J. S. & H. Construction Company, Plaintiff-appellant, v. Richmond County Hospital Authority et al., Defendants-appellees, 473 F.2d 212 (5th Cir. 1973)

J. S. & H. Construction Company, plaintiff below in this diversity case, appeals from the district court's order staying further proceedings pending arbitration between J. S. & H. and defendant-appellee George A. Fuller Company.¹  We affirm.

George A. Fuller Company, a Maryland corporation with its principal place of business in New York, contracted as prime contractor with Richmond County Hospital Authority, Augusta, Georgia, to build a university hospital. The "General Conditions" of the prime contract included a provision that the parties would submit contract disputes to arbitration and that neither party had "a right of legal action" based on the contract until the arbitrators reached a decision.²  Fuller then entered into a subcontract with J. S. & H. Construction Company, a legal entity of New Mexico, under which J. S. & H. was to furnish labor and materials for the construction of the hospital. The subcontract contained no express arbitration provision, but it incorporated by reference the "General Conditions" of the prime contract and explicitly provided that the subcontractor assumed toward the prime contractor those responsibilities and obligations which the prime contractor assumed toward the Hospital Authority in the prime contract.³  Fuller and its surety, Aetna Casualty and Surety Company, executed a payment bond which guaranteed prompt payment for labor and materials used in the project and which provided that any action to recover on the bond must be brought within one year after Fuller ceased working on the project.

Within one year of the time Fuller ceased work on the project, J. S. & H. sued Fuller, Aetna, and the Hospital Authority in the district court for the value of work and materials supplied on the project and for damages resulting from breach of the subcontract by Fuller. The total claim exceeded one million dollars. The Hospital Authority cross-claimed against Fuller and Aetna, and the latter two defendants moved for a stay of proceedings pending arbitration between J. S. & H. and Fuller as provided in the "General Conditions" of the prime contract, which the subcontract appears to incorporate by reference. The district court granted this motion, and J. S. & H., wishing to avoid arbitration and proceed directly to litigation, prays on this appeal that we vacate the stay order.

J. S. & H. argues that the incorporation of the prime contract's "General Conditions" by reference was ineffective to make the prime contract's arbitration provision a part of the subcontract, so that J. S. & H. is not contractually bound to arbitrate. To support this position J. S. & H. cites several Miller Act⁴  cases⁵  which hold a similar general incorporation by reference in a subcontract insufficient to incorporate the disputes clause of the prime contract and argues that the policy considerations discussed in those cases apply with equal force to this case. Fuller and Aetna contend the arbitration provision was made part of the subcontract and seek to distinguish the Miller Act cases. Thus, the fundamental question on which the parties disagree is whether the arbitration provision was incorporated by reference into the subcontract.

We orient ourselves in this case by reference to two settled propositions, which no party disputes. The first is that in a contract "evidencing a transaction involving commerce," such as the subcontract in this case,⁶  arbitration provisions are "valid, irrevocable, and enforceable, save upon such grounds as exist at law or in equity for the revocation of any contract." 9 U.S.C.A. Sec. 2. In the Federal Arbitration Act, 9 U.S.C.A. Secs. 1-14, Congress has expressed a strong policy favoring arbitration before litigation, and the courts are bound to take notice of this broad policy as well as specific statutory provisions in dealing with arbitration clauses in contracts. The second undisputed proposition is that, as a matter of contract law, incorporation by reference is generally effective to accomplish its intended purpose where, as here, the provision to which reference is made has a reasonably clear and ascertainable meaning. These two propositions tend to indicate the arbitration provision in this case was a valid and enforceable part of the subcontract. The narrow contested issue which remains is whether the Miller Act cases create a special rule or exception which prevents incorporation of an arbitration provision by general reference in the subcontract in this case, which is not a contract subject to the Miller Act. Having examined these cases, we conclude they do not create such an exception.

In the Miller Act cases, the principal basis for judicial skepticism toward incorporation by general reference of the prime contract "disputes clause"⁷  has been awareness of the vulnerable position in which the disputes clause would place the subcontractor and of Congress's intent to protect the subcontractor by establishing specific statutory rights.⁸  The Miller Act provides that before the United States awards a contract for an amount over $2,000 for construction of a public building or public work to a contractor, that contractor must furnish a payment bond "for the protection of all persons supplying labor and material in the prosecution of the work provided for" in the contract. 40 U.S.C.A. Sec. 270a(a) (2). Upon default by the prime contractor, materialmen and laborers may sue on the payment bond in federal district court. 40 U.S.C.A. Sec. 270b. The bond required by the Act and the possibility of a suit on it often provide the subcontractor's only insurance against financial disaster due to a prime contractor's default. In no case does the subcontractor have a claim or lien against the government-owner. United States for the Benefit of B's Company v. Cleveland Electric Company, 4th Cir. 1967, 373 F.2d 585, 588. If the disputes clause were deemed a part of the subcontract, the nature of the obligation it would impose on the subcontractor is problematic. It would not provide for participation by the subcontractor in the administrative proceedings described in the disputes clause or for arbitration between the prime and the subcontractor:

There is no procedure by which the claim of the subcontractor can be presented against the United States except as it may become a claim of the prime contractor, since there is no contract, express or implied, between the subcontractor and the government. United States v. Blair, 321 U.S. 730, 737, 64 S. Ct. 820, 88 L. Ed. 1039. The subcontractor has no standing before the Contracting Officer or the Board of Contract Appeals, and no provision is made for the hearing of disputes between a prime contractor and a subcontractor.

Fanderlik-Locke Company v. United States for the Use of M. B. Morgan, 10th Cir. 1960, 285 F.2d 939, 942. Prime contractors have argued that the disputes clause would require the subcontractor to be bound by the result of the administrative dealings between the government and the prime contractor which are relevant to the subcontractor's claim. See, e. g., Fanderlik-Locke Company v. United States for the Use of M. B. Morgan, supra; H. W. Caldwell & Son, Inc. v. United States for the Use and Benefit of John H. Moon & Sons, Inc., 5th Cir. 1969, 407 F.2d 21. Courts have recognized, however, that this arrangement would amount to a virtual forfeiture of the subcontractor's Miller Act rights.

If [the subcontractor] is limited to the presentation of his claims as provided for in the "disputes clause" of the prime contract, he has surrendered his right to the benefits of the Miller Act provisions. The findings of the administrative authorities as to the amount he is entitled to recover would be conclusive, unless the court determined them to be "fraudulent, arbitrary, capricious, or so grossly erroneous as necessarily to imply bad faith." See 41 U.S.C.A. Sec. 321. An agreement should not be construed to bring about such a result unless it be "manifest by plain language" of the contract.

Fanderlik-Locke Company v. United States for the Use of M. B. Morgan, supra, 285 F.2d at 943. The very purpose of the Miller Act was "to provide security for those who furnish labor and material in the performance of government contracts," Id. 285 F.2d at 942, and "the courts do not favor finding that a subcontractor has contractually abandoned his rights under the act." H. W. Cald-well & Son, Inc. v. United States for the Use and Benefit of John H. Moon & Sons, Inc., supra, 407 F.2d at 23.

J. S. & H.'s position under the arbitration provision at issue in this case is significantly different from the position the subcontractors would have occupied under the disputes clause in the Miller Act cases. Under the arbitration provision J. S. & H. does not lose its right to press its claim against Fuller and need not passively rely on Fuller's presentation of a corresponding claim to the Hospital Authority. The arbitration procedure provided contemplates participation by both prime and subcontractor, and J. S. & H. may pursue and protect its own interests in the proceedings. The arbitrator's award may later be subjected to judicial scrutiny. A contract provision of this type requiring arbitration before litigation is not a harsh one or, we think, one which a subcontractor would probably not intend to accept by way of a general incorporation by reference. On the contrary, such a contract provision provides a common and rational means for settling contract disputes and accords fully with the policy of the Federal Arbitration Act. We find the rationale of the Miller Act cases inapplicable to the instant case, and hold that the prime contract arbitration provision was incorporated by reference into the subcontract and is binding on appellant J. S. & H. Cf. Uniroyal, Inc. v. A. P. Epstein & Sons, Inc., 7th Cir. 1970, 428 F.2d 523.

J. S. & H. makes an alternative argument which deserves only brief mention; it contends that even if the action on the subcontract was properly stayed pending arbitration, the action on the bond should not have been stayed. By its terms, the bond insures payment "for all labor and material used or reasonably required for use in the performance of the [prime] Contract." Any obligation under the bond must derive from a contractual obligation, and an action on the bond cannot precede a determination of the contract debt. The opposite conclusion would be inconsistent with the terms of the bond and would completely circumvent and render meaningless the arbitration provision which we have held to be a part of the subcontract.

The order of the district court staying proceedings pending arbitration is affirmed.