Negotiation and Drafting of Construction Contracts
Significant risks to the construction contractor can arise from the contracts entered into for various projects. However, these risks can be managed by a thorough understanding of key contract provisions and assistance of counsel in negotiating and drafting contract provisions to clarify rights and obligations of the parties, fair allocation of risks, and other protections that may be available. A well-drafted construction contract clearly defines key terms such as scope of work, price, terms and conditions of payment, and allocation of foreseeable risks.
The contract process in the construction industry often starts with the bidding process.
Bidding for construction jobs can make or break the construction contractor. It is essential for the contractor to know how to effectively bid for work to make a profit and have a successful business. There are a number of ways to bid construction contracts. But whichever method is used, success depends upon developing the most accurate cost estimate and formulating the lowest reasonable bid.
A project can be either private or public. Usually a private project is one let by a private individual or entity, while a public project is let by a governmental entity. The private project process usually involves solicitation of quotes or formal bid proposals from contractors, bids or offers by the contractors, and acceptance of the bid, resulting in a legally enforceable contract. On the other hand, the public construction contract bidding process must follow set requirements under federal, state, and local laws.
Construction contracts are usually priced according to one of several methods involving two basic types, fixed price and cost reimbursable.
Two more common fixed price methods are Lump Sum and Unit Price.
Lump Sum is an agreement to a fixed price prior to the contract award which is not subject to adjustment except for changes in the scope of work. An example would be an agreement that the contractor will build a garage for a fixed price of $15,000. Under this scenario, the contractor bears any overage in labor and/or material costs.
Unit Price is an agreement to a fixed price for a given unit of work and the total price is the unit price times the quantity of items delivered, installed or erected. An example would be an agreement that a contractor build a garage for a set price per square foot.
One of the more common cost reimbursable methods is Cost Plus Fee. Under this method, the agreement is for payment of all contractor labor and material costs plus a fee which can be expressed as a percentage or a lump sum, such as an agreement that a contractor will build a garage for the cost of labor and materials plus 25%.
Ten significant contract provisions that should be considered are as follows:
Scope of Work – Statement of the scope of work including quality, completeness of design, and nature of the parties’ duties is critical to avoiding costly disputes later.
Price and Payment Methods – Typically the contract will contain a schedule for specific items of work and, as they are completed, the contractor certifies that a percentage of the work is completed and will request payment for it.
Insurance – At a minimum, construction contracts require insurance coverage for comprehensive general liability (CGL), automobile, and worker’s compensation coverage. Additionally, some type of proof of insurance may be required from subcontractors. The owner may also provide for other insurance coverage to protect against risks such as catastrophic events.
Indemnification – One party agrees to cover certain losses which might be incurred by the other party as a result of claims which might arise under the contract, holding the other party harmless.
Warranties and Bonds - Certain warranties are customary such as a warranty that goods furnished will be of good quality. Contract bonds such as performance and payment bonds may be required guaranteeing completion of the project and payment under the contract.
Project Changes and Change Orders – Provision for submission and approval of necessary changes in plans and specifications during the course of the project.
Delays – Contracts often provide an allowance of certain delays, and penalties for other delays by the contractor.
Suspension and Termination – If the contractor fails to comply with the certain provisions of the contract, the owner may suspend or terminate the contract.
Disputes – Many contracts contain an arbitration clause which requires disputes to be resolved in arbitration rather than in court.
Transaction Rules for Particular Industries – Construction contracts should set out required industry procedures for the transaction where necessary.
A properly negotiated and drafted construction contract will be fairly complex if it is to be clear as to all material terms and provide for a fair allocation of risks. Any contractor or owner preparing to take on a construction project would be well advised to have a solid understanding of all of the primary contract provisions and to seek legal counsel to assist in negotiation and drafting of the construction contract. Failure to understand the contract one signs or the failure to seek assistance of counsel are not legal defenses to problems that might arise later after the project is underway.