Pass-Through Claims and Liquidation Agreements

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1 Pass-Through Claims and Liquidation Agreements by Gregory J. Dukellis, Senior Partner Watt, Tieder, Hoffar & Fitzgerald, L.L.P.* On construction projects, it is not uncommon that a party is damaged during performance of its work due to the acts or omissions of a third party with whom it does not have a direct contractual relationship. For example, on large projects, subcontractors often times perform major aspects of the overall construction, such as the concrete work, steel fabrication/erection or mechanical, electrical, plumbing work, and these trade subcontractors can be the most severely impacted by owner caused delays and disruptions. In such a scenario, it may be beneficial for the prime contractor and subcontractor(s) to align their common interests in a claim against the responsible party (the owner, in this example) as opposed to litigating amongst themselves. On such projects, the attraction of a pass-through or liquidating agreement quickly becomes evident. The prime contractor and its subcontractors can be powerful allies or, conversely, significant adversaries with the general contractor caught in the middle between a disgruntled owner and claimant subcontractors. On dispute ridden projects, it is also not unusual that an owner and its design professionals will align against the prime contractor and its subcontractors. Liquidation agreements or pass-through claim arrangements allow parties with related but distinct interests to align themselves for the purposes of seeking recovery of their damages from the party deemed most responsible for the damages incurred. Prior to entering into a pass-through or liquidating arrangement, some basic issues should be considered. Because the specific issues involved on any particular project may be complicated, this article only intends to set forth some basic guidelines for prime contractors and subcontractors contemplating liquidation and pass-through claims agreements. In a future newsletter, we will address guidelines and issues project owners should consider in formulating liquidation agreements with their architect/engineer, construction manager or general contractor As a threshold issue, most jurisdictions in the United States permit a prime contractor to bring suit against an owner and seek recovery of damages on behalf of a subcontractor on a pass-

2 through basis. There are, however, notable exceptions to this general rule. Some jurisdictions do not permit a pass-through cause of action except under very limited circumstances. For example, Virginia is one jurisdiction that does not recognize liquidating agreements with pass-through claims, except on contracts with the Virginia DOT. Other jurisdictions require the liquidating or pass-through agreement to include particular terms or admissions of liability from the general contractor to its subcontractors. Accordingly, legal counsel should be consulted on any particular case when considering a pass-through or liquidating arrangement to be sure it is appropriate under the controlling law. Assuming that pass-through arrangements are permitted, it can be advantageous to both the prime contractor and subcontractors to enter into pass-through or liquidation agreements when the losses are clearly owner-caused. For example, without pass-through or liquidating agreements, parties damaged by the acts of a third party frequently see their respective recoveries eroded because of battles amongst themselves, a situation thoughtful agreements can avoid. Agreements also help to avoid multi-party litigation with the potential for inconsistent results and multiplied legal costs. For example, a subcontractor with a relatively small loss in relation to an over-all project claim may particularly benefit from the resources available to a prime contractor while minimizing its own costs. Pass-through agreements also permit parties to combine their documents and witnesses in a coordinated presentation of the evidence against the party primarily responsible for the damages. Set forth below are some of the general guidelines which should be addressed in the preparation of a pass-through or liquidation agreement between a general contractor and its subcontractors. These guidelines, however, are not intended to replace professional consultation on any specific project and are subject to the project s controlling law. 1. As a prime contractor, your subcontractor clauses should contemplate the passthrough scenario and specifically require that the subcontractor be bound by the dispute resolution procedures of the prime contract for owner caused claims. Again, however, be forewarned that depending on the controlling law, the passthrough or liquidating agreement may have to include certain terms or, as in Virginia, be prohibited except in limited circumstances.

3 2. As a prime contractor, the subcontract should limit the subcontractor s recovery on owner-related claims to amounts actually recovered from the owner so as to seek to avoid additional litigation with the subcontractor. 3. As a prime contractor, if possible, your subcontract should provide that all nonowners related claims, including any payment bond claims, are stayed until final resolution of claims covered by the prime contract s dispute process. 4. Any pass-through or liquidation agreement should specifically identify the rights and obligations of each party. For example, an agreement should define the obligations of cooperation between the parties and identify which party will be responsible for taking the lead in the prosecution of claims. Responsibility for producing documents and providing witnesses for key meetings, deposition, trial and/or arbitration should be addressed. 5. A pass-through or liquidation arrangement should set forth the responsibilities of the parties for the costs of litigation, including attorneys fees and expert fees. It should also provide a formula for allocating any recovery obtained as a result of the claim, whether such amounts are recovered in the form of a lump sum settlement, a judgment, or an arbitration award. 6. Prime contractors should seek to retain full settlement control of claims. 7. Conversely, subcontractors with a substantial portion of an over-all claim should seek the right to participate in settlement discussions and the right to not be bound by any settlement not approved by the subcontractor. The above items cover only the most basic of issues related to pass-through and liquidation agreements. Nonetheless, under the right circumstances, such arrangements provide for a costeffective manner in which subcontractors and prime contractors, in a cooperative format, may

4 pursue claims against the party primarily responsible for the damages suffered. This allows the parties to combine resources, clearly define their respective rights and responsibilities, and, most importantly, to focus their efforts on recovery of damages from the responsible party. * Watt, Tieder, Hoffar & Fitzgerald, L.L.P Greensboro Drive, Suite 100 McLean Virginia 22102

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