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.
