Your Subcontract: Deconstructed
A Provision-by-Provision Analysis of Your Subcontract
Part Two of a Five Part Series

By Alexander Barthet

Your subcontract; Done right, it can be both a sword and a shield in your dealings with your subcontractors. Careful consideration should be given to each provision such that the risk and benefit of each are measured against the scope of the work and the contract price. This series is designed to give you a better understanding of each provision so that you can better manage the risks and exploit the benefits in your negotiations.

In this second part, we shall discuss Article 4: The Subcontract Price, Article 5: Payment, Article 6: Time, and Article 7: Extensions of Time.

Article 4: The Subcontract Price

While the actual price may be listed on the first page, it is important to state that “the Subcontract Price shall be paid in exchange for the exacting performance and timely completion of the Work and the performance of any and all duties and obligations set forth in the Subcontract and the Contract Documents.” This makes clear that payment shall only be made upon full compliance with the contract documents.

Even if the subcontract is a lump sum contract, you should include an exhibit to the subcontract which sets forth the agreed unit costs for the most common materials and labor provided by the subcontractor.  Also state that any materials or labor not listed shall be billed at the subcontractor’s actual cost plus an agreed percentage for overhead and profit.  Stating the unit costs is critical as it minimizes surprises when it comes to the cost of extra work.  Additionally, it takes much of the guesswork out of change orders as the only issue to determine is the quantity of the material or labor.  Once determined, the cost of the change is the result of a simple mathematical calculation.

Relatedly, a provision such as “the Subcontract Price and all unit prices shall be deemed to include any and all taxes, insurance and bond premiums, storage, delivery, transportation, and overhead and profit” should give you comfort that the prices listed are not subject to further increase. Such certainty will allow you to better control your costs on the job.

Article 5: Payment

If you bill by AIA payment applications, you will likely demand the same procedure from your subcontractors. If so, you should specify the form in the subcontract. On larger projects, it is useful to use an agreed form of the schedule of values so that the breakdown of the work is mutually agreeable. This will also minimize frontloading by the subcontractor.

More importantly, you should include a valid pay-when-paid provision in your subcontract.  A pay-when-paid provision states, simply, that you have no obligation to pay the subcontractor until you receive payment from the owner.  Such a provision can effectively shift the risk of owner non-payment to the subcontractor.

There have been many court decisions about this topic. In short, the law requires that your pay-when-paid provision be unambiguous by including, for example, a statement that payment from the owner is a “condition precedent” to payment to the subcontractor. This magic language is of critical importance as seemingly similar phrases have been held invalid by courts of law. A portion of a sample final payment provision could read: “Payment shall be made within thirty days of final completion of the construction project, written acceptance of the same by the Owner and design professional, tender of all manuals and warranty certificates, final releases and releases of lien from all subcontractors and suppliers, and as a condition precedent, receipt of final payment from the Owner.” If there are other conditions you wish to place on payment, those should be added to the provision. Note that these conditions should be altered, as appropriate, when referring to progress payments.

Just as important as the language in the subcontract is the language in the prime contract, especially if the prime contract is incorporated into the subcontract. This is because if your prime contract requires you to provide proof of payment to the owner before you are entitled to payment, courts of law may invalidate your subcontract pay-when-paid provision. So we are clear, most sophisticated owners require proof of payment to all suppliers and subcontractors, at a minimum, upon final payment to you, the general contractor.

The reason such a provision in the prime contract could invalidate your subcontract pay-when-paid is that it creates a stalemate between the owner, general contractor and subcontractors as to who will pay first. The owner will not pay until the contractor pays the subcontractors, but the contractor won’t pay the subcontractors until the owner pays the contractor. It is deadlock. For policy reasons alone, the Florida Supreme Court has ruled that in such a situation, the subcontractor wins and the general contractor loses. Said another way, even if the subcontract contains a valid pay-when-paid provision, the contractor will have to pay its subcontractors before the owner pays the contractor when the prime contract contains such language.

Your question, of course, is how to avoid this result. Unfortunately, there is no tested method to circumvent this situation. However, here are a few practical, but not necessarily legally tested suggestions. First, you could avoid incorporating the prime contract in your subcontract. This move is fraught with its own perils such as the possibility that without referring to the prime contract, you may not fully define the subcontractor’s scope of work, responsibilities, and other liabilities you may owe to the owner. This is particularly true for significant subcontractors such as mechanical, electrical and plumbing.

Second, when incorporating the prime contract, you may wish to include a statement that excludes the prime contract’s payment provisions. You could also state that as to payment, the terms of the subcontract govern over the prime contract. This may provide some relief.

Other material provisions which should be in the payment provision of your subcontract include the requirement of providing releases. You should demand that your subcontractors execute an agreed form of release in exchange for each payment. The form should be broad and general in nature, not merely limited to a lien release. It is critical that the form of the release be attached to the subcontract as an exhibit. There are two reasons this is important. First, under the law, unless specifically agreed to otherwise, the only form of release a subcontractor is obligated to sign is the simple form found in the lien statute. Second, by using a broad form release, you can effectively have the subcontractor release you from any and all claims, not just lien claims, every month. Many a subcontractor has been unable to pursue claims for delay and unexecuted change orders by accepting a progress payment and unwittingly tendering a general release.

Finally, a catchall statement such as the following is essential to attempt to give you leverage over the subcontractor in the event of a dispute: “Contractor reserves the right to withhold, without notice, as an additional reserve and without limiting its other rights and remedies, an amount sufficient: (i) to defend, satisfy and discharge any asserted claim that Subcontractor (or anyone providing any Work hereunder) has failed to make payment for labor, services, materials, equipment, taxes, or other items or obligations furnished or incurred in connection with the Work or has caused damage to the Work or to any other work on the Project; (ii) to complete the Work if it appears that funds remaining to be paid under the Subcontract, including retainage and exclusive of back charges, are insufficient to complete the Work; (iii) to reimburse Contractor for any back charges incurred as a result of any act or omission by Subcontractor hereunder; (iv) to protect Contractor from the possible consequences of any other breach or default by Subcontractor hereunder; or (v) to secure Contractor with respect to any breach by Subcontractor or its affiliates, parent company and subsidiaries under any other agreement with Contractor with any default on any agreement with Contractor being considered a breach of all agreements with Contractor.”

As a side note, the last phrase in the above statement is known as a “cross-default” provision. An illustration may be the best way to explain how this provision is designed to work. Let’s assume you hire ABC Electric as the electrician on projects A, B and C. Let’s also assume that you had ABC Electric sign three separate agreements, all containing a cross-default provision. Then, if ABC Electric breaches the contract on project B (let’s say it is the cause of the project’s delay), then it is in breach on projects A and C. Under this provision, you may also have the ability to backcharge ABC Electric on projects A and C for the damage caused on project B.

Article 6: Time

Completing a construction project within its originally scheduled completion date is the goal of every good contractor. However, planning for the possibility that completion may be delayed is the mark of a successful general contractor. There is no reason you can’t use your subcontract to minimize the risk of construction delays.

First and foremost, it is critical to include a schedule or, at a minimum, a commencement and completion date in your subcontract which coincides with the start and finish dates in the prime contract. If you use a schedule, it should be a critical path schedule and attached as an exhibit to the subcontract. Notwithstanding, on larger projects, you should also require your subcontractors to provide periodic updated manpower, material delivery and schedule information so that you can update the master schedule accordingly.

It also goes without saying that it is essential to hold the subcontractors to the same schedule and project completion requirements as you owe to the owner. One way to do this is by the following sentence “Time is of the essence and therefore, Subcontractor shall be liable for all indirect, direct, actual, consequential, special, and liquidated damages arising out of Subcontractor's breach of this Subcontract and the Contract Documents.”

Next, you should reiterate to the subcontractor in no uncertain terms that the Subcontract Price will not be adjusted due to changes in the project’s schedule, generally, and the pace of the work, specifically. The following is one way to accomplish this task: “The Subcontractor acknowledges that the Subcontract Price is based on the fact that the Contractor is not liable, absent actual fraud or intentional misconduct, for any damages or costs due to delays, accelerations, impact, non-performance, interferences with performance, suspension or changes in the performance or the sequence of the Work, whether or not caused by the Contractor.”

Finally, the subcontract should recognize that the schedule is going to change and, when it does, define who will bear that risk. As the contractor, you want that risk borne by the subcontractors whenever possible. To address situations when the subcontractor is the cause of the delay, a provision such as the following may suffice: “If the progress of the Work or of the Project has been delayed or impacted by any fault, neglect, act, omission or failure to act by Subcontractor or any of its subcontractors and/or suppliers, Subcontractor shall accelerate its Work by, without limitation, increasing its workforce and working overtime, all at Subcontractor's sole cost and expense, as Contractor shall deem necessary or desirable at its sole option and discretion to make up for all time lost and to avoid delay in the completion of the Work or the Project. The failure by Contractor to direct Subcontractor to engage in such acceleration shall not relieve Subcontractor of the consequences of its delay.” Remember that it will still be your responsibility to direct the work of subcontractor, including any necessary acceleration. Any such direction should be done in writing and, if possible, reference the subcontract by article number.

As to the other trades, make it clear to the subcontractor that its recourse is against them directly, not you as the middleman. An example would be an electrical subcontractor’s claim for delay for incomplete framing. A sample provision reads “In the event the Work is damaged, or should the Work be delayed or interfered with by any other subcontractor or other contractor on the Project, the Subcontractor and each such subcontractor or other contractor shall be directly responsible to the other, each shall look solely to the other for compensation, and Subcontractor shall not seek compensation or damages from Contractor by reason thereof.”

Article 7: Extensions of Time

If the time for construction needs to be extended, you would surely like three things to occur. First, you would like to receive timely notification of the claimed delay and request for extension. Second, you would surely like to limit any subcontractor claim to a time extension (and not additional compensation). Finally, if any costs must be paid to the subcontractor, it would be best to limit those costs to their pro rata share of anything you may recover from the owner.

As to the first issue, your subcontract should require the subcontractor to timely document in writing any claims for additional time. This will allow you to verify and substantiate the claim (and make necessary adjustments to minimize its impact). The following provision should suffice: “If Subcontractor claims to need an extension in the completion time requirements of this Subcontract, in whole or in part, Subcontractor shall give Contractor written notice thereof within seventy-two (72) hours after Subcontractor's first knowledge of the occurrence of the first condition giving rise to such event. No such request for an extension of time shall be valid unless written notice is given as required above. After delivering written notice of a perceived cause of delay, Subcontractor shall proceed to execute the Work, even though the time extension has not been fully agreed upon.”

The second component is known as a “no damage for delay” provision. In short, it means that to the extent that the subcontractor suffers a schedule impact, its remedy is limited solely to a contract time extension, not additional compensation. Generally, such provisions are valid and enforceable, so long as the party seeking the benefit of the provision (usually the contractor) is not the cause of the delay. An example of a no damage for delay clause reads: “Subcontractor expressly agrees not to make, and hereby waives, any claim for monetary compensation and/or damages, including those resulting from increased labor or material costs, on account of any delay, obstruction or hindrance for any cause whatsoever, whether or not foreseeable and whether or not anticipated including, but not limited to, causes that would entitle the Contractor to an extension of time under the Contract Documents and agrees that the sole right and remedy therefore shall be an extension of time commensurate with the delay suffered, so long as Subcontractor provides Contractor the required 72-hour written notice and said delay was on the critical path.”

The final component attempts to tie any recovery that may be obtained from the owner to the claims of the subcontractor. Such a provision could act as a cap on any claim. It may also allow you to control the prosecution of the claim. For example, it could read: “Notwithstanding anything to the contrary, and in the sole discretion of the Contractor, in the event the Owner delays the Contractor and the Subcontractor is thereby delayed, the Contractor may submit any and all claims by the Subcontractor for additional compensation to the Owner provided however that (i) the Subcontractor has timely submitted to the Contractor all notices and claims required by the Contract Documents, with respect to delays and the Subcontractor shall accept the Contractor's prosecution of such claims at the Subcontractor's expense and the Contractor's payment to the Subcontractor of any money that the Contractor may receive from the Owner upon Subcontractor's claims, in full and complete satisfaction and liquidation of Contractor's obligation to Subcontractor, it being understood and agreed that the Contractor shall not have any other liability or responsibility to the Subcontractor by reason of Owner caused delays. The Contractor shall, at all times, retain the right to direct the prosecution of the claims and to decide, in its sole discretion without further liability to the Subcontractor, whether such claims should be abandoned, settled or litigated, which decision shall be final and binding on the Subcontractor.”

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Future articles will discuss other key provisions of your subcontract – look for part three in this five part series.

This series only covers some of the many aspects involved in contracting. Each situation and contract is unique and you should contact a lawyer to assist with your specific situation.

This article was first published in the January 2008 issue of South Florida Homebuilder as the second of a five part series on contractor-subcontractor contracts.

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Article Concepts: contract, written agreements, signers, contract specific, contract documents, work, performance

 

© 2008, The Barthet Firm