The penalty clause is a powerful contractual tool designed to deter the various parties involved in a project from breaching their contractual obligations and to ensure compensation in the event of such a breach. When a project falls behind schedule, the delay penalty imposed by the owner can quickly become a major financial burden for the general contractor. The question then becomes whether these penalties can be passed on to the subcontractors and/or suppliers responsible for the delays.
In this article, we examine three common situations: (i) incorporating the main contract clauses into the subcontract, (ii) including a penalty clause specific to the subcontract, and (iii) the challenges that arise when there is no penalty clause.
I. Can penalties be transferred to the subcontractor?
Coordinating the work and meeting deadlines is first and foremost the general contractor’s responsibility and as such, it bears the financial consequences of any site delay toward the owner. To limit its exposure, the general contractor may incorporate certain clauses from the main contract into its subcontracts, including those relating to delay penalties.
These clauses are primarily intended to compensate the general contractor for penalties imposed by the owner rather than to penalize the subcontractor directly. Accordingly, any penalties claimed by the general contractor against the subcontractor must be pursued under the rules governing contractual liability.[1] To obtain compensation, the general contractor must demonstrate that the subcontractor is liable for the delay and that there is a causal link between the liability and the imposed penalties.
Once the subcontractor’s liability has been established, the general contractor is entitled to claim the entire penalty under the principle of full compensation, even if that amount exceeds the value of the subcontract.
However, the wording must be clear and explicit. The subcontract must specify that the relevant provisions of the main contract apply equally to the subcontractor, and the subcontractor must have access to the contract documents. Otherwise, the enforceability of the penalties could be challenged.
II. Should you include a separate penalty clause in your subcontracts?
Some general contractors choose to include specific penalty clauses in their subcontracts rather than simply incorporating the terms of the main contract. These clauses may apply to delays in executing the work and/or failing to deliver items that are essential to the project.
When penalties are stipulated for non-compliance with a specific obligation, such as submitting technical documents, it is preferable to clearly state that the penalty applies to the delay without releasing the party from the obligation itself. In other words, the general contractor must retain the right to require delivery of the document, even if a penalty is imposed. Since these deliverables are usually required by the client, the general contractor is still obligated to provide them, regardless of any penalty imposed on the responsible subcontractor.
Such clauses are more common in privately negotiated contracts. In a public tendering context, for instance through the Bureau des Soumissions Déposées du Québec (BSDQ), subcontractors may be reluctant to accept penalty clauses that are not included in the tender documents.
III. What happens when there is no penalty clause in the subcontract?
The general contractor faces a major legal obstacle when attempting to impose a penalty on a subsequent party in the contracting chain that is not bound by a penalty clause or the terms of the main contract. Penalty clauses only bind the parties who have consented to them.
To enforce a penalty clause against a third party (such as a subcontractor or supplier), it must be shown that the delay penalties were reasonably foreseeable to that party when it entered into the contract.[2]
Case law provides two practical scenarios for determining whether penalties imposed by the project owner on the general contractor can be enforced against subcontractors.
a. The subcontractor or supplier is presumed to have been aware of the penalty clause.
In Signalisation Laurentienne Inc. c. Entreprises Michaudville Inc., Signalisation Laurentienne contested a holdback applied by the general contractor, Michaudville, arising from penalties imposed by the Ministry of Transport of Quebec (“MTQ”) on the grounds that the subcontract did not include a penalty clause. In response, the judge stated:
[TRANSLATION]
[113] It is true that the penalty stems from the contract between Michaudville and the MTQ. As the Court previously recognized, Signalisation was required to review the necessary documents, determine its obligations regarding signage and understand the potential consequences of not meeting them before submitting its bid.
[114] Moreover, Signalisation did not dispute this, and the fact that it had reviewed the relevant information before bidding is proven.
The Court concluded that Signalisation Laurentienne’s obligation to review the tender documents was sufficient to enforce those terms against it.
b. The subcontractor or supplier is unaware of the existence of a penalty clause.
In Schréder Inc. c. Guillevin International,[3] the Superior Court had to determine whether the manufacturer, Schréder, could contest the refusal by Guillevin, a distributor, to pay the amounts owed for the manufacture and supply of lighting equipment. Guillevin had agreed to a deduction on its invoice representing the penalty applied by the general contractor to the subcontractor responsible for the electrical work and was applying the same mechanism to Schréder.
The Court concluded that the penalty could not have been considered foreseeable damage to Schréder when the company entered into the contract. Since Schréder was unaware of the main contract terms when it signed its own contract, it had no knowledge that such a penalty existed. The Court also ruled that by refusing to pay Schréder the owed amounts, Guillevin had indirectly imposed a penalty on Schréder despite there being no such provision in the contract. The burden was on Guillevin to prove the damages caused by the faults attributed to Schréder and the causal link. However, the evidence Guillevin presented did not demonstrate the consequences of the delays attributed to Schréder.
These decisions show that where a contracting party did not have access to the main contract before concluding its own contract and was unaware of the penalty clause, courts are likely to refuse to enforce those penalties.
In any case, when responsibility for delays is disputed, detailed evidence must be presented to allocate the delays among the project parties and, if applicable, apportion the claimed damages.
Conclusion: protect your projects with well-drafted contracts
Penalty clauses are an effective tool for encouraging all parties involved in a project to meet contractual deadlines. Due to the significant financial consequences of these clauses, they should be considered early in the project to ensure the appropriate contractual mechanisms are in place.
For a penalty clause to have the intended effect, it must be well-drafted. An abusive, ambiguous or incomplete clause may lead to disputes. Similarly, applying a penalty clause can complicate dealings between the various parties in the contracting chain typical of construction projects. Poor alignment between the main contract and subcontract clauses can lead to difficulties during the project, particularly regarding responsibility for delays and the applicable mechanism in such circumstances.
Are you currently negotiating a contract or facing delay penalties? Our construction lawyers can review your contracts and help protect your interests. Contact our Construction and Infrastructure team for an assessment of your situation.
[1] Art. 1458 C.C.Q.
[2] Art. 1613 C.C.Q.; Baudouin, J-L., Jobin, P-G. and Vézina, N., Les obligations, 6th ed., Cowansville, Éditions Yvon Blais, p. 810, nos. 817 and 884?.
[3] Schréder Inc. c. Guillevin International, 2023 QCCS 3489.
