Ten Killer Contract Clauses

Kegler Brown Construction Newsletter

Assuming a prudent Subcontractor has maintained the leverage to negotiate subcontract terms through conditioning his bid upon acceptable subcontract language, he will be walking a fine line between removing onerous provisions and chasing away new business. Therefore, subcontractors may want to focus on the true "deal breakers."

My personal list of frequently encountered "killer contract clauses" follows:

1. Contingent Payment Clauses: "Pay When Paid" vs. "Pay If Paid"

"Pay When Paid" subcontract clauses are structured in a way that payment from the general contractor to the subcontractor is conditioned upon prior receipt of payment from the owner to the general contractor. Ordinarily, the subcontract will state that payment is due to the subcontractor within a certain period of time after receipt by the general contractor of payment from the owner. Such a conditioning of payment in a subcontract is known as a "Pay When Paid" clause.

Many courts have traditionally interpreted "Pay When Paid" provisions as an unconditional promise to pay, with the time of payment being postponed until the happening of a certain event, or after a reasonable period of time has elapsed if such event does not take place. That means that the general contractor must pay within a "reasonable time" if the triggering event does not occur — not that the general contractor need not ever pay the subcontractor in the event of non-payment by the owner.

With increasing frequency, many general contractors have been inserting "Pay If Paid" provisions in their subcontracts, stating something to the effect that the subcontractor assumes the risk of non-payment by the owner and payment by the owner to the general contractor is a condition precedent to payment by the general contractor to the subcontractor. In this way, the general contractor is attempting to insulate himself from any liability to the subcontractor at any time in the event of non-payment by the owner.

A "Pay If Paid" clause not only shifts the credit risk associated with the owner to the subcontractor but also the risk that the owner will not pay the contractor because of disputesinvolving performance wholly unrelated to the subcontractor's scope of work.

Court decisions in many states have upheld the validity of "Pay If Paid" provisions if they unambiguously express the intention of the parties to shift the credit risk to the subcontractor.

Yet there is a growing legislative and judicial trend finding "Pay If Paid" provisions against public policy and unenforceable. In those states contractors must pay subcontractors within a reasonable period of time for their work.

2. No Damage for Delay

Despite the unalterable fact that "time is money" on any construction project, "no damage for delay" clauses purport to limit the subcontractor's remedy for delay to a time extension, but no additional compensation.

3. Waiver of Lien and Bond Rights

In many states, the waiver of lien and bond rights in advance of payment at the time of contract is enforceable. Subcontractors should vigorously resist giving up the additional payment security provided by lien and bond rights.

4. Unconditional Lien Waivers Before Payment

Many subcontracts require an unconditional lien waiver from the subcontractor in advance of payment, which may waive lien rights even if the promised payment is never received. An acceptable compromise might be to offer a conditional lien waiver in advance of payment to be followed by an unconditional lien waiver once payment is received.

5. Incorporation by Reference

All subcontractors should be alert to the provisions of the prime contract when an incorporation by reference clause is encountered. Particularly inequitable are provisions which incorporate only the contractor's responsibilities, but not his rights, against the owner.

6. Change Orders in Writing

As change orders are typically the most contentious issue between parties on a construction project, subcontractors should pay special attention to the notice and approval provisions for change orders contained in both the subcontract and prime contract and ensure that they are satisfied.

Subcontractors may want to resist provisions which allow the general contractor to direct the changed work without an agreement in advance to pay a mutually acceptable price for the change.

Subcontractors should also insist upon similar notice from the general contractor before "backcharges" or deduct change orders can be assessed.

7. Dispute Resolution

Many subcontractors favor arbitration over litigation. Virtually all subcontractors should resist venue and jurisdiction provisions that attempt to force the dispute to be resolved in an inconvenient forum far from the project. It is also important that a subcontractor's claim not be stayed pending resolution of any contractor/owner dispute.

8. Broad Form Indemnity

Subcontractors will want to minimize the risk shifting in indemnity clauses, particularly if they relate to non-insurable risks. Examples of unacceptable risk shifting might include a broad indemnification relating to matters other than personal injury and property damage, indemnification of a party from its own negligence and indemnification for OSHA fines, particularly any enhanced penalties based upon the contractor's prior experience on unrelated projects.

9. Integration

Subcontractors who neglect to carefully compare the scope of work in the Subcontract to their earlier bid proposal are greatly disappointed to learn that this standard clause will allow the Subcontract to control over the bid proposal or any prior negotiations. Some add the bid proposal as an exhibit to the Subcontract to deal with this problem.

10. Acceptance of Final Payment as Waiver

Under this clause, unresolved subcontract claims or change order requests may be inadvertently waived when final payment is received for the original contract sum. Therefore, subcontractors are counseled to avoid this provision, or in the alternative, to be careful not to request payment in full until all claims are resolved. An acceptable compromise might be to exclude written claims which remain pending when final payment is received from such an inadvertent waiver.