Potential Liability Under Flow Down Liquidated Damages Provision

Construction and Procurement Law News, Q3 2016

Firm Alert

Author(s)

Some of the most overlooked (and important) provisions in construction contracts are “incorporation by reference” and “flow-down” clauses, whereby a party potentially assumes responsibility for liability and obligations outlined in ancillary documents, such as contracts between other parties. While these risk-shifting provisions are often separately spelled-out in the headings of the agreement, they can also be embedded within other contractual terms. They can have long-reaching implications for project profitability. The recent Massachusetts state court case of Tutor Perini Corp. v. Montgomery Kone, Inc., confirms that these crucial risk-shifting provisions may be strictly enforced by courts and may subject a party to significant liability even many years after the work is accepted.

Tutor Perini arose from the well-publicized Central Artery/Tunnel (“Big Dig”) project in Boston, Massachusetts. General contractor Perini-Kiewit-Cashman (a joint venture among Tutor Perini Corporation, Kiewit Construction Co., Inc. and Jay Cashman, Inc.) (“PKC”) entered into a $377,933,000 prime contract with the Massachusetts Highway Department. PKC thereafter entered into a subcontract with Montgomery Kone, Inc. for $3,400,000 for the installation of elevators and escalators in the South Station of the tunnel. The subcontract between PKC and Kone expressly provided that in the event the MHD assessed liquidated damages against PWC for delays to the project, that Kone “shall be proportionately liable for those damages pursuant to the terms and conditions under the owner’s contract, provided that the delays are proven proportionately to be the responsibility of [Kone].” The liquidated damages amount in the prime contract was $14,000 per day.

During the course of work, MHD changed the sequencing of the planned events along the critical path, and the project ran into significant delays. The project schedule required Kone’s work to be complete by September 2002, but the MHD did not accept it until January 2004. During this time, PKC advised Kone in writing that Kone’s work was behind schedule and that PKC would begin assessing $14,000 per day in liquidated damages as provided by the subcontract. Because of the repeated delays to the project, disputes also arose between PKC and the MHD as to compensation owed. MHD’s chief engineer later issued a decision in 2009 finding that PKC had “abandoned” the project schedule, that PKC was not entitled to any delay damages from MHD, and that liquidated damages should be assessed against PKC in “accordance with the Contract requirements.” MHD assessed $13,046,000 in liquidated damages via a contract modification in December 2010.

Following the assessment of the liquidated damages, PKC filed suit against Kone and its performance bond surety in 2013. While PKC’s performance bond claim against the surety was dismissed due to the expiration of the applicable two-year statute of limitations on the face of the bond, the presiding Massachusetts Superior Court judge ruled that PKC and Kone expressly allocated the risk of the assessed liquidated damages between themselves in the subcontract through the flow-down clause. Therefore, PKC’s claim for Kone’s proportionate share of the liquidated damages could move forward to trial - more than twelve years after Kone completed its work on the project!

While PKC must still affirmatively prove Kone’s proportionate liability for the assessed liquidated damages at trial, the potential liability to Kone far exceeds its original subcontract price. As such, Tutor Perini is a stark reminder that 1) each provision of the contract must be closely scrutinized in order to assess both the present and future liability on a project, 2) courts will generally enforce the parties’ agreement in its entirety, including all incorporated and flow-down obligations, and 3) liability on a contract can continue long after the completion of the work, even many years after a party has (supposedly) closed the book on a project.