General Practice, Solo & Small Firm DivisionMagazine

Real Estate Law

Small Construction Contracts: Big Issues

By Carl J. Circo

Parties. The contract preamble and signature blocks should accurately identify the parties and specify the type of any entity and the place of its organization. The contractor should also be qualified to do business and, if required, licensed in the appropriate jurisdiction to perform the contract work.

Project Delivery System. The construction industry has developed several alternative contract structures that parties sometimes refer to as "project delivery systems." These arrangements differ in how they allocate the basic responsibilities and risks of a construction project, affecting how a lawyer will address contract issues. No matter what system the parties select, the contract should unambiguously describe the role of the contractor and others involved and not just make shorthand references to a particular system. The main alternative contract structures are: (1) the traditional project delivery system; (2) a cost plus fee contract; (3) a construction management contract; (4) a design-build contract; (5) a fast track or phased project; and (6) a turnkey contract.

Scope of Work. The scope of work in many contracts is ambiguous because the contract documents include a confusing array of proposals, modified proposals, contractor "clarifications" and miscellaneous correspondence that led to the agreed price. The contract should clearly restate the cumulative agreement that these documents embody, rather than incorporating by reference, or simply having as exhibits, potentially conflicting, incomplete or extraneous correspondence and memoranda. It should also accurately portray the role of the architect or other owner representative.

Payment. The client must understand the risks involved in each payment approach. For a fixed price to be realistic and reliable, the description of the scope of work must be clear and complete. In a cost plus fee contract, the parties must decide whether to state the contractor’s fee as a dollar amount or a percentage of costs, whether the contract will provide for a guaranteed maximum price, whether the contract will provide an economic incentive for the contractor to complete the project below budget and whether owner changes that reduce the cost will also reduce the fee.

In the simplest form of turnkey contract, the contractor owns the property, there is a combined contract for construction and sale of the improved property, the sale closes when the contractor has substantially completed the project and the contractor finances the project during construction. With the possible exception of a deposit, the buyer pays for the project only after completion. Alternatively, the buyer pays the contractor in installments as construction progresses, with the buyer taking the risk of paying for work on a project that the buyer does not yet own.

The timing of payment raises several issues. With each payment method, the owner normally holds back some money until completion. The contract should specify relevant procedures. An allowance is an estimate or arbitrary amount included in the price to cover an item of undetermined cost, and an alternate is another item or items that the contractor may substitute for items the contract specifies. If the contract price is based on any allowances or alternates, the contract should clearly identify them. The owner should understand that it will pay the excess if an allowance item ultimately costs more than the allowance built into the contract price.

Warranties. The contract should contain a standard of performance. It may include a simple representation that the contractor is qualified to perform the work, will use only new material of good quality, will employ qualified workers and subcontractors and will complete the work as required by the plans and specifications listed in the contract and in conformance with all applicable building codes and legal requirements. Commonly, the contractor warrants all work and materials for one year after completion (or substantial completion). In many circumstances, a contractor should not independently warrant appliances and equipment, but should pass through to the owner all manufacturers’ warranties.

Changes to the Work. Ordinarily, an owner should reserve the right to make changes in the work that do not radically alter the contractor’s responsibilities. The contract should set out a procedure for the approval and implementation of proposed changes, requiring that change orders be in writing and signed by both parties (as well as the owner’s architect or engineer, if appropriate). The contract should require the parties to agree on any changes to the contract price or completion schedule before the contractor starts any additional work.

Contractor Defaults and Mechanics’ Liens. Payment and performance bonds in the full contract amount are the customary protection against a contractor default and liens. Bonds are impractical in many smaller projects, and small contractors may be unable to provide bonds. In some situations, the contractor may be able and willing to provide assurance to the owner through a letter of credit. In all cases, but especially in the absence of bonds or a letter of credit, the contract should obligate the contractor to provide lien waivers. At a minimum, the contractor should provide full lien waivers on its own behalf and from all major subcontractors and suppliers before final payment. Careful owners that are willing to spend time monitoring the project will require partial waivers with each progress payment. Alternatively, the owner can disburse progress payments through a disbursing agent under an escrow agreement.

Property Damage and Personal Injury. A contractor should indemnify the owner against most claims for damage and injury arising out of performance of the work. The contractor should try to avoid an indemnity provision that is broader than the contractual liability coverage under its public liability insurance policy.

Insurance. Every construction project involves insurance requirements, including: (1) builder’s all-risk coverage to insure the construction work in progress; (2) commercial general liability insurance; (3) automobile insurance; (4) contractual liability coverage for the contractor’s indemnity obligations; and (5) workers’ compensation and employers’ liability coverage. The owner should obtain an insurance certificate from the contractor.

Schedule. Scheduling considerations include: (1) whether the contract should identify one overall completion date or multiple completion dates for project milestones; (2) whether the parties agree to liquidated damages for late completion; (3) whether the contractor receives a bonus for early completion; and (4) any owner responsibility for avoiding delays, such as the prompt approval of plans and samples. The owner and its lawyer should assess the damages that may result from a project delay and how the owner can protect against those damages.

What Else? The lawyers for the parties should consider: special services that the contractor may provide or services for which the contractor will receive additional payment; requirements for subcontractors or suppliers; any special features of the site or location, such as the need for rezoning and the availability of basic utilities; the contractor’s obligation to keep the site clean and provide final cleanup; coordination between the contractor’s work and any work the owner will provide directly or through separate contractors; whether to designate individuals who will act in a binding capacity as the parties’ representatives; permit and building code requirements; whether deed restrictions require a design committee to review the plans; whether the contractor should provide as-built drawings or any operating manuals for appliances or equipment; the right of either party to terminate the contract for cause or, in the case of the owner, solely for convenience; contract assignability; arbitration or other alternative dispute resolution procedures; special procedures for sales tax exemptions; compliance with legal requirements; and special requirements that a construction lender may impose.

Carl J. Circo is a shareholder of Stinson, Mag & Fizzell P.C. in Overland Park, Kansas. He is the co-chair of the Real Property Division’s Design and Construction (including Americans with Disabilities Act) Committee.

 

- This article is an abridged and edited version of one that originally appeared on page 33 in Probate and Property, November/December 1997 (11:6).

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