Be careful with flow-down provisions

March 18, 2016

Werner11headshot LAW
Werner Sabo, FAIA, CSI
A flow-down provision states the terms of the contract at a higher tier are also binding on the lower-tier contractor. For instance, the subcontract between the general contractor and the electrical installer usually contains a flow-down provision stating the terms and conditions in the owner-contractor agreement are binding on the installer as well. This means there may be terms in the general contract affecting the electrical installer, even though they are not found in the subcontract.

Flow-down provisions can also affect architects in design-build agreements. When an architect is hired by the general contractor within such a delivery system, he or she may be affected by terms in the contract between the owner and the contractor. This was the scenario in Centex/Worthgroup LLC v. Worthgroup Architects LP (365 P.3d 37 [Ct. App. New Mexico, 2015])—but with a twist.

In this case, the owner contracted with Centex, a design-build contractor, for an expansion and renovation project. Centex then entered into a subcontract with the architect. The work of the architect included the design of a mechanically stabilized earth (MSE) wall. This wall ultimately failed, and Centex sued the architect for more than $6 million in damages for the incurred redesign and repair costs.

The prime contract between the owner and Centex contained a “limitation of liability” clause requiring the design subcontractors to Centex to obtain errors and omissions (E&O) insurance in an amount not less than $3 million. The clause further stated the owner agreed to limit Centex’s liability to whatever sums the owner was able to collect from such insurance.

The subcontract with the architect contained a flow-down provision, which stated the architect would, except as otherwise provided, assume all rights and obligations toward Centex that Centex had toward the owner under the prime contract. The subcontract also contained an incorporation-by-reference clause, which required the architect to perform its work in strict accordance with the prime contract and incorporated the prime contract by reference. Finally, the subcontract had a general liability clause that made the architect responsible for redesign costs and additional construction costs of Centex and/or the contractor required to correct the architect’s errors or omissions.

The architect obtained a $3 million E&O policy from Lexington. When the MSE wall began to fail, the owner demanded Centex remedy the defects and damage. Centex then spent more than $6 million for others to redesign and repair the MSE wall. It demanded payment from the architect’s insurance carrier. Lexington paid Centex $3 million, representing the full policy limit for the claim. However, this left Centex more than $3 million short.

In the lawsuit, the architect claimed the limitation of liability clause, which was incorporated into the subcontract through the flow-down clause, limited Centex’s ability to recover damages arising from design errors and omissions. Centex argued the limitation of liability clause did not apply because the subcontract contained a specific general liability provision.

The court held the limitation of liability provision in the general contract could not be reconciled with the subcontract’s specific language. On the one hand, the limitation of liability language set a limit to the amount of damages that could be collected; on the other hand, the subcontract’s general liability clause stated the architect was responsible for redesign and additional construction costs required to correct its errors or omissions. No limitation is set forth in that language, making the two provisions irreconcilable. Since the more specific provision in the subcontract controlled, the architect was responsible for the excess costs.

Contracts are meant to lay out the framework for the allocation of liability in case something goes wrong. In other words—who takes the risk for errors and omissions, and for how much. A limitation of liability clause is one way a party can set a cap on how much damage it would incur in a worst-case scenario. However, such provisions must be carefully thought out and coordinated with the remainder of the contract. In examples like this one, where the architect’s contract consists of several documents (including some incorporated by reference), care must be taken to ensure the whole thing works as intended.

An attorney knowledgeable about construction law in the jurisdiction of the project should be consulted in preparing contracts. The bigger the project, the more important this becomes.

Werner Sabo, FAIA, CSI, concentrates his practice with Bryce Downey & Lenkov in construction, copyright, and real estate law. A licensed architect, he is a member of CSI (a past-president of the Chicago Chapter) and a Fellow of both the American Institute of Architects (AIA) and Association of Licensed Architects (ALA). Sabo is a construction arbitrator and mediator for the American Arbitration Association (AAA), active on several bar association committees, and a lecturer on construction law to a variety of professionals and students. His book, Legal Guide to AIA Documents, published by Aspen Publishing, is in its fifth edition. He can be contacted via e-mail at wsabo@bdlfirm.com[1].

Endnotes:
  1. wsabo@bdlfirm.com: mailto:wsabo@bdlfirm.com

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