United Arab Emirates: Bridging the contractual gap between an employer and a sub-contractor

Last Updated: 16 July 2010
Article by Eric Teo

What are the rights of an employer in the event a nominated sub-contractor fails to deliver the standard or quality of material and workmanship that the employer had expected to receive? Common wisdom dictates that the employer would ordinarily seek recourse against the main contractor for the sub-contractor's failure, but are there any alternatives?

To answer the above question we need to firstly understand that there are, in practice, two types of sub-contractors: domestic sub-contractors and nominated sub-contractors. Secondly, we should examine the contractual relationships between the three parties, i.e. the employer, the main contractor and the sub-contractor.

Nominated Sub-Contractor
By industry definition, nominated sub-contractors are contractors chosen by an employer who then contract directly with a main contractor to perform a specific scope of works. They are usually specialist trade contractors who would provide both the design and construction services. It is common practice for an employer to source and invite prospective nominated sub-contractors to participate in some form of procurement or bidding exercise. The employer will negotiate the commercial and legal terms with the successful sub-contractor, who will then enter into a sub-contract with a main contractor based upon those pre-agreed terms.

To facilitate the procurement of nominated sub-contractors, the conditions of a main contract will often contain provisions that allow an employer to select and nominate sub-contractors, an example is Clause 59 of the FIDIC 1987 4th edition Red Book Conditions of Contract (as for the FIDIC 1999 1st Edition Red Book see Clause 5). In return, a main contractor will usually receive additional money in the form of profit and attendance. The profit element is a form of compensation to the main contractor for the lost profit that it would have earned should it have been allowed to sub-let that part of the works for itself via a domestic sub-contractor. As to the attendance element it is intended to cover the necessary preliminaries expenses that a main contractor would incur in accommodating and managing the nominated sub-contractor as though it was its own domestic sub-contractor.

Apart from monetary compensation, it is also common practice to include in the conditions of a nominated sub-contract an indemnity by a nominated sub-contractor in favour of a main contractor. The indemnity is intended to protect a main contractor against any breach, default or negligence on the part of a sub-contractor in performing its obligations under the sub-contract. In addition, there should also be provisions which require a sub-contractor to ensure that a main contractor will not be in default of its own obligations under the main contract by reason of the nominated sub-contractor's actions. There are a number of standard form main contract conditions which entitle the main contractor to claim extension of time in the event that the project is delayed by the nominated sub-contractor (see for example the JCT Standard Form of Building Contract, which is widely used in the UK).

On the other hand, to the benefit of the nominated sub-contractor, main contract provisions would usually contain a payment mechanism that allows an employer to make direct payments to nominated sub-contractors in certain situation (see Sub-Clause 59.5 of the FIDIC 1987 Red Book). In this regard it is to be noted that Article 891 of the UAE Civil Code1 prohibits a sub-contractor from pursuing against the employer for money owed to it by the main contractor. Therefore, these direct payment provisions would to some extent provide an incentive for a nominated sub-contractor to contract with a lesser known main contractor. However, they are usually intended to work one way only. In other words, the employer has the sole discretion whether to exercise its rights to pay the sub-contractor directly when any such situation arises.

Domestic Sub-contractor
In relation to domestic sub-contractors, the main contractor retains its discretion to employ any number and any kind of sub-contractors as it sees fit in order to fulfill its obligations under the main contract. Such discretion is provided in Article 890(1) of the UAE Civil Code2 but it is subjected to restrictions that could be imposed under the main contract, for example Sub-Clause 4.1 of the 1987 FIDIC Red Book requires the main contractor to obtain prior consent before it is able to sub-contract any part of the works.

It is also an industry norm that a main contractor's obligations towards an employer would remain intact and unabated regardless of whether sub-contractors are domestic or nominated. In short, main contractors would be vicariously liable to employers for any failure, default or neglect on the part of its sub-contractors, be it nominated or domestic (see Sub-Clause 4.1 of 1987 FIDIC Red Book, this is supported by Article 890(2) of the UAE Civil Code3). This is the reason why most standard forms of main contract would allow a main contractor to raise objection against the nomination of any particular sub-contractor if it has reason to suspect the capability or ability of that particular sub-contractor (see Sub-Clause 5.2 of 1999 FIDIC Red Book).

Privity of Contract
Irrespective of whether a particular sub-contractor is a domestic or nominated sub-contractor, unless an employer and a sub-contractor enter into an agreement that is connected to the main contract or the project, neither party will have any contractual liability towards the other in relation to the main contract or the project. Therefore, it is not unusual for employers to require nominated sub-contractors to provide the former with direct warranties or indemnities in relation to the sub-contractors' performance.

These warranties and indemnities are, in effect, agreements between the employer and sub-contractor whereby the latter warrants or guarantees that the material, equipment or workmanship to be provided under the sub-contract will be of certain standard, quality or specification. However, depending on the terms of the agreement, a wider liability may be sought to be imposed upon a sub-contractor; for example, an indemnity for any failure under the terms of the sub-contract.

With the above in mind, it is interesting to note a recent decision of the High Court of the Hong Kong Special Administrative Region, Court of first instance, Hong Kong Housing Authority v Rotegear Corporation Limited [2009] HKCFI 625. The Hong Kong Housing Authority (HKHA) was the employer of a mixed development project (the Project) and Rotegear Corporation Limited (RCL) was the nominated electrical works sub-contractor. In the proceedings, HKHA sued RCL for the recovery of damages due to the latter's failure to discharge its obligations under the sub-contract between RCL and the main contractor, Nishimatsu (the Sub-contract).

In the proceedings, RCL argued that HKHA did not have any right of action against it because between them there was no contractual relationship in existence. RCL argued that the proper party that HKHA should be seeking redress from was Nishimatsu. HKHA argued that RCL had warranted that it would carry out works under the sub-contract diligently in accordance to the main contractor's works program and without delay to the project, and such warranty gave HKHA the right to take action directly against RCL.

As it turned out prior to executing the sub-contract, RCL was invited by HKHA to tender for the electrical works of the Project. The successful tenderer was then required to enter into a sub-contract with HKHA's main contractor. The learned judge (Reyes J) concluded that the correspondence between HKHA and RCL during the tender stage gave rise to a contract between HKHA and RCL.

The form of tender submitted by RCL stated that it would "...complete the whole of the Sub-contract works without delay to the Main Works and to complete the whole of the Sub-contract works and any Section thereof in accordance with the Contractor's progress of the Main Works...". HKHA was concerned with the low tender price submitted by RCL and requested RCL to confirm the offer. In response to the request RCL confirmed its offer price by way of a letter wherein it stated: "...[w]e can mobilise all necessary resources for carrying out the Works to meet with the specified programme if the project was awarded to us."

The judge construed that the said form of tender together with RCL's confirmation letter constituted an offer by RCL in consideration for it to be nominated by HKHA as a sub-contractor to Nishimatsu and HKHA's subsequent nomination constituted an acceptance to that offer. Consequently, a contract between the parties had arisen and HKHA was entitled to recover from RCL additional costs and expenses as a result of securing a replacement sub-contractor.

In the proceedings, RCL was not legally represented, but instead, it was represented by its director. The judge rejected the director's argument that there should have been an express provision within the form of tender that provided HKHA the right to enforce a tenderer's promise before any direct action could be taken against RCL. RCL further stated that no sub-contractor would have intended that its promise given during a tender meeting would be actionable by HKHA.

The judge did not also agree with the argument that there must be a reciprocal right that would allow RCL to sue HKHA otherwise the promise made by RCL could not be enforced.

The above decision appears to have not given sufficient regard to the intent and purpose of the industry practice in relation to the nomination of sub-contractor. Even though Reyes J indicated that it was clear from the tender documents that the successful sub-contractor was to eventually enter into a sub-contract with the main contractor, and that HKHA's nomination was based upon the terms stipulated in the tender documents, he did not go on to discuss how the contract he found between the employer and the sub-contractor interacted with the sub-contract between the sub-contractor and the main contractor. This left unanswered two important questions. Firstly, assuming the main contractor had also instituted an action against RCL for its failure to carry out the sub-contract works diligently, could both the employer and the main contractor have recovered damages from RCL? Secondly, could RCL raise any limitation of liability clause that may be included in the sub-contract as a defence against the employer's claim?

Although this decision has no legal standing in the UAE, it nonetheless serves as a useful reminder to both nominated sub-contractors and employers operating in the UAE that they should always be mindful of the communications they exchange, and not to simply assume that by adopting a nomination mechanism of subcontracting it is given that neither of them would be liable to the other.

From a UAE law perspective, the decision above could have gone the other way, as unlike the approach taken by the learned judge in that case, local courts in the UAE would likely place more emphasis and importance on industry practice. There are plenty of provisions in the UAE Civil Code4 by which the law recognises a particular industry or custom practice as an unwritten but binding condition between contracting parties. Furthermore, the local courts would be more amenable to inquire into the intention of the parties by having regard to the nature and custom of the transaction5.

Assignment
In the absence of a contractual nexus between an employer and a sub-contractor, neither of them would be able to sue the other for any of their action or inaction in connection with the project. The way in which the contractual gaps between an employer and a subcontractor can then be bridged is by way of an assignment of the main contractor's rights and liabilities. The assignment can take the form of a main contractor passing on its rights against an employer to a sub-contractor (see Article 891 of the UAE Civil Code) or its rights against a sub-contractor to an employer. It can also take the form that a main contractor drops out from the main contract and is substituted by a sub-contractor through a tri-partite agreement between all three parties (which is legally known as a novation).

However, a main contractor's freedom to assign is often curtailed by the conditions of the main contract. For example, Sub-Clause 3.1 of the 1987 FIDIC Red Book prohibits a main contractor from assigning any part of its contract without prior consent from an employer. And as one would imagine, very rarely would an employer be willing to provide its consent to facilitate a sub-contractor to seek recourse against it. On the other hand, Sub-Clauses 4.2 and 63.4 of the same conditions oblige a main contractor to assign the benefits of certain sub-contracts that it had entered into to an employer in particular circumstances.

Liability in Tort
Apart from an employer and a nominated sub-contractor entering into an agreement (or all three parties including the main contractor, if novation is to be adopted) in order to bridge the contractual gap between them, the law may also impose a liability in tort on either of the parties for negligent conduct or representation made to the other party. The English House of Lords decision of Independent Broadcasting Authority v EMI Electronics Ltd and BICC Construction Ltd (1980) 14 BLR 1 provides a good illustration.

In the above case, BICC was the nominated design and build sub-contractor to EMI who was the main contractor of IBA for the design and construction of a television aerial mast. The mast was cylindrical in shape and 1,250 feet tall. Before the construction of this mast, a similar but shorter mast was being built at another location and had experienced violent oscillation during its construction. As a result of this occurrence, a representative of IBA wrote to the chief designer of BICC suggesting to him that further investigation should be carried out to better understand the effect of a phenomenon known as vortex shedding: a phenomenon which would create varying lateral loadings on a cylindrical structure at varying wind speed and would therefore cause the cylindrical mast to oscillate. In response to this suggestion, the chief designer stated that the phenomenon was well known with cylindrical structures but BICC was satisfied that the mast would not oscillate dangerously. The representative of IBA relied on BICC's assurance that the mast would be safe and did not pursue his concern any further. The mast was completed in 1965 and collapsed in 1969.

On the facts, the House of Lords found that BICC was negligent for failing to consider the effect of ice loading in conjunction with the loading caused by vortex shedding at certain wind speed. As a result, the assurance given by BICC that the mast would not oscillate dangerously was held to be a negligent misstatement, and because it owed a duty of care to IBA it was found liable to compensate in tort. However, the House of Lords did not agree with the argument that the assurance given by BICC amounted to a collateral warranty which was actionable. The reason for this was because there was no evidence to suggest that either BICC or IBA had the intention to create a contractual relationship based upon the said assurance.

Conclusion
As mentioned above, employers and nominated sub-contractors need to be mindful of the contents and intents of their communications at all times, be it before or after the nomination and subsequent acceptance by a main contractor to enter into the eventual sub-contract. Even if, based on the conduct and representations made between an employer and a nominated sub-contractor, the law does not recognise the existence of a contract between the parties it may still find one of the parties to be liable to the other in tort (which is what happened in IBA v EMI and BICC). This is all more important because, unlike English law, the UAE laws relating to harm caused to others (i.e. tort) does not appear to prohibit a party from recovering pure economic loss6, i.e. compensation for purely financial loss as opposed to physical damage to property or personal injury.

Should the parties need to enter into a contract before a main contractor comes on board (probably because the employer wishes the sub-contractor to commence design work or procurement activity in advance), then it would be good risk management practice for that contract to be carefully substituted or replaced when the sub-contract is eventually entered into between the main contractor and the nominated sub-contractor. This can be done by novation or assignment, or by subsuming the terms of the initial contract into the subsequent sub-contract.


Footnotes
1 Article 891 states: A sub-contractor shall have no claim against the employer for anything due to him from the first contractor unless he has made an assignment to him against the employer.
2 Article 890(1) states: A contractor may entrust the performance of the whole or part of the work to another contractor unless he is prevented from so doing by a condition of the contract, or unless the nature of the work requires that he do it in person.
3 Article 890(2) states: The first contractor shall remain liable as towards the employer.
4 For example see Articles 46, 47, 50 and 264.
5 See Article 265 of the UAE Civil Code.
6 Article 292 states: In all cases the compensation shall be assessed on the basis the amount of harm suffered by the victim, together with loss of profit, provided that that is a natural result of the harmful act.

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.

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