The terms of a written subcontract can create economic incentives for a subcontractor’s customer to withhold or delay payments, or even to deny a subcontractor’s right to any payment for extra work. Negotiating fair subcontract terms is therefore vital for a subcontractor to improve its cash flow. Experience fewer cash-flow problems by identifying the risks and costs associated with different subcontract terms and using ASA’s model language to get the terms you want.
Every Contract Is a Job Cost
The first step in addressing cash flow issues is for estimators of subcontract work to understand that all of the terms of a proposed subcontract necessarily affect the subcontractor’s estimated cost to perform.
For example, if a subcontractor’s work is improperly scheduled, the subcontractor will incur extra costs as it re-arranges its work force, equipment, and activities on the job site. Any competent estimator will understand that the amount of time afforded for performance will affect the subcontractor’s cost to perform.
Retainage and other payment-related terms have direct effects on cash flow that also affect costs. Money has time value — that’s why banks can charge interest on loans — so clearly the rate of retainage should affect a subcontractor’s estimate. Terms requiring subcontractors to assign particular values to items on their “schedule of values” should have the same kinds of effects, because the schedule of values sets the payment schedule.
Costs of Risks
Most of the terms in a written subcontract, however, are designed to increase the subcontractor’s risk of loss, not directly affect the subcontractor’s cost of performance. Estimating the cost of potential losses, which may ultimately never occur, is arguably the most difficult and important job that a construction subcontractor performs.
Risk clearly has a cost. Otherwise, insurance companies couldn’t make money, Moreover, the risk of unanticipated events, unforeseen conditions, and design changes is clearly greater than zero. Who will pay for the added costs of a design change or an unforeseen condition?
Contract terms that allocate risk, including no-damage-for-delay clauses, “hold harmless” terms, and back charge provisions, will govern the answer to this question.
In addition to the “boilerplate” terms that shift risk, subcontractors also have to consider the risks created by disclaimers in the plans and specs. A contract requiring a subcontractor to perform any work “consistent with the purpose and intent of the Plans and Specifications,” (1) for example, amounts to a disclaimer that the plans are complete, and can be used to force a subcontractor to perform extra work for free, as at least one subcontractor in Florida can attest.
The lesson is that risk has a cost. Therefore, risk-shifting contract terms, like other job costs, should affect a subcontractor’s cost estimate for the work. If a subcontractor’s cost estimate does not predict such job costs, the estimate is not complete. (2)
But I Won’t Get Any Work!
Even if there were a way for subcontractors to accurately forecast the cost of scope-expanding terms, no damage-for-delay terms, and other terms, most would be reluctant to add those costs to their bid estimates for fear they would price themselves out of the market.
But there is a solution: Condition your bid number on fair contract terms. In fact, subcontractors that specify their own terms can lower their bid estimates by eliminating “contingency” amounts from their estimated costs.
A subcontractor that bids a job “per plans and specs” gives its customer the power to say “I accept” and legally obligate the subcontractor to sign whatever subcontract form was specified in the bid documents. When a subcontractor specifies its own subcontract terms, however, the customer can’t force unfair terms on the subcontractor.
The “ASA Subcontractor Bid Proposal (2005)” provides ASA members with a tool they can use to protect themselves from unanticipated cost of risk and unfair payment terms, and improve their cash flow. ASA members are encouraged to borrow terms from the ASA form to improve their own “scope letters” or other bid-limiting documents, or to use the form as-is.
ASA Forms Fairly Allocate Costs of Time and Risk
The “ASA Subcontractor Bid Proposal (2005)” specifies that “Subcontractor and Customer will execute an American Institute of Architect’s A401-1997 subcontract form … supplemented and modified as provided by this bid proposal, which shall be incorporated by reference into the final subcontract.”
The A401-1997 had a fair payment clause, not a contingent payment clause. It limits retainage to amounts retained by the owner, and provides for early release of retainage if permitted by the prime contract documents. It entitles the subcontractor to equitable adjustments of time and price in the event of changes to the design or schedule. It had a fair, comparative form “hold harmless” clause that obligate the subcontractor to pay only for losses it causes, or that its own sub-subcontractors cause.
The “ASA Subcontractor Bid Proposal (2005)” also supplements the A401-1997 terms by limiting insurance obligations to “Subcontractor’s existing insurance program evidenced by its certificate of insurance available on request.”
It allows the subcontractor to control the payment schedule by attaching. “Subcontractor’s schedule of values” to the bid. It details job-site values” to the bid. It details job-site services, like parking and hoisting facilities, for which the customer will be responsible.
It allows the subcontractors to opt out of an owner-controlled insurance program or contractor-controlled insurance program, or else to specify flat- rate prices the subcontractor will pay for such insurance, so that payment of retainage will not be delayed for “credit calculations” that can take 18 months, 22 months, or longer. It also provides that “all costs of collection, including a reasonable attorney’s fee, shall be paid by Customer” in the event that the subcontractor has to sue for payment.
If a subcontractor starts work before the general contractor’s form subcontract arrives on its desk, the “ASA Subcontractor Bid Proposal (2005)” would obligate the contractor to sign an A401- 1997 incorporating the subcontractor’s bid proposal because the general contractor will be deemed to have accepted the subcontractor’s bid proposal “by conduct.”
The subcontractor could properly refuse to sign its customer’s terms and could suspend work if its customer refused to pay in accordance with the A401-1997’s right to suspend work for nonpayment.
If the customer sends the subcontractor its own subcontract form before allowing the subcontractor to start work, however, ASA documents provide another solution to protect cash flow: the “ASA Subcontract Addendum (2005).” The Addendum assumes your customer’s proposed subcontract will be considerably less fair than the A401-1997 specified by ASA’s bid form.
It specifies that your “scope of work includes only the following,” with a blank provided for you to describe your scope in your own terms. It restricts “hold harmless” terms, counters no-damage-for -delay terms, and stipulates fair warranty terms. It also supplements your customer’s subcontract form with the same terms that ASA’s bid form would incorporate into an A401-1997 form.
Subcontractors also may find useful idea for countering the effects of a customer’s overbearing subcontract form in the “ASA Short Form Subcontract Addendum (2005),” which squeezes some of the most important payment and risk-allocating terms onto a single side of a sheet of paper. It’s straightforward economics: your cost estimates can’t make any sense if they don’t price all of the contract terms.
Subcontractors that don’t specify their own contract terms take a huge risk that their cost assumptions will not be matched by the final subcontract form. Improve your cash flow and save your money by using ASA documents to get control over the terms that you’re putting a price on every time you bid.
(1) (See the Sunhouse Construction case, 841 So.2d 496 [Fla.App.3 2003], where this language was used to require a subcontractor to perform work additional to the work in its bid estimate, at no charge, after significant changes were made to the design of a public school project.)
(2) (The American Society of Professional Estimators’ Standard Estimating Practice, 6th ed. [B Ni Publications Inc., 2004], p. 81, states: “Read the general and supplementary conditions of the contract and thoroughly understand them. As an example, AIA Forms 101, 201, and 401, have different types and levels of project requirements. Notes on the contract from, insurance requirements, allowances, alternates, and addenda are an integral part of the estimate.”)
(Brian Cubbage is ASA senior director and counsel, government and industry relations.)
(C) 2006 Foundation of the American Subcontractors Association/Naylor Publications (www.contractorscompass.org). Reprinted with permission.