The Dotted Line: How to effectively manage an underperforming sub
This feature is a part of "The Dotted Line" series, which takes an in-depth look at the complex legal landscape of the construction industry. To view the entire series, click here.
When a subcontractor doesn't perform according to the terms of its contract, it can often can turn a general contractor's or owner's experience of a great project from dream to nightmare.
In the execution of many construction projects, subs provide the bulk of the labor and materials. The entire job can be impacted if any one sub fails to meet the schedule or provides a substandard product — whether it’s the utilities contractor that can't provide enough workers to complete its scope of work or the drywall company that leaves a mile-long punch list of cosmetic repairs.
Fortunately, general contractors can help keep a bad situation from getting worse through a well-worded subcontract and sound procedures.
Start with proper vetting
General contractors, said Justine Kastan, attorney at Rutan & Tucker LLP in Palo Alto, California, should check with their state licensing agencies to confirm their subs’ licensure status. Some states, such as Florida, make it easy by offering a searchable public database that reveals if the licensing board has ever taken action against the sub.
Because it is important to get a sense of a sub’s performance history and ability to financially carry its portion of the project, many general contractors require potential subs to submit qualification packages, Kastan said, that include financial data and other background information.
Bonding capacity is another indication of a sub’s financial and operational health. Even if there is no payment or performance bond required for the project, the fact that the sub can secure one if needed is a nod to that company's stability.
The best questionnaire or application, however, won’t be as effective as possible if there is not adequate follow-through with the sub's supplier and customer references.
Build in protection through subcontracts
Subcontracts, though, are typically the final word on a general contractor’s and sub’s obligations to each other, and there are ways general contractors can protect themselves through this agreement. Of course, what’s in the best interest of the general contractor is not always in the best interest of the sub, so each must review the contract with their own position in mind.
For instance, there are two basic types of terminations written into a subcontract — Termination for Cause, or default, and Termination for Convenience. For-cause terminations typically occur when a subcontractor fails to meet quality or schedule expectations, but convenience terminations can be for most any reason.
The most significant difference between the two is what each party is entitled to — or must pay — when a termination happens.
A Termination for Cause provision could have a subcontractor pay for any cost overruns incurred during completion of its scope of work, less what it is owed at the point of leaving the project. Subcontractors could also owe liquidated damages, a predetermined amount beyond project-related costs that covers certain breaches set forth in the contract. Liquidated damages, for example, might include a late fee imposed for every day the sub fails to meet the schedule.
Obviously, it's in the best interest of subs, said attorney Elizabeth Marchionni with Kaufman Dolowich Voluck LLP in Woodbury, New York, to request that liquidated damages provisions be struck from their subcontracts.
Conversely, keeping the Termination for Convenience clause might be critical for general contractors dealing with a problem sub that hasn’t yet breached the contract. However, such a termination would likely result in the general contractor having to pay the sub's demobilization costs and perhaps a termination fee in addition to what it owes the sub for properly executed work at the time of departure.
Termination is the final step that, even under the best circumstances, could eat into the project schedule and budget. So it’s best for the general contractor to try to mitigate the situation before that point.
That effort should start at the beginning of the project, Kastan said.
“There is really no substitute for an honest and open relationship from day one,” she said. “This means transparency as to risk allocation, contract terms, schedules and more. If the parties have a good relationship and a transparent work plan, then the company principals can get together at the first sign of trouble and come up with a strategy to keep the work moving forward.”
Specify short remediation times
In terms of quality, Quinn Murphy, attorney at Sandberg Phoenix & Von Gontard P.C. in St. Louis, said a general contractor should specify a very short remediation turnaround time, which is the period a sub is given to correct its work or catch up to the schedule. This way, he said, the overall timeline is less likely to be impacted.
A typical notice period, Murphy said, is 72 hours. However, if the sub doesn’t meet the deadline but is making a solid effort to do so, the attorney said he wouldn't recommend that the sub be terminated, particularly if the firm provides written assurances.
But a general contractor can only rely on full protections of the subcontract’s notice provisions, Murphy said, if it sets clear deadline and quality expectations and makes clear the ramifications for not meeting those conditions, and then documents the sub’s performance in a very clear fashion throughout the job.
In addition, he said, the general contractor could require subs to provide performance and payment bonds, which guarantee completion, whether that means supplementing the sub's workforce or replacing it entirely. The payment bond guarantees that the sub's bills are taken care of, but they add to the project's cost.
The general contractor can also protect its interests through payment terms, Marchionni said, that ensure enough retainage will be held to cover potential back charges.
Define protection for subcontractors
If all of this sounds like a one-sided deal for the general contractor, subs have some ways of creating a more favorable balance of power on the project.
"I would suggest that the sub try to make the events that would lead to or justify a Termination for Cause as objective and as quantifiable as possible,” Murphy said. This means the more details the better, like identifying specific time periods the sub will have to correct a deficiency and what constitutes “behind schedule,” so that general contractors can’t take advantage of ambiguities.
“If something does go wrong,” Kastan said, “the subcontractor needs time to react and correct the situation. The longer these periods, the better, as far as a subcontractor is concerned. Longer notice and cure periods provide more of a chance to correct the situation before the general contractor may terminate."
If termination is necessary, there are still ways the sub can protect itself. Broadly speaking, she said, the sub should be sure to recover the amounts it spent on the work (including overhead), costs associated with demobilization and a reasonable profit that it would have made.
"If the termination is relatively amicable, a general contractor will likely agree to pay all of these costs," she said. But "if the termination is adversarial, the general contractor likely will not."
In a sort of end run around the traditional subcontracting process, a smart sub, Marchionni said, might have its own contract, and, depending on how vital the sub's services are, the general contractor might be inclined to sign it. "Subs often think they don't have a chance," she said, "but this is not always true. My advice to subcontractors is don’t keep your contract in a drawer. Know what it says. Engage in contract negotiations even if you don’t think you have the bargaining power. You never know."
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