March 08, 2019

How Low Does It Flow? Can a General Contractor Rely upon an "Incorporation By Reference" Clause in a Subcontract to "Flow Down" Important Obligations from an Owner Agreement?

Richard S. Robinson Senior Counsel, Peckar & Abramson, P.C. , New York, New York

You are the outside counsel for a General Contractor.  Your client has just entered into a construction services agreement with an Owner for a new project. The agreement contains lots of obligations and potential sources of liability and requires your client to "flow down" some or all of these obligations and liabilities to its Subcontractors. Your client is not worried about the "flow downs" because its form of Subcontract contains language something like this excerpt from the AIA A401-2017 form of Subcontract:

ARTICLE 2   MUTUAL RIGHTS AND RESPONSIBILITIES
The Contractor and Subcontractor shall be mutually bound by the terms of this Agreement and, to the extent that the provisions of AIA Document A201–2017 apply to this Agreement pursuant to Section 1.3 and provisions of the Prime Contract apply to the Work of the Subcontractor, the Contractor shall assume toward the Subcontractor all obligations and responsibilities that the Owner, under such documents, assumes toward the Contractor, and the Subcontractor shall assume toward the Contractor all obligations and responsibilities that the Contractor, under such documents, assumes toward the Owner and the Architect. The Contractor shall have the benefit of all rights, remedies, and redress against the Subcontractor that the Owner, under such documents, has against the Contractor, and the Subcontractor shall have the benefit of all rights, remedies, and redress against the Contractor that the Contractor, under such documents, has against the Owner, insofar as applicable to this Subcontract. Where a provision of such documents is inconsistent with a provision of this Agreement, this Agreement shall govern.

Unfortunately, Mr./Ms. Counsel, you may have reason to be worried. The tough legal question you must raise with your client is: Can the client rely upon this language, or similar "incorporation by reference" language, to successfully "flow down" all General Contractor obligations and liabilities to Subcontractors?  In some cases, the answer to this question may be an emphatic "no." The devil is in the details and the details depend upon the state where the project is located.

For example, in New York, the law is clear that "incorporation clauses in a construction subcontract, which incorporate by reference clauses in the prime contract into the subcontract, bind a subcontractor only to the prime contract provisions relating to the scope, quality, character and manner of the work to be performed by the subcontractor."[1] This begs the question of exactly which clauses in the prime contract relate to "scope, quality, character and manner of the work to be performed by the subcontractor?"[2]

New York courts have answered the "scope, quality, character and manner of the work to be performed"[3] question by stating that such items as project schedules,[4] plans and specifications, surveys, engineering reports, and change orders[5] can be incorporated by reference into a subcontract through the type of language shown above. On the flip side, New York courts have also answered this question by stating that critically important items such as indemnification provisions,[6] non-specific insurance provisions,[7] dispute resolution clauses,[8] forum selection clauses,[9] "pay when paid" provisions[10] and "no damage for delay" provisions[11] do not relate to "scope, quality, character and manner of the work to be performed by the Subcontractor"[12] and cannot be "flowed down" to a Subcontractor through a generalized incorporation by reference clause.

A number of states, including Connecticut,[13]  Missouri[14], and Rhode Island[15] follow the same approach as New York. However, other states, such as Alaska[16], Arizona[17], California[18], Georgia[19], Illinois[20], Kentucky[21], North Carolina[22], Ohio[23], Pennsylvania[24], and Washington[25] do permit (under widely varying circumstances) the generalized “flow down” of obligations from General Contractors to Subcontractors through some form of the language cited above. Still other states such as Indiana[26], Maryland[27], and Texas[28] do not fall into either of the above camps.  Instead, such states construe all contract documents, including the prime contract, subcontract and all exhibits, together "in an effort to harmonize and give effect to all of the provisions of the contract so that none will be rendered meaningless."[29]

These widely varying interpretations of the applicability of the "incorporation by reference" and "flow down" doctrines present significant issues for General Contractors and their counsel. General Contractors most certainly want to avoid a form of legal "scope gap" in which the General Contractor's exposure to liability under its agreement with an Owner is not counter-balanced by similar liability owed from a Subcontractor to the General Contractor. In the case of critical, non-scope of work contract issues such as consequential damages, liquidated damages, availability of remedies for different types of delays, indemnities and hazardous materials provisions, substantial legal and financial consequences may result from a drafting misstep. To further complicate matters, larger General Contractors may find themselves performing construction services in multiple states under a Master Agreement with an Owner and face differing resolutions of these issues depending upon location.

How then can a General Contractor account for the various potential legal and commercial outcomes that may arise in connection with "incorporation by reference" and "flow down" issues? The answer is simple but labor intensive. If it is important to the General Contractor that a specific provision of its agreement with an Owner be included in Subcontracts, the critical provision should be clearly called out in the Subcontract to avoid any possible ambiguity. For example, rather than simply reciting that "the Subcontractor shall assume toward the Contractor all obligations and responsibilities that the Contractor, under such documents, assumes toward the Owner and the Architect," a prudent counsel for a General Contractor may want to take the next step and specifically list in the Subcontract all the critical provisions from the Prime Contract that the Subcontractor will be bound to other than work related provisions. It is also important to recite in the Subcontract that that the Subcontractor has been provided with copies of all the Contract Documents containing the "incorporation by reference" or "flow down" obligations. Finally, if possible, it is advisable to obtain the Subcontractor's signature separately with regards to acceptance of all such documents. Following these steps will greatly improve the chances of enforcing such obligations against the Subcontractor regardless of what state the construction project is located in.  

Endnotes

1. S. Leo Harmonay, Inc. v. Binks Mfg. Co., 597 F.Supp. 1014 (S.D.N.Y. 1984, aff'd, 762 F.2d 990 (2d Cir. 1985).

2. Id. at 1023.

3. Id.

4. Commercial Elec. Contractors, Inc. v. Pavarini Constr. Co., Inc., 798 N.Y.S.2d 708 (Sup.Ct. N.Y. County 2004).

5. Bussanich v. 310 E. 55th Street Tenants, 282 A.D.2d 243 (1st Dep't 2001).

6. Spiegler v. Gerken Bldg. Corp., 35 A.D.3d 715 (2nd Dep't 2006).

7. Bussanich  282 A.D.2d at 244.

8. Secured Sys. Tech., Inc. v. Frank Lill & Son, Inc., 2010 WL 11549354 (W.D.N.Y., June 17, 2010).

9. CooperVision, Inc. v. Intek Integration Technologies, Inc., 794 N.Y.S.2d 812 (Sup.Ct., Monroe County, 2005).

10. Empire City Iron Works, Inc. v. Ins. Co. of N. Am., 1991 WL 19809 (S.D.N.Y., January 31, 1991).

11. S. Leo Harmonay, 597 F.Supp. at 1026.

12. S. Leo Harmonay, Inc., 597 F.Supp. at 1023.

13. Secured Systems Technology, Inc. (choice of law and dispute resolution provisions from prime contract not incorporated into subcontract under Connecticut law).

14. Howe v. Fru-Con Constr. Co., 851 S.W.2d 769 (Mo. Ct. App. 1997).

15. A. F. Lusi Constr., Inc. v. Peerless Ins. Co., 847 A.2d 254 (R.I. 2004).

16. Indus. Indem. Co. v. Wick Constr. Co., 680 P.2d 1100 (Alaska 1984).

17. Weatherguard Roofing Co. v. D. R. Ward Constr. Co., Inc., 152 P.3d 1227 (Ariz. Ct. App. 2007).

18. Slaught v. Bencomo Roofing Co., 30 Cal.Rptr. 2d 618 (Ct. App. 1994).

19. Binswanger Glass Co., Inc. v. Beers Constr. Co., 234 S.E. 363 (Ga. Ct. App. 1977).

20. Turner Constr. Co. v. Midwest Curtainwalls, Inc., 543 N.E.2d 249 (Ill. Ct. App. 1989).

21. ESI Cos., Inc. v. Ray Bell Constr. Co., Inc. 2009 WL 4060478 (Ky. Ct. App. Nov. 25, 2009).

22. Am. Nat'l Elec. Corp. v. Polythress Comm., 604 S.E.2d 315 (N.C. Ct. App. 2004).

23. KeyBank Natl. Assn. v. Sw. Greens of Ohio, L.L.C., 988 N.E.2d 32 (Ohio Ct. App. 2013).

24. Bernotas v. Super Fresh Food Mkts., Inc., 863 A.2d 478 (Pa. 2004).

25. Wash. State Major League Baseball Stadium Public Facilities Dist. v. Huber, Hunt & Nichols-Kiewit Constr. Co., 296 P.3d 821 (Wash. en banc, 2013).

26. MPACT Constr. Group LLC v. Superior Concrete Constructors Inc., 802 N.E.2d 901 (Ind. 2004).

27. Schneider Elec. Bldgs. Critical Sys., Inc. v. Western Surety Co., 231 Md.App. 27 (Ct. Spec. App. 2016).

28. G.T. Leach Builders, L.L.C. v. Sapphire, VP, LP, 456 S.W.3d 570 (Tx. Ct. App. 2013).

29. G. T. Leach Builders, LLC, 456 S.W.3d 570, 582.