April 1, 2011

Follow These 10 Steps Before Signing a Contract


By Katie Jeremiah

Spring 2011

When project funding finally comes through, owners and contractors alike are eager for shovels to hit the ground. Owners are reluctant to engage in what they perceive to be time-consuming contract negotiations, and contractors are fearful that if they object to unreasonable contract terms, the work will go to someone else.

A contractor should never sign a contract without understanding and negotiating key terms, no matter what. Contractors under pressure should pay attention to these important points:

1. Perform a background check.

A company's history may predict difficulty in collecting payment for work performed under contract. A public database can reveal important details about a business.

Legal existence. A simple search through Washington's Secretary of State Corporations Division will show whether a business is properly registered in the state. In some states, like Oregon, the corporations division website will also show whether the company has timely paid annual fees for each year it has been registered.

The search function may also show that an individual who is a member or officer of the contracting entity has been a member or officer of other businesses that are now inactive and the duration of that former business's existence.

Contractor's license. The state Department of Labor and Industries maintains a searchable database to show whether a business is actively licensed to perform work as a contractor and to verify the status of workers' compensation premiums, bonding, liability insurance, department of revenue account, outstanding lawsuits and outstanding warrants.

Regulatory compliance. Agencies like the Occupational Safety and Health Administration, the Environmental Protection Agency and the Mine Safety Health Administration maintain public databases of inspection history and enforcement activity against individual businesses. This information can be immensely helpful in evaluating a firm's regulatory compliance history.

Litigation and bankruptcy. Your attorney may be able to do a more comprehensive search that will reveal details regarding a firm's litigation history and any past or pending bankruptcy filing by the business or its individual members or officers.

You may consider requiring a joint check agreement or a payment bond as a condition of the contract if details revealed in these searches indicate that a business or its members or officers have a history of not maintaining good standing with government agencies or have a track record for litigation or bankruptcy.

2. Verify that the contract identifies your business, and that you are licensed and registered to do business.

Confirm that the name on the contract reads exactly as the name is registered with the state. If you sign a contract under the name of a business that is not properly registered at the time you enter the agreement, you may be assuming personal liability for any contract you sign.

Also verify that your business is actively licensed and in good standing as a contractor with Labor and Industries. Your business may be liable for infractions for each day — and for each jobsite — that it advertises, offers to do work, submits a bid, or performs work without an active contractor's license.

3. Know the source of project funding.

The funding source may limit remedies that are available to a contractor that has not been paid for the work it performs.

If the project is for a public improvement, traditional mechanics-lien rights do not exist. A contractor who is seeking to collect from the government must file a claim against the payment bond, if one exists for the public improvement.

In some public improvements, there may be no payment bond available. For example, when the federal government enters into a timber sale contract with a private party, it usually requires that the purchasing party make improvements to the government land in order to harvest the timber. Because it is government land, traditional mechanics-lien rights are not available — and surprisingly, in most timber sale contracts, no payment bond exists for the benefit of contractors making improvements to the government's land.

The payment bond that is provided by the contractor purchasing the timber benefits only the government if the contractor defaults. If subcontractors make improvements to the government land and do not get paid by the contractor, they are left with no remedy but to collect directly from the contractor. This can be particularly problematic if the contractor is insolvent or files for bankruptcy.

Also, pay attention to whether funding sources for a contract trigger prevailing wage requirements, bonding requirements, or the new E-Verify program required by federal projects and projects receiving federal stimulus dollars. Failure to meet specific requirements tied to the funding can jeopardize your payment and may even result in civil or criminal penalties.

4. Read the payment terms.

Sometimes obscure language turns a simple payment term into a risky "pay-if-paid" clause. An unassuming contractor can be left holding the bag if an upstream party does not pay. While many states have prohibited this arrangement, Washington still allows it.

5. Understand retainage terms.

When negotiating payment terms, remember to discuss retainage, including how much is withheld (it cannot exceed 5 percent on a Washington public works project) and when it is released. Make sure that any contract requiring preliminary lien releases does not waive your right to lien unpaid retainage.

6. Understand the indemnity arrangement.

Contractual indemnity, designed to shift risk between the parties, tends to be complicated and thus difficult to understand. It can be an easy way for owners to shift liability to a contractor for activities not within that contractor's control.

If something goes awry on a project — even long after a contractor's obligations are fulfilled — an indemnity provision can require a contractor to assume risk for the actions of a party the contractor did not even know existed — actions completely unrelated to the contractor's own performance.

If a party is indemnifying you, indemnity is only as good as the party providing the indemnification.

If you are uncertain about a party's ability to pay, you may want to consider an alternative method of risk allocation.

7. Watch for terms that waive workers' comp immunity.

If a subcontractor's employee is injured on the job and seeks damages from the general contractor, the contract may compel the subcontractor to indemnify the general contractor for damages paid to the employee, despite the fact that the subcontractor would ordinarily be protected from liability for the employee's injury through its workers' compensation policy.

8. Consult your insurance agent about limits.

Your insurance agent can confirm whether your policy covers the insurance obligations required under the contract.

You should speak with your agent about the type of work you are contracting to perform — you could be nullifying your insurance policy by signing a contract that obligates you to perform work that is prohibited by law or otherwise excluded from the policy. For example, your policy may be invalid if the contract contains overly broad indemnification language or if you contract for illegal work such as engineering without a proper license.

Just because you have insurance does not mean you are actually protected.

9. Verify the contract does not violate state law.

Washington statutes have specific requirements regarding contract terms that may make certain terms in the contract unenforceable if they do not comply and may compromise a contractor's right to lien the project. For example, one statute requires a specific disclosure provision be made in contracts for certain types of projects, and if the disclosure statement is not provided in a substantially similar format to that provided by the statute, the contractor may not bring or maintain a lien claim.

10. Read the contract.

As obvious as this is, it cannot be overstated, particularly when the parties are in a rush to start the project. Contracts are frequently prepared by merging, cutting and pasting from multiple sources. This practice often results in typographical errors, which can inadvertently result in the shifting of risk to an unwary contractor. A critical eye can identify these errors and other conflicting provisions that may have disastrous consequences.

If you are under pressure to execute a contract with minimal modification, remember that signing the contract blindly can subject you to uncontrolled risk, particularly if it obligates you to assume risk created by acts over which you have no control. A contract may seem to be a 50-pound paperweight riddled with incomprehensible legalese, but attention to important details — even for small contracts — will help ensure that you will be paid and avoid grave civil and criminal consequences.

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