May 1, 2012
Of backcharges, deficiencies, warranties and guaranteesBY ROBERT KENNALEY
Those who work in the construction industry often become confused about how backcharges, deficiencies, warranties and guarantees differ from one another and how these items relate to one another on a construction project. They can arise as between: owners and contractors; owners and consultants; contractors and subcontractors; subcontractors and other subcontractors; subcontractors and suppliers; and in a host of other permutations and combinations. In a two-part series of articles, I will attempt to demystify some of the confusion surrounding these concepts.
The backcharge is an accounting mechanism or step. It is used by a person who has hired another for the supply of services or materials to avoid paying for those services or materials, on the basis that money is owed back for some reason. For example, an owner might assert a backcharge against the contractor for the cost of rectifying damages that the contractor caused in damaging the owner’s building. Similarly, a contractor might assert a backcharge against a subcontractor for the cost of rectifying the subcontractor’s work, and a subcontractor might backcharge a subcontractor or supplier of its own, for the supply of deficient product.
You will very rarely see the word “backcharge” referenced in an actual contract or subcontract. Many contracts will, however, use various types of language to establish the right of the hiring party to claim for, or clawback from, monies otherwise owing under the contract, for certain reasons. In law, the application of a backcharge is the exercise of a right of ‘set-off.’ It is the right of one party to set-off as against monies owed to another on the basis that the other party owes monies back to it.
Generally speaking, the right to set-off need not be set out in the contract in order for a party to rely on it. In addition, generally speaking the basis of the set-off need not relate to the project in question. Accordingly, for example, an owner could backcharge, or set off against, a contractor for costs incurred or monies owing on a completely different project. Indeed, the owner could set off against a contractor for amounts owing which are entirely unrelated to construction.
Accordingly, so long as the hiring party can establish that monies are actually owing to it, that party can generally apply a backcharge, or set off, against monies which it otherwise owes to the person it hired. In practice, backcharges are commonly applied in construction, rightly or wrongly, for incomplete work, completion costs, deficiencies, unfulfilled warranty obligations and delay. In each case, however, for the backcharge to be appropriate the person raising it would have to show they are entitled to the costs associated with the backcharge, on the basis that the person against whom it is being applied is solely and fully responsible for same.
Although the concept of a deficiency is rather straightforward, it is surprisingly often misunderstood in practice. Most particularly, the distinction between incomplete and deficient work is often blurred in the field. Incomplete work, as the name suggests, is work that a contractor or subcontractor undertook to perform or supply as part of its contract or subcontract. It cannot be considered “deficient” because it has never been started. Deficient work, on the other hand, is work that has been performed or supplied, but is not in conformity with the contract documents.
Care should be taken to ensure that incomplete and deficient work are properly distinguished from one another. It is common, for example, for a consultant or owner to lump the two categories together in assessing what the contractor and/or its subcontractors need to do to complete the work. In that regard, a deficiency list is often prepared which actually incorporates both incomplete and deficient work.
One reason for keeping the distinction between the two concepts clear lies in how, and when, a backcharge can be properly applied. For simplicity, we will use the owner and contractor relationship in providing examples, although the analysis will apply to any contract or subcontract for the supply of services or materials in the construction context. It is most often the case that the contractor will only invoice for the value of the work it says it has actually performed. This is particularly the case in many, if not most, commercial contexts, where the owner or the consultant will only certify payments on the basis of the percentage of the contractual scope of work actually supplied, to date. In this context, the owner might be entitled (in some circumstances) to apply a backcharge for the anticipated cost ofcorrecting deficiencies in work that the contractor had already invoiced for. (I will discuss this in more detail in my next article.) However, unless the work in question had already been invoiced, it would generally not be appropriate for an owner to backcharge for the cost of completing work.
It is only where the owner is entitled to terminate the contractor’s right to perform the work that a backcharge for incomplete work should be applied. Even then, the backcharge should be limited to the premium additional costs of hiring someone else to complete that work. This is because the contractor has the right to complete the work (and be paid for it), unless he has breached the contract such that the owner is entitled to take the work over. Even then, the owner cannot get the work for free: He or she has to credit the contractor for the agreed upon cost of the incomplete work, and should only be entitled to a claim, or backcharge, for any additional costs associated with taking over the work.
In my next article, I will discuss the circumstances where an owner or contractor seeks to apply a backcharge for a deficiency in which the person responsible for the deficiency is willing to correct it, at no cost. We will also discuss the difference between deficiencies and warranted work, as well as when, if at all, a contractor or subcontractor is required to respond under warranty. Finally, we will discuss the concept of the guarantee, in the context of how that concept might differ from the concept of warranty.
Rob Kennaley practises construction law in Toronto. He speaks and writes regularly on construction law issues and can be reached for comment at 416-368-2522 or at email@example.com. This material is for information purposes and is not intended to provide legal advice. Readers who have concerns about any particular circumstance are encouraged to seek independent legal advice in that regard.