Construction Law Shifts with Techniques
As seen in Business North Carolina magazine’s special Law Journal, June 2008.
Construction has grown more sophisticated in recent years, as material science, building practices and technology combine to produce better buildings. For better or worse, construction contracting has kept pace with this trend. While this contributes to a more controlled, scientific approach to building, it also makes it easy to get bogged down in contract details and miss the forest for the trees.
A general understanding of construction contracts will help owners negotiate better deals and project results. While contracts ultimately should be reviewed by an attorney, owners can complete much of the preliminary work by considering the basic objectives of a construction agreement, the necessary components of such agreements and when and how to use standardform agreements.
Objectives of a contract
A contract is a promise or set of promises that the law will enforce if either party fails to perform. Most contracts are enforceable — whether written or not — but putting an agreement in writing can help avoid disputes later by setting forth the basic understanding of the parties. It also can allocate the risks inherent in a construction project to one side or the other, establish procedures to govern the construction process and establish legal mechanisms that will set the rights of the parties in the event the agreement is breached, or if certain stated events occur.
Nuts and bolts
When preparing to work out an agreement, it is helpful to have a list of the typical components of a construction agreement. Some items to consider are:
Project scope: What is included in the project and what isn’t? The clearer this can be defined, the better. The plans and specifications should be incorporated by reference and listed by date and page.
Price: How will the owner purchase the project? If the job is lump sum, defining the scope of work included in the stated price is critical because other work will give rise to claims for additional compensation. If the job is cost plus a fee, it is critical to delineate between the types of costs that are reimbursable and those to be paid out of the contractor’s fee.
Timing and payment procedure: If the owner is using bank financing, the lender may impose conditions on disbursement of funds. Payment provisions in the contract should be consistent with lender requirements.
Construction time: Late jobs increase the owner’s costs in financing, alternate facilities and management. Therefore, owners should consider whether to assess liquidated damages for delayed completion. In order to enforce this provision, the owner must establish that the sum established is reasonably related to the actual damages the owner would sustain in the event the job is completed late.
Project management: Does the owner have the capabilities to manage the project details with in house-personnel, or should a third party be retained?
Risk allocation: Typical risks include unforeseen site conditions, material price escalations, hazardous materials, damage to third parties, insolvency of prime contractors or subcontractors and bad weather. Typically, the party with the best ability to manage a risk — or to insure against it — should bear it. While an owner might see advantages to having the contractor assume all risks, that will add to project costs.
Owner termination clauses: Often the owner will need the right to unilaterally terminate the contract for convenience, subject to a formula to compensate the contractor for work completed prior to termination.
Insurance and bonds: Most contractors carry general liability, workers’ compensation and automobile insurance. These typically will not pay an owner if the work under contract is damaged or incorrectly built. A builder’s risk insurance will cover the replacement of the work in the event of a stated loss. Payment and performance bonds protect the owner if the contractor fails to complete the contract or fails to pay its subs. (These are almost always required for public work. In the private sector, bonding is available but the owner will pay the bond cost.)
Work and product warranties: The typical builder warranty is one year for repairs or replacement of defective materials. Extended product warranties may be desired and should be considered.
Valid indemnification provisions: An indemnity is an agreement by one person to defend another party and pay damages that party is obligated to pay to a third party. An automobile insurance policy, for example, will defend the insured against a suit complaining of motor vehicle negligence — and pay any resulting damages. Indemnity provisions are critical risk-shifting mechanisms in construction contracts. The owner usually wants to be indemnified from every other participant. Your attorney should write these provisions to make sure they’re enforceable under state law.
Provisions for changes in the work: The owner will want the abilities to change the work and control additional compensation for the changes.
Legalese: All construction contracts require provisions addressing dispute-resolution procedures, choice of law and venue for disputes, waiver or exclusion of damages and remedies and lien waivers and subordinations. These are best reviewed with your attorney.
Standard construction agreements
The expense of re-inventing the wheel for every project often makes standard agreements more economical than a custom contract. These agreements are published by several industry groups and include owner/architect agreements, owner/contractor agreements, general-conditions agreements and others. These documents are typically arranged in families, which include documents necessary for all parties contracting on a project. It is important that the same form documents be used for all contracts issued on a project so that consistency is achieved.
Forms may be procured for all types of project delivery systems (traditional design-bid-build projects, construction-management contracts, design-build projects, multi-prime, etc.) and for various pay structures (lump-sum, cost-plus, etc.) However, as most documents reflect the needs and interests of the drafter, standard form agreements tend to be biased toward the group that prepared the agreement, which can be a disadvantage in using these forms.
Given the number of options available for the structure of a project — and the number of forms available for contracting on such projects — proper use of a form requires selection of the proper one. It must be closely analyzed to determine what custom modifications are required, given the intended arrangement and understanding of the parties. Otherwise, it’s likely that the expectations of the parties will not correspond to the standard terms of the contract entered.
Success
Hopefully, the explanation of the big picture of construction agreements, plus the nuts and bolts required in most construction agreements, will assist owners in developing, analyzing and negotiating contracts. Remember, better contracts make for better projects.