subcontracting

Subcontracting: An Overview and Should you Back-to-Back?

Subcontracting is seen in a number of sectors including construction, transportation, manufacturing and information technology. A subcontract will always be related to another contract - often called the ‘main contract’ or the 'prime contract'. Two parties will have entered the main contract and then one of those parties may wish to subcontract some of their obligations. The scope of these subcontracted obligations can be as wide as the parties wish (subject to any subcontracting rules in the main contract). The key point here is that the main contract is still in place with the two original parties remaining liable to one another. The party to the main contract who subcontracts will therefore remain liable for any work undertaken by their subcontractor.

Subcontracting – general

For clarification we will use the following terms throughout this blog:

  • Customer – the party to the main contract who is paying the Main Contractor for the work that the Main Contractor must carry out.
  • Main Contractor – the party to the main contract who has agreed to carry out the work that the Customer needs.
  • Subcontractor – the third party who has been subcontracted by the Main Contractor to carry out some or all of the work that the Main Contractor has agreed to carry out under the main contract.

In general, the Customer is obliged to accept the Subcontractor’s performance if the Subcontractor fulfils all that the Main Contractor had agreed to do under the main contract. Although this may not suit the Customer, if they failed to expressly prohibit subcontracting in the contract they will be deemed to have consented to the subcontract, unless they can bring themselves within the scope of one of the legal restrictions on subcontracting.

Subcontracting – liability

This is the way the chain of liability will work in a subcontracting relationship: if the Subcontractor’s work does not fulfil its assigned obligations in the main contract, the Customer will be able to sue the Main Contractor for breach of the main contract, and the Main Contractor will be able to sue the Subcontractor for breach of the subcontract:

Customer

Main Contractor

Subcontractor

It would seem therefore that the Subcontractor would not be liable to the Customer. This is not always the case, however. A Subcontractor could be liable in tort, for example, where the Subcontractor is found to owe a duty of care to the Customer and is negligent in carrying out the work such that they, for instance, cause physical damage to the Customer’s property.

Back-to-back or stand-alone?

The term ‘back-to back’ agreement is used to refer to a particular kind of subcontract. This expression is used when all of the terms used in the Main Contract are incorporated by reference into the back-to-back subcontract. They are normally used when the rights and duties of the Subcontractor in relation to the Main Contractor closely mirror those under the main contract. Creating a back-to-back agreement might be as simple as changing the names of the parties on the main contract and including a 'back-to-back' clause therefore transferring all the duties in the main contract to the subcontractor. However, as we discuss in the next section, this can create problems.

In a full back-to-back subcontract agreement, the Main Contractor is essentially a front man for the Subcontractor. As such, the Subcontractor will normally be willing to assume full liability for the performance of the works as defined in the main contract, and there is often little difference in the pricing or wording of the two contracts. In a partial back-to-back agreement, the Subcontractor agrees to discharge some but not all of the main contractor’s obligations under the main contract.

A stand-alone subcontract agreement can be read and understood without reference to the main contract. The clauses in this sort of subcontract might have little in common with those in the main contract. The Main Contractor will need to be careful to ensure all the relevant obligations and liabilities are still passed to the Subcontractor.

Disadvantages of back-to-back agreements

Many reasons are given for being wary of back-to-back agreements. These include:

  • A mirror back-to-back layout will most likely not be appropriate for every clause in a main agreement. Careful consideration should be given to the question as to whether the simple transfer of an obligation from the main agreement to the back-to-back agreement will result in obligations that achieve the original intention of the parties and that they are enforceable. Provisions that might not ‘back-to-back’ neatly include intellectual property, confidentiality, limitations of liability, liquidated damages and data protection.

Example:

The main contract says that the Main Contractor will keep the Customer’s (as defined above) intellectual property confidential. The back-to-back subcontract will then say that the Subcontractor will keep the intellectual property of the Main Contractor confidential. This is wrong. The subcontract should say that the Subcontractor will keep both the Main Contractor’s and Customer’s intellectual property rights confidential (or any other arrangement agreed by the parties)!

  • Where there are multiple subcontractors and a complicated specification in the main agreement it can be difficult to work out which obligation falls on a particular subcontractor. Defining the subcontractor’s scope of work may result in as much effort as the drafting of a stand-alone subcontract.
  • A back-to-back contract is only as good as the main contract. The customer might be content to have simple sweeping obligations in the main contract, but the main contractor might see the need to spell out more detailed obligations in a tailor-made subcontract.

Should we have a standalone (not back-to-back) contract?

It depends on the context. As the answer will usually require careful analysis it is advisable to seek professional guidance. The solution we usually come up with is a hybrid - a back-to-back contract which also covers those areas in the contract where simply back-to-backing rights and obligations doesn't work.

Restricting subcontracting

The following are ways in which subcontracting can be restricted:

  • The main contract expressly or implicitly prohibits subcontracting. If a party wishes to stop subcontracting, they should include an express clause in their contract stating so. This usually comes in the form of a boilerplate clause.
  • The contractual obligations are of a special nature that require personal performance by the original contracting party. Examples include contracts for composing music or writing a book.
  • It can be implied from the circumstances that the original contracting party has promised performance. If it can be shown that the original contracting party was chosen because of their particular personal qualifications, skill, competency or financial position, then performance cannot be subcontracted.
  • Statutory or regulatory restriction. Certain regulated contracts can only be carried out by authorised persons, for example, insurance contracts, consumer credit agreements. If the subcontractor doesn’t hold the appropriate licences, the subcontract will be unenforceable.

Subcontracting - Data protection

It is important to consider that data protection obligations will pass down the subcontracting chain. The Subcontractor will be a sub-processor and all sub-processing arrangements are prohibited unless the Customer has given prior written consent. The Main Contractor should check the data processing provisions and subcontracting provisions in the main contract to see what they say about sub-processing. The Main Contractor must enter into a sub-processing agreement with the Subcontractor that imposes the same data protection obligations on the Subcontractor as are imposed on the Main Contractor by the Customer. The Main Contractor, as with other obligations assigned, will be fully liable for the performance of the Subcontractors’ data protection obligations.

Checklist

  • Is subcontracting allowed? Check that the main contract does not prohibit subcontracting.
  • Boilerplates in the main contract. The back-to-back agreement will incorporate by reference all the terms of the main contract including boilerplate clauses. Boilerplate clauses are found at the end of most contracts and cover issues found in all contracts such as how notices should be given or which legal system the contract operates in. It will be important to check that the boilerplate clauses in the main contract, if back-to-backing, are giving sufficient legal protection and do not need adding to.
  • Flow down of obligations from the main contract to a back-to-back agreement need to make sense.
  • Where there is an international element to the arrangements you need to ensure that the governing law of the main contract gives the main contractor effective recourse against the subcontractor and vice-versa.
  • Sub-contracting of data processing obligations – check that the Customer has given its prior written consent to the sub-contracting of any data processing obligation set out in the main contract.

Final thoughts

Subcontracting is common practice, especially in large projects requiring delivery of a range of skills and services, so it is important to understand how subcontracting works. If you are planning on engaging a subcontractor to help you deliver a project then make sure that you have the right contract in place that mirrors your obligations under the main contract. If your subcontract agreement is not drawn up properly you could be left being sued by the Customer because of your subcontractor's poor performance while unable to sue the subcontractor yourself.

If you have any questions about subcontracting or about contract law more generally please contact Neil Williamson.


liquidated damages clauses

Liquidated Damages Clauses: Supreme Court Overrules on Failed Software Delivery

Liquidated damages clauses exist to create certainty around how much can be claimed when a contract is breached. Put another way, they are introduced to deal with the difficulty of predicting the amount potentially recoverable as damages for breach of a contract. A recent ruling by the Supreme Court in Triple Point Technology Inc v PTT Public Company [2021] UKSC 29, explored liquidated damages clauses effectiveness in the context of the failed delivery of a software system. The case also explored the effectiveness of exclusion clauses and the definition of negligence.

Liquidated damages clauses

Liquidated damages clauses frequently appear in commercial contracts and, most commonly, in relation to late or defective performance, particularly in the fields of construction, engineering, supply of goods and shipping contracts. Advantages of liquidated damages clauses include:

  • The parties can know in advance what their liability is and how much they could receive in a breach specified by liquidated damages clauses.
  • They could make recovery of damages easier. This is due to the fact that liquidated damages clauses are enforceable regardless of needing to quantify the loss actually suffered by the innocent party, as would be the case when considering the amount payable to the innocent party when unliquidated damages apply (read our blog on the topic: Damages for Breach of Contract). The claimant simply must show that a breach of contract falls within the scope of the liquidated damages clause. It therefore follows that a claimant may be able to recover more than would be recoverable if the damages were unliquidated (as affirmed in Philips Hong Kong v AG of Hong Kong [1993] 61 BLR 41).
  • Vice-versa, liquidated damages clauses can work in favour of the party responsible for the breach where the damages caused would be more if unliquidated. When considering the drafting of such a clause, it is important to have these considerations in mind, including who is likely to be in breach and what sort of magnitude is imaginable, whilst also being aware that if liquidated damages clauses do not represent a genuine pre-estimate of potential damages, they could be deemed invalid.
  • They help with dealing with minor breaches in long-term contracts (such as construction) and so help to maintain a commercial relationship when there have been minor breaches throughout. In this vain, liquidated damages can be applied to specific obligations in a long-term commercial agreement and so compartmentalise potential breaches.

Can you still claim for general damages when liquidated damages clauses are included in the contract?

Usually, liquidated damages clauses relate to specific breaches and so only apply to the scope of the breaches referred to in the clauses themselves. Therefore, general damages will be claimable for breaches beyond the scope of liquidated damages clauses, subject to any other provisions in the contract. There have, however, been some unusual exceptions to this rule. Including:

So long as liquidated damages clauses clearly state the sort of breach they apply to and how they will operate, the exceptions referred to above should not apply. In Triple Point v PTT the case hinged upon some ambiguous wording in a liquidated damages clause, further proof that such clauses need to be considered at length. We now explore this recent case in depth.

Liquidated damages clauses: Triple Point v PTT

Triple Point Technology Inc (Supplier) contracted to design, install and maintain a software system for PTT Public Company (customer). Payment was due in instalments on completion of milestones. The supplier’s performance did not meet the contractual timetable. Some of the delayed work was accepted and paid for but the customer refused to make other payments for work not yet completed. The supplier suspended work and the customer terminated the contract.

Liquidated damages clauses point in Triple Point v PTT

The supplier brought an action for payment of its unpaid invoices. The customer counterclaimed for damages and liquidated damages under the contract, as provided under article 5.3:

“If the supplier fails to deliver work within the time specified and the delay has not been introduced by the customer, the supplier shall be liable to pay the penalty at the rate of 0.1% (zero point one percent) of undelivered work per day of delay from the due date for delivery up to the date the customer accepts such work, provided, however, that if undelivered work has to be used in combination with or as an essential component for the work already accepted by PTT, the penalty shall be calculated in full on the cost of the combination.”

As shown in bold above, the point here was whether PTT had to accept the work for the liquidated damages to be payable. Put another way, article 5.3 could be interpreted to mean that damages for delay would only be payable under this clause if the work was eventually completed and accepted by PTT, which was not the case. Whilst the Court of Appeal held that the clause did not apply because the work was never completed, the Supreme Court criticised this and ultimately overruled it, deeming it inconsistent with commercial reality and the accepted purpose of liquidated damages clauses. The Supreme Court said that parties must be taken to know the general law, that is, that the accrual of liquidated damages comes to an end on termination of the contract, and so given the work had not been completed up to this point, the clause would apply. After that point in time, the parties must seek damages for breach of contract under general law.

The limitation clause point in Triple Point v PTT

Article 12 of the contract placed a cap on the amount of damages that could be recovered and included an exception from that cap for “negligence”:

“… The total liability of the supplier to the customer under the contract shall be limited to the contract price received by the supplier with respect to the services or deliverables involved under this contract. … This limitation of liability shall not apply to the supplier’s liability resulting from fraud, negligence, gross negligence or wilful misconduct of the supplier or any of its officers, employees or agents.”

The Court of Appeal held that the word ‘negligence’ must mean some independent tort and did not mean breach of a contractual duty of skill and care. In other words, the Court of Appeal concluded that the cap applied to negligently performed contractual duties and therefore Triple Point’s liability for its negligent approach to contractual duties would be limited by the cap. The Supreme Court disagreed, holding that negligence should be given its natural and ordinary meaning of removing from the cap all damages for negligence on the supplier’s part, including damages for negligent breach of contract. Therefore Triple Point’s negligent approach to contractual duties was not capped and their total liability (including under the liquidated damages clause) amounted to just over $14.5 million.

Draft carefully

The context in which liquidated damages clauses classically apply is in a construction context. This is because construction projects span many years, many stages of development and, usually, many parties. Consequently, to thread these various elements together without allowing small-scale breaches to break down a project, liquidated damages clauses are a useful way to define exactly what remedy is available for failed or delayed sections of work. As shown by Triple Point v PTT, these clauses are also significant in any long-term delivery supply contract and employment contracts also often make use of them. This ruling will be received with relief by many, especially considering many were concerned by the lack of commercial consideration in the Court of Appeal’s decision.

What becomes clear from looking at case law in this area is that the wording of liquidated damages clauses can have a significant impact on how they will be interpreted if a contractual relationship goes to litigation. Given the often-bespoke nature of these clauses because they concern the specific work to be done and any imaginable remedies, there is a risk that the wording can be loose and therefore seeking legal advice is very important. These clauses need to be meticulously thought through.

If you have any questions about liquidated damages clauses or about contract law more generally please contact Neil Williamson.


COVID-19 force majeure

COVID-19 Force Majeure and Frustration

COVID-19 has sent shockwaves throughout the business world. For some businesses the impact has been severe and they will find it difficult or impossible to perform contracts entered into before the onset of the pandemic.

In this blog we provide an overview of how businesses may be able to rely on force majeure or the doctrine of “frustration” so as to avoid liability for failing to perform their obligations as a result of COVID-19.

Contractual Position

If you are working under a contract governed by English law the starting position is that you must perform that contract. So, even if you are affected by COVID-19 you must still perform that contract and if you fail to do so you will be liable. There are two key exceptions to this rule: the operation of any force majeure clause in your contract and the common law concept of frustration.

COVID-19 Force Majeure

Unlike in other jurisdictions, English common law or statute does not recognise force majeure. So if your contract does not contain a force majeure clause you cannot use force majeure as a means to avoid liability for non-performance.

If your contract does contain a force majeure clause then you will need to check it to see how it deals specifically with each party’s rights and obligations. Key factors to consider are set out below.

Is COVID-19 covered?

Assuming COVID-19 is not specifically covered as a force majeure event, check if it is the type of event that would fall under general force majeure wording (e.g. pandemic or similar wording), or whether there has been a government decision or administrative action preventing performance that meets the political interference language which is commonly included in definitions of force majeure.

Should the party that wishes to claim force majeure have guarded against COVID-19?

Check if the contract excludes events that could have reasonably been provided against, avoided or overcome. In the COVID-19 context, the current pandemic is not likely to be foreseeable. On the other hand, parties who elected to enter contracts with reasonable knowledge of the virus’s potential consequences, such as in January of 2020 when the virus began to attract attention in China, may have a more difficult foreseeability argument.

Is COVID-19 the true reason for not being able to perform the contract?

The party that is seeking to rely on force majeure must usually establish that the force majeure event has prevented or hindered it from performance of the contract. This is mostly a factual question but, again, will also turn on the exact wording of the clause. For example, some force majeure provisions require performance to have been rendered impossible, so the burden on, for example, a contractor to show that it could not have sourced staff, equipment or materials from elsewhere will be high. Generally, force majeure clauses are not so generous as to offer relief where services or goods will simply be more expensive to perform or obtain.

Mitigation

The party that is claiming force majeure relief is usually under a duty to show that it has taken reasonable steps to mitigate or avoid the effects of the force majeure event. Check whether being able to rely on force majeure is conditional upon you mitigating the effects of COVID-19.

Notice requirements

Parties will wish to ascertain whether prompt notification is a contractual condition precedent to relief. In that situation, a failure to notify in the prescribed manner will result in a party being unable to rely on the provision. In other cases, a failure to notify will not prevent a party from relying on a force majeure provision and the only consequence will be a potential damages claim (if the other party has suffered a loss). The courts have not always taken a consistent approach to the interpretation of notice provisions, and clearly the safest course of action is to ensure strict compliance with any notice provisions in the prescribed manner and as soon as possible

What are the consequences of establishing COVID-19 force majeure?

In most contracts, establishing force majeure will lead to relief from performance, thereby avoiding the risk of a default termination, and an extension of time to target dates. Commonly, parties bear their own costs arising from any force majeure delay but there are exceptions where compensation may be payable after a certain duration or certain costs are payable from one party to another. Extended periods of force majeure can lead to a right for one or more parties to terminate the contract. If the parties do not wish this to happen, it is important to engage in discussions sooner rather than close to the deadline. It may be preferable for these to be held on a without prejudice basis.

COVID-19 Frustration

In the absence of a force majeure clause, a party to a contract may be able to rely on “frustration”. Frustration is a common law right that allows a party to be discharged from its contractual obligations if a change of circumstances makes it physically or commercially impossible to perform the contract or would render performance radically different from that agreed to when the parties entered into the contract. This test may be satisfied if the commercial purpose of the contract is no longer achievable. Delay caused by COVID-19 could in principle be a frustrating event, depending on the nature of the contract in question and the length of the delay.

The focus will be on the parties’ specific contractual obligations and whether they have ‘radically changed’ as a result of the spread of COVID-19 to the extent that requiring a party to comply with its strict contractual obligations would mean requiring it to do something fundamentally different from that which it originally promised to do. In other words, it will be important to identify the consequences of the pandemic on the parties’ ability to perform the specific contract in question. It is unlikely to be sufficient that circumstances have changed in society generally or that performance of the contract has become more onerous or expensive or even uneconomic.

Consequences of frustration

Frustration discharges a contract meaning that all current and prospective rights and obligations are cancelled. All sums paid by a contracting party before the frustrating event will be repayable, subject to the court’s discretion (broadly) to give credit for expenses incurred or benefits provided by the other contracting party.

If you have any questions or need help with any COVID-19 force majeure or frustration issues please contact Neil Williamson or call us on 0203 637 6374.


EM Law Liquidated Damages

Liquidated damages – are they payable even when the contractor does not complete the works?

For this reason, the parties to these contracts often pre-determine the level of damages to which a party is entitled in the event of certain specified breaches occurring. These pre-determined damages are known as liquidated damages and are often triggered when there is a failure to complete works within a specified time. In this blog we take a look at the recent case of Triple Point Technology Inc v PTT Public Company Ltd and consider whether a liquidated damages clause can survive the termination of a contractor’s engagement.

Liquidated damages - current position 

The question of whether or not a liquidated damages clause will trigger a payment obligation when a contractor does not complete works has been disputed by the courts on numerous occasions over the past few years. The conventional position, derived from earlier case law, is that an employer will be entitled to claim liquidated damages for delay up to the point of termination but must bring a general damages claim for any delays which accrue after that date. The logic is that, after termination, the contractor loses control of the time for completion, especially if another contractor is employed to complete those works. However, the cases of Halland another v Van Der Heidenand GPP Big Field v Solar EPC Solutionsmuddied the waters by concluding that an employer could claim liquidated damages for the period after termination. So where do we stand now? The recent Court of Appeal case of Triple Point Technology Inc v PTT Public Company Ltd has offered some much needed clarity on this issue.  

Triple Point Technology background 

In 2012 Triple Point Technology entered into a contract with PTT Public Company Ltd for the supply of a software system. Under the contract, Triple Point were to provide the new software system in two phases, with each phase having multiple stages of work. In the first phase, the new CTRM System would replace PTT’s existing system, and in the second phase the new CTRM System would be developed to accommodate new types of trade. The contract also contained a liquidated damages clause, referred to as Article 5(3), which stated:

“if contractor fails to deliver work within the time specified and the delay has not been introduced by PTT, the contractor shall be liable to pay the penalty at the rate of 0.1% of undelivered work per day of delay from the due date for delivery up to the date PTT accepts such work…” 

In February 2013 Triple Point Technology began working on the project however the first two stages of phase 1 were completed 149 days late. Nevertheless, Triple Point submitted an invoice in respect of this work, which was duly paid by PTT. Triple Point then submitted further invoices in respect of work which had not yet been completed, on the basis that the payment dates for such work had passed. However, PTT refused to make such payments and in May 2014 Triple Point Technology suspended work. By February 2015 PTT had terminated the CTRM contract and Triple Point technology had commenced proceedings in the High Court. 

High Court decision

Following termination of the contract, Triple Point Technology commenced High Court proceedings against PTT for the sums it said they were due. PTT counterclaimed for damages for delay and damages upon termination. In the High Court, Mrs Justice Jefford dismissed the claim and awarded PTT just under $4.5 million of which just under $3.5 million represented liquidated damages for delay pursuant to Article 5(3) of the contract. As the further milestones had not been reached, Triple Point Technology were not entitled to further payments. Triple Point were therefore not entitled to suspend work in May 2014 and were accordingly in repudiatory breach of contract. 

The appeal decision 

Triple Point Technology appealed Mrs Justice Jefford’s decision. Among other grounds of appeal, Triple Point Technology argued that Article 5(3) should not be engaged because it should only apply when work was delayed, but nonetheless completed and then accepted by the employer. In this case, the work was delayed and the contract was subsequently terminated. 

The Court of Appeal held that there were three different approaches towards clauses providing liquidated damages for delay, namely: 

  • The liquidated damages clause would not apply at all (as in the case of British Glanzstoff manufacturing Co Ltd v General Accident, Fire and Life Assurance Co Ltd);
  • The liquidated damages clause would only apply until the point of termination (as in the case of Greenore Port v Technical & General); or
  • The liquidated damages clause would continue until the second contractor achieved completion (as in the case of Hall and another v Van Der Heiden).

In the court’s view, the question of whether the liquidated damages clause ceased or continued to apply up until termination, or even beyond that date, depended on the wording of the clause itself and there was no blanket rule that applied by default. Relying heavily on the reasoning in British Glanzstoff manufacturing, Sir Rupert Jackson stated that there was “no invariable rule that liquidated damages must be used as a formula for compensating the employer for part of its loss.”

Sir Rupert Jackson also held that Article 5(3), which focused specifically on delay between the contractual completion date and actual completion, had no application in a situation where a contractor never completes the work. It followed that PTT was entitled to recover liquidated damages of $154,662 in respect of Triple Point Technology’s 149 day delay and would have to bring a claim for general damages in respect of any other delays. Although Sir Rupert Jackson emphasised that every case would turn upon the wording of the clause in question, he did cast doubt on the previous decisions in Halland GPP

Liquidated damages - concluding thoughts

The case of Triple Point Technology v PTT Public Co illustrates how the law in relation to liquidated damages is far from settled. Parties to construction or software contracts should think carefully about when they want their liquidated damages provisions to apply. Clear and effective drafting is therefore key to ensure that you do not encounter any surprises when bringing a claim for breach of contract. If you have any questions about liquidated damages clauses in construction contracts or software agreements please contact Neil Williamson.