The Toler Firm LLC A Construction Law Firm Timothy N. Toler September 23, 2015

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1 The Toler Firm LLC A Construction Law Firm Timothy N. Toler September 23, 2015 Negotiating 8 Key Contract Clauses from the Contractor s Perspective (Part 1 of 2) 1 This is the first of a two-part overview of eight key contract clauses likely to be negotiated between a Contractor and project Owner. A description of each type of clause will be followed by a discussion of some concerns raised from the Contractor s perspective. Reference will be made to form construction agreements issued by the American Institute of Architects (AIA), specifically the AIA Document A General Conditions of the Contract for Construction ( AIA A or A201 ). Part one will discuss Scope of Work, Payment, Changes in the Work, and Delays and Extensions of Time. Part two will address Limitations of Liability, Warranties and Guarantees of Performance, Terminating Performance, and Dispute Resolution. 1. Scope of Work A scope of work clause defines what work is to be performed under the agreement. The scope is usually set forth in general terms at the front of the agreement and detailed in one or more appendices. For example, the general terms of AIA A include: The term Work means the construction and services required by the Contract Documents... and includes all labor, materials, equipment and services provided or to be provided by the Contractor to fulfill the Contractor s obligations. (A , 1.1.3) 1 This paper is not legal advice. The principles and opinions expressed are general in nature and are intended only to give the reader a guide in the subject matter addressed. Every legal problem in construction is different, with its own unique facts. General principles alone are not sufficient to solve legal problems. The services of a lawyer are required to provide legal advice and guidance in specific cases. 1

2 This includes all items necessary for the proper execution and completion of the Work and reasonably inferable from [the Contract Documents] as being necessary to produce the indicated results. (A , 1.2.1) The prudent Contractor will seek clarity and specificity in describing the contractual scope of work. An ambiguous description may result in the Owner interpreting the scope of work more broadly than the Contractor. The battle will be fought during the course of the project when the Owner and Architect refuse to grant the Contractor a change order for what the Contractor believes is additional work, for which additional compensation is due. The A201 Contract Documents include the General and Supplementary Conditions, Drawings and Specifications. All should all be thoroughly reviewed to be sure that all Work has been properly identified and to eliminate ambiguities and conflicts concerning the scope of work within the Contract Documents. 2. Payment a. Methods of Payment The contractual method of payment for the Contractor s work will serve to allocate certain risks between Contractor and Owner and will often dictate the types of disputes most likely to arise between Contractor and Owner on the project. Methods of payment include the following: Lump-Sum (or Fixed-Price) Here the Contractor performs and completes the work for a fixed sum. This payment method is suitable for straightforward work, such as that in residential and commercial buildings of standard construction; work that can be fully illustrated and specified to provide a maximum of design information, and which will be carried out on sites having predictable conditions and having a minimum of risk. 2

3 Under a fixed-price contract, the Contractor assumes a significant degree of risk for unknown variables that may or may not actually occur (such as rising material costs, availability of labor, bad weather, etc.). The Owner will likely pay a premium built into the fixed-price to cover the Contractor s perceived risk arising from the unknown variables and contingencies that may or may not actually occur. The prudent Contractor will require an amount of design information sufficient to estimate the construction cost and his overhead with considerable accuracy. An advantage is simplicity, greater clarity and certainty as to the rights and obligations of the parties. Unit Price Here the Contractor performs a unit of work for a fixed price, with the total quantity of material and labor being uncertain. Suitable for work consisting of comparatively few different items, frequently in large quantities (such as excavation work, pipelines, sewers, roads and dams). Contractor assumes the typical risks of rising material costs, availability of labor, bad weather, etc. The Owner assumes the risk of serious inaccuracies in the approximate quantities of work resulting in a higher total cost than anticipated. The contract should express how and by whom the work will be measured to calculate the quantity of work completed. Cost-Plus-Fee The Owner pays Contractor all the costs of the work, plus a fee to cover the Contractor s operating overhead and profit. This payment method is the antithesis of the lump-sum method. Here the Owner assumes the risk for unknown variables (such as rising material costs, availability of labor, bad weather, etc.). The Contractor is assured of full payment for all labor and materials that go into the project. 3

4 A cost-plus-fee contract demands from both parties a much greater degree of mutual trust and confidence than other kinds of contracts. The fee is either a fixed, lump-sum fee or calculated as a percentage of the Contractor s direct construction costs. Guaranteed Maximum Cost-Plus-Fee The Contractor assumes the risk that total construction costs will exceed his guaranteed maximum cost. Consequently, as with the lump-sum payment method, the prudent Contractor will require an amount of design information sufficient to estimate the maximum cost with considerable accuracy. This payment method is often accompanied by a sharing clause, by which the Contractor and Owner agree to share any savings made by completing the work for an amount less than the maximum cost. b. Progress Payments. Construction agreements typically call for progress payments, commonly on a monthly basis for work completed in the previous month. The Owner thus finances the project to completion. The Owner protects itself by including in the contract various conditions precedent to a progress payment, that is, various conditions that must be met before a progress payment becomes due. These conditions to payment may include: Inspection of the work before payment is authorized. Right to withhold payment for defective work. Progress payments to be made based upon milestones or a schedule of values. Retainage provisions for example, the Owner may withhold up to 10% of each progress payment until the work is substantially complete. The Contractor s primary concern is late payment or nonpayment for work performed. Delay in payment forces the Contractor to finance the project. Absent an 4

5 effective pay if paid clause, the Contractor may even be obligated to pay subcontractors without prior receipt of funds from the Owner, a dire circumstance. The Contractor might negotiate for less than ten percent (10%) retainage, particularly if the Contractor is required to post a payment and performance bond (providing financial protection to the Owner), or must advance significant funds for materials at the start of the project (on which the Contractor cannot withhold retainage from the material supplier who typically demands full payment within 30 days of delivery). The Contractor might seek an exemption from retainage for full payment items such as materials and rental equipment. An alternative is to permit withholding of ten percent (10%) retainage until the project is 50% complete, with a reduction in retainage to 5% or even zero thereafter. If the Owner is permitted to withhold 10% retainage from the Contractor until final completion, the Contractor is going to be faced with payment obligations for final completion to some subcontractors before being completely paid by the Owner for the entire work. This is going to cause severe cash-flow problems for the Contractor and liens against the property of the Owner. The Contractor must negotiate its subcontracts in light of the payment provisions in the Owner contract, including retainage to be withheld from subcontractors. Also, contingent-payment provisions ( pay if paid clause) that make payment by the Owner to the Contractor a condition precedent to payment by the Contractor to the subcontractor may provide substantial protection to the Contractor. Contractors should negotiate for clauses, such as A , that allow a Contractor to stop work in the event of the Owner s non-payment. Section 9.7 permits the Contractor to stop work until payment has been received, obtain an extension of the 5

6 completion date, and obtain an increase in the contract amount to cover the Contractor s costs of shut-down, delay and start-up, plus interest. 3. Changes in the Work Changes in the contractor s work are common and may occur due to any number of reasons, including: Owner s changing requirements. Incomplete design or errors and omissions in the design. Unanticipated ( differing ) site conditions. Construction contracts will typically grant the Owner the right to unilaterally change the Contractor s work, but only where there is also provision for making fair compensation to the Contractor. A properly drafted change order clause will provide for: The Owner s unilateral right to order a change within the scope of the contract. Obtaining the Contractor s cost proposal and assessment of impact upon remaining work. A procedure for determining compensation for the change. The AIA A , Article 7, provides three procedures for making changes: Change Order When the owner, architect and contractor all agree on (1) the scope of the change to the Work; (2) the amount of the adjustment to contract price, if any; and (3) the extent of the adjustment in contract time, if any; Construction Change Directive When only the owner and architect agree, and the contractor is directed to proceed, prior to agreement on an adjustment of contract price and contract time. Applies only to changes within the general scope of the contract ; Minor Changes may be issued by the architect alone if the change does not involve an adjustment in contract price or time. 6

7 Under the A201, if the Contractor disagrees with the method for adjustment of the contract price, the method and the adjustment shall be determined by the architect using certain procedures set forth in the AIA documents. (AIA A , et seq.) A unilateral changes clause, such as that set forth in the AIA A , Article 7, potentially subjects the Contractor to financing the changed work until agreement can be reached on an adjustment of contract price and contract time. If the Owner has the contractual right to order changes or to direct the Contractor to proceed with the work absent agreement upon the cost and time impact of the change, the changes clause should at least be drafted to facilitate prompt resolution of cost and time extension issues. Without this, the Owner s ability to unilaterally order a significant change that impacts the Contractor s cost and time will likely result in claim arbitration or litigation. The changes clause should specifically address how the time and cost impact will be determined or calculated if the parties cannot agree, and when payment will be made for the changed work. 4. Delays and Extensions of Time Most construction contracts define when the Contractor must complete the work, either by specifying a date for substantial completion or by reference to a number of days after the work commences or an attached schedule. This is referred to in the AIA documents as the contract time. Section 8 of the A201 discusses time, and specifically, when the contract time may be extended or adjusted. Section 8.3 of the A201 provides the Contractor will have the right to a time extension for an act or neglect of the Owner or Architect, or of an employee of either, or of a separate contractor employed by the Owner; or by changes ordered in the Work; or by labor disputes, fire, unusual delay in deliveries, unavoidable casualties or other causes 7

8 beyond the Contractor's control; or by delay authorized by the Owner pending mediation and arbitration; or by other causes that the Architect determines may justify delay, then the Contract Time shall be extended by Change Order for such reasonable time as the Architect may determine. Section 15.1 of the A201 specifies the procedure to be followed in providing written notice for claims for extensions of the contract time. Such claims must be made within 21 days after occurrence of the delaying event. Section discusses the claims related to adverse weather delays. Section states that this Section 8.3 does not preclude recovery of damages for delay by either party under other provisions of the Contract Documents. From the Contractor s perspective, the key question is: If the Contractor is delayed for reasons beyond the Contractor s control, is the Contractor entitled to both an extension of time and damages resulting from the delay ( compensable delay ), or only an extension of time ( non-compensable delay ). Owners want to limit compensation for delays. Contractors want to be compensated for delays beyond their control. Compensable delays might include the Owner s failure to make the site available for the Contractor to start Work, late delivery of drawings and specifications, and unforeseen site conditions. Section 8.3 of the A201 provides an acceptably broad itemization of excusable delay events for the Contractor, and the Contractor should resist narrowing this scope. An Owner s insistence that the Contractor be able to demonstrate an impact to the Contract Time in order to obtain a time extension is generally not unreasonable. Delay to non-critical items that do not impact the Contractor s ability to complete on time generally do not justify a time extension. 8

9 The AIA A201 provides for 21 days notice from the Contractor of a delay event. Some other form agreements require notice within 14 days. Anything less than fourteen days is generally problematic for the Contractor. A no damage for delay clause will bar a Contractor from recovering compensation or damages for delay even when the delay is due to causes beyond the Contractor s control. If a Contractor accepts such a clause, the risk of non-compensable delay damage must be calculated into the Contractor s price. Such clauses are best avoided from the Contractor s perspective, when possible. When a no damage for delay clause is coupled with a waiver of consequential damages clause, the Contractor may be completely barred from recovering for any damages caused by the Owner s delay. If forced to accept a no damage for delay clause, the Contractor must be certain the clause is mirrored in its subcontracts. 9