Pros and Cons in Subletting, Designation, Assignment, Nomination and Novation in Construction Contracts

Sub letting reduces dependency on directly employed labour. It results non-wage cost of employment such as redundancy payment and offsets the risk associated with the responsibility by transferring them. Sub letting is necessary when to employ specialists of proven reliability and repute to face technical complexity involved in a project. There are two distinctly different modes of sub letting that everyone is known to; domestic and nominated.

The domestic subcontract is a direct contract between a sub-contractor and the main contractor where the sub contractors are treated as an internal composition of the main contractor for the purpose of responsibility. This is a form of letting sub-contracts whilst giving the employer some choice where the main contractor is given a list of names of sub-contract companies to whom he may go for that package of works. Usually, the employer may reasonably expect the contractor to progress the work on a domestic sub contract basis with one of the sub contractors put forward by the main contractor. The contractor should be allowed to entertain the benefit of any pre-agreed rates and prices in their domestic sub contract without justifiable objection.

However, the contractor shall not sub-let whole of the works. The ‘subletting’ clause further prohibits sub contracting any part of the work without the engineer’s consent, or unless the contract expressly permits. Engagement of labour on piecework basis is not a subletting by definition so that the contractor does not require consent for provision of site labour. Regardless of any consent, the contractor will be fully liable for the defaults of the sub contractor as if they were the defaults of the contractor himself. Sub contracting with the approval of the engineer does not relieve the contractor of any of his obligations and liabilities whatsoever, which inter-alia refers to quality, workmanship, time, cost and other obligations, whether express or implied. The general principle is that the contractor is responsible for performance of his obligations and cannot excuse his breach by reference to having sub-contracted that part of his performance. This means that the contractor is responsible for performance of all his obligations under the contract who may delegate performance but not responsibility, of course subject to express terms of the contract.

Hence, the contractor must ensure that the works are sub contracted on legal agreements binding the sub contractor in all obligations under the main contract in so far as they are applicable to his part of work. The sub-contract is then intended to create a contractual relationship between parties, in order to allow the contractor to perform part of his obligations under the main contract. Insofar as the sub-contract is intended to create legal relations, it is subject to the same principles which apply to the formation and operation of any contract. If a contractor is to avoid introducing additional risk in sub-contracting the performance of his obligations under the contract, he must take an additional care to ensure that the terms of the sub-contract are consistent with those of the main contract.

If the contractor does sub-contract part of the works without consent, then it may amount to a repudiatory breach of contract where the employer will be discharged from further obligation under the contract including payment, since the contractor's substituted performance will amount to non-performance. The employer will also be entitled to damages for the repudiatory breach. This applies mutatis mutandis to the contractor and sub-contractor.

In contrast, nomination is the process by which the employer nominates, selects or approves a party who will perform a subcontract or specialist trade role under a subcontract with the main contractor. It is a means for the employer to retain some control over the selection of specialist contractor without directly involved in contractual arrangements with the specialist. The employer is able to choose which company he wishes to use and that decision does not necessarily have to be based on price. The timing of the involvement and appointment of the sub-contractor is left to the employer to meet his requirements. The appointment of a nominated sub contractor does not also depend merely because a provisional sum exists.

A reservation is always existing where the contractor may make an objection on reasonable grounds against entering into a nominated sub contract when the nominated sub contractor refuses to accept the terms having a back to back effect (the like obligations and liabilities as are imposed on the contractor towards the employer by the terms of the main contract, except usually the payment terms). The objective of the sub contract is that, so far as possible, the sub contractor must discharge the obligations of the main contractor insofar as they related to the works. These obligations will be both the primary one (the execution of the work) and the secondary one (the obligation to pay damages). Nevertheless, the employer has no direct contractual relationship with the sub-contractor as the sub-contract itself is still placed by the contractor. This option may leave the unsuspecting employer with no remedy against the sub-contractor for default, and the risk of there being no recourse against the contractor either.  However, in the absence of express terms to the contrary the employer may be able to place liability for the sub-contractor’s default on the contractor, who had no choice in the appointment; an outcome which many would regard as unfair. This is why the author believes in a tripartite agreement that is always better than bi-lateral.

The FIDIC recognizes that the failure of nominated sub contractor to perform can have serious consequences for both main contractor and the employer. Therefore, it is important to ensure that the main contractor is prepared to collaborate with him. Thus, the main contractor need not employ anyone against whom he has reasonable objection; or who refuses to enter into a subcontract which: is back-to-back with the main contract; and which indemnifies main contractor in respect of nominated sub contractor's breaches and against the negligence of his workmen and misuse of any temporary works. These rights of veto are crucial, and contractors generally must not feel reluctant to exercise those rights. Thus, the main contractor 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, and the preparedness to commit to completion of its works on a date that coincides with the program.

If the main contractor declines to enter into a subcontract with nominated sub contractor, the engineer will have several alternative lines of action open to him. The engineer can nominate an alternative sub contractor to whom main contractor would not object, or omit the work that is the subject of the nomination from the main contract and have it carried out by an independent contractor as long as the contract allows.

The employer may when the identity of the subcontractor is known at the time of tender, designate a subcontractor in the contract document itself. This is a ‘designated sub-contract’ (DSC) that differs from nominated (NSC) with regard to payment provisions and objection. There are more limited rights of objection by main contractor with regard to a DSC than with regard to an NSC, on the grounds of insolvency, technical incompetence, etc.

An assignment is not a subletting, and vice versa. The underlying considerations are not the same. By assignment, the new occupant - the assignee - becomes the tenant itself. Hence, assignment is making over or transference to another the whole or part of the contract, any obligation, benefit or interest that may be derived under the contract. The ‘assignment’ clause restricts the contractor to make such assignment in full or partial without prior written consent of the employer, except the routing of the monies due under the contract to the contractor’s bankers. Any attempted assignment without consent is therefore amounts to claims by the employer. A contractor who decides to assign without approval therefore takes the risk of his employment being terminated. However, the employer’s consent shall not be unreasonably withheld or delayed and it is also necessary for the employer to remain in a strong position contractually in order to withhold his consent from an assignment.

Assignment differs from novation (discussed later in this article) in so much that the parties to the contract do not change where privity of contract still exists between the parties. The consent of the third contracting party is not necessary. So, a party to a contract (the assignor) is able to transfer the benefit of a performance he is to receive under that contract to another person (the assignee) who is able to enforce performance in his own right, without the consent of the other party (the debtor). Accordingly, a burden of a contract simply cannot be assigned without the consent of all parties simply because the equity acts so as to keep things fair.

There is always an express prohibition against an assignment. The making of an assignment is not a breach of contract because it is an act without legal effect. The assignment is ineffective unless a later consent is given. It is common in leases for a prohibition against assignment save with consent, not to be unreasonably refused. If consent is not sought, it can not be said to have been unreasonably refused. It is no answer that no reasonable objection could have been made had consent being sought.

Probably the most common use of assignment is in relation to collateral warranties. The collateral warranties given by consultants, contractors and sub-contractors are often assigned to subsequent owners or leases. Assignment can do no more than transfer rights available to the assignor; it is not capable of creating new rights in favour of an assignee. Thus while the employer can in theory assign the right to have a building adequately designed for instance, it is unclear what right would be transferred to sue for damages in the event of breach.

The obligations of the contractor are vicariously performed by sub contractors. However the contractor could unless there is a prohibition, assign to another the benefit of the contract. If a contractor has so assigned his rights, there are obvious dangers of solvency and inability to actually complete the works, which is why such assignment is often discouraged. When there is such a restriction on assignment, and a contractor has nevertheless assigned the benefits of the contract, the assignee can not enforce its rights to receive payments with a third party to account to him for the benefits he receives from the other contracting party. 

Under an assignment, the parties to a contract will not change. The transfer will only involve the benefit, not the burden, of a contract. It is an exception to the usual legal rule in that a person who is not a party to the contract is permitted to obtain benefit from that contract. Therefore a contractor can not assign to another contractor the obligation to build and the employer can not assign another party the obligations under its contract this is not surprising otherwise any party to a contract could get out of his or her obligations by the simple expedient of an assignment. If a party to a contract wants to assign its burden, it will have to enter into a fresh contract whereby its obligations will be discharged as against the other contracting party and there will have to be an agreement between the person taking the burden of the contract and the other original contracting party that this is the case. This is novation.

A novation agreement is one by which the parties to a contract agree that one of them should be replaced by another party who will in every respect assume the rights and obligations of the outgoing party as though he had always been a party to the contract. The outgoing party is released from any liability under the contract. Novation makes for a much cleaner break than a simple assignment, especially for the assignor, since once the contract has been novated, he has no further liability under the contract. The new party, on the other hand, could be held liable for some breach of contract which occurred before he became a party to the contract but which is only discovered later. Hence, the body of this agreement usually has three elements. In the first, the new contractor (the assignee) agrees to become a party to the contract and to be bound by all its terms. In the second clause, the employer releases the outgoing contractor (assignor) and accepts the new contractor. The third clause is really there for record purposes, to show payments made to the outgoing contractor at the date of the agreement. It may also be useful to specify any amount which is owing to the employer by the contractor at the novation date and specify if the outgoing or incoming contractor will be responsible for paying it. However this situation can not be confused with the provision where the FIDIC recommends parties to find where they stand financially in a unilateral valuation at the time of contractual forfeiture. What is important is to see whether the ‘clean break’ principle has been secured when contracts are novated and in the mean time, without saying that a novation agreement is not a stand-alone document.