As with any legal issue, the response is never black and white, but yes, a subcontract dispute may ultimately be governed by federal law if there is sufficient federal interest.
Most contracts include a choice of law provision setting out what substantive law the parties agree will govern any dispute that may arise between them. Because subcontracts are commercial agreements between private parties, the controlling law will likely be that of the state of either or both of them or where the work is being performed. Moreover, even if the parties have not identified the applicable law, the default application will normally be state law.
However, instances occur where courts will override the application of state law. Noting that there is generally considered to be no privity between a subcontractor and the government and that applying state law to the construction of contracts between government contractors and their subcontractors is standard, courts have nevertheless held that certain private contractual arrangements are of such importance that uniform federal law must be applied irrespective of the parties’ intent or state law.
The question, then, is what constitutes sufficient federal interest.
In one instance, a disputes clause in a subcontract was interpreted by the dispute procedures applicable to the prime contract. U.S. v. Taylor, 333 F.2d 633 (5th Cir. 1964), adhered to on reh'g, 336 F.2d 149 (5th Cir. 1964). The court determined that the “expeditious administrative determination of disputes arising under [the subcontract was] a matter of such importance to the federal government that the law controlling such determinations between the government and prime contractors so far as applicable should apply to the construction of the disputes clause.” In this case, the government was an assignee of the prime’s claims against the sub for contractual overpayments and sued the subcontractor on those claims. And it supervised most of the work on a cost-type contract for the construction of a gas diffusion plant.
Another example is Danis Industries Corp. v. Fernald Envtl. Restoration Mgt. Corp., 947 F. Supp. 323 (S.D. Ohio 1996). Here, the issue was whether the parties’ choice of law provision, which attempted to confer subject matter jurisdiction on the federal court by choosing federal law, was valid. The court determined that sufficient substantial federal interests were present so as to apply federal common law, upheld the choice-of-law provision, and retained jurisdiction. It reasoned sufficient federal interests were present because the prime contract was for the clean-up of a government facility once used to construct nuclear weapons, taxpayers were the ultimate payor, and the clean-up effort would have significant impact on the local community
The takeaway for primes and subs on this point is to be prepared for the fact that despite agreement on specific terms in a subcontract, an instance may arise where a court determines that federal common law applies instead of state law. Meaning, the parties will want to survey the law and make a reasonable determination on the likelihood that substantial federal interests would be triggered by the prime contract and consider how any application of federal law would impact a dispute.