Understanding Contracts: The Contractor and Subcontractor
Let’s face it: there comes a point when we realize we can’t do it all. Accordingly, many businesses hire contractors to perform services ranging from payroll, marketing, janitorial, or even tax preparation. Contracting for these operations enables businesses to focus on their core competencies rather than peripheral tasks that are not at the heart of their business or for which they don’t have in-house expertise. When contracting for services, it is important to understand the distinction between contractors and subcontractors. Understanding the differences enable businesses to structure their contracts to retain the right amount of control over the work product.
What is a contractor?
Contractors are people or entities that are parties to an agreement for goods or services. In some cases, contractors perform the entirety of their contract obligations themselves. For example, let’s say a business contracts with a marketing firm to prepare a marketing plan for a new product launch. In this example, the contract for the marketing plan is between two parties: the business and the contractor (the marketing firm). The contractor is a single entity, whether it consists of one or five hundred employees who perform the contracted services – development of the marketing plan.
What’s a subcontractor?
In other cases, the contractor will rely on additional entities, or third parties, to fulfill a portion or sometimes even all of its contract obligations. These additional entities are termed subcontractors. Importantly, subcontractors are not parties to the contract between the business and the contractor. Rather, subcontractors enter into separate agreements with the principal, or “prime,” contractor to perform discrete portions of the contractor’s contract obligations. Subcontractors usually specialize in a particular skill set. Drawing on the example above, it is easy to imagine a scenario where the marketing firm would require specialized graphic design expertise for graphics to be included in the marketing plan. If the marketing firm doesn’t already have this expertise in-house, it might enter into a separate contract with a graphic design subcontractor to create graphics for the marketing plan.
Why does the distinction matter?
Businesses need to know which entity to hold accountable, and how much control they have over potentially multiple entities contributing to a final work product. In our marketing plan scenario, if the business is ultimately unhappy with the graphic design images included in the marketing plan, the contractor is responsible for remedying the work because the principal contract is between the business and the contractor. The business does not have any legal rights to direct or enforce the terms of the contract between the contractor and the subcontractor. It is therefore the contractor—and not the business—that must go back to the subcontractor to request any changes. This could prove to be no big deal, or it could get complicated. What if the subcontractor is now loaded down with other work and can’t change the images right away? Or what if there is a dispute between the contractor and subcontractor over the fee for the changes? You can see why it is crucial to understand the implications of subcontractors performing services under a contract. And then of course there is always the intellectual property ownership, which can create a whole additional nest of problems that need to be addressed in the principal contract with the contractor, and in-turn, between the subcontractor and contractor.
Proactive and careful contract drafting is key to mitigating exposure to subcontractor complications. The most straightforward way to eliminate subcontractor complications is to spell out that subcontractors are not permitted under the contract. But subcontractors are often both needed and beneficial for a project. At the early stages of contract negotiations, businesses should ask potential contractors whether they contemplate using subcontractors for some or all of the services. If so, businesses can incorporate terms in the contract to build in controls. For example, a business may require a contractor to obtain its approval before bringing on a subcontractor. Businesses might also require contractors to incorporate terms of the principal contract into the contract between the contractor and subcontractors to create consistency.
Understanding the distinction between contractors and subcontractors is important for businesses, particularly in the contract drafting stage. Building in the right amount of oversight into your contracts can help mitigate complications down the road.
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