A Dangerous Myth: That a Great Subcontract Will Prevent Claims on a Poorly-Executed Project

Construction and Procurement Law News, Q3 2018

Firm Alert

Author(s)

Well-drafted, legally-enforceable agreements are key to any construction company’s risk management strategy. This is especially true for subcontracts, which serve as a contractor’s critical tool to coordinate a successful project among multiple subcontractors with varied scopes of work.

But, as emphasized by the recent opinion Rai Industrial Fabricators, LLC v. Federal Insurance Company, a strict and unambiguous subcontract may not protect the contractor from claims where the contractor’s actions fail to comply with the subcontract or are beyond the reasonable contemplation of the parties when executing the subcontract.

In Rai Industrial, subcontractor Agate Steel (“Agate”) filed an action against general contractor Sauer Incorporated (“Sauer”) arising out of Agate’s work on a federal project in Fort Hunter Liggett, California. Agate alleged four causes of action against Sauer: (1) breach of contract (extra work), (2) breach of contract (delay and disruption), (3) unjust enrichment, and (4) breach of the implied covenant of good faith and fair dealing.

Each of these causes of action arose out of Agate’s assertions that Sauer failed to behave in a manner consistent with Agate’s reasonable expectations when entering into its subcontract for the erection of structural and miscellaneous steel on a training complex project for the U.S. Army. Agate claimed that Sauer failed to enforce change order provisions (including unilaterally implementing changes to the project schedule and significantly revising project drawings during the course of construction), and failed to pay undisputed amounts to Agate. According to Agate, Sauer’s actions required Agate to extend its on-site schedule from 121 days to 422 days; to field-modify nonconforming steel provided by another subcontractor; to procure 4,000 additional steel clips; and to assemble steel stairs on-site, all contrary to the subcontract terms and project drawings.

Sauer’s subcontract with Agate contained a broad no-damages-for-delay provision that disclaimed all liability “for any delay, disruption or interference” to Agate’s work due to a large number of causes, including delayed material deliveries from Sauer, delayed site access by Sauer, defects in plans or specifications, and changes ordered in the work by Sauer. The subcontract also expressly restricted Agate’s relief for changed conditions only to the extent of any actual relief Sauer received from the owner. In Sauer’s view, these contract provisions barred Agate from bringing the claims it alleged.

The federal trial court denied Sauer’s motion to dismiss Agate’s claims because Agate’s allegations (if proven) would fall within the reasoning of prior opinions awarding a subcontractor recovery despite and beyond the terms of its subcontract. These opinions included an exception to the enforceability of a no-damages-for-delay provision where a contractor unreasonably (by way of conduct beyond the contemplation of the parties) delayed the subcontractor; a ruling that the parties “abandoned” the construction contract by failing to follow its procedures; and another ruling that, by imposing an excessive number of cardinal changes to alter the original scope, the parties similarly “abandoned” their subcontract. The court granted Sauer’s motion to dismiss Agate’s claim of unjust enrichment, but with leave for Agate to amend. The court also denied Sauer’s motion to dismiss Agate’s fourth claim of breach of the implied covenant of good faith and fair dealing.

Thus we have a reminder that even sophisticated, well-drafted subcontracts may not prevent subcontractor claims where the subcontract collects dust in a file cabinet rather than serves as a portion of the framework for site management decisions. Or, as another moral to this story: while skilled attorneys drafting and negotiating agreements are useful and necessary, contractors cannot ignore the critical importance of having experienced contracts managers, project managers, and site superintendents in construction risk management who are familiar with the terms of their subcontracts.