Acing the Agreement: How to Avoid Major Risks Involved in Subcontractor Contracts
NOTE: This article is intended to inform our readers about construction business-related concerns in the United States. It is in no way intended to provide legal advice or to endorse a specific course of action. For advice on your specific situation, consult your legal counsel.
Spending that hour or two putting together an ironclad agreement with your subcontractor and keeping it on hand using construction software is always worth the effort.
Don’t believe me? Consider the following case:
Back in 2011, the Virginia construction company was building a house for the Kemps and claim they put in an additional $605,694 worth of work based on verbal change orders from the client.
But the contract required all change orders be in writing. That led to a legal battle in which the judge was forced to figure out the true content of their agreement, and after all the time, attorney fees and headaches, neither party ended up happy.
Nightmare scenarios crop up when general contractors don’t have a good agreement in place, as there are major risks involved in subcontractor contracts. Imagine you’re right in the middle of a time-sensitive project with an impatient client and a profit margin that is already razor-thin—and suddenly you hear the following:
“That change order you requested wasn’t in the original contract. You’re going to need to pay us extra for that.”
“This piece wasn’t in the Scope of Work. We’re not prepared to do it.”
“I don’t remember agreeing to that. Where’s the documentation?”
Relationships between construction managers and subcontractors get messy when there aren’t good agreements in place, leading to delays, cost increases and even lawsuits.
There are three steps you must take when entering into an agreement with a subcontractor in order to avoid a major dispute that could totally upend your next project.
1. Avoid Informal or Verbal Agreements
It doesn’t matter that you’ve known Dave the Subcontractor for 25 years and you know he’s a great electrician. It’s a bad idea to rely on informal or verbal agreements, and here’s why:
Disputes rarely have anything to do with the ability of the subcontractor—rather, they’re a miscommunication between the two sides. That’s really all that a contract or agreement is: clear communication of what is expected between all parties.
And it doesn’t matter that it’s a small job, either. Every bit of work a subcontractor does for you has implications for your project and legal liability attached to it.
Handling anything with an informal agreement risks causing a chain reaction of delays to your project and it also opens you up to a lawsuit that may cost many times more than the value of what you hired the subcontractor to do.
They say “good fences make good neighbors.” It’s equally true that “good agreements make good business partners.”
What You May Hear: “I can start work on these pipes in an hour, and I should have it wrapped up by the end of the day. We’ll shake hands on $800 flat and that’ll be good enough for me.”
What You Should Say: “Let’s get a written agreement in place first that spells out the scope of work. I need documentation for everything and I’d rather wait a day and do this right.”
2. Use an Industry-Standard Template
A bad subcontractor agreement can throw your entire project into chaos. Why risk it by creating your own from scratch when there are plenty of industry-tested ready-made templates out there to choose from?
The American Institute of Architects, a nonprofit trade organization, has a number of documents ranging from general agreements to more specific templates. Here are a few of their most popular templates:
Contractor-Subcontractor Agreement: Used to establish the responsibilities and obligations between the contractor and subcontractor.
Change Order: Used for implementing changes in the work agreed to by the owner, contractor and architect.
Application and Certificate for Payment: Used when a contractor applies for payment and the architect certifies the payment is due.
Certificate of Substantial Completion: Used for recording the date of substantial completion of the work.
Work Changes Proposal Request: Used for requesting quotes for changes or orders on the project.
What You May Hear: “Here’s an agreement I’ve drafted that I’m fine with us using.”
What You Should Say: “That’s great. Here’s an industry-standard template. We’ll use this as the framework and incorporate anything extra from the agreement you made into this document. Then let’s have a lawyer take a quick look at it.”
3. Make Sure Your Agreement Has These 8 Key Features
Before you settle on an agreement, you need to check that it has a number of key features to ensure you have all your bases covered. I’ve identified eight absolutely fundamental aspects that a good subcontractor agreement needs to include:
Scope of Work
This is the most fundamental aspect of your agreement, and it needs to be very, very detailed. If your Scope of Work is too broad, it’s hard for a subcontractor to complete the job as you envision it. It also opens you up to having to accept the subcontractor’s work even if it’s not quite what you wanted.
An agreement should lay out milestones with deadlines attached. It should also specify any damages for not meeting those deadlines.
Change order rules
Change orders are one of the most contentious aspects of subcontractor agreements. Lay out very clear ground rules for change orders—i.e., they have to be written and mutually agreed upon.
Your agreement needs a clause laying out what will happen if the relationship ends early—i.e., do you owe a base amount? Can an agreement be terminated for any reason or only for a specific cause?
An agreement should be a little proactive, so you should have a clause in there that places the responsibility on subcontractors to provide a competent and qualified personnel, and to ensure their supply chain is capable of handling this job.
Delve into the details on what qualified means. That way, you don’t have unskilled labor risking mistakes on something that could jeopardize your entire project.
This seems obvious, but there are a lot of ins and outs when it comes to pricing. For example, you’d need to define not just the total price of the project, but how it will be paid out (lump sum, cost plus fee etc.), who specifically is the recipient (and what bank account to send it to) and when the amount will be paid.
Insurance and indemnity
Your agreement needs to lay out the subcontractor insurance requirements in case something goes wrong. Also, the agreement needs to ensure that the subcontractor will indemnify the owner for all third-party claims caused by the performance of the subcontractor.
By putting an arbitration clause in your contract, you give yourself an advantage if a dispute arises. The subcontractor will have to pursue claims through binding arbitration and voids their right to be heard in court, which can be an enormous cost-saver if the worst comes to pass.
What You May Hear: “This agreement looks good enough to me.”
What You Should Say: “Does it cover this list of subjects? If not, we need to work on it more until it does.”
Refresh Your Subcontractor Agreement Process ASAP
If you don’t have a good subcontractor agreement process in place right now, you open yourself up to the risk of a major disagreement that turns the project on its head and creates the possibility of a crippling lawsuit. The good news is you can take a few simple steps right now to get your firm on the right track and lower the risk to your business:
Gather all of your current agreements together.
Draw up a list of what types of documents you’ll need going forward, based on your past experience with subcontractors.
Download the templates from AIA for each.
Use them as a framework and add any additional elements from your current agreements to them.
Have a lawyer review them to make sure they are airtight.
Find construction software that has a strong document management feature to keep all the documents in order and easy to find if a disagreement arises.