Afterthoughts: Flowdown Clauses

What are the three most significant errors contractors make when dealing with flowdown clauses?

1) I think the first error is just having a blanket provision in the front;  a blanket clause that says wherever you see the term “Government” insert “prime contractor” and wherever you see the term “contractor” insert “subcontractor”  because a number of the clauses just don’t work well that way.

2) Incorrect drafting or not complete enough drafting of a disputes provision that gives both parties the opportunity to resolve disputes in a reasonably efficient way.   This entails drafting  two provisions.  One provision for when a subcontractor claims that the government has caused it to incur additional expenses and will need  the prime to sponsor the claim.  The other provision is for disputes between the contractor and subcontractor where the government is not a participant in any way.

3) Overreaching.  Often primes are asking for too many rights from the sub.  The example that comes to mind is asking for the blanket right to terminate for convenience rather than attaching that right to government’s right to terminate for convenience.

 

Are there specific contract types (either at the prime-government or prime-sub level) that create a greater risk when clauses are not tailored as they are flowed down?

Subcontracts merit significantly greater risks when they are fixed price.  When a sub is asked to take a fixed price subcontract, it needs to first determine what type of contract the prime contractor has.  If the prime has a cost reimbursement contract and then wants the sub on a fixed price contract, it puts more risk on the subcontractor.  Primes may be inclined to fight even harder on the price when they know the government is going to look over their shoulder because they are operating under a cost reimbursement contract.

 

What sort of guarantees or protections should a prime contractor be concerned about with respect to establishing their subcontract arrangements?

A contractor has to flow down a whole series of mandatory clauses and then we talked about 6 or 7 non mandatory which the prime contractor has to flowdown in order to protect themselves.

These clauses, which we discussed on the webinar, include termination for convenience, termination for default, changes, dispute, and payment clauses.

Those clauses are going to be necessary — the only question is how broad a right a contractor should take.

 

What are the major considerations when structuring a disputes clause? 

I thought all along that the most important issue is the disputes clauses because they are so rarely done well.

There are two different dispute clauses to consider.

First, the disputes clause when the government has initiated some action – defective specs, government caused delay – that impacts the sub.

The sub can’t sue the government directly; they have to come through the prime and here the Severin Doctrine comes into play. Severin [Severin v. U.S., 99 Ct. Cl. 435 (1943) cert. denied, 322 U.S. 744 (1944)] held that if the contractor didn’t owe the sub anything then it can’t bring the claim. So the prime had to owe the sub something in order to sponsor a claim related to their issues.

What we have found is that you can draft a clause that says we [the prime] agree to bring the claim for you but all we are required to pay you is what we recover. If we/you lose the claim, you get nothing. This has been accepted by the courts as a way to solve the requirement of Severin that something be owed to the subcontractor. What overhangs this solution is that when the contractor brings the claim, or allows the sub to bring it in their place, the prime contractor has to submit the CDA certification. And that makes contractors pretty nervous because a lot of the times they don’t have full information that allows them to come to the conclusion that the claim is a winning suit or not or completely accurate. The requirement is clear that they [the prime] has to submit it, but they can explain when submitting the certification that, for some reason, they have not had full access to the information – because, for example, the sub is a competitor and will not give full access to internal information and costs. But it scares the contractor and makes it more difficult to submit these types of claims. So you have to come to some agreement in the subcontract about how you are going to handle this should it arise.

Now there are also disputes between the prime and the sub. Tim Sullivan, during the webinar, noted that he was not in favor of arbitration as a means of resolving such disputes even though it is pretty common to see these arbitration clauses in the subcontract. I’m inclined to agree for a couple of reasons. One, it is expensive. You have to pay for three arbitrators time and that can get costly. Two, it can be a bit cumbersome because when you set it up, you have to get three arbiters and all the other people involved (including attorneys, parties, and witnesses) committed to the same period of time. And if it doesn’t end within allotted time it can take some time to reconvene everyone. My guess is that we have actually seen a movement away from arbitration because it is so difficult. But we don’t have conclusive data to show if that is really true.

My recommendation would be to use mediation in lieu of that and deal with one mediator and agree that with the outside help you can resolve the dispute without having to litigate.

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