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STA LEGAL LOG – FEBRUARY 2020

Is Your Liquidating Agreement Enforceable?
&
If So, What Are Your Responsibilities?

By Henry L. Goldberg, Legal Counsel, Subcontractors Trade Association
Partner, Moritt Hock & Hamroff LLP

Liquidating Agreements play a significant role in construction disputes in New York.   However, increasingly we are seeing a lack of understanding of what is required to have a legally enforceable agreement and what is required if you do. This is the first of a two-part article which will address these two aspects of liquidating agreements.

New York law is somewhat unusual regarding liquidating agreements. The basic rule is that an enforceable liquidating agreement requires “(l) the imposition of liability upon the general contractor for the subcontractor’s increased costs, thereby providing the general contractor with a basis for legal action against the owner; (2) a liquidation of liability in the amount of the general contractor’s recovery against the owner; and, (3) a provision that provides for the ‘pass-through’ of that recovery to the subcontractor”.

What does this all mean and why?

New York contract law is well settled that a subcontractor cannot sue an owner directly because it is not “in contract” or in “privity of contract” with the owner.  A subcontractor’s claim can only be pursued against an owner by using the general contractor as a privity “bridge” over the legal gap between the subcontractor and the owner.  New York courts take the position that for this “bridge” to be legally effective, the general contractor must affirmatively acknowledge liability so that the imposition-of-liability requirement (the first of the three set forth above), can be met.

While the imposition-of-liability requirement provides the legal “fiction” that the subcontractor has a contract bridge to the owner, this requires an uncomfortable admission by a general contractor of liability for the full amount of a subcontractor’s claim.   However, this can be limited, (as we have seen in requirement “2” above) to only the extent that a general contractor actually collects against the owner on behalf of the subcontractor.    In other words, this “liquidates,” or sets as certain, the general contractor’s liability.   It will only be to the extent the general contractor is successful in collecting against the owner on behalf of the subcontractor.

As with every contract, the covenant of “good faith and fair dealing” is implied in a liquidating agreement.  In the context of a liquidating agreement, it requires the general contractor to “take all reasonable steps” so that a subcontractor’s right to actually recover from an owner is protected.

What this actually requires will be discussed in more detail in the second part of this article.  In anticipation of that discussion, think of the consequences of a general contractor, for example, missing the statute of limitations on a claim against the owner, which would completely preclude a subcontractor’s claim.  Would that be “taking all reasonable steps”?   If not, how far must the general contractor go in pursuing the subcontractor’s claim to avoid additional liability?  That additional liability would, of course, be the loss of the protection a liquidating agreement provides the general contractor’s to limit exposure to its subcontractor to only what it collects on the subcontractor’s behalf from the owner.  How much resources must the GC expend in doing so?  What legal, (or claim consulting), fees must it incur?  (More on this in Part II.) To what extent must it be successful?

It is clear that many liquidating agreements in New York are not enforceable and lack the required imposition-of liability on the part of the contractor.  Many general contractors fail to prepare New York-enforceable liquidating agreements.  They commonly only provide for requirement “2” and “3” above, regarding the “liquidation of liability” and the “pass through.”

A liquidating agreement in New York can take many forms.  It can be a separate agreement or it can simply be incorporated in a subcontract itself.  Either way, it is perfectly acceptable,  and enforceable provided all three of the above requirements are clearly set forth.

Finally, complicating the matter, is a question of whether any of these three requirements can be “inferred” when not actually set forth in the contract.  In a recent New York appellate case, the court held that the critical general contactor’s “assumption-of-liability” for all of the subcontractor’s damages was “clearly implicit” when looking across two or more different documents.  Although the magic words regarding the general contractor’s “assumption-of-liability” were not present, the court, surprisingly, found that it was “clearly explicit in the expressed terms of the alleged liquidating agreement,” holding that it be contained in more than one document.  For example, from multiple emails, or as in this case, from ancillary documents “filling-in” legal deficiencies in an inadequate liquidating agreement.

There is often a question as to who benefits more from a liquidating agreement. It can be a win-win situation.  The subcontractor is able to pursue its claim against the owner, without incurring potentially extensive and legal and consulting fees, and doing so without having to directly sue its general contractor client.  The general contractor is protected to the extent that it avoids paying any out-of-pocket damages to the subcontractor for damages caused by the owner and can pursue a subcontractor’s claim as a “tag-along” to its own claim thereby limiting claim costs and fees.

As stated, liquidating agreements play a major role in construction disputes, and a basic understanding of them, and their enforceability, is essential.  More on the “use and abuse” of liquidating agreements next month.

Henry L. Goldberg, is a partner at Moritt Hock & Hamroff LLP, and the Chair of its Construction Practice Group. Please feel free to contact Mr. Goldberg directly at (516) 873-2000 or via email at hgoldberg@moritthock.com with any questions.