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How to Structure Subcontractor Agreements to Protect Your Growing Business

Updated: Mar 25


Building Security: Crafting Subcontractor Agreements to Safeguard Your Business Growth

As your business expands, you may find it necessary to bring on subcontractors to help complete projects and meet increased demand. While subcontracting allows you to take on more work, it also exposes your business to new risks. Carefully structuring your subcontractor agreements is crucial to protect your interests. In this article, you will learn key provisions to include in subcontractor contracts. We will cover payment terms, intellectual property rights, insurance and liability, termination clauses, and more. With a well-drafted subcontractor agreement, you can confidently scale your business through strategic partnerships while safeguarding your company's finances and reputation. Let's examine how to put together a subcontractor contract that promotes growth without compromising your business.


Defining Subcontractor Relationships for Business Growth


To leverage subcontractors for growth, you must establish clear terms upfront.


Scope of Work


Define the scope of work in granular detail, including timelines, deliverables, and quality standards. Be specific about what is in and out of scope to avoid misunderstandings that lead to cost overruns or missed deadlines.


Payment Terms


Establish prompt payment terms, such as net 15 or net 30 days. However, withhold a percentage, often 10-20%, until final approval and acceptance of work. Reserve the right to withhold payment if work does not meet the agreed scope and standards.


Ownership of Intellectual Property


Ensure any intellectual property, like software code, content, or designs, produced for your company is assigned to your company. Require subcontractors to sign over the rights to any IP and obtain warranties that the work is original and does not infringe on any other party’s IP.


Indemnification


Include indemnification clauses that require the subcontractor to defend and indemnify your company against any third-party claims arising from their work or negligence. This transfers risk away from your company.


Termination


Establish termination for convenience and termination for cause terms. Termination for convenience allows either party to end the relationship at any time with written notice. Termination for cause allows you to immediately terminate if the subcontractor breaches the agreement.


Confidentiality


Require non-disclosure agreements (NDAs) to protect sensitive company information. NDAs should remain in effect even after termination of the relationship.


Defining these key terms in your subcontractor agreements helps ensure productive, risk-mitigated relationships that fuel business growth. With transparent communication and well-documented expectations, subcontractors can become a valuable extension of your team.


Key Provisions to Include in Subcontractor Agreements


Defining the Scope of Work


Clearly defining the scope of work is crucial. Specify key deliverables, timelines, and milestones to establish expectations upfront. Failure to do so can lead to budget overruns, delays, and conflict. Carefully delineate roles and responsibilities for yourself, your employees, and the subcontractor. Specify who will provide materials and equipment. Detail what will happen if the scope changes.


Payment Terms


Establish a payment schedule tied to the completion of work phases or deliverables. Require invoices with details on work performed and costs incurred. Reserve the right to withhold a percentage of each payment (e.g. 10%) until final delivery and acceptance. Include a “pay-if-paid” clause making subcontractor payment contingent on your receipt of payment from your customer.


Ownership of Intellectual Property


Specify that you will own all intellectual property rights in the work product. Require subcontractors to sign work-for-hire and non-disclosure agreements. Without clear terms, subcontractors may claim ownership or sell information to competitors.


Termination Rights


Allow for termination without cause, while still requiring the subcontractor to transition work back to you. Specify circumstances constituting cause for termination, e.g. failure to meet deadlines, breach of contract terms, change in control of subcontractor. Outline consequences of termination, including compensation owed for work performed.


Insurance and Indemnification


Require subcontractors to carry adequate insurance, e.g. commercial general liability, professional liability, and workers compensation. Specify minimum coverage limits. Include indemnification provisions to protect you in the event of claims by third parties arising from the subcontractor’s work.


Lopes Law's subcontractor agreement solutions address these key issues, protecting your business as you scale and delegate more work to qualified subcontractors. Let us help you draft agreements tailored to your unique needs and industry.


Managing Risks and Liabilities With Strong Subcontractor Terms


Fortifying Your Business: Mitigating Risks Through Robust Subcontractor Terms and Conditions


To protect your business, clearly define the scope of work, responsibilities, and liabilities in your subcontractor agreements.


Define the Scope of Work


Specify the tasks, deliverables, deadlines, and quality standards expected of the subcontractor. Be as detailed as possible to avoid confusion and disputes later on. For example, if hiring an IT subcontractor, specify exactly which systems they will develop or maintain, the programming languages or software to be used, testing procedures, documentation requirements, and service level agreements.


Allocate Responsibilities


Explicitly allocate responsibilities between your company and the subcontractor. For instance, state who will provide the necessary equipment, materials, and workspace. Specify who is responsible for permits, licenses, and insurance. Assign accountability for workplace health and safety, confidentiality, and data security. Failure to properly allocate responsibilities can expose your business to legal and financial liability.


Limit Liability


Include provisions to limit your liability for the subcontractor’s work. For example, require the subcontractor to indemnify your company against third-party claims arising from the subcontractor’s negligence or poor work quality. You may also limit liability to a certain dollar amount or the fees paid under the agreement. However, check your local regulations regarding permitted liability limitations. Some jurisdictions prohibit overly broad liability waivers.


Allow for Termination


Include terms allowing either party to terminate the agreement if needed. For example, you may terminate due to poor performance, quality issues, or changes in business needs. The subcontractor may terminate if payments are not made or for other breaches. Be sure to specify required notice periods, responsibilities upon termination, and any compensation owed for work completed. Strong termination clauses give both parties an exit strategy in the event the relationship does not work out as intended.


With well-drafted subcontractor terms managing risks and liabilities, you can take on more work and fuel your company’s growth, confident that your interests are properly protected. Carefully defining the working relationship upfront leads to fewer problems down the road and helps ensure a successful partnership.


Structuring Payment Terms Favorably in Subcontractor Contracts



Empower Your Business: Optimizing Payment Terms for Stronger Subcontractor Contracts


When negotiating payment terms in subcontractor agreements, it is critical to establish provisions that reduce risks for your business. As the hiring company, you want to avoid being liable for payments before work is completed to your satisfaction. You also want to build in safeguards in case the subcontractor fails to perform.


Require Incremental Payments Based on Milestones


Rather than paying the full amount upfront or in a single lump sum, structure the agreement to provide payment in installments tied to the successful completion of milestones. For example, you may pay 25% upon contract signing, 25% after materials have been delivered, 25% once work is 50% completed, and the remaining 25% upon final inspection and approval. This approach ensures you are only paying for work that has been done.


Include Retainage Provisions


A retainage provision allows you to withhold a percentage, typically 5-10%, of each payment until the end of the project. The retainage acts as a safeguard in case the subcontractor fails to complete work or remedy issues. Once all work has been completed to your satisfaction, the retainage amount is paid. This provides an incentive for the subcontractor to perform fully.


Require Unconditional Lien Waivers


For construction projects, an unconditional lien waiver is critical. This document waives the subcontractor’s right to file a mechanic’s lien on the property for nonpayment. Requiring an unconditional lien waiver with each payment installment protects you in the event the subcontractor is not paid by the general contractor or property owner. Be sure the lien waiver covers the amount paid for that installment as well as the total paid to date.


Allow for Backcharges


Include provisions allowing you to backcharge the subcontractor for costs incurred to remedy issues or complete unfinished work. For example, state that if the subcontractor fails to correct work that does not meet contract standards, you may hire another contractor to do so and deduct those costs from payments due to the subcontractor. This assigns responsibility for nonperformance to the subcontractor.


With well-structured payment terms that anticipate risks, you can engage subcontractors to aid your business’s growth while protecting your financial interests. Carefully negotiating these provisions will serve you well in managing projects and relationships successfully.


Using Subcontractor Agreements to Protect IP and Confidentiality


Protecting Intellectual Property


As your business grows by leveraging subcontractors, it is crucial to establish clear terms regarding intellectual property (IP) ownership and usage rights. Your subcontractor agreement should specify that any intellectual property, including inventions, software, documentation, creative works, or trade secrets created by the subcontractor within the scope of the engagement shall be the sole property of your company. This includes rights to use, modify, distribute, and sublicense such IP. Failure to address IP ownership upfront can lead to disputes and loss of control over valuable assets.


Preserving Confidentiality


Your subcontractors will likely be exposed to sensitive information about your business operations, customers, financials, trade secrets, and more. A robust confidentiality clause in the subcontractor agreement is therefore essential. This clause should prohibit the subcontractor from disclosing or using any of your confidential information for any purpose other than performing their services. It should also survive the termination of the agreement. Consider requiring subcontractors to sign a separate non-disclosure agreement for access to extremely sensitive data.


Limiting Subcontractor Relationships


To avoid overreliance on any single subcontractor and reduce risks, include provisions in your subcontractor agreements that limit the subcontractor’s ability to further subcontract or delegate work to third parties without your prior written consent. You may want to require that any further subcontracting is subject to the same terms and conditions as in the agreement with you. You should also retain the right to request replacement of any sub-subcontractor at your sole discretion.


By addressing intellectual property, confidentiality, and subcontractor relationships proactively in your agreements, you can facilitate growth through subcontracting while safeguarding your business-critical assets and interests. With the right legal protections in place, subcontracting can be a valuable strategy for emerging companies to access specialized skills and scale rapidly. But without those protections, it may pose serious risks. Comprehensive, professionally-drafted subcontractor agreements are well worth the investment.


Tax Implications of Subcontractor Relationships


Payroll Taxes


When hiring subcontractors, you are not responsible for withholding payroll taxes like Social Security and Medicare from their payments as you would for employees. However, subcontractors are still required to pay self-employment tax on their net earnings. As the business hires the subcontractor, you do not need to match the Social Security and Medicare taxes. This can represent significant tax savings for your company.


Income Taxes


Subcontractors are also responsible for paying their income taxes on earnings from their work for your business. You are not required to withhold any federal or state income tax from their payments. At year-end, you will provide subcontractors with a 1099 tax form reporting their total earnings for tax purposes. This differs from employees where you withhold income taxes and issue W-2 forms.


Ensuring proper classification of workers as either employees or subcontractors is important to avoid potential issues with the IRS. If subcontractors are later reclassified as employees, your business may face penalties for failure to withhold and remit payroll taxes. You should consult with your tax professional to determine the appropriate classification based on the level of control and independence in the working relationship.


Sales Taxes


In many states, services provided by subcontractors may be subject to sales tax. Your business, as the purchaser of those services, is typically required to pay any sales tax due. Sales tax rates and rules around subcontractor services vary significantly between states and localities. You should check with your state's sales tax authority to determine your obligations. Failure to properly collect and remit sales tax can result in interest charges and penalties.


Carefully structuring subcontractor agreements and staying up-to-date with the tax implications of these relationships is key to managing risk for your business. With the proper diligence, subcontractors can provide flexibility and specialized expertise to support business growth. However, it is important to understand the tax differences compared with employees to ensure full compliance.


When You May Need a Business Lawyer for Subcontractor Agreements


Guiding Your Business Safely: Recognizing When to Engage a Lawyer for Subcontractor Agreement

As your business grows and takes on more complex projects involving multiple subcontractors, it is wise to consult an experienced business lawyer to review and draft subcontractor agreements.


Defining Scope of Work


For large, multi-phase projects with several specialized subcontractors, having a lawyer define the scope of work, responsibilities, and accountability for each subcontractor is essential. Ambiguous or incomplete scopes of work can lead to delays, cost overruns, and legal disputes if expectations are not clearly outlined.


Addressing Intellectual Property


If your subcontractors will be creating or contributing intellectual property, such as software, content, or design work, a lawyer can draft agreements that properly assign or license IP rights to your business. Failure to address IP ownership upfront could inhibit your use of the work product or allow subcontractors to make IP claims against you in the future.


Managing Risk


Subcontractor agreements should address various risks, such as non-performance, poor work quality, budget overages, and liabilities. A lawyer can include provisions for performance milestones, quality standards, cost controls, indemnification, and limits of liability to help mitigate risks. They can also require subcontractors to carry adequate insurance to protect your business.


Complying with Regulations


If your subcontractors will handle sensitive data, operate heavy equipment, or work in regulated industries like healthcare or finance, legal review is essential. Lawyers can ensure your agreements comply with relevant privacy laws, safety regulations, and industry standards to avoid penalties or legal issues.


Negotiating Complex Terms


For large-scale, high-budget projects, subcontractor agreements may need to address complex payment terms, performance incentives, confidentiality, non-compete clauses, and more. An experienced lawyer can negotiate terms that adequately protect your business interests while still attracting top subcontractor talent. They can also push back on unreasonable demands to reach a fair and balanced agreement.


In summary, for small, straightforward jobs, you may be able to manage subcontractor agreements on your own. But as your subcontracting needs become more sophisticated, a business lawyer’s expertise in defining work scopes, addressing IP and risk, ensuring regulatory compliance, and negotiating complex terms can prove invaluable. Their involvement helps safeguard your business and set subcontractor relationships up for success.


How Fractional General Counsel Can Help With Subcontractor Contracts


As your business grows, engaging subcontractors for various projects becomes increasingly complex. Contracting with subcontractors requires navigating legal issues around scope of work, payment terms, intellectual property, liability, and termination. Fractional general counsel, also known as part-time general counsel, can help establish subcontractor relationships that protect your business interests.


Define the Scope of Work


The scope of work section should clearly outline the subcontractor’s responsibilities and key deliverables. Fractional general counsel can help draft language that is specific yet flexible enough to accommodate changes. They can also advise on including provisions for approving change orders to the scope of work.


Address Payment Terms


Payment terms that are fair to both parties should be outlined. Fractional general counsel can recommend terms that comply with laws around subcontractor payments and prevent issues like subcontractor liens. They can also suggest including a “pay-if-paid” provision, whereby you are obligated to pay the subcontractor only if and when you have received payment from your client.


Clarify Intellectual Property Ownership


Any intellectual property, like software, created for your projects should be owned by your company. Fractional general counsel can ensure subcontractor agreements include comprehensive intellectual property assignment and work-for-hire provisions. They can also advise on non-disclosure agreements (NDAs) to protect sensitive business information.


Limit Liability and Allow for Termination


Carefully drafted indemnification, limitation of liability and termination clauses are important for risk management. Fractional general counsel can recommend clauses that appropriately limit your liability for the subcontractor’s negligence while still being enforceable. They can also suggest termination for convenience provisions that allow you to end the relationship when needed.


Engaging fractional general counsel to help draft and negotiate subcontractor agreements allows you to gain critical legal expertise without the expense of hiring full-time staff. Their guidance can help establish relationships with subcontractors that fuel business growth while mitigating legal and financial risk. With the support of fractional general counsel, you can expand your capabilities through subcontracting with confidence.


Subcontractor Agreement FAQs: Your Top Questions Answered


Unlocking Clarity: Expert Answers to Your Subcontractor Agreement Questions

As an established business looking to scale through subcontracting, you likely have several questions about structuring effective subcontractor agreements. Below are answers to some of the most common questions we receive from clients.


A well-crafted subcontractor agreement establishes the scope of work, payment terms, and obligations of both parties.


What key provisions should be included?


Key provisions to include are: scope of work, payment terms, intellectual property ownership, confidentiality, termination rights, insurance requirements, and dispute resolution terms. Clearly articulating the expectations and responsibilities upfront helps mitigate risks down the road.


How much oversight and control can I exert over subcontractors?


The level of oversight and control depends on the nature of the work. Generally, subcontractors should be able to work relatively independently. However, businesses can require subcontractors to: provide regular status updates, comply with company policies, use designated tools/software, and meet predetermined deadlines or milestones. Businesses should avoid treating subcontractors like employees.


Am I liable for a subcontractor’s negligence or poor work quality?


You may be liable if the subcontractor’s work causes harm or damage. Requiring subcontractors to carry adequate insurance, including professional liability insurance, can help reduce risks. It is also advisable to include indemnification provisions, requiring the subcontractor to indemnify you against claims arising from their work. Conducting due diligence in the subcontractor selection process and including performance requirements and standards in the agreement also help avoid liability issues.


Can I prevent a subcontractor from working for competitors?


Non-compete and non-solicitation clauses can be included to prevent subcontractors from working for competitors or soliciting your other subcontractors/employees during the engagement and for a reasonable period after termination. However, such clauses must be narrowly tailored based on jurisdiction and the nature of the work. Overly broad clauses may not be enforceable.


Consulting an attorney to tailor an agreement for your specific needs and jurisdiction is the best way to gain clarity on these issues and properly structure your subcontractor relationships. With well-drafted agreements in place, businesses can leverage subcontracting to accelerate growth in a managed, strategic fashion.


Conclusion


Protecting your business as it grows requires forethought when structuring agreements with subcontractors. Carefully weigh the benefits and risks of proposed terms. Consult qualified legal counsel to ensure your interests are secured, without being unduly restrictive or creating unreasonable burdens. Approach negotiations as collaborations, seeking mutually agreeable outcomes. With well-crafted contracts in place, you can confidently scale your operations through partnerships, while safeguarding your company's future. Though the devil may be in the details, those details need not be diabolical with proper planning. Your business relationships can thrive when contracts reflect understanding, fairness and shared purpose.


If you need professional legal assistance, please contact us. We're here to help.

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