Contractor’s Approach to Risk Allocation VIII – Subcontractor Selection

Contractor Approach to Risk Allocation VIII – Subcontractor Selection Clauses

In this edition of my series addressing equitable risk allocation in construction contract, I am going to discuss those clauses where an owner seeks input or control over a contractors subcontracts and subcontractor selection.

In Construction Manager at-Risk projects, a certain amount of input by the Owner is expected and built into the pricing structure of those contracts. In traditional design/bid/build work, most contractors assume they have full control over subcontractor selection. However, contracts that seek to provide an owner information and input into subcontractor pricing and subcontractor selection are not uncommon. In some cases, these contractual clauses shift the risk of subcontractor default to the contractor even though the contractor had little control over the selection of the subcontractor. This creates and inequitable situation that simple contract language can address.

Subcontractor Qualification Clauses:

In some contract documents, meaning both the general conditions to a contract and the technical specifications, owners have begun to assert control over subcontractor qualifications and selection. In my dealings with owners, these controls are desired because of the detrimental effect a subcontractor default can have on a project. The owners feel comfortable and confident that their chosen contractor is qualified and can perform good work. However, the owner becomes concerned that the subcontractors may create performance problems.

Despite the built-in protections offered by traditional contract arrangements—the contractor is responsible for compliance with the plans and specifications, the contractor is responsible for timely delivery of the project, and the contractor provides a performance bond to secure against default—owners are still trying to assert control over subcontractor qualifications out of concern that the traditional remedies are inadequate or that default can be avoided by the assertion of additional controls.

Contract language that has typically been used for pre-approved equipment manufacturers is now being used for subcontractors performing major scopes of work. This language can present difficulties for contractors without prior dealings or relationships with the pre-approved subcontractors. In some situations, the mandated use of subcontractors can actually increase the likelihood of delay or default.

Essentially, the reason these clauses are being used is to ensure that quality subcontractors are selected to perform on projects. What both owners and contractors should understand is that there are more equitable means of crafting these provisions to ensure the ultimate goal of quality performance is met. For example, a more-owner friendly, but less onerous, provision might list pre-approved subcontractors but also allow the contractor to submit additional subcontractors for the owner’s consideration and approval in addition to the owner-selected subcontractors.

A more balanced provision would allow the contractor to solicit pricing from subcontractors of its own choosing and then share that information with the owner. The procedure could extend further collaboration to a joint determination as to the subcontractor that provides the best value to the project. In using a provision like this, contractors should emphasize the need to control the means and methods of performance and should therefor insist on an override veto of an owner’s decision on subcontractor selection if the parties disagree as to the best value subcontractor.

An owner who might insist on more control over subcontractor selection should be faced with a negotiation that shifts the risk of subcontractor default to the owner. Certainly, if the mandated subcontractor’s pricing proposal exceeds the contractor’s preferred subcontractor, the owner should be required to execute a change order increasing the contract sum by the difference. Additionally, the contractor should insist that the owner forgive any delays or related damages that result from subcontractor default.

Certainly, the most advantageous contracts for contractors on this issue are silent with regards to subcontractor selection. Traditionally, industry form contracts deal with subcontractors by allowing contractors complete control over subcontractor selection in design/bid/build projects. The increasing use of alternative delivery and pricing methods has created an opportunity for the parties to become more creative with their contract drafting and negotiation.

Subcontractor Pricing and Replacement Clauses:

There are two other clauses that warrant discussion in this column. Although not very frequent, certain contract modifications I have been presented with in the recent past contain clauses that allow an owner to receive both subcontractor pricing and subcontract agreements from the contractor. The motivation for requesting this information is to ensure that the owner, on fixed price contracts, is getting the best price. However, in a bid situation, this information is not needed. Furthermore, the request for this information may create a sense of mistrust between and owner and contractor that can erode the necessary commitment to partnering for a successful project.

An owner’s interests are not served by see what a contractor buys out its scopes of work for from various subcontractors. If an owner insists on seeing pricing information from subcontractors, contractors should approach that negotiation in the same manner as discussed above. If a contractor has selected a subcontractor that was not the lowest bidder and the owner mandates the use of the lower priced subcontractor, then the contractor should insist that risks of price and time escalation because of that subcontractor potential default should lie with the owner. Its inequitable for an owner to interfere with the contractor’s management of the project and then expect the contractor to assume the risk associated with that interference.

In conclusion, an owner’s desire to assert more control over subcontractor qualifications, selection, and pricing may serve a legitimate interest, but it places excess risk on a contractor that deviates from traditional risk allocation. It creates an inequitable shift when subcontractor selection is removed from a contractor while the risk of subcontractor default remains with the contractor. A more equitable allocation, should the owner seek to retain some of this control, is to place the risk of default on the party that retains control over selection.

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