Five cashflow pitfalls subcontractors can avoid

Paul Ives is head of dispute resolution at Gateley Vinden

It’s an extremely frustrating time for the construction industry. As a result of global disruption, there are still many ongoing issues such as delays, material shortages and cashflow restrictions. Consequently, many companies are now seeking advice as to their rights and how best to protect their businesses – especially subcontractors.

We are seeing an alarming trend where subcontractors are repeatedly facing damaging contractual disputes with employers and main contractors. Here are five common issues that can cause shortfalls for subcontractors.

1. Not being paid for work

As finances become restricted, it is becoming common practice to delay or reduce payments to subcontractors. Even buoyant subcontractors may face insolvency as a result. But what are your options should you not receive payment of sums due under a construction contract?

It is important to understand the difference between ‘non-payment’ and ‘abatement’. Non-payment is the failure to make a payment that is due under contract, whereas abatement relates to the contractor reducing payment based on their assessment of the completed work.

In terms of abatement, the only option is to challenge the valuation produced by the contractor. If negotiations fail, then the subcontractor would need to consider dispute-resolution options such as adjudication or mediation.

However, non-payment refers to the situation where a contractor fails to pay by the final date specified in the contract. As long as the agreement satisfies the legal definition of a construction contract, and the subcontractor has given the appropriate amount of notice, the subcontractor can suspend the performance of any or all of its obligations until payment is made in full.

While many may be quick to walk off site in protest, it is essential that subcontractors fully understand the payment terms and conditions of the contract before any suspension is threatened, notified or imposed.

2. Notice provisions in construction contracts

Notice provisions are essentially clauses in contracts that play an important role in the construction industry. They are designed to notify parties of potential problems and provide sufficient time to respond. However, the notice provisions for subcontractors – especially those relating to delays and disruption, loss and expense – are becoming increasingly difficult to meet.

Many subcontractor contracts now feature a condition precedent added to notice provision clauses that must be satisfied before an entitlement can arise. If the condition precedent is not satisfied, then entitlement is lost. Not only does this place a significant burden on subcontractors, but the condition precedents are often used to catch them out.

It’s important that subcontractors review any notice provisions before entering into a contract and, if possible, negotiate more favourable terms that enable them to manage the risk accordingly.

3. Design responsibility

Design responsibility is a common point of dispute that can lead to significant cost and time implications for subcontractors. It is becoming common for employers and main contractors to attempt to include contractual provisions that make the subcontractor responsible for the accuracy and suitability of the design produced by others. This is a major red flag, as it unknowingly exposes subcontractors to risk.

Another issue is the inclusion of ‘fitness for purpose’ obligations, requiring the subcontractor to guarantee the performance of the design, as opposed to a requirement to use reasonable skill and care. Many professional indemnity insurance policies do not allow for this obligation, and a subcontractor could find themselves exposed and not fully insured. 

4. Liquidated damages

A well-drafted clause could enable a main contractor to automatically deduct liquidated damages if the subcontractor does not complete the works by the agreed completion date. This could lead to a main contractor deducting a significant sum from the subcontractor, or even reducing the sum due to zero. From a cashflow perspective, this has the potential to be extremely detrimental for subcontractors.

In many instances the main contractor may be fully aware that the subcontractor is not responsible for the critical delays; however, it could use its contractual rights to deduct liquidated damages as a bargaining chip to negotiate the final account and even restrict cashflow. From a subcontractor’s perspective, this situation needs to be avoided at all costs.

5. Final accounts

Subcontractors need to make sure they are settling final accounts before it’s too late. In recent cases, we have seen main contractors reject claims from subcontractors due to the expiration of the limitation period.

In one particular case, if the claim had been left for one more week, it is likely the subcontractor would have lost their entitlement to pursue the dispute through formal proceedings. This would have resulted in the subcontractor losing its entitlement to a significant sum. To avoid this situation, subcontractors should be settling final accounts without delay.

Check your contracts

There is a common theme with these five contractual issues. They highlight how important it is for subcontractors to thoroughly check construction contracts and their contents before entering into agreements with employers or main contractors.

By being aware of any clauses, time periods or provisions that would affect the subcontractor’s right to be paid for completed work, subcontractors would be in a position to either renegotiate more favourable terms or ensure practices were put in place to protect themselves.

And a lengthy and expensive contractual dispute may be as detrimental as not being paid at all.

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