Practical Law

I have recently returned to private practice from a secondment with a major contractor client, which was an excellent experience as it allowed me to see life very much from the client’s point of view and understand, first-hand, many of the issues that clients face on a regular basis.

One issue that came up several times during my secondment was the “back-to-back” principle when drafting sub-contracts. 

Even on the smallest construction project, some of the construction work will be sub-contracted. In complex construction projects, there are numerous project participants with different capabilities: the contractual arrangements are complex, the contractual chains are long and extensive, and it is very common for sub-contracts and supply agreements to be back-to-back with main contract provisions. In other words, all or part of the obligations of the main contractor under the main contract are replicated in the sub-contract; all or part of the obligations of the sub-contract are replicated in the sub-sub-contract and so on down the contractual chain. The aim of this approach, perhaps obviously, is to avoid gaps in obligations and liabilities among the various project participants and is clearly most advantageous for a main contractor, which may have single point responsibility for all aspects of the project as between it and the employer.

While the back-to-back principle is relatively straight forward and uncontroversial in itself, problems often arise in practice from the way in which the various different contracts are documented. Poorly drafted contracts can be difficult to interpret and invariably give rise to time consuming and expensive disputes.

How to draft back-to-back contracts: some problems

There are three main approaches:

• Using general words to incorporate particular terms of the main contract by reference and expressly excluding or varying other terms, for example those relating to price. While this may have the advantage of being a relatively quick and cost efficient process, there are inherent risks in this approach. The parties are unlikely to have focused in detail on the allocation of particular risks or obligations, it may simply be unclear as to what terms have or have not been incorporated and there are likely to be a number of inconsistencies between the two contracts that will almost inevitably lead to problems of interpretation later on.
• Drafting a stand-alone contract that sets out in detail the particular terms and conditions that are specific to it. This avoids the disadvantages of the “incorporate by reference” approach but will be time consuming, and therefore more expensive, as the parties will need to think carefully about those obligations that will be stepped-down in their entirety, those which will need to be tweaked to fit the particular sub-contract (for example, scope of work, time periods, level of liquidated damages) and those that are not stepped-down at all.
• Using standard form contracts that already include back-to-back provisions in main contracts and sub-contracts. However, my experience is that standard form contracts are nearly always amended to a greater or lesser extent to reflect the parties’ agreed risk allocation or to reflect the particular requirements of the project in question. In these circumstances, the parties may be tempted to contract on the basis of the standard form sub-contract and incorporate the agreed amendments to the main contract “by reference”. This runs the same risk as already outlined when the “incorporate by reference” approach is adopted. In my view, there is no substitute for ensuring that each of the amendments are accurately replicated within the sub-contract, as appropriate. Otherwise, the considerable amount of time and effort spent negotiating and agreeing the main contract may be wasted.

Some pitfalls

This issue was considered in the recent case of Imtech Inviron Ltd v Loppingdale Plant Ltd, in which the court held that the main contract adjudication provisions were not incorporated into the sub-contract.

In that case, the parties adopted the “incorporate by reference” approach although obligations relating to insurance, indemnities and jurisdiction were addressed in separate provisions. This allowed the claimant to argue that the extent to which obligations in the main contract were incorporated into the sub-contract depended on whether they were classed as primary obligations (those relating to the work to be carried out and how it was to be done) and secondary obligations (those which related to insurance and indemnities). The adjudication provisions were secondary (or even tertiary) obligations, as they governed the way in which disputes about substantive rights and obligations were to be resolved and as such, were not incorporated into the sub-contract. The court agreed.

This is a good example of the risks inherent in taking a more “general” approach to stepping-down provisions from one contract to another. Having said that, drafting a stand-alone contract is not a straightforward task. In addition to dispute resolution provisions, there are a number of key provisions that will need to be specifically addressed in the sub-contract and not simply replicated. These include:

• Design development and liability for design (if any).
• Completion dates, relevant events, extensions of time and associated loss and expense.
• Defects liability and associated provisions.
• Limits/exclusions on the sub-contractor’s liability.
• Payment terms.
• Termination events and compensation on termination.
• Interface issues (where there is more than one sub-contract).

What lessons can be learned from this?

There is no hard and fast rule as to which approach to adopt when drafting back-to back sub-contracts. The key lesson is to avoid the temptation to take what may appear to be the easy option: generic wording that seeks to incorporate “all obligations relevant to the sub-contract works on a back-to-back basis” will rarely achieve its intended purpose. In my view, the parties should:

• Take time to agree the appropriate risk allocation and record it in clear, unambiguous terms.
• Think carefully about which obligations and liabilities are to be passed to the subcontractor, which are best left with the contractor.
• Consider what issues need to be specifically dealt with at sub-contract level.
• Consider how any interface risk can be addressed.

This type of thorough and systematic process should be adopted as an integral part of negotiating a back-to-back contract, whichever drafting approach is adopted.