by James R. Lynch, Esq., Ahlers & Cressman, PLLC

Whether you negotiate your own subcontracts or rely on your lawyer to do the heavy lifting at contract time, a savvy subcontractor should understand the basic purpose of common subcontract provisions, and be prepared to negotiate for fair and commercially reasonable terms. While most sophisticated subcontractors are skilled at negotiating the core terms of a subcontract—scope of work, price, and time—a few simple but less obvious tweaks to common subcontract terms and conditions can go a long way to protect a subcontractor from unfair results when a dispute arises.
From the desk of an experienced construction lawyer, below are my top five “boilerplate” provisions that subcontractors too often overlook during contract negotiations, along with tips on language to include and to avoid.

Delay/Liquidated Damages

Contrary to popular belief, liquidated damages are not a penalty for late performance. In fact, in many cases the consequence of late performance can be much higher without a liquidated damages provision than with one. Below is a checklist of points to negotiate a fair liquidated damages provision to benefit all parties:

1. Clearly define when liquidated damages will apply. This can be based on a specified duration or a date certain. Clearly state all assumptions supporting the contract time. Where feasible, the general contractor’s schedule should be attached to your subcontract to establish your baseline schedule.
2. Negotiate a Reasonable Rate. This requires a project-specific inquiry, considering factors such as daily project burn rates, anticipated management/consultant costs, extended overhead, upstream liquidated damages, and subcontract scope and size.
3. Make it Exclusive. Negotiate for express language indicating the specified liquidated damages are the exclusive remedy for late performance. An example is as follows:

   Subcontractor’s payment of liquidated damages as specified in this section shall be the sole and exclusive remedy for any delay by Subcontractor in the performance of the work or completion thereof.
   

4. Caps. Consider negotiating a cap on the aggregate liquidated damages. The cap may be an amount equal to your fee, the total contract price, or any other justifiable amount.

Payment Terms

Use Net Payment Terms, and Clarify Pay-When-Paid Provisions. In a subcontractor’s ideal world, payment would always be due within a defined time period after each application for payment (e.g. “Net 30”). Some subcontractors can achieve this by specifying “net” payment terms in their proposals. More often, however, general contractors will not commit to pay subcontractors until they receive payment from the project owner. As such, “pay-when-paid” provisions have become commonplace, with contractors agreeing to pay subcontractors within X days after receipt of funds from the owner. As a subcontractor presented a pay-when-paid clause, you should negotiate for language calling for payment within a “reasonable time” if the owner fails to pay, and specify what time will be deemed “reasonable” if there is a significant payment delay. At a minimum, this will clarify the issue is only one of the timing of your payment, not your right to payment. That is, your “pay-when-paid” provision will not be misconstrued as a “pay-if-paid” provision, under which you are not entitled to any payment if the owner fails to pay.

Pay-if-paid or “conditional payment” terms are unlawful in some states, and require specific language to be effective in others. As a subcontractor, you should strike pay-if-paid language wherever possible, and many general contractors are willing to negotiate to convert pay-if-paid into pay-when-paid terms.

Negotiate for a Right to Stop Work for Nonpayment. Absent from most contractor forms, insert a provision that you may suspend work if you are not timely paid all undisputed amounts. For example:

In the event Subcontractor does not receive payment of all undisputed amounts within thirty (30) days after submission of an application for payment, then upon seven (7) days’ written notice to Contractor, Subcontractor may suspend work until all undisputed amounts are paid. For purposes of this paragraph only, an “undisputed amount” means any amount or portion thereof specified in Subcontractor’s application for payment, including any payment items, changes, and claims therein, to which Contractor has not provided specific written objection. The subcontract time and price shall be equitably adjusted to reflect any shutdown, delay, and start-up pursuant to this paragraph.

You can usually cleanly insert such suspension language directly into the section governing the timing of payments, the provision for suspension of work (if any), or the terms governing continuation of work during disputes (if any).

Never Give Up Your Lien Rights. This is unlawful in many states. A subcontractor’s lien rights are a powerful source of leverage and a possible last resort on a financially distressed project.

Indemnity

An indemnity provision comes into play when the general contractor or owner incurs some liability as a result of a subcontractor’s work. Your overarching goal as a subcontractor is simple: You should only be required to pay for liabilities to the extent caused by your fault, and covered by your commercial general liability (CGL) insurance. Otherwise, you could be required to pay for a claim even if you did nothing wrong, and even if you had no reasonable way to manage and price for the risk of that claim.

Generally, your CGL insurance will only cover claims by third parties for bodily injury or physical property damage caused by your negligence. As such, you should always negotiate for an indemnity provision limited to the following:

1. Third party claims
2. For bodily injury or physical property damage
3. To the proportionate extent caused by your negligence

As a practical matter, these points can often be incorporated through relatively simple redlines. For example, the following broad-form indemnity provision that could require you to defend and pay for a claim not caused by your fault (or pay a grossly disproportionate share) and not covered by your insurance:

Subcontractor shall defend, indemnify, and hold harmless Contractor and Owner from and against any and all claims, liabilities, or obligations of any kind whatsoever, arising out of or relating to Subcontractor’s work.

The subcontractor’s indemnity checklist above can be inserted through simple edits:

Subcontractor shall defend, indemnify, and hold harmless Contractor and Owner from and against any and all claims, liabilities, or obligations of any kind whatsoever by third parties for bodily injury or physical property damage, but only to the proportionate extent arising out of or relating to negligence by Subcontractor in the performance of Subcontractor’s work.

Many state-specific laws may affect the indemnity provision—and you should consult your legal counsel on this complex issue—but these basic points will go a long way to avoid turning your company into the project’s insurer.

Changes & Claims

Beyond a basic reminder to read and confirm that the change and claim processes align with the process the parties actually intend to use—a point too often missed by subcontractors and generals alike—the following negotiating points and questions can help you achieve more fair and practical procedures, and ease the consequence of technical failures.

Strike Forfeiture Language. While it is not unreasonable for the general contractor to require early notice and an opportunity to address potential change orders and claims with reliable information, it is not reasonable to strip a subcontractor of an otherwise valid claim for extra time or compensation simply because the subcontractor has not strictly complied with the often complex, overly technical, overlapping, and sometimes conflicting provisions governing written notices and claim documentation. To avoid this result, you should search for and strike terms such as “strict compliance,” “condition precedent,” “waive,” and “forfeit,” and consider adding a provision such as the following:

Notwithstanding anything to the contrary, a party’s failure to provide any notice strictly in the time and form required shall not result in a waiver of an otherwise valid right or claim unless, and only to the extent that, the party entitled to receive such notice demonstrates actual harm resulting from such failure.

Require Executed Change Orders for Extra Work. A strict pre-work Change Order requirement protects the general and owner against claims for extras after the work is completed. It also protects the subcontractor from being directed to perform extra work without prior agreement on the cost and time adjustments. However, it can also be a trap where the subcontractor performs time-sensitive extra work in good faith based on clear direction, but the contractor later denies the requested Change Order. As a subcontractor, this means it is important for you to be firm in requiring signed Change Orders before you perform any extras. If you cannot agree on your entitlement or cost, demand a formal Change Directive.

Include a Clear “Change Directives” Procedure. A good “Change Directive” process will require a written Change Directive when Change Order terms cannot be agreed, specify how interim compensation will be determined, and dovetail with the Claims provision. Again the key for you as a subcontractor is to demand that the general follow its own procedures and issue a formal directive before you commence any extra work.

Remove Advance Change Order Limitations. Does a signed Change Order automatically waive all related rights and claims? What about cumulative impacts, which might only arise or are only identifiable when change orders become excessive? Is there any limitation on the time or money you may receive for certain types of changes? As a subcontractor, you should any such advanced limitations in the subcontract documents where possible, and instead address specific issues in the individual Change Orders to be issued during the work.

Dispute Resolution

While there are many other important subcontract terms that come into play more often, the Dispute Resolution provision makes the Top 5 here because most subcontractors overlook it as a possible item for negotiation, yet it can have important long-term consequences.

Keep It Simple. As a general rule, the more mandatory steps in the dispute resolution process, the more costly it will be for you to enforce your rights as a subcontractor. While it may be desirable to try to resolve disputes initially at the project level, then through direct executive negotiations, and then by mediation before finally commencing litigation or arbitration, each of those steps takes time and costs money. Where feasible, you should negotiate to make these aspirational, not mandatory prerequisites you must fulfill before litigation or arbitration.

Litigation vs. Arbitration. While there is no one-size-fits all option, you should understand the differences between litigation and arbitration and recognize that this is often a negotiable term.

Arbitration is a private resolution process where an experienced lawyer, industry professional, or panel hears the case and renders a binding decision. Generally, the parties agree on the arbitrator or panel’s qualifications, if not the individual arbitrator(s). The arbitration hearing typically occurs within six to 12 months of filing. Discovery is usually more limited than litigation. The process is less formal. The proceedings are not public. Appeals are usually more difficult than in court.

By contrast, litigation is an open public process where a judge and/or jury decides the case. Judges are generalists and not usually construction specialists. Trial is often scheduled 12 to 18 months from filing. The discovery process is formal and can be extensive. All filings and proceedings are public, unless sealed by court order. Appeals are relatively common and can take years to resolve.

The important point here is to consider which process best suited to the types of disputes most likely to occur on your project, and negotiate for that process when appropriate. On a complex project with novel means and methods where the most likely disputes will be highly technical, arbitration may be a better option for all parties. On a simple but financially risky project where the most likely disputes relate to payment issues, the formality of the litigation process may be more desirable.

While you should always read your subcontract carefully and understand your rights and obligations, engaging in active negotiation with a general contractor on key terms such as those above can not only reduce your risk as a subcontractor, but it can also help all parties avoid potential disputes down the road, and set a beneficial tone of professionalism and conscientiousness to carry forward into a successful project.

James R. Lynch represents and advises property and project owners, general contractors, trade contractors/subcontractors, and design professionals on a variety of matters, including contracts and claims, litigation and arbitration, alternative dispute resolution, risk evaluation and management, real estate transactions and disputes, procurement, bid protests, and insurance coverage matters. He additionally provides general outside counsel to several closely-held Pacific Northwest companies. Since joining Ahlers & Cressman in 2011, Lynch has recovered millions of dollars for clients on construction and real estate claims, and successfully defended his contractor and developer clients from millions more in potential liability. He can be reached at (206) 287-9900 or jlynch@ac-lawyers.com.