June 1, 1996
By Dean B. Thomson
The Minnesota AGC Standard Subcontract Agreement is one of the most widely used subcontract forms in the region. Although it was revised slightly in 1989, the current form of the subcontract has undergone little change since 1985. Given recent developments in the law and general experience with the current form, MnAGC decided that it was time to review the form to determine whether any revisions were appropriate.
Accordingly, MnAGC formed a subcommittee composed of representative general contractors, subcontractors and attorneys to review the subcontract. After 18 months of meetings, the subcommittee recommended revisions to the form, and the MnAGC’s board of directors recently approved the new subcontract that the subcommittee proposed. The author was a member of the subcommittee and will describe in this month’s Briefing Paper the major changes found in MnAGC’s new standard subcontract.
General contractors and subcontractors constantly debate which one of them should bear the risk of owner insolvency. General contractors often incorporate “pay when paid” clauses in their subcontracts to avoid this risk. In essence, “pay when paid” clauses make the general contractor’s obligation to pay subcontractors contingent upon the owner’s paying the general contractor for the subcontractor’s work. If the owner never pays or is insolvent, the general contractor never has to pay the subcontractor. Naturally, subcontractors do not like these clauses, and have recently lobbied unsuccessfully for legislation banning such clauses.
MnAGC’s old standard subcontract contained language which many construed as a “paid when paid” clause. The Minnesota Court of Appeals, however, has ruled that the language in the old form did not create an enforceable “pay when paid” clause. See Mrozik Constr., Inc. v. Lovering Associates, Inc., 461 N.W.2d 49 (Minn. Ct. App. 1990). Therefore, to remove any confusion, the new form expressly obligates general contractors to pay subcontractors within a reasonable period of time not to exceed 60 days even if the owner has not paid the general contractor on account of the subcontractor’s work. In other words, the new form does not change the Court of Appeals’ reading of the old form and does not attempt to create a “pay when paid” clause.
There may be occasions, however, in which the parties are willing to agree to use a “pay when paid” clause so that each party bears the risk of owner insolvency to the value of the work each will perform. Therefore, the MnAGC created Standard Contingent Payment Rider B50.2, which modifies the new form’s payment terms to include an enforceable “pay when paid” clause.
As a possible compromise between the extremes of either agreeing or not agreeing to a “pay when paid” clause, the MnAGC also created Standard Deferred Payment Rider B50.1. In essence, this rider still obligates the general contractor to pay subcontractors if the owner is insolvent, but requires subcontractors to defer their right to payment until the general contractor has exhausted its collection efforts against the owner. This rider reflects what several subcontractors indicated was their actual practice and effects a limited sharing of the risk of owner insolvency.
In sum, the new form clarifies that it does not contain a “pay when paid” clause, but also provides the option of two riders, one of which creates a “pay when paid” clause and the other a subcontractor’s right to deferred payment. These optional riders reflect the MnAGC’s philosophy that the risk of owner insolvency should be a matter of negotiation between the general contractor and subcontractor on a project-by-project basis.
The old form was less than clear regarding what events would allow a general contractor to terminate a subcontractor, how the termination was to be accomplished, and whether a general contractor could even terminate the subcontract as opposed to merely “taking over” the subcontractor’s work.
The new form attempts to set forth the terms and conditions of termination more clearly. If a subcontractor fails to repair faulty work, comply with the schedule agreed to by the parties, make payment to sub-subcontractors or suppliers, or comply with any substantial term of the subcontract, then the general contractor may give the subcontractor written notice of default. If the subcontractor fails within 3 working days after receipt of the notice to commence and continue satisfactory correction of the problem, then the subcontractor will be in default of the subcontract, and upon an additional 3 calendar days written notice the general contractor can terminate the subcontract.
Upon default, the general contractor can terminate the subcontract and finish the work, or repair or replace the defective work and charge the cost of the completion or correction to the subcontractor together with any liquidated or actual damages caused by the subcontractor’s default. After a termination, the old form required the subcontractor to leave its materials on site, but the new form also obligates the subcontractor to leave its supplies, tools and construction equipment on the site for use of the general contractor in completing the subcontract work. All major standard form owner/general contractor contracts (e.g., those published by the AIA, EJCDC, and National AGC) impose a similar obligation on the general contractor if it is terminated pursuant to its contract with the owner.
The old and new forms require the subcontractor “to proceed with the work in an orderly and reasonable sequence directed by the Contractor.” Arguably, the general contractor can enforce this provision by withholding payment from the subcontractor for failing to comply with the schedule, as long as the schedule established an “orderly and reasonable sequence” for the work. Under the old form, however, the general contractor could not terminate a subcontractor for failing to comply with the schedule; termination was only an option if the subcontractor did not complete its work within the time provided. The new form provides that termination is possible not only for failing to complete on time, but also for failing to comply with the schedule during performance. This should allow the general contractor the ability to correct a problem before the final completion date is missed. To avoid the subcontractor’s being whip-sawed by unreasonable schedules, however, the new form allows the general contractor to terminate a subcontractor only if the latter repeatedly fails to comply with a schedule “agreed to by the parties.” This emphasizes the importance of both parties meeting at the start of the project to develop a mutually agreeable schedule.
Notice of problems or claims is now a reciprocal duty under the new form. The general contractor must give written notice of all known claims against the subcontractor within a reasonable period, but not more than 30 calendar days after knowledge of the claim. On the other hand, the subcontractor must give the general contractor written notice of claims for extra time or money so as to allow the general contractor to give timely notice of those claims in accordance with the terms in its contract with the owner. Timely notice is defined as 3 working days prior to the expiration of the relevant notice period in the general contractor’s contract with the owner. This underscores the importance of subcontractors’ obtaining copies of the general contractor’s contract with the owner so that everyone understands the controlling time limits for notice.
The insurance requirements for subcontractors are now part of the text of the new form to emphasize their importance and standardize the specified coverages. The limits for the specified insurance will be those stated in the subcontract form, or, if none is specified, the limits specified in the agreement between the owner and general contractor will govern. The insurance must be provided by a company having an A.M. Best Rating of B+12 or better, but this requirement may be waived if a subcontractor is self-insured (for example, for Workers’ Compensation).
The subcontractor also promises to hold the general contractor and other subcontractors harmless from damages due to its failure to perform the subcontract. Under the new form, damages to be indemnified now include legal fees incurred as part of the loss or to enforce the terms of the indemnity.
The old form required the subcontractor to arbitrate disputes if the general contractor was required to arbitrate disputes with the owner. The new form now requires the subcontractor to also engage in alternative dispute resolution procedures, such as mediation, if such procedures are also specified in the general contractor’s contract with the owner.
A common source of disputes between general contractors and subcontractors is back charges for clean-up. In an attempt to reduce the number of these claims, the new form requires that the subcontractor clean its debris from the job site, but requires that the general give the subcontractor 3 working days’ notice before the general performs the clean-up and charges the subcontractor for it.
The amount of money a general contractor withholds to cover the cost of correcting a subcontractor’s allegedly defective work is also a frequent source of disputes. The new form limits a general contractor’s withholding to 150 percent of the sum of the claim pending resolution of the dispute.
Undertaking emergency safety precautions can sometimes create unintended liability. To encourage safe practices, the new form retains the provision allowing general contractors to undertake emergency safety measures affecting the subcontractor’s work, but adds that this right does not create or impose a duty on general contractors to inspect or be responsible for the subcontractor’s safety procedures.
The new form deserves careful study because it defines the rights and duties between general contractors and subcontractors. Although many changes were made, the new form does not address many outstanding issues still present from the old form due to an inability to reach consensus on the appropriate solution. Nevertheless, the new form should prove to be an improvement over the old in terms of both substance and clarity.
At best, however, the new form only approximates what many believe to be a fair allocation of risk between general contractors and subcontractors in the context of today’s market conditions. As with any standard form, modifications may be necessary to address the risks associated with a particular project or company.
This Briefing Paper has discussed only some of the highlights of the new form; many other changes were made. Those wishing to discuss the effect of the changes made or receive a black-lined copy of the new form identifying all the additions or deletions to the old form are encouraged to contact the author.
This discussion is generalized in nature and should not be considered a substitute for professional advice. © FWH&T