Flow-down, or pass-through, provisions are among
the most important provisions in all subcontracts, at least from the
perspective of general contractors. These classic risk-transfer provisions
provide that the subcontractor will be bound to the general contractor in the
same fashion that the general contractor is bound under its contract with the
owner. (As a practical matter, general contractors must provide access to the
owner contract in order for the flow-down provision to be enforceable against
the subcontractor. Prudent general contractors ought to redact sensitive
information, including business terms (like their fee and other aspects of the
deal) and bank wire transfer information.) These
provisions are often accompanied with language throughout the subcontract that
dually requires the subcontractor to follow the prime contract between the
owner and the general contractor, in the event there exists a conflict or gap
between provisions in the subcontract and the prime contract. For example, a
prudent general contractor could draft a notice provision that requires a
subcontractor to submit notice in writing within a desired amount of days and
include the language “unless the General Contract Documents require notice
sooner.” In short, flow-down provisions are a nice backstop for general
contractors to ensure that they are following the requirements set forth in
their contracts with the owner.
However, even the best of backstops have their limits – and
such limits often come to light in the face of agreements to arbitrate. In a
recent flow-down showdown, the California Court of Appeals illustrated these
limits when it refused to enforce an arbitration agreement that was flowed-down
from a prime contract. See Remedial
Construction Services, LP v. AECOM, INC., 65 Cal. App. 5th 658, 666 (Cal.
App. 2d Dist. 2021). There, the subcontract incorporated by reference a prime
contract that included an arbitration agreement and required, like all
flow-down provisions do, that the subcontractor assume towards the general
contractor “all obligations and responsibilities contained in the Prime
Agreement.” Notably, the subcontract itself did not contain an agreement to
arbitrate. The court thus found that since “[t]he Subcontract [did] not
evidence an intention, clear or otherwise, for arbitration of disputes,” the
agreement to arbitrate was unenforceable against the subcontractor in its
disputes with the general contractor.
For those tracking flow-down showdowns, this
result was unsurprising. Just over a decade earlier, the New York Court of
Appeals came out the same way in a very similar case. See Wonder Works Construction Corp. v. R.C. Dolner, Inc., 73 A.D.3d
511, 514 (N.Y. App. 1st Dep’t 2010). There, a subcontract also lacked an
agreement to arbitrate and, instead, simply incorporated by reference the prime
contract which contained such agreement. Like California, the New York Court of
Appeals reasoned that an arbitration agreement must be unambiguous in
expressing a clear intent of both parties to arbitrate disputes. Id. at 513; see Remedial Construction Services, 65 Cal. App. 5th at 661 (“In
the absence of a clear agreement to submit a dispute to arbitration, we will
not infer a waiver of a party’s jury trial rights.” (citing Avery v. Integrated Healthcare Holdings,
Inc. 218 Cal. App. 4th 50, 59 (2013)).
To avoid having their own flow-down showdowns, general
contractors – and their lawyers – must keep in mind that the duty to arbitrate
can only be imposed by clear written agreement. See 9 USC § 2; New York Convention of the Enforcement of Foreign
Arbitral Awards, Article II. As recognized by the Supreme Court in the series
of cases known as the ‘‘Steelworkers Trilogy,’’ ‘‘arbitration is a matter of
contract and a party cannot be required to submit to arbitration any dispute
which [it] has not agreed so to submit.’’ United
Steelworkers v. Warrior & Gulf Navigation Co., 363 U.S. 574, 582
(1960); accord AT&T Technologies,
Inc. v. Communications Workers of America, 475 U.S. 643, 648 (1986). Since “[a]rbitration is a matter of contract
and a party cannot be required to submit to arbitration any dispute which [it]
has not agreed so to submit,” determining who actually agreed to arbitrate is
always a threshold matter. See “Steelworkers Trilogy”; Mitsubishi Motors
Corp. v. Soler Chrysler-Plymouth, Inc. (quoting Moses H. Cone) (“The first
task of a court asked to compel arbitration of a dispute is to determine
whether the parties agreed to arbitrate that dispute. The court is to make this
determination by applying the ‘federal substantive law of arbitrability,
applicable to any arbitration agreement within the coverage of the [Federal
Arbitration] Act.’”).
The best way to achieve both a clear agreement to arbitrate
with a subcontractor and one that is
not in conflict with the dispute resolution procedures in the owner contract is
to draft a flow-down dispute resolution provision that explicitly references
arbitration. So, just like how prudent general contractors can draft notice
provisions that require subcontractors to submit notice in writing within a
desired amount of days, “unless the General Contract Documents require notice
sooner,” the same can be drafted in the dispute resolution context. For
example, a subcontract should explicitly provide that disputes must be resolved
in strict conformance with the General Contract Documents. The subcontract
should also provide that, “at the election of the General Contractor,” disputes
will be arbitrated or submitted to court of a specified location (either a convenient
jurisdiction for the general contractor or the project). The arbitration
agreement should provide (1) the rules of arbitration, generally it is the
American Arbitration Association’s Construction Industry Arbitration Rules, (2)
the situs of the arbitration, (3) the number of arbitrators, (4) consideration
of a nominal sum included in the subcontract price, and (5) a waiver to jury
trial, in all-capitals. The rule of thumb when it comes to arbitration
agreements is to keep them clear. And that same clarity should be carried forth
by flowing-down the requirements of the owner contract – nobody wants to be in
the position of both litigating and arbitrating essentially the same case
because the arbitration was not fully agreed to.
In the event your agreement lacks a clear agreement to
arbitrate, courts,* like those
in Remedial Construction Services and Wonder Works, must determine the scope
of the arbitration clause at issue, so as to determine what the parties
actually agreed to do. The Federal Arbitration Act (or “FAA”) provides a
liberal policy of promoting arbitration because it was drafted to override the
then long-standing judicial hostility towards arbitration and to make
arbitration agreements “valid, irrevocable, and enforceable.” 9 USC § 2; Moses H. Cone Memorial Hospital v. Mercury
Construction Corp., 460 U.S. 1, 24 (1983) (noting that courts are to
“rigorously enforce agreements to arbitrate.”) So, on the one hand, if a court
determines that an arbitration clause exists, “any doubt concerning the scope
of arbitrable issues should be resolved in favor of arbitration, whether the
problem at hand is the construction of the contract language itself or an
allegation of waiver, delay, or a like defense to arbitrability.” Id. at 24. However, it is “equally clear
that the ‘federal policy alone cannot be enough to extend the application of an
arbitration clause far beyond its intended scope.’” Fuller v. Gutherie, 565 F.2d 259, 261 (2d Cir. 1977). “After all,
the purpose of the FAA ‘was to make arbitration agreements as enforceable as
other contracts, but not more so.’” Prima
Paint Corp. v. Flood & Conklin Mfg. Co., 388 U.S. 395, 404 n.12 (1967).
Thus, on the other hand, arbitration cannot be compelled unless it is found
that both of the parties (1) agreed to arbitrate and (2) intended the arbitration clause to cover the particular dispute. Another
way to avoid being a party to the arbitration agreement is to assert that you
lack the ability to pay. In such scenarios, there is a possibility that the
fees of an arbitration (like the institutional ones and the ones going to the
tribunal, but not the legal fees) might provide a basis for invalidating an
arbitration agreement in its entirety. In other words, the right to be heard
trumps the federal policy favoring arbitration.
In conclusion, general contractors ought to continue
transferring risk through flow-down provisions, but must be particularly
prudent in the face of agreements to arbitrate. Again, the best way to achieve
the upper hand is by explicitly reinforcing the application of the flow-down
provision and referencing the agreement to arbitrate within the subcontract.
And, if a subcontractor challenges the applicability of arbitration, at least
you brought the bigger gloves to the fight.
* Note, however, that pursuant to the Doctrine of
Kompetenz-Kompetenz, arbitrators are competent enough to decide their jurisdiction.
See Schein v. Archer & White Sales,
Inc., 139 S. Ct. 524 (2019) (upholding this principle in a recent January
2019 case where parties contracted to have an arbitrator decide not only the
merits of a particular dispute, but also gateway questions of arbitrability).
Thus, court interference may not be necessary at this initial jurisdiction
stage.
Author Lexie
Pereira is a JD/MBA candidate at Boston College Law School and Carroll
School of Management graduating in Spring 2022 and studying to become a
litigator, with a specialty in construction law. Currently, she works as a Law
Clerk at Consigli Construction Co., Inc., serves on the Editorial Team of the
ABA’s Forum on Construction Law’s Dispute Resolver blog, and acts as the
Student Liaison of the ABA's Forum on Construction Law. At school, Lexie is the
President of the Real Estate Law Society and the President of the
Eagle-to-Eagle Mentoring Program. Lexie grew up in the construction industry
and has spent time working as an estimator, field engineer, laborer, and, of
course, in the legal capacity at Consigli and formerly Hinckley Allen and Pillsbury
as a Summer Associate. After graduation, she will be joining Pillsbury
Winthrop Shaw Pittman LLP as an Associate.
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