In this first episode of a special two-part series, Executive Vice President Daniel Frazee and Landscape Group Vice President Drew Garcia, interview Charles Stec, J.D., accomplished attorney at Lanak & Hanna, to discuss how construction companies can best navigate subcontract agreements.

Show Notes: ⁠ ⁠⁠⁠⁠⁠⁠Subscribe to Rancho Mesa's Newsletter⁠⁠⁠⁠⁠⁠

Host: ⁠⁠⁠⁠Daniel Frazee, Drew Garcia

Guest: ⁠⁠⁠⁠⁠Charles Stec

Editor: ⁠⁠⁠⁠⁠⁠Megan Lockhart

Music: "Home" by JHS Pedals, “News Room News” by Spence

© Copyright 2024. Rancho Mesa Insurance Services, Inc. All rights reserved.

TRANSCRIPT

Daniel Frazee: Welcome everyone and thanks for joining us. I am Daniel Frazee, the construction group leader and we're back in StudioOne™ with Drew Garcia, our landscape group leader. Welcome Drew.

Drew Garcia: Dan, good morning. How you doing?

DF: Doing fantastic. We're really excited to be joined by Charles Stec, an accomplished attorney supporting the construction industry with Lanak and Hanna. Charles is here to share his experience in representing California trade and general contractors, which includes several of our clients. And more specifically, I think we're going to get inside two important but very distinct topics, subcontract agreements and indemnification. Welcome, Charles, to StudioOne™.

Charles Stec: Thanks for having me, it's my pleasure.

DF: So before we get started, Charles, tell us more about yourself and how you became so focused in the construction industry?

CS: Well, I actually got my start in the trades. I worked as a roofer back in the 90s and 2000s and worked on a lot of different projects: residential, commercial, public projects. Ultimately I still have and maintain a general contractor's license and when I got into the law I ended up gravitating back to construction both because of my experience but also because I believed as a lawyer that I could help contractor clients navigate the pitfalls of the construction industry by getting involved earlier.

What I've noticed in my practice is that many contractors don't consult with an attorney until something goes wrong and they get sued. And at that point, they've already got the contract, says what it says, the facts are the facts. What I like to do is get involved earlier. And at that point, we can look at contracts, we can look at what's going on in a project, and try to assess risks and minimize risks. So the firm I work for, Lanak and Hanna, were really a one-stop construction shop. We handle everything that's related to a construction business. So from the outset, we handle, for example, the contracts, but also bids during the project, labor issues that might come up. And at the end, collections such as stop notices and mechanics liens, or in the event something goes wrong, defending against a defect or a damages claim.

DG: Very good. Yeah, I think we can relate with your guys’ proactive approach to business and how you're trying to kind of consult with your customers in advance of an issue and obviously when there is an issue reacting to it and making sure that you're there for them. We take a similar approach to the way that we do our business. And when we jump into subcontract agreements you know Rancho Mesa we've got a number of different businesses that we help support. We could have general contractors; we could have trade contractors that are a part of a project. We've also got service contractors that might be subbing out small portions of their work where it might not be as glaring or they might think there's not a need to have a subcontract agreement.

Obviously, it's important. Can you talk to us about why the sub contract agreement is an important step in the relationship between two service partners and how it provides clarity?

CS: Sure, Drew. Let's start with the basic, what is the purpose of a contract? Really the purpose of a contract is to allocate risk by defining the rights and responsibilities between your two service providers to avoid disputes that are caused by misunderstandings or to set forth what's going to happen if something actually does go wrong. So generally what we see a lot of in the most common disputes between contractors and subs or a service provider and their subcontractor is simple things like payments, or what happens when there's extra work. So a subcontract agreement can be used to put those things into writing and set forth those basic terms; what that subcontractor is going to get paid, what the specific items that are included in their scope are, so if there is extra, we can define what is and what isn't extra, and then how that subcontractor is going to get paid. Are they getting paid on a progress payment, or are they getting paid on a lump sum when it's done?

If something does go wrong, the subcontractor agreement also has the benefit of setting forth how it's going to be resolved. For example, if that subcontractor doesn't finish their work or they get terminated, who's responsible for the cost to complete that work? Another example would be if there's an injury or damages that come from their work, how do we apportion that responsibility? And another example after that would be If something does go wrong and we can't resolve it, what's the procedure going to be? Are we going to go to litigation and spend years in court? Are we going to consider arbitration, which might cost us a little more upfront, but could get to a resolution faster?

The main point is a subcontract agreement is giving you an opportunity to allocate your risks, which allows you to better bid a project. If you are taking on a lot more risk, you're probably going to want to charge a premium for that risk. On the opposite side if you are passing that risk on to your subcontractor perhaps then you might be able to bid at a tighter rate. So a subcontract agreement's big main purpose is to really define things so that we know what's going to happen rather than leaving it up in the air.

DG: Well, so that makes sense. And when somebody's putting together a subcontract agreement, maybe it's the first one that somebody like you is putting together for a business. Is it kind of a, “hey, this one agreement fits all types of work that you might subcontract” or should the business look at more of a focused approach in terms of the type of work that they're subbing out or the type of project that they're on? Would that bring any nuance to the subcontract agreement?

CS: It would. So there's really two answers to your question Drew. First, yes, there are many general provisions that you're going to use through all your different types of subcontractors. Those are going to be those basic provisions like price, payment methods, what's the scope of work, how do we handle change orders, what's that procedure and the notice, maybe schedule and your insurance requirements.

But second, there's going to be some provisions that really are specific to the type of work you're subbing out. So take for example, if you're subbing out work where people are working in the ground, they're doing digging, they're doing trenching, they're planting materials. There's a large possibility that you could have unknown obstructions, whether there's big rocks or boulders in the ground or there's an unidentified utility. You might want to have a provision then that's going to assign who's responsible for those unknown encounters? Is it going to be the subcontractor who's then going to price it higher to deal with their risk of the unknowns? Or is it going to be the general contractor? Or is it going to be the owner? And that's going to affect both your pricing and bidding on the project, but it's also going to affect when that comes up, how do you deal with that dispute? Having that provision in place allows you to have the answer so you don't actually have to have a dispute and go to litigation.

Comparatively let's imagine that your subcontracting out work like roofing or windows or plumbing. Those come with the possibility of a water intrusion claim, there could be a leak there could be a burst pipe. So first and foremost we think well damages from that would probably be covered by insurance but there are other things that aren't and that's going to be those incidentals. For example, if you have a plumbing leak and it's in a residence or in a business, there's a possibility that owner is going to make a claim for loss of use or for a loss of profits because they haven't been able to operate their business. What we would want to then consider is whether or not you should have a consequential damages waiver that essentially says if there's these other indirect costs like the loss of use or like the loss of profits, who's going to be responsible for that? Is that going to be the owner or is that going to be the contractor or the subcontractor that caused the damage? And again, that's going to allocate to you how do you want to price this project? Because your bid is probably going to be affected by how much risk you're taking on. So those are two possible provisions that you might want to make more specific to your individual subcontractors and the type of work that they're doing.

DG: Got it. So obviously having open dialogue with a professional like yourselves in terms of what the project might look like for the business helps to kind of cater to the subcontract agreement or the specific needs of that agreement.

So in general, how often should somebody relook at their, the general provisions of their subcontract agreement that might be unanimous across all of their agreements? Is it an annual thing, bi-annual? Is there a recommendation in terms of how and those things should be re-looked at and revisited?

CS: Well, we generally recommend having your contracts re-looked at yearly. Now, some years there might be nothing to change, but other years there could be. The issue is the law is constantly evolving. So what the regulations are out there, whether it's from the CSLB or it's going to be from decisions from the court, are going to change over the years.

Let's take example, most common thing, pay. In the last several years, we've seen many revisions. Going back, not long ago, if paid provisions were allowed, which essentially said that the contractor and the subcontractor would share the risk that the owner doesn't pay. California has since prohibited those and said, no, that's not reasonable., it's against public policy, we want subcontractors to get paid. So now those are prohibited. Yet I still see them in contracts all the time that haven't been updated.

Similarly, California does allow pay when paid, which says that the subcontractor’s payment can be delayed until the contractor is paid by the owner. We saw just in the last couple of years, the court come back though and find one scenario where it decided to limit those provisions. And specifically, it was a lot of these provisions were being written to say that if the owner and the prime contractor got into a dispute, that the subcontractor had to wait to get paid until that dispute, whether it was litigation or arbitration, was resolved. Courts came out and said, that's not reasonable because it potentially makes that subcontractor who may have nothing to do with the dispute have to wait for payment for even years until that litigation is resolved. So the court said now that “pay when paid” provisions have to be reasonable. So I've been recommending in the last couple of years’ revisions to contracts to define what that reasonable period is.

So the answer to your question is ultimately contracts should probably be reviewed yearly. Some years it's going to be more, some years it's going to be less, but you want to stay up to date with the current codes, the current decisions, and the CSLB rules that are ever changing.

DG: Very nice. Now that makes sense. Last question, last subcontract question for you. So obviously having them is important, making sure that they are catered towards the work that you guys are, that you're putting into place. You know, I think the answer is probably obvious on this, when should that subcontract agreement be signed? But I'd like you to comment on that, but also what are some pitfalls if they're not signed before the project takes off? What are some concerns or what could that create in terms of, you know, future issues or maybe more immediate issues if that agreement isn't in place before the project takes off?

CS: Well, I think starting off, I would say what we've been talking about assigning risk and responsibility is really going to impact your pricing. So I would recommend having those agreements signed early.

What a lot of my contractor clients have been doing is they're doing master subcontractor agreements where with the regular vendors that they're using, they have an overall agreement that sets forth the terms and conditions and their assignment of risk and how they're going to deal with problems that they typically would foresee in an agreement that gets signed long before there's ever a job in place. Then when there's a particular job, they'll issue a purchase order and that purchase order will just incorporate the terms and conditions of that master subcontractor agreement. That's a really good place to be because then when you are bidding on a project, you already know how you are allocating risk amongst yourself, your subcontractor, and the owner, and you can price accordingly.

DG: Yeah. Again, it makes total sense.

DF: Okay. Well, tell us if people need to connect with you, what's a good way to start the dialogue?

CS: Again, thank you for having me here today. I can be reached at my office, it's (714) 451 -7919. Send me an email, that's cksetc@lanak-hanna.com or you can go to our website, which is Lanak-Hanna.com.

DG: Thank you again and thanks to our listeners for joining us and we'll see you next time.