Jonathan Cain | A bill of rights for subcontractors

Government subcontractors are usuallythought of as being at the mercy of theirprime contractors in obtaining paymentfor goods and services delivered by thesubcontractor to government customers.This problem becomes most acute when, for example,the prime defaults on its obligations to the governmentor has contract payments withheld for other reasons,such as to pay prior debts to the government.The subcontractor that hasfaithfully performed its primecontract and is entitled to paymentis left with a claim againstthe prime, but that claim maynot be worth much if the primeis weak financially. A subcontractortypically is unable to obtainrelief from the governmentbecause the subcontractor is nota party to the prime contract andthus lacks privity, the standingrequired to enforce a contract,against the government.If the subcontractor couldobtain that standing, it would have away to obtain payment for the goodsand services that it provided to thegovernment under its subcontractdirectly from the source of the funding.One of the few ways in which thesubcontractor achieves standingto make a direct claimagainst the government is to bedeemed a third-party beneficiaryof the prime contract.A subcontractor can claimthird-party beneficiary statuswhen the government's contractingoffice knows, or shouldhave known, that the government'spayment on the prime contractwas intended to directly benefit thesubcontractor. A difference existsbetween the contracting officer'sknowledge that a subcontractor willbe contributing to the performance ofthe prime contract and knowing thatthe government's payments areintended to directly benefit the subcontractor.Establishing this relationshipis not easy for the subcontractor.The U.S. Court of Appeals for theFederal Circuit gave some guidance ina recent case. A prime contractoragreed to manufacture goods for thegovernment and subcontracted part ofthe work. After several months, theprime stopped making timely paymentsto its subcontractor. The subcontractornotified the prime and the governmentthat it would make no further deliveriesuntil it was paid. Upon receipt of thisnotice, the contracting officer notifiedthe prime that it was aware of the paymentproblem and threatened defaulttermination and debarment if the issuewas not resolved.The prime and the subcontractorthen negotiated an agreement bywhich the prime agreed to have theagency make its contract payments toa bank and for the bank to pay thesubcontractor out of the receipts. Thecontracting officer agreed to this.When the government made thepayments to the bank, it withheldamounts that the prime owed to thegovernment under other contracts.As a result of the holdback, however,the payments were not sufficientto pay the subcontractor. The subcontractorsued the government, the governmentargued that the subcontractorlacked privity, and the Court ofFederal Claims dismissed the case.On appeal, the Federal Circuit heldthat government could not withholdfrom the subcontractor money thatthe government could have withheldfrom the prime contractor becausethe subcontractor had become athird-party beneficiary of the contract.By entering into the bank paymentarrangement with the contractingofficer's consent, the subcontractorestablished that the paymentswere for its direct benefit, and itcould not be liable for any amountsdue the government from the prime.Entering into such a paymentarrangement as part of the subcontractmay be worthwhile when dealingwith a prime that is financiallytroubled or has significant unsatisfiedobligations to the government.