Seven Key Strategies for Successful Subcontracting

Taking the time to read and understand your subcontract is a necessary step for any successful project. Although subcontracts are not uniform and can be quite lengthy, these are the top seven provisions you need to understand.

1. Incorporation by Reference / Flow Down

Subcontracts almost universally incorporate the Prime Contract between the owner and contractor by reference. Further provisions in the subcontract state that the subcontractor owes the contractor all the duties and obligations that the contractor owes upstream to the owner.

Subcontractors should try to limit this to documents and obligations that are specific to their scope of work. In other words, exclude items that are the responsibility of others or that are otherwise excluded by the qualifications and exclusions in the proposal or bid.

Most importantly, get a copy of the Prime Contract and review it (or have it reviewed by counsel) before signing the subcontract. This is not just a technicality.

2. Schedule

Subcontractors will want the ability to rely on and enforce the Project Schedule attached to the Subcontract. Accordingly, subcontractors should look to strike or modify any language in the Subcontract giving the contractor unfettered discretion to change the schedule.

Contractors will want to retain the right to re-sequence the subcontractor’s work at no additional cost. An example of this is: “Contractor may amend the Project Schedule from time to time as it sees fit, and Subcontractor agrees to adhere to such schedule and carry on Subcontractor’s Work promptly and efficiently as necessary to avoid causing delay in completion of the Project.”

3. No Damage for Delay

This relates closely to the schedule issue. Subcontractors will want any “no damage for delay” provision stricken. Otherwise, the parties can negotiate a “deductible,” whereby the first specified days of delay (i.e., 15 to 30 days) are absorbed by the subcontractor and any delays after that time period are compensable.

It should be noted that “no damage for delay” provisions are void to the extent a delay is chargeable to the owner or contractor. Ohio Revised Code (“R.C.”) 4113.62(C)(2).

However, if the clause does not completely preclude a subcontractor’s ability to recover these damages, it may be enforceable. For example, provisions that limit recoverable damages to the escalation in material and labor costs may be enforceable.

Also, provisions making recovery contingent on payment from an upstream source, e.g., “pay if paid,” may also be enforceable. As a contractor, these concepts should be written into the agreement in place of a blanket prohibition on the recovery of delay damages.

4. Subsurface or Concealed Conditions

Subcontractors should try to avoid provisions that require them to “accept” the project site and the site conditions or that otherwise shift the financial risk of unforeseen, unanticipated, or changed conditions. It is acceptable for the subcontractor to accept the site conditions as set forth in a geotechnical report, but many times the contract will state that the geotechnical report is “for information only, and may not be relied upon by the subcontractor.” In all cases, the subcontractor should be able to rely on the geotechnical report and make a claim for an equitable adjustment in the contract time and contract price if actual site conditions materially differ from those disclosed in the report.

Also note that these provisions may contain a strict notice period and/or liquidating agreement whereby a contractor has no independent liability to a subcontractor for differing conditions. These clauses typically state that a subcontractor can collect damages from a contractor only if, and to the extent that, the contractor recovers damages upstream from the owner.

5. Contingent Payment Provisions

A contingent payment clause is a contractual provision that makes payment contingent upon the happening of some event. In construction subcontracts, the typical contingent payment clause makes the subcontractor’s payment contingent upon the payment of the contractor by the owner. Contingent payment clauses can be “pay when paid,” which links the timing of the subcontractor’s payment to the time when payment is made to the contractor by the owner (allowing a reasonable time). “Pay if paid” provisions, on the other hand, specify that the owner must pay the contractor in order for the subcontractor to ever receive payment.

In Ohio, “pay if paid” clauses are enforceable per Transtar Elec., Inc. v. A.E.M. Elec. Servs. Corp., 140 Ohio St.3d 193, 2014-Ohio-3095. However, a contractor cannot cause the non-payment and then rely upon a “pay if paid” provision to escape liability.

Subcontractors will want to reject “pay if paid” provisions altogether or change them to “pay when paid.”

6. Indemnity and Insurance

Subcontractors should attempt to reject or limit any suggested indemnification provision by arguing:

• We are already adding the indemnitees to our insurance program as additional insureds;
• We are de facto indemnifying the indemnitees elsewhere in the delay / correction of defective work provisions; and/or
• We are indemnifying the indemnitees elsewhere against mechanic’s liens. Typically, however, contractors will not agree to the wholesale removal of an indemnification requirement.

The next fallback position is to limit broad indemnification provisions that require the subcontractor to indemnify and defend the contractor for uninsured losses. Look for language such as “arising out of or related to this Agreement.” The subcontractor should tailor any indemnification obligations to be co-extensive with its liability insurance coverage. Put another way, the goal is to limit its indemnity obligation to only those losses covered by insurance, e.g., caused by “bodily injury” or “property damage.” See AIA A201 General Conditions ¶ 3.18.1. Arguing that you are using standard AIA language can sometimes be successful. Further, overbroad indemnification agreements can be voided by anti-indemnity statutes, such as R.C. Section 2305.31.

Contractors will want broad indemnity that includes losses and expenses wholly unrelated to “bodily injury” or “property damage.”

7. Notice of Claims / Time Limits

Finally, most subcontracts include language stating that a subcontractor’s failure to secure a written change order before performing extra work or incurring any additional cost operates as a waiver. Ohio law recognizes the validity of such provisions, and they will be strictly enforced.

Subcontractors should attempt to soften this language, as well as any strict time limits or overbearing documentation requirements (like critical path analyses, etc.) for claims and change orders. Often, it is helpful to argue that the AIA family of documents allows 21 days to give notice of a claim and does not contain any documentation requirements.

Contractors, on the other hand, need to ensure that any notice requirements give them enough time to make claims upstream to the owner in accord with the Prime Contract.

Conclusion

Failure to appreciate and properly negotiate any one of these provisions can spell disaster. Uncompensated delays, uninsured indemnity obligations, and concealed conditions can cost hundreds of thousands of dollars. From either perspective — contractor or subcontractor —reviewing, understanding, and properly negotiating these terms is critical to project success. Most contractors and subcontractors will find it helps to have legal counsel assist in the review, especially for the first subcontract with a new party.

Please contact Marc A. Sanchez or any attorney in our Construction Practice Group if you have questions regarding best practices for subcontracting.