Every construction project carries a risk of monetary loss. For example, a worker could be injured, the project could be delayed, or the owner could simply refuse to pay for certain project work. Any of those adverse occurrences (not to mention almost limitless others) would cause monetary loss to the parties involved in the affected project. Certain subcontract terms will dictate which party will suffer that monetary loss. Here are three common risk-allocating subcontract terms that typically shift risk from the general contractor on to a subcontractor, and should therefore be renegotiated to protect the subcontractor or share the risk.
Indemnity is a concept found in many construction contracts. It means that one party (the “indemnitor”) will protect another party (the “indemnitee”) against some kind of harm, usually against “claims” like lawsuits. By indemnifying a general contractor, for example, a subcontractor inherits the general contractor’s risk to the extent of the indemnity. Indemnity comes in several flavors, starting with the blandest and most limited, where the indemnitor protects the indemnitee only from claims and damages caused solely by the indemnitor’s wrongdoing. For example, a drywall subcontractor under this limited form of indemnity would be responsible to protect the indemnitee only from harm actually and wrongfully caused by the drywall subcontractor.
On the other side of the spectrum, however, is broad-form indemnity. Under this kind of indemnity clause, the subcontract-indemnitor must protect the general contractor from claims and damage, even if the general contractor is solely responsible for the damage. On a construction project, this could mean, for example, that a drywall subcontractor that signed a broad-form indemnity clause would be responsible to protect the general contractor from flooding damage to a project’s drywall installation, even if the general contractor caused the flooding. Essentially, a broad-form indemnity clause requires a subcontractor to act like an insurance company, paying out for losses for which it was not otherwise responsible.
When presented with a broad-form indemnity clause, it is both fair and prudent to negotiate down to a limited indemnity that allocates risk to the party who actually did something wrong.
No Damages for Delay
Not every construction project ends on time, and project delays regularly cause subcontractors to incur additional, unanticipated costs such as unanticipated general conditions, equipment rental, or labor costs, including demobilization and remobilization costs. In addition to those direct costs, subcontractors can suffer lost opportunities (as their project team cannot work other projects while it waits for the delayed project to continue), and losses to its home office finances (as the delayed job likely was meant to provide partial funding for the subcontractor’s home office).
In fairness, the party responsible for a project being delayed should also be responsible for the additional costs caused by the delay. Unfortunately, many modern construction subcontracts contain a “no damages for delay” clause that essentially states that a subcontractor is not entitled to any damages arising out of delay, and instead would only be entitled to an extension of time within which to finish its work. For projects that are significantly delayed, this can turn a subcontractor’s finances upside down, as the additional unrecoverable costs can eat into any profit and overhead the subcontractor was to make on the project. The result is that a subcontractor inherits the risk of loss related to any project delay.
A reasonable alternative is requiring a general contractor to be responsible for some damages and some scope of delay. For example, it is fair that a subcontractor be reimbursed for the out-of-pocket costs of delay, which might include demobilization and remobilization costs, as well as the cost of fluctuations in the price of labor or materials over time. In addition, if a general contractor “actively interferes” with a subcontractor’s work (such as ordering the subcontractor to stop and start work off-schedule), then the general contractor should be required to pay for all damages caused by that active interference.
A “pay-if-paid” clause typically states that payment by a construction project’s owner is a condition precedent to a general contractor’s obligation to pay a subcontractor for project work. That is, under a pay-if-paid clause, the general contractor has no obligation to pay a subcontractor for work on a construction project unless and until the general contractor receives payment for that work from the project’s owner.
The essential problem with the pay-if-paid clause is that it transfers risk of the owner’s non-payment from the general contractor to a project’s subcontractors. This is inherently unfair, as the general contractor is the entity in the best position to manage payment disputes with the owner. It is even more unfair when you consider that subcontractors are already laying out funds for labor and materials rendered to the project, and are typically required to continue rendering labor and materials regardless of whether payment occurs in a timely fashion.
A reasonable alternative to pay-if-paid is the similarly-named “pay-when-paid” clause. Under Maryland law, for example, the pay-when-paid clause does not give a general contractor license to withhold payment from a subcontractor forever. Instead, the general contractor can only wait a reasonable period of time before paying the subcontractor, regardless of whether the owner has paid. This makes good sense, as it is fair that the general contractor have some time to resolve whatever payment dispute it may have with the owner, but because it has a direct contract and relationship with the owner, it is also fair that the general contractor bear the ultimate risk that the owner fails to pay.
When I draft or review contracts for subcontractors (or general contractors, for that matter), I scrutinize dozens of contract clauses, but I also consider what methods best protect the “bottom line” of finishing a project with a profit. Negotiating fair alternatives to the three clauses discussed goes a long way to protecting that profit from the risk of loss inherent to every construction project.