Nominated Subcontractors and Contractors Risk under FIDIC Conditions of Contract 1987 Red Book 4th Edition

Nominated Subcontractors and Contractors Risk under FIDIC Conditions of Contract 1987 Red Book 4th Edition

What is Nomination?

Nomination is the process by which the Employer nominates, selects or approves who will perform a subcontract or specialist trade role which is referred to as a Nominated Sub-Contractor (“NSC”). The NSC then enters into a subcontract agreement with the Contractor (“MC”). It is a means for the Employer to retain some control over the selection of specialist contractor or supplier without necessarily becoming directly involved in detailed contractual arrangements with the specialist.

Where as a “domestic subcontractor” is one in whose selection and appointment the Employer traditionally plays no part other than simply giving consent when that is required under the terms of the main contract. The appointment of the subcontractor is treated as something entirely for the benefit of MC (a “domestic matter”)

Although MC delegates performance of a part of the works to his domestic subcontractors, MC nonetheless remains fully responsible to the Employer with respect to these works. The Employer in no way underwrites the risk of subcontractor default. MC also is directly responsible to the domestic subcontractor for payment and for their fundamental co-operation.

 Why Nominate?

 Nomination is used because there are benefits for the Employer in using the system. The key benefit for the Employer is control over the choice of, and performance required from, NSC. Above all, the Employer reserves to itself the choice of subcontractor.

An NSC may offer the lowest bid or highest quality design input or some combination of price and quality benefits. NSC’s may have a proven track record for good work. The Employer may have developed a long-term business relationship with an NSC. The Employer may wish to use a proprietary system offered by the NSC.

Further, the Employer can, if he wishes, control the terms of the subcontract, including the price and scope of NSC’s work.

Another benefit is the potential for reduced procurement times. Some specialist subcontract work requires a longer lead time than the construction programme would allow such work must be started before MC has been chosen. Nomination allows for continuity when a specialist subcontractor has been selected before the MC is in place.

 Selection Procedure

In FIDIC’s Conditions of Contract for Works of Civil Engineering Construction (4th ed. 1987) (“Red Book 4th”), it recognises that the failure of NSC to perform can have serious consequences for both MC and the Employer. Therefore, it is important to ensure that MC approves of the subcontractor and is prepared to collaborate with him. Thus, MC need not employ just any NSC.

He need not employ an NSC:

                1              against whom he has reasonable objection; or

                2              who refuses to enter into a subcontract which:

                                2a           is back-to-back with the main contract; and

                                2b           which indemnifies MC in respect of NSC’s breaches and against the negligence of his workmen and misuse of any Temporary Works.

These rights of veto are crucial, and MC’s generally must not feel reluctant to exercise these rights.

Thus, MC can refuse the nomination if he has reasonable grounds for so doing. What is “reasonable” must take account of the importance of the timing of the nomination, the effect a post-contract nomination may have on MC’s programme, and NSC’s preparedness to commit to completion of its works on a date that melds with the programme.

Where, however, NSC has been appointed in advance of the Contract date, the right to object may be more limited, provided that appointment was notified to MC beforehand and no objection was made or highlighted as a likely reaction to formal nomination. Indeed the MC agreed to the use of the NSC by entering into a contract in which the NSC was specifically named thus to raise an object at nomination stage would be a breach unless circumstances in respect of the NSC had changed post contract execution.

 If MC declines to enter into a subcontract with NSC, the Engineer will have several alternative lines of action open to him. He can:

                1              Nominate an alternative NSC to whom the MC would not object.

                2              Omit the work that is the subject of the nomination from the main contract and have it carried out by an independent Contractor. There may be claim consequences.

                3              Seek to negotiate more favourable subcontract terms with the NSC.

                4              Subject to MC’s consent, allow the Employer to indemnify the MC against any liability he might suffer from contracting with NSC on the terms NSC will accept.

                5              Direct the MC to carry out the work or arrange for the supply of the goods himself through a variation under Clause 51. This also can have claim consequences in the event the Main Contractor raised objections.

Contractors Risks and their Mitigation

Selection Process

The MC under the provisions of the Red Book 4th Edition may be faced with insufficient description of NSC Works, other than perhaps the inclusion of a Provisional Sum in the Bill of Quantities.

The true nature of the NSC Works and its effect on programming often is only made apparent once the nomination occurs, which may be late on in the MC’s own Works and certainly after the terms of the Main Contract have been settled.

Further, MC may not have a fair opportunity to consider his power of objection to the nomination and/or to make constructive suggestions with regard to an alternative proposal.

A solution to the first problem may be achieved through tailored main contract amendments to the standard form conditions. The solution to the second problem involves contractors asking the right questions during the tender phase.

When the NSC will be placed after MC is selected, then Sub-Clause 59.2 provides the necessary veto right. When, however, NSC will be in place before the main contract tender process, a prudent tenderer will seek full details of the NSC and of the subcontract terms and conditions.

With this information, the prudent MC can consider his attitude to the nomination when there still is room to manoeuvre.

One option for the MC would be to attempt to seek amendment to the Contract Conditions so as to manage the risks

Sub-Clause 58.2 of the Conditions of Contract states:

“Use of Provisional Sums

In respect of every Provisional Sum the Engineer shall have authority to issue instructions for the execution of work or for the supply of goods, materials, Plant or services by:

                a)            the Contractor, in which case the Contractor shall be entitled to an amount equal to the value thereof determined in accordance with Clause 52,

                b)            a nominated Subcontractor, as hereinafter defined, in which case the sum to be paid to the Contractor therefore shall be determined and paid in accordance with Sub-Clause 59.4.”

The Contractor could seek to add the following to this clause.

“If the Contractor suffers delay and/or incurs costs by reason of the issue of an instruction pursuant to Sub-Clause 58.2 in circumstances where the work, goods, materials, plant or services, and/or the timing of the said instruction for the execution or supply thereof (as the case may be) were, in the reasonable opinion of the Engineer, not foreseeable by an experienced contract, the Engineer shall after due consultation with the Employer and the Contractor determine:

                (a)          any extension of time to which the Contractor is entitled under Clause 44, and

                (b)          the amount of such costs, which shall be added to the Contract Price, and shall notify the Contractor accordingly, with a copy to the Employer.”

Defects in Works and Materials

MC is responsible for the acts, defaults and neglects of any Sub-Contractor as fully as if they were the acts, defaults or neglects of MC. One possible exception is with regard to the design of any materials supplied by NSC. However, this is unclear.

The Sub-Contract must, however, specify that when NSC is providing design or specification of any part of the Permanent Works or of any Plant to be incorporated therein, he will save harmless and indemnify MC in connection with any failure to perform such obligations or to fulfill such liabilities’

If MC cannot secure suitable amendment of these provisions, then the problems MC will encounter are:

                1              With the possible exception of the fitness and/or quality of materials used by the NSC under the Red Book, NSC still is a subcontractor of MC for whom MC is responsible to the Employer.

                2              Whilst under the Red Book 4th there may be the protection of NSC’s indemnity with regard to design and specification of Permanent Works, in practice any prudent MC still will need to regard the presence of a design element in a nominated subcontractor with great caution.

The solution most likely to gain acceptance does not involve amendments to main contract conditions. Instead, in line with the principles of objection under both the Conditions of Contract, a part solution lies in subcontract drafting and reasonable objection.

Modifications could include:

.1            On or before the date of this Subcontract, the Contractor has made available for inspection by the Subcontractor copies of the Main Contract (excluding commercially sensitive information). The Subcontractor is deemed to have studied the Main Contract and to be fully aware of the obligations and potential liabilities of the Contractor thereunder. Without derogating from the generality of the foregoing, the Subcontractor is deemed to be fully aware of the adverse financial and other consequences for the Contractor which could arise under the Main Contract in consequence, in whole or in part, of a breach on the part of the Subcontractor of its obligations under this Subcontract (and, in particular, but without limitation, as a consequence of the Subcontract Works failing to be completed in accordance with the requirements of the Main Contract).

.2            The Subcontract shall assume and properly perform, as part of his obligations under this Subcontract, the Contractor’s obligations under the Main Contract in connection with the carrying out and completion of the Subcontract Works and so as to enable the Contractor to fully discharge its obligations under the Main Contract insofar as they relate to the Subcontract Works and so as not to cause to contribute to a breach by the Contractor of the Main Contract.

.3            The Subcontractor shall indemnify the Contractor against:

                (a)          any breach, non-observance and/or non-performance by the Subcontractor of such obligations;

                (b)          any act and/or omission of the Subcontractor which gives rise to the Contractor incurring liability to the Employer; and

                (c)           any claim, loss, damage and/or expense due to, or resulting from, any act, omission, negligence or breach of duty by the Subcontractor.

 and;

1              Insofar as he has not already done so, the Subcontractor shall immediately effect and thereafter maintain throughout the duration of the Subcontract Works:

                (a)          all insurances required under Law, including [Employer’s Liability Insurance] and [Motor Liability] insurance as stated in Appendix __; and

                (b)          until the twelfth anniversary of the Completion Date, professional indemnity insurance, as stated in Appendix __, in respect of his professional duties in the performance of its professional obligations under this Subcontract.

2              The insurances referred to in Clause 1 shall be effected with such insurers, and in such form and substance, as may be approved from time to time by the Contractor.

3              The Subcontractor shall not take any action or fail to take any action or (insofar as it is reasonably within its power) permit anything to occur which would entitle any insurer to refuse to pay any claim made under the insurances referred to in Clause 1.

4              The Subcontractor shall provide to the Contractor, upon reasonable request from time to time, proof (in the form of a letter or certificate from the Subcontractor’s insurer or insurance brokers) that all relevant premiums in respect of the insurances referred to in Clause 1 have been paid and that the policies remain in force and are held by the insured without encumbrance.

The general position underscores the importance to MC of:

                1              Due diligence, i.e. investigating NSC’s capacity to comply with his obligations under the subcontract.

                2              Reliance where appropriate on the right of reasonable objection.

Delay or Disruption of the Works

Under Clause 44 of the Conditions of Contract the extension to the Time for Completion shopping list simply does not include delay caused by NSC as a ground for an extension to the Time for Completion.

If MC cannot secure suitable amendment of these provisions, then the problem that the MC will encounter is that he will carry the risk of delay to the Works and resulting delay costs caused by NSC’s acts, defaults and/or breaches of contract.

The Employer is unlikely to agree to expand the extension of time shopping lists, so an alternative risk management solution is for MC to lay off the exposure to liquidated damages through a specific indemnity in the Subcontract Conditions. Such as:

1              The Subcontractor acknowledges that failure to achieve Completion of the Subcontract Works by the Subcontract Completion Date may cause the Contractor to suffer prolongation and other costs, expenses and losses

2              Without derogating from the generality of Clause .1, the Subcontractor acknowledges that the Employer shall be entitled to recover from the Contractor liquidated damages, calculated at the rate stated in Appendix to Tender to the Main Contract Conditions, if the Main Contract Works remain incomplete at the latest date for completion of the Main Contract Works pursuant to the Main Contract Conditions.

3              The Subcontractor shall indemnify the Contractor for any costs, expenses and losses referred to in .1 hereof and a fair proportion of any liquidated damages referred to in .2 hereof if and to the extent that the delayed completion of the Main Contract Works was caused (in whole or in part) by the Subcontractor, which sums shall be payable on demand as a debt.

Insolvency

It is unclear whether the Red Book 4th requires a re-nomination, and this probably is why we find references to the “named subcontractor.” Named subcontractor provisions represent an attempt by Employers to enjoy the power to select without any duty to re-nominate in the event their “named subcontractor” becomes wholly disabled from discharging subcontract obligations.

Therefore, MC is left to pick up the pieces and procure the completion of the Works.

One promising solution to the risk of NSC insolvency is, bonding.

Nomination practice in South East Asia as a whole and not just Malaysia does tend to lead to complex bonding issues, as the following contemporary scenario illustrates:

                1              The Employer nominated an NSC for a critical portion of the main contract works.

                2              The Employer stipulated to MC the terms and conditions of the subcontract. This did not include providing a bond for the benefit of MC. But, the subcontract required the NSC to procure a bond in favour of the Employer.

                3              MC did not object to NSC and did not independently require NSC to procure a bond in favour of MC.

                4              NSC defaulted, and as a result, MC was faced with additional costs to complete the Works.

                5              The Employer called the bond and, pursuant to the main contract conditions, used the funds to contribute to MC’s additional cost of completion.

                6              NSC reimbursed the bonding company and brought a Court Action against MC for an account of surplus bond monies.

The following addition to the Conditions of Contract would assist in this instance

By adding the following after Sub-Clause 59.1 of the Conditions of Contract this would go some way to prevent such an occurrence.

                “The Contractor shall not be required by the Employer or the Engineer, or be deemed to be under any obligation, to employ any nominated Subcontractor against whom the Contractor may raise reasonable objection or who declines to enter into a subcontract with the Contractor containing provisions:

                a)            that in respect of the work, goods, materials, Plant or services the subject of the subcontract, the nominated Subcontractor will undertake towards the Contractor such obligations and liabilities as will enable the Contractor to discharge his own obligations and liabilities toward the Employer under the terms of the Contract and will save harmless and indemnify the Contractor from and against the same and from all claims, proceedings, damages, costs, charges and expenses whatsoever arising out of or in connection therewith or arising out of or in connection with any failure to perform such obligations or to fulfill such liabilities, and

                b)            that the nominated Subcontractor will save harmless and indemnify the Contractor from and against any negligence by the nominated Subcontractor, his agents, workmen and servants and from and against any misuse by him or them of any Temporary Works provided by the Contractor for the purposes of the Contract and from all claims as aforesaid, and

                c)            that the nominated Subcontractor shall provide to the Contractor a guarantee or performance bond for the due performance by the Subcontractor of all of its obligations under the subcontract in such form acceptable to the Contractor issued by a bank or insurance company satisfactory to the Contractor, such bond to be for [ ] per cent of the subcontract price and shall be released on the date of issue of the final certificate under the subcontract”.

Conclusion

                1              Nomination is a risky process for MC’s, and it is open to abuse by Employers and Consultants.

                2              Contractors should, therefore, tread carefully when nomination is being proposed in construction projects.

MALCONLAW 2011