Construction Contracts and Risk Management

Construction Contracts and Risk Management Presented By: Perry Safran - Attorney psafran@safranlaw.com 919-828-1396 www.safranlaw.com 2013 This presentation can be downloaded at: www.safranlaw.com/sloresources 1 1

Program Outline Contracts: General Overview Contracts: Owner / Architect Agreement Contracts: Owner / Contractor Agreements with A/E Responsibilities Being Aware of New Developments Problem Clauses Risk Areas for Design Professionals Strategies to Mitigate Risk 2 2

PNC Arena 3 3

Construction Contracts: General Overview 4 4

Presentation Outline Elements of a contract Essential contract terms Potential dispute considerations Dispute resolution Summary 5 5

Elements of a Contract Three essential elements: an offer acceptance of the offer consideration 6 6

Essential Contract Terms 7 7

Contract Documents Typically, contract documents consist of more than just the construction agreement between the owner and contractor. There is usually a complete set of drawings, specifications, and modifications made after execution of the agreement. A well-drafted construction agreement will contain a provision that incorporates, by reference, the other project documents. 8 8

Scope of Work The agreement should contain a provision that clearly defines the scope of work to be performed. This provision should also clearly define all work that is NOT included in the work to be performed by the design professional. 9 9

Time for Performance A contract may, but is not required to, address the timeframe for the work to be performed. If a contract provides that time is of the essence, failure to complete the work precisely by the specified date constitutes a material breach of the contract. For a design contract, time requirements are generally considered fulfilled at particular milestones (design documents, construction documents, etc.) 10 10

Time for Performance Owner caused delays: in the event of an owner caused delay, the architect and/or contractor is entitled to a time extension equal to the number of days of delay and a change order for the additional costs resulting from the delay it is the claimant s responsibility to establish the cause, length, and costs associated with the delay, and he should therefore carefully document any delays 11 11

Time for Performance Architect-caused delays: liquidated damages may be assessed to the architect for causing a project to not be completed on time in the absence of a liquidated damages clause, the owner may be entitled to compensation for loss which fulfillment of the contract could have prevented 12 12

Changes for Contractors Changes clauses should specify the method by which changes will be handled. Typically changes require a written change order that is signed by both the owner and contractor. The change order should identify the new scope of work, additional cost or credit, and any time extension necessary. 13 13

Changes The changes clause may also specify the manner in which the costs associated with the change are to be determined. 14 14

Changes for Architects Typically the design contract should include provisions for dealing with scope changes Alternatively or in addition, the contract should include provisions for additional services, and how they should be priced. 15 15

Compensation We will discuss three typical contractual payment terms: lump sum, or fixed price unit price cost plus a fee or percentage 16 16

Compensation Lump sum or fixed price: In this type of contract, the owner and contractor agree, prior to entering the contract, to a fixed amount that the owner will pay the contractor for performance of the scope of work described in the contract the contractor assumes the risk that he can complete the work at a cost not exceeding the contract amount 17 17

Compensation Unit price: In this type of contract the owner and contractor agree to an amount that will be paid for each unit of the work performed. The unit should be clearly defined to avoid questions of interpretation. There should be a mutual understanding of the work included in the unit price--i.e. labor, material, transportation, sales tax 18 18

Compensation Cost-plus: In this type of contract, the owner pays the contractor for the necessary costs to perform the contract, plus a fixed fee (such as $5,000) or a percentage fee (such as 10%). In this situation the owner assumes the risk that the work can be completed at a cost that doesn t exceed the estimated cost. 19 19

Compensation Cost-plus: To minimize the owner s risk, cost-plus contracts often have a guaranteed maximum cost provision. In the case of such a provision, the contractor should insist on an incentive clause that allows the contractor to receive a share of any savings. 20 20

Compensation Cost-plus: Some payment issues that often lead to discrepancy and dispute are field office overhead, field supervision, travel, employment taxes and insurance, and direct payment by the owner to subcontractors. Make sure the contract clarifies such issues for both parties. A contractor may not intentionally inflate construction costs in order to receive a greater percentage fee. 21 21

Compensation If financing is required, the contract should specify whether the contractor or the owner is responsible for obtaining the construction loan, as well as the conditions for receiving draws upon the loan. Make sure you realize the risks involved with the owner obtaining the loan, as well as obtaining the loan yourself. 22 22

Compensation The contract should also outline the method by which the owner will pay the contractor. This included whether the contractor can receive payment for materials and equipment stored on or off site. Typically payments are made via monthly progress payments based on invoices or pay applications submitted by the contractor. 23 23

Compensation The payment clause should address due dates for invoices and payments, documentation required, and the circumstances upon which payment may be withheld or work stopped. If there is no progress payment provision in a contract, a contractor may not receive any payment until project completion. 24 24

Compensation Typically, an owner will withhold retainage each payment. Typically this amount has been 10%, and was often reduced to 5% upon completion of 50% of the project. The contract should address requirements that need to be met prior to final payment to the contractor. The contract should also define the rate at which interest will accrue on late payments. 25 25

Compensation Pay-when-paid or pay-if-paid clauses: In North Carolina, these clauses in a subcontract are unenforceable. Also, a contractor must pay his subcontractor the full amount received by the contractor for the subcontractor s work within seven days of the contractor s receipt of payment from the owner, or the contractor is obligated to pay the subcontractor interest from the eighth day until paid. 26 26

Inspections The construction contract will often outline the right of the owner or his agents to inspect the project, the frequency of the inspections, and prior notice that must be given, and the purposes of the inspections. Either the design contract or the construction general conditions, or both, will define what actions are required by the architect in terms of reviews of the work. 27 27

Default/Termination A contract may only be terminated as provided in the express terms of the contract, or in the event of a material breach of the contract. Construction contracts (including design contracts) frequently include detailed default clauses (termination for cause) that specify events that give rise to a right of termination. 28 28

Default/Termination Be careful that the default clauses do not allow an owner to terminate and take over your portion of the project when you may have committed only a minor violation. The provision should also provide for notice to the architect and a reasonable time, after notice, that an architect can correct any deficiency before termination occurs. 29 29

Default/Termination A design professional should also insist on a clause providing for the right to terminate or at least stop work for nonpayment by the owner. A contract may also contain a clause entitling the owner to terminate for convenience. This clause should specify the compensation to be paid to the architect in the event it is exercised. 30 30

Warranty There are two basic types of warranties in construction contracting: Express warranty Implied warranty 31 31

Warranty An express warranty is embodied in the contract. It includes the time period of the warranty, work covered by the warranty, work excluded from coverage, notice requirements, and terms for performance of warranted repairs. Generally, architects and other design professionals do NOT warranty their work in the traditional sense of guaranteeing correctness and good results. 32 32

Warranty An implied warranty is generally applied to the contractor, and warrants that a contractors work, including materials used, will be performed in a proper and workmanlike manner, unless excluded from the contract in bold and conspicuous type. This is not a requirement that the workmanship or materials be of the best quality, just ordinary care and skill be taken, unless the contract specifies so. 33 33

Dispute Resolution A contract should include provisions that apply to dispute resolution, such as the forum to be used (i.e. arbitration), venue for hearings (i.e. Wake County, NC), and the issue of recovery of attorney s fees. North Carolina courts are reluctant to award recovery of attorney s fees unless expressly allowed by the contract. 34 34

Reciprocal Attorneys' Fees Provisions The General Assembly has recently included a statute allowing for recovery of attorneys' fees in business contracts when the provision is reciprocal, i.e., allows either party prevailing in a dispute to recover its fees. Previously, to the extent any recovery of attorney fees was permitted, business contracts were governed by a statute limiting recovery of attorneys' fees on notes or other proof of indebtedness, to 15% of the principal amount claimed. Under the new statute, reasonable attorneys' fees are recoverable up to the principal amount claimed by or awarded to the prevailing party. Old contract provisions limiting recovery of attorneys' fees to 15% should be stricken. To be enforceable, the contract document must be signed by hand, not electronically, by both parties. NEW! 35 35

Potential Dispute Considerations 36 36

Statutory Considerations There are statutes of limitation that define time periods for pursuing action on a claim. Relevant statutes for construction claims (including by or against architects) include: three years from occurrence of breach on typical breach of contract claims three years from time of injury or damage for actions for personal injury or property damage based on negligence 37 37

Statutory Considerations More statutes of limitation: two years from date of death on wrongful death actions four years from time of breach on breach of warranty in the sale of goods actions three years from time of breach on other breach of express warranty or implied warranty claims 38 38

Statutory Considerations Statute of repose: this is a special statute enacted by the NC legislature to bar actions arising from defective or unsafe conditions of an improvement to real property this statute will bar any action six years after either the specific last act or omission by the defendant giving rise to the claim or the substantial completion of the improvement 39 39

Statutory Considerations The statute of repose defines nine categories of claims to which it applies, including: actions to recover damages for breach of a contract to construct or repair an improvement to real property actions to recover damages for negligent construction or repair an improvement to real property actions to recover damages for personal injury, death, or damage to property actions to recover damages for economic or monetary loss action in contract, or in tort, or otherwise 40 40

Statutory Considerations Almost every claim arising from a construction project is governed by the six year statute of repose. However, the statute cannot be asserted as a defense by a person who is guilty of fraud or willful or wanton negligence or who conceals such fraud or negligence. 41 41

Claims Basis The most common bases for claims by the owner against a contractor arise from breach of contract, negligence, and breach of warranty. The most common bases for claims by a contractor against the owner are breach of contract and breach of the implied warranty of the adequacy of the plans. 42 42

Claims Basis The most common bases for claims against an architect or engineer are for breach of contract and for negligence. Claims may be brought by a contractor against the architect, even though there is no privity (contract) between them. 43 43

Contract Interpretation If the performance or non-performance of a contract is the cause of a dispute, it is the court s responsibility to determine the intent of the parties at the time they entered the contract. The court will only interpret the contract. It cannot and will not make a new contract. The parties intent is based on what a reasonable person in the parties position would have thought the contract meant. 44 44

Contract Interpretation Some rules of interpretation: Ambiguity in a written contract will be construed against the party who drafted it Words used in a contract that have a particular meaning within a trade or industry will be allowed evidence to show the custom or trade meaning to explain or qualify the terms of the contract In limited instances, public policy will be used to nullify an otherwise enforceable term 45 45

Lien Rights A lien is a special right of parties who contribute labor, materials, equipment, or services for the purpose of improving property. This includes design professionals. The lien gives these parties security by allowing them to foreclose upon the improved land when moneys are owed, as an alternative source of payment. 46 46

Lien Rights Requirements that need to be met before a person is entitled to file a lien: a person must perform or furnish labor or professional design or surveying services or furnish materials do so pursuant to an express contract with the owner of real property for the improvement of the subject property 47 47

Lien Rights Always remember that your time to file a lien is not infinite. In North Carolina a lien must be filed within 120 days after you last furnished labor or materials for the project. In South Carolina, 90 days. Be sure to take extra care when filing a claim of lien. Once a claim of lien is filed, it cannot be amended. But, if the allotted time frame to file the lien has not expired, a claim of lien may be cancelled and a new one filed. 48 48

Lien Rights In order to enforce a lien, the claimant must file a lawsuit. Once a claim of lien has been filed and a lawsuit has been filed, the lien is perfected. A time limit also applies to enforcing a lien: In North Carolina the lawsuit must be commenced within 180 days of the last day the claimant furnished labor, materials or services. In South Carolina the lawsuit must be commenced within six months. 49 49

Lien Rights If a lawsuit is not commenced to enforce a lien within the required time, then the lien will be subject to discharge. If a final judgment has been rendered in favor of the owner, it will also be discharged. 50 50

Lien Rights A subcontractor or subconsultant does not have a right to a direct lien against the improved real property, only a right to a lien by subrogation through the rights of the contractor/consultant upon the property. The same time limits apply to a subcontractor s filing and enforcing of its claim of lien. New: As of 04/01/13 - Subs may use dates of first and last furnishing of the contractor/consultant. 51 51

Lien Rights New: As of 04/01/13 - Any potential lien claimant -- including engineers -- must give notice to a Lien Agent in order to preserve lien rights against a sale or financing of the property. Failure to give notice to the Lien Agent, or to file a claim of lien prior to recordation of a deed or deed of trust, will result in the claimant s lien rights being lost (if a sale), or subordinated to the lender (if a financing). See liensnc.com website for more information. 52 52

Dispute Resolution 53 53

Negotiation Negotiation involves reaching an agreement or resolution through compromise. This is an informal proceeding where parties resolve a dispute through discussion. Negotiation is typically quicker and less costly than other forms of dispute resolution. The services of an attorney are generally not required. 54 54

Mediation Mediation is basically a regulated negotiation. A third party, mediator, is involved. The mediator s role is to assist the parties in the dispute in reaching a resolution. The mediator does not render a decision or award, but acts as a consultant to help the parties reach their own settlement. 55 55

Arbitration Arbitration involves referral of a dispute to one or more impartial persons who render a decision. The decision may be binding or non-binding. In North Carolina, a party may not be forced to arbitrate unless there is a written agreement to arbitrate. Arbitration is often a good alternative to litigation as it is less expensive, and often quicker to proceed than litigation. 56 56

Litigation Litigation is the standard court action, in which a case is decided by a judge or jury. In North Carolina, all construction lawsuits involving less than $10,000.00 may be referred to court-ordered non-binding arbitration. If either party is dissatisfied with the arbitrator s award they may appeal to district court within 30 days of the award, and proceed with a trial of the dispute. 57 57

Litigation In all construction lawsuits involving $10,000.00 or more (if filed in Superior Court), the parties are required to submit the dispute to court-ordered mediation. If the parties are unable to reach a settlement through mediation, the case proceeds to trial. 58 58

Summary 59 59

Summary Contracts are a very important part of any construction project. Contracts lay the foundation for a contractor s responsibilities and can be important to your liabilities. If you become involved in legal matters, a well written contract could save you countless hours of time and money. 60 60

Summary A well-defined and comprehensive construction contract is a design professional s best defense. Design professionals should work closely with an attorney knowledgeable in their field to insure their needs are addressed when drafting or signing contract documents. 61 61

Key Provisions of Contracts Between Owner and Architect 62 62

The parties to the agreement Typically the contracting parties are the Owner of the project, and the Architect. Often the Architect will be responsible for contracting with engineers and/or other consultants. 63 63

The date of the agreement This is significant for purposes of measuring deadlines, including whether liquidated damages and/or completion bonuses may apply. 64 64

Scope of the Engagement The Architect is responsible for what he contracts to do, but only for what he contracts to do. Frequently the agreement will provide for the performance of certain basic services as part of the contract price, and then of other services on an as-needed basis at an additional unit price. The contract will establish whether the Architect is responsible for pre-construction services and programming, design services, and/or construction administration services. 65 65

The Responsibilities of the Parties The Contract should recite what is expected from each party, in terms of the nature and level of performance. Where the Architect has contracted to provide construction administration services, the Contract will frequently incorporate by reference general conditions which relate to the contract between the Owner and the Contractor, which creates tripartite responsibilities between the three parties. 66 66

Compensation There is no one method for determining payment for architectural services. You can be paid a flat fee You can be paid a percentage fee based on the cost of the project You can be paid on a unit price basis for specific services You can have a blended rate which takes into account any or all of these methods, along with other items The one most important factor is that the terms for compensation and payment need to be included and specified in the contract. 67 67

Dispute Resolution The AIA 1997 contract forms require mediation and arbitration, both administered and under the rules of the American Arbitration Association (AAA). The AIA 2007 forms require AAA mediation, but give the parties the option of selecting arbitration, litigation, or some alternative method of dispute resolution. ConsensusDOCS uses the checkbox option for selecting dispute resolution options, including mediation, arbitration, dispute resolution boards (DRB s), or litigation. 68 68

Contracts: Owner / Contractor Agreements with A/E Responsibilities 69 69

What do contractors expect from architects? AIA Contracts ConsensusDOCS 240 General Conditions (i.e., AIA B201) Privately drafted documents 70 70

Being Aware of New Developments 71 71

AIA B151-1997 vs. AIA B101-2007 72 72

ConsensusDOCS 240 73 73

Problem Contract Clauses 74 74

AIA B201-1997 General Conditions Risk Areas For Design Professionals 75 75

AIA B201-1997 General Conditions 2.1.1 The Architect is not the Owner s representative (except when he is) 76 76

AIA B201-1997 General Conditions 3.10 The Architect is responsible for receiving and reviewing construction schedules, and submittal schedules. 77 77

AIA B201-1997 General Conditions 3.12.4 The Architect is responsible for receiving and reviewing shop drawings, and responding thereto. 78 78

AIA B201-1997 General Conditions 3.12.10 The Architect is responsible for providing professional design services, not the Contractor. 79 79

AIA B201-1997 General Conditions Article 4 The Architect administers the Contractor s Construction Contract. 80 80

AIA B201-1997 General Conditions 4.2.1 The Architect is the Owner s representative for certain things. 81 81

AIA B201-1997 General Conditions 4.2.2 The Architect will visit the site and review the work and the progress. However, the Architect does not inspect, and does not control means or methods. 82 82

AIA B201-1997 General Conditions 4.2.4 The Architect is the one who communicates directly with the Owner and the Contractor they are not supposed to talk to each other directly. This rule continues in 2007, but NOT in ConsensusDOCS 83 83

AIA B201-1997 General Conditions 4.2.5 The Architect has the power to review and certify (or reject) applications for payment. 84 84

AIA B201-1997 General Conditions 4.2.6 The Architect has the authority to reject work that does not conform. 85 85

AIA B201-1997 General Conditions 4.2.8 The Architect prepares change orders. 86 86

AIA B201-1997 General Conditions 4.2.9 The Architect does conduct inspections to determine dates of Substantial Completion and of Final Completion. 87 87

4.3 The Architect is responsible for handling claims from the Contractor. 88 88

AIA B201-1997 General Conditions 4.4 The Architect is responsible for deciding on claims. 89 89

AIA B201-1997 General Conditions 9.4 / 9.5 The Architect receives and reviews Applications of Payment, and issues Certificates of Payment when appropriate. 90 90

AIA B201-1997 General Conditions 9.7.1 The Architect is responsible for issuing Certificates of Payment in a timely manner. 91 91

AIA B201-1997 General Conditions 9.8 The Architect is responsible for determining Substantial Completion. 92 92

AIA B201-1997 General Conditions 9.10 The Architect is responsible for determining Final Completion. 93 93

What Creates Risk for Design Professionals 94 94

PNC Arena - Lessons Learned 95 95

What makes a project risky? Cost Time Constraints Owner Requirements Space Size Creative Touches 96 96

What makes a project risky? Geographical Conditions Weather Factors The Team Design Subcontractors The Owner The General Contractor 97 97

What makes a project risky? Political Considerations Building Codes Building Inspectors Fire Marshals Green Requirements Activists Environmental Regulators 98 98

How do control your risk factors? Know your team Know your constraints Know your challenges Know your Owner s expectations Know your own limitations Work with everyone involved Consult with your insurer 99 99

Risk Management 100 100

Risk Management Risk management goes to the heart of design: what projects you select what design features you can incorporate curves thicknesses weight bearing elements use of light who you can work with certain owners certain contractors 101 101

Risk Management What are your expectations when you take on a project: scope of work level of services who are you representing are you providing construction administration how complete will your drawings be will you be drafting the drawings and specifications from scratch 102 102

Risk Management Risk management also requires a relationship with your insurance carrier type of policy amounts of deductibles and coverages costs of premiums communications with carrier notices of any problems additional insureds subrogation rights, if any 103 103

Risk Management The carrier does not have to be an adversary, and does not have to be just a necessity Specialty insurance agents can work cooperatively to provide preventative care 104 104

Risk Management What can you do with risk? Accept it. Take responsibility for the risk's costs and its benefits. Mitigate it. Minimize risk with planning or special skills. Allocate it. Select the parties to the construction process and allocate risks among them. Transfer it. Transfer risk through indemnification agreements or through the purchase of professional liability (errors and omissions) insurance. Avoid it. Some risks are either so unpredictable or so potentially costly that no amount of compensation would make them worthwhile to undertake. 105 105

Risk Management Utilize the resources you have for dealing with risk contract documents attorneys owners contractors partnering arrangements whether design/ build or collaborative insurers 106 106

Risk Management / Project Management Documentation is Key: preparing good A/E contract documents preparing good design documents preparing supplements and addenda preparing good specifications responding to RFI s 107 107

Risk Management / Project Management Management is Key tracking progress tracking submittals tracking RFI s tracking and processing pay requests it is not enough to simply be an intermediary 108 108

Risk Management / Project Management Scheduling is Key timely responses are important to all parties use and enforce schedule requirements as a tool, not as a weapon 109 109

Strategies to Mitigate Risk and Liability 110 110

What to do if you get a claim made against you: Report the Claim Your insurance policy will have notice requirements. The policy will have specific claim reporting procedures. You need to be familiar with these policy requirements before you get a claim, but you should also go back and review the policy provisions. Document your notice of claim. 111 111

What to do if you get a claim made against you: Contact Counsel If you have a preferred attorney, contact him when you get a claim. If you do not know a lawyer with experience with architect and engineer errors and omissions defense, your insurance company will provide you with a panel attorney. 112 112

What to do if you get a claim made against you: Visit the Project Site Gather necessary information and document relevant conditions. Document conditions with photographs, notes, and any other paperwork which is available. If necessary, have a third-party expert inspect the conditions, and in some cases, and file a report. When possible, coordinate your efforts with your legal counsel and/or your insurer. 113 113

What to do if you get a claim made against you: Retain Experts To prove a breach of professional duty, the claimant generally must present expert testimony. New: The NC General Assembly is considering, but has not yet passed, legislation to require a designer to submit a certificate of merit before a plaintiff can bring a professional malpractice claim against A/E. To defend a claim, you may need an expert also. Coordinate with your counsel and/or insurer. 114 114

What to do if you get a claim made against you: Manage the Claim Assemble in-house documents Review in-house documents Review documents in other offices (owner, contractor, subcontractors, subconsultants) Develop a written chronology of events that led up to the claim 115 115

What to do if you get a claim made against you: Manage the Claim Communicate with the insurance claims supervisor, your legal counsel, and your experts Attend depositions Give depositions Make your documents available for review by others Designate who will serve as the primary contact within your office. If this person did not work on the project, he or she will need the assistance of project team members for knowledge of facts and to review and manage documents. People who worked on the project that have since left your firm must be contacted to obtain their knowledge of facts. You should maintain a good relationship with them even if you have to pay for their time spent giving testimony or providing information. 116 116

What to do if you get a claim made against you: Subconsultants Advise your subconsultants of the claim. Require your subconsultants to assist in the defense, and to provide indemnification. Make sure the subconsultants notify their insurers timely. 117 117

What to do if you get a claim made against you: Prepare for Impacts Defending the claim will take a lot of time and effort for you and your firm. Do not expect to be as efficient in working on other projects at the same time. The more efficient you are with claims management, the lower the impact you may have on your continuing projects. 118 118

Keeping Clients Despite Claims 119 119

Keeping Clients Despite Claims Settling a claim may go against your initial instinct to defend your practice and your reputation. However, settlement of claims may help you save a relationship with your client. 120 120

Stay in Contact Communicate with the client as soon as you are served with a claim or a complaint. Depending on the situation, you may want this communication to go through your counsel Figure out how the client may be able to be appeased. 121 121

Be Candid Attorneys are likely to recommend that you do nothing and say nothing directly. Follow this advice even though it seems to conflict with the desire to communicate. If you are permitted to communicate with the client, always tell the truth. 122 122

Join Forces If at all possible, mount a joint defense. If the claimant happens to be the contractor, you may be working with the owner. If the claimant is the owner, you may be working with the contractor. In either event, you may need to work with subconsultants. 123 123

This is Not Personal If you are trying to keep this client, you have to be prepared to pay money, or to allow your insurer to make payment. You have to be willing to let go of the fight, and move on. 124 124

Questions and Discussion This presentation can be downloaded at: www.safranlaw.com/sloresources 125 125