A subcontractor should carefully consider its contractual right to time extensions in the event the prime contractor or another subcontractor has labor problems that affect its work. One option available to contractors is to operate “double-breasted.”¹ In general, a double-breasted contractor is a union contractor that forms a second, separate company which operates “open shop.” In essence, there are two employers, one union, one nonunion. In order to establish a legally correct double-breasted operation, the contractor must conclusively establish that both entities (i.e., the union operation as well as the open-shop operation) are distinct and separate business concerns and not merely convenient distortions, or alter egos, of each other. This form gives the contractor the advantage of being able to operate without a union where this is feasible while at the same time continuing operation of the union company where the use of union labor sources is desirable or required.

Of course, double-breasted operations do not guarantee freedom from labor problems, and the cost of maintaining two separate companies may be prohibitive for some organizations. Most important, the use of a double-breasted operation also requires careful adherence to very specific and technical labor law requirements. For example, the National Labor Relations Board (NLRB) has enumerated four criteria used to determine whether the two operations are truly independent in every conceivable aspect of their operation. These are: (1) common management and supervision of operations; (2) common control of personnel policies and labor relations; (3) interrelation of operations; and (4) common ownership or financial control.² Of these, the NLRB has held the most important factor to be the control that one party maintains over the other party’s labor relations.³

Double-breasted operations can be an effective alternative for a contractor that wants to compete with open-shop contractors in some areas while maintaining good relations with the union where union labor predominates. Contractors should seek the advice of a labor attorney before attempting to establish a double-breasted operation so as to ensure compliance with the requirements of applicable laws and regulations.

1. Enforcement of Subcontractor Bids

Practically every contractor has had a subcontractor or supplier revoke its bid or proposal after the contractor has entered into a contract with a third party in reliance on the subcontractor’s bid. This issue has generated substantial litigation between prime contractors and subcontractors, especially when severe inflation affects the construction industry.

Many early cases held that the subcontractor was not bound to the prime contractor; or, similarly, the supplier was not bound to the subcontractor, unless the parties had actually signed a contract.⁵ Therefore, bids and proposals could be withdrawn up until the point where the parties were bound by formal documents.

In recent years, many courts (but not all) have held that a subcontractor is bound to the prime, when notified within a reasonable time after award that the prime relied on the bid in obtaining the prime contract award and intends to use the subcontractor for the project.⁶ What constitutes a reasonable time for acceptance of an offer depends on the circumstances.⁷

The trend toward binding subcontractors to the prime contractor based on the bidder’s proposal, even without a contract document, is a response to the hardship a contractor faces when it is awarded a contract based on the subcontractor’s proposal, and then the subcontractor is not obligated to proceed with performance. Many contractors seek to avoid this problem by requiring that bidders also agree that their proposal will not be revoked for the same period of time allowed for award of the prime contract in the owner’s bid documents.

When a contractor is forced to hire a replacement subcontractor to perform the work following the original subcontractor’s repudiation of its bid or proposal to the contractor, the damages can be significant.⁸ Over the past five decades, courts have generally applied the same measure of damages in such instances.⁹ Typically, a contractor may recover the difference between the original subcontractor’s bid and the amount paid to the replacement subcontractor. This measure of damages, which is sometimes called “expectation damages,” places the contractor in the same position that it would have occupied if the original subcontractor had performed as promised.

2. Subcontractor Rights against the Prime Contractor

Although subcontractors may be responsible to prime contractors that rely on their bid, prime contractors are less frequently bound to the subcontractors whose bids were relied on by the prime.¹⁰ The fact that the prime contractor used the subcontract bidder’s proposal in its bid to the owner does not ordinarily provide the subcontractor with rights equivalent to those that the prime contractor may have to bind the subcontractor to a contract. But each set of circumstances must be judged on its own merits.

An argument has successfully been made that if the prime contractor sends the subcontractor a letter of intent or a clear statement that it intends to have the subcontractor perform the proposed work for a mutually acceptable price, and the subcontractor begins performance in reliance on the prime’s request, then there is a basis to find that the parties have entered into a contract, even though it is not completely reduced to writing. Under such circumstances, a subcontractor may be entitled to recover damages for breach of contract if the prime contractor later withdraws its commitment.

The fact that the parties have not executed a formal contract is not necessarily controlling. If the circumstances indicate that a subcontractor intends to perform a specifically identified scope of work on mutually agreeable basic terms of price and time, and if the subcontractor begins performance pursuant to such terms without objection from the prime contractor, there is support for a finding that the parties are bound to each other. Thus, the subcontractor may be entitled to a remedy for breach when it is later not allowed to complete the work.

1. Pay-When-Paid Clauses

A pay-when-paid clause generally obligates the prime contractor to make payment to the subcontractor when it is paid by the owner or within a reasonable time period after receipt of corresponding payment from the owner. One example of a pay-when-paid clause is: “The total price to be paid to subcontractor shall be $…no part of which shall be due until five (5) days after owner shall have paid contractor therefor…”¹⁸ The variations on this theme are almost unlimited. In spite of this clause, the prime contractor in the Thomas J. Dyer case was not released from its payment obligation even though the owner filed bankruptcy before final payment. The court in that case held that the payment clause failed to express that the parties’ intent was to shift the risk of the owner’s nonpayment from the general contractor to the subcontractor.

2. Pay-If-Paid Clauses

In an effort to avoid making payments to subcontractors even though payment has not been received from the owner, some prime contractors include a provision in their subcontracts making payment by the owner a “condition precedent” to the prime’s obligation to pay its subcontractors.²⁷ Such a provision is referred to as a “pay-if-paid” clause, under the theory that the contractor’s payment obligation only arises if it is paid by the owner. To be enforceable, such a contract payment provision must clearly show that the express condition is the mutual intent of the parties and that the parties recognize that payment may not be received from the owner so that the subcontractor assumes this risk as a part of the negotiated contract.²⁸ The arguments for or against a “pay-if-paid” clause are essentially the same as those set forth above in the discussion of “pay-when-paid” clauses.

Several courts recently have held that a subcontractor still may seek payment from a prime contractor, even with a valid pay-if-paid clause, when the contractor prevented the condition precedent from occurring. This is known as the Prevention doctrine.²⁹ For example, in the Northeast Drilling case, the prime contractor’s subcontract contained a valid pay-if-paid clause. The prime contractor failed to submit change order requests for additional work that the subcontractor had performed. As a result, the owner never paid the prime contractor for the additional work the subcontractor had performed, and the prime contractor never paid the subcontractor. The court found that the prime contractor’s actions in failing to submit the change order requests prevented the prime contractor from using the pay-if-paid defense during the subsequent nonpayment action brought by the subcontractor.

3. Changes to the Payment Terms Must Also Account for the Surety

After the subcontract is signed, there remains a potential for problems in the implementation of the agreement. The obvious problems are caused by a delay in payment or a dispute over the amounts earned for progress payments or for extra work. Careful draftsmanship and thoughtful consideration in advance will provide the parties with contract terms to measure and guide their performance. The subcontractor and prime contractor may find, however, that unexpected circumstances during performance may require a change in their expected payment procedures. Unexpected results may follow if the parties’ actions to accommodate the new circumstances are not carefully considered. For example, the prepayment of a subcontractor may discharge the subcontractor’s performance bond surety from liability. If a subcontractor falls behind schedule and is financially unable to increase its workforce to regain the lost time, the prime contractor may consider prepaying the subcontractor to finance the additional crews needed to regain the schedule while expecting to deduct the amounts advanced from later progress payments.

In one case, a prime contractor agreed to this arrangement but failed to obtain the approval of the subcontractor’s payment and performance bond surety.³⁰ When it sued the surety for the amounts prepaid to the subcontractor, the surety defended on the basis that the prepayments materially altered the subcontract and operated to discharge the surety from its obligations.³¹ The prime contractor’s payment bond surety may take the same position if the prime contractor is in default of its payment obligations after agreeing to alter the payment terms of its contract without obtaining the surety’s prior consent.

Some courts require that a surety show injury or prejudice in addition to a material alteration of the contract in order to be discharged from bond obligations.³² The lesson for all parties is that payment terms must be considered carefully when initially entering into the contract, and any change in those terms must be reviewed for its impact on the present obligations between the parties and the rights and obligations of sureties and other payment guarantors that may be affected.

1. The Right to Terminate

2. Considerations in Drafting Subcontract Default Clause

Some of the considerations that should be addressed when drafting or reviewing a subcontract default clause are set out in the following checklist. Use this checklist to determine if and how the subcontract addresses major issues in a default situation: