Subcontracting trade work is common practice in the construction industry and managing subcontractor default risk is crucial to ensure the success of projects and partnerships at multiple levels. For general contractors (GC’s), building positive working relationships with subcontractors while protecting their interests is vital. Striking a balance between these goals is key when detailing subcontract terms. Clear and fair, yet effective, subcontract terms can help achieve this, while reducing the likelihood of default and minimizing the potential for disputes. Consulting with legal experts experienced in preparing and reviewing subcontracts is invaluable. That said, below are some important best-practice subcontract clause elements to initially consider.
Having a clear and comprehensive subcontract agreement is an essential foundation. It should reference the plans, specifications, and schedules and detail the scope, deliverables, payment terms, and any specific performance expectations (i.e., square foot of drywall per day, cubic yards of concrete per day, tons of rebar per day, etc.). Any key GC/Owner contract requirements should flow down to the subcontract. A Time-Is-Of-The-Essence clause is recommended as this stipulates that the times and dates specified in the agreement are vital and mandatory. Generally, the more detailed the contract, the less room there is for misunderstandings and disputes. A GC may or may not wish to include the subcontractor’s bid documents but, either way, they need to be sure any inconsistencies between contract scope and proposals have been resolved. The subcontractor should be required to maintain adequate, appropriate, and required insurance coverages with proper limits, including liability, to protect against all relevant potential risks. Also, the GC should make sure all additional insureds are listed, as needed, and that they know the exclusions of the sub's policies.
A subcontractor should be able to provide proof of financial stability through a prequalification process and/or provide performance guarantees, such as a letter of credit or a performance bond, to ensure to a GC that they have an adequacy of resources to meet their obligations. A system should be detailed, contractually, regarding monitoring the subcontractor's progress and quality of work. Regular inspections and reporting can help identify issues early on and allow for corrective action. The subcontract needs to: address the owner’s warranty provision, mandate attendance to weekly coordination meetings and any other communication protocols, require submission of daily reports and include requirements for weekly input to the GC's current schedule. The extent to which the sub is required to protect (or repair) their work and/or completed work of others should be clearly spelled out, particularly regarding unilateral "back charges" that can be assessed at any time for failure to clean-up or correct non-conforming work. Additionally, the subcontract needs to address compliance with the GC’s and Owner's safety requirements. It should require designation of a person competent in safety management and a site-specific safety plan to be in place prior to work commencing. Indemnification and hold harmless clauses can reduce liabilities associated with negligence, accidents, injuries, or damage caused by the subcontractor.
Changes in construction work are common and a change order process should be established for how modifications to the subcontract will be handled. For example, the inclusion of unit pricing for changes could help avoid escalation costs. During construction, changes should be documented, approved, and signed off by both parties to avoid disputes later. Payment procedures should be established with a clear structure. Lien releases (and, perhaps second tier lien releases) and a detailed schedule of values should be required. The ability to withhold funds for breach of contract and rights of offset between multiple contracts a sub may have with a GC should be included as subcontract clauses.
The GC should also retain the right to remove any subcontractor personnel for just cause and the subcontractor should not be allowed to re-assign its superintendent, or any promised key personnel, without the contractor's permission. A list of sub-tier contractors and vendors ought to be required, with GC rights to reject, and contract assignment expressly forbidden without GC approval.
The subcontract should also establish escalation procedures for resolving issues that cannot be resolved at the project level. This might include involving higher management or third-party mediators. Specify a dispute resolution process (such as negotiation, mediation, or arbitration) to resolve conflicts amicably and avoid the potential of costly litigation. Include clear termination clauses that stipulate the conditions under which there are rights to terminate the subcontract. Common reasons include insolvency, bankruptcy, non-performance, or some other material breach of contract. The notice period and the consequences of termination should further be specified. Finally, define the remedies that apply in the event of a default. This might include the right to withhold payment, requiring the subcontractor to cover the costs of rectifying their default, or seeking legal action for damages.
One further consideration is to limit the number of individuals permitted to sign subcontracts. By restricting signing authority to a select few individuals, a GC can ensure they are held accountable for the terms and conditions of the subcontract. This helps prevent confusion and ensures responsible parties can be identified should any issues arise. Additionally, this practice can provide for additional risk management, consistency and control, efficiency, legal compliance, and an added security layer (regarding fraud or other unauthorized activities). Again, it is important to strike a balance as too much restriction could lead to bottlenecks in the decision-making process, potentially causing delays. Establishing clear guidelines and criteria for delegating signing authority can ensure decisions are made efficiently and responsibly.
Including well-crafted subcontract clauses in contracts, with these key considerations in mind, is crucial for mitigating risks associated with defaults to ensure a smooth and fair working relationship between the parties involved. A robust subcontract with clear and comprehensive clauses helps establish a transparent and equitable framework for the working relationship, reduces ambiguity, and provides a roadmap for addressing issues that may arise during course of the subcontract relationship.