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By: Thomas H. Welby Gregory J. Spaun Published: June 2019

Contractor Liable to Sub for Failing to Protect Sub's Claim Against Owner

A subcontractor has no direct contractual relationship with a project owner; that relationship is between the general contractor and the owner.  Accordingly, the sub cannot sue the owner directly, even if it sustains monetary damages caused by the owner.  Consequently, in response to this lack of contractual privity, the sub and the GC may enter into a liquidating, or pass-through, agreement, where the sub assigns its claim to the GC. The GC, in turn, prosecutes the sub’s passed-through claim against the owner, and then gives the sub any recovery.

Generally, a liquidating agreement is designed to limit, or liquidate, the GC’s liability to the sub to the amount the GC recovers from the owner. However, in order for the GC to limit that liability, it must pursue the sub’s claim in good faith. In the recent decision in the case of Rad and D’Aprile, Inc. v. Arnell Construction Corp., which was rendered by the trial court after remand from the appellate court decision discussed in the May, 2018, Attorneys’ Column, the court found that the GC had breached its duty of good faith and fair dealing under its liquidating agreement and, therefore, was directly liable to the sub for claims that ought to have been pursued against the owner.

Background

In June of 2001, the New York City Department of Sanitation entered into a contract with Arnell Construction Corp., as GC, to construct two new sanitation garages in Brooklyn. Arnell’s contract with the City required that any claims against the City be brought within six months of the City’s issuance of the certificate of substantial completion. In August of 2001, Arnell subcontracted with Rad & D’Aprile, Inc., for Rad to perform masonry work on the project.

In August of 2010, pursuant to a liquidating agreement it had entered into with Rad, Arnell filed a notice of claim with the City seeking damages on behalf of Rad for additional costs that Rad incurred due to various delays caused by the City. In December of 2010, Arnell sued the City on those claims.  The City moved to dismiss the lawsuit on the ground that it was untimely under the six-month limitations period provided for in Arnell’s contract. In May of 2012, the court dismissed Arnell’s lawsuit, finding that the City had notified Arnell in December of 2007 that the project was substantially complete, and that any lawsuit had to be commenced no later than June of 2008. Arnell filed an appeal and also moved to reargue the motion. Unbeknownst to Rad, while the appeal and motion to reargue were pending, Arnell settled with the City for $3,638,495.69. None of the settlement money was apportioned on account of Rad’s claim, but Arnell nonetheless released Rad’s claim in the settlement.

After that lawsuit was dismissed (and the secret settlement consummated), Rad sued Arnell directly for the same damages, alleging that Arnell had a duty to make a good-faith, diligent effort to prosecute Rad’s claim against the City, and that Arnell breached that duty by failing to commence the lawsuit against the City within the applicable six-month limitations period. Arnell moved to dismiss this claim but the trial court denied the motion, finding that the claim, as stated, was sufficient because Rad set forth facts which, if proven, would establish that Arnell had a duty of good faith and fair dealing independent of the subcontract, and that Arnell breached that duty by failing to commence the underlying action before the six-month limitations period expired. After the trial court’s order was upheld on appeal, Rad moved for summary judgment on its breach of the covenant of good faith and fair dealing claim, asserting that the facts of the undisclosed settlement, coupled with Arnell’s waiver of Rad’s claim in exchange for a recovery limited to its own claims, established that Arnell breached the covenant and should be held directly liable to Rad.

Decision

The trial court granted summary judgment to Rad, finding that the liquidating agreement was an express agreement for Arnell to be responsible for delays caused by the City, and that Arnell’s self-serving actions in failing to inform Rad of the settlement, and in releasing Rad’s claim in order to obtain payment on the contract-balance portions of its own claim, established that Arnell, in fact, breached the covenant of good faith and fair dealing, and that Arnell could not raise an issue of fact as to whether it diligently presented Rad’s claim sufficient to defeat summary judgment.

As to the extent of the claim, Arnell argued that as none of the monies recovered were on account of Rad’s claim, it could not be held liable to Rad under the liquidating agreement. The court dismissed such argument, finding that the fact that no money was recovered on Rad’s claim, together with Arnell’s failure to dispute that it would have received a substantially higher settlement on Rad’s (and its own) claim if it had been timely presented, was evidence that Arnell failed to take proper steps to preserve Rad’s claim. Accordingly, the court held that Rad’s recovery against Arnell could not be limited to the monies actually recovered from the City by Arnell, and that Rad was entitled to a trial on the issue of damages—a trial where it was free to introduce evidence of all damages that it incurred resulting from Arnell’s breach of the liquidating agreement.

Comment

Liquidating agreements are an effective way to address the problem of a sub’s lack of a contractual relationship with a GC by having that GC essentially admit the validity of the sub’s claims, confess liability on those claims, and then prosecute those claims on behalf of the sub with the promise that the recovery would be passed along to the aggrieved sub. The benefit to a sub is that claims which would otherwise be barred because of the lack of privity of contract with the owner can be adjudicated. The benefit to the GC is that its liability is limited to the amount it ultimately recovers on the liquidated claims. However, as we saw from the first Rad decision, in order to enjoy the protection of that limitation of liability, the GC must be diligent in prosecuting the sub’s liquidated claims. Further, as we saw from the second Rad decision, where it is established that a GC was not diligent in prosecuting its sub’s claims, the sub is not limited in the amount of damages it is entitled to prove to what ended up being recovered from the owner. Accordingly, GCs and prime contractors would be well advised to take their responsibilities under a liquidating agreement seriously or else be prepared to be held responsible for the entirety of the sub’s claims.

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