When appointing a subcontractor, a supplier's key concern is ensuring seamless delivery of the services per the requirements of the main contract in place with their client.
In this article, our Commercial Solicitors have identified five essential points for suppliers to consider when contracting with their subcontractors.
A subcontract is an effective way to delegate contractual obligations to a third party and is used in many sectors, particularly technology, manufacturing and construction. A supplier may be the main contractor tasked with delivering a large project, or there may be a bespoke element of their service offering requiring a certain piece of software or technical expertise.
Whatever the reason for subcontracting, the chain of liability is key. The supplier, as the main contractor, remains liable for the performance of the main contract and will normally be liable to the client for any default in performance by the subcontractor. The client is usually not entitled to sue the subcontractor for breach of contract unless they have a claim in tort or a direct third-party right.
Therefore, the supplier should put appropriate provisions in place with its subcontractor to minimise and manage the supplier's risk exposure to the client. Here are five key things you should consider when subcontracting.
Can you Subcontract?
As a general rule, unless the main contract specifically prevents the supplier from appointing a subcontractor, then the client must accept a subcontractor's performance where that subcontractor has met all the main contractor's obligations.
However, it is common to see express restrictions on subcontracting in contracts – for example, a supplier might need to seek prior written approval from the client before being able to appoint a subcontractor.
Subcontracting may also be implicitly prohibited by providing that certain obligations must be performed personally by the supplier – for example, where the client chose the supplier for their particular qualifications, skill, competence or financial position. This should be considered on a case-by-case basis each time a supplier looks to appoint a subcontractor.
Who is the Subcontractor?
If the subcontractor fails to perform, the supplier must step into the subcontractor's shoes; therefore, it is essential to contract with the right subcontractor. In some cases, the supplier's hands might be tied due to the client requiring the use of a particular subcontractor (such as an incumbent provider of services they wish to continue using).
A supplier should always conduct due diligence on subcontractors to assess their suitability, skills, reliability and resources, which could include:
- Their historic performance for clients and the client in question (if the supplier has to appoint the incumbent provider as a subcontractor);
- The technical and organisational security measures and data protection practices that the subcontractor has in place if the subcontractor processes (or sub-processes) personal data;
- The jurisdictions in which the subcontractor operates and the details of their supply chain;
- The group structure (if any), to ascertain if there is potential for a parent company guarantee to cover the subcontractor's failure to perform the contract and
- Their credit rating and insurance cover.
What Contractual Protections should a Supplier require from a Subcontractor?
A balance will need to be struck when flowing down the obligations from the main contract to the subcontract – it may be tempting for a supplier to flow down all obligations and liabilities to the subcontractor and include indemnities to cover any potential breach or default.
However, there may be acceptable gaps in some subcontracts which reflect the risk and reward of the main contract – for example, the value of the main contract may be much higher than the value of the subcontract. Following due diligence, it may be more efficient to target key risks (for example, strict service level commitments from the subcontractor) or, as mentioned above, to seek security via a third-party guarantee.
A supplier should also consider what is being subcontracted, all or part of the suppliers' obligations, and if the latter, then it is extremely unlikely that the subcontractor will or should have full responsibility for delivery of the main contract or take on all liabilities that may arise under the main contract.
Obligations which should always be flowed down include:
- key milestones for delivery (and the consequences for not meeting these);
- acceptance processes (to avoid confusion at delivery);
- any dependencies which a party might require from another party to satisfy its obligations;
- appropriate liability provisions and indemnities from the subcontractor;
- intellectual property provisions.
Additionally, it may be a requirement under the main contract that the supplier engages any subcontractors on the same or similar confidentiality terms as are in the main contract between the supplier and client.
Do any Regulatory Standards or Requirements need to be Met?
There may be compliance requirements under regulations, legislation or the main contract, which need to be included in the subcontract:
- Data Protection – where a sub-processor is appointed, the same data protection obligations in the main contract must be imposed on the sub-processor.
- Client or supplier policies – there may be mandatory policies included in the main agreement which must be brought to the attention of the subcontractor (such as anti-bribery and corruption and modern slavery compliance).
- Industry requirements, such as cybersecurity and ISO standards, must be met.
Who owns the Output of the Subcontractor's Work?
The supplier must consider the terms on which the subcontractor licenses its intellectual property rights to the supplier and the client.
Are the licence terms wide enough to allow the supplier to effectively perform its obligations under the main contract, and will the licence allow the client to achieve its desired outcome? Where applicable, the supplier might consider an assignment of the intellectual property rights in any deliverables the subcontractor produces.
The supplier should also assess how the subcontractor engages the individuals who may be producing the IP – if produced through employees, the subcontractor will automatically own the IP, but if the subcontractor engages other third parties to undertake such tasks and develop the IP, then the subcontractor themselves will require an assignment from those contractors to own the rights to be delivered under the main contract.
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.