On the enforceability of pass-through claim liability clauses

Nov. 5, 2019

This column published as "Miller Time" in November 2019 issue

Prime contractors working on public projects typically seek to limit their liability to subcontractors for so-called “pass-through claims,” which the prime receives from the owner on the sub’s behalf.

This is accomplished through subcontract language that addresses how: (1) a subcontractor claim is presented; (2) costs of pursuing the claim are allocated or shared; 3) the parties will cooperate in pursuit of the claim; and 4) proceeds are to be divided and distributed. Most importantly, however, these provisions usually provide that the subcontractor must accept as full satisfaction of any pass-through claim the amount, if any, the prime actually recovers from the owner. This limitation of liability is generally well accepted within the industry, and until a federal court decision in California, contractors and subcontractors viewed these clauses as applying to a surety’s liability under the prime contractor’s payment bond as well.  

In Foundation Fence, Inc. v. Kiewit Pacific Company, No. 09cv2062 DMS, 2010 U.S. Dist. LEXIS 108915 (S.D. Cal. Oct. 13, 2010), the defendant prime contractor, who was performing a border fence project for the U.S. Army Corps of Engineers (COE), hired a subcontractor to fabricate and install a portion of the fence. During construction, the sub filed two claims with the prime. The prime treated the first claim as a pass-through claim and submitted it to the COE. When the prime received a second claim from the subcontractor, it requested the sub make a few changes to the claim document and resubmit it. Dissatisfied with the changes, the prime requested the subcontractor to make additional changes, but the subcontractor refused. Instead, it filed a lawsuit under the Miller Act payment bond against the prime and its surety.

The prime contractor and surety sought dismissal of the case because the underlying claims were subject to two provisions in the subcontract that provided, in pertinent part, that the subcontractor agrees to submit to the owner, through the prime, any claims for which the owner is liable and “agrees that it will accept such adjustment, if any, received by Contractor from Owner as full satisfaction and discharge of such claim.” The language similarly provided that the “subcontractor agrees to be bound by any final determination as rendered on its claim ... and in no event [shall] be entitled to receive any greater amount ... than Contractor is entitled to and actually does receive from Owner on account of Subcontractor’s claims(.)” The prime thus argued that this language prevented the subcontractor from short-circuiting the claims process and, in any event, the subcontractor’s recovery under the bond would be limited to that which the prime recovers from the COE.

The subcontractor, on the other hand, argued that (1) its claims are not “pass-through” claims and thus are not covered by the relevant provisions; and (2) even if they are pass-through claims, the provisions cited by the prime amount to an illegal implied waiver of the subcontractor’s Miller Act payment bond rights. 

In a surprising decision, the court agreed with the subcontractor. It viewed the relevant provisions as an implied payment bond claim waiver and ruled that since such a waiver was not clearly expressed as required in the Miller Act, 40 U.S. Code § 3133(c), it was invalid.

On the surface, this case appears to be nothing more than an unfortunate result for the prime that may be remedied by altering the subcontract language for future projects. However, since 2010, several federal courts have concurred with this holding, and it has had a profound negative impact on the enforceability of pass-through claim liability clauses on federal projects. Indeed, 40 U.S. Code § 3133(c), which was cited by the court, also provides that any waiver of the right to bring a payment bond claim must be executed “after the person whose right is waived has furnished labor or material for use in the performance of the contract.” Thus, by holding that the pass-through claims liability clause constitutes a payment bond waiver, the court essentially held that such clauses contained within subcontracts are unenforceable in future Miller Act payment bond cases. This is precisely what several of these subsequent court decisions have been based upon. Accordingly, although these provisions are perfectly enforceable from a contractual standpoint, subcontractors can circumvent their effect in some areas of the country by simply bringing a payment bond lawsuit against the payment bond surety rather than suing the prime.

About The Author: Caudle is a principal in Kraftson Caudle LLC, a law firm in McLean, Va., specializing in heavy-highway and transportation construction. Caudle can be contacted via e-mail at [email protected].

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