August  17, 1998

Bulletin # 19: The "Killer" Contract Part 2

In many parts of the country, subcontractors operate under AIA or AGC subcontract forms or some modified version of those forms. Those documents have been developed over the years with the participation of owners, general contractors, subcontractors, architects and other construction professionals. Each form incorporates some balancing of interests among the various parties to a construction project. The evolution of the forms has generally reflected a construction industry trend toward a "team" approach to construction and efficient and fair resolution of disputes.

On the other hand, many subcontractors have, from time to time, confronted "proprietary" subcontract forms. These documents are typically developed by a general contractor for use on its own projects. Some of these subcontract forms are simply a general contractor’s attempt to clarify or improve upon the standard forms. However, in some instances the proprietary subcontract can pose significant dangers for the subcontractor. It can look much like a "standard form," but may be gutted of many of the protective provisions in the standard forms or skewed completely in favor of the general contractor. Contract Bulletin #18 discussed the fate of a subcontractor under one such "killer" contract.

To summarize, Acme Sheet Metal had signed a proprietary subcontract form for a large project. Almost from the start, the project was plagued with delays, late payments and other problems. A reputable architect known to the subcontractor was replaced in the middle of the project. When the subcontractor finally decided to act, it discovered highly unfavorable language in the subcontract form. For example, many of its claims were deemed to be waived because of the failure to provide prompt notice. Yet, the subcontract prevented the subcontractor from leaving the job. Only at that point did Acme begin to carefully document its claims and diligently provide notice.

As the job neared completion, Acme and its attorney met to review the dispute resolution mechanisms under the subcontract. Once again, the news was not good. The contract contained an arbitration clause that specified that all claims and disputes must be resolved by arbitration. However, the arbitration clause contained no procedure as to selection of arbitrators, timing for arbitration or the ability of a party to obtain information from the other party prior to the arbitration hearing. Unlike the standard subcontract forms, the arbitration clause also omitted any reference to the Construction Industry Arbitration Rules of the American Arbitration Association. Those Rules typically give all parties significant guidance as to the presentation of their claims and defenses in construction arbitration. How was Acme to arbitrate under the circumstances?

The subcontract also required that all claims be submitted to the architect as a prerequisite to arbitration. No time limit was set for the architect’s review or decision as to the claims. Acme submitted all of its claims to the architect and heard nothing. When it requested a meeting with the architect to review the claims, the request was denied. It took three months before Acme got a response from the architect that substantially all of its claims were denied. At the same time, the general contractor made an offer to settle all of Acme’s claims for ten cents on the dollar and agreed that it would release the retainage at the same time that Acme settled its claims. Despite its difficult cash position, Acme refused this offer.

Acme’s attorneys then suggested that the claims be arbitrated through the American Arbitration Association using the Construction Industry Arbitration Rules. The general contractor’s attorneys responded that this proposal was unacceptable and that the matter should be arbitrated by a panel of three arbitrators, with one selected by the subcontractor, one selected by the general contractor and one selected by the architect. Since the architect had already refused the claims, Acme knew that the proposed process would lead to the denial of its claims. After several months of wrangling over the arbitration process, the general contractor once again made a minimal offer of settlement, which Acme considered more seriously.

Finally, frustrated with the delaying tactics and absence of an effective remedy under the subcontract, Acme’s attorney commenced an action in court requesting that the court throw out the mandatory arbitration provision due to the absence of any procedure for arbitration. The subcontractor asked the court for the right to resolve its claims in a court proceeding. After several hearings (and more delay and expense to Acme), the court determined that the "killer" subcontract was sufficiently unclear as to the arbitration procedure as to be unenforceable on that point. The court declared that it had jurisdiction to resolve Acme’s claims. At that point, the general contractor’s attorney approached Acme with an offer of twenty cents on the dollar and indicated that it was the final offer and that the general contractor would appeal any adverse decision of the court. If it did not accept the offer, Acme was told that it would be years before it was paid on any of its claims. After further negotiations, the subcontractor accepted twenty-five cents on the dollar on its claims and the case was dismissed. The project was finally over.

What had started as such a promising opportunity for the subcontractor had turned into a nightmare. The "killer" subcontract had taken a heavy toll on Acme, its operation, and its cash flow. The point of this saga is not that every proprietary subcontract is unfair or a "killer" contract. Every subcontract form should be carefully reviewed before the subcontractor signs it. However, when the subcontractor confronts a non-standard form, there is particular reason for caution and diligence. That is the only way to avoid the "killer" contract.


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