Out-Law Analysis 11 min. read
12 Jan 2023, 3:31 pm
In large infrastructure projects, it is common to see a subcontractor refusing to carry out work unless it receives additional payment above that to which it is entitled.
When work is delayed, the main contractor has to manage the impact of this subcontractor’s lack of progress on other subcontractors on site, while minimising the risk of its own liability to the employer. If the main contractor bends to a subcontractor's demands, it has no guarantee of recovery of the additional sums paid.
Main contractors can use various contractual tools to “encourage” their subcontractors to progress the works. These tools include, amongst others, instructions, employer claims, delay damages and encashment of bonds.
Contractors should always keep their key risks and liabilities in view when engaging subcontractors and seek advice early on to prepare for and mitigate these risks through appropriately tailored subcontracts. Contractors should be well-advised on the consequences of committing to any course of action, especially if it involves making any additional payments.
Assuming that the same or similar provisions have been incorporated into the relevant subcontract on a back-to-back basis, the provisions of the International Federation of Consulting Engineers (FIDIC) Conditions of Contract for Construction, MDB Harmonised Edition 2010 Edition (Pink Book 2010) will give contractors a reference and possible solutions.
In many cases, the main contractor may feel that the most practical solution is to make an additional payment to the subcontractor, with the possibility of setting off the additional amount from future payments. However, keep in mind that there are potential difficulties to doing so.
This is because a court or tribunal is likely to refuse to reimburse any ‘ex gratia’ payments made to subcontractors unless the main contractor can prove the payments were made under economic duress. Despite no additional work performed by the subcontractor, courts have held that the “practical benefits” of making the additional payment, such as avoiding the expense of engaging another subcontractor and preventing liquidated damages liability to the employer, can constitute sufficient consideration for the payment.
Under English law, a main contractor will only be able to recover the additional payment if the subcontractor is found to have exerted illegitimate economic pressure on the main contractor which left it no reasonable alternative option but to pay. However, economic duress arguments depend heavily on the factual circumstances, are difficult to succeed on and often require costly litigation. If the main contractor considers that it is under duress to make an additional payment to the subcontractor, it is important for the main contractor to ensure that no liability to make the additional payment is recorded in the recitals of the deed of payment and to state that it reserves its rights in respect of such payment.
If the subcontractor is in financial distress, it may not be possible to recover any payments should that subcontractor become insolvent at a later stage. Although the main contractor would have recourse to any performance bond, this may not be enough to compensate it for all losses. If the main contractor suspects that the subcontractor is at risk of insolvency, be sure to seek advice as to whether it may be more cost effective to call in the bond or reach a negotiated agreement with the subcontractor before any insolvency and termination issues arise.
The most common reasons why a subcontractor might refuse to proceed with works without additional payment from the contractor include:
Main contractors should first consider the reasons why this situation has arisen, as often this will dictate the most appropriate course of action from the outset to best preserve its position.
Industry standard contracts will usually include most of the following provisions which the main contractor can invoke to encourage the subcontractor to maintain progress with their works.
One of the first steps a main contractor should take is to notify the subcontractor of its primary obligation under the subcontract to proceed diligently and complete the works within the time for completion and the consequences of failing to do so.
This fundamental obligation is almost universally included in all industry standard form contracts and is found phrased variously in the FIDIC Pink Book in sub-clauses 4.1 ‘contractor’s general obligations’, 8.2 ‘time for completion’ and 8.6 ‘rate of progress’. A general obligation to proceed with the works diligently is also included in many other industry standard forms and private contracts. Indeed, this obligation is sometimes implied under the applicable law of the contract.
Another provision that the main contractor can invoke is the subcontractor’s obligation to comply with instructions from the engineer or main contractor’s representative stated in sub-clause 3.3 instructions of the engineer in Pink Book.
Under this provision, the main contractor can notify the subcontractor to proceed with the requested works in the manner directed. This is particularly relevant if the subcontractor has been directed to undertake the works in a certain manner, including in circumstances where the subcontractor alleges that there has been a variation of the works.
Industry standard contracts will often include a provision which requires the subcontractor to allow the main contractor’s personnel or other subcontractors to carry out their work. This will assist the main contractor to mitigate disruption to other ongoing work when faced with an idling subcontractor.
The right to impose delay liquidated damages (LDs) is a crucial element of any construction contract used to incentivise timely completion of subcontract works and to protect the main contractor’s financial position in the event of delay.
The threat of LDs is especially effective if the time for completion is imminent. However, it may be less helpful if the works are still far away from the time for completion. Therefore, one way to prompt the subcontractor’s timely progress throughout the course of the works is to provide for completion milestones in the LDs regime under the subcontract at the outset, with separate LDs attaching to each milestone at key dates throughout the contract period. Alternatively, incentive bonus payments for achievement of targeted milestones are commonly used to encourage progress.
Most LD regimes will include a maximum cap on the LDs payable under the subcontract, so it is also important for the main contractor to calculate during the works an estimate of whether and if so when the cap is likely to be reached. This is especially the case if the subcontractor is already experiencing major delays, past which the main contractor will be financially exposed up the line. If the maximum cap under the subcontract is already reached there will of course be minimal incentive for the subcontractor to maintain or expedite its progress of work.
At the contract negotiation stage, the main contractor should consider its right under the subcontract or the governing law to claim general damages against the subcontractor as against its own liability to the employer under its contract arising through that subcontractor’s delay. Access to general damages for delay-related losses is rare in the presence of a liquidated damages clause. This is because delay liquidated damages should generally be the only damages due from the subcontractor for failing to complete the works within the time for completion.
For contracts that include a schedule of interim payments, the main contractor should also notify its subcontractors that such payments are to be made by reference to the actual progress achieved in executing the works. However, unless the subcontract expressly provides for milestone payments, main contractors cannot simply withhold payments due because of the subcontractor’s lack of progress. In this case, main contractors should take care to comply with their payment obligations in accordance with the subcontract, as non-payment to the subcontractor may backfire and entitle the subcontractor to legitimately suspend works.
The engineer appointed to inspect and supervise the construction of the works is normally given the power to monitor and manage the programme of the works. When the actual progress is too slow to complete within the time for the completion or when the progress has fallen or will fall behind the programme, the engineer may give instructions for the subcontractor to issue a revised programme and methods to expedite progress to complete in time.
Once the engineer has given its instructions, the subcontractor in turn will have to adopt the revised programme and methods at its own risk and costs, unless the methods were instructed by the engineer to reduce delays resulting from causes which would allow for an extension of time for completion under the subcontract.
A timely reminder to the subcontractor that lack of progress or falling behind schedule could lead to adoption of the revised programme and methods at its own risk, may force the subcontractor to rethink its position.
If the subcontractor refuses to proceed with the works, depending on the terms of the subcontract, the main contractor may be able to raise claims for breach of contract against the subcontractor under FIDIC Pink Book sub-clause 2.5 'employer’s claims', assuming terms are passed down. Potential claims include failure to comply with instructions, failure to proceed with the works without reasonable excuse, abandonment of the works, or breach of due diligence. The gravity of the situation can be emphasised by issuing default notices to the subcontractor as warnings for potential termination.
The threat of termination and potential liability to pay general damages for breach of contract may be powerful enough to deter delay and encourage the subcontractor to progress the works to completion.
As noted above, if the main contractor claims delay liquidated damages, it is not entitled to claim general damages for breach of contract against the subcontractor for failure to complete on time as well.
Another tool available to the main contractor is cashing in the performance bond or other security – for example, a parent company guarantee - which the subcontractor is likely to have provided under most industry standard contracts. In cases where a parent company or other guarantee has been provided, notice of an intention to call on such guarantees or bonds can also be used to escalate the situation and achieve compliance with instructions, or indeed calling on such bonds when such threats to do so are ignored.
Calling on a performance bond will usually result in serious financial and reputational consequences for the subcontractor, and a warning may well prompt the subcontractor to reconsider its situation.
A main contractor should be well-advised as to the conditions and notice requirements before exercising the right to call on the security, as failure to precisely follow the procedure and requirements of the bond can lead to an invalid call and the bondsman’s refusal to pay out under the bond.
Disputes over whether a call is valid are not only costly and protracted, but the outcomes often uncertain. The subcontractor may seek an injunction to restrain the call if the call is invalidly made.
The main contractor is usually entitled to extend the time for completion for the benefit of the subcontractor. This may be useful in circumstances where the subcontractor is unable or unwilling to proceed due to compensation events that are the main contractor’s risk. For example, temporary manpower or supply chain issues brought on by the impacts of pandemic or conflict.
Standard form contracts will provide the main contractor with the power to extend the time for completion in various circumstances. See for example, sub-clause 8.4 extension of time for completion, sub-clause 8.8 suspension of work and sub-clause 19.1 definition of force majeure of the FIDIC Pink Book, which should be incorporated back-to-back into the subcontract.
Depending on the wording of the specific provision, the main contractor should be wary of the subcontractor’s potential entitlement to additional payment for the extended period. The main contractor should also consider whether it can invoke corresponding clauses upstream with the employer and ensure that it has received all documents and information from the subcontractor required to comply with its own notice provisions and prove its case.
There are prescribed circumstances under the FIDIC Pink Book which, if incorporated into the subcontract, entitle the subcontractor to suspend works or to complete the works within an extended time. Statutory entitlement to suspend is also provided under some legal systems.
In addition to the prescribed causes of delay that warrant extension of time for completion, circumstances under which suspension of works and extension of time for completion for delays suffered as a result is allowed under FIDIC Pink Book include (assuming passed down into the subcontract):
Disagreement by the subcontractor in respect of the engineer’s valuation of works or variations is not usually a reason to allow for suspension or extension.
The main contractor can consider its right to vary the subcontract works, which generally includes a power to omit certain works and have the contract price revalued.
However, many standard form contracts prevent the omission of works if the intention is to redistribute them to another contractor, even if the subcontractor is refusing to proceed in a timely manner. Some legal systems also include a statutory prevention of redistribution of omitted works. A main contractor should consider at the negotiation stage whether it can incorporate into its subcontracts an express power to omit works for failure to proceed.
Some contracts may contain an express power allowing the main contractor to step-in and direct any sub-subcontractors in the subcontractor’s place in certain circumstances, which will allow the main contractor to bypass the subcontractor and carry out or manage the subcontract work directly.
Under FIDIC Pink Book, where a subcontractor fails to proceed with the works in accordance with the contract, upon terminating the contract under sub-clause 15.2, the subcontractor must immediately comply with instructions for the assignment of any sub-subcontract and the main contractor may complete the works or arrange for other subcontractors to do so, and the main contractor may recover from the subcontractor any extra costs of completing the works.
Given that an invalid termination can amount to a repudiatory breach of contract on the part of the main contractor, advice should always be sought before any termination to ensure the main contractor has the requisite entitlement to do so.
It will usually be difficult for the main contractor to obtain an order of specific performance against the subcontractor due to the difficulty of enforcing the complex performance obligations of a construction contract. However, the main contractor may be able to obtain an injunction to prevent the subcontractor from breaching specific contractual obligations in certain circumstances. For example, courts have granted injunctions to require a contractor to provide access to site or to return materials.
Co-written by Horace Ng of Pinsent Masons.