What is a subcontractor to do when the owner has demanded additional work, but has refused to pay for it? Typically, a subcontractor cannot sue the owner because the subcontractor doesn’t have a contract with the owner. Perhaps the subcontractor and general contractor should enter into a liquidating agreement through which the general contractor can pursue the claim on behalf of the subcontractor.
Liquidating agreements bridge the privity gap between owners and subcontractors who sustain damages because of the others actions. Liquidating agreements or pass-through agreements grant the general contractor a release of its liability to the subcontractor after the general contractor prosecutes the subcontractor’s pass-through claim against the owner and gives the subcontractor any recovery.
The benefit to liquidating agreements is that when they are properly drafted, they avoid the application of the Severin doctrine. This is the doctrine established in Severin v. United States, a 1943 case, in which the court held that a subcontractor could not recover against the Government if the general contractor was not also liable to the subcontractor on the same claim. This means that the general contractor must be obligated to pay the subcontractor regardless of whether the subcontractor claim is ultimately paid by the Government.
A well drafted liquidating agreement provides that the subcontractor will release all claims it may have against the general contractor in exchange for the general contractor’s promise to pursue the subcontractor’s claim against the Government. Liquidating agreements should have three basic elements:
- the imposition of liability upon the general contractor for the subcontractor’s increased costs, thereby providing the general contractor with a basis for legal action against the owner;
- a liquidation or set amount of liability in the amount of the general contractor’s recovery against the owner; and
- a provision that provides for the pass-through of that recovery to the subcontractor.
In addition to these basic elements, the covenant of good faith and fair dealing will be implied. This covenant requires the general contractor to take all reasonable steps so that the subcontractor’s rights to an eventual recovery, if any, from the owner will be protected. Courts have held that this means that the general contractor has a duty to make a good faith effort to present the subcontractor’s claim to the owner in a fair and serious manner.
Take Away: When a subcontractor is owed money by an owner, negotiating a liquidating agreement with the general contractor may provide an excellent opportunity for recovery.