Incorporation of the Prime Contract: A Hidden Benefit

Virtually every subcontract agreement incorporates by reference the prime contract between the general contractor and the owner. Too often subcontractors do not obtain a copy of the prime contract and consequently become bound to terms and conditions they have not seen much less read. Moreover, the contractual provision incorporating the prime contract may state that if a conflict exists the contract language must be interpreted in a way that favors the general contractor. For example it may state:

"In the event of variations, conflicts, or inconsistencies between or among the terms, provisions or conditions of this Subcontract and any other Contract Documents, the terms, provisions and conditions which grant greater rights or remedies to Contractor or impose higher standards with regard to the obligations, responsibilities and scope of work of the Subcontractor shall control."

This provision, while seemingly favorable to the general contractor, does provide a benefit to a subcontractor because it fails to address the "rights" of a subcontractor. Consequently, if the subcontract allows for a larger overhead and profit markup than the prime contract, the allowable overhead and profit markup is a "right" of the subcontractor, not an obligation, responsibility or part of the scope of the work; nor is a right or remedy of the Contractor. Thus, the stated overhead and profit of the subcontract will control.

These "precedence clauses" as they are called must be carefully drafted and reviewed. Moreover, as always, a subcontractor should obtain copies of all contract documents incorporated into the subcontract.

Contractual Indemnity Provisions

The Maryland Court of Appeals recently reiterated the various legal principles that trigger indemnification rights. In the context of contractual indemnity provisions, the Court recognized three basic types of indemnity provisions: (1) indemnity against loss or damage, under which the indemnitee may not recover until it has made payment or otherwise suffered an actual loss or damage within the scope of the indemnity; (2) indemnity against liability, under which an action may be brought as soon as the liability is legally imposed, as when judgment is entered, even though no actual loss has yet been sustained (the judgment has not been paid); or (3) a promise by the indemnitor “to perform a certain act or make specified payments for the benefit of the indemnitee,” under which an immediate right
of action accrues upon the failure of the indemnitor to perform, regardless of whether any actual damage has been sustained.

As evidenced by these three types of contractual provisions, the risk and exposure for the party providing indemnification in a contact can vary greatly depending upon the type of indemnification provision. Consequently, the indemnification provisions in construction contracts warrant careful scrutiny before execution.

Building Plans: Implied Warranty of Accuracy

A well-settled principle in Maryland construction law is if a contractor is bound to build a project in accordance to the plans and specifications prepared by the building owner, the contractor will not be responsible for the consequences of defects in the plans and specifications. This responsibility to the contractor is not affected by standard contract clauses requiring contractors to visit the site, check the plans, and to inform themselves of the requirements of the work. Plans and specifications provided by an owner contain an “implied warranty” of accuracy. This essentially means a contractor should be able to assume plans and specifications are reliable enough to use as the basis for the purpose intended.

If there are defects in the plan and specifications and the contractor incurs damages as a result, the contractor may be able to recover its damages from the owner. Recovery by the contractor could include damages suffered for delays in the work arising out of the defective plans and specifications and an equitable adjustments because of increased costs.

There are, however, provisions to protect owners. If a contractor knows or should have known defects existed in the plans and specifications prior to construction, but continues with the construction regardless of the defect, a contractor will be precluded from recovering any alleged damages. Contractors should ensure there are no obvious defects with the plans or specifications or they will be held responsible for any costs resulting from the defective plans and specifications. Prior to submitting a bid for work, a contractor should ask questions if any ambiguities exist in the bid documents. A simple telephone call to the procurement officer or owner will save parties from possible issues and additional costs down the road. Also, if the contractor discovers an issue with the plans and specifications during construction, it would be best to notify the owner of the potential problems. Defective plans and specifications also need to cause actual damage to the contractor.

Owners should beware of defective plans and specifications when hiring contractors to construct or renovate a private house, commercial building, or even remodeling office space. The burden, however, is on both the owner and the contractor to ensure the plans and specifications are accurate.

If you have further questions, please contact Michael Siri at 410-583-2400 or siri@bowie-jensen.com.

Defective Specifications

A recent Federal Circuit case underscores a contractor's rights to equitable adjustment when the owner provides defective specifications. In this case, the contractor made a claim for a constructive change as a result of having to proceed under what it contended were omissions in the specifications. The Government took the position that since the specifications were defective the contractor should not have relied upon them. Citing to well established precedent, the trial court had expressed that

"[w]hen the government provides a contractor with defective specifications, the
government is deemed to have breached the implied warranty that satisfactory
contract performance will result from adherence to the specifications, and the
contractor is entitled to recover all of the costs proximately flowing from the
breach."

The Government also argued that the Contractor should have discovered the defect during the bid. However, this argument was rejected as well because discovery of the error would have required a calculation that a contractor making a bid would not reasonably be expected to make.

The Federal Circuit affirmed, and stated that the defective specifications made performance "impracticable," creating a constructive change that entitled the contractor to equitable adjustment.

For questions contact Matt Hjortsberg (410) 583-2400 or at Hjortsberg@bowie-jensen.com

Authority to Issue Changes on Govt. Contracts

The Federal Circuit released an opinion that should serve as a cautionary tale on some of the perils of contracting with the Federal Govt. This case arose out of claims for equitable adjustment on a renovation project at the Great Lakes Naval Research Center.

The Federal Circuit reversed many of the findings in favor of the General Contractor on the basis that the Project Manager for the Navy did not have actual authority to approve the changes claimed by the General Contractor. The prime contract incorporated by reference many of the standard clauses from the Federal Aquisition Regulations (FAR)and the Naval Facilities Engineering Command clauses that conferred sole authority to the Navy's Contracting Officer (CO) to approve and issue modifications to the contract.

After execution of the contract but before construction began the parties attended a meeting that the contract required the CO to attend. The CO, however, did not attend and instead the Resident Officer In Charge of Contracts,(ROICC) who was also the Project Manager, attended. At the conference, the Navy issued a detailed set of construction guidelines that designated the ROICC as the person in charge of contract administration and as the designated recipient of all correspondence. The Navy also gave a presentation that stated that no modifications to the contract could occur without written notification from the ROICC. Following a personnel change in the ROICC/PM position, the General Contractor submitted a RFI seeking “documentation of assignment of authority” and the “level of authority” of ROICC/PM, among others. The Navy responded to this RFI with respect as follows:

"Mr. Tim Meland. Project Manager: Serves as the Government Construction Manager on all assigned projects. Responsible for construction management and contract administration on assigned projects while providing quality assurance and technical engineering construction advice. Provides technical and administrative direction to resolve problems encountered during construction. A project manager analyzes and Interprets contract drawings and specifications to determine the extent of Contractors’ responsibility. Prepares and/or coordinates correspondence, submittal reviews, estimates, and contract modifications in support to ensure a satisfactory and timely completion of projects."

During the course of the project the ROICC responded to RFIs and approved deviations from the plans and specifications. At the conclusion of the project, the general contractor submitted a claim for equitable adjustment. The CO found entitlement on many of the changes and the parties proceeded to the Board of Contract Appeals where the General Contractor asserted that the only issue was a determination of quantum. However, the Navy then argued that the ROICC had no authority to approve modifications to the contract. The Board of Contract Appeals found that the ROICC PM directed changes that resulted in costs beyond those required by the contract and that these changes were compensable because the delegation of authority clause in the contract gave him responsibility for construction management and contract administration.

The Federal Circuit reversed, holding that despite the conduct of the Navy, its ROICC PM did not have express authority to approve modifications to the contract. While the General Contractor argued that the authority was implied, the Court rejected this contention stating that where the contract confers authority solely to the CO to modify the contract, there is no way that the same authority could be implied in someone else.

The Federal Circuit sent the case back to the Board of Contract Appeals to consider whether the CO ratified, or adopted, the changes issued by the ROICC when the CO issued a letter finding entitlement. Ratification requires knowledge of material facts involving the unauthorized act and approval of the activity by one with authority. The Navy has taken the position that the CO did not have knowledge of all material facts when he issued the letter finding entitlement.

This case demonstrates how the failure to abide by the express terms of a contract can lead to a patently unfair result.

Matt Hjortsberg

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