KEY PROVISIONS IN A CONSTRUCTION CONTRACT

Contracts can be created with a simple conversation of a verbal offer an acceptance between two parties, with some consideration thrown in to make it enforceable.  Contracts happen to everyone on a daily basis.  We often enter into contracts with the people that we deal with on a day in and day out basis, often without giving it much thought.

While the legal requisites for formation of a legal contract are an offer, an acceptance, competent parties who have the legal capacity to contract, lawful subject matter, mutuality of agreement, consideration, mutuality of obligation, and, if required under the Statute of Frauds, a writing, this article will not explore the many types of contracts, nor delve into the finer points of contract formation.  It will however, explore some of the more common contract clauses that we see in written agreements. More often than not, complex construction business contracts are entered into after a formal negotiation process, with the details of the terms integrated into a written instrument that it ultimately signed and executed by the parties entering into the contract. Negotiating and drafting any type of commercial or transactional contract, whether it be an open account agreement or construction contract, is an exercise in risk allocation.  It is crucial that you read and understand the contracts that you sign, as contracts govern the terms of the agreement, and if valid, will be enforced by the courts. Changes, modifications and clarification of issues can be handled easily at the front end of a contract negotiation; however, once the contract is executed you or your company are legally obligated to follow the terms of the contract. In order to allocate that risk, the individual reviewing the agreement must first be able to identify and understand the risks likely to be encountered. The ability to do this effectively, is driven not simply by a familiarity with construction law, but by a fuller understanding of your business operations and the project itself.

A detailed risk identification and assessment exercise performed early in project development and prior to executing contracts will identify not only the legal questions, but also those business risks and issues inherent to a given project. Through the process of negotiation and the inherent communication chains created in a negotiation, all participants are better informed at the outset of the project, the contract will likely better serve the parties, and the odds are enhanced that the participants’ anticipated benefits and goals from the transaction will be met. As a direct result of time spent at the front end understanding the contract terms and risk allocation, everyone should benefit by the end of a project.

A limitation of liability clause can be one of the most effective risk allocation tools available to contractors, design firms and material suppliers. However, these clauses can also be among the most difficult to negotiate and one of the most contested in the litigation arena. Therefore it is critical that any limitation of liability clause be carefully negotiated and drafted in a fair and equitable manner that is likely to hold up to a challenge in court. Generally, courts don’t favor limiting a party’s liability for their own negligence, but they will uphold these clauses when they are fair, reasonable and mutually agreed to by parties with equal bargaining power and opportunity to negotiate. It is important to note that these agreements will not apply to any third parties to a dispute.

The rationale of such a clause is that one party, often the project owner, has the most to gain from a business agreement and therefore should accept the greatest degree of risk in the event problems arise. Typically, the subcontractor or design professional’s potential reward for a project is simply an hourly fee, and a supplier gets only a small margin on materials.  Another way of looking at these clauses to shift greater risk to the party that has the greatest control over the transaction. Many attorneys suggest choosing a reasonable fixed amount, such as $50,000 or $100,000, as the liability limit. Others set the limit at the greater of a fixed amount or the full amount of the contract. Other limitation of liability agreements equate the dollar cap to the amount of professional liability insurance available. If you use this type of limit, make certain the wording reflects “insurance coverage available at the time of settlement or judgment” in the event your policy limit has been eroded by other claims. You will not always be successful in negotiating a limitation of liability clause. However, simply discussing a limitation of liability clause provides momentum to explore various issues of risk management and risk allocation on a project.

Negotiating and drafting any type of commercial or transactional contract, whether it be an open account agreement or construction contract, is an exercise in risk allocation. In order to allocate that risk, the individual reviewing the agreement must first be able to identify and understand the risks likely to be encountered. The ability to do this effectively, is driven not simply by a familiarity with construction law, but by a fuller understanding of your business operations and the project itself.

Through the process of negotiation and the inherent communication chains created in a negotiation, all participants are better informed at the outset of the project, the contract will likely better serve the parties, and the odds are enhanced that the participants’ anticipated benefits and goals from the transaction will be met. As a direct result of time spent at the front end understanding the contract terms and risk allocation, everyone should benefit by the end of a project.

Here are a few typical clauses found in construction clauses that deserve special attention and focus during the contract negotiation process:

NO DAMAGE FOR DELAY CLAUSE

One of the great risk allocators in the construction industry is the no damage for delay clause. The contractor in bidding the project must carefully examine the contract documents to determine whether or not there is, in fact, a no damage for delay clause contained within the terms of the contract. If there is one, the contractor must bid the contract with knowledge that such a clause exists and it will have the burden of proof to get around the no damage for delay clause. Customarily, this provision provides that while the contractor or subcontractor is not entitled to a claim for delay damages, it will be entitled to an extension of time. Many times the contract will provide that the contractor is entitled to no damage for delay, but, on the other hand, the owner or contractor is entitled to liquidated damages for any delay caused by the contractor or subcontractor.

CONTRACTORS REVIEW OF DOCUMENTS

In general, owners are responsible to contractors for errors and omissions in the construction plans and specifications. As a result, owners frequently seek to insert exculpatory clauses in contracts shifting the risk of defects in the plans and specifications onto contractors or subcontractors. In general, the exculpatory clause to be enforceable must be sufficiently specific so as to put the contractor on notice that he or she should not under any circumstances rely on the accuracy of the plans and specifications to prepare an estimate for the cost of the work to be performed. Many contracts provide that the contractor must inform the owner and seek correction of or clarification of any document deficiencies such as errors, omissions or inconsistencies and to do so prior to proceeding with the work. In the event that the contractor then proceeds recognizing such error, inconsistency or omission and fails to report it to the owner or architect, the contractor will then be responsible should the installation prove defective.

INDEMNITY CLAUSE

Often contracts contain clauses that read something to the effect that each party shall indemnify, defend, and hold the other party harmless from and against any and all claims, actions, suits, demands, or judgments asserted, and any and all losses, liabilities, damages, costs, and expenses, including, attorneys’ fees alleged or incurred arising out of or relating to any operations, acts, or omissions of the indemnifying party. This means that the indemnifying party will pay the damages, claims, expenses and other types of payments listed in this provision if the indemnified party, incurs damages as a result of something the indemnifying party does related to the agreement. The things the indemnifying party could do that would result in liability to the indemnified party are listed at the end of the provision (essentially acts or omissions under the agreement). This provision requires that the indemnified party promptly notify the indemnifying party of a claim and allow that party to control the defense or settlement of the claim. An indemnification provision addresses the risk that your company might be liable for damages resulting from something the other party does related to the contract.