Doug Staebler, Custom Concrete Company, Inc., Westfield, IN

Over the past year, there has been a marked increase in the use of subcontractor agreements in residential construction. Although these agreements were used for years in commercial construction, residential contractors often operated on handshake agreements. Like it or not, those days are probably gone for good, and we must learn to operate in an environment that is increasingly legalistic and prone to litigation.

These agreements often create unreasonable obligations on subcontractors, with potentially devastating financial consequences. This article discusses the reasons for the increased use of subcontractor agreements, and what it means to subcontractors. Subsequent articles will focus more closely at indemnification clauses, as well as strategies for negotiating changes to agreements with our customers.

The biggest factor driving the use of subcontractor agreements is the surge in litigation involving homebuilders, especially those involving mold. The frequency and amount of losses create large losses for insurance companies. In an attempt to limit future losses, insurers are determined to push liability for claims on to subcontractors or suppliers. This is accomplished by a combination of tightly worded indemnification provisions combined with strict insurance requirements for subcontractors.

Many insurers stopped writing coverage for homebuilders, and now only a few markets remain for builders to obtain the insurance coverage they need. Builders fear being cancelled or non-renewed and take requests from insurers seriously. In many instances, insurers provide contracts to their homebuilder customers with orders to get them signed by all of their subcontractors. Failure to obtain signed contracts from all subcontractors can jeopardize continued coverage.

The motivation behind the use of subcontractor agreements varies significantly. Large national builders use subcontractor agreements as an important piece of an overall risk management program. In most cases, the agreements are drafted by attorneys from national corporate offices. Conversely, local builders are often given subcontractor agreements by insurance companies, with instructions to get them signed by all subcontractors. They usually had no direct involvement in drafting the agreements, and often have little familiarity with them.

Unfortunately, there are many misconceptions about these agreements and how they operate. Agreements are often long, detailed documents with lots of legal jargon that is difficult to understand. At first glance, they appear to clarify each party’s duties and obligations, and seem fairly balanced between the parties. In reality, the agreements are one-sided, written entirely to benefit the builder. Upon close examination, it is difficult to find anything in the agreement that protects subcontractors. Another misconception is that unfair contract provisions will not be enforced by the builder or by the courts. In reality, courts will generally enforce any provision agreed to in a contract, even those considered unfair or one-sided.

So what options do we have when presented with these agreements by our customers? At first glance, it appears we have little choice but to sign the agreement if we want to work for the customer.

It is difficult to find problem provisions in the agreement, let alone negotiate changes. We feel additional pressure knowing that most subcontractors simply sign the agreements as drafted. However, if carefully executed, most customers, even large national builders are open to discussion about the agreements, and will agree to reasonable changes.

It is helpful to divide contractual provision into three categories. The first are provisions that are operational in nature, such schedules, materials, supervision, change orders, and quality standards. While still important, these provisions will generally work themselves out in daily operations. If problems are encountered, they can generally be resolved in the field as they occur. Ultimately, if reasonable solutions cannot be found, and the issues are significant enough, it may not be profitable to continue working for that customer. In general, it is best to focus on other areas of the contract.

The second category involves provisions dealing with payments to subcontractors. In addition to providing for normal payment terms and procedures, there are two common provisions that pose problems for subcontractors. The first is a “No-Lien” provision. In these instances, subcontractors legally waive their right to file mechanics liens. Builders have valid reasons for seeking these provisions, but we should use extreme caution in agreeing to waive lien rights. An alternative solution is an agreement to reinstate lien rights if certain conditions and delinquencies arise.

Another problem provision is the “pay when paid clause”. These provisions are commonly found in commercial projects, and state that the general contractor (builder) has no obligation to pay subcontractors until the general contractor is paid by the owner. In essence, our payments are dependent on the owner, and we may have little or no contact with them, and no knowledge about their financial status. Additionally, we will suffer from any dispute between the owner and general contractor.

The third category involves indemnification clauses, and other provisions dealing with construction defects, personal injuries, and other liabilities. These provisions are potentially the most severe, and impose substantial and unreasonable obligations on subcontractors. This area will be more fully discussed in the next article.

As our businesses grow, greater amounts and net worth are needed to sustain and operate the business. Unfortunately, the equity in our businesses is at risk to litigation or other claims. These agreements are simply too important to ignore. But if we approach them correctly, there is a surprising ability to make necessary changes to the agreements.