The construction contract:
A financial minefield for the unwary

By Kenneth E. Voss

By request, this article, first published in August 2001, is being reprinted as a guide for subcontractors to better understand key subcontract clauses. An addendum to subcontract, which can help address these contract issues, is available in the "Members-Only" section of the national American Subcontractors Association Web site, www.asaonline.com.

No one in their right mind would knowingly attempt to cross a minefield without first detecting and disarming any land mines.

Failure to do so could result in serious injury or death.

By analogy, construction subcontract provisions can represent a financial minefield as potentially devastating to the financial life of a subcontractor. A subcontractor who signs a construction contract without doing more than merely reading the provisions relating to price and scope of work has effectively chosen to walk through a legal minefield, exposing the business to serious financial harm or total ruin.

It is of paramount importance that the subcontractor, before signing the contract, detect and disarm any subcontract provisions posing financial risk. How best to do so depends on the subcontractor's familiarity with and understanding of the contract terms and conditions. It also depends on the amount of time the subcontractor spends reviewing the contract documents.

It might be more feasible for the subcontractor to delegate the contract document review to a lawyer. In many cases, especially when the owner is a government entity, the terms and conditions are included in an invitation to bid. Here it is important that the subcontractor review the terms and conditions prior to submitting a bid, because if the prime contractor accepts the bid, the subcontractor is bound to those terms and conditions.

Subcontractors will not always be successful in disarming all financial risk from a contract, but if they are aware of them, they can at least make an intelligent evaluation and make an informed judgment as to whether they wish to assume those risks.

Spotting danger

Where are some of these contractual financial land mines likely to be found? The following is a brief list of terms and conditions that deserve special attention.

• Definition of subcontract. Be aware that the term subcontract is usually defined to include not only the subcontract agreement itself, but also the contract between the owner and prime contractor as well as special and general conditions, specifications, drawings, addenda and any other documents incorporated in the subcontract by reference. It is essential to review all of these documents before signing the subcontract. In most cases, the prime contractor will make a copy of the prime contract documents if the subcontractor requests them, although the prime might choose to delete the prime contract price.
  
  
• Definition of owner. Especially in the case of nonpublic construction, it is important to know who the owner is in order to make a judgment of the owner's creditworthiness. This is important because it might be necessary for the subcontractor to file a construction lien on the project if the prime contractor is unable or refuses to make payment. Depending on the owner's financial situation, the project might be substantially encumbered so that a lien would be of little or no value.
  
  
• Conditional payment terms. It is important to know the distinction between "pay-if-paid" and "pay-when-paid" clauses. The former is void in Wisconsin. The latter might substantially extend the time for payment and put the subcontractor in a cash-flow bind.
  
  
• Retainage. The subcontractor should not be subject to retainage any greater than that imposed by the owner on the prime contractor.
  
  
• Indemnification. The subcontractor should assume liability only for its own negligence and not that of the owner, prime contractor, engineer or architect. It is important to watch for so-called broad- and intermediate-form indemnification provisions, which can make the subcontractor liable for the negligence of others.
  
  
• Additional-named insured. Many prime contractors want to be covered by the subcontractor's insurance for injuries and damages for which primes are responsible. Some will even name the subcontractor's insurance as primary, meaning that any claims will be satisfied by the subcontractor's insurance before the prime's is affected.
  
  
• Lien waivers. Lien waivers should never be given in advance of payment unless the waiver is conditioned upon the subcontractor's receipt of payment. This is especially true with substantial payments.
  
  
• Notice provisions. There are numerous clauses requiring a notice from the subcontractor for such matters as delays, changes and extras. Often, it's required that these notices be given within unreasonably short time periods.
  
  
• Warranties. The subcontractor should factor a cost for warranty work into the contract price, but it is essential to know the length of the warranty period. It is important to watch for contract terms that require the subcontractor to warranty its work for one year or the period required in the prime contract, whichever is longer. In that case, it is essential to review the prime contract to know the subcontractor's warranty obligation. It is also important to determine if the warranty period starts upon completion of the entire project or upon completion of the subcontractor's work. It is preferable to have the warranty run from the date of substantial completion of the subcontractor's work.
  
  
• Liquidated damages. Often, provisions for liquidated damages are found only in the prime contract. That, however, does not relieve the subcontractor's responsibility for damages where the prime contract is incorporated by reference in the subcontract.
  
  The subcontractor should not be responsible for liquidated damages, except when they are assessed because of and only to the extent of the subcontractor's delay in performance.
  
  
• Dispute resolution. If the contract provides for submission of disputes to arbitration, the prime contractor should not be given the option of choosing between arbitration and litigation, depending on which forum the prime believes will benefit it. While some attorneys prefer arbitration and others litigation, the contract should provide for one or the other.

These are only a few of what I consider potential financial land mines in construction contracts. It is generally good advice for subcontractors to have their contracts reviewed by a lawyer so the most serious risks are not only identified but that counter provisions are developed to offset or disarm those risks.

Kenneth E. Voss is counsel to Hurtado SC and chapter counsel to ASA of Greater Milwaukee.

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