwary”

Amy Elizabeth Garber and Robert J. Symon | Buildsmart

When crafting a liquidation or “pass-through” agreement for a subcontractor claim against the government, the key provision from the prime contractor’s perspective is a release from any liability for the subcontractor’s claim with the exception of amounts recovered from the government related to that claim. If the release language is too broad, however, the agreement may provide the government a legal defense to the pass-through claim known as the Severin doctrine. The Severin doctrine prohibits a prime contractor from passing through a subcontractor claim to the government if the prime contractor is not liable for the subcontractor’s claimed costs. Simply put, to pass through a subcontractor claim, the prime contractor must maintain some form of liability for the subcontractor claim or risk rejection of the claim. Indeed, if the prime contractor expressly disclaims liability for the subcontractor’s claim or the subcontractor’s release of the prime contractor is too broad, the Severin doctrine may bar the claim and the government will rely on this defense before ever looking at the merit of the claim.

A recent decision issued by the Armed Services Board of Contract Appeals demonstrates how far the government has tried to stretch the Severin doctrine defense. See Alderman Building Company, Inc., ASBCA No. 58082 (May 21, 2020). Alderman Building Company was the general contractor, pursuant to a contract with the Navy, on a renovation project at a Marine Corps base. The project suffered from significant government-caused delays. Alderman sponsored a pass-through claim on behalf of its subcontractor, Big John’s Electric Co., Inc. seeking compensation for the delays. One of the recitals in the pass-through agreement between Alderman and Big John’s stated that “the Owner is the ultimate responsible party to pay for the Subcontractor’s and Contractor’s claims.” In this appeal, the Navy argued that the Severin doctrine mandated dismissal of the claim because, vis-a-vis the recital language, Alderman had asserted it was not responsible for the costs Big John’s incurred.

Fortunately, the board rejected the Navy’s argument holding that the Navy failed to demonstrate that Alderman was not responsible for Big John’s costs. First, the board noted that the pass-through agreement did not contain an “iron-bound release” and it did not contain an “express undertaking” to release Alderman from any obligation to Big John’s. Second, the board found “Alderman’s unqualified undertaking” in the pass-through agreement to promptly pay any amounts owed to Big John’s. The board stated this fact to be the “antithesis” of any release of Alderman’s liability.

Although Alderman is a victory for the contractor, it is also a cautionary tale. In terms of a “victory,” the board imposed a strict burden on the government to demonstrate that the prime contractor has no liability for a subcontractor’s claim pursuant to the Severin doctrine. Nevertheless, this case serves as a warning to carefully avoid language in a pass-through agreement that would suggest in any way, shape or form that the prime contractor has no liability for the subcontractor’s claim by factoring in the likelihood that the government will look to a Severin doctrine defense to avoid liability for an otherwise meritorious claim.

Subcontractor Pass-Through Claims Are Vulnerable to the Severin Doctrine

Eric Frechtel and Amy Elizabeth Garber | Bradley Arant Boult Cummings LLP | January 24, 2018

Two recent decisions – one from the U.S. Civilian Board of Contract Appeals and the other from the U.S. Court of Federal Claims – provide opposing holdings on whether the government can raise a “Severin doctrine” defense to subcontractor “pass-through” claims based on broad language in subcontractor progress payment releases. In light of these different perspectives, contractors should take steps to ensure that such releases do not doom legitimate subcontractor pass-through claims.

Pass-Through Claims and the Severin Doctrine

Subcontractors cannot directly sue the government because they do not contract with the government, i.e., they are not in “privity” of contract. A pass-through claim is a subcontractor claim against the government that a prime contractor (who is in privity of contract with the government) brings on behalf of a subcontractor. The Severin doctrine holds generally that a prime contractor presenting a pass-through claim can recover damages only if the prime contractor remains liable to the subcontractor for those damages.

The Board (Turner Construction Co. v. Smithsonian Institution)

Turner, the prime contractor, passed through approximately $7 million in subcontractor delay and disruption claims in a dispute involving the renovation of the National Museum of American History. Each progress payment release stated, in relevant part, that the subcontractor: “represents and warrants that there are no outstanding claims by the [subcontractor]… through the date of Application for Payment No. __ except for any retention, pending modifications and changes, or disputed claims for extra work as stated herein[;]” and “does hereby forever release, waive, and discharge … any and all … claims and demands … by reason of delivery or material and/or performance of work relating to the project through Application for Payment No. __, except for those items listed under No. 1 above.” The relevant progress payment releases did not list the pass-through delay and disruption claims under No. 1. The board held that even though the progress payment releases did not carve out the pass-through claims, the Severindoctrine did not bar them mainly because the releases were “clearly tied” to each progress payment. Their main purpose was to ensure that subcontractors had paid lower tiers and that the project site remained unencumbered, not to relieve Smithsonian, vis-à-vis releasing Turner, from any liability for overall project delay.

The Court (MW Builders, Inc. v. United States)

The court in MW Builders, on the other hand, broadly applied subcontractor progress payment releases to bar pass-through claims. MW Builders, the prime contractor, passed through approximately $1 million in subcontractor delay claims in a dispute involving the construction of an Army Reserve Center in Sloan, Nevada. The progress payment releases in question were from one subcontractor, Bergelectric, which stated in relevant part: “[Bergelectric] irrevocably and unconditionally releases and waives … any other claims whatsoever in connection with this Contract … through the end of the period covered by this Application ….” These releases covered the entire period of Bergelectric’s delay claim.

In contrast with the Smithsonian disposition, the court held that the Severin doctrine barred the Bergelectric pass-through claim. Unlike the board’s narrow interpretation of the progress payment releases in Smithsonian, the court declined to consider evidence of the limited intent of the releases. Instead, based on the broad language in the releases and the fact that the releases did not expressly reserve Bergelectric’s delay claim, the court determined that the releases barred all claims by the subcontractor.

Takeaway Points

These two recent decisions involved similar language in progress payment releases but had opposite results. In the board case, the subcontractor claims survived under a narrow interpretation of the progress payment releases, while in the court case, the subcontractor claims fell victim to the government’s Severin doctrine defense based upon a broad interpretation of the release language. Together these cases demonstrate the unpredictability of whether a judge will construe broad language in progress payment releases as a bar to subcontractor pass-through claims; and they serve as a reminder that contractors must be wary of the Severin doctrine. In anticipation of the government’s defense, contractors should carve out subcontractor pass-through claims from progress payment releases. It is also prudent for prime contractors and subcontractors to enter into “liquidation agreements” to define and preserve subcontractor pass-through claims. Without such vigilance, otherwise meritorious claims could be vulnerable to the government’s Severin doctrine defense.