Lump sum subcontract?   Perhaps not due to a recent ruling where the trial court said “No!” based on the language in the subcontract and contract documents generally incorporated into the subcontract.

This is a ruling on an interpretation of a subcontract and contract documents incorporated into the subcontract that I do not agree with and struggle to fully comprehend.  The issue was whether the subcontract amount was a lump sum or subject to an audit, adjustment, and definitization based on actual costs incurred.  Of course, the subcontractor (or any person in any business) is not just interested in recouping actual costs, but there needs to be a margin to cover profit and home office overhead that does not get factored into field general conditions.  

In United States v. Travelers Casualty and Surety Company, 2018 WL 6571234 (M.D.Fla. 2018), a prime contractor was hired to perform work on a federal project.  During the work, the Government issued the prime contractor a Modification that had a not-to-exceed value and required the prime contractor to track its costs for this Modification separate from other contract costs.  In other words, based on this Modification, the prime contractor was paid its costs up to a maximum amount and the prime contractor would separately cost-code and track the costs for this work differently than other work it was performing under the prime contract.   

The prime contractor hired a subcontractor to perform a scope of fireproofing work relative to the Modification.  The subcontract amount was $646,886 and the subcontractor claimed it was due and owing $376,609 upon completing the work and filed a lawsuit against the prime contractor’s Miller Act payment bond.  

The prime contractor argued that the subcontract amount was not lump sum and was subject to definitization, auditing, adjustment, and change, although it certainly is not uncommon by any means that a prime contractor working under a cost-plus scenario to enter lump sum subcontracts.   The subcontract contained the following language:

• The Contractor agreed to pay the Subcontractor for the complete performance of the Subcontract the sum of $646,886, subject to additions and deductions for changes agreed upon in writing…and Contractor further agreed to make all partial and final payments in accordance with the terms and provisions of the Subcontract Documents.
• The Subcontractor had to submit a complete and accurate schedule of various parts of the Subcontractor’s work aggregating the total sum of the Subcontract, itemized and detailed as required by the Contractor and supported by such evidence as to its correctness as the Contractor may direct.
• Each partial payment and final payment would be subject to final audit and adjustment and Subcontractor agreed to reimburse the Contractor for overpayment.
• The Contractor was entitled to make changes in the work that could cause an increase or decrease in the work.
• The Contract Documents including certain Federal Acquisition Regulation (FAR) clauses were incorporated into the Subcontract.

The subcontractor argued that this was not a unit cost contract, but a lump sum contract, and it did not agree to any such changes (such as those that would have removed a scope of its work).  Thus, the subcontractor completed its work and should be entitled to the subcontract amount.

The trial court did not agree with the subcontractor: “The Court finds that the Subcontract contains unambiguous language which shows the Subcontract amount was subject to definitization, adjustment, and audit, rather than being a fixed-price amount.”  United States, supra, at *6. 

Huh!!??!!

The language in the subcontract was relatively standard subcontract language included in most subcontracts.   The changes clause is standard that allows the contractor to increase or decrease the work and the subcontractor is required to proceed with any changes.  The schedule of values language is standard, which is nothing more than an administrative vehicle for purposes of allocating payment based on percentages of work performed.   The overpayment clause is relatively standard.  As the subcontractor argued, the subcontract amount was not based on specific unit costs measured against a specific unit of measurement.  The subcontract did not unequivocally state that the subcontractor would be paid a cost of the work plus a specific markup for profit and overhead.   Nothing of the sort and nothing identifying what should be construed a permissible cost of work versus an impermissible cost of work so that the subcontractor could specifically track its costs of work.  There was nothing that identified the subcontract amount would be reconciled based on the subcontractor’s actual costs of the fireproofing work.  If it did, then the argument that it was not a lump sum amount makes sense.  But, what is there to audit?  The subcontractor’s actual costs should be less than the fixed amount in light of a profit and overhead margin.  The subcontract did not identify what this margin should even be.  If it were a unit cost contract, that margin would be built into the unit costs.  If it were a cost of the work subcontract, as mentioned, it would clearly specify what the agreed markup was and the permissible costs of work to be tracked.  Also, nothing in the subcontract mentioned the subcontractor would only be paid its time and materials based on a specific labor rate where the profit and overhead would be built into the labor rate.

As it pertains to the FAR clauses, the trial court held that, “Incorporation by general reference only incorporates the quality and manner of the subcontractor’s work from the prime contract, not the rights and remedies he may have against the prime contractor.”  United States, supra, at *8.   This makes sense and, for this reason, the trial court held that the general incorporation by reference language only incorporated the FAR clause or the Modification at-issue only if they refer to the quality and manner of the subcontractors’ work.  Based on this, the trial court explained that language in the Modification requiring the prime contractor to track its costs was incorporated  into the subcontract because it related to the manner in which the work was to be completed.  This does not make sense as the prime contractor is tracking the fireproofing costs by buying out that scope at a fixed amount.  

The trial court’s interpretation based on rather common and standard subcontract language could ultimately turn every fixed price subcontract that requires an audit as a requirement of the subcontractor to track actual costs without any true understanding as to how actual costs are determined, reconciled, or what the appropriate markup should even be.

Please contact David Adelstein at dadelstein@gmail.com or (954) 361-4720 if you have questions or would like more information regarding this article. You can follow David Adelstein on Twitter @DavidAdelstein1.