A CFM’s Guide to Drafting Sensible & Useful Subcontracts
By Kenneth B. Franklin, Joy T. Davis & Antony L. Sanacory
Contractors plan for and price their work using sophisticated estimating and scheduling techniques and software and by including contingencies in their pricing.
But they do not always approach contract drafting with the same formalities, and the contract documents of even the most sophisticated GCs and subcontractors often include large gaps in risk allocation that cannot be addressed by pricing alone.
When subcontract drafting is approached systematically and early, the contracting process itself can be a powerful tool to help identify and manage potential problems and risk areas.
This article describes common bottom line contract terms and a methodical approach to subcontract drafting that results in terms that help, rather than hinder, management of a project.
GCs and subcontractors alike can apply the principles identified in this article and dramatically decrease their risk exposure.
The Issue: Market Trends Require Improved Subcontracting Fundamentals
Owners continue to shift risks to the GCs and subcontractors, being guided by finance and management principles that encourage less owner risk in large capital projects.
This trend is not only evident in the increasing owner preference toward firm pricing, but owners are also asking contractors to bid more frequently on conceptual design, and then complete the design in connection with the construction work. This seemingly minor change can shift risks associated with design errors from the owners to the contractors.
The broader trend of shifting construction risks to contractors has overlapped other trends that increase contractor exposure. For example, GCs increasingly rely on subcontractors (and, indirectly, sub-subcontractors) to perform greater aspects of project work. Technology that is incorporated into projects is becoming more complex and sometimes unproven. Building materials are increasingly regulated and changing, and may be sourced from multiple countries with different construction standards than in the U.S.
The recent economic downturn not only decreased the number of available, capable, and qualified professionals, but the departure of many individuals from the industry has taken a toll on long-standing, trusted relationships. The GC finds itself bridging ever-increasing gaps of contractual risks amongst a growing group of interested parties.
The way work is awarded doesn’t help the subcontracting process. Owners typically begin their contracting process before the GC may even know of the project. The owner will assess its technical requirements, scheduling needs, financial projections, legal obligations and appetite for various aspects of construction risks.
GCs, in turn, often simultaneously receive draft commercial terms and project specifications, and are given little time to provide a technical proposal and take exception to the owner’s proposed commercial terms.
While contractors use PMs, schedulers, and estimators to estimate and plan each item of work, a short bidding period and the desire to “get the work in the door” may cause contractors to not only forego serious negotiations of commercial terms, but also to discount the importance of carefully reviewing them.
All of these trends combine to increase contractor risk and are driving the need for improved subcontracting fundamentals.
The Solution: Sound Subcontracting Fundamentals
It’s important to approach this process similar to performing work on a project – one step at a time.
Step #1: Appoint a Contracting Team
Relying on purchase order forms for construction support or direct labor won’t cut it. Subcontract forms that you’ve “always used” should only be considered as a starting point, not required forms.
In order to achieve sensible and useful subcontracts, you must first select a team that has the skills and time to conduct a thorough contract review. It’s critical to have personnel familiar with construction contracting principles as well as the work to be performed.
For example, at a minimum, your contracting team should consist of someone with experience drafting or administering construction contracts (an attorney, if circumstances allow), an operations person that understands how the work will practically be performed in a “real world” environment, and a finance person who understands the financial risk and milestones that must be weathered to keep the project profitable.
A thorough effort by this team will ensure that the most common Subcontract and Pricing Gaps (see Exhibit here) are identified and addressed appropriately.
Step #2: Mind the Gaps
The contracting team should understand each provision of the prime and subcontract documents and confirm they make sense from an operational perspective.
The team must consider which aspects of a project are critical and understand how certain bottom line contract provisions will affect these critical aspects of the project. A detailed checklist (seen here: checklist 1, checklist 2) can help with this process.
All projects have certain aspects with narrow margins for error and a disproportionate impact on the project schedule. The GC needs contractual leverage to manage the project for the benefit of all parties involved, including dealing with unexpected circumstances or changes that may threaten these critical aspects of work.
Some critical aspects of a project may be obvious (such as getting a building pad ready so a foundation can be poured).
However, identifying the less obvious aspects and understanding how to manage them requires a degree of familiarity that comes from day-to-day involvement in project planning.
Step #3: Conduct a Page-By-Page Review to Ensure Obligations & Rights Flow Down Appropriately
The contracting team should engage in a process – literally, a page-by-page comparison of the work to be performed and the prime contract and subcontract terms – to ensure that the prime and subcontracts are consistent and allow for successful and profitable completion.
Because the GC is responsible to the owner, a subcontractor’s responsibilities should be consistent with the GC’s responsibilities to the owner. Thus, relying unquestioningly on old subcontract forms invites (and almost ensures) large Subcontract and Pricing Gaps.
For example, if the owner directs a change in the design or construction of some aspect of the project, the GC often needs to require additional action (or inaction) by its subcontractors – even if such actions are not spelled out in the original subcontract. Likewise, even when the owner directs changes, the prime contract may require notice of price changes be accompanied by a fixed price change quotation. If the GC does not follow the contractual change process, or worse yet, if the subcontractor responsible for a changed scope of work is not required to assist in that process, then the owner may be relieved from paying for valid additional costs.
Subcontract provisions that refer to or incorporate certain aspects of the prime contract – often called flow-down provisions – enable a GC to plan and coordinate a construction project more effectively. However, despite the practical need for some consistency, overly inclusive flow-down provisions may be unfair and may not always make sense. The challenge for GCs and subcontractors is to identify which terms should flow down and how to draft clear provisions that make sense under the circumstances.
Step #4: Test the Process to Achieve the Desired Outcome
Experience teaches that doing things the right way takes time. And in order for any process to achieve a desired outcome, it must not only objectively and predictably lead to that outcome, but process must also be followed.
This article lays out an objective process for arriving at sensible and useful subcontracts. It is your responsibility to confirm the process is being followed.
Set aside time for a formal meeting where the contracting team walks you through the checklist (seen here: checklist 1, checklist 2) explains its answers to the questions identified in that checklist. Test the team with questions about the schedule, possible changes, and project cash flow. Contracts should not be signed unless they withstand this testing process.
You would not cut corners in the work your company performs, so why would you cut corners in the contract documents that allow you to perform the work in an organized, predictable, and profitable manner?
With some extra planning and hard work, you can apply the processes described in this article to arrive at sensible and useful subcontract documents and eliminate risky Subcontracting and Pricing Gaps that could threaten your company’s financial viability.
KENNETH B. FRANKLIN is a Senior Associate in the Trial Practice Group of Duane Morris, LLP in Atlanta, GA. He has experience representing and advising owners, GCs, and subcontractors in all aspects of the construction process.
Kenneth also represents clients in a wide variety of other legal areas, including Internet law, corporate formation, creditor/debtor’s rights litigation, and general business litigation.
Kenneth has a BA from Davidson College in Davidson, NC and a JD from University of Georgia School of Law.
JOY T. DAVIS is an Attorney with MasTec, Inc. in Coral Gables, FL, a leading infrastructure construction company operating across a range of industries.
She manages and directs all commercial contract matters for the company’s wireless telecommunications construction subsidiary, MasTec Network Solutions, LLC, and counsels internal business clients with regard to risk exposure, protection of company assets, enforcement of contract provisions, contract disputes, and regulatory compliance on new and existing contracts.
Joy served as a panelist at a presentation for CFMA’s Georgia Chapter in 2013. She received her BBA with honors from the University of Georgia and her JD from Mercer University, where she was a George W. Woodruff scholar.
ANTONY L. SANACORY is a Partner at Duane Morris, LLP in Atlanta, GA. Tony has handled numerous construction disputes for owners, GCs, subcontractors, and suppliers in a number of different venues.
Tony is a frequent author for CFMA Building Profits and treasurer of CFMA’s Georgia Chapter as well as chair of its Education Committee. He received his BA from The Pennsylvania State University and his JD from Duke University. A veteran of the U.S. Army, Tony received commendations for his service in Korea and Kuwait.
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Copyright © 2014 by the Construction Financial Management Association. All rights reserved. This article first appeared in CFMA Building Profits. Reprinted with permission.
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