As construction projects become more complex, new technologies and innovations more specialized, trades more regulated, and bidding more competitive, general construction contractors have become increasingly reliant on subcontractors to perform construction contracts. The result is that general contractors are less able to control, inspect, and even assess the work. Yet despite this continued shift, general contractors continue to assume almost complete contractual responsibility for job completion.
Imagine this scenario from a recent case that was tried to verdict. A construction contract for a large building renovation included the installation of two elevators. The contract documents and specifications (all drafted by the building owner) identified the specific elevator equipment and required that it be installed by that equipment manufacturer or a manufacturer-approved installer. In addition, state regulatory laws required that any elevator equipment be installed by a state-licensed elevator mechanic and inspected by a state-licensed elevator inspector. These same regulations prohibited the general contractor from even purchasing the equipment. The scope of work with the owner required the general contractor to “procure and install” the elevators, but under the same contract documents and state regulations, the general contractor had no control in the selection of the equipment, the selection of the subcontractor, or the installation itself. The installation was completed and the elevators were placed into service. Though operational, the elevators were wrought with breakdowns and service calls, which were ultimately determined to have resulted from a poor installation by the subcontractor.
Despite clear evidence that the general contractor had no involvement in the installation, no means or ability to control the installation, and no expertise to assess the quality of the installation, the general contractor could not escape the contractual requirement to “install” the equipment. A jury found the general contractor liable for breach of contract and responsible for the improper installation. Faced with work completed exclusions in all applicable insurance contracts, the general contractor can only hope to collect on a breach of subcontract claim, assuming the subcontractor is solvent.
This example highlights an extreme situation where the general contractor was found contractually obligated despite being completely powerless to ensure the work was performed correctly. But in today’s highly specialized world, general contractors often find themselves in similar situations with the lack of expertise to manage and inspect work of specialized subcontractors. In such situations, the general contractor should proactively look for ways to manage and allocate this risk as part of the initial contract and subcontract formation.
This risk management and allocation can be accomplished in a number of ways:
First, every effort should be made to draft and modify contract obligations to limit or exclude certain highly specialized and regulated work from the scope of the contract. In the above example, the specifications and the law did not allow the general contractor to select the equipment, choose the subcontractor, participate in the installation, or perform the inspections necessary to place the elevators into service. The scope of work in the contract should be drafted to manage the risk for the general contractor that would result in contract performance upon meeting only those markers it can actually achieve.
Second, the general contractor should consider completion waivers to release future claims against the contractor related to the specialized work (in this case, after the elevators were inspected and placed into service by a licensed inspector).
Third, a general contractor should require a specific warranty that covers the subcontractor’s work be provided to the owner. This warranty should be granted directly to the owner from the subcontractor and provide a remedy at law for the owner directly against the subcontractor for the quality of the specialized work.
Fourth, a subcontractor performance bond should be considered or negotiated as part of the contract price. While performance bonds have typically been used to ensure a general contractor’s faithful performance of its contract with the owner, general contractors should also consider requiring performance bonds from their first-tier subcontractors to manage and allocate the specialized risk that is inherent in many current construction projects.
While these options may require certain monetary concessions as part of the initial contract price or in negotiations with subcontractors, this is likely money well spent. Reliance on contractual remedies against a subcontractor simply may not provide the general contractor with adequate remedy and protection. In the example above, the subcontractor is likely insolvent, and a judgment for breach of subcontract is likely uncollectable. Bottom line: careful review and planning in the initial contract negotiation phase is critical in today’s construction climate to properly manage and allocate risk.