“Pass-Through” Agreements Minimize Costs, But Are Not Without Potential Pitfalls

Michael Strong
July 7, 2008 — 1,302 views  
Liquidation or “pass-through” agreements are becoming an increasingly popular option in both public and private construction disputes. Although these types of agreements can be used in several different scenarios, the most common example involves situations in which a subcontractor and general contractor agree that the owner is responsible for the damages claimed by the subcontractor.

Without a liquidation agreement in place, the subcontractor would be obligated to bring its claims directly against the general contractor, who in turn would sue the owner. This arrangement requires the involvement of additional parties, and as a result is expensive and time-consuming. In contrast, liquidation agreements allow the general contractor to “pass through” or sponsor the subcontractor’s claim by bringing a claim directly against the responsible party and agreeing to turn over what recovery, if any, it ultimately obtains. By avoiding additional layers of litigation, costs are minimized.

However, a number of issues dictate when and if a liquidation agreement is appropriate. First, courts are split on whether the general contractor has to pay, confess or admit liability to the subcontractor to sponsor the claim, or whether it is sufficient that the general contractor merely be exposed to the subcontractor’s claim.

Second, attempts to pass through claims may expose the general contractor to liability to the subcontractor in situations where the subcontractor does not agree that the owner is responsible for its claim, or the subcontractor does not agree to be bound to the result obtained by the general contractor.

When deciding whether the claim will be pursued directly by the general contractor, or by the subcontractor in the general contractor’s name, several concerns must be addressed. Among them:

If the general contractor pursues the claim directly, does it have a right to deduct its attorneys’ fees and costs incurred from any recovery?

  • Does the subcontractor have the right to participate, through its counsel or its expert, in the presentation of the claim?
  • How should the recovery be apportioned between the parties in the event the general contractor is also pursuing an additional, independent claim?
  • How would the recovery be divided between the general contractor and subcontractor in the event that a judgment or settlement fails to do so?
  • How would the claim be resolved if the general contractor and subcontractor do not agree on what is a viable and fair settlement?

Many of these issues can and should be addressed as part of the initial contract drafting stage of the project to potentially avoid the necessity of negotiating a new, separate “pass-through” agreement when a dispute arises.

Michael Strong practices business litigation and commercial litigation. He can be reached at (816) 460-5539 or [email protected]

Michael Strong

Lathrop & Gage L.C.