Negotiate and draft “pass through” clauses you can live with

Owners, contractors, subcontractors and lower-tier contractors must have a sound understanding of the operational details and triggers of “pass-through” provisions as their terms can significantly impact the obligations and risks of performing for lower-tier contractors. 

What is a pass-through clause?

Pass-through clauses (a.k.a. flow-down or conduit clauses), typically incorporate by reference the terms of a prime contract between owner and general contractor into a subcontract, thereby binding subcontractors to the same duties and obligations – and to the same extent – as the general contractor has to the owner. Pass-through clauses may use general “substantially as follows” or “substantially the same as” language, but, importantly they are not uniformly worded and can have the effect of imposing obligations never negotiated or contemplated by the lower-tier contractor. However, when drafted and used correctly pass-through clauses can provide protections to all parties by unambiguously flowing down specific upstream obligations of general contractors to the subcontractors who are actually performing the majority of the work. 

How are pass-through clauses implemented? 

It is in the owner’s interest to bind the subcontractor to the same obligations as the general contractor. For the general contractor, pass-through clauses provide a way of ensuring that subcontractors, suppliers and other downstream parties are required to comply with certain prime contract requirements. 

However, subcontractors may attempt to reject responsibilities flowing down to them when the pass-through terms lack sufficient clarity as to the subcontractor’s specific contractual and compliance obligations. Subcontractors will want to limit or reject overly broad pass-through clauses which – for example – make them assume responsibilities meant for other parties or that incorrectly excuse a prime contractor for its mistakes while still flowing down the responsibility for the mistakes to subcontractors. 

Other pass-through clauses may require that subcontractors be paid by the general contractor when the general contractor is paid by the owner. In such a scenario, a savvy subcontractor will want to reduce the risk of non-payment by negotiating and re-drafting terms to avoid limiting the subcontractor’s rights or remedies in the event of a claim or payment dispute. 

Subcontractors and contractors should work collaboratively to negotiate, revise or remove pass-through clauses that are of concern or to re-balance the risks. 

There are many other scenarios to which pass-through clauses can apply and where their effectiveness depends upon how well all parties can agree on their interpretation, such as: 

  • Who has authority to approve a change order, claim or delay notification and in what form it should be submitted, detailed, and supported by documentation? 
  • Who will have the responsibility for prosecuting a claim against the owner and how the recovery and attorney’s fees will be allocated – whether arbitration or litigation – and which parties will be required or permitted to participate? 
  • What happens if there are pass-through claims of subcontractors (i.e., claims the owner is responsible for) and claims that are only between the general contractor and a subcontractor? 

Importance of properly drafted pass-through clauses

As the “pass-through” language in prime contracts and subcontracts tends to “flow-down” damages, limits of liability or indemnification downstream – from the owner and general contractor level to lower tiers of subcontractors and suppliers – pass-through clauses become no less important than any other terms in a construction contract. 

It is essential that drafters review the prime contract and the complete set of the upstream documents in order to craft effective pass-through provisions. Moreover, well-drafted pass-through provisions should only include terms that already exist in the prime contract; and should not flow down the entire prime contract because doing so introduces contradictions with other subcontract terms. 

To assist parties with drafting pass-through clauses, The American Institute of Architects (AIA), in its A201™–2017 provides subcontractual relations language, used in owner-general contractor agreements, by which contractors can require subcontractors to be bound to the contractors by the same prime contract terms and to assume toward the contractor all the obligations and responsibilities that the contractor assumed toward the owner. It also allows subcontractors the benefit of all rights and remedies against the contractor that the contractor – by the prime contract – has against the owner, and requires the contractor to identify to subcontractors any terms and conditions of the subcontract that may be at variance with the prime contract documents.

Similarly, the AIA’s language establishing the contractual relationship between contractor and subcontractor in the A401™–2017, which cross-references A201–2017, passes “the duties and responsibilities of the Contractor under the Prime Contract to the Subcontractor with respect to a portion of the work designated in the completed A401–2017 document.” 

The enforceability of pass-through clauses in complex construction agreements often hinges on the perceived clarity or ambiguity to both upstream and downstream parties. In order to avoid unintended legal or financial consequences the critical drafting process should be assisted by professionals experienced in commercial law and construction law and with accessibility to all of the upstream and downstream documents.

Pass-through interpretation and enforceability can vary by state

The location of the project plays a significant role in how pass-through language may be interpreted and enforced. Therefore it’s important to understand the nuances of applicable state laws when drafting and implementing pass-through clauses. 

For example, in New York, courts have held that general “incorporation clauses” in a subcontract can only bind a subcontractor to the “scope, quality and manner of the work to be performed by the subcontractor.” While many states take the New York approach, other states do allow a generalized “flow down” of obligations via “incorporation clauses.” And still other states construe all contract documents, including the prime contract, subcontract and all exhibits, together in an effort to harmonize and give effect to all of the provisions of the contract so that none will be rendered meaningless.

Pass-through best practices

Below are a few other examples of best practices that should be considered when reviewing or drafting pass-through provisions:

  • Negotiate pass-through terms at the pre-bid stage so that the costs/benefits of undertaking flowed-down obligations may be factored into bids. 
  • Parties should work collaboratively to address gaps in risk-shifting or risk-sharing and develop acceptable levels of risk. 
  • Limit the requests for pass-through revisions to a small group of terms or issues (and not to the prime terms) to increase acceptance. 
  • Avoid using general “incorporating by reference” language that can be misinterpreted to merely incorporate prime contract for a limited purpose. 

FinPan, Inc. hosts courses on AEC Daily

finpan logoFinPan, Inc. is proud to announce that it now has two courses on AEC Daily. The second course, “Current Trends in Design: Curbless Shower Systems” finished in the AEC Daily Top 20 courses completed for its first month, over the summer of 2018. It placed 5th overall with 159 hours completed by the specifying community. FinPan’s first course, “Water Management Solutions for Traditional and Curbless Shower Pan Installations” is also available online. 

Jeff Ketterer

Jeff Ketterer

“We are pleased to offer architectural and design professionals an objective overview of trends in our industry all while helping to promote the tile industry,” said Jeff Ketterer, Corporate Trainer for FinPan. “The course is an overview of how curbless shower pans are designed for durability and safety, and meet the needs of accessible designs. Discussions on traditional methods and new modern ones are addressed from a design and installation process along with their associated benefits and drawbacks. 

“In today’s digital age, it is critical to provide sufficient resources towards online educational and training portals as they create a far more convenient and timely platform for the specifying community to broaden their horizons and learn about new and innovative products and methods,” he added. “Lunch and learns are still a great educational tool, but the time limitations from both the supplier and specifier sides make them more difficult to set up than ever before.” 

For those companies looking to broaden their reach to architects, interior designers, contractors and other industry professionals, AEC Daily is a great outlet to consider. AEC Daily is a developer and host of online education courses for the construction industry. It is an e-learning provider and is one of the largest sources for free online construction education courses that offer Continuing Education Units (CEUs) for its participants. It provides the opportunity to manage and satisfy CE requirements in a secure, easy-to-use website that is available 24/7. Course completion is automatically reported to applicable industry associations such as American Institute of Architects (AIA), Interior Design Continuing Education Council (IDCEC) and many more
associations.

Several companies in the tile industry already have courses available such as LATICRETE, Noble Company and Tile Redi. Check out AEC Daily online at aecdaily.com to learn more. To learn more about the products offered by FinPan check out their website at
finpan.com.

Is there an information toxic dump in your office?

Does your organization have offices, file cabinets, storage rooms, and offsite facilities full of unidentified paper files and electronic documents? If so, you probably have an “information toxic dump!” Twenty-five years ago most organizations had a “central filing system” and “Mabel” – whose sole responsibility was ensuring that the records that the organization needed for legal reasons were maintained properly. Managers had private secretaries who were paid to make sure that when their bosses were done with the papers in their office, they were transferred (with the help of file clerks) to the central filing system. The central filing system was purged on an annual basis. 

Then Bill Gates made it possible for organizations to put a computer on every desk, and the dynamics of records management changed dramatically. “Mabel” and the file clerks were fired or transferred to other positions. Central File Rooms were turned into offices. The file cabinets were scattered around offices wherever there was space – supply rooms, hallways, and individual offices. Managers were expected to manage their own information and do their own filing. Secretaries became administrators with projects of their own. Soon, records management as it existed began to disintegrate! 

Records management today

Today in most offices, information exists in three “silos” of information:

  1. Individual offices
  2. File cabinets scattered around the office
  3. Office storage rooms and offsite filing facilities

The information in individual offices is managed somewhere between very well or very poorly – depending on the skills of the individual employee – but in any case is rarely available to other members of the organization should the employee who has the information, or filed it, be unavailable.

The information in file cabinets scattered around the office is “owned” by no one in particular. Theses file cabinets primarily contain files no longer needed by individual employees, or left by employees who are no longer there. Even though they often contain information that could be useful, individual employees don’t know it exists, and thus end up creating new information. The information in storage rooms and offsite filing facilities contains vital information that could save money, or cost millions of dollars in the case of an audit or lawsuit. Unfortunately, offsite storage often contains information that should never have gone there, but no one wanted to take the time or effort to clean it out! 

Why records management really matters

Your ability to accomplish any task or goal is directly related to your ability to find the information you need when you need it. Finding information in every organization – regardless of whether it is in paper or electronic format – is becoming an ever-increasing challenge. This inability to find information causes all sorts of problems for the organization and for the individual – wasted time looking for information or recreating already-existing information, missed opportunities, and increased stress, which in turn results in increased health care costs.

Research shows that 80% of the information kept in most offices is never used. Ironically, the more information that is kept, the less it is used, simply because it’s too difficult for employees to find. Often employees can’t even find the documents they themselves created – let alone any information created by another employee – especially someone who is no longer with the organization. As a result, it’s easier to just start over!

Who is responsible for the problem and what can be done about it? 

Blame for the records management debacle falls in several courts:

  1. Management blames employees for the problem.
  2. Employees blame management for the problem.
  3. Organizations don’t have a user-friendly system.
  4. Employees aren’t trained on the filing systems.
  5. Management fails to look at records management as an ongoing activity.

To create and maintain an effective records management program, we must answer the following six questions:

  1. What information should we keep?
  2. In what form?
  3. For how long?
  4. Who is responsible for maintaining the information?
  5. Who needs access to the information?
  6. How can everyone who needs the information find it? 

Now here is the reality: Answering those six questions requires the cooperation of everyone in the organization. It can easily take up to one year, or even longer, to answer them, since accuracy requires addressing the questions over a one-year business cycle at a minimum.

Creating and maintaining an effective records management system 

I’ve developed a five-step process called The Productive Environment Process™, which can be applied to organize information in any organization. 

  1. State your vision. If your records management program is successful, what will you be able to do that you can’t do now? What positive effect will an efficient records management program have on the organization and your customers? 
  2. Identify your obstacles. What currently prevents you from having a successful system? 
  3. Commit your resources. How much time, money, and human resource power are you willing to put into the project?
  4. Design your SYSTEM (Saving You Space Time Energy Money). What tools (software, existing filing systems that work well, etc.) do you currently have that will be helpful in the process? What other tools are available? What processes do you need to apply? A crucial component is applying The Art of Wastebasketry® to eliminate unnecessary records. 
  5. Maintain your success. What procedures do you need to develop and implement so the system you create will continue to work long after the creators of the system are gone? 

Note the common word in those five steps: “Your!” It would be wonderful if creating a records management system was simply a matter of buying a book or hiring an expert who told you exactly what to do. A successful records management program, however, requires people, processes and technology. It must be supported by management, customized for the organization, and executed by everyone in the organization to succeed on an ongoing basis. 

According to an article in the July 2010 issue of Journal of Accountancy, a paperless strategy can yield savings of 30% to 40%. Some of the savings comes from reduced overhead costs, such as what you spend on paper or real estate expenses, while others come from the increased efficiency of working digitally. Every firm is different and the extent to which it goes digital varies, but a paperless strategy will reduce costs and improve profitability, even in ways firms haven’t considered up front. 

Designing, implementing, and maintaining an effective records management program is the best place to start on the road to a “productive environment™” – an organized office in which everyone can find what they need when they need it so they can accomplish their work and enjoy their lives.

As Mark Twain stated so eloquently, “Progress starts with the truth.” The first step is for management to agree on the definition of a successful records management program. It is important that this conclusion be reached with the involvement of administrative staff – because the reality is that often management doesn’t really understand all the information that is necessary for staff to accomplish the objectives that management expects.

© Barbara Hemphill 2010-2018

Trademarks and Registrations are the property of Barbara Hemphill

The change order process – what goes wrong?

Subcontracts issued from the prime contractor (referred to as “contractor” in this article) contain very descriptive language regarding the change order process. The language clearly outlines the process for written direction to proceed and the process to be followed for the issuance of a change order document, required for the subcontractor to invoice and collect payment. Changes to the work can occur in several ways:

  • Owner-initiated request for program change
  • RFI response that results in a change
  • Submittal response that results in a change
  • Value engineering acceptance 
  • Contractor issues a change document (i.e., ASI, CCD, RFQ)
  • Contractor directs work authorization by email

Changes can come rapidly and sometimes several in a day, especially for the contractor. The contractor’s goal is to protect its interest by managing the risk with an efficient method of change management, all the while continuing to perform work to prevent changes from affecting the schedule. The change order approval process and the progress billing process don’t occur as rapidly as the changes that must be put in place. Therefore, the contractor must establish the responsible party for the change, obtain and submit pricing as quickly as possible, and obtain owner approval if necessary. Then the contractor must direct the subcontractors per the terms of their agreement to perform the work with a promise of a subsequently-issued subcontract change order.

What goes wrong?

The problem with this process is the contractor many times can’t come to agreement with owners on the merits of a change. Relationship with the owner, delivery methods, personalities and experience all come into play. The quantity of changes can increase very rapidly, and if the onsite project team doesn’t have the experience or ability to follow the terms of its contract to protect itself and its subcontractors, the project team loses control. In its haste to keep the project on track, it tries  different methods to get the subcontractors to proceed, which can effectively shift the risk of nonpayment to the subcontractor. These methods include: giving the subcontractor’s field foreman verbal vague authorization; not responding to written notifications of change; and giving an incomplete authorization to proceed while being very careful that entitlement or approval of the price or pricing method is not given.

The plan is to coerce the subcontractors into performing the changed work, so if the contractor can’t come to agreement on merit with the owner at a later date, it has effectively shifted the risk of nonpayment to the subcontractor. At that point the contractor can hide behind the actual change provisions of the contract to protect itself by stating that the terms and conditions of the contract were not followed.

Rather than sticking to the change provisions of the contract agreements, a weak project manager will try to be as vague as possible in his direction to proceed, making sure he is not giving direction per the subcontract agreement. That’s why contractors give indistinct responses to tile contractor change requests usually by email and sometimes even verbally stating things like:

  • “PROCEED”
  • “Approved”
  • “Proceed on a T&M basis”
  • “Proceed on your price not to exceed”
  • “You are hereby directed to proceed”
  • “We are directing you to proceed as required by the terms of the subcontract”

These directions are unclear at best and are attempts to get the subcontractor to proceed without agreeing on merit or cost. This allows the discussion on merit to occur after the work is complete. A simple direction such as described above may be a weak authorization to proceed, but it does not grant entitlement or approval of a price. 

What should subcontractors do?

Read the subcontract change order terms very carefully and insist on following the process as described. Use these terms to your benefit if possible. Only proceed with a method allowed by the subcontract terms.

To be as successful as possible in collecting payment requires taking four steps:

  1. Giving proper notice of change to the contractor
  2. Receipt of direction to proceed as described in the subcontract
  3. Written agreement on entitlement to a change order
  4. Agreement on the price or pricing method

The steps do not always occur at the same time, but when subcontractors proceed and incur costs without all four steps being satisfied, they are at risk for nonpayment. Insisting on following the process as described in the agreement puts subcontractors in the best position to collect payment for the change. 

When a contractor is unclear in responding to a request for change, a simple communication asking for clarification should be sent:

Thank you for the authorization to proceed on this Request for Change. It is our understanding that this work is a change to the subcontract and a Subcontract Change Order will be subsequently issued for the price quoted in our Request for Change dated ________. Please confirm that our understanding is correct so that we can proceed, or if we have misinterpreted your direction, please clarify.

With this response the contractor is forced to come clean with his intent and the subcontractor has solidified its position to collect payment. If a contractor will not confirm or becomes agitated in his position, there is a reason. Either he does not have the contractual authority to authorize the change, or has not received the approvals necessary to grant merit. 

Remember, contractors’ project managers will often sway subcontractors to proceed prior to approaching the owner. Subcontractors will vastly improve their chances of collecting payment by understanding the contract, and being alert and disciplined in forcing the contractor to follow the agreement.

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