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Entering into a Head Contract? Tips for Alleviating the Head-Ache of Subcontracting

Overview

Head contractors can avoid being painfully squeezed between what their clients want and what their subcontractors will deliver by involving potential sub-contractors early in the head contract negotiation process.

What is a head contract?

It is quite common for two parties - A and B - to enter into a contract on the understanding or with the expectation that B will then subcontract with other(s) - C - to conduct the actual work governed by the first contract. The agreement between A and B is a head contract.

Subcontracting problems

Negotiating the head contract between A and B may or may not proceed smoothly. Reaching agreement on the terms of the subcontract between B and C is an entirely separate matter, and often not without some real head-aches along the way.

B’s hands are effectively tied by the terms of the head contract, in relation to timing, performance levels and allocation of risk and liability. Yet C will routinely sweep that aside. After all, if B agreed to such terms, then isn’t that B’s problem? C may further argue that it did not agree (and would not have agreed) to those same terms, and has no intention of now underwriting B’s failings. (As many in B’s position will know, such arguments are rarely accurate, with A usually driving the negotiating process.)

Unless B is willing to accept the liability gap between what A requires and what C will agree to accept (which is rarely advisable), the subcontract negotiations will be at a stalemate. This is potentially a huge issue for B if it has deadlines to meet under the head contract, and is reliant on C to meet them.

Case study

Lawyers are often only brought in after the head contract has been finalised, and then asked to draft and finalise the subcontract.

In a recent matter, FAL Lawyers were instructed to act for a client B at an early stage of the head contract negotiations. The client took the very sensible step of circulating the draft head contract to C (in this case, a number of other parties), with A’s knowledge and consent. Our client requested C to comment on the document, making it clear that whatever obligations it was required to perform under the head contract would be passed down to C.

Following a review of the head contract, C provided a number of comments, the majority of which were reasonable. Such comments were then factored into B’s negotiation of the head contract with A. There were some successes and some failures in terms of what amendments A was willing to accept.

Of fundamental importance, however, was that B was able to inform C that it had tried to secure C’s requested amendments, and where it had been unable to do so, this was due to A’s refusal. Accordingly, the terms of the head contract (and in large part, the subcontract) represented the extent of what was acceptable to A.

As a result, when it came time to negotiating the subcontract between B and C, the ensuing process was quick and painless. Two of the C parties had no comments whatsoever and accepted the subcontract as is. The third such party only had a few, very minor, comments which were quickly put to bed.

There is little doubt that the additional, early step of circulating the draft head contract to C for comment, and incorporating the issues raised by C as part of B’s negotiations with A, saved significant time (and costs) when it came to subcontract time.

Of course if A doesn’t agree to circulating the draft head contract to C, then you may wish to:

  • ensure that the head contract is not binding until you’ve entered the subcontract; and

  • reserve rights to re-negotiate with A if critical issues arise in negotiating the subcontract with C.

Conclusion - Tip for Alleviating the Head-Ache of Subcontracting

Where appropriate (and with the A party’s consent, if necessary), the potential prescription for a pain-free subcontracting process is clear. Consult with your subcontractors early when negotiating a head contract, and many of the head-aches down the track may be alleviated.

If you have any queries, please contact Peter Francis, Jason Watson or Richard Browes.

7 September 2012