A prime contractor contracted with the City of Dallas to build levees around a water treatment plant. The contract called for excavation of two areas to create storm water detention lakes and for miscellaneous work such as trash removal, linear depth checking and surveying.

The prime contractor entered into two subcontracts with a single subcontractor, one for levee construction, the other for excavation of the storm water detention lake. Material excavated from the lake was to be used, to the extent it met specifications, for construction of the levees. After work began, the subcontractor discovered that the excavated material had a low plasticity index and could not be used to construct the levees. The subcontractor determined that it would need to manufacture fill material (by mixing sand and clay), which caused the subcontractor's costs to increase dramatically. When the prime contractor informed the city of the increase in costs to the subcontractor, the city said it would deny any claim.

The prime contractor and the subcontractor entered into a liquidation agreement allowing the prime contractor to file suit on behalf of the subcontractor against the city on a pass through basis. The prime contractor sued the city in U.S. District Court and obtained a favorable jury verdict. The city appealed to the 5th U.S. Circuit Court of Appeals. On appeal, the city argued that because there was no privity between it and the subcontractor, the District Court erred in concluding that the prime contractor could recover damages on behalf of the subcontractor. Because the Texas courts had never decided whether pass through claims were permissible, the 5th Circuit certified two questions to the Texas Supreme Court: (1) Whether Texas recognized pass-through claims; and (2) If yes, what are the requirements, if any, to assert a claim?

The Texas Supreme Court relied on Bruner and O'Connor on Construction Law (2003) as well as other secondary sources that define a pass-through claim as "a claim (1) by a party who has suffered damages (in this case, a subcontractor); (2) against a responsible party with whom it has no contract (here, the city); and (3) presented through an intervening party (the [prime] contractor) who has a contractual relationship with both."

The court looked to how federal courts handle pass-through claims. The court explained that in breach of contract actions against the federal government, contractors are permitted to pursue pass through claims. The court also considered how other states handle pass-through claims. The court found that "[o]f the nineteen states that have addressed this concept in published opinions, eighteen treat pass-through claims favorably, and only Connecticut explicitly rejects them." Joining the majority of state and federal jurisdictions that have considered the issue, the Texas Supreme Court held that pass-through claims would be recognized under Texas law. Interstate Contracting Corp. v. City of Dallas, 47 Tex. Sup. J. 434, 2004 WL 835705, 2004 Tex. LEXIS 354 (2004).

The court noted that "[p]rivity of contract, as a necessary predicate to suit on a contract, has a long and settled history in this State" but reasoned that "[a] contractor should be allowed to recover costs from the owner regardless of whether the contractor performed the work itself or through a subcontractor." Any other holding would result in a windfall to the owner because the subcontractor would lack privity with the owner, and the contractor would lack standing to sue the owner for damages suffered by the subcontractor. Citing a New Jersey case, Buckley & Co. v. State, 356 A.2d 56, 73 (N.J. Super. Ct. Law Div. 1975), the court reiterated that "the owner would be in the extraordinary position of being responsible to no one regardless of the nature or extent of its liabilities under the contract."

Even though a subcontractor is not in privity of contract with an owner, the court determined that pass-through claims recognize the continued liability of a contractor to its subcontractor. The court limited its decision to construction contracts involving owners, contractors and subcontractors, and explained that "[i]n this context, it is not potential liability but continuing liability that gives the contractor standing to sue the owner. Therefore, our recognition of pass-through claims does not run afoul of. requiring privity of contract and standing for a party to maintain a suit."

As for the requirements for presenting a pass-through claim, the court held that the contractor must have some liability upon which to base the pass-through claim. To defeat a pass through claim, an owner bears the burden of proving that the contractor would not be liable to the subcontractor if it refused to present the pass-through claim. These requirements comport with the long-standing rule requiring a party to have suffered some harm to have standing to sue.

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©2004 Thelen LLP