Volume 1, Number 2
|Table of Contents|
How Construction Contracts Cause Litigation
An explanation of some of the common causes of construction claims.
We live in a litigious society, and the construction industry contributes its fair share of disputes. Claims and litigation seem to be an inevitable part of construction projects, but this does not mean that nothing can be done to reduce the risks, or at least limit the delays, disruptions and expense, caused by conflicts on construction projects. History teaches that the parties and projects may change, but the issues and types of disputes surrounding construction projects do not. Knowing the areas where conflict is likely to arise, and carefully planning to address them, can reduce the risk of conflict, and therefore increase the chance of a successful project for all concerned.
Some of the areas which generate conflicts are as follows:
Owner-drafted contracts frequently reflect the mentality that conflict can be avoided by protecting the owner from all possible claims. Such contracts contain exculpatory language, waivers and limitations intended to bar virtually all claims by the contractor. The idea is to protect the owner from all foreseeable and unforeseeable risks by shifting responsibility for those risks to someone else.
One-sided contracts, however, may generate as many claims as they prevent.
Construction claims principally are caused by: (a) unforeseen or changed project conditions, (b) changes in the work, (c) late provision of drawings, access, permits, equipment or materials, (d) inadequate drawings or specifications, and (e) interference in the work. When commencing construction, contractors justifiably expect that all necessary permits are in place; they will have access to the work; they will receive timely engineering and owner-supplied information; shop drawings will be promptly reviewed; and unexpected conditions or changes will be fairly compensated. Where these expectations are not met, contractors often lose money on a project, prompting claims no matter what the contract provides. In a worse case scenario, severe losses may force a contractor out of business, resulting in a failure to complete the work and the attendant delays, disruptions and inevitable costs to the project.
Construction disputes are more likely to be avoided through a fair allocation of project risks. The guiding principles are that risks should be allocated as follows: First, risks should be allocated to the party who has direct control over the portion of the process that creates the risk. Second, where no party has direct control, risk should be allocated to the party who is best able to protect against an unexpected loss or casualty. Finally, where no party has control, risks become the responsibility of the owner, who is the party that initiated the construction project and presumably is the ultimate beneficiary of the results.
Project Delivery Systems
The delivery system selected for a project, and the contract structure reflecting that system, can greatly affect the risk of conflicts regarding such fundamental issues as scope, time, money and risk allocation.
The traditional single-prime contract for a fixed price between the owner and contractor is the most commonly used and best understood project delivery format. This type of contract, with a clear chain of command, removes all ambiguity regarding which party is responsible for management of the construction work and which is responsible for the design.
Driven by market forces, recent decades have seen the use of innovative project delivery systems and innovative contract forms reflecting those systems. Design-build, construction management and fast-track delivery systems often provide economic benefits to the owner. An owner may need an office building by April, a shopping center by June, or a school by September. Such circumstances can justify a fast-track or design-build approach.
Innovative project delivery systems, however, often blur the traditional roles and responsibilities of parties on a construction project. Owners should understand that the use of non-traditional contract approaches creates greater risks of misunderstandings, particularly where the scope of work and compensation are changing continuously during the project. Owners, therefore, should understand that the contingencies involved in non-traditional construction approaches are greater than in the traditional single prime contract approach, and should plan accordingly.
An incomplete, inaccurate or poorly coordinated design inevitably will produce a project with conflicts and unanticipated costs and delay. Conversely, nothing diminishes the risk of misunderstanding and litigation, and provides more protection for the owner, than an accurate and complete design.
The traditional single prime contract can succeed only if, when the contract is priced, the plans and specifications are reasonably detailed and complete. Otherwise, the contract sum becomes an unreliable figure subject to changes and claims for delays and impact damages.
However, in order to obtain a complete and accurate design, the owner must give its architect/engineer a reasonable period of time to develop a complete set of plans and specifications, and provide a fair fee for that service. The owner who pinches pennies with its architect and sets an unreasonable schedule invites substandard plans/specifications, and time and cost overruns. The owner's failure to pay fairly for adequate design and engineering will drive its design team to use off-the-shelf specifications and uncoordinated drawings, requiring the contractor and the design team to design the project as construction progresses.
For similar reasons, fast-track construction increases the risk of misunderstanding and litigation. While commencing construction before a complete design is in place may be justified by the owner's economic needs, the costs and risks of that approach should be considered when estimating cost and projecting completion dates.
Views differ on whether, and to what extent, a contract should provide additional compensation for differing site conditions. Some form contracts (such as the federal and American Institute of Architects standard general conditions) include a differing site conditions clause which entitles the contractor to additional compensation for unexpected subsurface conditions meeting certain criteria. Some owners (public and private) model their contracts on these forms. Other owners utilize contracts that are silent on the issue, or expressly prohibit recovery for differing site conditions while placing all of the risk of the unknown on the contractor.
The assurance of equitable compensation for differing site conditions encourages prudent contractors to submit lower bids, unencumbered by contingencies for unknown conditions. Perhaps just as importantly, a differing site conditions clause helps protect prudent contractors against being underbid by competitors who are either too careless or too reckless to include such a contingency. Because hidden conditions can make the difference between a profitable contract and a financial disaster, competent contractors often insist on an equitable adjustment clause before submitting a bid on a job with significant risk of differing site conditions.
No matter which approach is taken, the wise owner will make a thorough subsurface investigation so that as much can be known about the site as possible. That information should be shared with the contractor whether performing under a differing site clause or as a part of a contract with exculpatory language.
Reliable structural engineering and design, and realistic pricing by the contractor, cannot be generated in the absence of such knowledge. A good exploratory program by a competent engineering firm will diminish misunderstandings and disputes resulting from extra work and foundation failures. The quality of this investigation, as much as an exculpatory clause, will diminish disagreements leading to litigation.
Generally, the owner has no contractual obligation to provide for inspection or site monitoring. The contractor has the obligation to provide its work in accordance with the plans and specifications, and free from defect. Nevertheless, the prudent owner will provide on-site representatives for significant projects. That representative may be from the architect's office or it may be a permanent employee of an owner who does major construction work.
Unfortunately, some owners, even on large projects, attempt to avoid overhead costs by cutting corners here. Even if the owner ultimately proves that the contractor made a bad pour or connected the steel improperly, it is infinitely better that the defect be discovered early rather than well into the construction stage, where litigation is usually the result. A good inspection is the contractor's and owner's best friend. It is just common sense for the owner to protect itself from the catastrophic consequence of others' failures.
Who is in Charge?
A careful reading of many construction contracts makes it difficult to find anyone in charge. The architect's role has dwindled from inspector, to observer, to an occasional presence disclaiming most responsibility. The architect/engineer often provides generic specifications, pushing true design responsibilities for specialty items down through the prime contractor to various sub-levels of subcontractors and suppliers. There have been catastrophic failures because no one was in charge, with each of the parties attempting to shift the risk to another.
The owner and its architect/engineer, whatever their approach to exculpatory and risk-shifting provisions, should carefully review technical data to make certain that the project will function, even if that means that an owner has to employ outside consultants or experts during the construction stages.
The contractor also should not allow its subcontractors' work to be performed and integrated into the project without careful observation. The contractor is responsible for its subcontractors. It is in charge of their work, and needs to assure that it is properly done.
The shop drawing process seeks to avoid failures and misunderstandings by allowing the contractor to demonstrate the detailed application of the architect/engineer's design. It is here that the prime contractor, the owner and architect have the best opportunity to avoid non-conforming products or defective work. Unfortunately, prime contractors often rubberstamp subcontractor and supplier submittals while relying on the architect/engineer for approval or disapproval.
Although the architect has final legal responsibility to approve or reject shop drawings, a contractor who does not give time and attention to this area substantially increases the risk of failure and litigation. Contractors have a substantial self-interest in making sure that material and equipment suppliers conform to the design plans, and that no unauthorized changes have been made. In short, all parties who have the opportunity to review shop drawings bear the responsibility to do so in order to assure successful project completion, no matter what the contract provides.
The areas discussed above, if given proper attention, present opportunities to reduce conflict on construction projects, so long as all parties recognize their responsibilities. The contractor must provide quality workmanship. The architect must provide a quality design. The owner must pay a reasonable price for these services. No contract language will prevent disputes where these responsibilities are not met.
New Jersey Lawyer, the Magazine, October, 2002
Copyright © 2002 by New Jersey State Bar Association; Robert C. Epstein
Copr. (C) 2004 West, a Thomson business. No claim to orig. U.S. govt. works. This article is reprinted with permission from West, a primary sponsor of the General Practice, Solo and Small Firm Section.