Leapfrogging Privity - Preserving Owner-Direct Claims Against Subs

by Snell & Wilmer

Utah law requires that owners’ claims against general contractors and design professionals with whom the owner has direct contracts (collectively referred to hereafter as “generals”) and their respective subcontractors and subconsultants (collectively referred to hereafter as “subs”) for construction and design defects be based upon contract rather than tort. This does not present a problem when owners bring claims against generals with whom they are in privity, but does present problems when owners want to sue subs directly, a situation that often arises particularly in design-related cases. Thus, owners must be vigilant when contracting with their generals to ensure that generals include language in their subcontracts and consulting agreements (collectively referred to hereafter as “subcontracts”) that provide owners with third-party beneficiary rights to pursue claims against the subs. This has become even more necessary in today’s construction industry when even venerable and trusted generals are struggling to survive.

Utah courts long ago concluded that when dealing with construction claims, Utah courts would not accept negligence and negligent misrepresentation claims that many other jurisdictions embrace.[1] This was a conscious decision. The Utah courts’ reasoning was based on the economic loss rule and the “importance of the parties' right to negotiate the terms of a contract, limited only by statutory prohibitions or public policy.”[2] The Utah legislature subsequently codified the economic loss rule and required plaintiffs in a construction or construction design defect case to be “in privity of contract with the original contractor, architect, engineer, or the real estate developer.”[3]

To overcome this rule in Utah, an owner is best served by ensuring that the subcontracts identify the owner as a third-party beneficiary. “Third-party beneficiaries are persons who are recognized as having enforceable rights created in them by a contract to which they are not parties and for which they give no consideration.”[4] To be a third-party beneficiary under Utah law, a plaintiff must show that the contract was “undertaken for the plaintiff's direct benefit and the contract itself must affirmatively make this intention clear.”[5] To determine this intent, the court must “look to the language of the contract to determine its meaning and the intent of the contracting parties [and] consider each contract provision . . . in relation to all of the others, with a view toward giving effect to all and ignoring none."[6] Thus, to preserve rights against subs, an owner is best served making sure that the direct benefits intended for the owner are reflected in the subcontracts. In addition to language in a subcontract that specifically states that the subcontract is intended to provide a direct benefit to the owner, two other potential options may exist for establishing a third-party beneficiary claim under Utah law: 1) incorporation of the prime contract into the applicable subcontract; and 2) a flow down provision in the subcontract.

The owner may require his generals to include language in the various subcontracts that incorporates some or all of the terms of the prime contract into the subcontracts.[7] By incorporating the terms of the prime contract into the subcontract, the owner ensures that the subcontractor “would be subject to and abide by the governing plans and specifications of the [prime contract]. In turn, that ensured [the general] would deliver to [the owner] ‘precisely the Project it…agreed to.’”[8] Although it does not appear that any Utah court has decided whether incorporating the terms of the prime contract into the subcontract makes the owner a third-party beneficiary, it stands to reason that if the terms of the prime contract call out distinct benefits to the owner and those benefits are incorporated into the subcontract, then the owner would or ought to be a third-party beneficiary of the subcontract.

The second potential option is for the owner to require the general to include “flow down” provisions in the various subcontracts. A “flow down” provision typically states that it is the intent of the parties to have the terms of the prime contract that are applicable to the sub’s work on the project flow down to the subcontractor. “Such clauses mean that ‘the same rights and duties should flow equally from the owner down through the general contractor to the subcontractor, as well as flowing from the subcontractor up through the general contractor to the owner.’”[9] “In effect, ‘[t]he parties to the subcontract thus assume the correlative position of the parties to the prime contract.’”[10] To date, it does not appear that any Utah case has articulated the circumstances under which flow down clauses create third-party beneficiary rights in owners. Considering the Utah courts’ requirement that parties to construction contracts negotiate the specific terms of their contracts, it would seem only logical that the courts adopt a rule that if the provisions of the prime contract “flow down” to the subcontract, then they provide a distinct benefit to the owner giving rise to third-party beneficiary rights against the sub.

In today’s constantly evolving construction industry, owners will want to maximize their protections against the errors of the subcontractors working on their projects. To do this, owners can maximize their rights by requiring that their generals include language, either direct language naming the owner as a third-party beneficiary of the subcontracts, or through incorporating the prime contract into the subcontracts, or having key terms of the prime contract flow down to the subcontracts, and by following up and obtaining copies of the subcontracts to make sure this was in fact done. Otherwise, the owner may just have a breach of contract claim against the generals who are now out of business.  This type of language and follow up should allow the owner to directly make subcontractors accountable to them.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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