Flow-down, Liability, Prime Contract, Subcontract, Subcontractor

It’s a Flow-Down, Not a Flow-Up

Subcontracts between a general contractor and subcontractor often contain a flow-down provision stating that the terms and conditions in the owner/contractor agreement (the “Prime Contract”) are also binding on the subcontractor—making the subcontractor obligated to provisions in the Prime Contract—thus begging the question: if the subcontractor is required to assume the general contractor’s obligations, does it also then acquire the general contractor’s rights and protections under the Prime Contract? Not necessarily—as decided by the court in Nelson v. Vernco Constr., Inc., 08-10-00222-CV, 2018 WL 2440773, at *18–19 (Tex. App.—El Paso May 31, 2018, no pet. h.).

In Nelson, TxDOT entered a Prime Contract with Hood for road and utility infrastructure construction.  The Prime Contract provided that in the event of a change in work where the parties could not agree to a price adjustment, Hood would be paid according to a force account markup (“FAM”), which compensates for actual cost of labor, materials, and equipment, with an additional percentage for overhead and a mark-up for profit.  Hood retained Vernco for the water utilities under a subcontract containing a standard flow-down clause and a change order provision requiring Vernco to seek in writing an equitable price adjustment for any changes in its work.  The project required larger sewer pipes than specified in the Prime Contract (causing a change in the scope of Hood’s and Vernco’s work), so Hood sought a change order from TxDOT.  When Hood and TxDot could not agree on a price, the FAM was invoked.  Vernco did not seek an equitable price adjustment in writing from Hood, but anticipated receiving the benefit of the FAM invoked as between Hood and TxDOT.

When Hood refused to pass the FAM onto Vernco, Vernco filed suit claiming that the flow-down provision in the subcontract must be read reciprocally to require Vernco to assume Hood’s duties under the Prime Contract, while affording Vernco all of Hood’s rights under the Prime Contract, including a right to the FAM.  The court disagreed, holding that: “[w]e cannot assume that the presence of a flow-down provision in a contract automatically places a subcontractor and prime contractor in the same relative positions as the prime contractor and the owner, with all parties able to enforce rights and remedies against anyone in the contract tiers above them.”  Id.  The court reasoned that a subcontractor only acquires the general contractor’s rights where the subcontract expressly bestows upon the subcontractor the rights and remedies provided to the general contractor in the Prime Contract, and that Vernco’s subcontract did not do so.

The Lesson: a subcontractor only acquires the rights of a general contractor under the Prime Contract where the subcontract—in addition to flowing-down the general contractor’s obligations—also flows-up to the subcontractor the benefit of all rights and remedies against the general contractor, which the general contractor under the Prime Contract has against the owner.

 

 

 

 

 

 

Kyle is a partner in the litigation practice of Porter Hedges. He represents clients negotiating contracts and in construction related litigation. His experience includes handling disputes and negotiating and drafting contracts involving large public and private commercial, industrial, energy and infrastructure projects, including petrochemical plants, EPC projects, and power plants. To read Kyle’s full bio, click here.