BY JACOB ZAHNISER
Every construction project starts with the contract: It is the cornerstone of the project and is for all purposes the rulebook. A good contract defines the scope of the work, sets the budget, dictates the schedule, and governs the parties’ obligations when something unexpected happens—and it always does. Whether you are an owner, general contractor, or subcontractor, the contract will determine the success or failure of a project. Because the contract is the foundation for a successful project, a current and complete contract review, before the agreements are signed, is critical.
Contract review is an important management tool that ensures your contracts reflect your understanding and agreement of the parties’ intent and expectations. However, expectations, laws, and contract interpretation are always evolving, causing what was once a “great contract” to become obsolete. Regular contract review can highlight ambiguities or outdated provisions and should identify areas for possible improvement. In addition, some contract terms have hidden pitfalls that can adversely shift risk among the parties potentially limiting the financial benefits of a project. In short, a contract with unclear or biased provisions can be devastating in the event of a dispute or payment delay. The following are common provisions that should be reviewed carefully.
1. Claims and Change Orders
One of the most important and most litigated contract provisions deals with claims and change orders. Contracts typically require a contractor to submit a change order or make a claim within a certain number of days after the occurrence of the event giving rise to the change order or claim. Identifying changes early is critical to protecting the ability to be compensated for added costs. First notice requirements almost always have short time limits and late notice can eliminate the right to compensation. In addition, prompt action means that events are fresh in everyone’s minds, and gives other parties the opportunity to mitigate the financial and schedule impacts, avoiding end-of-job surprises and lawsuits. Perhaps the most important failure is to follow the claim procedure that may result in the waiver of the claim. Everyone should have working knowledge of the contract’s claim and change order provisions.
2. Supporting Documentation
After safety, identification of the type and content of the documents that must be submitted to receive timely and complete payment or to support a claim or change order is the most important activity on a construction project. Good documentation protects the financial health of the contractors and without it bad things happen. Typical documents include the following: (1) executed payment applications; (2) payroll or progress; (3) payment requests; (4) documents substantiating the payment request; (5) lien waivers; and (6) documentation showing evidence that the submitting contractor has made, or intends to make, payments to its subcontractors or material suppliers. With regard to application for final payment, typical documents accompanying final payment application include the following: (1) as-built drawings; (2) operations and maintenance manuals; (3) manufacturer and other warranty documentation; (4) evidence of necessary start-up testing; and (5) final lien waivers. It is important for all contractors to know and understand the contractually required documents and include all of them in payment applications or claims to ensure timely payment.
3. Certification Requirements
More sophisticated projects, and all government projects, require a contractor to certify certain items with each payment application. These certifications can include certified payroll, as well as ongoing representations about the basis for payment. In some contracts, satisfactory proof of the proper use of prior payments is required before the current request is processed. The consequences of missing or incorrect certifications can be a loss of a deal or payment or more serious fines. In extreme cases contracts can be barred for future government work.
4. Reimbursable Expenses
Cost plus time and materials contracts generally detail allowable or reimbursable cost items. However, the contract may also exclude costs from reimbursement or disallow any markups on certain items. In these types of agreements record keeping is critical, because owners and upstream contractors have the right to audit the downstream contractor's records to verify expenses. If the downstream contractor overcharged, they will be liable for reimbursing the overcharge with interest. Contracting parties may avoid common disputes that arise over these types of “overhead” costs by agreeing in advance how they will be paid or using a lump sum contract.
5. Indemnification and Insurance
The indemnity and insurance provisions of a construction contract are tremendously important but often receive little to no attention during contract negotiation and drafting. These provisions place the financial responsibility for inherent risks on the downstream contractors. These provisions are viewed as boilerplate in the beginning of the project, but when a claim arises they are hotly contested and can have disastrous ramifications if not properly drafted or followed.
Every contractor should have the indemnity and insurance clauses reviewed annually. These seemingly innocuous contract provisions can shift liability among the parties and the law is constantly changing.
The Contract Impacts the Bottom Line
Understanding your contract’s requirements for payment and claim procedures minimizes the risk of surprises and mistakes that can delay payment or inadvertently waive the claim. Understanding your contract’s indemnification and insurance requirements is equally important to avoid serious financial consequences like buying more liability than the contract is worth. Nobody likes paying a lawyer, but it is always a best practice to have your contracts reviewed by a qualified attorney familiar with the construction industry. By taking care of the contract, you are taking care of business and protecting the bottom line.