Case Study: the Contractor and the Sub

contracting risk.jpg Picking up where we left off in The Owner & The Contractor, the contractor now faces a dilemma. The customer wants to switch the projects, and now demands that the contractor move a retrofit forward and a new construction project backward.

Beyond the “make-to-order” manufacturing structure followed by the contractor’s factories, major component systems that the contractor buys from suppliers present scheduling and sequencing problems. Custom engineered and manufactured projects require the "make-to-order” process, so outside purchase items like equipment platforms, welded conveyors, chutes, and maintenance catwalks all add to the scheduling complexity. Not only does the contractor have to juggle manufacturing schedules in its plants, the contractor also has to persuade the suppliers of these other component systems to adjust their manufacturing schedules.

Outsourced Platforms

This project is located in California, a state known for earthquakes. Structural engineering to meet the seismic conditions of the state is complicated by the fact that the building codes for material handling equipment differ from the requirements for buildings. Seasoned material handling systems suppliers know to use specific terms to define and describe the systems to the local municipal authorities when applying for permits.

One example is the use of the term mezzanine to describe an equipment platform or a catwalk. In architecture, a mezzanine is an intermediate floor between the main floors of a building. Architectural mezzanines are often open on one side, overlooking the floor below. These mezzanines are part of the building's structural construction. The industrial mezzanine, however, is a freestanding structure, typically made of steel, installed separate from the building structure. An industrial mezzanine can always be removed from a building.

Most building officials do not know the difference between architectural and industrial mezzanines. California building codes do not draw a distinction between the architectural and industrial versions; the code just refers to mezzanines. The building codes do consider that a mezzanine can hold people, and as such the code requires mezzanines to be built to the same standards as the upper floors of a building, a standard that far exceeds the typical design requirements of industrial mezzanines. So, seasoned material handling equipment suppliers know to use the terms industrial platform or equipment platform to describe these systems, so that the code compliance officers know which of the building codes to apply for permit approval.

While the contractor had built conveyor systems in high seismic zones of California in the past, on this specific project the management team used the term mezzanine in the permit applications and on the drawings submissions. The building department officials, although they were aware of the difference, applied the more stringent code requirements to the equipment structures, requiring substantial redesign and augmentation to the size of the steel members, the foundation footings, and the bracing of the structure. By the time knowledgeable personnel (people outside the contractor's organization) understood the problem, it was too late to change the descriptions on the permit in order to prevent substantial cost and schedule escalation.

Labor Contracting

Many material handling equipment suppliers tend to work with the same groups of installation contractors for on-site labor. The practice supports a close association between the supplier and the installers, providing a level of consistent installation quality. As the installations happen around the country, the installation crews travel to work on site. If a supplier has an established relationship with a local installation contractor, they may use the local resource, but the more specialized the equipment system, the more likely the supplier will use an installer they know can do the work. In most cases, the installers are not licensed construction trades, nor do they carry specialist licenses in the states that require licensed installers.

The contractor in this case follows a different drummer, hiring local contractors for millwright and installation duties. For most of its history in the US, the contractor provided services under the direction and contracting of the general contractor running the project, installing baggage handling systems in airports. These projects typically received federal funds, and therefore required the use of union labor. Millwrights, welders, and structural steel contractors typically are licensed construction contractors, accustomed to the typical construction contracting process.

Because of the past business, the contractor used the general contracting form of contracting. The company has a reputation for being tough, and sometimes unfair or unforgiving toward subcontractors. The company used Installation Services Agreements and Project Services Agreements for contracts. The contract structures used flow-down structures, under which changes in the contracts between the owner and the contractor affected the contracts between the contractor and the subcontractors.

Locating, vetting, and contracting with local contractors for mechanical and electrical installation of the systems requires time and effort at the local level. When the project schedule shifted, the contractor had not completed all of the engineering, let alone completed the search for contractors. With the new deadline looming (a year earlier), the contractor had to hire subcontractors quickly. Without fully vetting their qualifications, the contractor hires a regional conveyor installation company to do the mechanical installation of the bolted conveyor systems, and contracts a local millwright company for the installation of the welded conveyors and chutes.

Opportunity Purchases

Meanwhile, progress on the main system platforms went slowly. The platform suppliers, following the traditional practice of hiring traveling installation contractors, started the hard work of erecting the heavy steel. Because of the schedule changes, the platform supplier could not meet the new deadlines. Under pressure to meet the new schedule, the conveyor contractor orders three other platforms from another supplier who could fabricate and install to meet the schedule.

Labor Contracting and Sub-Contracting Subs

The platform installation subcontractor who won the main platform install did not have sufficient internal crews to execute the project, so the sub hired another company to do the actual work. Multiple tiers of subcontractors—one sub hires another sub who can hire another sub—have become more of a normal practice in the past decade.

In this project, the platform supplier hired Installation Company A to perform the install. Installation Company A placed a project manager on site and hired Subcontractor B to perform the work under Installation Company A’s supervision. To make things more interesting, Subcontractor B did not have any employees, but used contractual agreements with other companies to provide qualified labor from Slovenia and Germany. In this situation, the labor employed to build the platforms also had experience installing conveyors and other automated material handling equipment.

Confused? These levels of complexity are becoming more common on projects as companies employ fewer W-2 employees, instead using independent contractors as single-project employees.

So, in this situation, the Owner contracts:

...the Prime/General Contractor, and they contract to buy a platform from...

...the Supplier, who makes the material, and they contract...

...Installer Company A, which provides project management, and they contract...

...Subcontractor B, who provides direct supervision and tools, and they contract...

...Labor Companies C, D, and E, which provide the direct labor.

Five tiers of contracts define these relationships. The contract between the Owner and the Prime Contractor may be a performance-guided contract, focused on the performance specifications of the systems, and terms and conditions as set by the owner. Certainly the terms and conditions of that agreement include some form of indemnification, putting pressure on the Prime Contractor to pay their bills and ensure that nobody puts liens on the property. You may expect the contract between the Prime and the A-level sub to be a bit less complex, and the contract between the A-level and the B-level to be even less complex, and the contracts between the B and C levels to be even less complex than that.

In this case, the contract between the Prime and the A level sub-contractor rivals the depth in paper of the contract between the Owner and the Prime. A 22-page, two-column, nine-point type, fine-print Installer Services Agreement (ISA) and a 35-page, 12-point Project Services Agreement (PSA) is what the Prime issues to the sub-contractor. Add in over 120 pages of drawings, 20 pages of example forms, and 12 pages of schedule, all referenced on a single page in the appendix of the PSA, and you find a large, complex, and incomplete contract package.

Get below the A level of the sub-contractors and the contracts become much simpler. Agreements become only a few pages, hashing out a few key points like payment terms, reporting, and insurance requirements. In some projects this kind of contracting looks more like purchase orders, because in some cases that is exactly the contract used between the subs of subs.

If complexity can breed mischief due to misunderstanding of the language used in the agreement, then the vagueness of purchase-order contracts can also breed mischief, mainly due to omissions of issues that people want to ignore.

Note: Just as a reminder given the nature of this series, I am a logistician and IANAL (I am not a lawyer).