Careful: That Flow-Down Clause is Loaded (or, “How Incorporation by Reference” Can Leave Marks in Unintended Places)

We all do it. We all use multipart agreements, or structure transactions where multiple parties are agreeing to the same set of terms and conditions, or seek to bind remote parties to a unified set of obligations, because it makes sense to do that from any number of perspectives. In construction, the practice has existed beyond memory: use of “incorporation by reference” or “flow-down” clauses to impose consistent contractual obligations down the chain of privity is so common as to be remarkable only in its absence.  When done lazily, however, problems can result, particularly in the areas of dispute resolution, as illustrated by recent court decisions concerning arbitration clauses that were “incorporated by reference”.

In G&G Builders, Inc. v. Lawson, 794 S.E. 2d 1 (W.Va. 2016), a contractor who entered AIA A-111 (1997) contract form with a homeowner could not enforce the arbitration provisions of the AIA A-201 (1997) agreement, which are incorporated by reference into the A-111 because the owner had not been provided with a copy of the A-201 at execution. According to the West Virginia court, “…a general reference in one writing to another document is not sufficient to incorporate that other document into a final agreement.” The court ruled that, for incorporation by reference to be effective, the incorporating writing must make clear reference to the document incorporated so that the parties “assent is unmistakable…”; the document incorporated must be described “beyond doubt…”; and it must be certain that parties had knowledge of and assented to the incorporated document. The third part was the problem in G&G; where the owner had never seen the A-201, his argument that he never assented to it was compelling, and the court ruled that he couldn’t be bound by a document he never saw.

Similarly, sort of, in Schneider Electric Buildings Critical Systems, Inc. v. Western Surety Company, 231 Md. App. 27 (2017) a performance bond surety defeated an arbitration provision set forth in the prime contract, where the prime contract was incorporated into the performance bond. Significantly, in Schneider, the bond itself expressly required litigation (which created an ambiguity about what the surety agreed to do). The court ruled that the surety’s obligations extended only to its principal’s performance duties, but not to every ancillary contractual commitment, a facile means of harmonizing the bond form with the contract’s arbitration provision.

The common thread between G&G and Schneider is assent. In each case the court’s decision hinged on evidence that the party resisting arbitration had actually assented to the contract language requiring it. The homeowner in G&G never got a copy of the document purportedly binding him. In contrast, the surety was not party to the negotiation of the construction contract, though it presumably had a copy as part of its underwriting process. Although it guaranteed its principal’s contract performance, the evidence was strong that the surety did not contemplate arbitration of disputes arising under its bond. In each case there was genuine dispute over the fundamental terms of the agreement.

There are a few simple ways to avoid results like the above, which mostly add up to “don’t be lazy”. First, when entering an agreement with multiple parts or sets of conditions like the AIA A-111 (1997), attach all the parts to the execution set rather than referring to them in the abstract, and make sure everybody gets a copy and acknowledges receipt. Second, carefully check incorporated documents for consistency with one another (or, if you can’t do that use a priority clause identifying the controlling document). Third, when surety is required involve the surety early and be sure that its bond form dovetails with the contract. Avoid the easy, broad-brush approach. The time it saves is not worth the pain that can result.

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The opinions expressed on this blog are those of the author and are not to be construed as legal advice.

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