There are key clauses you should know in construction contracts.
By Lance Currie
Clearly and properly allocating risks in the construction contract right improves the likelihood of a successful project and avoids disputes. Standard forms, like the American Institute of Architects’ A201 General Conditions of the Contract for Construction, are a common starting place, but which clauses are most critical to owners or contractors? The clauses below arguably generate the most discussion and negotiation, and owners and contractors would be wise to familiarize themselves with each.
Site Examinations and Conditions
Despite best efforts, construction can run into unknowns. For example, unknown utilities or unexpected groundwater levels, may lurk below the surface. Who bears the cost of concealed or previously unidentified conditions? The owner typically provides copies of any surveys or testing to the contractor during the bid process.
And owners often hire a geotechnical engineer for a soils report. Under the A201, the contractor can receive an equitable adjustment if the conditions differ “materially” from the contract documents or are “of an unusual nature” and not “ordinarily found.” Owners negotiating these provisions should also try to limit or disclaim representations about site conditions, and instead place the burden to inspect on the contractor. Meanwhile, contractors might try to remove the “materially” qualifier. A middle ground would require the contractor to diligently inspect the site but allow for adjustment if a condition is truly unforeseeable.
Consequential and Liquidated Damages
Consequential damages are those that “result naturally, but not necessarily.” A classic example is lost profits. If a multifamily project is delayed six months, the owner’s lost rental income would be consequential damages. This sounds simple, but legal disputes abound over what constitutes consequential damages.
The A201 includes a mutual waiver of all consequential damages, but in practical terms, owners are much more likely to have consequential damages then contractors. An owner’s consequential damages will often result from delays, so owners are more likely to agree to the waiver if there is also agreement on a liquidated damages provision for delays.
Liquidated damages are damages agreed upon in advance, which can mitigate uncertainty while still providing protections for an owner. Owners should include a provision allowing recovery of actual damages for delay if the contractor successfully challenges the liquidated damages provision as an unenforceable penalty. Contracts may still want a cap on the total recoverable liquidated damages.
Limitation of Liability – Damage Caps
Limitation of liability provisions provide a cap on damages that one or both parties can recover in the event of a dispute. Caps are generally bad for owners but good for contractors. Negotiations over such caps, or any other provisions for that matter, will depend on leverage. When the market is booming, contractors can push harder because they can likely find other work. During bear times, owners can more successfully limit contractor protections. Agreeing to a limitation based on the amount of the contractor’s fee will seldom cover the damages caused to the owner. If the contractor insists on a cap, pushing for a limit based on the available insurance better protects the owner.
Owners want warranties that are broad in scope and time, while contactors want the opposite. The A201 includes warranties for good quality materials and equipment, work conforming to the contract documents, and work free from defects. Owners may want to add that work must be “suitable for the purposes intended,” “done in a good and workmanlike manner,” and completed such that manufacturer warranties are maintained.
Contractors would want to avoid these additions if possible and add a time period for warranties to expire. Compromise might include some of the owner additions, but with time limits for different products (exp. roof for 10 years, HVAC for five years, etc.).
Damages for Delay
Contracts almost always require project completion by a specified date. Under A201, contract completion can be extended by owner or architect changes or unforeseen events such as labor disputes, fire, casualties, etc. Owners want to limit these provisions to only delays caused by owner action, while contractors want to expand to anything beyond a contractor’s control. A middle ground might allow extensions only if the delay could not have been avoided by the contractor’s “reasonable diligence.”
No-damages-for-delay clauses go further, preventing the contractor from recovering damages it suffers while keeping the jobsite running during a delay. There are usually exceptions to these clauses, either written into the contract or in each state’s law. In Texas, for example, the provision will not apply if the delay is caused by fraud.
Termination for Convenience
When an owner terminates a construction contract for convenience, issues include what notice the owner must provide, logistics of stopping (paying subs, protecting work, etc.), profit or overhead owed to the contractor, and assumption of obligations and warranties. The A201 requires written notice, instructs the contractor to take necessary steps to protect the work, and states that the contractor is entitled to overhead and profit even on work not executed.
An owner would want to strike the last clause (overhead and profit), while a contractor would want to keep it and add that it is no longer responsible for any warranties. Often parties agree to a termination fee of a flat rate that covers demobilization and lost opportunity costs to contractor.
Most states create a safe haven if owners withhold a certain percentage of the contract price to pay subcontractors should they not be paid by the contractor. Typically, if an owner retains the amount required by statute (in Texas it is 10 percent), then the owner’s liability is capped at the withheld amount.
Practically, however, retainage gives owners added leverage to ensure final punch list items are completed. The logistics of retainage can be hard on contractors, as they may not be able to negotiate full retainage rights with each subcontractor. Depending on what is allowed in the state where your project is located (which may also differ between public and private projects), negotiating to reduce the retainage or staggering the retainage (exp. 10 percent until 50 percent completion, and then reduced to 5 percent) may relieve the strain on the contractor while still providing the owner necessary protection.
Contractors typically indemnify owners against certain losses related to the construction project. The A201 provides such indemnity arising out of performance of the work, but limited to bodily injury, sickness, disease or death, and only to the extent caused by negligent acts or omissions of the contractor. Contractors likely want to stick with the standard AIA language. Owners would want to add a duty to defend, expand the indemnities (exp. to officers, directors, and shareholders), and broaden the scope to any damages. Critically, any form indemnity language needs to be closely reviewed to ensure it conforms to state law.
The parties should agree ahead of time how disputes will be handled. The AIA forms require mediation, but allow parties can then to elect whether to resolve disputes in arbitration or at the courthouse. If arbitration is selected, the best practice is to specify how an arbitration will proceed, such as the number of and selection process for arbitrators, what discovery is available (documents only, or depositions as well?), and the type relief that can be awarded (limited to money damages, or also injunctive relief?) Arbitration is more likely to succeed in its goal of reducing litigation costs if parties agree to the process in advance.
Understanding the above clauses is a good first step to negotiating an effective construction contract. These contracts are complicated, however, and parties can avoid significant headaches if they consult with counsel during negotiations. At a minimum, attorneys can help with checklists or other tools to help your company evaluate which provisions are most critical for your business. The best path to avoiding disputes starts with all parties having a clear understanding of the agreement, and that begins with a good, well-understood construction contract.
Dallas-based attorney Lance Currie is a partner with Carrington, Coleman, Sloman & Blumenthal, L.L.P. He advises commercial owners and contractors on construction projects and resolving disputes.