Most prime contractors seek to insulate themselves from liability to subcontractors for actions of the project owner, yet provide a conduit for them to recover via pass-through or sponsored claims to the owner. As a few recent cases demonstrate, the laws among the states vary considerably.
Generally, only a party in contractual privity with an owner may bring suit against such owner for claims associated with a project. Under the Severin Doctrine, which is applicable to pass-through claims on federal projects, a prime contractor may nevertheless present claims to and sue the government on behalf of its subcontractor if the prime contractor proves it is liable to the subcontractor for damages sustained by the latter. Fortunately, in order to be considered liable to a subcontractor for purposes of the Severin Doctrine, a prime contractor need not actually make a settlement payment to the subcontractor. Rather, it is acceptable if the liability is conditioned upon, and limited to, the prime contractor’s actual recovery from the government.
This conditional liability can be specified either in the parties’ subcontract or in a specially prepared liquidating agreement executed at the time a particular claim is submitted to the government. Consequently, prime contractors and subcontractors performing federal work need only familiarize themselves with the particular requirements of a liquidating agreement in order to protect themselves against a privity of contract defense.
Taking a waiver
State law governing public contract pass-through claims is typically decided on the basis of sovereign immunity, and courts ruling whether such claims are permissible turn on whether the particular state legislature has expressly waived sovereign immunity. In Kay and Kay Contracting, LLC v. Tennessee Dep’t of Transp., 2010 WL 2553657 (Tenn. Ct. App.), the Tennessee Court of Appeals acknowledged that while there are sound public policies for allowing a prime contractor to bring claims on behalf of its subcontractors, the language of the Tennessee statute authorizing prime contractors’ lawsuits against the state applies solely to prime contractor breach-of-contract claims. The court reasoned that the legislature was free to amend the statute if it concludes that pass-through claims should be allowed in the future.
Other states, such as New York, have attached conditions to pass-through legislation similar to the Severin Doctrine whereby the prime must be expressly liable to the subcontractor pursuant to a subcontract or liquidating agreement.
In Travelers Casualty and Surety Co. v. Dormitory Authority – State of New York, 2010 WL 3419196 (S.D.N.Y), a surety that took over a public project for a defunct contractor sued at the completion of the project on behalf of four subcontractors. Travelers claimed that it had contingent liability to three of the subcontractors by virtue of separate liquidating agreements it executed with each of them, and it relied upon language in the subcontract to establish liability to the fourth. The state challenged Travelers’ liability to the fourth subcontractor.
The court acknowledged that under New York law, a prime contractor can establish liability to a subcontractor either by a liquidating agreement or language in the underlying subcontract. The language must, however, clearly establish liability and must expressly provide for passing through the amount received by the contractor to the subcontractor.
The subcontract language in question comports with that which is widely used in the industry and prohibited the subcontractor receiving a price increase unless, and to the extent, the contractor recovers from the owner. However, the court ruled that although the language provided for a pass-through of any damages recovered by the contractor from the owner, it did not expressly mandate that the contractor pay the subcontractor the amount it receives. Apparently, the court was looking for an affirmative statement to that effect.
