Drafting Construction Contracts: Ensuring the Right to Stay Miller Act Claims Pending Arbitration and/or Resolution by the Government.

7579416_sDisputes between the prime contractor and subcontractors are a common occurrence that a prime contractor should foresee—and adequately protect against—during the drafting of the applicable subcontract. This Insight discusses contractual language and legal enforcement of two dispute-related issues: (i) the ability of the prime contractor to stay a subcontractor’s Miller Act lawsuit for government-caused problems pending resolution with the government; and (ii) the ability of the prime contractor to force arbitration of subcontractors’ Miller Act claims, including second-tier subcontractors. 

A. Staying Miller Act Claims Pending Resolution by the Government.

In the event that a subcontractor files a Miller Act lawsuit arising out of or relating to government-caused problems, the timing of such a lawsuit may put the prime contractor in a problematic position. Federal courts generally do not enforce pay-when-paid or pay-if-paid clauses within subcontracts subject to the Miller Act, nor do courts generally enforce clauses that restrict the subcontractor’s recovery to the amount recovered by the prime contractor from the government. As a result, even after a prime contractor forwards the subcontractor’s claim to the government for consideration, the subcontractor may elect not to wait for resolution prior to pursuing a Miller Act lawsuit. By seeking immediately to enforce its claims directly against the prime contractor and its payment bond, the subcontractor may force the prime contractor to litigate and potentially pay the subcontractor prior to the government’s resolution of the subcontractor’s claim.

Fortunately, so long as the subcontract is drafted correctly and includes the appropriate language, a prime contractor can avoid the above scenario by obtaining a stay of the subcontractor’s lawsuit pending government resolution of the subcontractor’s claims. Subcontractors commonly argue that such a stay constitutes an impermissible waiver of its Miller Act rights, but this argument is misplaced. A distinction in the law exists depending on the level of specificity contained within the dispute provisions of the subcontract at issue, as discussed below.

1. Background

     Federal courts generally enforce the right of a prime contractor and subcontractor to contract for agreed-upon dispute resolution procedures. “The general rule is that parties are free to contract for dispute resolution procedures which, in effect, turn breach of contract claims into claims for relief under the contract.”[1] This general rule, however, is applied differently with respect to Miller Act claims. The Miller Act is construed liberally to protect subcontractors “from unscrupulous and insolvent general contractors,”[2] which has caused courts to review and apply dispute resolution procedures with increased hesitation and scrutiny. 

       Nevertheless, federal courts recognize that the Miller Act does not wholly strip contractors of their right to specify dispute resolution processes. Courts are generally willing to stay Miller Act litigation pending the government’s resolution of the subcontractor’s claim so long as the subcontract at issue contains a heightened degree of specificity. Under this analysis, the crucial and dispositive question is whether the language incorporating or setting forth the prime contract’s dispute procedures is considered “general” or “specific.”[3]

With respect to “general” incorporation, courts consistently prohibit the incorporation of a prime contract’s disputes clause into a subcontract by way of a general, non-specific incorporation clause (e.g., “everything in the prime contract is hereby incorporated in the subcontract”). For instance, in H. W. Caldwell, the Fifth Circuit denied a prime contractor’s motion to stay a subcontractor’s Miller Act proceedings pending government resolution. The subcontract at issue merely provided that the subcontractor would be bound to the prime contractor in the same manner as the prime contractor was bound to the government, as set forth by the following contractual language:

The Subcontractor agrees… to be bound to the Contractor by the terms of the General Contract between the Owner and Contractor, and the General and Special Provisions, Drawing and Specifications, and to assume toward the contractor all the obligations and responsibilities that he, by those documents, assumes toward the owner insofar as concerns the subject matter of the Agreement.[4]

Because the above language did not specifically incorporate the dispute resolution procedures of the prime contract, the court held that the subcontractor was not bound by the disputes clause of the prime contract. In so holding, the court observed, “Though these terms of the contract seem to bind the subcontractor to all the terms of the general contract, similar provisions have been held not binding with respect to the ‘disputes’ provision.”[5]

In DDC Interiors, Inc. v. Dawson Constr. Co., Inc., a federal district court similarly refused to enforce the prime contract’s disputes clause against a subcontractor when the subcontract did not specifically state as such. Because the prime contract’s disputes clause was “not specifically referenced anywhere in the subcontract,” the court found that incorporation was “general rather than specific” and therefore not enforceable against Miller Act lawsuits.[6]

In contrast, courts have granted motions to stay Miller Act suits where the subcontract at issue explicitly subjected the subcontractor to certain dispute resolution procedures. In United States v. Daniel, Urbahn, Seelye and Fuller, a federal court stayed a Miller Act suit where the subcontract expressly set forth that all owner-caused disputes shall first be decided by the project’s owner, the Atomic Energy Commission.[7] Similarly, in United States v. Dick/Morganti, a federal court stayed a subcontractor’s suit pending completion of the administrative resolution process expressly set forth in the subcontract.[8] The court recognized that a stay of litigation—so long as litigation will resume at some point—is not equivalent to a waiver of Miller Act rights and thus not subject to the same standard of specificity and clarity applied to waivers. In fact, further distinguishing a stay from a waiver of rights, the court noted that a stay of a subcontractor’s claims pending government resolution is often in the subcontractor’s best interests:

Indeed in many situations, the subcontractor may have a financial incentive to stay its Miller Act suit. For example, by staying the judicial proceeding, a subcontractor can avoid costly litigation and rely on the general contractor’s more ample resources to advance its claim through the Contract Disputes Act’s administrative process. Moreover, because the Contract Disputes Act includes stringent time limitations, resolution may be reached in a more timely manner.[9]

Accordingly, so long as the subcontract expressly incorporated and/or reasonably set forth the applicable disputes procedure, a court is therefore unlikely to stand in the way of a request to stay the proceedings pending government resolution.

2. Practical Considerations

     The ability of a prime contractor to obtain a stay against a subcontractor’s Miller Act lawsuit depends, as discussed above, upon the level of specificity contained in the subcontract. Consider, for example, the following clause:

To the extent a claim, dispute, or controversy arises out of, or relates to, problems caused by Owner or for which Owner is responsible (“Owner Disputes”), such Owner Disputes shall be resolved pursuant to the dispute resolution clause set forth in the Prime Contract.

This clause specifically incorporates the Prime Contract’s disputes clause, distinguishing itself from subcontracts where incorporation of the disputes clause was “general rather than specific.”[10] A court is therefore likely to allow the prime contractor to obtain a stay of the subcontractor’s Miller Act lawsuit pending resolution by the Owner.

Nevertheless, due to a relative paucity of applicable judicial decisions, the requisite level of specificity necessary to obtain such a stay cannot be ascertained with certainty. Dicta from one court, for example, has implied that, instead of merely incorporating the prime contract’s disputes clause, the subcontract perhaps should also “describe or discuss” the disputes clause within the subcontract.[11] Accordingly, when drafting the disputes clause of a subcontract, a drafter should do the following: (i) specifically incorporate the prime contract’s dispute resolution clause; (ii) explicitly set forth the relevant dispute procedures contained within the prime contract; and, (iii) for utmost caution, expressly set forth that the subcontractor shall agree to a stay of any action it files, including Miller Act suits, until the dispute resolution and appeals process between the prime contractor and government is exhausted.

B. Staying Miller Act Claims Pending Arbitration.  

Prime contractors often prefer arbitration for resolving subcontractor disputes in lieu of litigation in federal courts, and federal courts generally enforce arbitration provisions against Miller Act claims. Although the express language of the Miller Act requires plaintiffs to bring suit in federal district court within the same district in which the contract was to be performed, jurisprudence holds that the provisions of the United States Arbitration Act are not inconsistent with and not subservient to the Miller Act. As set forth by one federal court, the Miller Act therefore does not interfere with an agreed-upon arbitration provision:

No change in the terms of the contract is warranted merely by virtue of the fact that plaintiff brings a Miller Act claim…. The fact that this is a case under the Miller Act does not change the contract, or substitute that act for its terms.[12]

Moreover, courts have noted that arbitration clauses—including venue provisions—are not generally subject to heightened scrutiny since the venue and jurisdiction requirements set forth under the Miller Act were intended to benefit defendants, not Miller Act plaintiffs.[13] Accordingly, arbitration language does not constitute an impermissible waiver of a subcontractor’s Miller Act right to sue, and a prime contractor can successfully stay the litigation of a subcontractor’s Miller Act claims in federal court pending resolution via arbitration.

When drafting an appropriate arbitration provision, one potential scenario not to overlook is the possibility of Miller Act lawsuits by second-tier subcontractors against the prime contractor and/or its bond. It is often in the prime contractor’s best interest for such lawsuits also to be subject to arbitration requirements and/or consolidated with any claims alleged by the first-tier subcontractor. The following is an example of an arbitration provision that addresses such a scenario:

The Prime Contractor and Subcontractor agree that all disputes between them shall be resolved by binding and final arbitration, which, unless the parties mutually agree otherwise, shall be in accordance with the Construction Industry Rules of the American Arbitration Association currently in effect. Subcontractor and Prime Contractor expressly agree that any arbitration pursuant to this Section may be joined or consolidated with any arbitration involving any other person or entity (i) necessary to resolve the claim, dispute or controversy, or (ii) substantially involved in or affected by such claim, dispute or controversy. Both the Prime Contractor and Subcontractor will include appropriate provisions in all contracts they execute with other parties in connection with the Project to require such joinder or consolidation and to require resolution of claims via arbitration.

So long as the prime contractor’s subcontractors include such arbitration requirements in contracting with their own subcontractors, the prime contractor can maintain its right to arbitration in the event of a Miller Act claim by a second-tier subcontractor. In fact, even if the second tier subcontractor simply sues the surety under the applicable payment bond, a prime contractor can intervene in the action and successfully stay the action pending arbitration.[14]

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[1] Seal & Co., Inc. v. A.S. McGaughan Co., 907 F.2d 450, 454 (4th Cir. 1990).

[2] United States v. Dick/Morganti, 2007 U.S. Dist. LEXIS 84750 (N.D. Cal Oct., 30 2007) (citing United States v. Weststar Eng’g, Inc., 290 F.3d 1199, 1205 (9th Cir. 2002)).

[3] See, e.g., Fanderlik-Locke Co. v. United States, 285 F.2d 939, 942-43 (10th Cir. 1960); H. W. Caldwell & Son, Inc. v. U. S. ex rel. John H. Moon & Sons, Inc., 407 F.2d 21, 23 (5th Cir. 1969); DDC Interiors, Inc. v. Dawson Constr. Co., Inc., 895 F. Supp. 270, 273-74 (D. Colo. 1995).

[4] H. W. Caldwell, 407 F.2d at 22-23.

[5] Id.; see also Fanderlink, 285 F.2d at 942-43.

[6] DDC Interiors, 895 F.Supp. at 273.

[7] United States v. Daniel, Urbahn, Seelye and Fuller, 357 F. Supp 853, 861-62 (N.D. Ill. 1973).

[8] Dick/Morganti, 2007 U.S. Dist. LEXIS 84750 at 9.

[9] Id.

[10] See DDC Interiors, 895 F. Supp. at 273-74.

[11] Id. at 274.

[12] United States ex rel. Humbarger v. Law Co., Inc., 2002 U.S. Dist. LEXIS 4702 at 7 (D. Kan. Feb. 20, 2002). See also United States v. ETS-Hokin Corp., 397 F.2d 935 (9th Cir. 1968); United States ex rel. De Lay & Daniels, Inc. v. Am. Emp’rs Ins. Co., 290 F. Supp. 139, 140 (D.S.C. 1968) (“The fact that this is a case under the Miller Act does not change the contract, or substitute that act for its terms.”).

[13] Id.; see also Am. Emp’rs Ins. Co., 290 F. Supp. at 140-41; Coken v. Nat’l Union Fire Ins. Co of Pittsburgh, PA, 103-CV-00222, 2003 WL 22937731 at *2-3 (M.D.N.C. Dec. 2, 2003) (unpublished) (allowing transfer of Miller Act case where there was an applicable venue selection clause in the parties’ subcontract selecting a federal district other than the district in which the project was performed and in which the suit had been brought).

[14] See, e.g., United States ex rel. MPA Const., Inc. v. XL Specialty Ins. Co., 349 F. Supp. 2d 934, 939-43 (D. Md. 2004); United States ex rel. Tanner v. Daco Constr., Inc., 38 F. Supp. 2d 1299, 1304-05 (N.D. Okla. 1999). In Tanner, the court noted that if a subcontractor could avoid arbitration requirements in a subcontract by suing only the surety, such a result would effectively render arbitration provisions meaningless. Stated the court:

[If] the Court were to deny defendants’ motion to stay, the arbitration mandate . . . in the subcontract would be rendered meaningless, and, in every public works project where the subcontractor agrees to a similar clause, the subcontractor could circumvent the arbitration provision by suing the surety. It seems grossly inefficient to have the parties arbitrate and litigate at the same time or bear unnecessary expense and the risk of inconsistent results. . . . [I]n the interests of judicial economy, it is more efficient for [contractor and subcontractor] to arbitrate the underlying dispute before requiring [the surety] to litigate the dispute in federal court.

Tanner, 38 F. Supp. 2d at 1306.