#2 - Caught in The Middle

No man is an island, and the same applies for Contractors in the oil service industry, and most other industries for that matter. In order fulfill and deliver in accordance with the agreed Scope of Work, contracting with sub-suppliers is a part of the project routine. But so is liability, indemnifications, liquidated damages and other sanctions for delays and defects.

As a Contractor you will normally be liable towards the Company, including for the actions or omittances of your sub-suppliers. And that is fair. The Contractor is the expert, the Contractor picked them out and the Contractor integrated them in the project. This is not always true, considering the concept of Company Provided Items and Company Designated Sub-Suppliers, but that is a discussion for another time.

So how does the Contractor avoid getting caught in the middle and end up paying for other people's mistakes. Enter the concept of "back-to-back". The concept is easy to understand; Contractor may be liable towards the Company, but the financial risk is moved to the sub-suppliers. However, the concept may be complicated to apply correctly and sufficiently effective.

Consider this. The Contractors' Scope of Work will normally be more extensive than the Scope of Work of any given sub-supplier, whilst the sub-suppliers Contract Price will be lower. Furthermore, the sub-supplier's delivery time is normally very different than the Contractors' delivery time. These obvious factors - there are others which are more complicated - will have an effect on everything from caps on liability, through calculation of liquidated damages to warranty.

It is not uncommon that the Contractor makes use of a simple Purchase Order towards a sub-supplier and includes a sentence stating that the terms of the Contractors' main contract with the Company shall apply "back-to-back", or by lifting some terms from the main contract and inserting them in the contract with the sub-supplier. That will most probably leave the Contractor caught in the middle. Here's why, and a couple of important things to remember.

The Contractors' liability towards the Company is normally capped at a certain percentage level of the Contract Price, say 50%. The sub-supplier's Contract Price is normally lower, hence, by applying a simple "back-to-back" reference or adopting the same term, the sub-supplier's liability is capped at 50% of their Contract Price, not the Contractor's Contract Price. By using simple math and increase the sub-supplier’s liability cap beyond 50% the Contractor will be able to push a larger part of the liability towards the sub-supplier

The same principle applies to liquidated damages. By using a higher percentage towards sub-suppliers than received from the Company, the Contractors' exposure will be reduced accordingly. Whilst on the topic of liquidated damages, remember that it does not necessarily help to increase the percentage if you forget to align the liquidated damages milestones in the main contract with the milestones you agree with the sub-supplier.

So, the day has come. The project is finished, delivery has taken place. Payment milestones has been met. Everybody's happy. Then a letter arrives, there's warranty issues. Root cause analysis is performed, and it turns out that the defect stems from shoddy work by a sub-supplier. The only problem is that the sub-suppliers' warranty has expired. Not because the warranty period was any shorter than the Contractors' warranty, but because the starting point was "from delivery", the same wording as the main contract. You see where I am going with this? A sub-supplier normally delivers before the Contractor makes delivery under the main contract, so make sure that the sub-suppliers' warranty period does not expire earlier than the warranty period under the main contract. Simple, yes, but easy to forget and not necessarily the case if the wording in the sub-contract has not been adapted beyond a simple "back-to-back".

The above is not just good contracting, it's even fair. The sub-supplier was after all the one making the mistake in the first place.