The Dotted Line: Inside the 'dance' of subcontractor negotiations
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.
Negotiating a subcontract can be a tricky process. Different types of subcontracts are currently in use — such as documents from ConsensusDocs, the American Institute of Architects, the Design Build Institute of America, government contracts and custom forms unique to a contractor or owner. However, a few big issues remain points of negotiation no matter what form of contract is used. Of course, the more the subcontract is worth, the higher the stakes, so deliberations are bound to get a little tense.
According to Bill Scott, executive vice president of Texas-based Linbeck Group, it's nothing personal. "Subcontractors are my favorite partners," Scott said. "We can't build projects without them. We have to have them."
However, that doesn't mean that subcontractors get whatever they ask for when it comes to striking a clause or rewording something in their subcontracts. And it doesn't mean that a subcontractor is always going to feel comfortable with what's in the subcontract to sign and go forward with the project. Industry experts point to a few main obstacles that consistently emerge when negotiating subcontracts, and offer advice on how to navigate them.
Why 'it's all driven from the owner'
Many of the contractual items that a subcontractor might consider distasteful in a subcontract have their parallels in the prime contractor's contract with the owner, Scott noted. "It becomes a dance around how you handle your risk management for the project, but it's really all driven from the owner's contract," he said. "The only way to protect ourselves and manage risk is ... to share it."
After decades as a drywall, metal framing and stucco contractor, Anthony Sierra of JP Sierra Inc., said he believes there's almost always more room for negotiation than the general contractor is willing to engage in, and he is often presented with a one-sided document. He said that although "very few general contractors use an AIA form for subcontracts these days," he finds them to be the most fair to subcontractors. He admitted, however, that when he makes changes to a subcontract, "it doesn't go over well." In fact, he said, he's lost a contract or two because of it. "The shorter the contract, the more I trust it," he said.
"Contractors' hands are tied to a certain degree," John Patrick Curran, partner at Sive, Paget & Riesel, said. Subcontractors have to understand, he said, that they may have to end up playing by the same rules outlined in the prime contractor's contract with the owner, whether they like it or not.
One of the issues that almost always emerges is the indemnity language in a subcontract. Scott noted that subcontractors are more than happy to indemnify Linbeck or the owner for their own negligence, but they don't want a broader indemnification clause like many owners want. "Whatever the indemnity that we're able to get with the client, we have to pass that to our subcontractors," he said.
"That's in almost any subcontract now," Sierra said, "but it also goes for the owner, the GC, the architect and the engineers. It seems like there's no real responsibility other than for the subcontractor. They're the ones on the hook for everything." He said that in his experience, design professionals routinely disclaim the drawings or blueprints they designed or engineered, yet, as a subcontractor, he has been required to obtain engineered drawings.
"Indemnification clauses are always controversial because people try to throw too much into them," Curran said. "They just kitchen sink it."
Cash flow is lifeblood for most contractors, so it's not surprising that payment terms are high on the list of negotiable items, namely "pay when paid" clauses. Scott said there is a "pretty big gap" between how much profit the general contractor usually makes versus what a subcontractor thinks a general contractor makes, so sometimes subcontractors will want to change the terms of their subcontract to require Linbeck to pay up even if the owner hasn't yet made payment. "You've got to tie (the subcontractor's payment) to the owner's payment," he said. "Pay when paid has been the only way that we as a business enterprise can operate."
Sierra added, "That should be a clause that the general contractor only has with the owner because a subcontractor might not get paid because the GC didn’t get paid for something that doesn't have anything to do with the subcontractor's work." For example, he said he has seen his pay for drywall work held up because of a dispute the general contractor had with the owner over masonry work.
Curran said these types of clauses are standard, but it's important for subcontractors and contractors alike to know that "pay when paid" clauses come with an upper limit in many states. Eventually, he said, even if an owner does not make payment, the contractor still must pay its subcontractors, which can lead to major financial problems for the contractor.
Part and parcel with payment also comes the issue of retainage, the amount withheld from earned payments, usually 10%, to cover any as-of-yet undiscovered deficiencies in the work. This is an accepted industry practice, but, according to these experts, most owners are amenable to a retainage reduction schedule, especially for subcontractors that appear early in the project timeline, such as the site work or foundation subcontractor.
Sierra said he's seen a wide variety of retainage scenarios, and he believes that it's more of a way to make up for calculation errors if the general contractor's supervisors mistakenly approve work that, in reality, is not yet complete.
"You don't want to be holding onto 10% until substantial completion of the entire job for those early trades," Curran said. "Then again, if you are the (prime) contractor, you don't want to be funding that retainage release out of your own pocket." It's imperative to have that change show in contracts at every level, he added.
Change order directives
One contractual issue that subcontractors frequently push back against involves change order directives. These directives can require them to perform work not in their subcontract at the direction of the owner or contractor's field personnel if the time it will take to negotiate the change order will interrupt the workflow of the project.
While Scott said that Linbeck's clients might sometimes use that clause as a way to deal with all change orders, he said his company includes language in its subcontracts that tell a subcontractor not to proceed with a change unless they have received written direction to do so. Even then, Scott noted, some clients will turn that into a habit of trying to renegotiate the dollar value of those changes at the end of a project. "There are some owners who persist in that kind of bad behavior," Scott said.
"I just don't do it," Sierra said. "Unless I get a change order, then I don't do it. I have to have an amount, and I have to have an agreement that it's an approved change order."
However, Curran holds another view. "As long as it says you can't make them work for free, then provisions like construction change directives are really quite common," he said. "They're in the AIA forms. The realities of a project are that you can't stop everything to spend a week or more negotiating a change order."
Scott said that in these situations, it often comes down to a "leap of faith" by the subcontractor that Linbeck will treat that change order fairly. In fact, it's that faith that is part of the relationship that results in a long-term subcontractor often not even reviewing its subcontract before signing and starting work.
Nevertheless, Scott said Linbeck encourages subcontractors to go over all contract documents in detail. "If they want to come look at our owner contract, we welcome that because if they're willing to be looking at that, then we have a subcontractor partner who is sophisticated enough to understand how and what drives contractual language," he said.
However, when it gets down to the bottom line, Scott said that Linbeck tries to build those trusting relationships with subcontractors necessary for a project during the entire subcontract negotiation process as well as the work that follows. "It's building relationships, and the relationships drive people's behavior," he said.
Sierra added that integrity — on the part of both the contractor and subcontractor — is the most important element present in subcontractor negotiations, "or you might as well forget the whole thing."
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