Mastering Subcontractor Agreements: How to Draft and Use Them effectively

A subcontractor agreement, or subcontractor commercial contract, is a legal agreement between a contractor and subcontractor that sets out the terms and conditions of their relationship and the provision of services/projects to be undertaken. A subcontractor agreement is typically used where the contractor needs a subcontractor to help complete a product or service. The construction industry is commonly using the subcontractor agreement.

Through the subcontracting agreement, the contractor can delegate certain obligations to the subcontractor to ensure task completion. In brief, to draft a subcontractor agreement successfully, you should follow these steps:

1. Negotiate all terms and conditions of the subcontractor agreement. The terms you should include in the subcontractor agreement include:  

• The scope of work

• Indemnification

• Warranties

• Dispute resolution

• Payment terms

• Compensation

• Policies and procedures

• Termination

2. You should then draft the agreement in writing and send it to the subcontractor for review.

3. Then, review the agreement, sign, and execute.

These elements will be explored in more detail below.

What is a subcontractor agreement? 

As we briefly explained, a subcontractor agreement, or subcontractor contract, is an agreement that sets out the terms and conditions of the relationship between a contractor and subcontractor for the provision of services to a third party.

A subcontractor agreement is a separate contract entered into by a party (contractor) to the contract (main contract). In a subcontractor agreement, the main contractor agrees with another person (the subcontractor) that the subcontractor will perform some of the contractor’s obligations under the main contract. In exchange for this undertaking by the subcontractor, the contractor agrees to provide the subcontractor with consideration of some kind – usually a fee or payment.

The other party to the main contract (the customer) is generally obliged to accept performance by the subcontractor, so long as the subcontractor has done everything agreed to by the contractor.

Why are subcontractors used? What benefits do they bring? 

Subcontracting delegates contractual obligations to another party and is especially common in the construction, manufacturing, and transportation industries. It offers many benefits to contractors: 

Firstly, engaging subcontractors helps to save costs. Subcontractors can be brought on for a short period to help when the contractor is working on a large project. Subcontractors also tend to be cheaper when used for short periods compared to full-time employees.

Secondly, subcontractors often have substantial expertise in certain niches or provide a particular service. Subcontractors can offer superior service and expertise that regular employees do not have.

Do I have to write a new subcontractor agreement every time I want to subcontract obligations? 

If a subcontractor is regularly engaged by the contractor, the subcontractor and contractor should create a subcontractor master agreement to make things easier. A master agreement is a written repository of the terms based on the subcontractor will provide services each time they are engaged by the contractor.

Instead of writing a new contract each time the subcontractor is engaged by the contractor, parties can merely execute a purchase order or job order and incorporate the terms of the master agreement therein. Entering into a master agreement is a useful way to consolidate two or more agreements into one agreement.

We have created various comprehensive subcontractor master agreement templates. Each template differs based on which party it is drafted to favour: the subcontractor, company, or neutral.

• This template is written in favour of the subcontractor. You can access this template here.

• This template is written in favour of the company. You can access this template here.

• This template is written in neutral form. You can access this template here. 

If a subcontractor is not regularly engaged by a contractor, then the subcontractor and contractor will have to enter into a subcontractor agreement for a single job.

Again, we have created various comprehensive subcontractor agreement templates for single jobs. Each template differs based on which party it is drafted to favour: the subcontractor, company, or neutral.

• This template is written in favour of the subcontractor. You can access this template here. 

• This template is written in favour of the company. You can access this template here.

• This template is written in neutral form. You can access this template here. 

Employee v. Subcontractor

You might be wondering what the difference is between employees and subcontractors. Here is a brief overview of their differences: 

When can a contractor subcontract obligation(s)? 

Before writing a subcontractor agreement, a contractor should check his/her agreement with the customer (the ‘main agreement’) to check if it permits the contractor to use subcontractors to fulfil those obligations.

Subcontracting obligations must be done with the legal terms of the agreement in mind.

Generally, the customer to the main contract must accept a subcontractor’s performance of any obligations so long as the performance is complete. The exception to this is if the main agreement between the contractor and customer restricts subcontracting of the obligations involved.  

If the main agreement is silent regarding subcontracting and does not permit nor restrict it, this will generally be treated as consent to subcontracting of the obligations stated therein.

On a broader scale, the common law provides that subcontracting is not legal if the obligations fall into one of the following categories:  

1. The main contract prohibits subcontracting expressly or implicitly

The main contract prohibits subcontracting expressly if it includes a clause to the effect that the obligations stated should not be subcontracted whatsoever.

2. The obligations are of a special nature requiring personal performance by the party in the original contract

Some contractual obligations are such that the original party’s performance is the essence of the contract. This might be, for example, a contract to paint a picture or write a play. Subcontracting would defeat its purpose.

3. If it can be implied from the circumstances that the contractor has promised personal performance

Whether it can be implied that the contractor has promised personal performance depends on whether the contractor has promised to deliver a result or has promised to personally perform the obligation.

If it is the former, the customer should accept the subcontractor’s performance. However, if it can be shown that the contractor was chosen because of their skill, competence, or other qualifications, it can be implied that the contractor has promised personal performance, and the performance of the obligations cannot be subcontracted.

If the contractor has directly promised personal performance yet, the contractor still subcontracts performance; this would amount to a breach of contract. This is the case even if the subcontractor is equally or more well qualified to perform the obligations at issue.

4. Legal restrictions

Certain contracts, particularly those in regulated industries, can only be performed by authorised persons. An example of this kind of industry is the insurance industry – insurance contracts can only be performed by persons with the relevant authorisation necessary.

If in these circumstances, obligations are subcontracted, and the subcontractor does not hold the appropriate license, the subcontract and the obligations under it will be legally unenforceable.

                                                                                                                     cr. AB Electrical & Communications Ltd

                                                                                                                       (https://www.abelectricians.com.au/)

How do I write a subcontractor agreement?

A subcontractor agreement should expressly incorporate relevant terms of the main contract. This will ensure that the subcontractor’s obligations link clearly with the contractor’s duties to the customer in the main contract. To enter into a subcontractor agreement, you should remember to follow these steps:

1.    Negotiate and finalise all terms and conditions of the agreement

2.    Draft the agreement in writing and send it to the subcontractor for review

3.    Review the agreement, sign and execute 

When completing step one, negotiating and finalising all terms and conditions of the agreement, make sure to include the following terms as they are of particular importance:

1. Scope of work

The subcontractor agreement should specify the exact scope of work performed by the subcontractor.

The work specified should be accurate and precise. A lack of accuracy and precision can create confusion for both the subcontractor and contractor.

It creates difficulties for the contractor because it will be more difficult to say for sure whether there has been a default by the subcontractor. Likewise, the subcontractor will not be able to determine whether they have defaulted or performed all their obligations as required by the subcontractor agreement.

2. Indemnification

Indemnification clauses frequently feature in subcontractor agreements – they typically obligate the subcontractor to indemnify (i.e.: compensate) the contractor for any loss or expenses incurred because of the subcontractor’s performance of his/her obligations under the subcontractor agreement.

In this sense, indemnification tools are used by contractors to transfer risk associated with the subcontractor contract to the subcontractor. 

3. Warranty

The subcontractor agreement often specifies a warranty on the work product concerning quality and workmanship. Warranties hold the subcontractor liable to properly perform any obligations that are initially performed shoddily.

The specificities of any warranty are dependent on the project at hand and the expectations which follow.

4. Dispute resolution

Parties often agree beforehand on how certain disputes should be resolved if they do arise. Often, this is done by agreeing to arbitration or mediation clauses.

These stand as alternative methods of dispute resolution to going to court where an independent arbitrator or mediator, depending on the case, hears the case and offers a resolution.

Arbitration or mediation clauses typically specify the location where the arbitration or mediation should take place, the rules which must be followed in proceedings, etc. The difference between arbitration and mediation is that an award in arbitration is binding on the parties, whereas in mediation, the award is not binding on the parties.

5. Payment terms

Different subcontractor agreements will feature varying payment terms.

Two common terms used to reference payment include ‘pay if paid’ and ‘pay when paid'.  

Pay if paid is where the contractor will only pay a subcontractor if the contractor receives payment from the customer under the main contract. Pay when paid is where the contractor will only pay a subcontractor when the contractor receives payment from the customer under the main contract.

In essence, these are conditional payment terms – they pass on some of the risks of non-payment from the contractor to the subcontractor.

Whether the contractor chooses these payment terms or resolves to simply pay an up-front fee depends on the financial position of the contractor. If the contractor is in good financial standing and is not relying on receiving fees from the customer under the main contract to pay the subcontractor, he might choose the option of a simple upfront flat fee payment.

If not, the contractor may choose to adopt either of the ‘pay if paid’ or ‘pay when paid’ options.

6. Compensation

This term outlines how the consideration for the subcontractor’s services will be calculated – such as whether is it a flat fee agreed to at the outset or if payment is to be determined depending on the number of hours the subcontractor spends on the work, etc.

7. Policies and procedures

The subcontractor agreement should explicitly state any policies and procedures that must be followed by the subcontractor when performing the obligations within the agreement. 

8. Termination

The agreement should state whether or when either party has a right to terminate the agreement and what rights they possess following termination.

Liability of a subcontractor to the main contract 

In a subcontractor agreement, the contractor remains liable for performance to the customer under the main contract. This means that if there is an incomplete performance by the subcontractor, the contractor will be liable for performance to the customer under the main contract. The customer will not be able to sue the subcontractor for breach of contract unless they have a claim in tort or a direct third party right.

The customer cannot sue the subcontractor for the breach because a subcontractor agreement is a distinct, separate contract that does not affect the legal position of the parties to the main contract.

This is the case due to the doctrine of privity of contracts. This doctrine states that one can only enforce the benefit of or be liable for an obligation under a contract if they are a party to that contract. In the case of subcontracting arrangements, there are two separate agreements to consider: the main agreement and subcontracting agreement. The main agreement only has two parties to it: the customer and the contractor. The subcontract also only has two parties to it: the contractor and subcontractor.

The important point here is that the subcontractor and customer are not parties to the same contract. They do not have any contractual relationship with each other. This means that there is no privity of contract between them, meaning that A cannot sue C if C's performance does not meet the requirements of the contract between A and B.

So, if A (customer) enters a contract with B (contractor) to provide construction services to A, and B subcontracts a part of the work to C (subcontractor), C has no rights and obligations under the main contract, as that exists between A and B. A, also, does not have any rights and obligations under the subcontract between B and C. This means that if any work carried out by C does not meet the specifications of the agreement between A and B, A can sue B for breach of their agreement, and B can likewise sue C for breach of the subcontract. However, A cannot sue C on its own because of the lack of privity between them.

Please note that this is just a general summary of the position under common law and does not constitute legal advice. As the laws of each jurisdiction may be different, you may want to speak to your lawyer.