Read the fine print
This month we are at the letter “N” in our alphabet series and we take a look at nominated subcontracts in construction contracts. Nominated subcontracts are typically a feature of contracts where the employer carries out the design for a project (through an architect or engineer) and engages a main contractor (MC) separately to construct that project. These sorts of contracts are also called “employer’s design” or “construction only” contracts.
Most building contracts are placed on this model, as well as many infrastructure contracts. For instance, the basic form of contract in the FIDIC Suite is the Red Book, which is an employer’s design contract. In such contracts, the MC is usually allowed to engage subcontractors to carry out parts of the work. However, there are instances where the employer wants a specific provider of work and he does not want to give the MC the freedom to choose a subcontractor, because the MC’s interests are to choose the cheapest compliant subcontractor while the employer’s preferred supplier is more expensive.
The obvious way for the employer to gets the provider it wants is to award separate contracts to the MC and to its chosen supplier. But this solution is not a practical one. If the employer enters into separate direct contracts, he has to ensure that all the works have been properly allocated so that nothing falls between the cracks.
As a result, a practice began to evolve whereby the employer would award the main contract to a MC but would reserve certain aspects of the work to be carried out by a ‘named’ or ‘nominated’ subcontractor (NSC). The employer would then negotiate the terms with the NSC separately and require the MC to enter into a subcontract with the chosen NSC. At the tender stage for the main contract, there would be a provisional price for the NSC works (so that the MC does not have take a risk for the NSC’s price) and the MC would receive a percentage mark-up on the NSC’s price for attendance. The MC would however be liable for the NSC’s work and would remain liable to the NSC for payment.
However, there are three main issues that have arisen with such arrangements. First, the NSC is often a specialist supplier of works (such as elevators, or external cladding). Therefore, inherent in their supply is an element of design. The MC, to whom the NSC is nominated, often carries no responsibility to the employer for design – because, as explained above, this arrangement is used mainly in Employer’s Design contracts. What happens if the nominated contractor is negligent in its design? Contractually, the MC is responsible to the employer for the NSC’s work – but at the same time, the MC is not responsible for any design. The English courts have held that, in such circumstances, the MC is not liable for the NSC’s design default. This places the employer in an invidious position as he is not in a direct contractual relationship with the NSC and therefore cannot sue the NSC for breach of contract. The solution is for the employer to either bring an action for negligence in tort, or to require the provision of a collateral warranty directly from the NSC so that the employer can sue for breach of that warranty.
Secondly, NSCs will usually require the employer to include in the main contract a protective provision that allows the employer to pay the NSC directly if the main contractor has failed to make payment to the NSC. This is not an ideal provision for the MC as there could be situations where the MC’s decision to not make payment to the NSC is because the NSC is in default (such as delay) which in turn has caused the MC to be in default. Often, the employer’s and the MC’s interests are not aligned in these circumstances as the employer wants the NSC to complete its works and is therefore incentivized to make the direct payment sought by the NSC. However, this is also a risky situation for the employer as, if the MC subsequently establishes that the NSC was indeed in default, the employer could find himself in breach of his contract with the MC as the direct payment would have been made in circumstances where the MC was not in default of payment to the NSC.
Thirdly, there have been situations where the NSC has either gone into liquidation or has otherwise repudiated the contract with the MC. If the NSC was a domestic subcontractor selected by the MC, the risks arising from the liquidation or repudiation would have lain with the MC. However, if such liquidation or repudiation is by a NSC, the MC is entitled to require the employer to make a nomination of a new NSC or to otherwise vary the contract. The MC will be entitled to relief for any delay and additional cost arising as a result of such re-nomination.
The NSC arrangement can therefore increase risks for an employer in this way. The NSC system was meant to give employers a ‘best of both worlds’ solution but it has not always worked out to the employer’s advantage or to the benefit of the project. Other solutions – such as placing a turnkey contract with the supplier that the employer prefers, or the writing of specifications in the tender documents such that the choice of subcontractors is radically narrowed – are being adopted more often because of some of the inherent weaknesses of the NSC arrangement.
• ShouravLahiri is the principal at Lahiri LLC, a Singapore-based law firm specialising in construction and engineering law and arbitration. He can be reached at shourav.