Notify contracting officer of prime’s failure to make subcontractor payment

Notify the government contracting officer in writing, promptly, if subcontractor payment by the prime is late.  While the government does not have “privity of contract” with a subcontractor (meaning the government’s contract is with the prime contractor, not with the sub), the contracting officer will often exert pressure on the prime contractor to make timely subcontractor payments.

Sometimes, the government will agree to modify the prime contract to require government contract payments be made jointly to the prime and a key subcontractor.  This status as an official joint payee gives rise to the subcontractor being considered a “third party beneficiary” of the modified prime contract.  If the goverment then fails to make joint payment as contractually agreed in the contract modification, and the prime does not pay the sub, the subcontractor can sue the government directly for breach of contract.

Subcontractor third-party beneficiary status upheld by courts

The United States Court of Appeals for the Federal Circuit recognized the subcontractor’s status as a third party beneficiary in such a case years ago.  D&H Distributing Company v. United States, 102 F.3d 542 (Dec. 12,  1996)  The government modified the prime’s contract requiring the government to make joint payments to the prime and subcontractor.  The government then failed to make joint payments as required by the modification, and the prime contractor failed to make subcontractor payment.  The Court of Federal Claims dismissed the subcontractor’s suit against the government, but the Court of Appeals for the Federal Circuit reversed the lower court.  The subcontractor as a third party beneficiary of the contract modification can sue the government directly for damages resulting from the government’s breach of the modified contract.   Further, even if the modification is interpreted as an assignment of rights under the contract, assented to by the government, the subcontractor can still successfully hold the government liable if it fails to make payment in accordance with the contract modifiation terms.  So under either theory – third party beneficiary, or assignment with the assent of the government – the subcontrator has a remedy directly against the government for failure to make the payment jointly with the prime as required by the modified contract.

Subcontractor payment on government contract not subject to setoff by government

One a subcontractor has status as a third-party beneficiary, the subcontractor is entitled to payment without any setoffs for amounts due to the government by the prime contractor on unrelated contracts.  Only government claims against the subcontractor can be setoff from payment due the subcontractor under the contract.  “Setoff is a device that facilitates the efficient reconcilation of competing claims between the same parties.”  J.G.B. Enterprises, Inc. v United States, 497 F.3d 1259 (Aug. 2, 2007).   In J.G.B., the United States conceded that JGB was a third-party beneficiary.  “A subcontractor is a third party beneficiary to the government contract when the CO knew or should have known that the government’s payment on the contract was intended to directly benefit the subcontractor” (citing the D&H  decision).  The government contracting officer was aware that the change in payment arrangements was intended to ensure payment to JGB.  Accordingly, JGB is a third-party beneficiary and the government cannot reduce the payment to JGB because the government has outstanding claims against the prime contractor.

Sue for subcontractor payment in the right court and beware statute of limitations!

The United States Court of Appeals for the Federal Circuit dashed hopes for a Navy subcontractor payment in the recent case of FloorPro, Inc. v United States, 680 F.3d 1377 (May 31, 2012).   The government and contractor entered a contract modification directing the government finance office to issue a joint check payable to the prime contractor and subcontractor.  (The prime was having financial troubles).  The finance office instead made the payment only to the prime contractor, who failed to pay the subcontractor.  Subcontractor FloorPro, Inc. communicated with the contracting officer, submitted a claim to the Navy, and filed an action against the Navy at the Armed Services Board of Contract Appeals (“ASBCA”).  The ASBCA said FloorPro was a third-party beneficiary and found the government liable for damages plus interest for the government’s breach of the contract modification.

When the government appealed, however, the Court of Appeals for the Federal Circuit said the ASBCA did not have jurisdiction under the Contract Disputes Act (“CDA”) to hear a third-party beneficiary claim.  The CDA applies only to contractors, not subcontractors.  The Court left the door open, however, for the third-party beneficiary subcontractor FloorPro, Inc. to sue the government in the Court of Federal Claims under the Tucker Act, 28 U.S.C. § 1491(a)(1).

FloorPro, Inc. did just that.  It filed suit against the government in the Court of Federal claims.  The government sought to have the case dismised based on the 6 year statute of limitations having run out.  The Court of Federal Claims found in favor of subcontractor FloorPro. Its decision turned on the interpretation of when FloorPro’s claim against the government accrued.  The government appealed its loss, and the United States Court of Appeals, Federal Circuit, vacated the lower court’s decision and ordered the lower court to dismiss FloorPro’s case for lack of jurisdiction.  The 6-year statute of limitations must be strictly construed since a waiver of the government’s sovereign immunity is involved.  FloorPro waited too long to sue in the right court. It didn’t matter that FloorPro had been pursuing payment by the government the whole time.

If subcontractor payment on government contracts is your problem, do not delay.  Contact Hindson & Melton LLC for representation.   The potential pitfalls are many, and our law firm can work with you to improve your chances of payment.
Karen S. Hindson – July 3, 2012

The Court was concerned about circumstances where small business concerns enter teaming agreements, with their primary contribution to the team effort being their 8(a) eligibility. In this case, an 8(a) janitorial service firm (C & L) obtained a multi-million dollar contract for mortgage loan servicing.

C & L’s subcontractor MGC in actuality performed more than 50% of the contract work, which violates the requirement that the 8(a) contractor perform at least 50% of the work. MCG wanted to be paid for the work under its subcontract. C & L and MGC wound up in a dispute, with C & L essentially trying to take over the HUD contract and cut its subcontractor out after using the subcontractor’s qualifications to get the contract award. The subcontractor sued C & L to enforce it’s subcontract and the Court refused to enforce it.

The Court found the subcontract unenforceable because it is against public policy – it hindered the 8(a)’s control of its contract and discouraged the development of the 8(a) firm. The Court also found the subcontract unenforceable as an agreement in furtherance of a unlawful purpose – the unlawful performance of a set-aside HUD contract. Finally, the Court found the subcontract unenforceable because under SBA regulations at 13 CFR Section 121, CLS as contractor could not be unduly reliant on its subcontractor. The subcontract yielded joint management to the subcontractor and gave the subcontractor the right to be paid for labor expenses in excess of the 50% limit. The Court quoted Quinn v. Gulf & Western Corp., 644 F.2d 89, 94 (2d Cir. 1981), stating “A court of law will not enforce an agreement which is illegal for the parties to make.”

The Court concluded that both parties contributed to the fraud and wrongdoing of the subcontract and that this tainted the HUD contract, rendering it void from the beginning. The Court declared that both parties had “unclean hands” and refused to enforce the subcontract, declared the HUD contract void, and notified the agency contracting officer of its decision.

Prior to entering its ruling, the Court tried to get the parties to settle their dispute, and expressed its concerns about the contract. The parties failed to resolve their issues and insisted that the Court rule. As a result, both parties lost their contract.

For more information about 8(a) contracts and subcontracts, contact government contract attorney Karen Hindson at Karen S. Hindson PC, government contract lawyers in Charleston and Atlanta.

OMB is required to establish a free public website containing full disclosure of all Federal contract award information. The public may view first-tier subcontract award data at http://usaspending.gov.

Contractors must now report executive compensation and first-tier subcontract awards on contracts and orders expected to be $25,000 or more (including all options), except classified contracts and contracts with individuals.

Reporting requirements are phased as follows:
1. Until September 30, 2010, any newly awarded subcontract
must be reported if the prime contract award amount was
$20,000,000 or more.
2. From October 1, 2010, until February 28, 2011, any newly
awarded subcontract must be reported if the prime contract award
amount was $550,000 or more.
3. Starting March 1, 2011, any newly awarded subcontract
must be reported if the prime contract award amount was $25,000
or more.

FAR 4.1400 requires the total compensation of the five most highly compensated executives of contractors and first-tier subcontractors to be reported by name and total compensation. There are certain exceptions which are detailed in the new FAR provisions, and certain definitions such as “compensation” are essential to fully understanding the new requirements.

For more information about the new requirements contact government contracts attorney Karen S. Hindson of Hindson & Melton LLC.