You are on page 1of 4

BACK TO BACK CONTRACTS

This article looks at the impact of


subcontracting clauses and
comments on risk management for
contractors.
Traditional Approach
In the past contractors on major
projects were often asked to accept
subcontracting clauses that involved
an obligation to seek approval before
work could be subcontracted. The
contractor was also required to agree
that subcontracting would not relieve
the contractor from responsibility.
Prescriptive Approach
Over time these simple clauses have
been replaced by significantly
expanded clauses. In some cases the
clauses impose an obligation to seek
approval to subcontract and dictate
the terms which must be included in
the subcontracts:
The contractor must ensure that any
subcontract between the contractor
and a subcontractor contains
provisions XY&Z and is otherwise on
terms acceptable to the principal.
Further, some principals require
contractors to obtain Warranty Deeds
from subcontractors.
The requirement to incorporate
provisions XY&Z in subcontracts and
to obtain Warranty Deeds may be
limited to certain material or key
subcontracts, being either nominated
subcontracts or subcontracts over a
certain value.
Arguably, both the traditional and
prescriptive approaches should
ultimately reach the same destination.
That is, even where the simple clause
is adopted the principal can dictate

the terms of the subcontract by


withholding consent until satisfied
with the terms. However, in practice
the workload for contractors seeking
consent seems to increase where the
prescriptive approach is applied.
Risk for Contractors
Inevitably the requirement to
incorporate provisions XY&Z into
some or all of the subcontracts adds
to the time and cost involved in
negotiating the subcontracts. In
normal situations the requirement
should not create too many
problems, especially in cases where
the work to be subcontracted
involves ordinary construction related
activities to be carried out by
Australian contractors.
However, difficulties can arise where
the contractor finds that provisions
XY&Z are:

Dispensations
When the contractor finds that it
cannot persuade a subcontractor to
accept provisions XY&Z or to offer a
Warranty Deed, the contractor may
need to ask the principal to waive
some of the subcontracting
requirements. However, contractors
should not assume that the answer
will be either quick or favourable. The
principal is likely to seek advice from
its lawyers on the request for a
dispensation where:
the request involves an important
clause in a material contract; or
the principal does not have a clear
understanding of why the
requirement was prescribed in the
first place.
Whether a dispensation will be
granted may depend on a number of
factors, including:

not available in the market; or


not appropriate for the particular
subcontract.
There are a number of reasons why
this can happen. For example, the
contractor may find that some
suppliers are simply not prepared to
bid on provisions XY&Z. The best
commercially available terms may be
the suppliers standard terms of
supply and the warranty may be the
suppliers standard warranty. This is
particularly relevant to suppliers of
material and equipment, even for
very high value purchase orders. The
same applies to suppliers of off-theshelf information technology, where
the terms may be presented on a take
it or leave it basis.

the state of the relationship between


principal and contractor;
the reason why clause XY&Z was
prescribed as a requirement;

whether the contract is a material


contract;

the scope and value of the


subcontract;

any recommendation on the


subject given by the principals
lawyers.
There is no guarantee that relief from
strict compliance will be granted,
particularly where a material
subcontract is involved.

Examples of Prescriptive Clauses

the subcontract;

Each subcontracting clause is


different.

grant the right to terminate for

In some cases, the obligation involves


the usual requirement to seek consent
before subcontracting and a
requirement to incorporate various
provisions in the subcontract dealing
with, for example, agreement that:

require the subcontractor to

the subcontractor must comply


with the Construction Industry
Training Fund Act 1993 and pay any
levies;

disruptive subcontract personnel


may be removed from site by the
contractor or principal;

the subcontractor must comply


with safety, heritage and
environmental laws affecting the
project;

the subcontractor is required to


mitigate costs incurred as a result
of any legal challenge to the
project or in the event of a native
title claim.
Such requirements may reflect what
would ordinarily have been included
by the contractor in standard
subcontracts.
In other cases, the obligations are
highly prescriptive and go beyond
what would ordinarily have been
included in subcontracts.

convenience;
submit to a particular kind of
dispute resolution regime and to
be bound by the outcome at the
top tier.
Often where the subcontract is
material the subcontractor must
provide a Warranty Deed to the
principal, in addition to the usual
Tripartite Deed dealing with the step
in scenario.
That is, depending on the terms of
the Head Contract, the subcontractor
may be required to sign 3 related
contracts:

Subcontract;
Warranty Deed; and
Tripartite Deed.
Risk Management
Management Identification
and Assessment

impose insurance obligations that


match the contractors obligations;

require the subcontractor to


accept assignment or novation of

appropriate for the particular


subcontract in any event.
If time and budget permits (subject to
compliance with bid confidentiality
requirements) discussions with
potential subcontractors may assist.
The optimal outcome would be to
lock away subcontracts in advance to
eliminate the risk of post award
problems. In the real world, this is not
always possible. Where time is short
and the budget is tight, it may be
necessary to make an educated guess
about what subcontractors in the
market will accept.
Particular Back to Back Clauses

Insurance

identification of the obligations

Many Head Contracts dictate


minimum insurance requirements for
both the contractor and its
subcontractors.

that the contractor will be


required to pass through to
subcontractors; and

the likelihood that some or all

deal with audit and access rights;

whether provisions XY&Z are

This involves:

exclude (where applicable) the

rights, in particular ownership,


licence and escrow requirements;

the contractors standard


subcontract documents or (if not)
whether to allow extra money in
the project budget for the cost of
preparing the documents; and

Managing the risk associated with


back to back subcontracting
obligations starts at bid stage with
risk identification.

The contractor then needs to assess:

deal with intellectual property

whether it will be possible to use

Although this article does not attempt


to cover all the different aspects of
back to back clauses, some general
comments regarding insurance,
intellectual property and dispute
resolution clauses follow.

For example, some Head Contracts


require that any subcontract over a
certain value should contain
provisions in equivalent terms (with
necessary amendments) to secure the
principals rights under the Head
Contract, including provisions which
expressly:
relevant State based legislation
regarding proportionate liability;

for long lead items;

preparation of a list of potential


subcontractors who may be
affected by the requirements,
including suppliers and service
providers.

subcontractors will reject


provisions XY&Z;

the likelihood that some of all


subcontractors will demand more
money to accept provisions XY&Z;

the likelihood that it will take


longer than usual to negotiate
some subcontracts, in particular
whether this will affect any key
subcontracts or affect the
contractors ability to place orders

Even if the contractor is willing and


able to comply with the insurance
requirements, subcontractors may be
in a different position.
In the optimal situation, the
subcontractors can be asked to
confirm whether they could comply
with the insurance requirements
before the contractors bid is
submitted. Where time and budget
do not permit a detailed investigation,
the contractor may need to rely on
experience and common sense to
assess whether the requirements are
likely to cause problems.
Some insurance requirements that
would cause problems for the
contractor may also cause problems
for subcontractors. There are a
number of provisions that appear on a

regular basis that fall into this


category, including requirements to
effect:

professional indemnity and other

vest IP ownership rights in the


principal;

grant the principal the right to


modify and develop the IP;

policies in joint names;

a public liability policy which


includes a cross liability clause by
which the insurer agrees to waive
all rights of subrogation;

policies that include provisions


requiring the insurer to notify the
principal in writing at the same
time it gives notices of cancellation
or any other notice under the
policy.
The contractor should be wary if the
Head Contract requires
subcontractors to effect policies that
have a deductible (excess) not
exceeding $............. The dollar
amount nominated may be
significantly lower than the deductible
in the subcontractors policies.
Where the Head Contract calls for
insurance policies to be obtained from
insurers licensed or incorporated in
Australia this may be a problem for
subcontractors who have insurance
policies arranged by a foreign parent.
Intellectual Property
Where the project involves IP
deliverables, the contractor should
assess whether it will be able to
secure agreement on the required
terms with the relevant
subcontractors.
Even if the IP provisions which are to
be passed down to subcontractors are
carefully drafted, they may not
necessarily be appropriate for the
range of subcontractors who will be
engaged: one size may not fit all.
These provisions are potentially
relevant to a range of subcontractors,
including designers, equipment
suppliers and IT suppliers.
It should come as no surprise that an
equipment supplier or IT supplier will
have strong views on the IP clauses
and that these clauses may be deal
breakers.
If the Head Contract imposes an
obligation to secure agreement from
subcontractors (or subsubcontractors) to:

grant the principal the right to give


third parties access to the IP;

provide access to source code; or


deposit source code in escrow,
then each of these requirements
needs to be discussed in detail with
the subcontractor and the
subcontractor may also need to
discuss terms with its own
subcontractors.
Where a subcontractor is going to be
paid to develop any system involving
IP, the contractor should carefully
investigate what rights (if any) that
subcontractor is prepared to offer.
If the primary computer system is
linked to third party products (such
as an accounting package) then the
rights on offer from the sub-supplier
should also be investigated as these
are also likely to be subject to the
subcontracting obligations. It may be
possible to obtain a copy of the End
User Licence Agreement from the
sub-supplier to check the terms.
Dispute Resolution
Some Head Contracts impose an
obligation on the contractor to ensure
that subcontracts contain a particular
kind of dispute resolution regime.
Some require the contractor to sign a
multi-party dispute resolution deed
and to flow this arrangement down to
subcontractors.
Even if the proposed regime is
acceptable to the contractor, it may
not be acceptable to subcontractors.
Some subcontractors (particularly
foreign parties) have mandatory
corporate policies on this subject. If
the subcontractors corporate policy
requires London based arbitration
under UNCITRAL, the subcontractor
will not be pleased to find they are
expected to accept the outcome of an
arbitration or expert determination
higher up.
If a Dispute Resolution Board is to be
established at the higher level,
consideration needs to be given to

whether it is realistic to expect


subcontractors will accept the DRBs
recommendation.
Risk Management - Seeking
Amendments to the Draft Contract
Although some contractors know that
there are going to be problems, they
fail to raise concerns at bid stage,
fearing that too many noncompliances in the departures table
will affect their prospects of success
on the bid.
If the contractor decides to adopt this
approach, it should do so with its eyes
open to the possibility that:

the principal may not grant


dispensations;

the dispensations may not be


granted promptly; and

the amount of work and costs


involved in the subcontracting
exercise may be higher than usual.
Depending on the issue, it may save
time and money to put forward a non
compliance in the bid and to explain
why certain provisions are either not
appropriate or not commercially
achievable. The contractor may wish
to propose that the obligation should
be to use reasonable endeavours
rather than to ensure that provisions
XY&Z are included in the
subcontract. The best time to have
the discussion is before the contract
is signed, rather than seeking
dispensations after award.
Drafting Shortcuts
When faced with an obligation under
the Head Contract to secure a back to
back outcome downstream, some
contractors adopt a drafting shortcut
which attempts to flows down
obligations from the Head Contract,
for example:
The subcontractor agrees to be
bound to the contractor by the like
obligations by which the contractor is
bound to the principal under the
Head Contract unless otherwise
varied in this subcontract and the
subcontractor acknowledges that it
has been provided with a copy of the
Head Contract.
There is an obvious problem with this

approach because terms such as


equivalent provisions and like
obligations are open to a range of
interpretations. Nevertheless, some
contractors may view this ambiguity
as helpful: whether the provision is
effective to flow the obligations down
to the subcontractor is not necessarily
the contractors primary concern.
The contractor should note that this
kind of clause may not be acceptable
to the principal, particularly for
material subcontracts. The principal
may insist on a cut and paste
approach which replicates the full text
of clauses from the Head Contract
into the subcontract (or a schedule of
the subcontract) with appropriate
amendments. If so, this has
implications for the amount of time
required to prepare the subcontract
and the negotiations may also be
slower than usual.

Penny Swain
Director
T +61 3 9606 3200
F +61 3 9606 3222
pswain@molinocahill.com.au

Disclaimer
The content of our publications is intended
only to provide a summary and general overview on matters of interest, current at the time
of publication. The content is not intended to
be comprehensive, nor does it constitute legal
advice. You should seek legal or other professional advice before acting or relying on any of
the content.