Liability Rolls Downhill: How Flow Down Clauses Can Harm You

Since the construction of multifamily projects typically involves several parties, it is crucial to craft your contracts with the utmost care. Failure to do so could greatly increase your risk of contractual liability to third parties, particularly when those provisions known as flow down clauses are involved.
Morgan Headshot thumbnail

Since the construction of multifamily projects typically involves several parties, it is crucial to craft your contracts with the utmost care. Failure to do so could greatly increase your risk of contractual liability to third parties, particularly when those provisions known as flow down clauses are involved.

It is common presumption that a multifamily developer who has signed an agreement with a general contractor is bound solely to the terms of the prime contract, unless expressly stated. And conversely, that subcontractors are only liable for the obligations set forth in the contract between them and the general contractor. However, the reality is often far more ambiguous. Contracting parties need to be especially wary of flow down clauses, which are commonly included in standard industry form contracts such as AIA forms. Also referred to as conduit or pass-through clauses, these provisions bind subcontractors to the rights, duties and obligations set forth in the prime contract.

The risks of signing a contract with flow down clauses are typified in the following case. Unaware that the lenders had pulled funding for a 1,500-unit retirement community project underway in Ohio, the subcontractors continued construction until the general contractor received official notification to suspend work on it. The subcontractors filed mechanic’s liens for approximately $9 million shortly thereafter, but the lenders filed a complaint for foreclosure of the mortgage and other related claims in the same week. The subcontractors argued that their liens had priority over the construction mortgage, but the trial court ruled in favor of the lenders in 2011 and the appellate court upheld the decision in 2013.

Read the entire blog here.