A subcontract defines, among other things:

• what a subcontractor is required to do,
• the time within which the subcontractor is required to do it,
• the consequences for the subcontractor if it fails to meet the time obligations,
• the assistance the subcontractor is required to provide to the main contractor to assist the main contractor in administering the main contract,
• the interfacing that is to go on between subcontractors, and
• the events entitling additional time and cost.

The subcontract constitutes both the rule book and the map for the subcontractor; defining what is required and the consequences of failing as well as broadly illuminating the manner in which the subcontractor may go about the task. The rules and the path of each project are different, and the requirements for each subcontractor on each project are also likely to be different. If the subcontractor is not provided with a clear and concise rule book and map, but rather a broad and generic indication of what is basically required, the subcontractor is unlikely to precisely perform as the main contractor would like.

Here are two common but dangerous habits in respect of subcontract drafting:

The ‘pro forma’ subcontract

It is quite common for major contractors to hold one or a number of ‘pro forma’ subcontracts, which are then routinely released to all subcontractors on all projects. There is an upfront time and cost saving benefit to this approach, as one subcontract can be drafted in a manner that seeks to allocate all transferrable risk onto the subcontractor, and the document can then be used repeatedly.

The major, and quite obvious, risks that arise from this strategy are that a pro forma subcontract will rarely, if ever, accurately address the relevant risks in the specific project, will rarely identify the subcontractor’s obligations with sufficiently clarity as to aid the subcontractor’s compliance and delivery, and will not take account of any specific or unusual main contract provisions. Indeed, the time and cost saving of pro forma subcontracts can very quickly be eroded by additional contract administration work and subcontractor supervision that can result form the use of a pro forma subcontract that is inappropriate for a specific project and does not effectively serve its function.

Rather, it may be appropriate to hold ‘draft precedent’ subcontracts, which may have been derived from previous projects and which contain the major necessary clauses and a typically suitable risk allocation. Such a document may represent a skeleton structure, around which the project-specific subcontracts can then be created. This will ensure that the end product is a bespoke subcontract suitable for the project, however the time and cost will be minimised by using a pre-existing base document. This is, of course, substantially different to rolling out the same pro-forma agreement to each subcontractor on each project.

The ‘back to back’ subcontract

Another common but potentially disastrous approach to subcontract drafting is to stipulate that the subcontract is ‘back to back’ with the main contract and the subcontractor is required to comply with all relevant obligations of the main contract. Commonly, this brief form of subcontract will include a copy of the main contract as an appendix.

This is fraught with problems and is, in many ways, a completely unreasonable way to contract with subcontractors. Under this strategy, the main contractor is effectively saying that the subcontractor is required to identify all the obligations that may be relevant under the main contract to the performance of its works, and to then comply with the obligations it has identified. There is a significant risk of the subcontractor failing to identify all of its obligations and consequentially failing to meet these obligations. There is also a risk of disputes regarding the interpretation of the main contract with respect to the subcontract works. In circumstances where the main contract is administered by an engineer, there may be issues with the administration of the subcontract, particularly regarding whether the main contractor has the authority to act as the ‘engineer’ when administering the subcontract.

As with ‘pro-forma’ subcontracts, briefly drafted ‘back to back’ subcontracts risk exposing a main contractor to significantly greater administration hassles and pose a threat to the efficient delivery of the subcontract works. In the event of formal dispute in respect of an insufficiently drafted ‘back to back’ subcontract, there is a high likelihood of greater legal fees being incurred and a longer and more complex process for resolving the dispute that would be the case if a clear and accurately drafted bespoke subcontract had been used.

Subcontractors frequently hold the key to successful project delivery. It is therefore critical that main contractors draft appropriate subcontracts, administer subcontracts successfully and manage subcontractor relationships. The time and cost invested in bespoke subcontracts at the commencement of a project can return big dividends in terms of efficiency and smooth project delivery and can often provide some protection to the main contractor in the event that problems arise on the project.

By Sachin Kerur and William Marshall

We are, of course, speaking of subcontractors. Whether through management contracting or more traditional procurement, subcontractors continue to play a major role in project delivery and are often instrumental in on time and on budget completion. One would naturally then assume that the documentation and management of subcontracts would be a matter of prime importance for contractors and for the industry. In practice, however, the drafting and administration of subcontracts is often given insufficient thought and the management of subcontractors is often poor.
While every project and contract is different, we think there are four strategies that can assist in managing subcontractors and maximising successful project delivery.

1. Bespoke subcontracts – ‘back to back’ is not enough

It is perplexing that contractors will often spend significant amounts of time negotiating and understanding the issues within the main contract, and then seek to engage its subcontractors with an inadequate and imprecise reference to ‘back to back’ obligations. ‘Back to back’ has no precise legal meaning, and seeking to impose a wholesale risk transfer of all obligations in the main contract to each of the subcontractors does little to assist the subcontractor in delivering its works in the manner that is actually required by the main contractor.

The allocation of risk in the main contract is, of course, critically important to the main contractor, as is a detailed understanding of the risks and obligations contained therein. It is equally important, however, that the main contractor allocates appropriate and clear risks to each of its subcontractors in a manner that will ensure the subcontractor understands its express obligations and will be bound to deliver in a manner and at a time that will enable the main contractor to comply with its obligations. The only sure-fire way to achieve this is to draft bespoke subcontracts for each project and, in many cases, for each specific subcontracted scope of works. The issue of subcontract drafting will be addressed in detail in part 2 of this blog series.

2. Subcontractor cash flow fear

All but the largest of subcontractors are susceptible to cash flow risks and are painfully aware of their position in the payment hierarchy. In jurisdictions where ‘pay when paid’ clauses are legal and enforceable (such as the UAE), main contractors frequently utilise such clauses to protect their own cash flow position, to the detriment of the subcontractors. The protection of cash flow is a legitimate and necessary imperative for a main contractor, but it is equally important to discuss issues with subcontractors and to explain the reasons for delayed payment and the likely solutions to the subcontractor’s concerns. This managerial ‘hand holding’ can go a long way to reducing subcontractor fear and subcontractor disputes, delivering an appreciable efficiency gain for main contractors in terms of management and administration time. Maintaining a dialogue with subcontractors is important to mitigating the potential fall out from slow payment.

3. Co-ordination and programming

The role of a subcontractor is often quite simple – deliver a precise scope of work within a precise time. While simple in isolation, the interaction of many subcontractors working on the same site and the issues of overall project deliver can affect the practical ability of the subcontractor to deliver its required works. Problems of access often arise and efficiency is often lost when multiple subcontractors are working in a small area on the same site. These issues increase the risk for subcontractors and can create a hostile atmosphere on site. This in turn creates risks for the main contractor due to potential disputation and a likelihood of more adversarial subcontract management from subcontractors, resulting in more claims and the need for an investment of additional administration and management time by the main contractor.

One solution is, of course, to seek to program the performance of subcontractor’s works in a manner that will minimise the concurrent performance of works in the same part of the site but this is often not an available solution. It is important to ensure there is adequate coordination and communication between subcontractors, ideally at project ‘toolbox’ meetings, so that minor hurdles to project delivery can be resolved before they impact on individual subcontractor’s programmes.

4. Relationships

It may be clichéd, but strong, positive relationships with subcontractors can prove to be good insurance for the main contractor when projects turn bad. The ability of the main contractor to deliver the project often rests in the hands of his subcontractors, meaning that the assistance of subcontractors to overcome project delivery problems can reduce the likelihood of ‘up the line’ disputes for the main contractor. Main contractors should for that reason seek to strengthen relationships with subcontractors. Using the same subcontractors on subsequent projects and developing an understanding of the subcontractor’s business can assist in building such relationships.
Subcontractors frequently hold the key to successful project delivery. It is therefore critical that main contractors draft appropriate subcontracts, administer subcontracts successfully and manage subcontractor relationships. In Part 2, we will consider the use of standard form subcontracts or pro-forma subcontracts and the risks involved in this strategy.

By Sachin Kerur and William Marshall

As a consequence, who will bear the risk of non-payment has becomes a frequent negotiation point, particularly so during periods of economic uncertainty. Imagine that two sophisticated corporations spend thousands of dollars and hundreds of hours of the best legal talent available to negotiate a contract for the construction of a large project to be located in the United States. The negotiations are lengthy and contentious; they are the very definition of ‘arms-length’.

As with all negotiations, the give and take often involves an adjustment to the contract price in exchange for amendment of a certain risk allocation or other material term. At the end of the long process a final deal is struck and the contract is executed. Imagine further that as part of the negotiations, the contract price was increased in exchange for a “pay-if-paid” clause, i.e., a clause that says the construction manager has no obligation to pay the subcontractor for work, unless the owner first pays the construction manager for that work. Under these circumstances, where there is no reason to question the validity of the contract, it would be natural under general principles of U.S. contract law, where “freedom of contract” supposedly reigns, to expect that all of these contract provisions would be enforced as written.

But the aforementioned negotiations involved a third-party. A party that was silent during all of the negotiations, but who gets the final say regarding every provision she wants to influence: public policy. And in some states, public policy will invalidate a provision to share the risk of non-payment through a ‘pay-if-paid’ clause.

In New York, for example, the Court of Appeals (New York’s highest court) has held that a “provision which forces the subcontractor to assume the risk that the owner will fail to pay the general contractor is void and unenforceable as contrary to public policy.” West-Fair Electric Contr. v. AETNA, 87 N.Y.2d 148 (1995). The basis of the Court of Appeals decision was New York State’s mechanics’ lien law, which provides that subcontractors have the right to file a lien against real property to which they have contributed manpower or material to improve. Because a pay-if-paid clause threatened that right, such clauses were found to be contrary to public policy. So much for freedom of contract!

By Jeffrey Gans