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Contractor House of Horrors: What to do When Subs go Bad

October 5, 2012

Overview

I recently received a call from a general contractor and client with an all-too-common question: "I just had a subcontractor show up on site and tell me, ‘I'm going out of business and won't finish the job.' What do I do?"

Like death and taxes, another "sure thing" in the life of a general contractor is that at some point, a subcontractor will go bad. Luckily for the general contractor in this case, he had planned ahead.

By planning ahead, I mean the general contractor had in place a solid written subcontract agreement, which allowed the general to take immediate action to terminate the subcontractor, secure the work in progress and replace the subcontractor. The subcontract also required timely lien waivers and releases, so there was no risk of being stuck paying twice for the same work already done.

But without a good subcontract in place, the job of covering for a bad subcontractor gets more risky and potentially much more expensive.

Dealing with a defaulting subcontractor during construction can be a nightmare, but there are ways to avoid the horrors. First, the subcontractor may not be forthcoming about its problems. It may simply fall behind schedule or start making excuses about why materials are not being supplied timely on-site. This is where the breach and cure provisions of a subcontract come into play.

Do not hesitate to trigger a notice to cure provision – or if there is none, make it clear to the subcontractor – in writing – that it is in default and must correct it within a specific time. If the subcontractor cannot make good on the agreement, be prepared to terminate subcontractor and cover the work.

If the subcontractor is terminated, or simply walks off the job, the next step is to minimize the disruption in project sequencing. The general contractor is still directly responsible to the owner for all of the subcontractor's work. Make sure that the owner is informed of the situation and talk to all of the other subcontractors whose work or schedule could be affected. While under normal circumstances, the owner is not required to modify the project schedule, the owner may be willing to do so, and under some circumstances (such as a force majeure) there may be contractual relief in either schedule or price.

As for other subcontractors, again this comes down to having a good written subcontract that allows the general contractor scheduling flexibility. Even without a good subcontract, a good subcontractor will work with the general contractor to accommodate a change.

After scheduling is worked out, a replacement must be found. Review the general contract and confer with the owner on the selection of a replacement or receive confirmation if the work is going to be self-performed.

Also, keep track of all expenses, including employee time, taken to replace the subcontractor. Theoretically, all administrative expenses to replace the subcontractor, any increased costs or delay expenses paid to other subcontractors attributable to the breach, and any increase in the cost of the work and materials themselves over the original subcontract price is recoverable from the defaulting subcontractor.

Once the work is covered, the final step is to seek compensation for the breach from the subcontractor. In many cases, there may be no money to collect, regardless of how costly the subcontractor's breach. In other cases, there may be assets available, bonds covering performance, or some other motivation for the subcontractor to make good, at least financially, for the default.

As before, much can depend on the quality of the subcontract agreement and the provisions for recovery and dispute resolution. The subcontract could contain retainage provisions, personal guarantees, or some other security device that could aid in recovery. There may be an attorney fee clause that would make litigation over the breach unattractive to the subcontractor. And if there was faulty work that caused damage to other work on the project, the subcontractor's liability insurance may offer some relief.

In any event, the key to avoiding the nightmare of the defaulting subcontractor is knowing what to do and doing it. And it is always best to have a good subcontract agreement in place.

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