Large construction projects, including international construction projects, are commonly structured such that an owner hires a prime contractor who assumes responsibility for the execution of the overall project and, in turn, that main contractor transfers performance of the various components comprising the project to one or more subcontractors and/or suppliers. In entering into such subcontracts, the contractor will typically seek to pass its contractual obligations and liabilities towards the owner down to its subcontractor(s) through what is called a “back-to-back” or “flow down” contracting arrangement, thereby leaving the contractor with as few obligations or responsibilities relating to the project as possible. In a nutshell, the back-to-back principle is a method where the terms of the prime contract become a part of the agreement with another party down the subcontract chain.
Although such back-to-back agreements appear simple and straightforward conceptually, they require comprehensive knowledge of the terms and conditions of all of the referenced or mirrored agreements and highly rigorous drafting. As poorly drafted back-to-back agreements or flow-down clauses can lead to complex and time consuming disputes, it is imperative when drafting or reviewing such agreements to meticulously consider all provisions contained in the relevant contracts and also to remain cognizant of external factors that may affect the validity or enforceability of back-to-back agreements. This article briefly addresses certain key areas that parties may wish to consider in drafting back-to-back agreements, and also discusses particular concerns that may arise on international construction projects.
Introduction To Back-To-Back Agreements
The predominant approaches to structuring back-to-back subcontracts are the incorporation by reference approach and the stand-alone agreement approach. An additional approach is the use of a standard form subcontract. Each of these approaches is addressed briefly below.
Incorporation by reference of the prime contract involves incorporating applicable terms by reference in a subcontract agreement and expressly excluding or varying in the subcontract those provisions that are clearly not applicable (such as clauses relating to contract price or other similar terms clearly specific to the prime contractor only). Although this method may seem to be the quickest and most efficient structure for a back-to-back agreement, incorporation by reference is sometimes more complicated than drafting a stand-alone agreement. For example, meticulous attention must be given to ensuring that all of the back-to-back provisions are appropriate and are in fact incorporated into the subcontract properly. The parties must also ensure that the terms and conditions remain consistent between the two agreements. Furthermore, the necessity to constantly cross-reference the prime contract can also be inconvenient for the subcontractor(s).
A stand-alone agreement contains all of the terms and conditions of the prime contract that are specific to the subcontract. Although a stand-alone agreement eliminates any need for cross-referencing between the contracts and eases concerns regarding accuracy and consistency, drafting such an agreement from scratch can also be time consuming and expensive because the parties must analyze and determine which provisions will be incorporated into the subcontract and which provisions will require modifications and adjustments.
Finally, another approach is the use of a standard form subcontract, which includes back-to-back provisions from the main contract. An example of such a standard form contract in the international arena is the FIDIC Subcontract for Construction for Building and Engineering Works Designed by the Employer, a standard form subcontract intended to be back-to-back with the FIDIC Red Book 1999 edition and FIDIC Pink Book. The efficacy of the standard form contract approach varies, however, because parties typically amend standard form contracts to their respective preferences, thereby running the risk of inadvertently creating inconsistencies between the prime contract and subcontract.
Examples Of Areas To Be Aware Of When Drafting Back-To-Back Agreements
When drafting or reviewing back-to-back agreements, it is imperative to closely examine all contract provisions. Certain areas that may be of particular concern, include, but are not limited to the following:
• Extension of time and additional payment;
• Changes/variation procedures;
• Claims procedures;
• Completion requirements and deadlines;
• Defects liability requirements and deadlines;
• Limitations on liability;
• General or liquidated damages;
• Suspension and termination;
• Cooperation and coordination of parties;
• Force majeure;
• Governing language and law;
• Dispute resolution;
• Payment requirements and procedures;
• Key deadlines and notice requirements; and
• Confirmation of subcontractor’s cognizance and thorough knowledge on the terms and conditions of the prime contract.
The approach to these issues may vary depending on a number of considerations, including whether the party in question is the prime contractor or subcontractor.
For example, expanding upon a few of the issues above, the prime contractor may wish to focus on imposing obligations—equally as stringent as the prime contract—on the subcontractor relating to deadlines and notice requirements, so as to preserve the ability of the prime contractor to pass on any subcontractor claims to the owner. Additionally, the prime contractor may seek to insert language providing that the subcontractor’s recovery will be limited to the compensation that the prime contractor is able to recover under the prime contract (provided, of course, that any such compensation is actually applicable to the subcontract). The prime contractor may seek to insert language in the subcontract requiring that the subcontractor perform all of the prime contractor’s obligations under the prime contract as applicable to the scope of work under the subcontract. Among other issues, the prime contractor may also want to ensure that termination clauses in the subcontract mirror termination provisions in the prime contract, as applicable.
On the other hand, the subcontractor may try to include an obligation on the prime contractor to adopt and adhere to an established pass-through claims procedure in order to avoid undermining the subcontractor’s position under the subcontract and increase the subcontractor’s ability to recover from the owner. The subcontractor may also wish to insert language stating that the subcontractor, in the event the prime contractor breaches the subcontract, may be entitled to recovery from the prime contractor that is not limited to the amount of compensation that the prime contractor is able to recover under the prime contract.
The foregoing represents only a small sampling of the issues that parties may wish to consider when drafting and negotiating back-to-back agreements. Given the number of considerations that come into play when drafting back-to-back agreements and the varying approaches taken by prime contractors and subcontractors, as highlighted above, negotiating back-to-back agreements that are both equitable and enforceable often requires the assistance of experienced counsel, and parties are advised to consult with counsel when negotiating such agreements.
A Cautionary Tale Of Incorporation By Reference
With regard to international construction projects, parties should exercise particular caution to ensure that back-to-back agreements are enforceable and consistent with the requirements of applicable law. For instance, the laws of certain countries may limit the extent that certain obligations or liabilities can be passed down to subcontractors.
As one cautionary example, a limitation was addressed this past April by the English courts in Imtech Inviron Ltd. v. Loppingdale Plant Ltd. (“LPL”). This case involved a back-to-back agreement between the prime contractor LPL and the subcontractor Imtech that incorporated by reference the prime contract. The prime contract required the parties to refer a dispute to adjudication as a condition precedent to litigation and to follow certain other specific rules relating to adjudication. Imtech referred a dispute to adjudication against LPL for failure to pay pursuant to an interim payment application. In response, LPL claimed that the adjudicator lacked jurisdiction to hear the dispute, as he had not been properly appointed under the terms of the prime contract
Imtech distinguished between primary obligations, such as those relating to the work to be carried out and the manner in which it was to be executed, and secondary obligations, such as those which related to matters including indemnification or insurance. Imtech argued that the extent to which obligations arising out of the main contract were incorporated into the subcontract depended on whether such obligations were primary or secondary. Because adjudication provisions were secondary obligations, there needed to be clear and specific indication that the parties intended to incorporate the adjudication clause into the subcontract. The court found that it was not clear whether the parties had intended to incorporate the adjudication provisions into the subcontract and thus, Imtech was not bound by the adjudication provisions of the prime contract.
Accordingly, under English law, a general incorporation by reference may not actually incorporate certain types of provisions from the prime contract to the subcontract: it may be necessary to draft express language into the subcontract that mirrors the desired provisions from the prime contract, rather than relying on a blanket incorporation by reference clause. Similar restrictions may arise under other local and international laws, and parties are advised to seek the advice of experienced legal counsel when entering into back-to-back agreements on international construction projects.
In short, it is of paramount importance that the parties carefully and comprehensively review the terms and conditions of the prime contract to ensure that all desired provisions are effectively flowed down to the subcontract and are consistent. Although potentially time consuming and tedious, each party should adopt a “walkthrough” or “step by step” approach for tackling each provision and confirming whether incorporation of that provision into the subcontract will be consistent with commercial and legal sense and will truly have the desired effect—regardless of whether the subcontract ultimately incorporates the prime contract by reference or is specifically drafted as a stand-alone agreement.