Subcontracts and Multiparty Arbitration in Construction Disputes

Given the large number of parties and interrelated agreements, including subcontracts, involved in construction projects, any dispute that arises in a main contract may have repercussions in the subcontract and can give rise to parallel arbitration proceedings.

In this chapter we discuss the use and importance of subcontracts in construction law, as well as their relationship to the main contracts. We then discuss the circumstances that give rise to multiparty arbitration in construction disputes. In doing so, particular attention is given to the FIDIC conditions of contract and subcontract for construction.

The importance and function of subcontracts in construction

International construction contracts have become invariably more complex. In practice, it is not easy for one contractor to have the technical expertise to undertake the whole of works. Thus, it is technically and financially more efficient for contractors to employ subcontractors to provide material or to execute parts of the works.^[2]

The use of subcontracts is also important for the employer, who only needs to enter into a single contract and obtain a single price for the whole works, including the price for subcontracts.^[3]

The main contract and subcontract in a construction project are typically interrelated, and in essence, a subcontract is concluded in view and in the light of the main contract.^[4] In a typical build-only contract, for example, the subcontractor will have to work on the basis of drawings submitted by the employer, whereas in a design-and-build contract, the subcontractor will have to work on the basis of the specifications given by the employer.

Moreover, changes affecting the main contract will usually affect the subcontract and vice versa. For example, any delay in the performance of the subcontract may give rise to liability of the contractor under the main contract. Similarly, if the employer requests a variation, this may affect the scope of works for the subcontractor.^[5]

Such interrelation can also be evidenced by explicit references in the subcontract to the main contract. In a subcontract, there are typically references to the main contract as well as the role of the engineer and the employer from the main contract and vice versa.^[6]

However, despite their close interrelation, the main contract and the subcontract for construction are typically separate. No multiparty contractual relationship is established between the employer, the contractor and the subcontractor. Similarly, no direct liability between the employer and the subcontractor arises, unless the contractual arrangements of the parties or the national law provide for it.^[7]

In effect, the several parties, namely the employer, contractor and subcontractor or subcontractors, form a notional ‘contractual chain’ whereby each party is bound by rights, duties and liabilities with regard to the party that it is linked with. The two parties at the end of this chain have no contractual relationship. However, every chain is as strong as its weakest link. Thus, if the two sets of contracts (employer–contractor and contractor–subcontractor) are not properly aligned in terms of contractual rights, duties and risks, the contractor may be exposed in risks and liabilities under the main contract, which it may not be able to pass on to the subcontractor under the subcontract.^[8]

For example, in the Canadian case of Smith v. Johnson Bros,^[9] the main contract provided for the right of the employer to suspend the works, in which case the main contractor would be entitled to claim extension of time, although not additional costs for suspension.^[10] The subcontract equally provided for the right of the main contractor to suspend works, but provided that in such a case the subcontractor would be entitled to both extension of time and costs for suspension. When the employer suspended the works, the contractor claimed extension of time from the employer under the main contract, but was faced with a claim for both extension of time and additional costs and expenses from the subcontractor under the subcontract.

There are two different types of subcontractors: domestic subcontractors and nominated subcontractors. A domestic subcontractor is chosen by the main contractor, whereas a nominated subcontractor is selected by, or agreed with, the employer under nomination agreements in the main contract.

Opting for a nominated subcontractor may be advantageous to the employer as well as to the contractor. From the employer’s point of view, nominated subcontractors allow the employer or the engineer to be involved in the choice of a specialist subcontractor and, thus, offer better control on the quality of the subcontractor’s work or the materials used.^[11] A nominated subcontractor may also save time, as the employer may identify the subcontractor before the conclusion of the main contract and inform the main contractor at the time of tender about the suggested choice of the subcontractor. If the employer intends to use nominated subcontractors, this should be made clear in the tender documents to give the contractor the opportunity to take this into account when pricing for the project.^[12]

From the contractor’s point of view, the contractor may want to involve the employer in the selection of the subcontractor in order to minimise its risk and liability from the subcontractor’s work.^[13] Whether this would be possible will depend on the factual circumstances surrounding the process of selection of the subcontractor and any direct contact that the employer may have had directly with the subcontractor.

A new provision in the 2017 FIDIC Red Book is Sub-Clause 5.1, which requires the contractor to obtain the engineer’s prior consent to all proposed subcontractors, except for suppliers of materials or (obviously) for nominated subcontractors. As is further stated in the provision, if the engineer does not respond within 14 days after receiving the contractor’s request, including details of the proposed subcontractor, objecting to the proposed subcontractor, the engineer shall be deemed to have given its consent.

In all cases, a nominated subcontractor cannot be selected by the employer against the contractor’s wishes. Clause 5.2.2 of the 2017 FIDIC Red Book, for example, provides that the contractor shall not be under any obligation to employ a nominated subcontractor against whom the contractor raises a reasonable objection by notice to the engineer no later than 14 days after receiving the engineer’s instructions, with supporting particulars.^[14] Reasonable objections include where the subcontractor lacks sufficient competence, resources or financial strength; or where the subcontractor insists on terms of the subcontract that are not aligned with the main contract, and that may leave the contractor exposed to liability against the employer, which the contractor cannot pass on to the subcontractor; or where the subcontractor does not agree to indemnify the contractor in case of negligence or misuse of goods by the nominated subcontractor, its agents and employees.^[15] If the contractor objects to the nominated subcontractor, the employer may be able to overcome such objection by agreeing to provide an indemnity to the contractor with respect to the contractor’s grounds for objection.^[16]

As mentioned above, there is no direct liability between the employer and the subcontractor and there is no multiparty contractual relationship in a typical contract–subcontract scenario. Thus, the contractor is usually liable to the employer and the subcontractor is liable to the contractor.^[17] These types of distinct liabilities under the two contracts are usually achieved by well-drafted back-to-back contracts.^[18] An example is the FIDIC Conditions of Subcontract for Construction, which were first published in 2011 to be used in conjunction with the 1999 FIDIC Conditions of Contract for Construction and now the 2017 edition.

The 1999 FIDIC Contract and the FIDIC Subcontract have 20 clauses each. ^[19] While the 2017 FIDIC Contract has 21 Clauses, they are very similar in content and structure to the FIDIC Subcontract clauses.^[20]

Instead of being drafted in back-to-back terms, some contracts and subcontracts purport to be aligned by importing provisions of the main contract into the subcontract by reference. However, incorporation by reference requires clear and express language as to what are the specific rights and duties incorporated in the subcontract.^[21] For example, in the case of Lafarge Redland Aggregate Ltd v. Shephard Hill Civil Engineering, the subcontract made extensive references to the main contract, including an obligation of the subcontractor to read and note the provisions of the main contract. The question before the English court was whether such references might establish direct liability of the subcontractor with regard to the employer. The court held that there was no privity between the employer and the subcontractor, and that while the provisions in the main contract may have had an important bearing on the contractual relationship between the contractor and the subcontractor, they did not establish a contractual relationship of any kind between the employer and the subcontractor.^[22]

While back-to-back contracts ensure that the rights and obligations of the parties under the main contract and the subcontract are aligned, no direct liability will arise between the employer and the subcontractor. As is now provided in Clause 5.1 of the 2017 FIDIC Conditions of Contract for Construction (Red Book), ‘the Contractor shall be responsible for the work of all Subcontractors, for managing and coordinating all the Subcontractors’ works, and for the acts and defaults of any Subcontractors, any Subcontractors’ agents or employees as if they were the acts or defaults of the Contractor’.^[23] The provision does not distinguish between domestic and nominated subcontractors, and is applicable to both.^[24]

Such wide and strict liability under FIDIC is not the case under some national laws. For example, English law provides that a contractor is not necessarily responsible for any design carried out by a nominated subcontractor, or for whether the subcontractor has complied with the performance specifications of the goods and materials.^[25]

Given such strict liability, any breach by the subcontractor of the contract may lead to a breach of the contractor under the main contract. This is why the subcontract will invariably include a clause providing that the subcontractor in such circumstances will indemnify the contractor.^[26]

Other clauses in the FIDIC Subcontract for Construction aim to align the rights and duties of the parties under the subcontract with those of the parties under the main contract.^[27] For example:

• Sub-Clause 1.8 of the FIDIC subcontract ensures that the same laws and language will govern both contracts;^[28]
• Sub-Clause 1.10 ensures that there is no privity between the employer and the subcontractor;^[29]
• Sub-Clause 2.2 provides that the subcontractor shall perform and assume all obligations of the contractor under the main contract other than where the provisions of the subcontract otherwise require, and execute the subcontract works and remedy any defects in such a manner that does contribute to any breach by the contractor of his obligations under the main contract;^[30]
• Sub-Clause 2.3 provides that instructions and determinations of the engineer must be notified to the subcontractor ‘as contractor’s instructions’;^[31]
• Sub-Clause 2.4 provides that the subcontractor shall have the same rights and remedies that the main contractor has under the main contract;^[32]
• Clause 8 coordinates the progress of the main contract and the subcontract and is aligned with the provisions in the main contract;^[33]
• Clause 14 passes the risk for delay in payments by the employer to the subcontractor;^[34] and
• Sub-Clause 14.6 endorses the ‘pay when paid’ method.^[35]

Similarly, the 2017 FIDIC Conditions of Contract for Construction (Red Book) include some provisions pertaining to the subcontract, notably Sub-Clause 5.2.4, which entitle the engineer to require the contractor to provide evidence that it has paid the nominated subcontractor the sums due under the payment certificates. If the contractor fails to submit such evidence, the employer is entitled under FIDIC to directly pay the nominated subcontractor and request the contractor to repay such amount.^[36]

As previously mentioned, direct claims or remedies between the employer and the subcontractor may be possible where the applicable national law provides for direct remedies.^[37] Direct claims or remedies are also possible if (under certain factual circumstances) the subcontractor can be held liable against the employer on the basis of an implied warranty with regard to the employer, or a direct collateral agreement between the employer and the subcontractor can be established.^[38] Thus, for example, in the case of Shanklin Pier v. Detel Products, where the owners entered into a contract with the contractors to repair and repaint a pier that was demolished during the war. The subcontractor met with the employer for the purpose of obtaining the contract for the repainting of the pier. During the meeting the subcontractor made certain warranties, including that it should have a life of at least seven to 10 years. The issue before the court was whether an enforceable warranty could arise between parties other than the parties to the main contract. The English court held that the employer was entitled to recover against the subcontractor for breach of an express warranty, notwithstanding that the contract was concluded between the contractors and the subcontractors.^[39]

Finally, direct claims may be possible if a duty of care is established by certain representations on the part of the subcontractor, as was the case, for example, in IBA v. EMI.^[40] In this case, EMI agreed to construct a television mast for IBA. EMI employed BICC as their subcontractors to design and execute the construction of the mast itself. Upon the collapse of the mast, IBA alleged breach of contract against EMI and BICC and alleged a breach of warranty directly against the subcontractor, BICC. Based on certain representations made by BICC in a letter it had sent to IBA, the court found that such communication between the employer and the subcontractor had established a duty of care to the employer and made the subcontractor directly liable with regard to the employer.

Multiparty arbitration in construction disputes

The completion of a construction project may involve several parties and interrelated agreements and any dispute between the employer and the contractor, for example, may often be based on the same facts and may raise similar legal issues in a dispute between the contractor and the subcontractor. in the same project.

While multiparty arbitration proceedings involving an employer, a contractor and a subcontractor may be difficult to have because of the distinct and, typically, bilateral nature of the main construction contract and the subcontract,^[41] it may be (under certain circumstances) in the contractor’s interest to make sure that one single tribunal decides all disputes that it has against the employer and the subcontractor.^[42] This is because it is the contractor who has the risk, for example, to recover in a subsequent arbitration from the subcontractor any amount of liquidated damages it may have been awarded in favour of the employer in a previous arbitration.

By contrast, the employer will generally have little interest in multi-party arbitration that involves subcontractors and will be able to hold the main contractor fully liable without concern of whether the main contractor will be able to pass on its claims to any other responsible party. As is rightly noted:

[I]f [the employer] is to defend claims, he would prefer to defend claims from a single source, namely the main contractor. The employer may fear that a multiparty arbitration procedure will be open to abuse by a recalcitrant party, given that it increases the opportunity for procedural objections. Furthermore, should he need to advance claims, he may well hope to be able to hold the main contractor fully liable, leaving him to pursue claims against the other parties involved.^[43]

Having said that, the employer may want to bring an arbitration claim against the subcontractor directly if, for example, the contractor has become insolvent,^[44] or if the employer can establish a direct duty of care or a direct claim against the subcontractor.^[45]

While a party may want a single tribunal to decide all disputes between an employer, contractor and subcontractor, multiparty arbitration will only be possible if all parties consent to it, either before the dispute arises or after it has arisen.^[46] Consent for multiparty arbitration before the dispute arises may be established if the arbitration clauses in the main construction contract and the subcontract expressly allow for multiparty arbitration, or if the applicable arbitration rules provide for multiparty arbitration.^[47]

In non-construction arbitrations, tribunals under certain circumstances may ascertain implied consent for multiparty arbitration on the basis of different legal doctrines such as agency, assignment, third-party beneficiary, incorporation by reference, alter ego or equitable or arbitral estoppel.^[48] Under these doctrines, an arbitration agreement between two parties can be ‘extended’ to bind a non-signatory party. However, under typical construction contracts and subcontracts, it is unlikely that an arbitration agreement in the main construction contract between the employer and the contractor can be ‘extended’ to bind the non-signatory subcontractor under any of the above legal doctrines. Unless exceptional factual circumstances exist, arbitral tribunals will not usually find a subcontractor to be, for example, the principal of the main contractor, or the assignee^[49] or the third party beneficiary of the main contractor, or the alter ego for the main contractor.^[50]

If all the relevant parties (employer, contractor and subcontractor) wish to resolve their dispute in multiparty arbitration proceedings, it is safer to enter into a single (umbrella) arbitration agreement, or to enter into two identical arbitration clauses (one between the employer and the contractor and one between the contractor and the subcontractor) that expressly provide for multiparty proceedings under certain circumstances. While umbrella arbitration agreements are not typically used in construction contracts, identical arbitration clauses providing for multiparty proceedings are not uncommon.

If the employer, the contractor and the subcontractor wish to enter into two identical arbitration clauses, they should be aware that unclear drafting may lead to confusion or disagreements.^[51]

For example, in City & General v. AYH,^[52] the main contractor, Kier, agreed to carry out works of refurbishment and rebuilding. City & General (CG) entered into a building contract with Kier (the main contractor) for the refurbishment and building of the former Patent Office Library in London, and appointed AYH to act as a project manager.

The contract between CG and AYH included an arbitration clause providing that any dispute would be referred to arbitration by a single arbitrator, and that if the dispute raised issues that are the same as, or connected with, issues raised in related disputes between either party and a third person, already referred to arbitration, the parties agreed that the dispute under the deed would be referred to the arbitrator appointed to determine the related dispute.

When a dispute arose between CG and AYH, an arbitrator had been appointed in relation to arbitration between CG and Kiev. CG and AYH disagreed as to whether their dispute raised issues that ‘were the same as, or connected with, issues’ raised in the arbitration between CG and Kiev and therefore whether it should be referred to the arbitrator appointed to determine the dispute between CG and Kiev. Relying on Judge Humphrey Lloyd’s decision in Trafalgar House Construction (Regions) Limited v. Railtrack,^[53] Justice Jackson noted that the arbitration clause was unclear and that, accordingly, it was proper to have regard to the commercial purpose of the arbitration clause – namely, to avoid multiplicity of proceedings. Noting that if a material portion in both disputes is connected, it makes commercial sense for both disputes to be dealt with by the same tribunal, Justice Jackson found that a number of issues in the arbitration against AYH were substantially the same as, or connected with, issues arising in the arbitration with Kier. He therefore ordered that the arbitrator who was appointed in the arbitration between CG and AYE be appointed in respect of the arbitration between CG and AYH.^[54]

The FIDIC Conditions of Contract and Subcontract include compatible dispute resolution clauses to achieve coordination between disputes that may arise under the main contract and the subcontract. For example, Sub-Clause 20.1 of the FIDIC Conditions of Subcontract provides that whenever the contractor is required under the FIDIC conditions of the main contract to give any notice or information to the engineer or the employer or to keep contemporary records, the subcontractor shall also give a similar notice or other information in writing to the contractor and keep the contemporary records that will enable the contractor to comply with the terms of the main contract. Similarly, Sub-Clause 20.2 of the FIDIC Conditions of Subcontract provides that if the subcontractor considers itself entitled to any extension of the subcontract time and any additional payment under the terms of the subcontract, the equivalent provision of Sub-Clause 20.2 of the main contract will apply, save that the period of notice for the subcontractor’s claims shall be no later than 21 days after the subcontractor became aware or should have become aware of the relevant event or circumstance giving rise to the claim. Such periods (and the period for the subcontractor to substantiate its claim) are deliberately shorter than the periods for the main contractor to give notice (and substantiate its claim) to the engineer under the main contract.^[55]

However, while under Clause 21 of the 2017 FIDIC Conditions of Contract and Clause 20 of FIDIC Conditions of Subcontract the dispute resolution processes under the two contracts are coordinated, they remain separate and distinct.

Thus, under Clause 20 of the FIDIC Conditions of Subcontract, if the subcontractor has a claim against the contractor, the contractor will make a fair determination of the claim.^[56] If the subcontractor is not satisfied with the determination, the dispute will be referred to the dispute adjudication board (DAB) of the subcontract.^[57] The contractor must then decide whether the dispute is related or unrelated to the main contract. If, according to the main contractor, the dispute under the subcontract is unrelated to the main contract, either party (i.e., the main contractor or the subcontractor) shall be entitled to refer the subcontract dispute to the DAB under the subcontract.^[58] If either party issues a notice of dissatisfaction against the decision of DAB under the subcontract, the main contractor and the subcontractor shall attempt to amicably settle the dispute and then proceed to bilateral arbitration.^[59]

If the contractor considers that the dispute under the subcontract involves an issue that is related to a dispute under the main contract, then in any notice of dispute given by the contractor or within 14 days of receiving a notice of dispute from the subcontractor, the contractor may notify the subcontractor, with reasons, that the dispute is related to a dispute under the main contract. In such a case, the parties shall not be able to refer a dispute to the DAB under the subcontract for a period of at least 112 days or as agreed between the parties. If the subject of the subcontract dispute has not been previously referred to the DAB under the main contract, the contractor shall refer such dispute to it, and the subcontractor shall afford the contractor all information that may be reasonably required to enable the contractor to pursue it, which includes the subject of the subcontract dispute.^[60] After the DAB under the main contract issues its decision (or if the period that the parties have agreed to defer any referral to DAB under the subcontract expires), each party has different options: the contractor is entitled to refer the subcontract dispute to the DAB under the subcontract, while the subcontractor has the option of either referring the subcontract dispute to the DAB under the subcontract or go straight to arbitration.^[61]

While the decision of the DAB under main contract will not be binding on the subcontractor or the DAB under the subcontract,^[62] the latter will invariably take it into account to decide the dispute between the contractor and the subcontractor. However, if the two disputes proceed to arbitration (under the main contract and under the subcontract), they will not be consolidated or otherwise harmonised, even if they are ‘related’.

Overall, the default Clause 20 under the FIDIC Conditions of Subcontract provides for a harmonised dispute resolution process only during the DAB phase. The referral of a dispute to the engineer (or contractor) and the arbitration procedure remain parallel procedures under the two contractors without any possibility of multiparty proceedings. Prominent commentators have criticised this approach noting that ‘If the sole goal were saving time and cost and avoiding inconsistent results, all disputes between the employer and/or the contractor and/or the subcontractor should be decided by a single DAB and a single arbitration procedure in which all three parties could participate.’^[63]

In addition to the default provision of Clause 20, the Appendix of the FIDIC Conditions of Subcontract provides for two alternative dispute resolution processes that the parties may agree to follow. In such case, the parties will have to amend default Clause 20 and incorporate one of the two alternative options.^[64] Under the first option, the dispute resolution process under the subcontract does not include a subcontract DAB: where a dispute arises, the contractor and the subcontractor will attempt to amicably settle the dispute and, failing any amicable solution, will refer their dispute to arbitration.^[65] If parties opted for this alternative dispute resolution process, there will be no harmonisation or coordination of the two processes at any stage.

Alternatively, the Appendix provides for a complex procedure with an aim of binding the subcontractor to the decision of both the DAB and the arbitration award under the main contract.

Specifically, within seven days after receipt of a subcontractor’s notice of claim, the contractor must notify the subcontractor of whether the subcontractor’s claim will be treated as related or unrelated to the main contract claim. Any disputes about whether the claim is related or unrelated will be resolved under the ICC Rules for a Pre-Arbitral Referee Procedure.

If the claim is treated as related, the contractor will submit a notice of the claim to the engineer under the main contract with the subcontractor’s support. If the contractor becomes entitled to extension of time and additional payment under the main contract, the contractor will have to pass on an appropriate share of the benefit to the subcontractor.

If the contractor wants to challenge the decision of the engineer, it may refer it to the main contract DAB and give the subcontractor a reasonable opportunity to be involved in the resolution of the dispute, including in the preparation of submissions, attending the hearing before the DAB and making oral submissions. When the DAB issues its decision, the contractor must notify the subcontractor within seven days, and unless the subcontractor issues a notice of dissatisfaction, the DAB decision will be deemed binding on the subcontractor. However, if the subcontractor is not satisfied with the DAB decision, the contractor may either give a notice of dissatisfaction under the main contract or disagree with the subcontractor. In this case, the dispute will be considered as being unrelated to the main contract and will be decided between the contractor and the subcontractor through amicable settlement and ICC arbitration.

After the contractor issues a notice of dissatisfaction, the contractor and the employer will attempt to resolve the dispute amicably under the main contract, with the involvement of the subcontractor. Failing an amicable settlement, the dispute will be referred to arbitration under the main contract, in which case the contractor will have to keep the subcontractor informed and, crucially, give the subcontractor a reasonable opportunity to participate. In all cases, the contractor will notify the subcontractor of an award within seven days, and the award will be binding on the subcontractor as it is binding on the contractor.

Overall, while the third alternative aims to produce an efficient means to resolve related disputes, it is highly complex and is likely to give rise to many issues, with anecdotal experience so far showing that it is not generally preferred by parties.

Arbitration rules allowing for third-party claims

Multiparty arbitration may be allowed where the applicable arbitration rules provide for third-party claims. Not all arbitration rules contain multiparty provisions. While some rules merely provide that multiparty proceedings are allowed where the parties consent to such joinder,^[66] Articles 7–10 of the ICC Rules of 2012 include detailed provisions that may allow:

• the joinder of a third party;
• claims based on multiple contracts; and
• the consolidation of multiple arbitrations.

Thus, the ICC Rules allow the joinder of an additional party, such as a subcontractor, if a request is made to the Secretariat before the confirmation of the tribunal, and the request must indicate the legal basis for the joinder. Joinder will be allowed if the Secretariat is prima facie satisfied that there is an arbitration clause that may be binding on all parties.^[67] If the Secretariat refuses the joinder, the party may ask a national court to determine whether the arbitration clause is binding on the non-signatory third party.^[68]

If joinder is allowed, claims may be made by any party against any other party, provided that they are made before the terms of reference are signed.^[69] Moreover, claims arising out of or in connection with several contracts may be made in a single arbitration, regardless of whether such claims are made under one or more than one arbitration agreement under the ICC Rules.^[70] This may apply where, for example, an employer has signed several contracts with different contractors and the contracts include an ICC arbitration clause.

Finally, the ICC Court may allow the consolidation of multiple arbitrations where:

• all the parties have agreed to consolidation;
• all of the claims in the arbitrations are made under the same arbitration agreement; or
• where the claims are made under more than one arbitration agreement if the arbitrations are between the same parties, the disputes arise in connection with same legal relationship and the arbitration agreements are compatible.^[71]

On a related note, multiparty arbitration may raise problems in relation to the constitution of the arbitral tribunal. The right to appoint an arbitrator is a sacrosanct right in international arbitration and remains instrumental in multiparty arbitration.^[72] This was confirmed in the well-known Dutco case where the French Court of Cassation invalidated an award where two respondents jointly nominated an arbitrator while reserving their right to challenge such appointment, and provided that parties should be treated equally in the constitution of arbitral tribunals. Arbitral institutions, including the ICC, have amended their rules in order to comply with this principle.^[73]

Where consent is not ascertained, it is generally difficult to have multiparty arbitration. In such cases, the parties may opt for appointing the same arbitral tribunal in the related proceedings^[74] or request concurring hearings^[75] in order to avoid inconsistent decisions regarding intertwined issues.

Notes