Key points to consider when subcontracting

Subcontracts are becoming increasingly common in some industries, especially in manufacturing generally, and security and defence in particular.

They are not the most exciting of documents and drafting and considering them needs a good deal of concentrated thought and reading.

The most important principle to bear in mind is that a head contractor is able, subject to their own contract terms, to delegate a task by way of sub-contract, but may not delegate their liability to the ultimate end-user or client to perform that task.

For this reason, it is critical that the main contractor be absolutely clear in its mind what functions it wants to subcontract.  Having done that, it needs to vet the financial standing, reputation in the trade, and available assets and resources of its proposed subcontractor.  Time spent on reconnaissance in this area is rarely wasted.

By the same token, the subcontractor will need to be confident in the main contractor’s ability to pay it and that its payments will cover the subcontractor’s costs and profit.  Of particular relevance here is the increasing practice of government departments to require their contractors to reduce their costs by a stated margin over the period of the contract.  The main contractor may seek to pass that obligation on to the subcontractor, but the subcontractor may not be able to make a corresponding reduction.  For example, if the main overhead of the subcontractor is materials bought from third party suppliers, the ability to reduce costs is beyond its control.  Indeed, it could end up performing the contract at a loss.

The key, therefore, is for the subcontractor to be able to see the main contract so it is fully certain of all main contract terms that may be visited on it.

Given the ultimate liability of the main contractor, it needs to ensure tasks delegated are adequately specified and performance standards are at least equal to those imposed on it under the head contract.  Reporting obligations should match, but subcontractors’ reports should be issued in time for the head contractor to issue its own.

A potentially difficult area is insurance, as the subcontractor may not be able to afford the amount of cover required of the main contractor.  In that event the subcontractor will want to limit its liability accordingly, but another solution, probably acceptable to the end user, is to become a co-insured under the main contractor’s policies.  A trap to avoid here is that if the main contractor becomes insolvent, the cover may be cancelled and/or the insurer may look to the subcontractor for payment of the full premium.

As with the vast majority of contracts, each party should identify the risks to which it is exposed and work with its insurance brokers to ensure it has adequate cover.

Subcontracts can be a vital source of business for smaller manufacturers and a useful way for larger ones to free up resources for major, often more lucrative, projects.  Both businesses will benefit but need to pay very detailed attention to what tasks flow down the contractual chain, and how and on what terms.

For support and advice if you are considering entering into an agreement, either as the main contractor or as a sub-contractor, contact David Ashcroft (01242 248218 david.ashcroft@bpe.co.uk) or another member of the BPE Commercial team.

These notes have been prepared for the purpose of an article only. They should not be regarded as a substitute for taking legal advice.