Contractors' Right to Assert
Subcontractors' Claims Recognized

By John S. Mrowiec

A common project pattern involves an owner-caused delay, owner's architect's errors or omissions or disputed extras. The event might have caused little or no damages to a prime contractor but caused substantial damages to one or more subcontractors.

Normally, because the subcontractor is not "in privity" with the owner, the subcontractor cannot sue the owner for the subcontractor's damages. The subcontractor may sue the prime contractor. The prime contractor then will want to sue the owner so as to recover from the owner any amount the contractor is ordered to pay the subcontractor.

The industry typically refers to a claim where the prime contractor sues the owner to recover the subcontractor's damages as a "pass-through claim."

Both federal and state courts have recognized a prime contractor's legal right to assert a subcontractor's pass-through claim against an owner under most circumstances. Often the prime contractor and subcontractor sign a "claims prosecution" or "liquidating" agreement providing for how the claim will be prosecuted and how the subcontractor will be paid.

View from Texas

Recently, a federal court that was obligated to apply unclear Texas law asked the Texas Supreme Court whether Texas law recognized pass-through claims against an owner when there was no privity of contract between the subcontractor and the owner. After surveying case decisions regarding federal contracts and state public and private contracts that had considered the question, Texas joined in the majority of courts that allow pass-through claims, Interstate Contracting Corp. v. City of Dallas, 135 S.W. 3d 605 (Tex. Apr. 16, 2004), reh'g denied, 2004 Tex. LEXIS 354 (Jun. 25, 2004).

The Interstate Contracting court concluded that federal courts addressing federal contracts have held that as long as the prime contractor remains liable to the subcontractor for the subcontractor's damages, the prime contractor may bring an action against the owner for the subcontractor's damages, Interstate Contracting, 135 S.W. 3d at 611. The reasoning is that "[the contractor] was the only person bound to perform his contract with the Government, and he had the undoubted right to recover from the Government [extra costs and services] whether that work was performed personally or through another" Interstate Contracting, 135 S.W. 3d at 610 quoting United States v. Blair, 321 U.S. 730, 737-38 (1944).

In the federal contracts context, the prime contractor originally could not pass-through a subcontractor's claim if the subcontract contained language constituting a "complete release" of the prime contractor. Severin v. United States, 99 Ct. Cl. 435, 443 (1943).

However, that "Severin doctrine" has been "narrowly construed" and "diluted" by subsequent cases that have "interpret[ed] releases and contracts generously to let contractors pursue their subcontractor's claims" Interstate Contracting, 135 S.W. 2d at 612 citing E.R. Mitchell Construction Co. v. Danzig, 175 F.3d 1369, 1371 (Fed. Cir. 1999); Morrison-Knudsen Corp. v. Firemen's Fund Ins. Co., 175 F.3d 1221, 1251 (10th Cir. 1999).

The Interstate Contracting court noted that 19 states, by state court or federal court decisions applying state law (some in multiple cases), had addressed the concept of pass-through claims. Eighteen states had recognized the validity of such claims and only Connecticut had not, Interstate Contracting, 135 S.W. 3d at 613-14. The Interstate Contracting case added Texas to the states recognizing the pass-through claim concept, Interstate Contracting, 135 S.W. 3d at 618.

Illinois Case

Remarkably, apparently none of the state appellate courts in or federal courts applying the law of our readership's area of Illinois, Indiana or Wisconsin had squarely addressed the issue of the validity of pass-through claims as of the time of the Interstate Contracting decision. Then, just months later, an Illinois court addressed the question in Paschen Contractors, Inc. v. City of Kankakee, 2004 Ill.App. LEXIS 1403 (3d Dist., Nov. 22, 2004).

In Paschen Contractors, a prime contractor sued a public owner asserting the prime contractor's own damages and those of an electrical subcontractor. The subcontract provided that the prime contractor would not be liable to the subcontractor for extras until the prime contractor had been paid by the owner.

The owner denied five of the prime contractor's change order requests totaling $1,940,130. "The net-effect of the denial" was that the prime contractor failed to pay the subcontractor approximately $1.6 million, Paschen Contractors, 2004 Ill.App. LEXIS 1403 at *5.

The prime contractor entered into a written "settlement agreement" with the subcontractor under which prime contractor paid the subcontractor $100,000 and they agreed to cooperate and prosecuted a "Consolidated Claim," Paschen Contractors, 2004 Ill.App. LEXIS 1403 at *5-6.

Although the procedural history of the case is lengthy and complex, the prime contractor ultimately sued the public owner to recover the consolidated claim.

Eight paragraphs of the prime contractor's pleading expressly raised the subcontractor's pass-through claims.

The owner moved to strike those allegations "citing the well-established rule that subcontractors may not recover against the land owner in the absence of a contractual relationship" Paschen Contractors, 2004 Ill.App. LEXIS 1403 at *6. The trial court agreed and struck the prime contractor's allegations seeking to recover for the pass-through claims.

As part of an appeal addressing many issues, the appellate court reversed the trial court's holding that the prime contractor could not assert the pass-through claims. The Paschen Contractors court agreed with the reasoning of the Blair decision: "[the owner] required [the prime contractor] to perform extra work beyond the terms of the contract. That [the prime contractor] subsequently engaged [the subcontractor] to perform some of that work is irrelevant. [The prime contractor] has the right to recover" Paschen Contractors, 2004 Ill.App. LEXIS 1403 at *19.

Therefore, Illinois has joined Texas, the federal contracting decisions and 18 other states in expressly recognizing the pass-through concept.

John S. Mrowiec is a partner with Chicago-based Conway & Mrowiec, a construction and public contracts law and litigation practice. He may be reached at (312) 658-1100. For information, go to the firm's Web site at www.cmcontractors.com.