By: Larry Caudle
Prime contractors performing work on public projects typically seek to limit their liability to subcontractors for so-called “pass-through claims” to that which the prime receives from the owner on the subcontractor’s behalf. Most important, these provisions usually provide that the subcontractor must accept as full satisfaction of any pass-through claim the amount the prime actually recovers from the owner. This limitation of liability is generally well accepted within the industry, and until a recent 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, hired a subcontractor to fabricate and install a portion of the fence. During construction, the subcontractor filed two claims with the prime contractor. The prime treated the first claim as a pass-through claim and submitted it to the U.S. Army Corps of Engineers. When the prime received a second claim from the subcontractor, it requested the subcontractor to 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, the subcontractor 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 agreed 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 received 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 U.S. Army Corps of Engineers.
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 waiver was not clearly expressed as required in the Miller Act, 40 U.S. Code § 3133(c), it was invalid.
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. Accordingly, although such clauses are perfectly enforceable from a contractual standpoint, subcontractors can circumvent the effect of them by simply bringing a payment bond lawsuit rather than a breach-of-contract lawsuit.
