5 Questions You Should Ask When Drafting Contracts
Signing a new construction contract agreement is an exciting time for both parties involved. For the owner, it means that the project is on its way and the actual construction process can soon be started. From the general contractor’s point of view, securing new work is generally a good sign of a steady business and opens the potential for more work down the road. On the other hand, the contract signing period can also be a trying exercise in each party’s patience and initial relationship.
Historically, the relationship between the owner and contractors has been strained. Before entering an agreement, it’s natural for both parties to want to protect their own interests and sometimes this can lead to one-sided contracts due to distrust and negative experiences in the past. According to a study by KPMG, only 32% of owners have a high level of trust in their contractors. Preexisting doubt of the other party’s intentions will naturally lead to tension and problems at the start of a project, and the general contractor might be quick to jump to legal action at a later date, resulting in significant expenses and wasted resources.
At the end of the day, the owner and contractors should be working for the common goal—completing a high-quality project within budget and on time. Despite the pressure to have all participating stakeholders sign documents as soon as possible so the project can get started, if you enter your agreement with a flawed contract, you put your project and company in the path of avoidable liability that distracts from your goal. Therefore, to ensure your contract is friendly for all involved, and as result reduce overall project risk, it’s important to take a step back and ask yourself the question—“is my contract setting up a project environment that fosters team-friendly collaboration amongst all parties?”
The Danger of One-Sided Contracts
For owners, the jeopardy of entering a one-sided contract can be detrimental to your project and unhappy contractors may take legal action when disputes arise—a time-consuming and costly expense. According to DCD Magazine, just eight of the most commonly used contract provisions that attempt to transfer risk increase contract prices by 20% or more, inviting failed projects and litigation in the future.
Therefore, examining if your contracts are two-sided is a good way to begin creating more team friendly projects that improve trust, efficiency during the construction phase, and reduces overall risk and costs. Below, we’ll provide you with top questions you should be asking when drafting and reviewing your contracts in order to help you keep the excitement of a new project while maintaining a professional and productive relationship with your contractors.
The Devil is Not in the Details: Is Your Contract Language Vague?
The most common problem in construction contract agreements is that one or both parties do not fully understand what is expected of them. Most importantly, a solid contract should fully explain what type of relationship each party is willing to enter. With a vague contract, you open your company and your project for liability and risk, and unhappy contractors could threaten to take legal action. To avoid this risk and move your project along, you should ensure your contract avoids ambiguous language and is specific about the expectations from both parties.
For the Scope of Work/Performance Duties Provision, details are essential. This provision is a description of the duties and responsibilities during the project, how work will be completed, and any other responsibilities of the contractor. Commonly, a problem arises when this provision contains incomplete descriptions or designs, resulting in unfinished or substandard work. If the owner goes back to the contractor and asks for rework due to negligence or refuses payment, the contractor may use the ambiguous nature of the contract against them in a legal battle. Therefore, the following should be incorporated into the Scope of Work/Performance Duties Provision and should be mutually agreed upon by the owner and contractor upon signing to avoid potential future disputes over the quality of work:
- Clear references to the project’s complete set of design documents and specifications
- Guarantees and descriptions of express warranties that the contractor will meet design standards and specifications according to documents
- Details of dispute resolution processes, and strongly consider adding in mediation, should they occur during the construction phase
- Quality of work assurance and specifically state what are the expectations from the contractor upon project completion
- Define how risk is allocated between owner and contractor
- Define the process each party must follow when they encounter project conditions that are unforeseen or unavoidable
Money Matters: How is Payment Being Addressed?
As the owner, it’s up to you on how you want to set payment and similar to the Scope of Work Provision, the more specific you can be, the better. No matter how hungry the contractor is for the job, they definitely want to know how, when, and on what condition they will be paid for their hard work. In a construction contract agreement, the Payment Provision will usually describe how the owner will be paying the builder. Usually, a good rule of thumb is to draft this provision as a schedule and detail key milestones, certifying what amount of work needs to be completed in order to receive a percentage of this payment. As the contractor’s responsibility, they will then typically notify you on a regular basis (typically billed monthly) on what amount of work has been completed according to the schedule, and apply for the corresponding payment. Consequently, this is the point where distrust often occurs, as the owner may feel like the contractor’s work isn’t being appropriately evaluated with a self-assessment. Therefore, it may be prudent to include some verbiage in the construction contract agreement that requires a representative from the owner’s side to participate in a complete site visit to validate the percentage of work billed. Including this requirement at this stage sets the early expectation for both owner and contractor. Moreover, this is a relatively simple strategy to implement during construction since an owner’s representative should already be onsite and making periodic site walks and visits.
Another strategy to combat this lack of trust and pending conflict is to employ the help of an outside inspector. This non-biased party will thoroughly inspect the work according to the payment provision and confirm if the contractor is actually meeting the standards and schedule and is eligible to receive the payment. Clearly defining the role of this independent party in the payment provision of the contract is important so the contractor fully comprehends that their work will need external evaluation before they can receive certain payments. By being clear about how payments will be handled up front and taking the risk of self-assessment out from the beginning, the focus goes back entirely on meeting key deadlines for project completion.
Cover Your Assets: Is Your Risk Coverage Extensive?
Most likely a no-brainer for seasoned project owners, it’s critical to understand your risk coverage, as it has the power to impact the progress of your project. Specifically, to truly establish a team friendly contract, is your property and builder coverage extensive enough? Although most liability insurance will include project accidents such as worker injury and damage to the property (not related to construction), in many situations, it doesn’t cover structural damage during construction. Sometimes, it’s possible to cover damage to projects under an owner’s existing property policy, but coverage limitations may exist that make procurement of a contractor’s risk policy more desirable.
If a builder’s risk policy needs to be procured, to eliminate any confusion, it should be clearly defined in your construction contract agreement whether it will be obtained by the contractor or owner. There’s no right answer for this and it’s often determined on a project-by-project basis. To make this decision, the following items should be taken into consideration:
- Type of project (e.g. new or renovation)
- Type of contract (cost plus or stipulated sum)
- Financing/lender’s requirements
- Location of project
- Surrounding risk potential to warrant additional insurance coverage
- Parties’ economic leverage to negotiate premium and coverage
- Contractor’s level of expertise
- Owner’s desire to have project-specific risk management
Another risk coverage strategy to consider is the Owner Controlled Insurance Program (OCIP) versus the Contractor Controlled Insurance Program (CCIP). This decision will certainly have financial impacts to the budget, but the project benefits from the simplification of the administration of all insurance policies from different insurance vendors.
If you fail to obtain extensive risk coverage and/or don’t make it clear if your contractor should be procuring their own, if damage or an accident occurs, you will likely get the blame as the owner. Construction is already a risky business, so with this in mind, make sure to play it safe to avoid a legal-gray area that could have been avoided with proper insurance.
Time to Make a Change: Are You Including a Change Order Provision?
Risk insurance is a given in construction contract agreements, but on the other hand, certain provisions are viewed as optional and important inclusions can be neglected as a result. Notably, most contracts don’t include a Change Order Provision. In fact, change orders remain a huge frustration to both owners and contractors alike but they are rarely addressed in the contract phase. As a result, the contractor is likely to inflate their prices to cover any likely project changes, leaving owners feeling like they are paying too much for the work they are receiving. Worst case scenario, misalignment on change orders can result in costly litigation if the contractor has underestimated the scope of change and construction could be stopped entirely until the issue is resolved.
To enhance project and contract transparency, a defined Change Order Provision will determine the procedures that the contractor will take in order to notify the owner of any changes to the project’s original budget and/or schedule due to updated building plans. As an owner, including this clause in your original contract shows you are willing to renegotiate to the contractor, should change orders occur, improving both the price of your contract and your working relationship with the builders. Additionally, incorporating this could save more money for the owner in the long run because you will not be paying contractors for potential project changes that may not actually occur. Basically, a Change Order Provision is a win-win for owners and contractors and this simple addition to your contract could dramatically impact the success of your project.
If you already include a Change Order Provision in your construction contract agreements, consider further defining how a general contractor will have to fund specific change orders. For example, if a change is purely owner elected, then this would be funded by the owner’s budget allowance. If a change is due to an unforeseen change such as discovering an abandoned pipe while digging underground, then this change would be funded by project contingency. Being very clear about how change orders will be funded will add another level of transparency to easy contractor’s minds—and prices.
Boss Matters: Who is Actually Overseeing the Work?
As mentioned, proper risk coverage is essential in a construction project and this often means that risk is transferred to those most suitable to manage it. For instance, the architect will provide the most general specifications and push design responsibilities for specialty items to the contractors, who in turn pass the actual work on to subcontractors. As an effect, in many construction contract agreements, it’s difficult to determine who is actually in charge. Because of an attempt to shift risk whenever possible, project failure is imminent when no one is the official authoritative figure that can assure the project is being completed according to the design and Scope of Work Provisions.
Therefore, it’s imperative to be clear in the construction contract agreement that the contractor should not allow subcontractors work to be performed without careful observation and assessment. Additionally, similar to how it’s good practice to employ an outside inspector to oversee work completed for the Payment Provision, as an owner, you may want to consider the use of consultants or experts during the construction phase to oversee the subcontractors work. For the same reason, it’s important to define in the contract ahead of time that the project will be inspected by a third party inspector. By being explicit in the contract of who the managing party is for determining key performance criteria, you are providing your project with more clear checks and balances to help mitigate risk from the start.
Just Read It: Are You Vigilant About Contract Review?
Although this may seem obvious, a thorough contract review process is critical—especially since most construction projects require multiple contracts and details can get blurred. There are a number of reasons why you want to review contracts to a high level of detail, but most accounts for the possibility of human error. Mistakes are bound to happen and there might be certain clauses, outdated information, or inconsistent statements that put you, your company, and contract workers in the line of unnecessary risk.
Beyond the obvious errors, you will want all necessary legal parties to review the construction contract agreement, too, as part of your risk-management process. Remember to include ample of time for a review, as some lawyers may not be completely briefed on the project specifics or parties involved and would need to examine the contract more carefully. Keep in mind that contract review between the owner, contractor, and their legal consultants can often be a shell game. In order to avoid lengthy delays during contract review, consider stipulating in the contract that you will be expecting at least one meeting where each party participates in a contract review with their respective lawyers. Remember, no agreement is likely to be perfect, especially at first draft, therefore a vigilant contract review process is absolutely necessary to keep the most avoidable risk at bay.
Use Friendlier Construction Contract Agreement for Better Projects
Like any good relationship, your construction contract agreement should fully address what’s in it for each participating party. No one wants to sleep with one eye open when they first enter a project, anticipating the worst and quick to jump to legal action, leaving you to play defense. Instead, by creating a more two-sided and team friendly contract, you begin your working relationship on the right foot, with more transparency and in the position to manage expectations earlier, before construction begins. As a result, both parties can focus on what’s really important—making your project a success.