Know the Flow: Addressing Flow-Down Provisions in Wastewater Treatment Plan Contracts

By: Shawn R. Farrell and Joseph L. Sine

On November 15, 2021, President Biden signed a $1.2 trillion infrastructure bill that dedicates approximately $82.5 billion for water projects, including the construction and renovation of a large number of wastewater treatment facilities across the country. With so much funding available and legislative time constraints on using these monies, we can expect projects to get awarded at a furious pace.

In that type of environment, it is often tempting to ignore our best practices, by drafting a specifically negotiated contract for the particular project at hand. Instead, many general contractors will simply seek to protect themselves with a blanket contract term incorporating their prime contract into their subcontracts. Likewise, many subcontractors will simply sign the subcontract without even asking for a copy of the prime contract, which has been incorporated into their contract.

Are They Enforceable?

Knowing that this type of practice is common in the industry, let’s explore if such “incorporation” or “flow-down” clauses are enforceable.

Our offices recently had a case concerning a water treatment project in New Jersey, where the New Jersey Water Supply Authority issued specifications that identified three potential suppliers to furnish and install a proprietary water treatment system.

One of the suppliers listed in the specifications sent a letter proposal to all contractors bidding the work, inviting the bidders to contact the company for pricing. The letter proposal, in a footnote, incorporated by reference the supplier’s standard terms and conditions into any future purchase order. After the successful bidder was awarded the contract, the contractor issued a purchase order to the supplier that had sent the above letter proposal.

A dispute between the owner, contractor and supplier arose as to the timely completion of the work and the imposition of liquidated damages. The supplier relied upon the letter proposal, and the flow down clause incorporating its standard terms and conditions as a defense to any liquidated damages.

To that end, the standard terms and conditions contained a limitation of liability clause, whereby the supplier only had the obligation to repair work, with no liability for delay or liquidated damages. The terms also provided the supplier with the right to collect attorneys’ fees if successful at trial. The most astounding fact of this case: the supplier never provided the standard terms and conditions to the contractor prior to the dispute.

A motion for summary judgment was filed to legally bar the supplier’s defenses, arguing: the letter proposal was not solely sent only to the contractor, but was merely a letter of introduction; no terms or conditions were mentioned in the purchase order; and the terms were not provided to the contractor; therefore, these terms could not legally bind the contractor to the terms.

Despite these facts, a New Jersey trial judge determined that the letter proposal raised a question of fact for a jury to decide if the letter proposal incorporated the terms and conditions into the purchase order.

This decision all but guaranteed a trial. A trial took place and ultimately it was found that the letter proposal was not enforceable. That case represents the best example of why understanding a “flow down” clause is important. Let’s explore what lessons can be learned from this decision; to avoid trials and what might be unintended consequences of accepting blanket incorporation clauses.

Enforcement of Flow-Down Clauses Vary By Language and State

The most important lesson to learn is the enforcement of a flow down clause varies drastically based on the precise language used and what state law is involved. For example, in some jurisdictions, such as New York, general flow-down clauses only bind the subcontractor to the prime contract provisions if those prime contract provisions relate to the scope of the subcontractor’s work. General provisions of the prime contract do not flow down unless they are specifically referenced in the subcontract.

Yet other jurisdictions, including Ohio and Georgia, construe general flow-down clauses more broadly than New York, holding both substantive and procedural terms from the prime contract are incorporated into the subcontract.

Even when there are clear and unequivocal incorporation of the prime contract, with the prime contract provided to the subcontractor, this does not end the analysis. Often there are conflicting terms between the prime contract and subcontract. In many jurisdictions, including Pennsylvania, New Mexico, and Alabama, if a specific provision in the subcontract conflicts with the term of a prime contract incorporated by reference, courts have found the terms of the subcontract control.

One way to ensure the terms you want to control is to include an “order of precedence” provision that expressly identifies which contract document controls in the event of a conflict. Further complicating matters, several courts have held that a subcontract cannot incorporate by reference a document that is not yet in existence or not made available to the subcontractor at the time of the execution
of the subcontract. Thus, it is important to make sure the prime agreement is both executed and made available to the subcontractor prior to the execution of the subcontract.

Conclusion

Flow-down or incorporation by reference provisions can greatly affect a party’s right to a specific claim, or defenses. Such clauses can also affect the method and location of dispute resolution, such as whether mediation, arbitration, or litigation in a specific jurisdiction is required.

• So now that you know the risk, here are some final points on how to negotiate your contract:
• Do not generally incorporate all terms of the prime contract, but be specific as to what responsibilities from the prime contract flow down to the subcontractor.
• Get a copy of any terms and conditions to be referenced in the contract—even from suppliers.
• If you don’t agree to the incorporation, strike it from the contract or, in situations like the New Jersey case, put in the purchase order to the supplier that no incorporation by reference to other terms is permitted.
  Ask your attorney about the enforceability of such clauses in the state your company is performing the work.

Shawn R. Farrell is a partner at Cohen Seglias in Philadelphia, Penn. For more than 20 years, he has represented general contractors, construction managers, owners/developers, subcontractors, design-builders, engineers, developers, and sureties in construction-related litigation. Shawn can be reached by email at sfarrell@cohenseglias.com or 267-238-4719.

Joe Sine is an associate at Cohen Seglias who concentrates his practice on construction litigation, assisting owners, contractors, and subcontractors on private and public projects. In recent years, he has handled cases relating to commercial, institutional, and residential construction, including heavy highway, hotel, pharmaceutical, school, and utility construction projects. Joe can be reached at jsine@cohenseglias.com or 267-238-4775.