Lori Samet Schwarz is a principal at Zetlin & De Chiara, a law firm in New York that serves the design, construction, and real estate industries.

Liquidating Agreements Can Streamline Litigation

Even when parties on a project do not have a contractual relationship, liquidating agreements may still allow recovery for damages.

by Lori Samet Schwarz

As construction projects become ever more complex, they amass a growing number of subcontractors and subconsultants. When there are significant changes to the scope of work or delays on a project, it is no longer just the owner and prime contractor who play the "blame game" - subcontractors today often contend that they have incurred damages as a direct result of an owner's conduct.

However, because a subcontractor is not in direct privity with the owner - meaning that the two entities do not have a contractual relationship - the subcontractor is limited to asserting its claims against the prime contractor that hired it. The prime, in turn, is left to try and recover those damages from the owner. Similarly, an owner can be damaged or delayed by a subcontractor's inadequate performance, yet the owner cannot assert its claims directly against that firm.

What results is often lengthy and costly litigation, particularly when the general contractor's prime contract does not impose the same liabilities as its subcontracts with subcontractors. As a result, liquidating agreements have become a useful tool to "bridge the privity gap between owners and subcontractors who sustain damages as a result of the others' actions," as stated in North Moore Street Developers v. Meltzer/Mandl Architects, a recent court decision in New York's Appellate Division, First Department.

The court faced an unusual spin on the topic, because the owner-developer of the project, North Moore Street Developers, had entered into a liquidating agreement with R.C. Dolner, the general contractor. In the agreement, the owner acknowledged and admitted liability for certain damages arising out of its own architect's errors, omissions, or design defects. The owner also agreed to liquidate that liability in the amount recovered from the architect and further agreed to pass through to Dolner the amount recovered from the architect on its behalf.

The agreement essentially allowed the owner to assert professional malpractice claims Dolner had made directly against the project architect, Meltzer/Mandl - even though there was no privity between the contractor and architect.

However, Meltzer/Mandl filed its own causes of action against various project parties. When third-party subcontractor defendants moved to dismiss the architect's causes of action, Meltzer/Mandl cross-moved to dismiss the owner's causes of action for damages claimed on behalf of Dolner. While a trial court had decided in favor of Meltzer/Mandl, the appellate court reversed that ruling and went to great lengths to instruct the trial court judge in how to properly apply the law.

Specifically, the appellate court raised two issues: (1) whether an owner can assert its independent claims against an architect in addition to those of the general contractor, and (2) whether an owner can enter into a liquidating agreement and admit liability to its general contractor even where it does not have any contractual liability. On both questions, the court answered yes.

The court cited another New York appellate court decision from 2001 in Bovis Lend Lease LMB v. GCT Venture, which states that to be enforceable "[l]iquidating agreements [must] have three basic elements: (1) the imposition of liability upon a party for a third party's increased costs, thereby providing the first party with a basis for legal action against the party at fault, (2) a liquidation of liability in the amount of the first party's recovery against the party at fault, and (3) a provision for the pass-through of that recovery to the third party."

In North Moore, the owner pointed to its contractual liability under the agreement with Dolner for delays caused by the owner itself and by those under its agency and control, such as the architect. The owner's complaint alleged that the architect's professional malpractice caused delays in excess of the 70 days provided in Dolner's contract, forming the basis for the owner's liability to Dolner.

While North Moore Street involves an unusual set of facts because the owner joined forces with the contractor against its own architect, it demonstrates the potential to streamline litigation by allowing for the creation of alliances that best suit the needs of the parties in the project. By picking the right relationships, litigants can focus on the primarily culpable party and circumvent the need for contractual privity in order for project grievances to be made whole.