Third Circuit, Reversing District Court, Holds Subcontract Payment Clause Shifted Risk of Nonpayment by Owner to Subcontractor
Joseph T. Imperiale
December 20, 2011
Sloan & Co. v. Liberty Mutual Ins. Co. 633 F. 3d 175 (3d Cir. 2011)
IOC developed a waterfront condominium project in Philadelphia. Shoemaker was the prime contractor for the Project. Shoemaker retained multiple contractors, including Sloan, who was to perform drywall and carpentry work. Liberty Mutual was Shoemaker’s payment bond surety. At completion, IOC refused to pay Shoemaker nearly $6.5 million. Of that amount, $5 million was due to subcontractors. IOC claimed, among other things, that some of the subcontractors’ work was untimely and deficient. Because of this, Shoemaker refused to pay Sloan of the remaining balance due under its subcontract, $1,074,260.
In May 2007, Shoemaker sued IOC. Shoemaker learned that IOC’s financial situation would leave it unable to satisfy a judgment. Shoemaker therefore settled with IOC for $1 million. IOC was still unable to pay the full amount of the settlement. Shoemaker offered its subcontractors their pro rata share of the amounts paid by IOC, but Sloan rejected that arrangement.
Sloan made a claim on the payment bond. Liberty Mutual denied the claim asserting that paragraph 6.f of the Subcontract contained a pay-if-paid clause, which conditioned Sloan’s right to payment on Shoemaker’s receipt of payment from IOC.
In December 2007, Sloan sued Liberty Mutual in federal district court. Sloan later moved for summary judgment asserting that paragraph 6.f constituted a pay-when-paid clause, which deferred its right to payment temporarily pending Shoemaker’s receipt of payment from IOC. The district court granted partial summary judgment in favor of Sloan, rejecting Liberty Mutual’s position that Sloan’s right of payment was conditioned on IOC’s payment to Shoemaker. Liberty Mutual appealed the case to the Third Circuit Court.
The Third Circuit first looked at paragraph 6.f, which provided in relevant part, “[f]inal payment shall be made within 30 days after the last of the following to occur, the occurrence of all of which shall be condition precedent to such final payment…” Among those conditions listed was “IOC shall have accepted the work and made final payment thereunder to Shoemaker.” Another condition was “Shoemaker shall have received final payment from IOC for Sloan’s work.”
The Third Circuit held that the first subparagraph of 6.f stated unequivocally that IOC’s payment to Shoemaker was a condition precedent to Shoemaker’s obligation to pay. The Court stated the language was sufficient to create a pay if paid clause in the first paragraph of 6.f.
The Third Circuit also rejected Sloan’s argument that the parties created an override provision in the second paragraph of 6.f, which provided:
Notwithstanding anything to the contrary in this paragraph 6.f, if within six months of the date that final payment is due to [Shoemaker by IOC], [Sloan] has not received final payment for its work, [Sloan] may pursue its claim against [Shoemaker] and its surety [Liberty Mutual] for final payment as follows:
If within six months of the date that final payment is due and payable to [Shoemaker], [Shoemaker] commences legal proceedings against [IOC] … to resolve its own claim for final payment [Sloan] agrees not to pursue its claim against [Shoemaker] or [Liberty Mutual] until the contract or dispute resolution and all appeals thereto are completed and become final ….
Upon completion of the contract or dispute resolution …, [Sloan] may pursue any remaining claim for final payment it may have against [Shoemaker or its surety].
The Court found that the language of the second subparagraph demonstrated that the contracting parties intended Sloan to have a claim against Shoemaker for any remaining claim for final payment in certain instances, specifically in the event that IOC failed to make payment defined as the entire unpaid balance of the prime contract within six months. The Court stated to understand what the parties intended it must read paragraph 6.f in connection with paragraph 20, the dispute resolution paragraph. Paragraph 20 provided in relevant part:
In the event [Sloan] asserts a claim for payment of the subcontract sum or a portion thereof in the event [Shoemaker] in its sole exclusive and arbitrary discretion submits such claim to [IOC] for a decision or determination, then all decisions and determinations made by [IOC] and its representative shall be binding upon [Sloan] even though [Sloan] may not be a party thereto ….
The decision or determination of [IOC] or its representatives making the first and/or original decision shall be final and conclusive on [Sloan] except to the extent that [Shoemaker] may in its sole exclusive and arbitrary discretion … appeal to other representatives of [IOC] or commence a proceeding in court or arbitration or other dispute resolution form ….
Then in such events [Sloan] agrees to be bound [Shoemaker] to the same extent [Shoemaker] is bound to [IOC] by any final decisions of said other representative of [IOC] or of a court of competent jurisdiction or by any final or interim award issued in arbitration or by any final decisions issued in any other dispute resolution forum….”
The Court noted that liquidating agreements that enable pass through claims, such as paragraph 20, can also serve to limit the subcontractors’ recovery to the amount the contractor recovers from the owner. The Court concluded that paragraphs 20 and 6.f created a mechanism for passing through Sloan’s claims for final payment and to limit Sloan’s recovery to the amount that Shoemaker received from IOC for Sloan’s work. The Court noted that this outcome was consistent with the way in which the parties chose to allocate the risk of IOC non-payment. Further, the Third Circuit held the parties intended per the second paragraph of paragraph 6.f to share the risk of IOC’s non-payment. Accordingly, the Third Circuit held that Sloan’s claim against Shoemaker was limited to its pro rata share of the settlement proceeds.