Contract Interpretation

A recent Georgia appellate court decision serves as a stark reminder to contractors on government projects that sovereign immunity, though frequently disclaimed in the contract, may limit a contractor’s ability to recover. In Fulton County v. SOCO Contracting Co., the contractor (SOCO) entered into a contract with Fulton County (the “County”) for the construction of a local cultural center.  The contract specified that the schedule could be extended and the scope of work could be altered by following the contract’s procedure for change orders, which required a written, bilateral agreement as to such changes.

After delays to the project, the County ordered changes to SOCO’s scope of work, but there was no evidence that such changes were executed through bilateral, written agreements as required by the procedure. SOCO even admitted that the County never issued a written change order extending the contract time or altering the scope. SOCO ultimately brought an action against the County for breach of contract and bad faith performance of the contract. The County asserted that any claims arising from unwritten change orders were barred by the doctrine of sovereign immunity.

In Georgia, the doctrine of sovereign immunity has constitutional status and may be waived only by an act of the General Assembly or the Constitution itself. Sovereign immunity is a threshold issue that must be addressed before the court may reach the merits of a case; the party seeking the benefit of the waiver of sovereign immunity bears the burden of proving such waiver, and whether it has been waived under undisputed facts such as these is a question of law.

The court asserted that although the County did waive sovereign immunity for breach of the written contract, it did not waive sovereign immunity for claims arising from modifications to the written contract that failed to follow the written change order policy outlined in the contract. The court concluded that SOCO provided no evidence that the change order procedure requiring a written change order was followed. The court determined that sovereign immunity could not be waived by the County for actions outside the written contract. Further, the court was unable to create an exception to the rules regarding waiver of sovereign immunity based on any reliance that SOCO may have placed on the County’s request for changes, upon the parties’ course of conduct, or upon facts that were deemed admitted. As a result, the court determined that there was a question of fact as to whether the County waived sovereign immunity and remanded the case for further consideration of whether the parties strictly complied with the contract’s procedure regarding written change orders.

The case highlights the fine distinction between compliance with a written contract and the breach of the terms of a written contract. It further serves as a stark reminder to contractors that the contract terms must be followed strictly to ensure the validity of an argument that the government waived sovereign immunity for breach of contract.

Fla. Stat. § 725.06 limits the scope of indemnification provisions in construction contracts.  Specifically, the statute limits the ability of an indemnitee (e.g., owner) to require an indemnitor (e.g., contractor) to indemnify the indemnitee for damages arising from the indemnitee’s own actions, omissions, or defaults. The statute sets forth the types of construction contracts for which the limitation is applicable as follows:

Any portion of any agreement or contract for or in connection with, or any guarantee of or in connection with, any construction, alteration, repair, or demolition of a building, structure, appurtenance, or appliance, including moving and excavating associated therewith…wherein any party referred to herein promises to indemnify or hold harmless the other party to the agreement, contract, or guarantee for liability for damages to persons or property caused in whole or in part by any act, omission, or default of the indemnitee arising from the contract or its performance, shall be void and unenforceable…(emphasis added).

In January, a Florida appellate court took a closer look at the applicability of § 725.06 to certain construction contracts in the Blok Builders LLC v. Katryniok decision. In that case, the court analyzed whether the statute applied to an excavation subcontract as part of a construction project to “perform all work necessary to provide access to underground [telecommunication] lines” as part of a telecommunications improvement project. The subcontractor was to perform all excavation necessary for access to the utility lines that were to be repaired and updated. After the subcontractor performed some excavation work near a residence, the driveway on the property collapsed while the resident was walking on it. The resident sued the subcontractor, the contractor, and the owner of the project for negligence.

In the lawsuit, the contractor claimed the subcontractor owed the contractor indemnity based on a provision in the subcontract that required the subcontractor to indemnify the contractor for any liability arising out of an injury to a third party whether such injury was caused in part, or in whole, by any act, omission, default, or negligence by the contractor. The subcontractor alleged that its excavation subcontract fell within the scope of the prohibition on such indemnity provisions contained in § 725.06, which made the indemnity provision in the subcontract void and unenforceable.

The court disagreed and ruled that the indemnity provision was valid. The subcontractor argued that excavation services were explicitly referenced in § 725.06 making the provision applicable to its subcontract. However, the court reasoned that the utility line improvement project did not involve the construction of any “building, structure, appurtenance or appliance,” so any excavation work performed on that project did not qualify as a covered construction agreement under § 725.06.  The court enforced the indemnity provision allowing the contractor to recover all damages incurred, plus attorneys’ fees and costs.

Statutes like § 725.06 exist in other states besides Florida, and it can be difficult to keep up with all the competing requirements and limitations under various states’ indemnification regimes. The Blok Builders case is a useful reminder of the importance of (1) keeping track of indemnity limitations in whatever state you’re working in and (2) paying attention to the scope of your indemnity obligations when negotiating any contract. While the contractor here was able to escape the nullification of its indemnity provision based on the type of construction services performed, slightly different statutory language or a contrary interpretation by the court could have resulted in the contractor being exposed to substantial liability and associated costs due to the resident’s injury. Since third-party injuries are never planned for on a project, understanding the scope of your indemnity obligations before executing any agreement is important.

Two recent decisions – one from the U.S. Civilian Board of Contract Appeals and the other from the U.S. Court of Federal Claims – provide opposing holdings on whether the government can raise a “Severin doctrine” defense to subcontractor “pass-through” claims based on broad language in subcontractor progress payment releases. In light of these different perspectives, contractors should take steps to ensure that such releases do not doom legitimate subcontractor pass-through claims.

Pass-Through Claims and the Severin Doctrine

Subcontractors cannot directly sue the government because they do not contract with the government, i.e., they are not in “privity” of contract. A pass-through claim is a subcontractor claim against the government that a prime contractor (who is in privity of contract with the government) brings on behalf of a subcontractor.  The Severin doctrine holds generally that a prime contractor presenting a pass-through claim can recover damages only if the prime contractor remains liable to the subcontractor for those damages.

The Board (Turner Construction Co. v. Smithsonian Institution)

Turner, the prime contractor, passed through approximately $7 million in subcontractor delay and disruption claims in a dispute involving the renovation of the National Museum of American History. Each progress payment release stated, in relevant part, that the subcontractor: “represents and warrants that there are no outstanding claims by the [subcontractor]… through the date of Application for Payment No. __ except for any retention, pending modifications and changes, or disputed claims for extra work as stated herein[;]” and “does hereby forever release, waive, and discharge … any and all … claims and demands … by reason of delivery or material and/or performance of work relating to the project through Application for Payment No. __, except for those items listed under No. 1 above.” The relevant progress payment releases did not list the pass-through delay and disruption claims under No. 1. The board held that even though the progress payment releases did not carve out the pass-through claims, the Severin doctrine did not bar them mainly because the releases were “clearly tied” to each progress payment. Their main purpose was to ensure that subcontractors had paid lower tiers and that the project site remained unencumbered, not to relieve Smithsonian, vis-à-vis releasing Turner, from any liability for overall project delay.

The Court (MW Builders, Inc. v. United States)

The court in MW Builders, on the other hand, broadly applied subcontractor progress payment releases to bar pass-through claims. MW Builders, the prime contractor, passed through approximately $1 million in subcontractor delay claims in a dispute involving the construction of an Army Reserve Center in Sloan, Nevada. The progress payment releases in question were from one subcontractor, Bergelectric, which stated in relevant part: “[Bergelectric] irrevocably and unconditionally releases and waives … any other claims whatsoever in connection with this Contract … through the end of the period covered by this Application ….” These releases covered the entire period of Bergelectric’s delay claim.

In contrast with the Smithsonian disposition, the court held that the Severin doctrine barred the Bergelectric pass-through claim. Unlike the board’s narrow interpretation of the progress payment releases in Smithsonian, the court declined to consider evidence of the limited intent of the releases. Instead, based on the broad language in the releases and the fact that the releases did not expressly reserve Bergelectric’s delay claim, the court determined that the releases barred all claims by the subcontractor.

Takeaway Points

These two recent decisions involved similar language in progress payment releases but had opposite results. In the board case, the subcontractor claims survived under a narrow interpretation of the progress payment releases, while in the court case, the subcontractor claims fell victim to the government’s Severin doctrine defense based upon a broad interpretation of the release language. Together these cases demonstrate the unpredictability of whether a judge will construe broad language in progress payment releases as a bar to subcontractor pass-through claims; and they serve as a reminder that contractors must be wary of the Severin doctrine. In anticipation of the government’s defense, contractors should carve out subcontractor pass-through claims from progress payment releases. It is also prudent for prime contractors and subcontractors to enter into “liquidation agreements” to define and preserve subcontractor pass-through claims. Without such vigilance, otherwise meritorious claims could be vulnerable to the government’s Severin doctrine defense.