When back to back isn’t good enough
Parties to a construction contract almost always agree to time obligations.
Even in a scenario where time obligations are not discussed as terms of the contract, there are statutory and legally implied standards.
It is true that parties can expressly agree to lesser time restrictions but this is a rare occurrence.
It begs the question, what happens when a party doesn’t perform?
Typically, a breach of contract entitles the harmed party to damages, the amounts of which may be agreed as a term of the contract (liquidated) or left unagreed (unliquidated).
If the damages are liquidated then there are some rules.
The damages must be a genuine pre-estimate of the likely cost which the harmed party would face if the contract were breached.
If the liquidated damages amount can be shown at a later date to offend this requirement, the liquidated damages may be unenforceable due to being deemed a ‘penalty’, which for one reason or another cannot be upheld.
Although there is some recent case law discussed here which suggests a change in thinking may be necessary.
However, the issue may not be that the terms are unenforceable, the issue may be that they are entirely enforceable and not considered properly.
A commonly used tool
The majority of people in the construction industry know of, and may even rely on liquidated damages terms often.
However, it is also common within subcontract agreements to find ‘back to back’ contractual provisions.
Back to back, is a term of trade which describes a contract that copies the obligations of one party and imbues those obligations on a different party.
The terms are often used in subcontract agreements and commonly include references to the ‘head contract’ as being the document which sets out the obligations of the subcontractor.
The intention being, whichever obligations apply to the main contractor, also apply to its subcontractor, thereby minimizing risk to the contractor and ensuring generally that the subcontractor is responsible for performing all of the work (other than managing the subcontractor).
Should the subcontractor delay the project such that the main contractor is charged liquidated damages, the subcontractor will also be liable to the main contractor for the same liquidated damages.
Where the issue occurs
Contractors must consider other factors before necessarily assuming back to back damages will be adequate.
A potential risk for contractors is to carry the liquidated damages amounts from the head contract to the subcontracts without variation.
The back to back philosophy being the usual option to mitigate risk.
The problem is, the damages amount is not sufficient. If the liquidated damages amounts simply matches that of the head contract, the main contractor may not be able to ‘recover’ its own costs related to the delay.
Further, in a scenario where the subcontractor is liable for delays, the main contractor may also be liable to pay for the delays experienced by other parties affected by the delays such as other subcontractors.
Indemnifications
It may be beneficial when drafting subcontract agreements to avoid liquidated damages at all.
A benefit of using liquidated damages terms is the avoidance of disputes pertaining to damages amounts at a later date.
However, considering the difficulty of accurately estimating the cost of delays where several parties are involved, it may reduce risk to adopt terms which indemnify instead of agreeing a damaged amount.
In any event main contractors must understand the back to back relationship of subcontractors when dealing with liquidated damage terms.
A good step is to undertake a contract risk review prior to executing the contract, so that potential disconnects in risk are avoided.
