Contract Issues in the Age of Labor Shortages

Talk to a construction company owner nowadays, or watch a newscast, and chances are the topic of labor shortages will arise. On September 2, the Associated General Contractors of America (AGC) reported that even amid project delays and supply chain disruptions, the supply of good-quality labor is insufficient to meet demand for ongoing construction projects. The AGC report was based upon a survey of AGC members, with 2,136 individuals responding in July and August of 2021. According to AGC, 61% of respondents reported worker shortages among their firms or their subcontractors’ firms, and 89% reported having difficulty filling hourly craft positions; 86% reported difficulty filling salaried positions as well. In its analysis, AGC noted that these results are similar to pre-pandemic figures reported in its August 2019 survey.

What do these shortages mean for contractors on the ground? An obvious consequence is that some contractors might be unable to adequately staff projects sufficiently to meet contractual obligations. In this scenario, owners or upper-tier contractors will likely turn to contractual remedies like the right to supplement a contractor’s workforce, to withhold payment, or in the most dire cases, terminating the contractor and asserting a performance bond claim. In the meantime, construction projects are still continuing. Congress’ recent passage of an infrastructure bill will mean additional opportunities and demand for builders.

The current economic climate therefore makes now a good time for contractors to understand and evaluate their contractual risk associated with labor issues. Typically, the risk of loss or damage associated with lack of adequate manpower runs downstream, with contractors and subcontractors bearing responsibility. Below are some provisions commonly found in contracts and subcontracts that could govern in the event that labor shortages impact performance.

1. Contractor’s duty to prosecute the work in a workmanlike and timely manner

A typical provision is as follows:

Time is of the essence of this Agreement. Subcontractor shall provide continual diligent effort at all times, maintain ample and competent manpower, plan for and secure materials and equipment, and shall maintain job progress in accordance with the current project schedule of Contractor and commensurate with all adjacent and related work.

This subcontract provision gives the subcontractor broad responsibility to staff its scope of work adequately and stay on the general contractor’s schedule; failing to do so could expose the subcontractor to liability for breach of contract. With schedules often subject to change, it is important for contractors to keep abreast of schedule changes — especially accelerations — and to send timely notices of any adverse impacts or events that will increase the subcontractor’s costs or that could entitle the subcontractor to additional time to complete the work. Typically, the contract will have a provision elsewhere setting forth a time frame and method for such notices — for example, that notices be made in writing to the project manager within two days of the event in question. These notice provisions are often strictly enforced.

2. The owner’s or general contractor’s available remedies for default events

Continuing from the above example, in the event that the subcontractor failed to comply with the schedule or failed to provide enough laborers (“ample and competent manpower,”) the general contractor might be within its rights to self-perform the work in question:

Should Subcontractor delay progress of the Work, or otherwise fail to timely perform its Work, Contractor may, at its option, and without prejudice to any other remedies it may have, after two (2) days written notice to Subcontractor, either (a) provide, or subcontract to provide, any such labor and/or materials and deduct the costs thereof (plus fifteen percent (15%) of all direct costs for Contractor’s overhead and profit for administering such work) from any monies due or thereafter to become due to Subcontractor, and deduct from any Subcontract balances any additional damages or liabilities incurred by Contractor as a result thereof, including any reasonable attorneys’ fees; or, (b) Contractor may, without prejudice to any other remedy, terminate this Agreement.

This clause is typical in that it gives the general contractor the option of self-performing the inadequately staffed scope of work or of subcontracting with another party to have the work done. In either scenario, the contractor can deduct its costs of doing so from the funds owed to the subcontractor, potentially even attorney’s fees. The option of termination also exists. Additionally, most contracts allow the owner or general contractor to withhold payment in this scenario, even if the payment is for undisputed work, if enough back-chargeable costs are reasonably anticipated.

Therefore, assuming some risk of these damages is an inevitable part of the construction business. Contractors and subcontractors concerned about these harsh consequences of labor issues that might not be entirely within their control have a few options to consider. One option is, during contract negotiation, to add language that adds a cure period after the two-day notice period — language requiring the contractor to give the subcontractor an opportunity to cure the default before being entitled to expend resources and back-charge them to the subcontractor. Adding additional days to the notice period might also help give the subcontractor additional time to fulfill its obligations by subcontracting temporary labor or by some other means. Contractors should consult with an attorney licensed in their jurisdiction on changes like this; if the default in question cannot be cured within the notice period, courts in some jurisdictions have held that a contractor or owner in this situation would still be entitled to proceed with self-performing the work, supplementing the workforce, or terminating the contract despite a notice period. Additionally, performance bonds may protect the owner or upper-tier contractor from these risks.

3. Liquidated damages

If the contractor or subcontractor’s failure to provide sufficient manpower results in project delays, it could also be liable for liquidated damages. A typical clause is as follows:

If Subcontractor fails to achieve completion of the Work in accordance with the Contractor’s Project Schedule, Subcontractor is otherwise responsible for delaying the progress of the Project and Contractor incurs any liquidated damages or other damages as a result, Subcontractor agrees to indemnify and hold Contractor harmless from all such damages, costs and expenses. In order to protect Contractor from liquidated damages assessed by Owner, Contractor may, in its sole discretion retain or recover from Subcontractor, as liquidated damages and not as a penalty, any and all liquidated damages  assessed against Contractor by Owner under the General Contract to the extent caused by Subcontractor.

Liquidated damages are perhaps the most daunting risk associated with a contractor’s failure to complete a project on time because if delays are significant, these per-diem charges can total to many thousands of dollars owed. Contractors should consult with an attorney licensed in their jurisdiction on how to manage this risk because jurisdictions vary on the extent to which liquidated damages clauses are enforceable. In general, however, contractors may consider negotiating clauses that limit their exposure to delays that impact the entire project instead of agreeing to pay daily penalties for delays that may be of little to no consequence to the owner.

Author’s note: This article does not constitute, and should not be construed as, legal advice on any particular scenario. For specific advice, consult with an attorney licensed in your state.

About the author: Caroline Trautman is an attorney with Oak City Law, LLP, based in Durham, North Carolina. Questions about this article can be directed to her at [email protected].