Five potential contractual pitfalls subcontractors should avoid

The construction industry is experiencing a difficult time, leading to many subcontractors looking at how best to protect their businesses. We outline five common issues which can cause shortfalls for subcontractors if not properly considered.

As a result of global disruption, the construction sector is facing many ongoing issues such as delays, material shortages and cashflow restrictions. This has led to an increase in the occurrence of subcontractors facing damaging contractual disputes with employers and main contractors. Here we consider contractual pitfalls which can cause shortfalls for subcontractors if not considered in advance.

1. Not being paid for work – what rights does a subcontractor have?

As finances become restricted across the industry, it is becoming more common to delay or reduce payments to subcontractors. This can be incredibly detrimental, meaning even buoyant subcontractors can face insolvency as a result. But what options does a subcontractor have if they do not receive payment of sums due under a construction contract?

When considering this issue it is important to understand the difference between ‘non-payment’ and ‘abatement’:

• non-payment: the failure to make a payment which is due under contract
• abatement: relates to the contractor reducing payment based on their assessment of the completed work.

The only option with abatement is to challenge the valuation produced by the contractor. If negotiations fail, then the subcontractor would need to consider dispute resolution options such as adjudication or mediation.

However, non-payment refers to the situation where a contractor fails to pay by the final date specified in the contract. As long as the agreement satisfies the legal definition of a construction contract, and the subcontractor has given the appropriate amount of notice, the subcontractor can suspend the performance of any or all of its obligations until payment is made in full.

While many may be quick to walk off-site in protest, it is essential that subcontractors fully understand the payment terms and conditions of the contract before any suspension is threatened, notified, or imposed.

2. Notice provisions in construction contracts – increasingly onerous for subcontractors

Notice provisions are essentially clauses within contracts that play an important role within the construction industry. They are designed to notify parties of any potential problems and provide sufficient time to respond. However, the notice provisions for subcontractors – especially those relating to delays and disruption, loss and expense – are becoming increasingly difficult to meet.

Many subcontractor contracts now feature a condition precedent added to notice provision clauses which must be satisfied before an entitlement can arise. If the condition precedent is not satisfied, then entitlement is lost. Not only does this place a significant burden upon subcontractors, but the condition precedents can be used to catch them out.

It’s important that subcontractors review any notice provisions before entering into a contract, and if possible negotiate more favourable terms which enable them to manage their risk accordingly.

3. Design responsibility – increased risk exposure for subcontractors

Design responsibility is a common point of dispute which can lead to significant cost and time implications for subcontractors. It is becoming common for employers and main contractors to seek to include contractual provisions which make the subcontractor responsible for the accuracy and suitability of the design produced by others. This is a major red flag as it unknowingly exposes subcontractors to risk.

Another issue is the inclusion of ‘fitness for purpose’ obligations, requiring the subcontractor to guarantee the performance of the design, as opposed to a requirement to use reasonable skill and care. Many professional indemnity insurance policies do not allow for this obligation and a subcontractor could find themselves inadvertently exposed and not fully insured.

4. Liquidated damages – potentially extremely detrimental for subcontractors

A well-drafted liquidated damages clause could enable a main contractor to automatically deduct liquidated damages if the subcontractor does not complete the works by the agreed completion date. This could lead to a main contractor deducting a significant sum from the subcontractor, or even reducing the sum due to zero. From a cash flow perspective, this has the potential to be extremely detrimental for subcontractors.

In many instances, the main contractor may be fully aware that the subcontractor is not responsible for the critical delays, however, it could use its contractual rights to deduct liquidated damages as a bargaining chip to negotiate the final account and even restrict cash flow. From a subcontractor’s perspective, this situation should be avoided at all costs.

5. Final accounts – do not delay

Subcontractors need to make sure they are settling final accounts in a timely manner. We have seen main contractors within recent cases reject claims from subcontractors due to the expiration of the limitation period.

In one particular case, if the subcontractor’s claim had been left for just one more week, it is likely they would have lost their entitlement to pursue the dispute through formal proceedings. This would have resulted in the subcontractor losing its entitlement to a significant sum. To avoid this situation, in order to protect their businesses, subcontractors should be settling final accounts without any delay.

Check construction contracts carefully

These contractual pitfalls highlight how important it is for subcontractors to thoroughly check construction contracts before entering into agreements with employers or main contractors.

Awareness of any clauses, time periods, or provisions which may affect the subcontractor’s right to be paid for completed work, will put subcontractors in a position to either renegotiate more favourable terms, or put in place measures to protect themselves.

A construction dispute resolution specialist can assist subcontractors review contracts to ensure they maintain their entitlement, reduce risk, and avoid costly disputes wherever possible. A lengthy and expensive contractual dispute can be as detrimental as not being paid at all.

Reworked from the original article published in Construction News.