Guest Column: Why Owners Should Care About Subcontracts Held by Construction Managers
- Jan 31, 2014
Many property owners do not participate actively in the development of subcontracts under a construction management agreement, but it’s important that they do. Paying too little attention to this part of the subcontracting process and yielding too much control to the construction manager (CM) can engender problems for the owner should an issue come up with either the construction manager or a subcontractor.
Why Owners Should Care About Subcontracts
There are a number of reasons that the owner should care about the contents of subcontracts, and not rely upon the “flow down” or “incorporation by reference” clause in the subcontract. Below are just some of the reasons:
- If the owner terminates the CM agreement, the owner or a new construction manager may inherit some or all of the subcontracts.
- Certain provisions may be mandated pursuant to governmental incentive programs, and the owner should not rely on the CM to ensure that those provisions are included in the subcontracts.
- Subcontracts will often contain a warranty or guaranty provision that differs from the similar provisions in the CM agreement, regarding the duration of the coverage or other salient terms or conditions. While the owner may look to the CM under its warranty or guaranty, should they decide to seek recourse against a subcontractor, they may be prejudiced if the subcontract terms are not as favorable as those in the CM agreement.
- With the owner being designated as an indemnitee and beneficiary under the subcontract, it is important to add a statement that such a designation should not be deemed to create contractual privity between the owner and the subcontractor (except for the subcontractor’s indemnity and other contractual obligations in favor of the owner) or otherwise give rise to any obligations or liability on the part of the owner in favor of the subcontractor.
- There are certain other subcontract provisions that the owner will want to remove or nullify, such as, a “liquidating agreement” or “pass-through” provision, a cross-default between the subject subcontract and other subcontracts between the CM and that subcontractor, and a clause permitting the CM to offset against payments due to the subcontractor on the owner’s project amounts that the subcontractor may owe the CM on a different project.
- The subcontract should permit the CM to assign the subcontract to the owner or its designee without obtaining the subcontractor’s consent. The assignment provision should state that the owner can effectuate the assignment simply by sending notice to the subcontractor (without the CM’s confirmation).
- To avoid any doubt as to whether the incorporation by reference of the CM agreement expires upon termination of that agreement, the subcontract should provide that if the agreement is terminated for any reason, it continues to be live as so incorporated.
- The force majeure provision in the subcontract should state that if the CM agreement is more restrictive in terms of the amount of time allowed for extensions, then the subcontract provision should be deemed modified to conform to those more restrictive terms.
- The owner should be named in the subcontract as a beneficiary under the subcontractor’s warranties and guaranties, as well as an additional insured and indemnitee, and an obligee under payment and performance bonds. The owner may also be required, by a lease or mortgage, to extend that protection to the lessor or mortgagee.
- In addition, the owner should be specifically designated as a third-party beneficiary under the subcontract with respect to all other provisions set forth in the subcontract expressly stated to benefit the owner or otherwise naming the owner.
The general practice is that the CM will use its own subcontract form, and even if the owner does review the form, they may not review the actual completed subcontract before it is executed or even obtain copies of the executed subcontracts.
There are several problems with this practice, from the owner’s perspective:
- Even if the subcontract contains a customary provision incorporating the CM agreement by reference, it is very possible that the CM will not provide a copy of the agreement to the subcontractor, which would make it more difficult to bind the subcontractor to provisions in that agreement.
- Even if the subcontractor is given a copy of the agreement, the inclusion of the customary incorporation by reference provision may not be sufficient to bind the subcontractor to certain key terms in the agreement, such as those not involving the scope, quality, character or manner of the work.
- When the approved form of subcontract is attached as an exhibit or otherwise established as the prescribed form to use, the owner should still review the actual subcontract agreements before they are executed to ensure that no material changes were made to the approved form.
- The owner’s failure to obtain copies of the executed subcontracts can present problems if they terminate the CM but want to continue working with the subcontractors under their existing subcontracts or if they seek to enforce beneficial subcontract provisions.
Correcting Problems with General Practice
- Given the CM’s desire to work with its own form of subcontract, the owner should provide a rider to be annexed to each subcontract, incorporating important concepts found in the CM agreement and addressing weaknesses in the CM’s form of subcontract.
- The CM agreement should require the CM to employ the subcontract form and rider annexed as exhibits.
- The CM should provide to each subcontractor a copy of the CM agreement, redacted to prevent disclosure of monetary and other confidential terms.
- The owner should review the final, execution version of the subcontracts (redacted if appropriate) to ensure that any changes made by the CM to the standard form are acceptable.
- The owner should obtain copies of the executed subcontracts (again, redacted if appropriate).
Michael Scheffler is real estate development practice group leader for Blank Rome L.L.P.