7. Purchase Order and Subcontract Agreements

Key Words and Concepts

  • Buyer
  • Seller
  • Sale of goods
  • Significance of labor at construction site
  • Uniform Commercial Code
  • Purchase orders for provision of services at site
  • One-time/continuing supply
  • Maximum quantity/approximate quantity
  • Conflicts in boilerplate
  • Flow-down language
  • “Red flag” purchase order provisions
  • Rules of payment and quantity measurement
  • “No pay until paid” provisions
  • F.O.B. point/freight/risk of loss
  • Sales tax
  • Purchase order terms and conditions
  • Long form/short form purchase orders
  • Essence of subcontracts
  • Flow of contract liability
  • Subcontract work per plans and specifications
  • Incidental subcontract work
  • Compliance with general terms and conditions of prime contract
  • “Red flag” subcontract provisions

Purchase orders and subcontracts are additional contracts that are closely related to the construction contract between owner and prime construction contractor. Although similar in some respects, they are fundamentally different in purpose.

Occasionally, a purchase order is used when a subcontract agreement would have been more appropriate and vice versa. Both are important contracts, and construction practitioners need to understand clearly the purpose and key features of each in order to decide which should be used for a particular business transaction and in order to draft them correctly.

Purchase Orders

Construction purchase orders generally are intended for transactions that involve the sale of goods by a seller and delivery of those goods to a contractor buyer at the site of a construction project. This purpose should be distinguished from the provision of services or the performance of work involving labor at or on the construction project site. For example, consider a transaction to provide fabricated structural or reinforcing steel to a construction jobsite. Such an undertaking clearly involves the provision of extensive quantities of labor to perform the fabrication work in addition to furnishing the basic raw material, but this labor is provided at the steel fabricator’s plant or yard, not at the construction project site. The fabricator is furnishing “goods” in the form of the fabricated structural or reinforcing steel.

Goods or Provision of Services?

In settling construction contract disputes, courts occasionally struggle with the issue of whether particular transactions constitute the sale of goods or the provision of services. Resolution of this issue may determine whether the provisions of the Uniform Commercial Code apply that affect the seller’s potential liability under the code. The issue is often resolved on the basis of whether the court believes the final product consists mostly of a manufactured material or product or mostly of on-site construction labor.

In a Florida case, a road-building contractor was sued because a passing car hit a drop-off during road-paving operations, then went out of control, killing the driver, and injuring a passenger. The suit alleged that the contractor was negligent in the “manufacture of a product.” Under this theory, the contractor would be subject to strict liability for defects in the product. A trial court concluded that the contractor was a “manufacturer” and was liable for defects in the product being manufactured, which allegedly caused the accident. The Supreme Court of Florida reversed the trial court, holding instead that the construction of a public road pursuant to a Department of Transportation contract did not constitute the manufacture of a “product” and that the doctrine of strict liability could therefore not be applied.[1] In another case, the United States Court of Appeals ruled that a contractor joint venture acted in the capacity of a merchant when it purchased a tunnel-boring machine, even though the tunnel-boring machine was intended for use on a sewer construction project, and therefore the transaction was governed by the Uniform Commercial Code.[2] In another case, a public utility contracted for the design and construction of a large reinforced concrete cooling tower for a power plant. After completion, the cooling tower exhibited a number of problems, and the utility sued the design-build contractor that had designed and constructed it. One of the utility’s positions was that designing and constructing a reinforced concrete cooling tower constituted the manufacture of a “product,” thus bringing the contract under the mantle of the Uniform Commercial Code, which afforded better avenues of recovery for the utility. The resolution of this kind of issue once again will depend on the determination of a court on whether the final installed product consists mostly of a manufactured material or product or mostly of on-site construction labor.

The lesson for construction practitioners is to treat all transactions involving the provision of significant amounts of on-site construction labor as a construction operation requiring the use of a subcontract agreement. On the other hand, transactions that do not involve the provision of significant amounts of labor at the construction site should be treated as the sale of goods. The sale of goods should be handled with a purchase order.

Use of Purchase Orders for Certain Jobsite Services

Although not appropriate for transactions involving significant amounts of labor at the construction site, purchase orders for the provision of certain services on or at the site that involve minimal labor are commonly used. Examples are the provision of chemical toilets, which are periodically serviced by the provider, the provision and collection of trash containers, and similar services.

Purchase Order Quantity Limitations

A purchase order can be limited to a one-time transaction that occurs once and is finished, or it may provide for a continuing supply of goods on an “as-required basis.” Purchase orders for a continuing supply may be either “open-ended” as to the total quantity to be furnished, or they may be limited to some stipulated maximum quantity stated in the purchase order. Some purchase orders state an approximate quantity.

Conflicts with Seller’s Sales Quotations

A “battle of the forms” may later develop when there are conflicts in boilerplate—that is, when the fine print on the back of preprinted vendor’s sales quotation document conflicts with similar boilerplate on the back of preprinted purchase order document. Vendors naturally try to obtain the most favorable sales terms possible, and the written quotations that they furnish usually contain conditions-of-sale language preprinted on the back of the quotation form aimed at achieving that result. Contractor/purchasers do likewise by using standard preprinted purchase order forms that have general conditions printed on the back, which put the contractor/buyer in the most advantageous position. To further complicate matters, buyers and sellers often negotiate “special” or “supplementary” terms and conditions applying to a particular transaction and to that particular transaction only. If any of these various terms and conditions conflict, and the conflicts are not identified and eliminated from the purchase order, future disputes between the parties are likely.

The courts’ reaction to these disputes has been mixed. In one case, a contractor purchased water treatment materials from a supplier under a sales quotation that stated in the boilerplate on the back of the quotation that, among other things, the supplier disclaimed the implied warranties under the Uniform Commercial Code. The contractor’s purchase order did not, by its terms, waive any of the contractor’s warranty rights, including those contained in the UCC. The South Carolina Court of Appeals ruled that the language of the purchase order did not disclaim the specific language in the supplier’s sales quotation and that the sales quotation governed.[3]

 

In an opposite holding, the Court of Special Appeals of Maryland held that an equipment supplier’s standard terms and conditions, which contain a disclaimer of liability for failure to make timely delivery, were overridden by the contractor’s purchase order that contained contradictory terms.[4]

Drafters of purchase orders should harmonize the preprinted purchase order and sales quotation language by making clear that one or the other controls. Also, it is important to make sure that the words entered on the face of the purchase order document describing the instant transaction do not conflict with the boilerplate on the back of whichever preprinted form is intended to control. Otherwise, “an argument waiting to happen” has almost certainly been created.

Flow-Down Language from Prime Contracts

When purchase orders flow from prime construction contracts, the two are closely related. Such purchase orders often contain explicit flow-down language intended to make all applicable provisions of the prime contract also apply to the purchase order.

Additionally, prime contractors need to specify that materials furnished by vendors for use on the project meet all requirements of the prime contract. The best way to do this is to incorporate the applicable section of the prime contract technical specifications by reference to the section and paragraph numbers when describing the material to be furnished in the purchase order.

“Red Flag” Purchase Order Provisions

Like other contracts, certain purchase order provisions stand out because of important particulars to which the buyer and seller agreed—that is, “red flag” purchase order provisions. The following discussion is not all-inclusive but covers most critical provisions that usually should be included.

Necessary Identifying Information

At the onset, the purchase order should prominently identify the following on the face of the document, using correct name styles:

  • Construction project for which the prime construction contract is held by the buyer
  • Owner for that project
  • Architect/engineer
  • Contractor buyer
  • Seller

Description of the Goods Purchased

An accurate and complete description of each separate item to be furnished must appear, including any appropriate references to specific sections of the prime contract plans and technical specifications where necessary. Part and parcel of this description is the quantity of each separate item to be furnished.

Shipping Instructions

Complete shipping instructions should be included, designating the exact name and address of the intended receiving party and instructions on how the goods are to be packaged and marked. This is particularly important in purchase orders for fabricated reinforcing steel to be delivered to the jobsite that is to be cut, bent, and tagged so that the individual bars are identified and in similar supply purchase orders for products such as miscellaneous metal or structural steel. Without correct definitive markings, these types of products can be extremely difficult to even locate in the contractor’s lay-down area after delivery, let alone identify each piece for correct installation or erection.

When the goods purchased are susceptible to damage in shipment or when identification of individual items at the jobsite may be difficult, packaging and marking instructions are particularly important. In one case, granite facing slabs that were quarried in the southeastern United States and shipped some distance to the jobsite developed disfiguring scars after the facing slabs had been erected on the face of the building. The scars were found to have resulted from the careless use of steel banding straps during shipment to the jobsite. Great expense was incurred to remove the disfigured slabs and replace them with new slabs from the quarry. The importance of the particulars of the packaging and shipping instructions in a case like this is obvious.

Pricing and Basis of Quantity Measurement

The purchase price and the basis of quantity measurement for payment must be clearly stated. The purchase price is normally stated for each line item in the purchase order as a lump sum price or as a unit price and extension against a stated quantity. The nominal dollar amount for the entire purchase order is the sum of the lump sum prices and/or extensions for all the line items.

Just as the rules forming the basis of quantity measurement for pay purposes were of critical importance in prime construction contracts (refer to Chapter 5), so are these rules important for purchase orders. Is the supplier of the material to be paid on the same basis as the contractor/buyer, or on some other basis? Purchase orders often contain a flow-down provision stating that the same rules defining the basis of measurement for payment from the owner to the prime contractor in the prime construction contract will also apply to the purchase order for payment from the prime contractor buyer to the seller.

Note that even in these instances, when the rules for measurement for pay purposes are stated in the purchase order to be the same as for the prime contract, the lump sum and unit prices typically will be lower for the purchase order since only the component of the total pay item for furnishing the required material is represented in the purchase order price.

Not all purchase orders contain flow-down provisions from prime construction contracts relating to measurement and payment. Prime contractors routinely purchase many items of materials or goods for which payment will be completely unrelated to the provisions of the prime contract.

Payment and Retention Provisions

The payment and retention terms have exactly the same significance to a seller under a purchase order contract as they do to the prime contractor under the prime contract with the owner. Their positions are virtually identical, just one step apart on the payment ladder. In this respect, it is common for prime contractors to impose the same payment and retention terms on their vendors, who are the sellers under the purchase order agreements, as the owner imposes on the prime contractor in the payment and retention provisions of the prime contract.

A frequently recurring contract problem between vendors and contractor buyers is the “no pay until paid” dilemma. The same problem arises between prime contractors and their subcontractors when the primes are using payments from the owner as their source of funds. Purchase order and subcontract payment terms usually contain a clause stating that the prime does not have an obligation to make payment until and unless payment has been received from the owner. The provision further states that once the prime has received payment, the vendor or subcontractor must be paid within a stated period, usually ten calendar days. Such provisions are legal and enforceable up to a point. However, situations can arise where the owner never pays the prime contractor, due to insolvency, being legally prevented from paying, or some other reason. Then what? Does the prime have an enforceable liability to pay, or is the vendor or subcontractor simply out of luck?

Most courts view the “no pay until paid” clause as less than absolute—that is, it will be enforced with respect to the timing of the prime’s obligation to make payment but does not excuse the prime from eventually paying. In the end, the prime, not the vendor or subcontractor, will have to pay and absorb the loss. In a few states, courts will relieve the prime from making payment if the purchase order or subcontract agreement explicitly states that receipt by the prime of payment from the owner is a “condition precedent” to any obligation of the prime to pay the vendor or subcontractor.

The following two examples illustrate the predominate court holding. In a New Jersey case, a U.S. District Court held that although the project owner’s insolvency resulted in nonpayment to a prime contractor on a shopping center project for the site work required for the project, the prime contractor was still liable for payment to the subcontractor who had actually performed the work, even though the subcontract agreement provided that the prime contractor was to pay the subcontractor “within thirty (30) days after acceptance and receipt of final payment from the owner of the building.” The prime contractor never received final payment for the work performed by the subcontractor from the owner but was still required to pay $101,760 to the subcontractor, the final balance due the subcontractor under the terms of the subcontractor agreement.[5]

In another example, a second-tier subcontractor remained unpaid for installation of exterior windows, walls, and doors for a building project because the prime contractor had encountered financial difficulties and had failed to pay the first-tier subcontractor for the installation work performed by the second-tier subcontractor. The subcontract agreement provided that

Subject to the terms and conditions of this contract, final payment will be made to UPG upon final acceptance of the work by the owner, the approval thereof by the architect, and the receipt of payment in full from the general contractor.

In overturning a lower trial court decision, the Commonwealth Court of Pennsylvania said:

The language of Article Six… merely addresses the time at which payment is to be made… Accordingly, we conclude that the trial judge erred in interpreting the language of the second paragraph of Article Six as imposing absolute conditions precedent to UPG’s entitlement to MTI’s final payment.[6]

An example of a case that turned on the presence of the words “condition precedent” in the payment language of the subcontract agreement is afforded by the 1991 decision by the Court of Special Appeals of Maryland. In that case, the general contractor had subcontracted exterior masonry work on a residential condominium project under a subcontract agreement that contained the following payment language:

It is specifically understood and agreed that the payment to the trade contractor is dependent, as a condition precedent, upon the construction manager receiving contract payments, including retainer [sic] from the owner.

After receiving progress payments, the subcontractor submitted a final invoice for $283,079, which the prime contractor refused to pay because payment had not been received from the project owner, who eventually filed for bankruptcy. In absolving the prime contractor from liability for payment of the $283,079, the court said:

In addition to providing a standard “pay-when-paid” clause, this contract further provides that payment by Carley Capital Group to Gilbane is a condition precedent to Gilbane’s obligation to pay Brisk. Regardless of whether the parties discussed the prospect of owner insolvency during their negotiations, the objective meaning of the clause is clear—Gilbane, the construction manager (general contractor), is not obligated to Brisk, the trade contractor (subcontractor), unless and until Gilbane is paid by the owner, CarleyCapitalGroup.[7]

Specified Delivery Schedule

The purchase order should carefully define the required delivery schedule for the material. This delivery requirement is equivalent to the statement of allowed contract time in a prime construction contract. In situations where the contractor/buyer is held to a tight performance period for the prime contract work, obtaining required materials from suppliers on time is obviously important.

Required Delivery Point

Another essential element is a statement defining the required point of delivery. This determines who pays the freight charges, which can be considerable, and who is responsible for the material in the event of damage or loss during shipment. Many purchase orders specify the delivery point to be the construction project jobsite. This typically would be done by stating “F.O.B. construction jobsite” (F.O.B. means “free on board”). In this case, the cost of loading the material by the seller and the delivery cost (the freight) is deemed to be included in the purchase price. Title does not pass to the buyer until the material reaches the jobsite where the buyer is required to unload the material. Under these circumstances, the seller would have to assume the risk of loss or damage during transit.

An alternate arrangement is for the purchase order to designate the delivery point to be “F.O.B. seller’s plant or yard.” In this case, title passes to the buyer when the goods are loaded by the seller onto transit vehicles supplied or arranged for by the buyer. The buyer owns and is responsible for the material from that point on. Which provision is stated in the purchase order is obviously important to both parties.

The following situation rather dramatically illustrates the importance of the preceding provisions in a purchase order. A tunnel contractor had procured a 12-foot diameter tunnel-boring machine (TBM) from a seller located some distance from the site of the tunnel project. During transport to the site, the TBM broke free of its lashings on the transport vehicle, rolled off the vehicle, bounced on the roadway shoulder, coming to rest in an adjoining farmer’s field. In a case like this, the particulars of the purchase order regarding the F.O.B. point were obviously important:

  • Who paid for recovering the TBM from the field, reloading it, and for any damage suffered, the tunnel contractor or the seller?
  • Suppose the TBM had rolled off the opposite side of the transport vehicle onto the opposing traffic lane and had collided with an oncoming car, injuring or killing innocent third parties. Who would be liable, the tunnel contractor or the seller?

The resolution of these and similar questions can be pre-agreed by buyer and seller by designating the intended F.O.B. point.

Sales Taxes

Similarly, the purchase order should make clear that any applicable sales taxes either are, or are not, included in the stated purchase price. Purchase orders can be written either way.

Purchase Order General Conditions

Most construction contractor’s purchase order contracts with material suppliers contain general conditions printed on the back of the purchase order form. These are usually titled “Purchase Order Terms and Conditions.” They normally contain all of the following general clauses usually found in prime contracts (discussed in detail in Chapter 5):

  • Disputes resolution
  • Changes
  • Termination provisions
  • Provisions in the event of late delivery
  • Conditions excusing late or nondelivery
  • Insurance and bond requirements
  • Indemnification
  • Escalation

These clauses have the same significance for the contractor/buyer and the vendor/seller as they do for the owner and the contractor under the prime construction contract.

Special or Supplementary Provisions

Finally, the purchase order may contain a section titled “Special Provisions” or “Supplementary Provisions,” where the buyer and seller record any special agreements or terms pertaining to that particular transaction. In the event of conflict with other provisions of the purchase order, courts give more weight to specially recorded terms than to preprinted terms. Although it concerns a conflict in a prime contract rather than in a purchase order, the following case perfectly illustrates the normal judicial treatment of the issue involved.

A pipeline company awarded a contract to a contractor to lay a 109-mile petroleum pipeline in Kansas. The contract, which in this case was typewritten, contained a broad indemnification clause, which, among other things, held the contractor responsible for all damages to the owner’s property. The contractor added a handwritten clause to the typewritten contract that stated:

Contractor shall not be liable under any circumstances or responsible to company for consequential loss or damages of any kind whatsoever including but not limited to loss of use, loss of product, loss of revenue or profit.

This handwritten addition was initialed by executives for both the contractor and owner prior to contract execution.

After completion of the project, the pipeline ruptured. The pipeline company attempted to obtain compensation for lost oil, cleanup costs, and damage to surrounding property. The contractor pointed to the handwritten clause as a defense against the claim of liability for these clearly consequential costs.

The Supreme Court of Kansas determined that the handwritten addition was in direct conflict with the typewritten indemnity clause in the contract. In resolving this conflict, the court ruled for the contractor by stating:

The second handwritten sentence of 2.03, when given its plain and ordinary meaning, clearly limits Willbros’ liability to Wood River for consequential damages. This handwritten provision controls and modifies the printed provision in 2.01 whereby Willbros agrees to pay Wood River for damages to Wood River’s property.[8]

Rather than wait for the decision of a court, which may take years, the best procedure is to coordinate carefully all provisions of the purchase order, each with the others, to identify and remove conflicts. This is commonly done by “lining out” conflicting preprinted language that the buyer and seller intend to delete from the agreement.

AGCC Forms of Purchase Order Agreements

Most general contractors have devised their own preprinted purchase order forms. However, for contractors who have not or in situations where vendors object to a particular company’s form of agreement, standard forms of agreement promulgated by the Associated General Contractors of America (AGC) are available. Examples of such AGC forms are those published by the Associated General Contractors of California (AGCC). Form AGCC-6 (Long Form Purchase Order) is intended for large transactions that extend over some period of time. Form AGCC-7 (Short Form Purchase Order) is intended for smaller, less complicated transactions. Users of both are advised by the AGCC to consult legal counsel before using or modifying these forms.

Subcontract Agreements

A threshold point regarding subcontracts is that a prime contract between an owner and a prime construction contractor must exist before a construction subcontract can exist. The context of the previous discussion on purchase orders focused on the consideration of purchase orders that resulted from a prime construction contract. However, a contractor often will also write purchase orders for miscellaneous goods that have no relationship to a particular prime contract. In the case of subcontract agreements, however, there must be preexisting related prime contracts.

The essence of a subcontract transaction is that a prime contractor who holds a separate contract with an owner decides to “lay off’ or subcontract a portion of the work to another contractor, called a subcontractor. The parties to the subcontract agreement, therefore, become the contractor and the subcontractor. It is important to realize that even when subcontracting a portion of the prime contract work to a subcontractor, the prime contractor still retains the original liability to the owner for the performance of that work according to the prime contract terms. What has occurred is the establishment of a secondary liability of the subcontractor to the prime contractor for the performance of the subcontract work in accordance with the terms of the subcontract.

Construction subcontract agreements will always involve the provision of significant amounts of labor, largely or entirely on the site of the prime construction contract. In addition, subcontract agreements may also involve the provision of materials—both materials that are permanently incorporated into the work (permanent materials) and those that are not permanently incorporated (job materials and supplies commonly called expendable materials). Subcontracts also may involve the use of construction equipment at the jobsite by the subcontractor for the performance of the subcontract work. In short, the subcontract involves all of the elements of work to be performed just as if the prime contractor had done the subcontracted work directly.

The subcontract work may be work that is directly spelled out and precisely described in the prime contract plans and specifications, or it may be work that, although related to the prime contract, is not directly spelled out and thus would be considered incidental to the contract. An example of the former is a subcontract calling for furnishing and driving precast concrete bearing piling that are clearly shown on the prime contract plans and completely described in the prime contract technical specifications. An example of incidental subcontract work would be a subcontract written by an excavation contractor on an earthfill dam contract with a building subcontractor to furnish and erect a temporary shop building on the project site to be used for repairing the prime contractor’s heavy earth-moving equipment. The prime contract would not ordinarily specify the construction of such a shop building as an item of required contract work so this work, although required, would be incidental to the prime contract.

Even in the case of a subcontract for work that is merely incidental, the subcontract often imposes some of the prime contract requirements on the performance of that work. For example, in the case of the above subcontract for constructing a shop building, the subcontract agreement commonly requires the subcontractor’s compliance with the prime contract on Davis-Bacon minimum wage rates, wage-hour laws, regulations pertaining to equal opportunity employment practices, and so on.

Subcontract “Red Flag” Provisions

Following are some of the more important “red flag” provisions of subcontract agreements.

Necessary Identifying Information

As with purchase orders, subcontract agreements should prominently provide the following identifying information using correct name styles where applicable:

  • Project for the prime contract
  • Owner for that project
  • Architect/engineer
  • Prime contractor
  • Subcontractor

Description of the Subcontract Work

The work to be performed by the subcontractor must be carefully and completely described, incorporating direct references to all applicable drawings and technical specifications and all other applicable sections of the prime construction contract. For some subcontracts, this description of the subcontract work will be relatively simple. In other cases, the description may comprise a number of pages of information and schedules of work items. When the subcontract work is exactly as specified in the prime contract, it is normal to describe the work by citing the particular drawings and sections of the technical specifications in the prime contract that define the work without reproducing them in the text of the subcontract. If pertinent portions of the prime contract general provisions are meant to apply, the subcontract should so state explicitly.

Pricing and Basis of Quantity Measurement

The subcontract price or prices and the rules to be applied to establish the basis of measurement must be clearly stated, in exactly the same manner as for purchase orders. For items of subcontract work directly lifted from the prime contract, the basis of measurement will often be exactly as stated in the prime contracts as if the work was being performed by the prime contractor. In other words, the subcontractor will be paid by the contractor in the same manner that the contractor is paid for the work by the owner, although generally not at the same price or prices. If the subcontract work is incidental to the prime contract, payment to the subcontractor is not related to the payment provisions of the prime contract.

Payment and Retention Provisions

The payment and retention provisions have exactly the same significance as they do for prime contracts and purchase orders and will not be discussed further (see the earlier discussion in this chapter on purchase orders). Also the “no pay until paid” issue arises in the same way as for purchase orders and is generally treated by the courts similarly. The clause will hold up except in cases where the owner never pays the prime contractor. Then, the prime will normally have to pay the subcontractor even though payment has not been received from the owner.

Contractor Control of Performance Time Requirements

Since the prime contractor is subject to the overall project deadlines, stringent performance time requirements can be expected to be written into all subcontracts. Generally, the prime contractor will retain the right to determine when the subcontractor is to perform the subcontract work. The subcontract will often state that “subcontractor shall perform the subcontract work on a schedule to be determined by contractor” or words to that effect. Under this arrangement, the contractor can schedule the subcontractor to perform the subcontract work in a manner that conforms to the overall project schedule, often requiring the subcontractor to move in, perform work, and move out a number of separate times.

Generally, the effect of these or similar provisions is to give the prime contractor complete control of the time requirements for the performance of the subcontractor’s work. However, this control must be exercised in a reasonable manner. Notification of when the subcontract work will be required must be furnished early enough for the subcontractor to plan and execute work efficiently. The prime contractor may not demand the impossible.

Separate cases, one in Texas and one in Idaho, illustrate how courts treat this issue. In the Texas case, a formwork subcontractor failed to staff the project at the required level of 40 to 48 manhours per day. This failure would have delayed the project by eight months if allowed to continue. The prime contractor terminated the subcontractor for default and performed the balance of the work with their own forces at an average of 68 manhours per day. The Court of Appeals of Texas ruled that the subcontractor had breached the subcontract and that the prime contractor was not required to sit by helplessly while the subcontractor fell further and further behind schedule. The default termination was upheld, and the prime contractor was allowed to recover the increased costs of completing the work from the subcontractor.[9]

In the Idaho case, when rainy weather delayed a subcontractor’s performance of foundation and other concrete work on a commercial building project, the prime contractor improperly pressured the subcontractor to pour concrete under unreasonable weather conditions. When the subcontractor refused, the prime faxed a termination letter to the subcontractor without any prior notice. Further, evidence at the trial indicated that the prime’s project manager directed a subordinate to “document” the subcontractor’s alleged poor performance. The subordinate then went back through the contractor’s daily report log, altering it by adding negative comments about the subcontractor’s performance.

The subcontractor sued, alleging breach of contract. The trial court jury found for the subcontractor and awarded them payment for all of the work performed, lost profit on the unperformed work, and $25,000 in punitive damages. On appeal, the Idaho Court of Appeals affirmed the jury award stating:

There is substantial evidence that Citadel’s actions were an extreme deviation from reasonable standards of business conduct. Because punitive damages are an appropriate sanction for oppressive conduct in the marketplace, we conclude that the District Court did not err in submitting the issue of punitive damages to the jury.[10]

Some subcontracts may explicitly state the start and finish dates for the subcontractor’s work. If this is the case, the subcontractor is liable for the consequences of failing to meet those deadlines, subject, of course, to any conditions of force majeure that are stated in the subcontract.

Damages in the Event of Late Completion

A well-drafted subcontract must deal with the subcontractor’s liability for damages in the event of failure to perform in accordance with the subcontract time requirements. A flow-down clause may impose the liquidated damages liability of the prime contractor to the owner on the subcontractor to the extent that the subcontractor’s failure to perform leads the owner to assess liquidated damages against the prime. In addition, the subcontract often will explicitly state the flow of contract liability—that is, the contract will provide that the prime contractor can recover additional damages from the subcontractor, if the prime’s cost of performance was increased as a result of delays caused by the subcontractor. In this situation, the liquidated damages collected from the subcontractor (equal to what the prime had to pay the owner) constitutes just one element of the total damages suffered by the prime due to the subcontractor’s failure to perform.

Subcontract Changes Clause

Most subcontracts will also give the prime contractor the right to make changes unilaterally in the subcontract work, delay or suspend the subcontract work, or terminate it in the same manner that the owner has these rights in the prime contract. Also, the subcontractor’s rights and obligations are similar to those of the prime contractor in similar circumstances under the provisions of the prime contract.

Insurance and Bond Requirements

The subcontract should clearly state the insurance and bond requirements that the subcontractor must meet. The insurance requirements are generally the same as for the prime contractor with respect to work under the prime contract. The subcontract may or may not require the subcontractor to furnish a performance bond and a labor and material payment bond, depending on the requirements of the contractor who drafts the agreement. Bid bonds are normally not required.

When the prime contractor intends that the subcontractor furnish a performance bond, many contractors write the subcontract to provide that failure to furnish a performance bond constitutes a material breach of the subcontract. This enables the contractor to terminate the subcontractor for cause and engage another subcontractor in the event that the subcontractor refuses, or is unable, to furnish the bond. In these circumstances, any price increase would be for the account of the original subcontractor. Subcontractors should not bid to general contractors or sign subcontracts drawn in this manner unless they are certain that they will be able to furnish a performance bond.

Indemnification

When the prime contract contains an indemnification clause, all subcontracts should contain a similar clause, so that the prime’s liability to the owner and architect/engineer for acts committed by the subcontractor is passed through to the subcontractor. Even when the prime contract does not require indemnification because the owner is protected by sovereign immunity or otherwise does not require indemnification, many subcontracts will still contain a comprehensive indemnification clause requiring the subcontractor to indemnify the prime. Although the owner is protected by sovereign immunity, the prime contractor is not and thus may require protection from the consequences of the subcontractor’s acts or failures to act that is afforded by the indemnification clause.

48-Hour and 72-Hour Clauses

Any well-drawn subcontract agreement enables the contractor to compel the subcontractor to perform the subcontract work in a timely manner under the general contractor’s general direction and control. This control will extend at least as far as the owner’s control with respect to the contractor’s performance under the prime contract and, in some cases, even further. The specific control provisions are the “48-hour” and “72-hour” clauses, present in most subcontract agreements.

The 48-hour clause pertains to the contractor’s right, after directing the subcontractor to remedy some default causing a problem on the project (such as failing to pick up their construction debris from the work site), to perform the necessary corrective work with the contractor’s forces for the account of the subcontractor if the subcontractor fails to remedy the default within 48 hours of receipt of the contractor’s directive. The 72-hour clause permits the contractor to terminate the subcontract agreement for default, after furnishing notice that the subcontractor is in default, the particulars of the default, and the corrective action required to remedy the default. The notification must be in writing and must put the subcontractor on notice that the default must be remedied within 72 hours from the date and time of receipt of the notice. If the subcontractor does not remedy the default within 72 hours of the notice, the contractor may terminate the subcontract. In particular cases, time limits other than 48 hours and 72 hours may be specified, although these time limits are common.

Both clauses are necessary to ensure the contractor’s control over the subcontractor to protect the contractor’s position with the owner under the provisions of the prime contract. Both are reasonable, provided they are fairly administered. Unreasonable exercise of these clauses could constitute a material breach of the subcontract on the part of the contractor (see Chapter 13).

Union Labor Only Clause

A clause should also be included in the subcontract agreement that binds the subcontractor to the provisions of any labor agreements containing a subcontracting clause to which the prime contractor is a party (see Chapter 6). Such a clause requires the prime to subcontract work only to subcontractors who agree to sign or be bound by the terms of the prime contractor’s labor agreement. The only way that the prime contractor can avoid breaching labor agreements containing such clauses is by inserting a clause in all subcontracts that ensures that the subcontractors will either sign, or at least agree to abide by, the terms of the prime’s labor agreements.

AGCC Forms of Subcontract

As in the case of purchase orders, most contractors have devised their own preprinted subcontract agreement forms. In situations where such agreements are not used, the standard forms of subcontract such as those promulgated by the Associated General Contractors of California (AGCC) are available. The short form standard subcontract, Form AGCC-4, is used for relatively minor, short-term subcontract situations. The long form standard subcontract, AGCC-3, is used for more complex, long-term subcontracts. The AGCC advises users to consult legal counsel when using or modifying these forms.

Conclusion

This chapter emphasized the fundamental difference between construction purchase orders and subcontracts and made clear the type of transaction for which each should be used. The close relationship of both documents to the prime construction contract was also emphasized as was the necessity for drafters of these documents to avoid conflicts between boilerplate preprinted on the back of the document forms and project-specific provisions entered on the face of the documents. Finally, the reasons why the typical purchase order and subcontract “red flag” clauses are necessary were stated, and the details of such clauses were examined in detail. Chapter 8 covers insurance contracts, another type of contract closely related to the prime construction contract.

Questions and Problems

  1. Who are the parties to a construction purchase order? What type of transaction is involved? How is this transaction distinguished from that of a subcontract? Is the provision of certain kinds of jobsite services properly handled by means of a purchase order? What kind of services?
  2. With regard to purchase orders, what is the meaning of “open-ended,” “one-time transaction,” “maximum quantity,” and “approximate quantity”?
  3. How do conflicts in purchase order terms and conditions-of-sale terms arise? What is the problem? What is the solution?
  4. What is flow-down language? What is the easiest way to be certain that materials furnished under a purchase order will meet the requirements of the prime construction contract?
  5. What are the generic names and the typical content of the “red flag” clauses for purchase orders discussed in this chapter?
  6. What typical flow-down language regarding the basis for measurement for payment is found in a purchase order? In what situation would a purchase order typically not contain flow-down language regarding measurement for payment?
  7. What is the import of the typical “no-pay-until-paid” provision in purchase orders? To what extent is this provision enforceable? In what situation is it not enforceable?
  8. What are two separate aspects of the declaration of the F.O.B. point in a purchase order? What do the letters F.O.B. mean? How do purchase orders handle the question of sales tax?
  9. What are the eight key issues discussed in this chapter covered by the purchase order terms and conditions typically found preprinted on the back of purchase orders? Are these subjects common to prime construction contracts also? What are special provisions or supplementary provisions with respect to a purchase order?
  10. What must preexist for a construction subcontract agreement to exist? Does this apply to construction purchase orders? Why or why not?
  11. What is the essence of a subcontract agreement? Is the prime contractor’s contract liability to the owner for work included in a subcontract changed in any way? What is the chain or flow of contract liability when a construction subcontract is created?
  12. What single most important fact about a subcontract distinguishes it from a purchase order? What may be provided by the subcontractor in addition to on-site labor? Must the work of a construction subcontract necessarily be directly and completely spelled out in the prime construction contract? May it be? Cite examples.
  13. Is incidental subcontract work necessarily subject to the general terms and conditions of the prime contract? Can it be? How can a prime contractor ensure that it is?
  14. Are provisions concerning how the subcontractor will be paid and the basis for measurement for payment for subcontracts typically handled differently or the same as for purchase orders? How about the payment and retention provisions?
  15. Describe two ways discussed in this chapter to require that the subcontract provides that the subcontractor wi11perform the subcontract work in a manner that conforms to the time schedule of the prime contract.
  16. Under a typical subcontract agreement, what are two separate kinds of monetary damages for which subcontractors may be liable if they fail to meet the subcontract time of performance requirements? Explain the basis for each. Do conditions of force majeure apply to subcontract work?
  17. Do typical subcontract provisions in regard to changes, delays, suspensions of work, and terminations differ, or are they the same as for prime construction contracts? For the subcontract situation, whose position is equivalent to that of the project owner? To that of the prime contractor?
  18. Are insurance and bond requirements for construction subcontracts generally the same or different than for prime contracts? How do many contractors state the requirements for the furnishing of a performance bond by the subcontractor? Why should such a clause give a subcontractor pause?
  19. If a prime contract does not contain a requirement that the prime contractor indemnify the owner, should subcontracts flowing from that prime contract still contain a broad clause that the subcontractor indemnify the prime contractor? Why or why not?
  20. What is the importance of the 48-hour clause? The 72-hour clause? Why are these clauses necessary?
  21. How should a prime contractor signatory to labor agreements containing subcontracting clauses avoid exposure to breach of those agreements when writing subcontract agreements? What could happen if this protection is not provided?

  1. Edward M. Chadbourne, Inc. v. Vaughn, 491 So. 2d 551 (Fla. 1986).
  2. S & M Joint Venture v. Smith Jnternat'l Inc., 669 F.2d 1106 (6th Cir.1982).
  3. Mace Industries, Inc. v. Paddock Pool Equipment Co., Inc., 339 S.E.2d 527 (S.C. App. 1986).
  4. USEMCO, Inc. v. Marbro Co., Inc., 483 A.2d 88 (Md. App. 1984).
  5. Seal Tite Corp. v. Ehret, Inc., 589 F. Supp. 701 (D.C.M.J. 1984).
  6. United Plate Glass Co. v. Metal Trends Industries, Inc., 525 A.2d 468 (Pa. Commw. 1987).
  7. Gilbane Building Co. v. Brisk Waterproofing Co., Inc., 585 A.2d 248 (Md. App. 1991).
  8. Wood River Pipeline Co. v. Willbros Energy Services Co., 738 P.2d 866 (Kan. 1987).
  9. D.E.W., Inc. v. Depco Forms, Inc., 827 S.W.2d 379 (Tex. App. 1992).
  10. Cuddy Mountain Concrete, Inc. v. Citadel Construction, Inc., 824 P.2d 151 (Idaho App. 1992).

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