Construction contracts are often times voluminous documents where those not accustomed to dealing with them on a consistent basis have trouble “seeing the forest through the trees.” This can make it difficult for owners to recognize and adequately negotiate the key terms that play the largest role in how construction risk and costs are allocated. In light of that challenge, below are ten questions owners should ask themselves before signing a contract with a contractor for a commercial project.
1. Is There a Consequential Damages Waiver?
Most industry form documents (AIA and ConsensusDocs) include such a waiver, which basically waives an owner’s right to loss of use, lost revenue and lost profits. If you are an owner or developer hoping to generate income once the project is complete, this provision can significantly limit the types of damages that can be recovered, such as additional financing costs and lost rental income, should the project be delayed for reasons beyond the fault of the owner. Additionally, the consequential waiver damage can play a significant role in what happens if there is a construction defect years later that either shuts down or limits the operations in the building and thus limits the amount of revenue generated.
2. Is There a Liquidated Damages Provision?
Particularly if the Contract includes a consequential waiver provision, significant consideration should be given regarding imposing liquidated damages to protect the owner or developer should the project be delayed. Liquidated damages generally come in the form of a per diem rate based on certain key project milestones, such as the final completion. These costs can be in the range of $1,000 to $10,000 per day depending on the size and type of project and should be sufficient to cover the owner or developer’s delay or extension costs. However, an unnecessarily exorbitant per diem rate will cause most legitimate contractors to factor that elevated risk into its price, so owners need to be mindful as to the amount because “there is no such thing as a free lunch.”
3. Is the Contractor Required to Provide a Performance and Payment Bond?
Consideration should be given as to whether the contractor should be required to provide a performance and payment bond. Performance bonds provide the best protection, in the form of a guarantee from a collectible entity, to the owner for both completing the project and for latent defect claims years later. Payment bonds ensure that all subs and suppliers are paid and that the project is lien free. In some cases a performance and payment bond is not necessary (such as for contractors with rock solid financials) and provides little additional value since there is a premium (which may cost about 1% of project cost) to provide bond coverage. Regardless, when electing not to bond a contractor, the owner should carefully weigh the risks versus the reward so that it goes in “eyes wide open.” A word to the wise, contractors that are not able to provide a performance and payment bond are the equivalent of high risk drivers that cannot get insurance, so even asking about the ability to provide a bond is a good indicator for owners.
4. If the Agreement is for Construction Management Services, does the Agreement Include an Appropriately Worded Requirement for the CM’s Standard of Care?
Many of the industry standard form contracts include provisions that the Construction Manager is to provide its services within the standard of care. However, this requirement should also be directly tied to the preconstruction estimates a construction manager typically provides during the design development stage. In almost all cases, the owner is relying on the contractor’s professional judgment and superior knowledge obtained through its extensive involvement in the planning to construct the project without exceeding the contract or budget amount and there is no reason why this standard should not be stated upfront.
5. Have You Coordinated the Insurance Coverage Stated in the Contract with Your Insurance Agent?
When it comes to insurance, owners are well advised to consult with their insurance agent to make sure the project is properly covered. Owners should provide its insurance agent with early drafts of the construction contract to make sure there are no coverage gaps. Additionally, owners should be mindful as to builder’s risk coverage and to make sure its policies meet the requirements of the contract. For example, most contracts will require the owner to carry boiler and machinery coverage in addition to builder’s risk. Regardless of the coverage, an owner, including any other related entities, should be identified on the contractor’s insurance policy as an additional insured.
6. What Costs are Recoverable by the Contractor under a Termination for Convenience?
It is common that under a termination for convenience, a contractor can recover its overhead and profit on work not performed. These could be significant costs that the owner sees little or no benefit from should a termination for convenience occur early in the Project. In most cases, owners should modify these terms so that overhead and profit is only paid on the work performed.
7. Does the Agreement Identify When and How the Guaranteed Maximum Price (GMP) will be Memorialized?
The timing as to when the GMP is memorialized plays a significant role in the risk the contractor (or construction manager) is taking. The later the date the GMP is memorialized, the less risk the contractor is assuming since the number of unknowns decreases with each day the design is further developed and construction progresses. This means the amount of contractor contingency should be less for those GMPs entered into late in the process versus those relatively early in the design process. Additionally, language should be added whereby the contractor acknowledges that the GMP includes costs for future design development consistent to meet the owner’s expectations, which should be defined in detail with the GMP.
8. What Happens if the Contractor’s Subcontractors Start Asserting Liens?
Owners are well advised to include contractual terms that address what happens if liens are filed by the contractor’s suppliers and subcontractors. These terms are especially critical when the liens arise because the contractor is not paying its suppliers and subcontractors even though it has been paid. Some protections an owner should seek are full indemnity and defense costs, including attorney fees, for these liens, along with the requirement that the contractor must either resolve them or bond them off within a specific period of time so that the owner’s title to the property does not become clouded by a series of liens.
9. What Kind of Notice Provisions Are There for Additional Work or Delays?
No one likes surprises that come with a price tag, so owners are well advised to make sure the contract includes sufficient written notice provisions. In particular, owners should consider including provisions that it is a condition precedent for entitlement to additional work (or time) that the contractor must provide written notice before proceeding. These provisions allow the owner to choose how it wants to spend its money and time instead of being surprised with a significant change request at or near the completion of the project. The recent trend, at least here in Ohio, is for courts to enforce these provisions, which when administered properly help facilitate communication throughout the project that hopefully minimizes the chances for disputes later.
10. Has the Contract Been Coordinated with the Requirements of the Lending Institution?
Owners that are financing the project through a construction loan often are required to provide certain documentation to the lending institution. These requirements could be in the form of releases for progress payments along with periodic inspections, which will affect when payments are issued. In many cases, the lending institution requires a consent of assignment providing that should the owner default on its loan payments, the lender can take over the project and assume control of the construction contract. This requirement should be something that is addressed in the construction contract. In short, owners are well advised to understand the requirements of the lending institution at the time it is negotiating the construction contract and include those specific requirements in the contract to avoid a situation where the contractor and lending institution are at odds with conflicting contract requirements.
