Contractual Risks in Construction Subcontracts – the 10 Red Flags

Gone are the days when a Subcontractor can simply put its contract in a drawer and rely on its good relationship with a main contractor or developer to ensure that a project runs smoothly, and it gets paid at the end. 

Today’s Subcontractor needs to understand its contractual obligations and manage them to avoid lengthy disputes or lack of payments. 

This article identifies 10 ‘Red Flag’ clauses in construction subcontracts and explains why they should be avoided – or at the very least managed - by Subcontractors: 

1. Read through / back-to-back clause: 
   
   A clause which subjects a Subcontractor to all conditions in the Head Contract between the Principal (the party who the work is being done for. For example, the owner of the building) and the Head Contractor (the main contractor responsible for day-to-day management of the project). 
   
   Where this clause is included, the Subcontractor can be subject to increased obligations (such as warranties and indemnities) in the Head Contract of which it is not aware. This clause can:  
   
   • Create significant ambiguity and confusion regarding the actual terms of the contract.
    
   • Extend a Subcontractor’s liability beyond what has intended, priced for and insured against. 
   
   
2. No damages for delay: 
   
   This protects the Principal or Head Contractor from receiving a time-related damages claim from a Subcontractor. The Subcontractor may be entitled to an extension of time, but it is not entitled to be paid for it. While the Head Contractor can recover liquidated damages if the Subcontractor is in delay, the Subcontractor does not have a mutual right and bears the cost of being delayed by matters outside of its control. It is not fair for the Subcontractor not to have that benefit, particularly when the Head Contractor does. 
   
   
3. Conditional payment provision or pay-when-paid clause:
   
   A contract provision that only entitles a contractor to payment when the payer has received funds from a third party. 
   
   These are actually prohibited provisions in New Zealand by the Construction Contracts Act 2002. Unfortunately, these are still often found in unique subcontracts – i.e. subcontracts drafted by the Head Contractor or developer which are not based on a template agreement such as Subcontractor Agreement 2017 (SA2017). This type of clause remains one of the most common excuses for non-payment. Head Contractors and Principals use pay-when-paid clauses to withhold payment, potentially indefinitely if they have not received payment from a third party. 
   
   These have been prohibited because of the significant impact it can have on industry cashflow.
   
   
4. Entire agreement clause:
   
   An entire agreement clause is a provision to the effect that a written contract:
   
   • Embodies all the contractual terms between the parties; and 
   
   • All previous agreements or understandings – whether written or oral – do not apply. 
   
   This clause prevents either contracting party relying on any additional documents or representations made before the contract was entered into such as term sheets or letters of intent. Parties often have pre-contractual discussions where very important matters are discussed or agreed. It is critical to have anything discussed written into the contract. If it is not included and there is an entire agreement clause, the Subcontractor will not be able to enforce the prior agreement. 
   
   
5. Indemnity clauses:
   
   An indemnity clause is a provision where the Subcontractor is liable for any losses or damage incurred by the Head Contractor arising from a certain event or set of circumstances. A contract will do this with wording like: 
   
   “…whether the damage be caused or contributed to by any fault, including negligence, of [the indemnified party], or by any person for whom [the indemnified party] is vicariously liable…”
   
   They are, in essence, an insurance mechanism for the Head Contractor and there is no mutual insurance for the Subcontractor.
   
   A Subcontractor’s liability may not be linked to its actual responsibility for the loss. Instead, it is linked to the Head Contractor incurring any loss at all on a project. The amount may also represent an amount significantly greater than what they would otherwise be liable for in Court. 
   
   
6. Disproportionate liquidated damages clause:
   
   Liquidated damages are a sum of money specified in some contracts as being the amount payable (per working day or calendar day) in the event of a delay by the contractor. This is an amount agreed by both parties in the contracting phase and is intended to be a fair representation of losses. This avoids disputes where the actual loss may be difficult to calculate.
   
   But, if the liquidated damages sum is completely disproportionate to the value of the contract (for example, if a contract is worth $10,000.00 but the liquidated damages are $12,500.00 per day), the risk to the contractor will exceed its expected benefit from the contract. 
   
   Head Contractors may have difficulty enforcing these clauses as they will have to prove that the relatively minor contract works caused the delay that led to the liquidated damages being claimed. Negotiating these clauses out before signing, or reducing them down to an amount that is reasonable, is far preferable to arguing later, especially with such disproportionate amounts at stake.
   
   
7. Unreasonably onerous time bar provisions:
   
   It is common for construction contracts to include detailed notice provisions which require a claim (for example, for a variation or extension of time) to be submitted within a certain time frame. If you fail to submit within that time frame, you cannot claim for the extension of time or variation. 
   
   An overly onerous time bar provision seeks to make it extremely difficult if not impossible to obtain an extension of time, or payment for an extension, even if the Head Contractor is able to obtain an extension under its contract. These are often referred to as Queen of Hearts clauses because a failure to follow the stringent process essentially kills your claim.  
   
   
8. Prescribed form for variations or extensions of time:
   
   A clause which makes payment for variations or extensions of time conditional upon the contractor submitting their variations or extensions of time in a prescribed and detailed format. 
   
   This is often coupled with a time bar clause so that if you do not apply for an extension of time or variation in the prescribed format, then you are barred from obtaining one.
   
   
9. Exclusion / Limitation of liability clause:
   
   A contract clause which exempts a party from liability to another party for loss or limits their loss. This clause prevents a Subcontractor from being able to recover damages. For example, it may be used by a scaffolding company to exempt them from liability for losses resulting from the erection of the scaffolding even if it the losses are caused by an employee of the scaffolding company.
   
   These clauses can significantly limit a party’s liability for damages or costs in specific situations or categories of loss. A party is not incentivised to prevent such scenarios occurring as they are not subject to the harm which results. They are often hidden in the fine print of terms and conditions!
   
   
10. Design obligations / buildability and constructability clause:
    
    This clause provides that a Subcontractor has accepted design obligations even when it has not prepared the design or had a role in its approval. 
    
    This clause usually expands the Subcontractor’s obligation to thoroughly inspect and consider the contract drawings (and other technical specifications given by the Principal). These are often called buildability clauses. Buildability clauses typically introduce obligations on the Subcontractor to respond to those drawings and specifications.
    
    The Subcontractor is essentially in the role of independent architect or designer even though they haven’t carried out the design themselves. It expands the risk from building only to liability for design risks involved in the project. The Subcontractor is often unaware and has not upheld the obligations or priced and insured against the risks.

Mitigating the Risks

Understanding your obligations and how a contract operates will reap benefits for your business, but it is important to manage your contract to minimise your business’ exposure to risk. So how does a business manage the risks involved in contracting? 

Managing your contract means taking an active role in agreeing to and mitigating or adhering to its terms. This can broadly be broken down into three steps:

1. Pre contract: Do your due diligence on the party you are contracting with to make sure that the project will run smoothly, and you will be paid along the way. If necessary, ensure you have the appropriate security in place to be paid once the project begins. For example, a deposit has been paid or a personal guarantee from a director. 
   
   
2. Understand and minimise the risks at the contracting stage by reviewing and assessing the contractual risks before negotiating and pricing accordingly. 
   
   
3. Manage your contract once it is underway to minimise risks by having awareness across the entire team of your obligations, documenting completed works and issues which arise, and having regular internal and external meetings to track progress. 

This article only identifies 10 ‘Red Flags’ but there are many more which can impact a Subcontractor’s ability to get paid. It also provides broad high-level advice for managing your obligations. If you would like further or more specific advice on contracting or need help resolving a construction dispute, get in touch with Ford Sumner and its division Tradie Law for help.

The information in this article provides you with general information that is true and accurate to the best of Ford Sumner’s knowledge.

Ford Sumner may change, delete, add to, or otherwise amend the information contained in the article without notice. Information in this article is not business, tax, or legal advice. You should take specific, professional advice before taking any action based on this information. Please call us at 04 910 3200 or email helpdesk@tradielaw.co.nz. 

While Ford Sumner has taken all reasonable care in placing the correct information on this factsheet, it cannot be liable for any inaccuracy, error, omission, or any other kind of inadequacy, deficiency, or flaw in, or in relation to the information contained in this article. Ford Sumner fully excludes any and all liability of any kind to any person or entity that chooses to rely upon the information.