Monday, 9 March 2015

"Incorporation by Reference" – More Dangerous Than it Sounds

Author: Corbin Devlin 

 It is common, almost universal, to find a clause in a construction subcontract that incorporates the prime contract by reference. However, the effects of such a clause can vary greatly. Too often, these provisions are considered boilerplate and they not given the consideration they deserve, by general contractors and subcontractors alike.

Alternate Approaches
These “incorporation by reference” clauses usually leave unanswered questions, particularly whether they are effective to incorporate the general conditions of the prime contract (e.g. payment terms, liquidated damages, dispute resolution, warranty…?) and if so, just exactly how the general conditions of the prime contract apply to the subcontractor.

The most comprehensive clause is one that not only incorporates the prime contract but also expressly binds the subcontractor to all prime contract terms; e.g. “any reference to Owner in the prime contract is interpreted as a reference to the Contractor, and any reference to Contractor is interpreted as a reference to the Subcontractor.” Such language is favored by some general contractors – it is no doubt very protective of the general contractor. CCA1 uses similar language. While such a clause might seem quite explicit, the cases show that such a clause actually leaves much room for dispute when it comes to the legal effect of the prime contract general conditions on the subcontractor. The general contractor’s relationship with the subcontractor is not a mirror image of the owner’s relationship with the general contractor, and so this type of clause leaves room for ambiguity. Ambiguity eventually leads to dispute, which does not benefit the general or the sub.

Another common approach is a relatively simple clause that states, in essence, “the prime contract is incorporated by reference.” This approach is less comprehensive from the owner's perspective. There is a body of case law that indicates such a clause really just incorporates those aspects of the prime contract that have clear application to the subcontractor; i.e. the drawings, specifications and schedule – but typically not the general conditions. Such a clause is therefore less ambiguous than our first example, although it is still open to dispute.

Another approach is to reference (or attach) specific provisions of the prime contract into the subcontract. This selective approach leaves much less room for ambiguity. It requires more work at the drafting stage, and is therefore much less common.

The best practice (in strict legal terms) may be to avoid incorporation by reference completely, by writing a subcontract that reinforces and coordinates with the relevant terms of the prime contract. But such a fulsome approach is usually quite impractical.

The Subcontractor Who Never Sees the Prime Contract
It is all too common that the subcontractor does not actually obtain or review the prime contract terms and conditions that are supposedly incorporated by reference. In such cases, the proper interpretation of the subcontract may depend on whether the subcontractor is in fact given access to the prime contract, or the relevant parts of it.

Sometimes a subcontractor is not given access to the prime contract. There is case authority suggesting that it will invalidate the “incorporation by reference” clause if the general contract denies the subcontractor access to the prime contract. Similarly, if a subcontractor is only given access to parts of the prime contract, the subcontractor has a good legal argument that the “incorporation by reference” is limited to those parts. 

Of course, it is a different scenario if the prime contract terms and conditions are made available to the subcontractor, but  fails to avail itself of the opportunity. Every time a subcontractor agrees to a clause that incorporates the prime contract by reference, without reviewing the prime contract terms and conditions, that subcontractor incurs a considerable legal risk.

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