Guide to Subcontracting Laws

Subcontracting is one of the ways in which construction companies and other businesses lower their overhead costs. In addition to saving money for themselves, they theoretically pass those savings on to their customers, thereby creating a mutually beneficial situation. However, it is important to follow subcontracting laws when "farming out" portions of a project to third parties.

Subcontracting Definition

A subcontractor, broadly speaking, is someone who performs services at the behest of another person or entity contracted to perform a specific project. Every state has a specific statute defining subcontracting so there are no ambiguities, and sometimes these definitions are worded different from those in other states.

The Texas Labor Code, for example, defines a subcontractor as "a person who contracts with a general contractor to perform all or part of the work or services that the general contractor has undertaken to perform"(§ 406.121(5)). Make note of the words "all or part," which indicates that a contractor can subcontract another company or individual for an entire project. This is often where contractors and clients come into conflict.

Arrangement of Contracts

In any situation where one person or entity is hired by another, a contract is form. In most cases, it is a written contract that defines the relationship between the two parties, including expectations for work performed and when payment is due.

It is important to understand that, in subcontracting, at least two contracts exist. The first is between the client and the prime or principle contractor; the second is between the prime contractor and the subcontractor. There is no contract, however, between the subcontractor and the client.

As far as the IRS is concerned, both the prime contractor and the subcontractor are independent contractors, though they might also be employers. This means that all contractors are responsible for paying their own taxes (whether quarterly or annually), including the self-employment tax imposed by the federal government.

Payment for Subcontracting

As stated above, there is a contract between the prime and subcontractor for the rendering of services (e.g. plumbing, electrical, masonry, etc.) This means that the prime contractor pays the subcontractor a specific fee (often a percentage of the former's payment from the client), and the subcontractor must collect from the principle on the job.

The exception to this rule is a situation where a prime contractor is not paid by his client. Many subcontracting contracts include a provision that makes services payable when the prime receives his check. If the client doesn't pay, the subcontractor is entitled to place a lien on the client's property until that bill is satisfied.

Liability

Subcontractors sometimes experience a false sense of security when it comes to their work because they haven't been hired directly by the client. However, if a subcontractor is negligent in his duties or does not perform his work in a manner that is considered "reasonable" for his profession, he might be liable for damages.

For example, let's say a construction company hires a subcontractor for the plumbing portion of building a house. The subcontractor comes in and fails to install the plumbing to code. As a result, the prime contractor must hire a replacement plumbing company and gets behind on other aspects of his job.

In this case, the prime contractor might be able to sue the subcontractor for damages. Additionally, the clients might be able to collect for any damages they suffered.

Understanding Subcontracting Laws

To ensure you are following all subcontracting laws (and that your clients are as well) it is important to be informed. Hiring an attorney to review your contract, for example, can prevent many legal problems in the future.