San Diego Business Contracts: Thoughts on Subcontractor-Limitation Clauses

Many standard business contracts, particularly service-related contracts, contain provisions limiting the ability of the parties to subcontract their obligations under the contract. These subcontractor-limitation clauses make business sense and common sense because trust, experience, and reputation are often the basis for forming the contract in the first place. Having some unknown subcontractor providing the services or goods creates undesired risk and uncertainty. Thus, the desirability and need for subcontractor-limitation clauses. Such clauses are often very simple — something like “Neither CUSTOMER nor SUPPLIER shall subcontract any of their obligations under this Agreement without the consent of the other. Consent shall be in writing, made prior to the subcontracting and a party’s consent shall not be unreasonably withheld.”

However, some caution is in order with these boilerplate provisions. As written, these standard clauses are overbroad, arguably prohibiting all sorts of subcontracting that is unrelated to the central concern of the parties. As such, these clauses may need attention at the drafting stage so that they are more narrowly tailored to the unique circumstances covering the services/goods that the parties care about. Consider that, in the modern business world, a significant portion of your business is actually subcontracted out even if you do not think of it in those terms. A few common examples include:

• Utility goods and services — phone, electricity, waste management, etc.
• Web and internet hosting services
• Delivery services
• Payment processing and various other administrative/overhead services
• Security — both physical and data/computer
• Legal and other professional services
• And more

Having these subcontracted services could be interpreted by a California judge to violate a vague and overbroad boilerplate subcontractor-limitation clause. But, you might say, “No way! What about the concept of ‘materiality?’” Likely, a judge would assume a “materiality” component into the subcontractor-limitation provision — that is, the parties prohibited subcontracting a material obligation under the agreement. But, why take the risk? Fixing this problem at the drafting stage is easy. You might also say, “No way! What party would argue breach of contract on such a frivolous basis?” If there is an advantage to arguing a breach of contract via prohibited subcontracting, a litigating party will exploit the advantage. Again, why take the risk?

There are several solutions to tailoring a subcontractor-limitation clause to what is important. Something as simple as adding the word “material” before the word “obligation” will help. “Material” could be further refined to mean a “significant proportion” or “essential component” of a party’s obligations. Another option might include the adding of a list as an exhibit to the agreement of subcontractors or subcontracting services that are pre-approved. What language is “best” depends on what the parties want to accomplish and the unique features of the business relationship.

Contact San Diego Corporate Law Today

If you would like more information with respect to business contracts in general, contact attorney Michael Leonard, Esq., of San Diego Corporate Law. Mr. Leonard provides legal services related to business law, contracts, corporate entity formations and maintenance, private securities offerings/sales, sale/purchase of a business, and mergers and acquisitions. Mr. Leonard can be reached at (858) 483-9200 or via email.

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