Following the construction industry and related legal topics in the United States.

Monday, June 16, 2008

NC Supreme Court Alters Incorporation by Reference

A recent case handed down by the North Carolina Supreme Court is likely to have a significant impact on how construction contracts are drafted in North Carolina.

In Schenkel & Shultz, Inc. v. Hermon F. Fox & Associates, 685 S.E.2d 918 (2008), the North Carolina Supreme Court held that the standard practice of incorporating the entirety of a prime contract into a subprime contract (e.g., subcontract or subconsultant agreement) by reference may be flawed. In Schenkel, the court considered whether Schenkel (the Architect) and Fox (the Engineer) intended to incorporate by reference the terms of an indemnification provision contained in the prime contract between Schenkel and the Charlotte–Mecklenburg Board of Education (the “Board”) in their subprime contract, the “Standard Form of Agreement Between Architect and Consultant (AIA Document C141 6th ed. 1987) (the “AIA C141 Agreement”).

The prime contract between Schenkel and the Board contained an indemnification provision that expressly provided for indemnification against loss arising from negligence or breach of contract. By contrast, the AIA C141 Agreement entered into between Schenkel and Fox only required Fox to perform its services “according to this Agreement with the Architect [Schenkel] in the same manner and to the same extent that Schenkel is bound by the attached Prime Agreement to perform such services for the Owner [Board].”

Fox contended that this language merely required it to perform its services in the same manner and to the same extent as Schenkel was to perform its services to the Board. Fox alleged that the term “services” should be construed narrowly so as to include only engineering services, and should not be broadly construed so as to include the indemnification obligations contained in the prime contract.

Schenkel responded that the language of the subcontract was a typical “flow–down” provision in which all the same rights and obligations of the subcontractor flow from the subcontract up through the general contractor to the owner, and conversely down the same contractual claim. Schenkel argued that the flow–down provision of the subprime contract incorporated by reference the entire prime contract, including the indemnification provision such that its subconsultant, Fox, should likewise be bound to the indemnification provision contained in its prime contract with the Board.

The Supreme Court agreed with the Court of Appeals and found that because the language of the AIA C141 Agreement was susceptible to differing yet reasonable interpretations, the contract was ambiguous and, therefore, summary judgment was inappropriate for either party. The Supreme Court sent the case back to the trial court for it to determine the “intent of the parties” with respect to whether the parties intended for the indemnification provision contained in the prime agreement to apply to Fox in the performance of its services under the AIA C141 Agreement.

The lesson to be learned from the Schenkel decision for construction law practitioners and professionals alike is to avoid the temptation to simply incorporate by reference the prime contract en toto. The better drafting technique, and the one that our Supreme Court appears to now require, is to expressly incorporate the provisions that the parties intend to govern in the event of a dispute, including, but certainly not limited to, the indemnification provision. (This entry published by Carson Culley, a member of Womble Carlyle's construction law practice group.)


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