INCORPORATION BY REFERENCE" IN TRADE CONTRACTS - WHAT REALLY FLOWS DOWNSTREAM?

A flow-down clause in a construction contract is a provision that incorporates by reference the terms of the prime contract into the subcontract. In theory, with a "flow down" clause, all obligations and duties of the general or prime contractor to the owner "flow down" to the subcontractor. In complex construction litigation, however, the issue of whether a subcontractor is effectively bound by operation of a "flow down" clause to a particular provision of the prime contract often arises.

A New York law case has discussed in detail regarding the important question of the enforceability of flow-down clauses in construction contracts.

In explaining the general principles involved, the Court stated:

The well-settled rule is that a reference by the contracting party to an extraneous writing for a particular purpose makes it a part of their agreement only for the purpose specified... Where incorporated matters refer to for a specific purpose only it becomes a part of the contract for such purpose only and should be treated as irrelevant for all the purposes.

Thus, certain, but not all, provisions in a prime contract can be enforced by a general contractor by asserting a "flow down" provision against its subcontractor.

The Court went on to observe, however, that:

In New York, this rule finds expression in the construction contract cases, which hold that general incorporation clauses in a construction contract, incorporating prime contract clauses by reference into a subcontract, bind the subcontractor only as to prime contract provisions relating to the scope, quality, character and manner of the work to be performed by the subcontract." (Emphasis added.)

These "scope, quality, character and manner of the work" type provisions go to the essence of the subcontractor's work since such work cannot be performed adequately without such standards being understood between the parties. As a result, the courts have held such provisions as having "flowed down" successfully against subcontractor and enforceable.

However, provisions other than those relating to the "scope, quality, character and manner" of the subcontractor's work, items which might be considered ancillary, will not bind the subcontractor unless the provision is specifically incorporated in the subcontract. The court distinguished, for example, critical dispute resolution provisions of a prime contract.

Provisions other than the scope, quality and character and manner of the work must be specifically incorporated to be effective against the subcontractor. In particular, clauses relating only to the resolution of the disputes are not incorporated by a mere general incorporation clause; instead clauses of this kind must be incorporated by language "sufficient and specific" to assure that the parties intended that they apply.

For the Subcontractor

From a subcontractor's perspective, it must realize that without such specific and expressed "flow down" language in its subcontract, it might not be liable to the prime to the same extent that the general contract is impacted by its prime contract. It should not be cajoled or coerced into giving up valuable rights because it was told such rights were not pursued in accordance with the strict dispute resolution or notice provisions of the prime contract between the general contractor and the owner.

G&C COMMENTARY

Increasingly, we encounter in our practice subcontract clauses which are simply unenforceable. Many general contractors can not seem to resist inserting overly self-protective clauses (e.g., "pay if paid") in their subcontracts. Subcontractors for their part must negotiate their subcontracts, and not accept them carte blanche. In doing so, subcontractors must be sophisticated enough to know what is enforceable and should be objected to and what would not be enforceable against subcontractors in any event. Understanding the difference should be an essential part of any such negotiations.

Henry L. Goldberg may be contacted by email, hlgoldberg@goldbergconnolly.com or by telephone, 516-764-2800.

©Goldberg & Connolly 2015

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