Construction projects are inherently risky on many different levels. The activities are potentially dangerous, contractors are required to assume legal responsibilities with respect to the scope, quality and timing of their performance, and certain rights may be limited under the contract documents. The risks and relationships that accompany a construction project can be varied and complex; therefore, it is crucial that a contractor understand the specific nature and scope of the risks and responsibilities it has accepted under a contract.
From a subcontractor’s perspective, the assessment of potential risk may be further complicated by the existence of a flow-down or incorporation by reference clause where the subcontractor is required to assume the obligations and responsibilities of the other party under a separate contract. A flow-down provision typically increases a subcontractor’s risks and may restrict available remedies, and the scope and enforceability of such provisions can represent a significant issue when claims or disputes over payment arise. In Ohio, a recent appellate court ruling has determined that the scope and/or applicability of flow-down provisions should be broadly construed, and, as such, a subcontractor’s ability to avoid such provisions would appear to be limited. KeyBank Natl. Assn. v. Southwest Greens of Ohio, LLC, 2013-Ohio-1243, 988 N.E.2d 32 (10th Dist.).
In Southwest Greens, the construction lenders initiated a foreclosure action and asserted related claims involving the construction of a retirement community that had yet to be completed. As the result of mechanics’ liens filed against the project, the general contractor and numerous subcontractors were joined in the action. Among other issues, the subcontractors maintained that their liens had priority over the construction mortgage given the record date of the original Notice of Commencement and the subsequent filing of the construction mortgage. The trial court ordered the parties to file motions for summary judgment on the issue of priority. The court ultimately granted the construction lenders’ motion, in part, based on the finding that the subcontractors had contractually agreed to subordinate their mechanics’ liens to the construction mortgage through language in the prime contract that was incorporated in the various subcontracts by reference.
The subcontractors appealed the trial court decision and, with respect to the subordination issue, argued that the prime contract and general conditions, which included the subordination language intended to be applicable to both the general contractor and all subcontractors, were not incorporated into their subcontracts. Id. at ¶ 10. In support of this position, the subcontractors contended that had the general contractor intended the prime contract and general conditions to be fully incorporated into the subcontracts, it would have attached such documents in full as exhibits and listed them specifically along with the other subcontract exhibits. Id. at ¶ 18. The subcontractors maintained that absent such incorporation, the parties did not intend for the prime contract and the general conditions containing the subordination clauses to apply to the subcontractors. Id.
In response, the construction lenders cited the flow-down provision in the subcontracts, which provided, in part:
Subcontractor shall be bound by the terms of the Prime Contract and all documents incorporated therein, including without limitation, the General and Supplementary Conditions, and assumes toward the Contractor, with respect to Subcontractor’s Work, all of the obligations and responsibilities that the Contractor, by the Prime Contract, has assumed toward the Owner.
Id. at ¶ 19.
The Court of Appeals recognized the enforceability of flow-down provisions and noted that the dispositive issue was whether the language of the provision in the subcontracts sufficiently incorporated the prime contract, and more specifically, the general conditions and the subordination clauses that the subcontractors sought to avoid. Id. at ¶ 20.
The subcontractors characterized the flow-down provision as one clause under which the subcontractors only agreed to be bound by and assume to the general contractor those obligations under the prime contracts and general conditions relating to the scope, quality, character and manner of the work to be performed under the subcontracts. Id. at ¶ 23.
By contrast, the construction lenders construed the flow-down provision as two separate clauses. Under the first clause, the subcontractors agreed to be bound by all documents incorporated into the prime contracts, including the general conditions that contain the subordination provisions; under the second clause, the subcontractors assumed the obligations of the general contractor pertaining to the subcontractors’ work on the project. Id. at ¶ 24.
Pursuant to its interpretation of the contract language, the Court of Appeals determined that the flow-down provision was not ambiguous and indeed contained two separate clauses as argued by the construction lenders. Id. at ¶ 28. In considering foreign authority cited by the subcontractors supporting a narrow construction of flow-down provisions, the Court of Appeals found that such authority could be distinguished from the current action and that Ohio courts and other jurisdictions have broadly construed flow-down provisions in analogous situations. Id. at ¶¶ 29-39. Ultimately, the Court of Appeals rejected all arguments raised by the subcontractors contesting the applicability and/or enforceability of the flow-down provision, holding that the provision at issue was drafted broadly and clearly bound the subcontractors to the terms of the prime contract, including the subordination provisions included in the general conditions. Id. at ¶¶ 44, 49. The court also rejected alternative theories raised by the subcontractors to secure payment from the construction lenders and affirmed the trial court’s decision in full.
Given the holding of Southwest Greens, subcontractors in Ohio should thoroughly review all documents incorporated by reference into their subcontracts and, to the extent possible, attempt to negotiate out documents and/or provisions that will create obstacles to securing payment or otherwise limit their rights in the event of a claim or payment dispute.