SUBCONTRACTOR ISSUES

By

Richard Gary Thomas
Thomas, Feldman & Wilshusen, LLP
Dallas, Texas

INTRODUCTION

The vast majority of commercial construction is performed by subcontractors.  It has been estimated that subcontractors accomplish between 75% and 85% of the commercial construction in this country.  The role of most general contractors in today’s construction industry  is that of “brokers of construction services.”

Subcontractors, therefore, provide the majority of labor and materials that builds America.  Subcontractors have the most capital invested in a construction project.  Thus, it could be argued that the subcontracting industry has more at risk than any other segment of the construction industry.  For these reasons, it is not an overstatement to say that subcontractors are “where the rubber meets the road” in the construction industry.

SCOPE OF PAPER

This presentation will identify some of the situations and issues confronted by counsel for subcontractors.  Included in the discussion are troublesome clauses often encountered in subcontract forms. The discussion emphasizes situations that often result in disputes.  The focus, therefore, is centered upon the time period before the subcontractor’s performance is significantly under way.  Because of time limitations, many subjects affecting subcontractors are not covered, such as collecting funds for “extra” work, job site document management, perfecting lien and bond claims, and prosecuting claims for delay and labor inefficiency.

THE AWARD

The first problem commonly encountered by subcontractors occurs shortly after they learn that they are the successful bidder.  Usually, the general contractor informs the subcontractor by saying something to the effect that:  “you have the job.”  Shortly thereafter, the general contractor instructs the subcontractor to proceed with performance by ordering materials and preparing submittals.  Sometimes, the general contractor will issue a “letter of intent,” and other times no such document is forthcoming.

Somewhat amazingly, most subcontractors proceed without any definite express contractual commitment from the general contractor.  At this point, the legal relationship between  the parties is totally undefined, or at least,  poorly defined.  Both, however, count on the hope that the legal relationship will be solidified at a later date. They conduct themselves as a defined legal relationship exists.  The general contractor uses the subcontractor’s bid in determining the contract price between the general contractor and owner.  The general contractor relies upon that particular subcontractor to do the job.  The general contractor puts “all its eggs in one basket” in the sense that no other subcontractor has prepared to do the work of that trade.  If, for some reason, the selected subcontractor does not work on the job, an automatic delay of the project results while the second subcontractor “catches up.”

Likewise, the subcontractor at this stage often contractually commits to purchase materials and equipment from suppliers in reliance upon performing the job.  Furthermore, the subcontractor may decline other work because of the anticipated demands of the job.   In short, both the general contractor and the subcontractor alter their positions in reliance upon the other, all without a clearly defined legal relationship.  This is either any attorney’s dream or a nightmare, depending upon one’s perspective.

Ambiguous legal relationships are fertile soil for misunderstandings and lawsuits.  If, at this stage, the general contractor arbitrarily decides to use another subcontractor, does the subcontractor have any right to make a claim for lost profits?  If the subcontractor decides that it does not want the job, can the subcontractor abandon it without liability to the general contractor?  If the project gets suspended indefinitely, does the subcontractor have a valid claim against the general contractor for suspension related expenses?  If the general contractor and subcontractor cannot agree upon important contractual terms, does the subcontractor have the right to discontinue work without potential liability?  In some of these scenarios, it is better for the subcontractor that there is no binding contract, while in others, it is better for the subcontractor that a binding contract exists.

There are many potential outcomes.  One merely resorts to principles governing formation of contracts to determine the legal relationships between the parties. Simply stated, all that is required to create an enforceable contract is that one party makes an offer, and the other party accepts that offer.  Smith v. Renz, 840 S.W.2d 702, 704 (Tex. App.—Corpus Christi 1992, writ denied).  A bid can serve as the offer, and the acceptance can be nothing more than the general contractor advising the subcontractor:  “you have the job.”  Urban Electrical Services, Inc. v. Brownwood Independent School District, 852 S.W.2d 676, 678, (Tex. App.—Eastland 1993, no writ) (submittal of a bid is an offer to enter into a contract); Turner, Collie & Braden v. Brookhollow, Inc., 624 S.W.2d 203, 213 (Tex. App.—Houston  [1^st Dist.] 1981) rev’d on other grounds 642 S.W.2d 160 (Tex. 1982) (When contract in writing signed by one party, accepted orally by the other who also performs thereunder and accepts the benefits thereof, the written contract is the governing document of the parties.)

It could therefore, be argued that a subcontractor performing work without a signed written contract means that there is an enforceable contract with only two terms:  (1) the scope of the work as defined by the bid documents (i.e., plans and specifications) and (2) the price.  Taken literally, that would mean the subcontractor gets paid nothing until the end of the job; i.e., there are no agreed payment terms providing for the monthly progress payments.  On the other hand, it may be argued that the payment terms are supplied by customs and practices in the industry to supply the intent of the parties.  Those customs and practices provide “standard” terms calling for monthly progress payments.  If that is the case, what would be considered “standard” relative to other clauses such as insurance requirements pertaining to general liability and workers’ compensation insurance?  What, if anything, would be considered “standard” on the subject of retainage?  What are the limitations for “standard” terms?

It may be argued further that in the absence of a signed written agreement, the last contract between the parties will supply the general terms of the agreement.  If that is the case, any credit decisions made on the prior project that were influenced by, for example, the ownership, financing, or bonding of the prior project would be extrapolated onto the current project.  That may be an undesirable result for the subcontractor.   Because a subcontractor consented to a contingent payment clause on one project of a particular owner is no indication that the same subcontractor would agree to a contingent payment clause on a project of a completely different owner.

Quite obviously, if a court should determine that an enforceable contract exists, the precise terms of that contract are unclear.  That means it cannot be predicted with certainty what the court will find the specific terms of the contract to be.  Hence, the subcontractor that being working without a signed contract is running a risk that it is performing under contractual terms that are quire unfavorable.  Of course, the same is true for the general contractor.

Conversely, it could be that no enforceable contract exists before both parties sign on the dotted line.  For example, it could be successfully argued that well-established customs and practices in the industry, as well as the intent of the parties, dictate that there is no binding obligation until there is agreement on all terms.  If so, a court would likely hold, under the doctrine of quantum meruit, that the subcontractor should be paid a reasonable price for work actually performed but deny recovery for anything else.

Under that scenario, the subcontractor likely incurs risks without realizing it.  The general contractor would arbitrarily switch subcontractors without being liable to the initial subcontractor to whom the job was first awarded.  That could be the result even though the first subcontractor has entered into non-cancelable purchase orders with suppliers for expensive equipment or materials.  In other words, a subcontractor could be legally obligated to buy materials or equipment but have no one to sell them to because there is no enforceable contract with the general contractor.  Furthermore, the disappointed subcontractor would have no claim for lost profits.

Each case will be governed by its own facts.  The bottom line, however, is that the outcome is unpredictable.  This is a situation to avoid when possible.

One way to improve the subcontractor’s position is to condition all bids expressly upon reaching a mutual agreement on acceptable contract terms.  Subcontractors can also condition their bids upon the use of the AGC/ASA/ASC subcontract form.  Better yet, the subcontractor can customize its bid form with favorable terms and state that acceptance of the bid constitutes acceptance of the subcontractor’s terms contained therein.  The standard bid forms of some subcontractors state that the mere utilization of the subcontractor’s bid number constitutes acceptance of the bid!  While these practices will not always cure the problems, they provide the subcontractor with much more protection that if they are not used.

THE SUBCONTRACT FORM IS NEGOTIATED

A.  The AGC/ASA/ASC Subcontract Form

In the distant past, a subcontract documented the business relationship between the parties without an extraordinary attempt to shift risk from one party to the other.  Subcontracts were commonly one page long.  Beginning around the early 1970’s, a trend commenced to shift many of the risks on construction projects to the subcontractor.  Around the early to mid-1980’s, this trend accelerated to the point where currently, some subcontracts are over one hundred pages long!  Risk shifting became the norm in the industry.  Under that trend, the vast majority of risks were transferred to subcontractors.

Many rationales were advanced to justify this trend.  One of the most popular was that since subcontractors perform the majority of the work, they are the ones that had the real control over most risks.  Hence, the risks properly belong with the subcontractor.

One practical reason for risk allocation in this manner is that owners were frequently successful transferring many of these risks to general contractors in prime contracts.  Having contractually accepted these risks in prime contracts, it became prudent for general contractors to attempt to pass them along to subcontractors.

Regardless of the merits of the rationale behind the extreme shifting of risks to subcontractors, the practice had many practical effects.  First, most subcontractors were smaller than the general contractors and less sophisticated in these matters.  That created an unequal bargaining position in favor of the general contractors.  The result was that subcontractors were overpowered, which resulted in the mass shifting of risk that exists today.

This risk shifting practice, unfortunately, promoted an adversarial attitude between the parties which promoted disharmony on project.  Disharmony, in turn, created disputes on the job site resulting in legal battles where no one is the real winner.  In the end, unreasonable and inequitable risk shifting in contracts worked to the detriment of overall project performance.  This has been recognized by studies conducted by the Construction Industry Institute.¹

In recognition of this problem, the Associated General Contractors (AGC), the American Subcontractors Association (ASA), and the Association of Specialty Contractors (ASC) formed a joint task force to develop a form subcontract.  This occurred in the early 1990’s.  The product of this effort is a contract form that does not favor any segment of the industry and attempts to allocate risks in a manner that promotes harmony on construction project.  Hopefully the use of this firm will result in a more fulfilling and profitable experience for all participants in the industry.

The new AGC/ASA/ASC subcontract form² supersedes the former AGC form 600 which will no longer be published.  The new form is a product of negotiation between the two industry segments, and thus, contains many compromises.  In other words, it allocates some risks to the subcontractor that, ideally, subcontractors would prefer to avoid, and vice versa.  That however, is the normal outgrowth of the negotiation process, the end result of which is a fair allocation of risk for both parties.

Whether the AGC/ASA/ASC form will gain general industry acceptance is yet to be seen.  Nevertheless, it indicates a significant trend in the industry away from the rampant attempts to shift risks to one segment of the industry.  The mere fact that these three diverse associations participated in this joint effort is momentous, in and of itself.  Perhaps it is the first step toward accomplishing a more healthy business atmosphere, which will hopefully produce greater economic rewards for all segments of the construction industry.

B.  The Subcontract is Formed

At some point after the subcontractor has been informed that the general contractor intends to award it the contract, the general contractor will forward a subcontract form to the subcontractor.  Unfortunately, some subcontractors merely sign the document without reading it.  This is because many subcontractors trust the general contractor to deal with them fairly, regardless of what the “paper work” says.  Often the subcontractor discovers that its trust in the general contractor was misplaced, once a problem on a project erupts.

It is rapidly becoming the norm, however, for subcontractors to review their subcontract and propose revisions.  Construction practitioners should encourage their subcontractor clients to do so.  If there is anything in a contract that the client does not understand, he or she should obtain professional advise.  Nobody should sign a contract containing terms that are not understood.  Likewise, subcontractors should be encouraged to seek revisions of clauses unfairly placing risks upon the subcontractor.  Usually, general contractors appreciate the necessity of this process and do not object to reasonable changes in the language.  Some of the more common clauses that are troublesome to subcontractors are discussed below.

C.  Troublesome Contract Clauses

1. Flow Through Clauses

Flow-Through clauses (also sometimes referred to as “Flow-Down” or Pass-Through clauses), in their most basic form, transfer responsibility for the project from the general contractor to the supplier or subcontractor.  Obligations owed to the owner by the general contractor “flow-through” to the supplier or subcontractor.  When subcontractors bid plans and specifications, they should have no problem with agreeing to assume the responsibilities of the general contractor owed to the owner with respect to the specific work of the subcontractor.  That is the essence of what subcontractors sell to their customers.

However, “flow-through” clauses quite often go much further.  Such clauses usually incorporate all of the prime contract documents into the subcontract.  Those prime contract documents include not only the technical plans and specifications pertaining to the subcontractor’s products, but also contain many other matters that govern the contractual relationship between the owner and prime contractor.  The “flow-through” clause often provides that the subcontractor assumes toward the general contractor all the obligations that the general contractor assumes toward the owner.  Even though this is probably not the intention of the parties, taken literally,  this clause could be argued to mean that the subcontractor agreed to build the entire project for the owner.

That result may truly be absurd.  Nevertheless, such a clause transfers many more obligations in the prime contract to subcontractors than the obligations confined to the technical plans and specifications pertaining to the particular work of the subcontractor.  Prime contract obligations transferred in these clauses likely include clauses that address:  insurance, indemnity, payment, warranties, extras, time requirements for performance, suspension of performance, termination of contract, claims, and dispute resolution.  Accepting an unrestricted “flow-through” clause means that the subcontractors agree to whatever was agreed to between the prime contractor and owner on these subjects.  It literally becomes the subcontractor’s agreement or contract with the general contractor.   A “flow-through” clause, therefore, should not be taken lightly and should not be thoughtlessly accepted.

The AGC/ASA/ASC “flow through” clause is set for the below:

ARTICLE 3

Subcontract Documents

3.1   The Subcontract Documents consist of this Subcontract Agreement No.       and the following listed documents, schedules ad attachments which are all incorporated by reference and made a part hereof:  (List applicable Subcontract Documents including special conditions, general conditions, specifications, drawings, addenda, modifications, exercised alternates, schedules, attachments, the Contract and/or other documents.  Identify, with general description, sheet numbers and latest date including revisions.)

3.2   The Subcontract Documents which are binding on the Subcontractor are set forth in Paragraph 3.1.  The Contractor shall make available to the Subcontractor, prior to the execution of the Subcontract Agreement, copies of the Subcontract Documents to which the Subcontractor will be bound.  The Subcontractor similarly shall make copies of applicable portions of the Subcontract Documents available to its proposed subcontractors and suppliers.  Nothing herein shall prohibit the Subcontractor from obtaining copies of the Subcontract Documents from the Contractor at any time after the Subcontract Agreement is executed.  Where any provision of the documents listed in Article 3 hereof, is inconsistent with a provision of this Subcontract Agreement, this Subcontract Agreement shall govern.  Nothing in the Subcontract Documents shall be construed to create a contractual relationship between persons or entities other than the Contractor and Subcontractor.

Note that the prime contract documents must be specifically listed before the subcontractor is bound to them.  Furthermore, the general contractor is obligated to provide copies of all the incorporated prime contract documents.

A typical proprietary “flow through” clause is set forth below.  Note how this clause  makes the subcontractor obligated for all obligations of the general contractor contained in the prime contract.

The Contract Documents for this Subcontract consists of this Agreement and any Exhibits attached hereto, the Agreement between the Owner and Contractor dated July 22, 1995, the Conditions of the Contract between the Owner and Contractor (General, Supplementary and other Conditions), Drawings, Specifications, all Addenda issued prior to execution of the Agreement between the Owner and Contractor, and all Modifications issued subsequent thereto.  Subcontractor agrees to be bound to Contractor by all of the terms of the Agreement between Contractor and Owner and by the Contract Documents and to assume toward Contractor all of the obligations and the responsibilities that Contractor by those instruments assumes toward Owner.

All of the above documents are part of this Subcontract and shall be available for inspection by Seller upon his request (Emphasis added)

The best option for the subcontractor is to delete “flow-through” clauses in their entirety.  One should be aware that these clauses are likely to be very important to the general contractor.  That is because it is most important to the general contractor to make sure that the subcontractor is obligated to the general contractor in the same manner the general contractor is obligated to the owner with respect to the subcontractor’s technical requirements in the plans and specifications.  A good middle ground, therefore, is to agree to the transfer of the prime contract obligations limited, however, to the obligations pertaining to the plans and specifications of the design professional which pertains to the subcontractor’s work.  Excluded from the transfer of obligations are those that pertain to the subjects mentioned above, including insurance, indemnity, payment, warranties, and so forth.  If the subcontractor is unable to negotiate such a middle ground revision, the subcontractor should at least make sure the clause cannot be interpreted so broadly as to mean that the subcontractor assumes virtually every obligation of the general contractor that is owed to the owner.

Even if the subcontractor is successful in narrowing the scope of the clause, it is still faced with two undesirable choices:  (1) the subcontractor must obtain a copy of the prime contract and carefully review it prior to signing the subcontract so that it can object to any terms that are totally unacceptable and become aware of the specific time deadlines and other requirements; or (2) sign the subcontract without reviewing the prime contract and hope that it does not contain anything very bad and gamble that no requirements and deadlines of the contract are missed.  The former is most time consuming, while the latter is careless, risky, and most ill-advised (but probably most commonly practiced).

Article 5.3.1 of the A.I.A. General Conditions³  provides that upon written request of the subcontractor, the general contractor shall identify to the subcontractor the terms and conditions of the “proposed subcontract” that may be at variance with the Contract Documents.  Since the word “proposed” is used, it appears that an obligation is intended for the general contractor to provide this information during the negotiation process.  It is unclear precisely what rights this clause confers upon the subcontractor prior to the formation of the subcontract.  Nevertheless, the clause is clearly intended to benefit the subcontractor, and hence, perhaps the subcontractor has rights as a third party beneficiary.  In any event, it is difficult to see how invoking this clause during the negotiation process could harm the subcontractor.

Therefore, if the subcontractor is neither successful in deleting the “flow-through” clause in its entirety nor negotiating a middle ground revision, it should at the very least send a letter similar to that found in the Appendix at Page 1.  If the A.I.A. General Conditions apply, the general contractor’s failure to comply with the request could be used against the general contractor.  It could well operate as a defense to any rights of the general contractor contained in the General Conditions.  Furthermore, it may even constitute a breach of contract on behalf of the general contractor which may invoke traditional legal and equitable remedies on behalf of the subcontractor.

2.  Payment Clauses

The payment clause in a subcontract is probably the most important clause to the subcontractor.  There are two different categories of payment clauses in Texas:  (1) pay-when-paid and (2) contingent payment (also known as “pay if paid”).

If the clause states that the general contractor will pay the subcontractor within a certain time period (eg.  seven days) after the general contractor receives payment from the owner, it is considered a “pay when paid” clause and is not interpreted to absolve the general contractor’s obligation to pay the subcontractor in the event that the owner never pays the general contractor.  Prickett v. Lendell Builders, Inc., 572 S.W.2d 57, 59 (Tex. Civ. App.—Eastland 1978, no writ).  On the other hand, if the clause clearly establishes the receipt by the general contractor of payment from the owner is a condition precedent to the general contractor’s obligation to pay the subcontractor, that condition must be met before the payment obligation ever arises.

Texas courts will go to great lengths to avoid construing these clauses to be contingent in nature.   For example, in Gulf Const. Co., Inc. v. Self, 676 S.W.2d 624, 626 (Tex. Civ. App.—Corpus Christi 1984, writ ref’d n.r.e.), the court held the following clause did not constitute a condition precedent to the general contractor’s obligation to pay the subcontractor:

“[W]hen the owner or his representative advances or pays the general contractor, the general contractor shall be liable for and obligated to pay the sub-contractor up to the amount or percentage recognized and approved for payment by the owner’s representative less the retainage required under the terms of the prime contract.  Under no circumstances shall the general contractor be obligated or required to advance or make payments to the sub-contractor until the funds have been advanced or paid by the owner or his representative to the general contractor.”

Gulf Const. Co., Inc. v. Self, 676 S.W.2d 624, 627. (Emphasis added)

The court reasoned that where the intent of the parties is doubtful or where a condition would impose an absurd result, the clause should be interpreted as creating a covenant rather than a condition.  Id.  The court also relied upon the rule that forfeitures are to be avoided when possible under another reasonable interpretation of the contract.  Id.  The court noted that words commonly associated with creating conditions precedent, such as “if” and “on condition that” were not used in the clause.  Gulf Const. Co. v. Self,  676 S.W.2d 629.  See also, Wisznia v. Wilcox, 438 S.W.2d 874 (Tex. Civ. App.—Corpus Christi 1969, writ ref’d n.r.e.).⁴ 

A typical clause that likely qualifies as contingent payment (or paid if paid) clause, is the proprietary form which is set forth below.

In addition to any other requirement of this Subcontract and the Contract Documents, Final Payment shall not become due unless and until the following conditions precedent to Final Payment have been satisfied:  (a) approval and acceptance of Subcontractor’s work by Owner, Architect and Contractor; (b) delivery to Contractor of all manuals, “as-built” drawings, guarantees and warranties for material and equipment furnished by Subcontractor, or any other documents required by the Contract Documents; (c) receipt of Final Payment for Subcontractor’s work by Contractor from Owner; (d) furnishing to Contractor satisfactory evidence by Subcontractor that all labor and material accounts incurred by Subcontractor in connection with his Work have been paid in full; (e) furnishing to Contractor a complete Affidavit, Release of Lien and Waiver of Claim by Subcontractor in the form attached hereto as Exhibit “D”, and as required by the Contract Documents.  Subcontractor expressly assumes the risk of non-payment by the Owner to the Contractor.  (Emphasis added)

The practitioner for the subcontractor should, at least advise the client of the effect of this clause.   It is suggested that appropriate revisions be made to eliminate the “condition precedent” nature of this clause.

The AGC/ASA/ASC approach to this subject is set forth below:

14.2.7  TIME OF PAYMENT  Progress payment to the Subcontractor for satisfactory performance of the Subcontract Work shall be made no later than seven (7) calendar days after receipt by the Contractor of payment from the Owner for the Subcontract Work.  If payment from the Owner for such Subcontract Work is not received by the Contractor, through no fault of the Subcontractor, the Contractor will make payment to the Subcontractor within a reasonable time for the Subcontract Work satisfactorily performed.

That clause almost certainly would not be construed as a contingent payment clause in Texas.  It appears to expressly adopt the “pay when paid” concept in that it provides that the subcontractor is entitled to payment within a reasonable time in the event the owner fails to pay the general contractor and the reason for the nonpayment is not the fault of the subcontractor.

3.  Indemnity

A “hot topic” in the construction law bar is “indemnity.”  That refers to the clauses where the subcontractor indemnifies the general contractor (and sometimes the owner and even the design professionals) from the consequences of accidents resulting in personal injury or property damage on the job site.  It is generally accepted among construction lawyers that there are three types of indemnity clauses:  (1) limited, (2) intermediate, and (3) broad form.

A “limited” indemnity clause imposes liability upon the indemnitor (i.e., the subcontractor) only to the extent of the indemnitor’s fault or negligence.  It is the most favorable type of indemnity clause for subcontractor.  As example of such a clause is the AGC/ASA/ASC contract clause set forth below:

12.1     INDEMNIFICATION  The Subcontractor shall indemnify and hold the Contractor, Owner, Architect, their agents, consultants and employees harmless from and against all claims, losses, costs and damages, including but not limited to attorneys’ fees, pertaining to the performance of the Subcontract and involving personal injury, sickness, disease, death or property damages, including loss of use of property resulting therefrom but not damage to the work itself, but only to the extent caused in whole or in part by the negligent acts or omissions of the Subcontractor, or any of the Subcontractors’ suppliers, manufacturers, or other persons or entities for whose acts the Subcontractor may be liable.  This indemnification agreement is binding on the Subcontractor, to the fullest extent permitted by law, regardless of whether any or all of the persons and entities indemnified hereunder are responsible in part for the claims, damages, losses or expenses for which the Subcontractor is obligated to provide indemnification.  This indemnification provision does not negate, abridge or reduce any other rights or obligations of the persons and entities described herein with respect to indemnity.  (Emphasis added)

Under an “intermediate” indemnity clause the indemnitor assumes all liability except for the sole negligence of the indemnitee (general contractor, owner or design professional).  An example of such clause is set forth below.

The Seller shall indemnify and hold harmless the Contractor and all its agents and employees from and against all claims, damages, losses, and expenses, including attorney’s fees, arising out of or resulting from the Seller’s work whether it is caused in part by the negligence of Contractor.   In any and all claims against the Contractor, or any of its agents and employees, by any employee of the Seller, anyone directly or indirectly employed by him or anyone for whose acts he may be liable, the indemnification obligation under this paragraph shall not be limited in any way by any limitation on the amount or type of damage, compensation, or benefits payable by or for the Contractor under workers’ compensation acts, disability benefit acts, or other employee benefit acts.  This clause is not intended to indemnify the Contractor for claims, damages, losses and expenses caused by the sole negligence of Contractor.  (Emphasis added)

“Broad” form indemnity clauses impose the entire risk of loss upon the indemnitor, even for the sole negligence of the indemnitee.  This is the least favorable type of indemnity clause for the subcontractor.  An example of a broad form indemnity clause is set forth below:

The Seller shall indemnify and hold harmless the Owner and Contractor and all their agents and employees from and against all claims, damages, losses and expenses, including attorney’s fees, arising out of or resulting from the performance of the Subcontractor’s work whether it is caused in part or in whole by negligence of Owner or Contractor.  In any and all claims against the Owner and Contractor, or any of their agents and employees, by any employee of the Seller, anyone directly or indirectly employed by him or anyone for whose acts he may be liable, the indemnification obligation under this paragraph shall not be limited in any way by any limitation on the amount or type of damages, compensation, or benefits payable by or for the Contractor under workers’ compensation acts, disability benefit acts, or other employee benefit acts.  It is specifically understood that this indemnity shall be interpreted as indemnifying Contractor and its agents and representatives from their own sole and/or partial negligence.  (Emphasis added)

The indemnitor’s obligation exists in this regard under the broad form even if the indemnitor is not negligent or in any way the cause of or directly involved in the cause of the accident or loss.

In most states, indemnity clauses are strictly construed and interpreted under the “clear and unequivocal” test.  That is, contractual language that “clearly and unequivocally” expresses in intent that the indemnitor assumes the liability for the indemnitee’s negligence is enforceable.  See eg., Black Diamond Coal Mining Co. v. U.S.K. Corp., 581 So.2d 839, 840-41 (Ala. 1991); Industrial Tile, Inc. v. Stewart, 388 So.2d 171 (Ala. 1980); J.E. Eley v. Brunner-Lay Southern Corp., 266 So.2d 276, 380 (ala. 1972); Batson-Cook Co. v. Industrial Steel Erectors, 257 F.2d 410 (5^th Cir. 1958); Murray v. Texas Co., 174 S.E.2d 231, 232 (S.C. 1934).

Whether specific language meets the “clear and unequivocal” test can be difficult to determine.  The Texas approach resolves that problem by eliminating the potential for ambiguity.⁵  In Ethyl Corp. v. Daniel Construction Co., 725 S.W.2d 705 (Tex. 1987), the Texas supreme court rejected the “clear and unequivocal” test and adopted the “express negligence” test.  The court stated:

“We hold the better policy is to cut through the ambiguity of those provisions and adopt the express negligence doctrine.  The express negligence doctrine provides that parties seeking to indemnify the indemnitee from the consequences of its own negligence must express that intent in specific terms.  Under the doctrine of express negligence, the intent of the parties must be specifically stated within the four corners of the contract.”

Ethyl Corp. v. Daniel Construction Co., 725 S.W.2d 708 (Tex. 1987).

The broad form and intermediate form indemnity clauses set forth above are likely to meet the express negligence test.  It is in the best interest of the subcontractor to modify such language so that the “express negligence” test is not met.  At least, attempts should be made to dilute the scope of such clauses so that they become a limited (or alternatively an intermediate) form of identify.

Often, indemnity agreements include the obligation to defend the Indemnitee in addition to the mere duty to indemnify.  There has bee a split of authority among the states whether the duty to defend is co-extensive with the duty to indemnify.  Texas, however, has resolved that conflict.

In Fisk Electric Co. v. Constructors & Associates, Inc.,        S.W.2d   (Tex. 1994), 38 Tex. Sup. Ct. J. 108 (December 1, 1994), the Court held that there is no obligation to indemnify an Indemnitee for the costs or expenses resulting from a claim made against it for its own negligence unless the indemnification agreement complies with the express negligence doctrine.  In other words, absent a duty to indemnify, there is no obligation to pay attorneys fees.

4.  Additional Insured

A subcontractor may successfully negotiate the reduction of the scope of an indemnity clause from broad form  to limited form,  but that victory may be hollow, and perhaps, totally worthless.  This is the case if the subcontractor agreed to a clause in the contract obligating it to make the general contractor (and perhaps also the owner and construction manager) an “additional insured” under the subcontractor’s (or supplier’s) general liability insurance policy.

An “additional insured” is no more or less than the name implies:  the general contractor becomes an “insured” under the subcontractor’s policy.  Just as any other “insured”, an “additional insured” is entitled to the benefits and coverages afforded by the policy.  Simple stated, an “additional insured” is an “insured” under the subcontractor’s policy in every sense of the word.

When a subcontractor is sued for something covered by its insurance policy, its insurance company will normally provide the legal defense and pay any settlements or judgments connected with the suit.  This occurs regardless of whether the subcontractor was negligent.  The same is true when a general contractor is sued if the general contractor has been made an “additional insured” under the subcontractor’s insurance policy.  The general contractor turns the suit over to the subcontractor’s insurance company for handling.  Since the general contractor is entitled to benefits and coverages afforded by the subcontractor’s policy, the general contractor expects the subcontractor’s insurance company to provide its legal defense and pay any settlements and judgments connected with the suit.  The negligence of the subcontractor is irrelevant to the general contractor’s rights under the subcontractor’s insurance policy.

The result is identical when the subcontractor agrees to a broad form indemnity clause.  When the general contractor is sued, it turns the defense of the suit over to the subcontractor’s insurance company.  Regardless of whether the subcontractor is negligent, the subcontractor’s insurance company must provide a legal defense for, and pay any settlements or judgments against, the general contractor.

Insurance premiums are determined, at least in large part, by the experience rating of the insured.  When the subcontractor’s insurance company expends funds in defense of suits against the general contractor, it is likely to cause the subcontractor’s insurance premiums to be increased in the future.  It makes no difference whether the insurance company expends funds in defense of the general contractor because it is an “additional insured” or by virtue of an indemnity clause.  The result is the same.  The subcontractor likely pays increased premiums in the future.

The result is identical, therefore, to the subcontractor when it consents to either a broad form indemnity clause of a clause that requires the subcontractor to make its customer an “additional insured.”  The inescapable conclusion is that it is totally illogical for someone who is philosophically opposed to broad form indemnity clauses to accept a clause requiring them make another party an “additional insured” under their insurance policy.⁶

“Additional insured” clauses can be located in several places in subcontracts.  They are most commonly located in the provisions relating to insurance.  Counsel for subcontractors who pay particular attention only to indemnity provisions of contracts are likely to miss “additional insured” clauses.  Therefore, the insurance provisions should be just as carefully reviewed as the indemnity provisions.

If the subcontractor is unsuccessful in “negotiating out” the additional insured clause and it  is determined that the clause should be accepted, counsel and the subcontractor should be aware that an endorsement to their insurance policy must be purchased from the insurance agent making the general contractor an “additional insured.”  Failure to procure such endorsement constitutes a breach of the contract.

Many “additional insured” clauses go farther than simply requiring the  subcontractor to purchase the “additional insured” endorsement.  These clauses commonly require that the subcontractor’s insurance policy provide “primary” coverage for the general contractor, and the general contractor’s own insurance coverage be “non-contributory.”  If this clause is accepted, it means that the subcontractor’s insurance company will not seek any contribution from the general contractor’s insurance company.

The problem with that is, ordinarily, subcontractors have no such control over the actions of their insurance company.  Most policies contain an “other insurance” provisions allowing the carrier to seek varied types of contribution from other insurance covering the loss.  If it is possible for the subcontractor to achieve the result required by that clause,  a special endorsement would have to be purchased from its insurance carrier.   Failure to procure such endorsement could expose the subcontractor to liability for large damages for that breach of contract.  Therefore, it is imperative that the subcontractor’s insurance agent or consultant be consulted on this subject before consenting to that undertaking.

5.  No Damage for Delay

The AGC/ASA/ASC subcontract expressly provides that the contract, “does not preclude recovery of damages for delay by either party.”  See, Article 13.3.2.  Most proprietary forms of general contractors do not utilize that approach.

Somewhat amazingly, most proprietary subcontract forms declare complete liability of the subcontractor to the general contractor for delays, while contemporaneously, declaring that the general contractor has no liability to the subcontractor for delays.  A typical clause to that effect is set forth below:

If Subcontractor is responsible for any delays in the time and sequence of the schedule, Subcontractor shall pay Contractor for all costs and damages suffered by Contractor as a result of such delays, including any damages against Contractor under the Contract Documents.

In the event that Subcontractor’s performance of the Work is delayed or interfered with, for any reason and for any period of time, by acts or omissions of Owner, Contractor of other subcontractor, Subcontractor may request an extension of time for performance of the Work, but shall not be entitled to any   increase in the Subcontract price or to damages or additional compensation as a consequence of such delays or interference, except to the extent that the Contract Documents entitle Contractor to compensation for such delays, and then only to the extent of any amounts that Contractor may, on behalf of Subcontractor, actually receive from Owner for such delays.   (Emphasis added)

The viability of these clauses is unsettled in Texas when certain facts exist supporting traditional exceptions to the enforceability of “no damage for delay” clauses.  For example, in City of Houston v. R.F. Ball Construction Company, Inc., 570 S.W.2d 75, (Tex. Civ. App.—Houston [14^th Dist.] 1978, writ ref’d n.r.e.), the court appeared to reject the well accepted exception known as “not within the contemplation of the parties.”  Under that exception, claims for delays arising from reasons or for durations not contemplated by the parties at the time of contracting are not precluded by the clause.

On the other hand, a well established case in Texas is Housing Authority of City of Dallas v. Hubbell, 325 S.W.2d 800 (Tex. Civ.  App.—Dallas 1959, writ ref’d n.r.e.).  In that case, the court held that arbitrary and capricious conduct on the part of a party using the clause as a defense renders the clause unenforceable.  In almost every delay claim scenario, the practitioner for the subcontractor will be able to cite to the court conduct of the general contractor that is, at least,  arguable, arbitrary and capricious.⁷

In light of these two cases, the viability of a “no damage for delay” clause is unclear in Texas jurisprudence.  The best option for the subcontractor is to delete the clause in its entirety.  Failing that, it is suggested that attempts be made to negotiate revisions that incorporate the concept of “reasonableness.”  That is, there will be no damage for delays unless they are of an unreasonable duration under the circumstances.  It is difficult for the general contractor to maintain the right to be unreasonable during negotiations about the clause!

Furthermore, it is a good idea to attempt to negotiate a revision that incorporates the “not within the contemplation of the parties” exception, discussed above.  The revision of this clause is set forth below and is food for thought in this regard.

No payment or compensation of any kind shall be made by the Contractor to the Subcontractor for damages because of delay in the progress of the Work from any cause, as long as such delay is of the type and duration that is reasonably anticipated to occur during the normal course of the construction process for commercial construction projects in the geographic area of this Project.  (Emphasis added)

6.  Partial Lien Waivers

It is standard in the construction industry for the general contractor to require subcontractor to sign certain forms in order to receive periodic payment during the course of the subcontractor’s performance of its contract.  These forms usually intend that the subcontractor waive or release its lien rights and claims against the owner, the owner’s property, and the general contractor.  The intent usually is that this  waiver or release is limited to the amount of the payment to the subcontractor.  In other words, partial waivers or releases are not intended to hamper a subcontractor’s rights to get paid for any amounts not yet received by the subcontractor.

Unfortunately, many partial waiver forms literally release much more than contemplated, even though they are entitled “Partial Waiver and Release.”  Quite often, when read literally, these documents operate to waive and release claims for which the subcontractor has not been paid.  For example, it is not unusual for a “partial waiver” to release the right of a subcontractor to receive payment for unapproved “extras.”  It is also not uncommon for a “partial waiver” to release the general contractor’s obligation to pay for work performed by the subcontractor, the payment for which is not yet due under the contract (eg., retainage).  An example of such a “partial release” form is set forth below:

EXHIBIT “A”

PARTIAL RELEASE

NOW, THEREFORE, inconsideration of the premises and of the sum of $      lawful money of the United States, being the full and entire sum due to Subcontractor for Subcontractor’s performance of the contract aforesaid for all work performed from the beginning of the contract to (date this is signed), in hand paid by Contractor receipt of which is hereby acknowledged, said Subcontractor does hereby remise, release, and forever discharge Contractor and Owner of and from any and all manner of actions, suits, debts, dues,  sums of money, accounts, reckonings, bonds, bills, covenants, controversies, agreements and demands whatsoever in law or in equity which the said Subcontractor has or may have for or on account of or in connection with the contract aforesaid for Subcontractor’s performance thereunder from the beginning date of said contract to (date this is signed).  (Emphasis added)

It may well be that the job site management of the general contractor does not intend this result.  Nevertheless, if the subcontractor finds itself in a dispute and the problem falls into the lap of upper management of the general contractor or its attorney, they may well take the position that the subcontractor has waived and released its claims.  Whether the general contractor should prevail with such contentions is beside the point.  The subcontractor has many available arguments to defeat the general contractor.   Traditional principles of contract interpretation, fraud and estoppel  likely apply to defeat the position of the general contractor.  Of importance in the contract formation stage is for the subcontractor to refrain from contractually obligating itself to sign such a “partial release” form to obtain monthly progress payments.

Therefore, subcontractors and their attorneys should be forewarned not to sign such forms during the course of performance.  Be cautioned, however, that these  “partial waivers” are often exhibits to the general contractor’s contract form.  There is usually a clause in the contract requiring the subcontractor to “submit the Partial Waiver and Release form attached as Exhibit .”  When reviewing the general contractor’s form subcontract, be sure to review the exhibits as carefully as all other clauses and avoid obligating the subcontractor to the use of a form like that discussed above.  Corrections should be made on the body of the partial release form in the exhibit itself.

7.  Termination For Convenience

Normally, neither party to a contract may terminate a contract without becoming liable to the other party for all resultant damages, including lost profits and any consequential damages.  A termination for convenience clause, however, gives a party the right to terminate the contract without cause and without any liability to the terminated party.  These clauses are often found in public contracts, but are not at all uncommon in the context of private contracts.

It is common for a termination for convenience clause to provide that if the right to terminate is exercised, the terminating party’s liability is limited to the reasonable value of any material or labor furnished to the project up to the point of termination.  An example of such a clause is set forth below:

The Contractor may, at its option, at any time, terminate the whole of part of this Agreement for the convenience of the Contractor.  Subcontractor agrees that upon any such termination, the Subcontractor’s sole remedy, shall be payment of full value for all work properly performed or materials delivered, plus reasonable profit thereon, less all payments Subcontractor has previously received on account of such work performed.  Subcontractor agrees to waive all claims for damages, including lost or anticipated profits, arising from or related to any such termination by Contractor.  (Emphasis added)

Under this clause there is no obligation for the terminating party to compensate the terminated party for any profit that may have been included in the contract price.  The subcontractor will lose the benefit of his bargain which is a legally cognizable right.

Many subcontractors may prefer not to run the risk of termination and potential loss of their profits, but will agree to a termination for convenience clause in order to get the job.  That is a business decision that should be best made by the subcontractor.  However, termination for convenience clauses may contain hidden risks involving much more than the potential of lost profits.

The unseen dangers of the termination for convenience clause lie in the subcontractor’s obligations to suppliers and lower tier subcontractors once the contract has been terminated.  The subcontractor may have ordered expensive equipment or materials that have been specifically designed for that particular project.  Furthermore, specially fabricated materials may be on order at the time that the contract is terminated which cannot be canceled.  In other words, the party whose contract has been terminated may be legally obligated to buy these items, but may have no one to whom the items can be sold.  These dangers should be recognized and dealt with accordingly.

To prevent a terminated subcontractor from being left “holding the bag”, there may be a couple of options which can be utilized.  First, a provision may be inserted in the contract that makes the terminating party responsible for all cancellation charges and all consequential damages caused by the termination.  In this way, the terminating party is responsible for all “non-cancelable” materials and equipment which were ordered in good faith in anticipation of their use on the project.

If that cannot be done, a subcontractor should try  to include its own termination for convenience clause in any subcontract or purchase order related to that project.  This can be accomplished by using appropriate “flow through” language in the subcontract or purchase order or by using an  independent termination for convenience clause.  If an independent clause is used, care should be taken to assure that there is no liability for lost profits and any other consequential damages.  By the contractor or subcontractor using its own termination for convenience clause, the risk of termination will be shared by all parties involved.

8.  Liquidating Clause

Most subcontract forms address dispute resolution in one way or another.  Many proprietary forms contain a specialized type of “flow through” clause designed to insulate the general contractor from the possibility of inconsistent results in proceedings fixing the liability of the owner and general contractor, on the one hand, and the general contractor and subcontractor, on the other hand.

To  accomplish this end, the forms typically require the subcontractor to make claims in the same manner and time periods required of the general contractor in the prime contract documents.  The forms further make the general contractor bound to the subcontractor in the same manner that the owner is bound to the general contractor.  These forms typically state that the general contractor can never be liable to the subcontractor for more than the owner is liable to the general contractor.

On first blush, none of these requirements appear unreasonable.  However, this scheme does not recognize that the general contractor’s deficiencies may be responsible for part, if not all, of the subcontractor’s damages and losses.  If the contractual scheme explicitly covers, in great detail, situations where the claims result from deficiencies of the owner, shouldn’t it likewise provide for instances when the general contractor caused or contributed to the subcontractor’s damages?  It is suggested that the subcontractor’s counsel attempt to revise these clauses in that manner.

Liquidation clauses commonly include language similar to the following:

In case of any dispute arising under the General Contract, Subcontractor agrees to be bound to the Contractor to the same extent that Contractor is bound to Owner by the terms of the General Contract and by any and all decisions or determinations made thereunder by the party or panel so authorized in the General Contract, whether or not Subcontractor is a party to such proceeding.  If Subcontractor is not a party in such proceeding, Subcontractor shall pay Contractor all expenses incurred by Contractor, including, Contractor’s attorney’s fees pertaining to such proceeding.  (Emphasis added)

Initially, this type of clause may not seem threatening, especially to a layman not experienced in legal disputes.  As an attorney for a subcontractor, it is suggested that one should advise the client to never contractually commit, at the pre-dispute stage, to be bound by a proceeding to which the subcontractor is not  a formal party.  To be represented by counsel of someone else’s choosing whose loyalty is to that other party, may be most ill advised.  To have no control over such things as the jury or arbitrator selection process and opening and closing statements in such a proceeding is frustrating at best.  To have no control over the order and presentation of evidence is ill advised for a subcontractor when it will be bound by the outcome of the proceeding.

It may be advisable for the general contractor and subcontractor to jointly pursue the subcontractor’s claim against the owner.  Indeed, that can often be advisable and is a common practice.  To contractually commit to that approach in advance of the dispute is unnecessary.  It can always be done after the dispute arises.  It is therefore, recommended that subcontractors be advised to refrain from consenting to these clauses.

EARLY ACTION AFTER THE FORMATION OF THE CONTRACT

August 15 Retainage Notice to Owner

After the subcontract is signed by all parties, early action should be taken to protect certain rights and secure certain information.  The only practical  way to secure lien rights to contractual retainage on privately owned projects is the procedure provided in Tex. Prop. Code Ann. § 53.057(b) and (c).  That section allows the first tier subcontractor to notify the owner of the retainage provision in the subcontract.  A suitable notice form is found in the Appendix at Page 2.  This notice is due on or before the 15^th day of the second month following the first work (or delivery of materials) after the retainage agreement is made.⁸ The timing of this deadline is illustrated below:  

Many subcontractors are either unaware of this requirement or ignore it.  Diligent counsel for the subcontractor, however, will make sure that his or her clientele is aware of the requirement and advise them to follow it.

A similar retainage notice is required on state public jobs.  However, the requirement is limited to lower tier subcontractors.  See, Tex. Gov’t. Code Ann. § 2253.047(b).

It should also be noted that on private projects, sending the notice is merely the first step in actually perfecting the claim for contractual retainage.  A timely filed lien affidavit must also be accomplished toward the end of the job.  See, Tex. Prop. Code Ann. § 53.052(a) and § 53.053(e).

Early notice is also required at the beginning of the job for specially fabricated materials on both privately owned and publicly owned projects.  See, Tex. Prop. Code Ann. § 53.058 and Tex. Gov’t. Code Ann § 2253.047(d).

In addition to these notices, other project-related information should be obtained at the beginning of the job.  For example, the subcontractor may:

1. request the legal description from the owner on privately owned projects (Tex. Prop. Code Ann. § 53.159(a)(1));
   
   
2. discover whether the job is bonded (Tex. Prop. Code Ann. § 53.159(a)(2) and Tex. Gov’t. Code Ann. § 2253.024(a)(2)); and
   
   
3. request copies of the owner’s affidavit of completion on privately owned projects (Tex. Prop. Code Ann. § 53.106(c)).

While all of the statutory requirements of these notices must be met,  none of the notices are required to be worded in legalese which may contain insensitive terms that may alienate parties prior to the job getting well under way.  The notices can be worded “diplomatically” so as not to offend the owner and general contractor.  A little ingenuity and effort by the practitioner can meet this objective while, at the same time, assuring compliance with all statutory requirements.

CONCLUSION

Subcontractors are challenged now more than ever to conduct their businesses in a professional manner.  This requires attention to matters that tradesmen of the past were able to ignore.  Wise selection of general contractors as customers, insistence upon fair contract terms, and perfection of lien rights and bond claims are essential to economic survival.  Counsel for subcontractors are challenged to educate their clients of these needs and be prepared to meet them.  Indeed, it is the attorney for subcontractors that will usher them into the next century.