In mid-big sized construction projects, the subcontract is a crucial part of the entire project. The various issues involved in subcontracting part of the works can determine the success or the failure of a project and/or can massively increase the financial risks and/or losses for either the Employer or the Contractor. The present note is the first of a series of three and will address the main issues and pitfalls which may arise out of the subcontracting of part of the scope of the works and suggests some solutions for the benefit of the parties.
The reasons why a Contractor subcontract part of the works can be various such as that the project is a large one or that a specific part of the scope of works requires specific skills and expertise that the Contractor does not have. There are also cases where it is the Employer which requires that part of the scope of work be carried out by Subcontractors with specific and 'proved' experience.
Generally the issues that arise out of in connection with subcontracting part of the works are those relating to:
- the extent to which the Contractor is entitled to subcontract part of the works and the selection of the Subcontractor in the case the Employer is involved (Part I);
- the liabilities of the Subcontractor (towards the Employer or the Contractor) (Part II);
- the payment of the Subcontractor (Part III).
1. THE RIGHT TO SUBCONTRACT PART OF THE WORKS
Generally the contract between Employer and Contractor provides if and to what extent the Contractor is entitled to subcontract part of the works and this will mainly depend on the type of contract. In this respect there are various scenarios and the main contract between the Employer and the Contractor may provide that:
- the Contractor can freely subcontract part of the works; or
- the Contractor can subcontract only specific part of the scope of works (for instance the electrical or mechanical part of the works); or
- the Contractor cannot subcontract certain specific part of the works (for instance those in respect of which the Employer has provided detailed design).
In many jurisdictions, there is no direct legal relation between the Employer and the Subcontractor and the main contract provides usually the conditions upon which the Contractor can appoint a Cubcontractor. In such a case it is always advisable to pay particular attention to the wording and to the right to appoint the Subcontractor. In some cases, for instance, the Contractor might be entitled to subcontract part of the works but only to local companies specifically in countries where the local legislation provides so.
All the above issues should be generally governed by specific clauses contained in the main contract but the Contractor should also take advice on what local legislation and the governing law of the contract provide.
2. THE INVOLVEMENT OF THE EMPLOYER IN THE SELECTION OF THE SUBCONTRACTOR
It is clear that the Employer (and certainly the Contractor) may suffer the consequences of a wrong selection of the Subcontractor and this may have an impact on the timing for completion or on the quality of works executed. Despite the fact that the liabilities for any default of the Subcontractor are generally borne only by the Contractor, the Employer may want to take all the necessary steps to minimize any such risk and this is the reason why in mid-big size projects (especially in EPC projects) the Employer might maintain a certain control in the selection process of Subcontractors.
In this respect, the main contract can provide that the Contractor:
- is entitled to subcontract part of the works provided that it obtains the prior consent of the Employer; or
- the Contractor can subcontract only to companies included in a list agreed between Employer and Contractor prior to the signature of the main contract; or
- the Contractor can subcontract to a third party identified or selected directly by the Employer.
Very broadly, FIDIC Red and Yellow Books do not require the Employer consent for suppliers of materials or for Subcontractors already named in the contract (unless otherwise provided in the Particular Conditions) while the consent is required for other proposed Subcontractors (but the consent cannot be unreasonably withheld or delayed).
Under the FIDIC Silver Book the interest of the Employer in the selection process is more limited since the Contractor is granted more autonomy and this is the reason why there are no provisions in respect of Employer's approval in respect of Subcontractor while the Contractor has only the obligation to notify the subcontract (if so provided in the Particular Conditions).
However, all the FIDIC Books provides for the right of the Employer to nominate a Subcontractor under Sub-clause 13 [Variations and Adjustments] which involves the full power of the Employer to instruct the Contractor to appoint a specific Subcontractor balanced however with the right of the Contractor to refuse that specific Subcontractor on the basis of reasonable objections.
It is clear therefore that all such circumstances, the interest of the Employer and of the Contractor may conflict and each of them should find the right way to mitigate their potential risks.
Suggestion for the Employer
The Employer will usually seek to exclude expressly any responsibility in the selection process by inserting a specific wording so that:
"the engagement of any of the listed Subcontractor will not imply any direct relation between the Employer and the Subcontractor and will not diminish in any manner the liability of the Contractor for any failure of the Subcontractor to perform its obligations"
As mentioned above, Sub-clause 4.4 of the FIDIC Silver Book provides that "The Contractor shall be responsible for the acts or defaults of any Subcontractors, his agents or employees, as if they were the acts or defaults of the Contractor."
As said before, this will apply also on the case the Subcontractor has been selected by the Employer so the Contractor should pay specific attention in such a case.
Suggestion for the Contractor
On the other hand, the Contractor needs to consider carefully the skills, expertise and track records of the Subcontractor especially in the case the Subcontractor has been nominated by the Employer. Therefore the Contractor will need to ensure to have a full 'power' over the Subcontractor and may need to consider to have a provision in the main contract so that:
"the Contractor shall reserve the right to replace at any time the Subcontractor in case of failure by the latter to properly and timely perform its obligations under the Subcontract".
Sub-clause 4.5 of the FIDIC Silver Book provides that, upon certain conditions, the Contractor has the right to object to Subcontractor nominated by the Employer:
"The Contractor shall not be under any obligation to employ a nominated Subcontractor against whom the Contractor raises reasonable objection [...] with supporting particulars."
Some indications of the reasons why the Contractor may reject to appoint a nominated Subcontractor are listed under Sub-clause 5.2 of the Red Book but it is always preferable to specify in the Particular Conditions or in ad hoc contracts what rights the Contractor have in such respect.
In the case where the main contract does not provide for a list of potential Subcontractor but instead that the Contractor will have the right to subcontract part of the works the risk of disputes increases. Usually the appointment of a Subcontractor will be subject to approval from the Employer or, instead, the Employer shall have the right to object to the appointment of a certain Subcontractor. In such situations, it is advisable to provide in the contract a specific procedure for the appointment of the Subcontractor pursuant to which the Contractor will send a notice of appointment to the Employer who will have in turn a limited period of time to raise reasonable and grounded objections.
It is obvious that the interest of both parties is to have any such dispute resolved at the earliest convenience and this because either the Employer or the Contractor will at the end suffer the financial consequence of any delay in appointing the Subcontractor. It is therefore advisable that the main contract provides for a procedure on how to solve quickly and efficiently any potential dispute in that connection.
Suggestion for the Employer
The Employer will be interested in having details of the proposed Subcontractor so that it will have the concrete opportunity to evaluate the proposed Subcontractor in terms of technical capabilities and financial standing as well as its track record. The Employer will usually also provide a list of requirements that the Subcontractor need to fulfil for its appointment.
The Employer's need is to have the appointment of a Subcontractor in a way that the works will not be delayed/disrupted. In case of dispute, the Employer may consider inserting in the contract a provision such as that
"in case of objections in respect of the appointment of the designated Subcontractor, the Contractor shall propose a new Subcontractor within X days and, if the Employer shall have no objections in respect of the new proposed Subcontractor the latter shall be appointed. Any dispute in respect of the reasonableness of the Employer's objections shall be submitted to the [dispute resolution method] only after the Subcontractor has been appointed".
An additional clause shall deal with which party shall bear the costs arising out of the dispute resolution body decision in respect of the abjections raised by the Employer.
Suggestion for the Contractor
The Contractor on the other hand will be interested in obtaining an immediate settlement of the objections raised by the Employer on a certain Subcontractor and this mainly because the Contractor will incur additional time and expenses in finding a proposing a new Subcontractor.
The Contractor may therefore be interested in providing in the main contract that:
"any objection raised by the Employer in respect of the appointment of the Subcontractor will immediately be referred to the [dispute resolution body] and no Subcontractor will be appointed until the dispute is resolved".
3. CONCLUSION OF PART I
The subcontract is a fundamental part of any major international contract. Specific attention should be given in the case the subcontract is selected or can be selected by the Employer as well as to any local legislation which requires the appointment of local Subcontractor.
The parties should include also a detailed procedure for the selection and appointment of Subcontractor bearing in mind that in many jurisdictions there is no direct legal relation between the Employer and the Subcontractor and therefore that any underperformance from the Subcontractor is borne by the Contractor only.
Part II of this note will address the liabilities of the Subcontractor (towards the Employer or the Contractor) while Part III will discuss about the payment of the subcontractor (Part III).
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.