It has been a feature of any major contract for many years now that substantial parts of the works to be undertaken by a main contractor is that he will in turn sub-contract parts of the scope of that works to others. In ‘building’ works it is not unusual for virtually all the actual works to be undertaken to be subcontracted with the main contractor only providing management and site facilities. Because of the heavy capital investment in primary equipment, in tunnelling works the practice of ‘subbing’ everything may be less usual, however it will still be commonplace to sub-contract such specialist services as drilling and grouting, specialist shaft sinking and, if not let as a separate contract by the employer organisation, any tunnel fitting-out works.
It is therefore important to have an appreciation of the principles involved in the sub-contracting of work. Of course this impacts most directly on the main and sub-contractors involved themselves, but it may also be a fact of life for engineers and employers that the performance of key sub-contractors can have a significant effect upon the successful outcome of a project.
Privity of contract
Unless very specific provision is made in either the main contract between employer and contractor or sub-contract between main and sub-contractor then the principle of privity of contract will apply to those two sets of arrangements. That means that there is no automatic right of recourse by the sub-contractor against the employer in the case of, for example, non-payment by the main contractor, nor is there a direct contractual route of recovery by the employer from the sub-contractor in the case of, for example, defective works, nor is there the automatic right to assign or novate the sub-contract in the event of main contractor default or termination.
Control of sub-contracting
The application of this principle means that in the case of the employer/engineer they may wish to exert some degree of control over the manner in which sub-contract works are let. If so, then this control can only be by way of inclusion of appropriate clauses in the main contract. The degree of control will vary from none to, perhaps more unusually, the annexation in the main contract of a fully drafted set of sub-contract terms and conditions which the contractor is then bound to use for the sub-letting of any of the work.
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By GlobalDataThe FIDIC forms take a middle road at Clause 4.4 where there is firstly a prohibition from sub-contracting the whole of the works in the manner of a management-only style as outlined above, thereafter the clause provides that the sub-letting of any works requires the engineer’s prior consent of the proposed sub-contractor. In normal circumstances it is submitted that this consent should not be unreasonably withheld although the clause does not actually say that and so it is open to the possibility of abuse where an engineer may withhold consent from any but his own preferred sub-contractor. An unsavoury practice, but something that in the real world of international contracting does happen on occasion.
Nominated sub-contractors
A desire of the employer/engineer to maintain control is the use of ‘nominated’ sub-contractors, as distinct from the normal terminology of ‘domestic’ sub-contractors for those sub-contractors selected and let by the main contractor himself. In the case of nominated sub-contracts the scope of the sub-contract package is ‘pre-bought’ by the employer organisation but the actual sub-contract entered into will still be between the main contractor and the nominated sub-contractor with the pre-agreed sub-contract price being subject to a percentage uplift payable to the main contractor.
Difficulties arise where the ‘pre-agreed’ terms are not those which the main contractor would normally enter into a sub-contract, some degree of protection can be provided against that eventuality for example by FIDIC Clause 5.2 which provides a right of reasonable objection on the part of the main contractor.
Nominated sub-contractors will normally be subject to special payment arrangements where an engineer’s payment certificate will ‘ring-fence’ the money, which is to be passed on to the nominated sub-contractor by the contractor. This favoured treatment often leads to the erroneous view on the part of main contractor’s staff that the work undertaken by, and the performance of, a nominated sub-contractor is somehow not their responsibility. It is only these special payment terms which set the nominated sub-contractor apart. The main contractor will still be held primarily liable to the employer for any delays caused by the nominated sub-contractor and any defects in its works.
Stepping down
There is understandably a desire on the part of a main contractor to pass on, in part at least, his risks arising under the main contract for that part of the works which has been sub-let, normally referred to as the main and sub-contracts being ‘back-to-back’. There is however, no rule or automatic presumption that the terms of the main contract will apply in the mechanisms, rights and responsibilities arising under the sub-contract. The normal rules of interpretation of contracts will apply and so the extent to which main contract terms are to be ‘incorporated by reference’ into the sub-contract will be a matter for express and clear wording in the sub-contract, a process usually referred to as ‘stepping down’ of main contract provisions into the sub-contract.
Stepping down of all the main contract provisions in their entirety can however cause difficulties both practically and in the amount of risk that can effectively be transferred through the sub-contract. For instance if the sub-contract merely ‘copies’ the main contract terms for making applications for payment then a sub-contractor would only be bound to make application to the contractor at exactly the time the main contractor is making application to the employer. It is suggested that is not best practice.
As regards risk transfer, it may be simply unrealistic to expect that the sub-contracting organisation is as financially robust as the main contractor to carry all the risk pertaining to that part of the sub-let works and the main contractor will need to carry some residual risk himself. To do otherwise may simply be acting contrary to commercial reality.
Pay-when-paid, pay-if-paid
One notable manifestation of a stepping down provisions is a ‘pay-when-paid; and its close cousin, the ‘pay-if-paid’ clause. The distinction between the two has been said that the former merely controls the timing when a particular payment becomes due from the contractor to the sub-contractor with the expectation that the amount will become due at some time, the latter though may extinguish completely the sub-contractors right to any payment at all in circumstances where the main contractor is not paid by the employer.
In the UK any such contingent payment provisions have been outlawed by virtue of the Housing Grants Construction and Regeneration Act 1998 and any attempts to circumvent the provisions of the Act in this regard have been robustly rejected by the courts, for example in the case of Midland Expressway v Carillion Construction Ltd[1]. The exclusion of such clauses under UK statute though will have no effect in other jurisdictions.
Again, it is highly questionable the extent to which such transfer of the risk of payment onto a sub-contractor is commercially viable. Starved of cash-flow in this way a sub-contractor is at much greater risk of insolvency with the consequent upheaval that would cause to the contractor’s own progress whilst seeking a replacement.
Time
In formulating sub-contract terms and conditions there will of course be other matters which are ‘domestic’ as between the main and sub-contractor which will not necessarily result in a like entitlement under the main contract. Foremost of these will be considerations as to the time in which subcontract works should be performed where a balance needs to be struck between the main contractor’s need for an amount of flexibility within his programme for the carrying out of the subcontracted scope and the sub-contractor’s need to know he does not have an open-ended commitment as to the amount of time he is required to be on site.
One solution adopted under some standard form sub-contracts is to leave the start date for a sub-contractor’s works flexible by means of giving a two or four week notice to commence, after which time the agreed sub-contract durations begins. Thereafter the sub-contractor would be entitled to extensions to that time arising out of either ‘domestic’ main/sub-contractor issues or main contract delays which can then be passed down in proportion to the sub-contractor.
Difficulties can arise where there are several interdependent sub-contractors working in a particular area. Whilst one can write in mutual co-ordination or co-operation clauses into each of these sub-contracts the primary responsibility for them working in harmony will rest with the main contractor. Delays by one sub-contractor may be grounds for delay and recovery of consequent costs by another sub-contract, but because of the privity of contract of each, as referred to previously, these claims will primarily be to the main contractor’s liability. Of course the main contract can then pass on costs arising to the defaulting sub-contractor but one can see that the handling of these claims and counter-claims can be a considerable burden on the commercial management of the project.
Dispute resolution
Matters that lead to a dispute on a project will not only impact the main contract but also perhaps more than one sub-contract. As a matter of good commercial management a main contract would settle his sub-contracts as best he can before embarking on a course of dispute resolution against the employer. This however, might not always be possible and one may find a scenario where a sub-contract begins proceedings against the main contractor who is then precipitated into taking a like action against the employer.
In court litigation and where the three corners of the above noted triangle are in dispute on much the same subject matter, then there is generally the mechanism for joining two of those parties as co-defendant. As has been described in previous articles however, by far and away the most preferred method of formal dispute resolution for construction cases is arbitration.
In arbitration there is no automatic right or facility to join other parties to a dispute, known as ‘joinder’ provisions. Such joinder facilities will either have to be written into the arbitration clause of both the main and sub-contracts or else be subject to a three-cornered agreement at the time of the dispute arising. Few standard form contracts have such joinder provisions and, given that relations between the parties at that point are not usually at their best, obtaining such agreement can be neigh on impossible.
In that circumstance the main contractor is left as piggy-in-the-middle and with something of a procedural and evidential nightmare. He may find himself fighting two substantial arbitrations at the same time. In one he is arguing against the sub-contractor that the problems are the fault of the sub-contractor, in the other that they are the fault of the employer. One can immediately see that both positions cannot be correct. One can also see that if he were at least able to join the sub-contractor on his side he would at least only have to gather evidence and argue his case in one direction, the arbitration tribunal will make a binding apportionment of any damages between the contractor and the sub-contractor.
One device which has been used to effect in some ‘building’ standard forms of sub-contract is that of ‘name borrowing’ where the sub-contract contains a provision whereby the sub-contractor stands in the shoes of the main contractor and takes his dispute directly to the employer, taking all responsibility for preparing and making the case but using the contractor’s name. Whilst this fairly novel approach may overcome some of the problems of a three-cornered arbitration, there is a salutary lesson to be learned from the case of Co-Operative Wholesale Society Limited -v- Birse Construction Limited[2] where, following an arbitral award against the employer of £4.75M in favour of Birse, £750,000 of which was for Co-Op on a name borrowing basis, the employer became insolvent. The English Court of Appeal held that Co-Op was still entitled to its full £750,000 from Birse even though Birse could only recover as unsecured creditors from the now insolvent employer.
Contract Law
