Can you cap that? Subcontract damages cap might not stick

Venable procurement attorneys Rebecca Pearson and Christopher Griesedieck, Jr., explain why subcontract reviews are more important than ever.

What happened in the court case?

The case involved a prime-sub dispute under a subcontract for the design and construction of a production facility for the Army. The prime contractor, BAE, argued that the subcontractor Fluor’s delays breached the subcontract, requiring BAE to compensate the Army. Fluor argued that BAE breached the subcontract by directing the changes, while refusing to equitably adjust the subcontract price upward by $183 million, as required by the subcontract’s changes clause.

The subcontract contained three “limitation of damages” provisions that the court ultimately concluded did not cap Fluor’s potential recovery from BAE under its changes theory. Two of these provisions stated:

Except as otherwise provided in this Subcontract, damages and remedies that may be recovered by either Party shall be limited as follows: For all claims, regardless of the basis on which the claim is made, the applicable party’s liability for damages arising under or related to this Subcontract shall be limited to $30M, $30M being defined as the value including all changes and the maximum liability for damages.

The third provision was the same, but left out the words “$30M being defined as the value including all changes and the maximum liability for damages.”

Even though two of the three provisions appeared to define the $30 million damages cap as applying to a claim by Fluor based on a changes theory, the court concluded that the cap did not apply to Fluor’s $183 million changes claim for two primary reasons.

First, the words “Except as otherwise provided in this Subcontract” created an exception to the damages cap for claims for equitable adjustments under the subcontract’s changes clause.

Second, Virginia Code § 11-4.1:1 prohibited a cap on damages for a subcontractor’s changes. That law states that a “provision that waives or diminishes a subcontractor’s … right to assert claims for demonstrated additional costs in a contract executed prior to providing any labor, services, or materials is null and void.” The court held that this law voided the damages cap because any work that Fluor had performed prior to the subcontract was pursuant to an undefinitized contract action, which was separate and apart from the subcontract.

What is the takeaway?

It is crucial for prime contractors and subcontractors to ensure that their subcontracts contain clear and consistent terms. Even seemingly small differences in wording can lead to significantly divergent interpretations later. The best defense is to invest in detailed subcontract drafting and review, including with counsel where necessary. A diligent review will typically include:

Accounting for the parties’ relative business cases for entering into the agreement, including factors influencing negotiating leverage (is the subcontractor the only practical choice to supply the relevant goods or services, or does the prime have other options?) and deal points (did the parties previously agree on a workshare as part of a teaming agreement?).

Consideration of the nature and scope of the work (standard commercial terms with mandatory Federal Acquisition Regulations flow-downs may be appropriate where the subcontractor’s performance is similar to what it offers to the private sector, but more specialized terms may be required for non-commercial work on complex federal programs).

Whether and which non-mandatory FAR and FAR supplement clauses will be flowed down to the subcontractor (e.g., whether to draft bespoke changes, stop-work, and termination-for-convenience clauses, or simply flow-down tailored versions of FAR 52.243-1, FAR 52.242-15, and FAR 52.2149-2).

Special attention to clauses with particular legal significance, including: whether one or both parties will provide an indemnity or list the other as an additional insured on relevant insurance policies; how each party’s intellectual property and proprietary information will be protected; what procedures will govern the resolution of disputes between the parties and with the government; and what audit, inspection and record retention rights the subcontractor will provide to the prime and/or the ultimate government customer.

In addition, parties to a subcontract need to be thoughtful when deciding what law should govern the interpretation of the subcontract and any disputes that arise. As this case shows, one state’s law may void contract clauses (such as liability caps) that may be permitted in other jurisdictions.

Rebecca Pearson and Christopher Griesedieck, Jr. are procurement attorneys with Venable LLP. Christopher is of counsel and his practice encompasses a wide range of government contract and grant-related matters, such as claims, requests for equitable adjustment and bid protests. Rebecca is a partner, litigator and former Air Force judge advocate who represents clients in all types of government contracts related counseling, including contract reviews, claims, disputes and litigation, including bid protest in federal forums, and civil False Claims Act defense.