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Nine Contract Provisions Subcontractors Need to Know

The Contract Shall Control

The role of the subcontractor in a construction project is unheralded and put upon, beset by the demands and requirements of general contractors, owners, and government agencies while meeting its own business obligations and trying to turn a profit. Frequently overlooked between “getting the work” and “getting the work done” is what should be treated as equally-important: contract review and, if possible, amendment. The contract not only serves to explain the rights and obligations between the parties, so that each, literally, knows what is expected of it, it also is the sole memorialization of those rights and obligations and consequently will serve as the (largely) unquestioned guide for a court or arbitrator if there is a dispute between the parties. Hence, it is incumbent upon the subcontractor to ensure that the contract is tailored adequately to the project and to understand its effect on the key aspects of the job. With that view, we can address nine common contract provisions that a subcontractor must give particular attention before signing on the bottom line.

1. Flow-Through Clause

The flow-through clause is a provision whereby the project’s owner imposes obligations and restrictions on a subcontractor despite that there is no direct contractual relationship between them. It accomplishes this by requiring that the general contractor’s contract with the subcontractor include a section stating that, generally, the project parameters agreed to by the general contractor also must become part of the agreement between it and its subcontractors (i.e., those agreements “flow through” to the subcontractors). The problem presented by a flow-through clause is not so much its substance, as these requirements often are not controversial and reflect common local practice, but that it offers no clear explanation of that substance. The subcontractor does not know to what it is agreeing. When presented a flow-through clause, then, a subcontractor should ask for a copy of the general contractor’s agreement. It can be redacted to hide confidential information (in anticipation of the general contractor’s only reasonable excuse for refusal). Otherwise, the subcontractor will have entered into an agreement that, at least in part, it has not even read.

2. Scope of Work

The primary issue regarding scope of work is the tension between the general contractor’s preference for generality and breadth and the subcontractor’s demand for specificity. At base, a nonspecific scope of work carries the threat that the subcontractor will be forced to pay unanticipated expenses. Further, scope-of-work issues are particularly problematic because they do not become apparent until the subcontractor is far into its work, if not done (at least from the subcontractor’s position). As a check against this issue, the subcontractor should confirm at the outset that the contract’s scope of work matches the work included in the bid proposal (fairly easy where the subcontractor also provided the design), ensure that the subcontract accurately states exclusions from the original bid and strike any “catch-all” provisions inserted by the general contractor. The telltale indication of these are statements to the effect that the subcontractor agrees to perform additional work necessitated by the subcontractor’s work as determined by the general contractor. A small provision, or even mere clause, that can lead to big cost.

3. Contingent Payment Clause

A contingent payment clause dictates those circumstances under which the general contractor becomes obligated to pay the subcontractor for its completed work. These provisions come in two different forms: “pay when paid” and “pay if paid.” The pay-when-paid clause simply determines the timing of payment to the subcontractor (after the general contractor is paid), but otherwise does not excuse the general contractor from its obligation to the subcontractor. The general contractor remains bound to pay the subcontractor regardless of whether the owner pays it. As for the “when” after the general contract is paid, the contractor should specify a number of days. Otherwise, the general contractor must pay within a “reasonable time.” Alternatively, the pay-when-paid creates an additional contingency for the subcontractor (beyond, for instance, completing the work) and shifts the general contractor’s risk of nonpayment onto the subcontractor. Clearly, the pay-if-paid clause should be avoided. Phrases indicating its presence include “condition precedent,” “subject to,” “upon condition,” and (obviously) “subcontractor assumes risk of nonpayment by owner.” Note that this punitive clause frequently is regulated or superseded by state statutes, include prompt pay laws, so a subcontractor need not despair if currently working under a pay-if-paid provision.

4. No-Damages-for-Delay Clause

The general rule is that a contractor (or subcontractor) can recover damages from the owner resulting from the owner’s delay or hindrance. In response, owners frequently insert a no-damages-for-delay clause into the prime contract precluding recovery of damages for owner-caused delay. This, in turn, affects subcontractors, as well, through operation of the flow-through clause. Instead of consequential monetary damages, the downstream parties are limited to an extension of time to complete the project. This, of course, can be no remedy at all, especially where the subcontractor has obligated most, if not all, of its resources to the present project and now is unable to meet its timetable for the next project in line. Further, no-damages-for-delay clauses usually are not affected by fair notice requirements. Rather, when presented with this provision, a subcontractor should insist that it be limited expressly by situations involving fraud, misrepresentation, bad faith or active interference by the owner and that it not operate against delays that otherwise would justify abandonment of the project or, better yet, that it only apply to types of delay specifically described in the agreement (all of which are common legal exceptions to these clauses).

5. Liens and Releases/Waivers

Lien law is state-law specific and, as a result, varies widely from jurisdiction to jurisdiction. Subcontractors almost certainly have familiarized themselves with the requirements of lien law in their respective states and are encouraged to do so. Some states permit waiver of lien rights and partial lien waivers are standard practice in those locales. The intended purpose is to cause a release of lien rights matched to claims for payment as they are satisfied. The subcontractor should be vigilant against lien waivers that release its right to payment for extra work performed by agreement, as well as payment for work performed for which payment is not yet due. Again, lien waivers should precisely relate to, and only to, work for which payment is made at that time. In a perfect world a subcontractor would refuse to sign lien releases but, as this is the real world, the subcontractor usually must be satisfied with reviewing and revising any promulgated release form before signing the contract.

6. Indemnification

Indemnification also is closely regulated by states and its character varies widely among them. Regardless, under certain circumstances its operation has the power to ruin a subcontractor financially. Broadly speaking, indemnification is the doctrine by which one party (the indemnitor) promises to safeguard or hold harmless another party (the indemnitee) from existing or future loss liability. There are three types of indemnity clauses: “limited,” which imposes liability only to the extent of the indemnitor’s fault of negligence; “intermediate,” in which the indemnitor assumes all liability except for the indemnitee’s sole negligence, and “broad,” which imposes the entire risk of loss upon the indemnitor, even for a loss event caused solely by the indemnitee (“I broke it, you fix it.”). Further, indemnity clauses usually require the indemnitor to provide a defense for the indemnitee, including paying for its lawyer. Indemnification provisions often are the most hotly contested subjects during contract negotiation, especially because the language of an indemnification provision is strictly-construed in most states (i.e., the wording matters). Most states require that indemnity provisions be “conspicuous,” which means they appear in all caps or bolded. Hence, they are not hard to find in a contract. Read them carefully.

7. Change Orders

All subcontractors are familiar with change orders. As contracts usually dictate that a subcontractor cannot refuse to perform extra work under most circumstances, it is important that subcontractors follow the contractor’s change order procedure precisely and, likewise, insist that the general contractor satisfy it, as well. If the subcontractor performs substantial extra work without a change order, and is refused payment, there frequently are remedies available under state law, including arguments that the owner or contractor waived the requirement or orally modified or supplemented the existing contract. The best practice, though, is to follow the proper process: get all change orders in writing, confirm oral directions by follow-up correspondence and, in turn, follow the change order itself precisely. The subcontractor should not assume it will be paid for extra work based upon its “good relationship” with the general contractor.

8. Termination for Default

There are two different categories of contract terminations, for default and for convenience, each governed by its own contractual provisions and body of law. “Termination for default” is allowed where one party is in default to an extent that constitutes a material breach of the contract. This almost always is invoked downstream by an owner or general contractor. Examples of actions considered sufficient default include failure to perform, to fix substandard work, to comply with laws, ordinances or code provisions or to pay subcontractors or suppliers. Often the contract designates the architect as the decisionmaker and requires it to issue a certificate confirming the sufficiency of the default. A notice requirement and a right to cure also usually are provided in the contract. A subcontractor should scrutinize the contract to ensure these saving provisions are present and otherwise confirm that there is a sufficient barrier to termination for default, as its effect can be punitive financially, including liability for consequential damages (not merely forfeiture of future payment and exclusion from the project). The general contractor should not be able to claim as a default what ordinarily would be a termination for convenience.

9. Dispute Resolution Procedures

Unless otherwise specified, the standard resolution procedure for a dispute between parties to a contract is a lawsuit in court. More and more frequently, though, construction contracts contain arbitration provisions that require the parties to litigate their case in binding arbitration. Both state and federal courts have made clear that these provisions are enforceable. If a subcontractor signs a contract containing an arbitration provision it must assume that it will be barred from court. The advantages of arbitration are speed, informality and a decisionmaker (the arbitrator) who is an expert in construction law and the world of contractors. The chief disadvantage is that arbitration effectively precludes appeal. The arbitrator’s decision is final. Arbitration provisions should be reviewed carefully to understand the allocation of up-front costs and the arbitrator’s power to award damages. Costs of arbitration far exceed those of the courthouse. Filing fees and arbitrator’s fees can run into the thousands of dollars or even five figures. The contract will dictate who pays and when. It is common for the defendant (respondent) to be relieved of that obligation prior to a finding of liability, but this likewise is a substantial barrier to the plaintiff (petitioner) as it initially must pay for both parties. Regarding damages, the arbitrator should be empowered to award the full gamut of damages under the law, including an award of attorney’s fees to the prevailing party. And, regardless of whether a case is in court or arbitration, mediation (non-binding until a then-binding settlement is reached) is available to the parties and is recommended as a relatively inexpensive tool to reach a settlement resolution.

Conclusion Because of time constraints and the desire to get down to business, subcontractors routinely sign lengthy contracts without closely reading the terms and conditions. Every clause in a construction contract is important and warrants your attention. It is important to understand your rights and obligations before you sign on the dotted line.  And in many cases, it is wise to retain counsel

ABOUT THE AUTHOR:

Daniel R. McCabe is a shareholder at the Dallas-based law firm of Canterbury Gooch Surratt Shapiro Stein Gaswirth & Jones, P.C. His practice focuses primarily in the areas of labor and employment law, including litigation, and civil trial work, including construction litigation, commercial, disputes, and personal injury matters. He is a graduate of Boston College and Texas Tech University School of Law. He can be reached at dmccabe@canterburylaw.com.

EDITOR’S NOTE:

AFSA’s contractor members are entitled to a free initial consultation on labor and employment issues from the law firm of Canterbury Gooch Surratt Shapiro Stein Gaswirth & Jones, P.C., located in Dallas. Questions should be directed to Daniel McCabe at )972) 239-7493 or fax 972-490-7739. McCabe will give initial advice, at no cost, to AFSA members, and if further action is deemed necessary, can assist members with finding counsel in their city.

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