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After a project owner terminated its prime contractor and paid an outstanding invoice owed to the subcontractor, it subsequently filed suit against the subcontractor alleging negligent construction and breach of contract.  Summary judgment was granted, and affirmed on appeal for the subcontractor, on the basis that (1) the Owner had no privity of contract with the subcontractor, (2) the Owner was not an intended third party beneficiary of the contract between the subcontractor and the general contractor, (3) the subcontractor owed no common law duty of due care to the Owner, and (4) the economic loss doctrine barred recovery by the Owner. McGreggor Enterprises, Inc. v. Hicks Construction Group, Inc., 2012 WL 28538 (TX 2012).

The subcontract in question was one that the court called an Associated General Contractors of America (AGC) “Standard Form of Agreement Between Owner and Construction Manager.”  In response to the subcontractor’s motion to dismiss based on lack of contract between itself and the owner, the owner argued that it was an intended third party beneficiary.  It based that argument on the following subcontract language:

 “SUBCONTRACT WORK.  To the extent terms of the agreement between the Owner and Contractor (prime agreement) apply to work of the Subcontractor, Contractor assumes toward Subcontractor all obligations, rights, duties and redress that Owner assumes toward Contractor.  In an identical way, Subcontractor assumes toward Contractor all obligations, rights and redress that Contractor assumes toward Owner and others under the prime agreement.”

 In reading that language, the court found no clear intention to create third party beneficiary status for the Owner.

The Owner, however, argued that even if the subcontract did not expressly create any third party beneficiary right for the Owner, there became a directly contractual relationship once the Owner paid the Subcontractor for the unpaid balance due on its services.  In rejecting that argument, the court explained that the subcontractor’s work had already been completed as of the time the Owner terminated the general contractor, and the only matter remaining was for final payment to the Subcontractor.  There was no assignment of the contract between the general contractor and the subcontractor.  Nor was there any evidence presented about terms of any alleged contract between the subcontractor and the Owner.  “Rather, [Owner] simply asserts that, because the final invoice was sent directly to [Owner] and was paid directly to [Subcontractor], the two had entered into a contract.”   The court said the Owner was essentially asking the court to “imply a contract.”  And this the court would not do, finding instead that “the payment was nothing more than the final act of the Subcontractor under the previously existing contract.”

Common law duty by the Subcontractor to perform its work in a good and workmanlike manner does not exist says the court.  The only remedy the Owner has would be against the general contractor who could then bring an action against the Subcontractor.

Negligence based action against the Subcontractor was dismissed pursuant to the economic loss doctrine.  The Subcontractor correctly argued that since it performed its work under contract to the general contractor “it only owed duties pursuant to the contract … and not duties relating to tort law.”  The subcontractor asserted “the loss [Owner] is suing for is economic loss directly related to the subject matter of the contractual relationships between the parties and, therefore, is not a viable subject for a tort action.  This is known as the economic loss rule.”  The court agreed, and concluded “We hold that the economic loss rule would prevent [Owner] from maintaining a cause of action against [Subcontractor].”

Comment:  The language of the subcontract in this case did not state that there would be any third party beneficiary rights for the project owner.  If it had done so, the outcome of this decision would have been much different.  The Subcontractor would have owed contractual duties directly to the Owner and the economic loss doctrine could not have been used as a basis for summary judgment.  It is important when subcontractors are reviewing and negotiating contracts that they not, without careful consideration, agree to language making the project owner an intended beneficiary.  I am seeing more subcontracts on major projects establishing such third party rights for the Owners, and I’m not sure that subcontractors are paying sufficient attention to the ramifications of doing so.

About the author: Article written by J. Kent Holland, Jr.,  a construction lawyer located in Tysons Corner, Virginia,  with a national practice (formerly with Wickwire Gavin, P.C. and now with Construction Risk Counsel, PLLC) representing design professionals, contractors and project owners.  He is founder and president of a consulting firm, ConstructionRisk, LLC, providing consulting services to owners, design professionals, contractors and attorneys on construction projects.  He is publisher of ConstructionRisk.com Report and may be reached at Kent@ConstructionRisk.com or by calling 703-623-1932.  This article is published in ConstructionRisk.com Report, Vol. 14, No. 9 (Oct 2012).

Copyright 2012, ConstructionRisk.com, LLC