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Apr 13, 2018

By Tamara McNulty

Recently, I co-presented at the ABA Forum on Construction Law’s 2018 Midwinter Meeting. The topic was pass-through claims and liquidating agreements. During the program our panel discussed how the actions of the contractor and the subcontractor during performance can unintentionally kill an otherwise legitimate pass through claim. One of these pass through killers occurs when a subcontractor is signing partial lien and claim releases to obtain its progress payments. We cautioned that this may render a later pass-through claim void because the prime contractor has no liability to the subcontractor for waived claims. On March 5, 2018, on a motion for reconsideration of a decision rendered last October at the Court of Federal Claims, MW Builders Inc. (“MW”) and Bergelectric learned this lesson the hard way.

As discussed in our paper, under certain circumstances, particularly in the federal arena, the ability to assert a pass-through claim is limited. The most well-known and significant limitation is imposed by the Severin Doctrine, which takes its name from the case of Severin v. United States, 99 Ct. Cl. 435 (1943).  Severin held that a subcontractor cannot sue the government directly due to the lack of privity between the parties, and further that a prime cannot sue an owner on behalf of a subcontractor to recover monies due to the subcontractor unless the prime is itself liable to the subcontractor.  Consequently, the Severin Doctrine mandates that recovery against an owner cannot be had where a subcontract or a release of liability expressly negates the prime’s liability to the subcontractor for the owner’s actions. In other words, if the prime has no liability of its own to the subcontractor, then it cannot bring a breach of contract claim against the owner on the subcontractor’s behalf.

The Severin Doctrine remains established law in claims involving the federal government on the basis that the government has waived its sovereign immunity only as to claims for which privity of contract exists. A pass-through claim that does not involve a prime’s own contractual liability to the subcontractor (and thus the prime’s own potential for loss based upon the owner’s actions) is not actionable against the federal government. See J.L. Simmons v. United States, 304 F.2d 886 (Ct. Cl. 1962) (“The decided cases make abundantly clear that a suit of this nature may be maintained only when the prime contractor has reimbursed its subcontractor for the latter’s damages or remains liable for such reimbursement in the future. These are the only ways in which the damages of the subcontractor can become, in turn, the damages of the prime contractor, for which recovery may be had against the Government.”).

By way of background in this case, MW entered into a subcontract with Bergelectric to provide a complete electrical system under its prime contract with the U.S. Army Corps of Engineers (“USACE”). MW Builders, Inc. v United States, 134 Fed. Cl. 469, 479 (Fed. Cl. 2017). Each time MW paid Bergelectric under the subcontract, the parties executed lien waivers extinguishing any claims Bergelectric may have had against MW. Moreover, the lien waiver and release language contained no express reservation authorizing Bergelectric to pass through claims for payment against the government. The lien waivers stated:

NOW, THEREFORE, effective as of receipt of the payment referenced in this Application, the undersigned [Bergelectric] irrevocably and unconditionally releases and waives any and all mechanic’s liens or other liens against the Realty or any other claims on any bonds or any other claims whatsoever in connection with this Contract and with the Realty through the end of the period covered by this Application, reserving however, all lien rights for materials and labor furnished or performed after said period and hold the Beneficiaries and their respective successors and assigns harmless against any lien, bond, claims or suits in connection with the materials, labor, and everything else in connection with this Contract, except with respect to the retainages to date, if any.

Id. at 511 (citation omitted) (emphasis added). Even worse for Bergelectric, it signed waivers covering the entire period of compensable delay.

The Court of Federal Claims had originally determined that Bergelectric’s pass-through claims had been waived where MW had Bergelectric sign lien waivers and releases in exchange for progress payments, which in its opinion, unambiguously released the MW from any future claims and did not reserve the subcontractor’s right to assert pass-through claims, even when this was not the parties’ intent. See Id., 134 Fed. Cl. 469, 531 (Fed. Cl. 2017)

MW had prevailed on its claim in the lower court but it moved on behalf of Bergelectric, that the Court of Federal Claims to reconsider its determination that Bergelectric waived the pass-through claims.

The court determined the pass-through claims were waived, reasoning that a prime contractor may pursue a subcontractor’s claim only if the prime contractor is liable to the subcontractor for those damages. Because MW was not liable to Bergelectric, it could not assert the subcontractor’s delay claims against the government. Although the appellant’s put forward evidence to demonstrate they did not intend to include the pass-through claims in the release, the court did not consider this extrinsic evidence relevant to interpreting the release language.

On reconsideration, MW argued manifest error because the court failed to consider the applicable case law requiring consideration of the evidence offered at trial regarding the parties’ lack of intent to waive Bergelectric’s pass-through claim in the progress releases.

Both Bergelectric and MW agreed that the release language was never intended to waive Bergelectric’s pass-through claim. Moreover, MW argued that the parties’ subsequent conduct validated that intent, and so the court should have considered the extrinsic evidence supporting this assertion. In the alternative, MW asked the court to reform the release language to conform to the parties’ intent.

MW cited a number of cases where the courts have held that the execution of a release did not bar a claim, where both parties continued to consider the claim or where there was no indication of an intent to release a given obligation.

The Court of Federal Claims disagreed, citing Barron Bancshares, Inc. v. United States, 366 F.3d 1360, 1375–76 (Fed. Cir. 2004) for the proposition that a contract provision is ambiguous only if it is susceptible to more than one reasonable meaning. In this case, the Court stated that MW’s and Bergelectric’s lien waiver and release contained an irrevocable and unconditional waiver of “any other claims whatsoever in connection with this contract and with the realty through the end of the period covered by this application.” Because this language reserved only those claims arising after the date of the application for payment, no right to pass-through Bergelectric’s claims to the government existed or was reserved. Accordingly, the court determined that the release language unambiguously waived all the subcontractor’s claims against MW and any related pass-through claims against USACE. Therefore, extrinsic evidence was not relevant, required, nor admissible to interpret the text of the release.

The court also explained the cases cited by MW were distinguishable because each involved a release executed between the contractor and the government, not between the contractor and a subcontractor. The Court noted it lacked jurisdiction to reform an agreement between a prime contractor and its subcontractor, and it reiterated that the Court’s jurisdiction is limited to contract claims between a plaintiff and the government, and therefore its equitable authority does not extend to reforming contracts between private parties.

We warned of this exact result in our paper to the ABA. If the parties desire to permit pass-through claims, they must be conscious of boilerplate language in certain documents, like releases and waivers, settlement agreements, etc.

For example, we wrote, a prime’s presentation of waivers and releases signed by the subcontractor in exchange for payment may bar a pass-through claim. In Appeal of H.E. Johnson Co., ASBCA No. 50861, 98-2 BCA ¶ 29,868, the subcontractor sought payment from the contractor based on the owner’s decision to change the location of several wells being constructed by the subcontractor. The subcontractor eventually signed an unconditional release for payment from the prime on the work it performed on the wells. The Armed Services Board of Contract Appeals (ASBCA) held that, because of the signed unconditional release, the prime contractor had no legal obligation to pay the subcontractor the amount the prime claimed for increased costs on the subcontractor’s behalf.

So what is the takeaway here? Contractors and subcontractors should take a long hard look at waiver and release language (wherever it is contained) and make sure that it preserves pass through claims in a clear and unambiguous manner or face the same fate as Bergelectric.

 

*Thanks and acknowledgement to Sean Calvert and Margery Newman, my co-authors on the paper to the ABA, whose work contributed to this article.

 


Tamara McNulty is a Partner at the law firm of Asmar, Schor & McKenna, PLLC practicing in the areas of Government Contracts and Construction law. She can be reached at (202) 244-4264 and TMcNulty@asm-law.com.