The Virginia Supreme Court recently rejected a contractor's flow down liability claim against its subcontractors for a state construction project and defect claims asserted by the state against the contractor after the passage of the five year statute of limitations, rejecting among other things contractor's indemnity arguments. Below is a summary of the decision prepared by Vandeventer Black Construction Team attorney Gretchen Ostroff.

Supreme Court of Virginia Rules on Prime Contractor’s Flow-Down of Statute of Limitations to Subcontractors and Reaffirms Prior Decision on Enforceability of Indemnity Agreements

WHAT YOU NEED TO KNOW:

In a recent decision, the Supreme Court of Virginia found that general clauses incorporating provisions from the prime contract were insufficient to flow down to subcontractors the open-ended statute of limitations applicable to most public contracts, which can create gaps between a prime contractor’s liability to the owner and what it is able to recover from subcontractors for damages they cause. The Court also reaffirmed that agreements to indemnify a party for its own negligence are against public policy and therefore void in Virginia construction contracts.

On November 3, 2016, the Supreme Court of Virginia issued an important decision regarding subcontract flow down provisions. Hensel Phelps Construction Co. v. Thompson Masonry Contractor, Inc., addresses a contractor’s ability to flow down to subcontractors the open-ended statute of limitations applicable to certain Virginia public contracts and reiterates the Court’s prior ruling on the enforceability of indemnity provisions in construction contracts.

The dispute in Hensel Phelps arose out of a contract for construction of a student health and wellness center at Virginia Tech. As the prime contractor, Hensel Phelps hired several subcontractors to complete portions of the work. Twelve years after final completion, Virginia Tech sued Hensel Phelps to recover costs of repairing defective work on the project. Although Virginia’s statute of limitations on contract claims is five years, the statute of limitations does not apply to the Commonwealth, so claims against a contractor by a state agency—such as Virginia Tech—can be brought at any time.

Hensel Phelps settled the claim and in turn sued the subcontractors and their sureties (referred to in this article collectively as “subcontractors”) for breach of contract and indemnity. The subcontractors filed various motions, including to assert that Hensel Phelps’ claim was barred by the five-year statute of limitations. The trial court granted the motions, dismissing the lawsuit.

On appeal in the Supreme Court of Virginia, Hensel Phelps argued that the subcontractors waived their right to raise the five-year statute of limitations via flow downs in their subcontracts. Each subcontract contained a provision requiring the subcontractor “to assume any and all guarantee or warranty obligations owed by Hensel Phelps to [the owner] arising out of [performance of the subcontract].” Hensel Phelps argued that because it was indefinitely obligated to guarantee and warranty the work, the subcontractors were correspondingly obligated to Hensel Phelps. It also argued that a subcontract clause binding the subcontractors to Hensel Phelps “by the same terms and conditions which [Hensel Phelps] was bound to [the owner] under the Contract” flowed-down the unbounded statute of limitations to the subcontractors.

The Court disagreed, finding that neither of these general incorporation clauses waived the applicable limitations period, because they did not “expressly acknowledge the right to a limitations period or intent to waive that right.” The Court found that the subcontractors were not bound to the statute of limitations waiver in Virginia Code Section 8.01-231 because the subcontracts did not themselves contain a waiver of the statute of limitations and failed to incorporate by reference the waiver in the prime contract.

In an alternate argument, Hensel Phelps argued that its claims against the subcontractors did not arise until it settled Virginia Tech’s indemnification claim (in 2014), and therefore it had sued them within the five-year limit. The Court rejected this argument too. Relying on its prior decision in Uniwest v. Amtech Elevator Services, Inc., the Court found that the indemnification clause in the subcontracts was unenforceable because it required the subcontractors to indemnify Hensel Phelps for its own negligence, which in Virginia is prohibited in construction contracts. Consequently, the Court struck the entire indemnification provision from the subcontracts. Without this provision, the subcontracts imposed no obligation on the subcontractors to indemnify Hensel Phelps with regard to Virginia Tech’s claim. Importantly, the Court found that a properly drafted indemnity clause (compliant with Uniwest) would have preserved Hensel Phelps’ claim against the subcontractors.

The takeaways from Hensel Phelps are that:

1. Prime contractors cannot rely on general subcontract flow down clauses to extend the statute of limitations on claims against their subcontractors to mirror the statute of limitations (or lack thereof) applicable to claims by the owner. Hensel Phelps makes this clear on public contracts—where the statute of limitations does not apply to the Commonwealth or its agencies—but the principle probably applies equally where private parties agree to extend the prime contractor’s liability to the owner past the applicable statute of limitations. Contractors can solve this problem by including properly-drafted, specific indemnity provisions in their subcontracts acknowledging a subcontractor’s intentional waiver of its rights related to the statute of limitations and other issues the contractor wishes to flow down from the prime contract.

2. Contractors should review their indemnity clauses to ensure compliance with Uniwest—specifically the prohibition against indemnifying a party for its own negligence in a construction contract. An indemnity clause that violates this policy will not be reformed by the court to comply with the law—it will be entirely stricken, potentially leaving the prime contractor without recourse against subcontractors for losses they cause.

Hensel Phelps is a reminder to contractors to carefully review prime contracts and subcontracts and to consult with an attorney when negotiating these agreements to help minimize potential risks.