For property owners and developers, the most important first step on any construction project may be hammering out a contract with their builders or contractors. Even for owners and developers who engage an owner’s representative on a project, it remains imperative that they understand the terms of the construction arrangement.
Investing the time to ensure that a contract clearly spells out expectations and delineates duties and responsibilities on both sides can be critical to the success of the project. A strong contract — one that is detailed, specific and realistic — can help reduce construction delays, cut costs, and avoid future litigation.
Conversely, relying on verbal agreements or a do-it-yourself contract template can leave real estate owners dangerously exposed should a dispute arise. A construction contract should be drafted by counsel to meet the specific issues related to a particular project. Though it’s impossible to anticipate every scenario that might arise, the agreement should address broad range of issues—from the project’s scope and schedule to change orders, insurance, indemnification, and payment processes, among others.
With that in mind, we have compiled just a few of the issues property owners and developers should consider when they negotiate construction contracts:
1) Scope of Work and Scheduling. Spelling out, in detail, who is responsible for what and when is crucial in helping avoid ambiguity and expensive change orders later in the construction process.
The scope and scheduling portion of the contract should set forth the work a builder or contractor is expected to perform, how that work will be completed, and any additional responsibilities. An owner may also want the builder to detail how unforeseen events will be handled; the use and interpretation of design documents; and how quality and completion of a job will be judged. Clarity is key. Descriptions of work should be as complete as possible to avoid confusion on either side.
Though owners or developers are protecting their rights, the negotiations process need not be adversarial. Owners and developers and their counsel should work closely with their builders and contractors to create terms that will foster success and diminish the likelihood of disputes.
For instance, the real estate owner or developer may have a timeline in mind for construction that the builder considers impossible to meet. The two sides should work cooperatively to create a more reasonable, mutually agreeable schedule – one that doesn’t set the builder or contractor up for failure from day one.
2) Change Orders. Invariably, major building projects require changes during construction. Not all of those projects, however, have a detailed process for change orders. It’s a key reason why so many disputes over changes erupt into protracted and costly disputes between builders and owners.
The problem may be solved by spelling out how changes will be handled in the construction contract. A step-by-step process should be in place for making a change to the scope of work in the contract. As a general rule, change orders should be in writing, and they should be signed by both the contractor and the owner. The order should also be reasonably detailed and spell out the reason for the change, and relevant information about how the new work will be completed and when.
However, an owner or developer should not go overboard. The process cannot be so onerous as to discourage compliance. Once again, the owner and builder should negotiate a mutually agreeable process up front and stick with it throughout construction.
3) Insurance. When negotiating a construction contract, owners and builders should ensure that their general contractor has the right type of insurance coverage and adequate policy limits to cover potential losses. Insurance requirements agreed upon by an owner and general contractor should be passed down to subcontractors as well.
Among the types of coverage contractors and subcontractors may be required to carry are automobile liability, commercial general liability, and workers compensation/employers’ liability. They may also be required to purchase an excess liability policy that covers amounts above their automobile and commercial general liability limits, as well as pollution liability coverage, among other policies.
4) Indemnification. The construction contract should explicitly settle issues of indemnification, determining who defends and holds harmless the other parties to the contract if a third party is injured. Contracts often require the contractor to indemnify a property owner or developer from claims caused by the negligence of a subcontractor of contractor. On the other hand, an owner may be asked to indemnify contractors and subcontractors if, say, hazardous materials are found at the construction site.
Owners should have a clear idea of each of the risks indemnified in the contract, who is responsible for the indemnity, the limits of their potential liability and whether the indemnifying party is adequately insured to cover potential losses.
5) Payment Application and Lien Waivers. Payments on a construction project can cause particular headaches for property owners. To avoid conflicts with a contractor and potential litigation, both sides should agree to a clear payment application, or pay app, process. While payment process and lien regulations vary from state-to-state, the following is some general guidance to help navigate these issues.
A pay app is, essentially, a detailed invoice that includes information about the work completed on the project. How much detail the application must include, at what intervals in the project applications should occur, how subcontractors should be paid, and the timeliness of payments all might be considered as part of a contract negotiation.
Similarly, the parties should determine how they will manage lien waivers. Lien waivers are legal documents that, when executed, serve as proof that a bill has been paid. For owners and their lenders, it’s critical to ensure lien waivers are collected from contractors and subcontractors to help prevent payment disputes, double payments, and liens from cropping up against their property.
For owners, it’s important to set the rules for how waivers will be handled. They should understand whether waivers will be conditional or unconditional. A conditional waiver is, as the name suggests, conditioned upon some other act – for example, the contractor may waive its lien rights on the condition that payment arrives in its account. Unconditional waivers have no such stipulations; liens are waived once the document is signed.
They may also negotiate partial lien waivers and final lien waivers. Under a partial lien waiver, contractors or subcontractors waive lien rights for a portion of the total value of a contract. For instance, a subcontractor may be paid $60,000 and accept payment in $20,000 increments. The subcontractor may execute a partial lien waiver when it receives each payment. A final lien waiver is for the entire value of a contract and is usually used to reflect a final incremental payment or when an entire balance on a contract is paid at once.
Careful contract preparation and review is essential to ensure a smooth and litigation-free construction process. Before negotiating, drafting, and signing a contract, property owners and developers should consult with an experienced attorney who can help them avoid the potential contractual pitfalls that can derail a project. To learn more about how Kaplan Voekler Cunningham & Frank can help, contact us for a consultation.