By: Michael Metz-Topodas
With each new subcontract negotiated, contractors have an opportunity for the “art of the possible”—a chance to negotiate the best possible deal to work on a new project. Doing so depends on considering not only the scope of work and pricing but also other commonly used terms and conditions, as these can affect how scope and pricing operate. To help subcontractors successfully enter agreements that maximize profit, here are considerations for negotiating several common contract provisions.
Construction subcontracts often contain provisions that excuse delayed performance, partial performance, or even non-performance resulting from an unpreventable or uncontrollable event, often called force majeure clauses. In the past, such clauses covered wars, floods, or acts of nature. Recently, they have received greater attention and use because the COVID-19 pandemic and related restrictions disrupted construction work nationwide. Generally speaking, courts will enforce such provisions but construe them narrowly and apply them only to events unforeseeable to the parties when they entered the contract. At the pandemic’s onset, when such clauses did not expressly list “pandemic” as a covered event, subcontractors faced challenges in obtaining protection under them. And now, over 18 months into this pandemic, it hardly qualifies as an unforeseen event. So, going forward, subcontractors should consider ensuring that the force majeure clauses in their agreements explicitly include specific unforeseeable instances that could reasonably threaten performance. Unfortunately, no agreement can cover all circumstances, so subcontractors must consider the risks presented for a particular project when negotiating such clauses and adjusting their pricing.
Typically, subcontractors provide bid pricing for a scope of work based on expectations for labor and materials costs. The executed subcontract locks in that pricing, shifting the risk to the subcontractor should any costs change between when the subcontract is signed and the work is performed. In the past, subcontractors often accepted such risk because they could rely on relatively stable materials markets. Recent pandemic aftershocks have resulted in larger price fluctuations for materials, potentially creating a greater risk to subcontractors. To account for such dramatic price changes, subcontractors can negotiate to have general contractors share some of this risk through price escalation provisions. Although such clauses come in almost endless varieties, they typically establish criteria under which the general contractor (GC) agrees to pay an increased contract price due to a rise in materials costs. For example, a clause may require that should average lumber prices rise during the time between execution and performance by more than 10% based on an agreed metric (e.g., a price index), the GC would compensate a portion of the subcontractor’s actual increased lumber costs. As this example reflects, such clauses can contain many details about the conditions and terms for adjusting the subcontract price due to materials escalation costs. Subcontract negotiations should find the best arrangement that fits the project’s circumstances.
Most contracts outline a scope of work with reference to applicable drawings and specifications. And most contractors know to review those documents carefully and raise questions and issues with the owner, designer, or GC regarding technical details and constructability. Some specifications, however, do not address the technical aspects of construction but merely direct that the final constructed product performs according to certain standards. For example, such performance specifications can require a building envelope to meet certain LEED standards regarding air infiltration.
Performance specifications create risk for subcontractors. To achieve performance specifications’ standards, a subcontractor may need to modify, adjust, or even redesign work performed in the field within what other project specifications permit. Those adjustments, modifications, or redesigns may require additional labor or materials, but receiving additional compensation via a change order for this in-scope work would likely face challenges. So, in negotiating agreements, subcontractors should pay close attention to performance specifications, the discretion afforded to meet them, and pricing and other terms so that they can control this risk as much as possible.
Subcontracts frequently include provisions that tie a subcontractor’s payment for work performed to the GC receiving payment for that work. Some clauses, typically called “pay-when-paid,” pertain to a payment’s timing and direct that when the GC receives payment for a subcontractor’s work, the GC must, in turn, pay the subcontractor, often within a specified time. The more stringent “pay-if-paid” clauses make a GC’s obligation to pay its subcontractor conditioned on the GC actually receiving payment for the subcontractor work performed. That means the GC has no obligation to pay a subcontractor for work performed and accepted unless and until the GC is paid for that work. Unlike a pay-when-paid clause, a pay-if-paid clause removes any independent obligation for the GC to pay its subcontractors and passes the risk of owner non-payment from the GC to the subcontractor. To account for this risk, subcontractors can adjust their pricing or negotiate to modify this language—both challenging propositions. Some jurisdictions, however, enforce a pay-if-paid clause only if it has very explicit and clear language that payment to the subcontractor is conditioned on the GC receiving payment.
Further, under many states’ laws, if the GC’s actions are causing non-payment for a subcontractor’s completed work, then the GC may lose the right to rely on a pay-if-paid clause. Lastly, a smaller number of states have found pay-if-paid clauses unenforceable. So, negotiating such payment clauses needs to account for the risk presented under the applicable law.
No Damages for Delay
Due to the many “moving parts” and other variables on construction projects, delays frequently happen. Such delays create extra costs for subcontractors—often additional labor and extended general conditions costs, to name a few. Typical subcontracts, however, limit a subcontractor’s remedies for delays to time extensions to the contractual deadline for the subcontractor to complete its work. These “no damages for delay” clauses present another area in which subcontractors end up bearing significant risk. Extensions of time relieve a subcontractor of liability for liquidated damages or other consequences from not meeting contractual deadlines but leave subcontractors without remedies for costs incurred from extra time spent on a project. In some jurisdictions, however, where an owner or GC causes a subcontractor’s delay by actively interfering with the subcontractor performing its work, the owner or GC cannot enforce a “no damages for delay” provision. Nor do such clauses apply to delays from events that were unforeseen when the parties entered the contract. Regardless of the defenses to a “no damages for delay” provision, subcontractors should negotiate their agreements to afford as much recovery as possible for delay costs. Otherwise, subcontractors should price their work to account for such potential costs.
Most subcontracts have clauses that require a subcontractor to continue working even after submitting a claim for payment or after initiating any other proceeding under the agreement’s dispute resolution process. Under this requirement, if a GC withholds payment to a subcontractor because it disputes the quality or extent of the work performed, or for any other reason, a subcontractor faces a no-win dilemma: keep working without getting fully paid or risk breaching the subcontract by stopping work. Fortunately, some states have laws that permit a subcontractor to suspend work for non-payment despite what a subcontract may direct, as long as the subcontractor complies with certain notice and other requirements. Such laws should play a role in gauging whether to negotiate or accept a subcontract’s requirement to continue working despite a pending claim or dispute.
Most subcontracts require the subcontractor to notify the GC about certain project developments, especially events that could lead to a claim for additional payment or performance time. Often, such notice requirements direct the form, delivery method, and, most importantly, timing for such notices. For example, AIA A201-2017 Art. 15, Sec. 220.127.116.11 requires notice of a claim within 21 days after the event leading to the request for extra payment or the claimant’s awareness of such an event (whichever is later). Negotiating such notice requirements depends on the requirements’ reasonableness relative to the project. Specifically, does the requirement afford sufficient time to prepare the notice? Are timing requirements measured from when the notice is sent or received? Also, applicable law can affect the burden notice requirements impose. Some states’ laws bar enforcing notice provisions when the party invoking them, usually the GC, has actual notice or does not suffer any prejudice despite a breach of the contractual notice requirements. In other states, a missed notice deadline almost invariably waives the right to any claim or right connected to that notice. So, for example, failing to provide a required 10 days’ notice likely makes a claim lost forever. In negotiating such provisions, subcontractors need to understand how they operate within both the project’s context and the applicable underlying law.
A common theme runs through these subcontract negotiation considerations: they vary with the circumstances of the underlying project and the law of the applicable jurisdiction. For that reason, subcontract negotiations benefit greatly when involving experienced construction counsel. The lawyers at Cohen Seglias have been helping clients analyze, assess, and negotiate subcontracts and their provisions for over thirty years and welcome further opportunities to continue supporting subcontractors in the difficult contract negotiation process.