Liquidating Agreements: Biting the Hand That Won’t Feed You
When a subcontractor has a claim for damages caused by the owner of the project, it must enter into a “liquidating agreement” with the contractor, permitting the contractor to assert the claim on the subcontractor’s behalf. When the contractor drops the ball, the subcontractor may find itself able to sue the contractor instead.
In the typical construction project, the Owner hires a general contractor (GC) and the GC hires one or more subcontractors (Subs). These Subs have no contract with the Owner and so if the Owner does something to delay or interfere with the Sub’s work, the Sub may not sue the owner directly. On the other hand, the damage was not caused by the GC, so the Sub cannot sue the GC either. What remedy does the Sub have?
The GC and Sub can enter into a Liquidating Agreement (LA) which creates a legal fiction. In a LA the Sub asserts its claim and the GC “admits” that it is liable to the Sub –– but only to the extent it is able to collect from the Owner on the Sub’s behalf. Sometimes the language of the subcontract itself provides for this pass-through procedure.
If the GC properly pursues the Sub’s claim against the Owner (often combined with the GC’s own claim), the Sub gets only what the GC recovers on the Sub’s behalf. If the GC collects nothing, the Sub is out of luck. Since the Sub has placed the fate of its claim in the hands of the GC, you can imagine that the Sub is not crazy about LA’s. But it often has no other choice.
In a recent case arising out of a sanitation garage project in Brooklyn, Rad and D’Aprile, Inc. (RAD) entered into a subcontract with Arnell Construction Corp. (Arnell) to perform certain masonry work at the NYC Department of Sanitation project. When the project was delayed by the City, both RAD and Arnell desired to assert a claim for damages against the City, as Owner. They entered into a LA to permit Arnell to assert RAD’s claim alongside its own.
When Arnell eventually filed its Notice of Claim and commenced the litigation, it turned out that it had blown the very short period of limitations in its prime contract (6-months from substantial completion). The Owner moved to dismiss the action and its motion was granted. That had the effect of killing both Arnell’s and RAD’s claim against the Owner. Was RAD out of luck?
The Appellate Division held that RAD could now pursue its claim against Arnell. It held that “like every contract, the contractual covenant of good faith and fair dealing is implied in a liquidating agreement.” In this context it means that the GC must “take all reasonable steps so that the [Sub’s] right to an eventual recovery, if any, from the [Owner] will be protected.”
There are two takeaways from this:
- Always check the period of limitations in the prime contract. Don’t count on the six years provided in the statutes. It can be, and often is, shortened by the contract to as little as 90 days; and
- Often a liquidating agreement is the only option available to a Sub delayed by an Owner. It is not very palatable because all control is relinquished to a GC which often has little or no interest in carrying the flag for the Sub and can settle for peanuts, or litigate without any enthusiasm. This case teaches that sometimes the path is easier to go against the GC for dropping the ball (i.e., not fulfilling its covenant of good faith and fair dealing) than to actually try and recover against the Owner.