Construction Basics: Top Ten Construction Contract Provisions to be Negotiated with the Owner–Part 1

Vol. 15 No. 1

By

 

After litigating numerous cases on behalf of construction Contractors and reviewing and negotiating hundreds of construction contracts, the authors are very familiar with the significant risks to construction Contractors arising from the contracts they sign. The good news is that it is sometimes possible for Contractors to avoid certain risks through awareness of key provisions during the negotiations with an Owner. By better understanding their own contracts, Contractors and their counsel can identify, in instances where negotiation is possible, appropriate changes that will clarify certain provisions, provide additional protections or more fairly allocate risks.

This article begins a two part “Top Ten” list of construction prime contract provisions, briefly explains the provisions, and identifies potential negotiating points from the Contractor’s perspective. The second part of this "Top Ten" list will be published in a future issue of Under Construction.

A. Scope of Work/Performance Duties

1. Definition – A critical contract term -- scope of work -- is often overlooked. Contractors usually trust their estimating teams to fairly and adequately estimate the scope of work shown on the Owner’s drawings. However, later (and vehement) disagreements about the Contractor’s expectations for quality, completeness of design documents and nature/scope of duties are not uncommon.

2. Explanation - Subjects not adequately evaluated during negotiation of contract terms often include “gaps” in scope of work, adequacy and completeness of design documents, coordination responsibility during construction, and responsibility for correcting incomplete/deficient designs created by the Owner’s design professionals. These problems are amplified in complex, fast track or design-build projects that often commence with incomplete design/performance specifications and by “design creep” (i.e., an Owner/designer attempts to abdicate design responsibility to the Contractor during construction).

3. Negotiation Strategies – Will the Owner expressly warrant that the design/construction documents are complete, fully coordinated, without defects, and ready for construction? If yes, include this express warranty in the contract for Contractor protection. If no, this unwillingness is a red flag. Alternatively, try to get the Owner to warrant the adequacy and completeness of all of the design with some minor exceptions.

B. Indemnification

1. Definition - Indemnification means that one contractual party agrees to assume responsibility for certain judgments resulting from third-party claims against the other party. One example is the indemnity clause from the AIA A201-2007 (General Conditions), Paragraph 3.18.1, which states in part that “the Contractor shall indemnify and hold harmless the Owner…from and against claims, damages, losses and expenses…arising out of or resulting from performance of the Work, provided that such claim, damage, loss or expense is attributable to bodily injury, sickness, disease or death, or to injury to or destruction of tangible property (other than the Work itself), but only to the extent caused by the negligent acts or omissions of the Contractor, a subcontractor, anyone directly or indirectly employed by them or anyone for whose acts they may be liable.”

Under 3.18.1, if a subcontractor's employee is injured because of actions or omissions of the Contractor, the Contractor must indemnify and “hold harmless” the Owner against resulting claims. In addition, the Contractor may be asked to indemnify the Owner against claims for property damage, IP infringement, liens and hazardous materials. Contractors are also frequently required by Owners to “flow down” such provisions in subcontracts.

2. Explanation – While the Contractor ideally wants to “flow down” the indemnity obligation/risk to subcontractors, that strategy does not always provide protection. Because multiple subcontractors may be working in the same area, it can be difficult to assign degrees of fault for a given act of negligence.

As examples, New Jersey law (N.J.S.A. § 2A:40A-1) prohibits a solely negligent Owner from seeking indemnification from a Contractor for property damage or injury. However, a partially negligent Owner may seek indemnification from the Contractor if other parties have contributory negligence. New York law (NY Gen.Oblig. § 5-322.1) similarly prevents an Owner from seeking indemnification from a Contractor for property damage or injury to the extent such damage is caused by the Owner itself.

3.Negotiation Strategies – Whenever possible, the Contractor should strive to limit its indemnity obligations to items for which it can obtain insurance. Another possible negotiation strategy is to seek mutual indemnification. If a claim involves design, the Contractor, by obtaining a mutual indemnification provision, retains the ability to recover from the Owner (who bears responsibility for its design).

Because state laws regarding the enforceability of indemnification clauses differ, counsel for Contractors should confirm the enforceability of indemnification clauses in the relevant jurisdictions.

C. Warranties and Bonds

1. Definition – AIA A201-2007, Paragraph 3.5.1 (Warranty) states in part that “the Contractor warrants to the Owner and Architect that materials and equipment furnished under the Contract will be of good quality and new unless otherwise required as permitted by the Contract Documents, that the Work will be free from defects not inherent in the quality required or permitted, and that the Work will conform to the requirements of the Contract Documents . . . the Contractor’s warranty excludes remedy for damage or defect caused by abuse, modifications not executed by the Contractor, improper or insufficient maintenance, improper operations, or normal wear and tear and normal usage.”

This general warranty commences upon the date of Substantial Completion and continues through the applicable statute of limitations or repose (usually covering the shorter of the two) and may also include specific manufacturer’s warranties for equipment, systems, and materials. A requirement that maintenance bonds be issued for some or all of the work for the duration of the warranty period may also be included. Systems, material and equipment warranties will typically commence upon the owner's use of the particular system, equipment, or product (especially in HVAC equipment warranties).

2. Explanation - Warranties allow the Contractor to “flow down” Owner complaints to Subcontractors and Suppliers. However, due to various warranty limitations, the Contractor may not receive complete protection from a warranty alone. The Contractor must guard against failures in coverage that may result in default and non-payment by the Owner. The Contractor's workmanship warranty and maintenance bond, if required, may expand responsibilities and, typically, will not include warranty disclaimers such as those provided by manufacturers. Awareness of warranty terms is important since, after a product warranty expires, the Contractor’s workmanship warranty may be called upon instead.

3. Negotiation Strategies - The Contractor should attempt to establish definite commencement/end dates for all warranties. Negotiate for a general warranty on materials/labor of one year. The Contractor should also consider whether to characterize repairs as “punch list” or “warranty” work. If the Contractor performs punch list work prior to final acceptance, the Contractor may still have lien rights as to retainage withheld by the Owner. On the other hand, if the Contractor characterizes the same repair activity as "warranty" work, the last date of such work cannot be used to establish the last day of work necessary for a lien claim. In the situation described above, it is against the Contractor's best interests to describe repairs as warranty work rather than punch list work. Finally, the Contractor should consider obtaining equal warranties from its Subcontractors (another example of “flow down”) and requiring larger Subcontractors performing substantial amounts of work to provide their own maintenance bonds.

D. Project Changes and Change Orders

1. Definition – Construction projects often begin with the Owner providing plans and specifications, followed by the Contractor agreeing to build to them for a stated price. Equally often, during the course of a project 1) plans and specifications prove to be inconsistent; 2) the Owner or the Owner’s design team wants to add/delete certain items; and 3) existing conditions prove different than expected. Suddenly, the project being built is different from the one the Contractor bid upon.

The contract documents typically address these situations through Change Order provisions that identify procedures for requesting and issuing Change Orders, timing, notifications, and dealing with the common situation of disagreement between the Contractor and Owner as to value of the changed work.

2. Explanation - The Contractor must assure its ability to recognize a change, promptly respond to change requests, and analyze the full impact of a change. Unfortunately, many standard form contracts do not provide for Change Orders initiated by the Contractor.

The Contractor may benefit from inclusion in the contract of a change order allowance as discussed below. Otherwise, the Contractor may be compelled to incorporate a value for change order risk into its contract price that could result in an unfavorable bargaining position or the Contractor losing the contract.

3. Negotiation Strategies - The Contractor should negotiate the valuation of change orders so overhead and profit are recoverable as well as labor materials and equipment. Of course, an Owner has a legitimate interest in receiving reasonably timely notification of a Contractor’s contentions concerning changes or delays for purposes of monitoring the project, budget, and schedule. However, the Contractor should insure that the prime contract contains sufficient time to provide notices and documentation, consistent with contractor’s staffing. The authors recommend no less than ten business days to provide initial notice and a more extended period for analysis and submission of additional documentation regarding the full impact of a given change. Because one change can impact the time and/or costs for an entire series of critical path events, the Contractor may also want to reserve its rights to submit a cumulative impact analysis in such situations.

In the event of disagreement with the Owner regarding Change Order valuation, AIA A201-2007, Paragraph 7.3.9, provides for the Architect to determine the amount of payment to the Contractor pending resolution of the dispute. The Contractor should negotiate for modification of this provision to include, at minimum, payment of the Contractor’s actual costs to perform the changed work during the dispute.

E. Delays

1. Definition - Standard form agreements allow Contractors to claim time extensions and/or damages when so-called “force majeure” delays occur, if the Contractor bears no responsibility for the delays. Force majeure delays, in addition to “acts of God,” may include labor disputes, material shortages, government agency actions and delays caused by the Owner or Architect. Contractor delay damages, in addition to basic costs, may include price escalations, acceleration costs and extended home office/field office overhead and costs.

Of course, if the Contractor bears responsibility for project delays, the Owner will not approve additional time or money. Most agreements provide in such cases for Contractor acceleration of the work, at no cost to the Owner, to overcome Contractor-caused delays. Owners also often include “liquidated damage” provisions that provide for payment of a fixed daily sum to the Owner if the Contractor fails to timely achieve the contractual Substantial Completion date.

2. Explanation - AIA A201-2007, Paragraph 8.3, treats force majeure delay as grounds for a Contractor time extension claim but does not specifically address compensation. Owners often seize on this omission as justification to include "no-damage-for-delay" clauses in their customized contracts. Such clauses limit Contractor remedies for delay to non-compensable time extensions. Because this Owner position is arguably inequitable, no-damage-for-delay clauses have been the subject of numerous court decisions and statutes. As state laws vary significantly regarding the applicability of no-damage-for-delay clauses to private construction projects, counsel for Contractors should confirm applicable laws if the project is in an unfamiliar jurisdiction.

3. Negotiation Strategies – The Contractor should strive in negotiations to include all possible non-Contractor-caused delays, including delays caused by the Owner’s separate contractors, as compensable events. Amounts and types of compensation, rather than compensation or not, should be the focus.

If the Owner wants to include liquidated damages as protection against Contractor-caused delays, the Contractor may choose to appear cooperative to the Owner by agreeing to this provision but negotiating a set limit upon the maximum number of late days/dollars available to the Owner in such circumstances.

If the contract is of a “Cost-Plus” variety, with or without a Guaranteed Maximum Price, the Contractor should seek to include a “Construction Contingency” in the contract. The Construction Contingency is a percentage of the total value of the contract that is potentially dedicated to reimbursement of the Contractor for the costs of its mistakes (such as delays caused by its subcontractors).


Advertisement

  • Under Construction

  • Subscriptions

  • Contact Us