Subcontracts are used throughout the modern global economy.
On a construction project they enable a contractor to buy in expertise. The contractor stays legally responsible for carrying out all its scope of works, and will try and safeguard its position by mirroring key obligations, processes, and quality requirements from the main contract in the subcontract. This is known as making sure the main contract and subcontract are ‘back-to-back’.
Subcontract options
There are a number of strategies for creating such a subcontract:
- Use a subcontract created specifically for the main contract, as then the obligations will match – this relies on an unamended main contract; if there are amendments then the subcontract will need similar amendments and option 3 applies
- Use any subcontract but add extracts from the main contract ie scope, quality, testing and processes to create express and clear obligations on the subcontractor – this enables the main contractor to ensure the subcontractor will help it to comply with its own obligations
- Attach a copy of the main contract documents and insert a general requirement for the subcontractor to comply, coupled often with an indemnity – this enables the main contractor to pass on any costs incurred if it or its subcontractors do not comply with the main contract obligations
- Create a bespoke subcontract with clear, fair and transparent terms which reflect the main contract (which the main contractor negotiated to be clear, fair and transparent).
The quickest ways to create a subcontract are options 1 and 3. However, as we rarely see unamended standard forms, let’s park option 1. Option 3 is the most common, but pretty lazy as it relies on negative enforcement ie the indemnity to ensure compliance, rather than positive obligations on the subcontractor (options 2 and 4).
Indemnity issues
When I review subcontracts I come across a number of issues with indemnities – which specifically should only apply where the subcontractor is in breach of its own subcontract. This is best illustrated with this tricky legal conundrum which I came across.
The subcontract said (edited for simplicity):
The subcontractor will observe and comply with the terms of the main contract that relate and apply to the subcontract works… The subcontractor indemnifies the contractor for acts and omissions which involve the contractor in any liability to the employer under the main contract
There were many inconsistencies between the subcontract and the main contract – with no attempt to make them back-to-back. One way around the inconsistencies is to slap in a subcontractor indemnity and hope it all works out (option 3).
To give you a flavour of the issues in this subcontract, let’s delve into just one area:
- The subcontract included no obligation on the subcontractor to provide warranties.
- The main contract included a requirement on the main contractor to get warranties from its subcontractors.
- If the main contractor does not get those subcontractor warranties, the main contract could allow the employer to (1) withhold all money from the main contractor – if warranties are a condition precedent to payment (ie no warranties, no money) – or (2) withhold agreed damages for failing to provide them.
- The subcontract does not include a discrete right to withhold payment or damages from its subcontractor because of the lack of warranties.
- The subcontractor indemnifies the main contractor for acts and omissions (eg failing to provide warranties) which involve liability to the employer.
So whilst the subcontractor has complied with its oblgations under its subcontract – which do not include providing warranties – the main contractor can still refuse to pay its subcontractor for failing to provide those warranties through the indemnity mechanism.
Bonkers!
What should you do?
If you are a specialist subcontractor, you need to understand how the web of contracts, insurances and indemnities can act against you on a project.
If you are a main contractor, focus on creating positive obligations in the subcontract so your subcontractor knows precisely what it needs to do to comply, rather than relying on negative remedies if they don’t… particularly where those obligations are hidden in the numbered documents or main contract package.
