A subcontract is a separate written agreement in which a prime contractor (also called a general contractor) hires another party to perform a specific portion of the work the prime contractor already owes under its own contract with the project owner. In federal procurement, the term covers any contract a subcontractor enters into to furnish supplies or services for a prime contract, including purchase orders and modifications to them.1Acquisition.GOV. FAR 44.101 Definitions The document matters because its clauses decide who gets paid and when, who absorbs the loss when something goes wrong, and what each side can do if the other fails to perform.
The Three-Party Chain and Why Privity Matters
Every subcontract sits inside a three-party structure. The owner hires the prime contractor. The prime contractor then hires one or more subcontractors to handle specialized work such as electrical, plumbing, or concrete. The legal concept that governs this chain is privity of contract: the subcontractor’s binding legal relationship runs to the prime contractor, not to the owner. The owner benefits directly from the subcontractor’s work, but no automatic legal link connects those two parties.
The practical consequences follow from that structure. If the owner refuses to pay the prime contractor, the subcontractor generally cannot sue the owner for breach of contract. If the subcontractor’s work is defective, the owner usually has to pursue the prime contractor, who then pursues the subcontractor. An express third-party beneficiary clause can create exceptions, but without that language privity controls, and the prime contractor sits at the center absorbing risk from both directions.
One boundary worth naming before anything else: the arrangement actually has to qualify as a subcontract and not a disguised employment relationship. The IRS evaluates whether a worker is a legitimate independent contractor using behavioral control, financial control, and the type of relationship, and a company that classifies an employee as an independent contractor without reasonable basis can be held liable for unpaid employment taxes under Internal Revenue Code Section 3509.2IRS. Independent Contractor (Self-Employed) or Employee A true subcontractor controls how and when the work gets done, bears the risk of profit or loss, invests in its own tools, and works under a defined scope rather than open-ended direction.
Scope of Work
The scope of work clause is where most disputes get prevented or born. It describes the specific tasks, materials, quality standards, and deliverables the subcontractor is responsible for. A well-drafted scope draws sharp boundaries around what the agreed price covers, so the subcontractor knows exactly what it signed up for and the prime contractor has a measuring stick for completion.
Vague scope language is one of the most common sources of construction litigation. When a clause says something like “all work necessary to complete the electrical system,” the two sides will inevitably disagree about what “necessary” includes. A better clause specifies materials by brand or grade, references applicable building codes, and identifies which drawings govern. Anything the prime contractor wants beyond what the scope describes triggers the change order process.
Change Orders and Extra Work
Almost every project changes during execution. The change order clause establishes how work outside the original scope gets documented, priced, and approved. The industry rule is that change orders must be in writing and authorized before extra work begins. A subcontractor who performs unauthorized extra work on verbal instructions from a superintendent is taking a serious financial gamble, because many contracts explicitly state that only written, signed change orders create a right to additional compensation.
A proper change order spells out the extra work, the effect on the project schedule, and the compensation method. Payment is usually a negotiated lump sum, agreed unit prices, or time-and-materials when the change is too uncertain to price in advance. The protection for subcontractors is to never start extra work without a signed change order in hand. The protection for prime contractors is to require written authorization in the contract, which stops subcontractors from padding invoices with work that was never formally approved.
Payment Terms
Pay-When-Paid vs. Pay-If-Paid
These two clauses sound similar and operate very differently. A pay-when-paid clause is a timing mechanism: the prime contractor can delay paying the subcontractor until the owner pays, but the obligation to pay still exists. If the owner is slow, the subcontractor waits. If the owner never pays at all, the prime contractor still owes the subcontractor after a reasonable period.
A pay-if-paid clause is far more aggressive. It makes the owner’s payment a condition that must happen before the prime contractor has any obligation to pay the subcontractor at all. If the owner goes bankrupt and never pays, the subcontractor absorbs the loss. The majority of states will enforce a clear and unambiguous pay-if-paid clause, though some have banned them as against public policy. The phrase to look for in the payment language is “condition precedent,” which signals a pay-if-paid structure rather than a timing provision.
Retainage
Retainage is the portion of each progress payment the prime contractor withholds as a cushion. Typical retainage runs between 5% and 10% of each invoice, and the money stays with the prime contractor until substantial completion or final acceptance. The point is to keep the subcontractor motivated to finish punch-list items, correct defects, and show up for the final walk-through.
Retainage sounds reasonable until you run the numbers on a long project. A subcontractor billing $100,000 a month at 10% retainage is floating $10,000 every month that will not come back for months or years. State prompt-payment laws increasingly cap retainage percentages and require timely release, but the specifics vary by jurisdiction. On the federal side, retainage typically cannot exceed 10%.
Schedule and Liquidated Damages
Subcontracts set specific dates for mobilization, intermediate milestones, and final completion. These deadlines synchronize with the prime contractor’s master schedule and with the schedules of other trades whose work depends on the previous one finishing on time. A missed deadline can ripple across the entire project.
Liquidated damages clauses address this by setting a predetermined daily charge for unexcused delays. Courts generally enforce these clauses when the amount represents a reasonable estimate of actual damages. If a court finds the figure is grossly disproportionate to any actual harm, it can strike the clause down as an unenforceable penalty.
Not every delay triggers these charges. Most subcontracts carve out excusable delays that stop the clock without penalty. In federal contracting, the standard clause excuses delays caused by events like natural disasters, fires, epidemics, strikes, government actions, and unusually severe weather.3eCFR. 48 CFR 52.249-14 – Excusable Delays Private contracts often mirror this list. The subcontractor still has to document the delay and notify the prime contractor promptly. Sitting on a delay claim for weeks and raising it after the deadline passes rarely works.
Flow-Down Clauses
Flow-down clauses (sometimes called conduit clauses) pull obligations from the prime contract down into the subcontract. The idea is straightforward: if the prime contractor promised the owner a certain quality standard, safety protocol, or dispute resolution method, the subcontractor doing that work should be bound by the same requirements. Without flow-down language, the prime contractor could be stuck with commitments the subcontractors actually doing the work never agreed to.
The common approach is incorporation by reference, where the subcontract states that specified sections of the prime contract are binding on the subcontractor as if written directly into the subcontract. This can cover insurance minimums, testing procedures, reporting requirements, and scheduling obligations. On federal projects, certain clauses are required to flow down by regulation.4Acquisition.GOV. FAR 52.232-27 Prompt Payment for Construction Contracts
Always request a copy of the prime contract before signing. A blanket flow-down clause accepted sight unseen means accepting obligations you have not read. Some prime contract provisions make no sense at the subcontract level, and a careful subcontractor will negotiate to limit the flow-down to provisions that actually apply to its trade.
Indemnification and Insurance
Indemnification clauses decide who pays when something goes wrong on the job site. In a typical subcontract, the subcontractor agrees to cover the prime contractor’s legal costs, settlements, and judgments arising from the subcontractor’s own negligence. A crew member who injures a bystander, or faulty installation that causes water damage, triggers the clause and shifts the financial burden back to the party whose work caused the problem.
The scope of these clauses varies widely. A narrow indemnification clause covers only losses caused by the subcontractor’s negligence, which is generally fair. A broad-form clause can require the subcontractor to indemnify the prime contractor even for the prime contractor’s own negligence, which effectively forces the subcontractor to insure the prime against its own mistakes. Many states have enacted anti-indemnity statutes that void broad-form provisions in construction contracts. Read the indemnification clause carefully and confirm whether the obligation is limited to your own fault or extends to the other party’s.
Insurance requirements usually sit alongside indemnification. Most subcontracts require commercial general liability coverage, workers’ compensation as required by state law, automobile liability for vehicles used on the project, and sometimes professional liability for design-build work. The prime contractor will almost always require being named as an additional insured on the subcontractor’s general liability policy, which entitles the prime to defense and coverage under that policy for claims related to the subcontractor’s work.
Bonding is separate from insurance. A performance bond guarantees the subcontractor will complete the work according to the contract. A payment bond guarantees the subcontractor will pay its own suppliers and lower-tier subcontractors. Bond premiums usually run between 1% and 3% of the subcontract value, and subcontractors with thin credit or limited track records may struggle to obtain bonding at all. On smaller subcontracts, the prime contractor may waive the bonding requirement and rely on retainage and indemnification instead.
Termination Rights
Termination for Convenience
A termination for convenience clause allows the prime contractor (or, on government contracts, the government) to end the subcontract at any time for any business reason, not just for poor performance. On federal projects, the standard clause permits the government to terminate “in whole or, from time to time, in part” whenever the contracting officer determines it is in the government’s interest.5Acquisition.GOV. FAR 52.249-2 Termination for Convenience of the Government (Fixed-Price) Private contracts often include similar language. The subcontractor is typically entitled to payment for work completed, costs incurred in winding down, and a reasonable profit on the finished portion, but not the profit it would have earned on the remaining work.
Termination for Default
A termination for default is the adversarial version. The prime contractor ends the subcontract because the subcontractor failed to perform. Before pulling the trigger, most contracts require written notice and a cure period giving the subcontractor a chance to fix the problem. In federal contracting, the standard cure notice allows at least 10 days.6Acquisition.GOV. FAR 49.607 Delinquency Notices If the subcontractor does not cure, the prime contractor can terminate and hire a replacement at the defaulting subcontractor’s expense.
The consequences are severe. The subcontractor may lose retainage, face liability for the cost difference between its contract price and the replacement’s charges, and damage its bonding capacity for future work. A cure notice should be treated with the urgency of a legal deadline, not a polite request.
The Subcontractor’s Right to Stop Work
The duty to keep working is not absolute. When a prime contractor fails to make undisputed payments without reasonable justification, courts have recognized that the subcontractor may be entitled to suspend performance. This is risky, because if a court later disagrees that the breach was serious enough, the stoppage can itself be treated as a default. Invoke this right only when the nonpayment is clear-cut and the financial exposure of continuing to work outweighs the risk of a default claim.
Dispute Resolution
Subcontracts commonly require the parties to try resolving disputes outside court. The usual structure is a tiered clause that calls for negotiation first, then mediation, and finally arbitration or litigation. Mediation is voluntary: a neutral helps the parties reach a settlement but cannot force a decision. Arbitration is binding: an arbitrator hears evidence and issues a decision courts will enforce, with very limited grounds for appeal.
The choice between arbitration and litigation has real consequences. Arbitration is usually faster and more private, but the limited appeal rights mean a bad decision is difficult to reverse. Litigation preserves full appeal rights and discovery tools but takes longer and costs more. Flow-down language often requires the subcontractor to follow whatever dispute resolution method the prime contract specifies. Check whether the clause requires disputes to be resolved in a specific city or state, because travel costs and unfamiliar jurisdictions can tilt the playing field before the case starts.
Payment Remedies When You Don’t Get Paid
The Miller Act (Federal Projects)
On federal construction projects exceeding $100,000, the Miller Act requires prime contractors to furnish both a performance bond and a payment bond before the contract is awarded.7Office of the Law Revision Counsel. 40 USC Subtitle II, Part A, Chapter 31, Subchapter III The payment bond protects subcontractors and material suppliers. Because mechanic’s liens cannot attach to federal property, the payment bond is the primary safety net.
A first-tier subcontractor (hired directly by the prime) that has not been paid in full can sue on the payment bond after waiting 90 days from the date it last furnished labor or materials, and must file suit within one year of that date. A second-tier subcontractor (hired by a first-tier sub) has an additional requirement: written notice to the prime contractor within 90 days of its last work before it can sue on the bond.8Office of the Law Revision Counsel. 40 USC 3133 – Rights of Persons Furnishing Labor or Material Missing these deadlines forfeits the right to claim against the bond.
Federal Prompt Payment
Federal construction contracts must include a clause requiring the prime contractor to pay subcontractors within seven days of receiving payment from the government.9Office of the Law Revision Counsel. 31 USC 3905 – Payment Provisions Relating to Construction Contracts The contract must also include an interest penalty clause charging the prime contractor interest on late payments, running from the day after the required payment date until the subcontractor is actually paid, at a rate set by the Secretary of the Treasury and published in the Federal Register.4Acquisition.GOV. FAR 52.232-27 Prompt Payment for Construction Contracts These protections apply only to federal projects; most states have their own prompt-payment statutes for state-funded and private work.
Mechanic’s Lien Rights
On private and state-funded projects, the mechanic’s lien is the subcontractor’s most powerful payment remedy. The lien attaches to the real property where the work was performed, putting a cloud on the owner’s title that has to be resolved before the property can be sold or refinanced. That gives the subcontractor leverage even without a direct contract with the owner.
Preserving lien rights requires strict compliance with deadlines and notice requirements that differ significantly from state to state. In most jurisdictions a subcontractor must send a preliminary notice to the owner within a set window after starting work, then file the lien within a separate deadline after completion. Missing either deadline by a single day can destroy the right. Lien waivers are routinely exchanged as part of the payment process: a conditional waiver releases lien rights only on actual receipt of payment, while an unconditional waiver releases them immediately regardless of whether the check clears. Never sign an unconditional waiver until the money is confirmed in the account.