When Disputes Arise: What Are Your Options?

Perhaps you are a general contractor who is being asked to bear the burden of delay damages after a season of unexpectedly heavy rains. The contract doesn’t require it. Doing so may bankrupt you.

Maybe you are an owner and things are going so slow that you’re stuck between a rock and a hard place. You’ve sold your old home and have no place to go. Or maybe your business has already marketed the grand opening and you’ve got customers and product scheduled to arrive — and no place to put them.

Then again, you could be an architect. The contractor is substandard, RFIs are flying and costs are skyrocketing, and the finger is being pointed at you and your design. You know it’s not design error, but the unsophisticated owner may buy the contractor’s excuses.

What to do?

  1. Mediation
  2. Arbitration
  3. Lawsuit

The traditional answer was to file a lawsuit if the dispute could not be resolved in the ordinary course of business. Today, however, there are options to filing suit that can prove to be more efficient in time and less costly for everyone. Collectively, they are labeled as “alternative dispute resolution” and each has its own set of benefits and disadvantages.

Mediation

Construction of even the most humble structure requires an interweaving of talents and a cooperation between contributors that works best when everyone is proceeding in an efficient and supportive manner. Disputes stall this process, and if informal negotiations do not find a quick answer to the problem, mediation may be the fastest method to get things smoothed out, and back on track.

Mediation is an informal process where the dispute is brought before a trained mediator for resolution. The parties can agree in advance on whether or not the mediation will be binding or non-binding upon them. The mediation can take place at any agreed-upon location, and the mediator need be only someone that the parties agree should act in this role. Ordinarily, mediators are construction professionals trained in mediation resolution techniques. Many attorneys with a background in construction law act as mediators in construction matters.

In some instances, the mediation will be a multi-party mediation since construction involves such an overlap of interests and issues. For example, representatives for the architect, general contractor, and owner may all participate in mediation. Similarly, two or more sub-contractors may participate in mediation with a general contractor.

After negotiation among the parties themselves, mediation costs are among the least expensive in dispute resolution. The mediator’s fee can be split among the parties, and with adequate preparation, the issue can be resolved in a very short amount of time.

Binding mediation involves a contract between the parties in which they agree to forego the right to file a lawsuit and to accept the decision of the mediator as final resolution of the dispute. This works well with keeping a construction project up and running.

In fact, binding mediation is a cheaper and faster option to a more formal arbitration and studies show it is gaining in popularity among construction professionals. Nevertheless, formal arbitration remains the most widely used alternative resolution method in the construction industry today.

Arbitration

Arbitration is more formal than mediation, and less so than trial. Arbitration has no discovery process – there are no depositions, nor any courtroom fights over whether or not the opposing party has a right to look at certain documents, for example. However, simplified rules of evidence do apply in arbitration proceedings and the resolution itself does have some of the formalities of a courtroom.

The decision-maker in arbitration can be a single arbitrator, or a group of individuals collectively referred to as an “arbitration panel.” The arbitration decision is final and cannot be appealed, unlike the traditional legal process, except in certain limited situations (e.g., the arbitrator failed to mention past business dealings with one of the parties and failed to recuse himself, etc.).

The American Institute of Architects includes a provision for arbitration of disputes in their contract forms, which have been widely used and adopted throughout the construction industry. The American Arbitration Association also promotes the use of arbitration in construction matters though its National Construction Dispute Resolution Committee (“CRE”).

The CRE promulgates rules and procedures for residential and commercial construction arbitration, as well as fact sheets, forms, and ethical guidelines that can be obtained online. (The CRE also offers some mediation documentation, as well.)

Arbitration can get a resolution in a relatively short amount of time: unless the matter is complex, the process can be completed within 90 days. If the parties have agreed to an accelerated process, then the time can be shorted to 30-60 days; with enough cooperation among the participants, arbitrations have been known to complete within as little as 14 days.

Arbitration can be costly. Preparation of the supporting documentation as well as the legal arguments to be advanced can become expensive. Compared to the same dispute in the traditional litigation process, however, arbitration will always be the cheaper alternative.

Arbitration must be agreed upon by the parties before the process begins. Most general contractors are insisting that arbitration clauses be included in their contracts, since their business encounters the most disputes and can be hardest hit by any conflicts.

Both state and federal law contain detailed requirements on arbitration clauses within contract documents. Since the arbitration provision effectively denies the parties their constitutional right to the courtroom process, protections are strict to insure that everyone understands exactly what they are foregoing when they sign their agreement to the arbitration option. Arbitration clauses must be in a certain size font, for example, and must contain clear explanatory language of the finality of the arbitration option.

Lawsuit

With the popularity of mediation and arbitration, are there still construction lawsuits? Of course. For some, the opportunity to have a jury trial is not something they are willing to give up. For others, the time and money involved in traditional litigation is not a significant detriment to them — and may even provide them a strategic benefit.

In big, complex disputes, traditional litigation does offer advantages and sometimes can be the only option. A general contractor filing bankruptcy may necessitate the filing of formal litigation. Violations of law or code may require court determinations of legal liability. Suspicions of fraud may require the formalities of full discovery. If the conflict is so large and voluminous that the project has stalled indefinitely, then why not file a lawsuit?

Traditional litigation insures that witnesses will be interviewed, depositions will be taken, and documents will be gathered from all available sources. Judges will be available to oversee the process: a party hiding evidence can be compelled to release it, and an unwilling witness can be subpoenaed and compelled to testify.

An owner, for example, may find it necessary to force the testimony of a subcontractor unwilling to speak up against a general contractor to whom he is dependent upon for future work. Similarly, a contractor may need formal subpoena power in order to obtain documentation from an engineer unwilling to volunteer information detrimental to an architect with whom he does repeat business, and an architect may need legal formalities to obtain financial evidence from a third-party concerning the liquidity of a non-paying owner.

Litigation takes time, and it can be expensive. Residential disputes are usually heard by a judge, and can be faster than a commercial dispute which ordinarily involves a full jury trial. Appeals can be filed, and the appellate process can take years before a final determination is reached.

Sometimes, lawsuits admittedly are filed with the full knowledge that the expected expense in time and money invites a settlement that might not have been so readily available otherwise. Sometimes, lawsuits are the only option. When issues such as illegality or fraud are involved, inter-party resolution simply may be insufficient and the traditional legal process may be required.

For more information:

American Arbitration Association
http://www.adr.org/

AAA’s National Construction Dispute Resolution Committee (CRE)
http://www.thecre.com/fedlaw/legal89/15710.htm

State of Louisiana – Arbitration and Mediation Acts
http://www.legis.state.la.us/lss/lss.asp?doc=107926
(you must enter each section number, this site does not automatically scroll through the statutes)

State of Washington – Arbitration and Mediation Acts
http://apps.leg.wa.gov/rcw/default.aspx?Cite=7

Bidding Errors and Change Orders – Avoiding a Nightmare: Part One

The goal in the design of any structure must be excellence, not perfection. Inevitably, there will be issues that reveal themselves during construction which are impossible to predict in the conception phase of any new project. Among the most common design alterations involve site conditions that differ from design expectations; an owner’s desire to alter the design in some way (“change in scope”); and the plans or specifications containing an inadvertent omission.

Owners, architects, and contractors approach this inevitability very differently. Owners prefer to have as little change as possible, unless they are requesting a design change, while architects have the overriding concern that the integrity of their design be protected. Meanwhile, experienced contractors know that refinements or minor adjustments will need to be made during the construction process to the design documents — even the highest quality drawings and specifications will need some tweaking as building progresses.

The inevitably of change during the course of construction does not mandate that major alterations to the initial schedule and design concepts should be expected. If all the participants do their parts well, the project should be completed with a minimum of change. Unfortunately, this is not always the case.

Bidding Errors

With any construction project, the owner and architect begin with a goal in mind. Once the design has evolved, and the initial drawings have been finalized, the general contractor enters the picture with the goal of turning the drawings into a three-dimensional reality. The owner may well have chosen both the architect and the contractor through a bidding process: here, several competitors compete for the work, and the owner chooses what appears to be the best bid for the job.

The general contractor will usually select the sub-contractors through a bidding process, as well. Additionally, the architect may use a bidding process to select engineers and other supporting professionals in the design phase.

Therefore, the owner choosing bids for both the architect and the general contractor may be deciding between bids that are built upon a prior bidding process. Bids upon bids are the underpinnings of the initial construction agreements.

It is here that bidding errors occur. In an attempt to land the contract, bids can be compiled too quickly, giving estimates without sufficient detail and cost support. Sometimes, bids are intentionally low-balled. The lowest bid may not be the best bid, and the owner that does not carefully study all the bids before him is inviting the aftermath of a sloppy bid: expensive and time-consuming bidding errors.

Bidding errors will require costly and preventable changes to be made during construction. The issue of which parties are to be held responsible for the cost in both time and money can also create expense: many lawsuits have resulted from disputes between owners, architects, and contractors over who pays what percentage of the costs caused by bidding errors.

Owner Abuse of Opportunity to Make Changes

Owners have the right to make changes to the project: it’s their property, after all, that’s being built. However, changes requested by an owner can skyrocket the costs of construction. What appears to be a simple request to change the size of a window or door may mean tremendous expense if framing has already occurred, for example.

Architect Administration, Design Error, and Changes to the Project

Architects usually administer the construction project. They oversee the building as it progresses, they answer any questions that the contractor may have regarding the plans and specifications, and they approve any changes made to the project. Architects can also make alterations to the design drawings as they view the site progression.

This may be a predictable addition: for example, not all the shop drawings and materials specifications are known when the work is bid. Sometimes, this is aesthetic. Occasionally, this is due to small or large errors in the design.

If the architect is not prompt in approving changes, or becomes excessive in the number of design changes he makes, then construction can be halted or delayed. Construction involves an inter-dependent relationship between many craftsmen, suppliers, tradesmen, and the like: an architect can effectively stop the job with excessive design changes, or tardy approvals to a requested change.

Contractor Changes to the Project

Contractors are usually responsible for most of the requested changes on a project. As building progresses, there will be discoveries on site of needed changes to the design documents. However, contractors who make changes without approval can cost time and money if their changes are faulty and need to be redone. Contractors who request excessive changes can also create tremendous expense: they may do so because of design error, but they may also be doing so to cover their own bidding errors or substandard performance.

The Change Order Process

In order to combat and control changes during the construction process, the construction industry has standardized the use of “change orders.” Change orders alter or modify the final documents upon which the construction contracts are based. They direct a change to the work plan which will impact the time and money needed to finish the project.

Usually, the change orders are written; however, some states – including Louisiana and Washington – allow for oral change orders. See, Cajun Contractors, Inc. v. Fleming Const. Co., Inc., 951 So.2d 208 (La.App 1 Cir. 2006), citing Pelican Electrical Contractors v. Neumeyer, 419 So.2d 1, 5 (La.App. 4 Cir.), writ denied, 423 So.2d 1150 (La.1982); CKP, Inc. v. GRS Const. Co., 63 Wash.App. 601 (1991); Bjerkeseth v. Lysnes 173 Wash 229 (Wash 1933).

In fact, change orders are so commonplace that they have become standardized. The form used most often has been provided by the American Institute of Architects, see “AIA Document G701™-2001, Change Order.”

RFIs

Requests for Information (“RFIs”) are not necessarily change orders. They are written communications between the contractor and the architect, where the contractor asks for information regarding the design documents. RFIs become change orders if they are properly approved as such by the architect, and sometimes, by the owner as well.

Since the owner usually has one contract with the architect, and a separate one with the contractor, the architect and the contractor need a method to communicate efficiently and fast, without the owner as a go-between, and the RFI has evolved to meet that need. The architect will provide a written form to the contractor to be used for all RFIs.

The American Institute of Architects describes this process in its section 3.2 of A201 the General Conditions for Construction (1997):

Before starting each portion of the Work, the Contractor shall carefully study and compare the various Drawings and other Contract Documents relative to that portion of the Work, as well as the information furnished by the Owner… These obligations are for the purpose of facilitating construction by the Contractor and are not for the purpose of discovering error, omissions, or inconsistencies in the Contract Documents; however, any errors, inconsistencies or omissions discovered by the Contractor shall be reported promptly to the Architect as a Request for Information in such form as the Architect may require.

RFIs are used by contractors when they find an omission in the documents, something unexpected is discovered on the site, or they meet with a discrepancy between various plans and specifications. RFIs also confirm information, gather notes from site visits and delineate meeting minutes.

Change Order Conflicts

Owners, particularly those building their new residential home, are suspicious of change orders as costing them money in the form of cost overruns and possibly even price gouging by the contractor, as well as causing delays in finishing the job. Owners want to avoid change orders.

Contractors, meanwhile, would prefer to maximize change orders on a project because they lose money with discounted change orders, as well as ones which are ignored, outright. Too often, they argue, the time and expense costs associated with a change are eaten by the general contractor or his subs.

Change Orders do solve issues. If everyone is cooperative, problems can be easily solved. However, when a change will impact either money or time, especially in significant amounts, controversies can result. This is particularly true when the change request contains ambiguities or unclear terms.

To avoid deadlocks, most construction contracts give detailed instructions on how change orders are to be written, including what steps must be undertaken before any change in work (more or less) is allowed. Change orders usually have to give the amount of dollars as well as the amount of time involved in the request. They usually have to be submitted within a certain number of days before the scheduled work, and signed by several designated individuals authorized in advance to approve or deny each change request.

Nevertheless, once construction begins and the number of RFIs escalates as well as the number of change orders, tempers may flare. Work stoppages may be threatened, termination of contracts may be considered, and heated arguments may arise if oral change orders are denied compensation because they weren’t put on paper. Delay damages can mount.

The construction project can become a nightmare as the necessity of requested changes is debated. The dispute can involve not only the need for the change, but who will bear the cost of the change.

Under the law, change orders are characterized as modifications to a written contract. Until a change order is valid, the old contract documents control. However, the legal determination of whether the change order is valid may necessitate the filing of lawsuits or the entering of dispute resolution forums that all the parties would be better off avoiding.

For example, contractors faced with time deadlines may proceed in good faith under oral change orders, only to have them later disputed because they were not put in writing. In some states, including Louisiana and Washington, oral change orders can exist under the contractual defenses of waiver, estoppel, and unjust enrichment. Unfortunately, that contractor may have to go to court to prove his point.

How to avoid this nightmare?

Over time, several methods for avoiding litigation and encouraging a smooth change process during construction have been advanced. For a discussion of these methods, see next month’s Bidding Errors and Change Orders – Avoiding a Nightmare: Part 2.

Construction Contracts 101: The Use of Standardized Contracts and Forms

In construction, it is not a question of whether or not to have a written contract: the real issue is how many contracts will be involved in the project. Construction is a complex process involving overlapping time, money, and labor concerns. How best to allocate the financial risks in the event that anything goes wrong — which it will — is wisely documented before work begins. Indeed, in most states and for most projects, written agreements are legally required.

For many years, there has been a continuing argument that construction contracts should be readily adaptable to standardization. Companies have promoted contract kits for both commercial and residential purposes; various associations, including notably the American Institute of Architects, have provided detailed contract examples and forms for the use of their memberships.

In fact, Fall 2007 saw the AIA revamping its sets of forms, as well as the introduction of www.consensusdocs.org — a web site containing the collaborative work of over 20 nationally-recognized construction associations in what they are deeming a revolution for the construction industry. Representing owners, architects, designers, engineers, general contractors, sureties, and a wide variety of subcontractors, www.consensusdocs.org provides standardized contracts and forms whose language has been negotiated and honed by representatives of all facets of the American construction industry.

Between the AIA and the ConsensusDocs project, have the issues and conflicts of the past regarding construction contracts and the allocation of risk been resolved? Have we entered into a peaceful, strife-free era for the construction industry? Probably not.

No matter the source of the written template, the individual project will require its own unique risk allocation. Environmental concerns will vary; the bargaining power between the parties will not be equal.

In each contract, in every situation, parties will want to insert provisions into the contract to favorably distribute their responsibilities and limit their liabilities. Additionally, the written language of each agreement must be weighed against the impositions of implied warranties, environmental requirements and restrictions, and the like — by local, state, and federal law — to the specific project.

The contractual language will also need to predict and preempt party disputes, in advance, for a broad range of possibilities, such as who bears the financial responsibility for:

  • Failing to properly fund the work;
  • Failing to secure (and pay for) easements;
  • Warranting the plans and specifications;
  • Interpreting the documents;
  • Assessing and allocating damages for delays in construction;
  • Terminating a party due to dissatisfaction with the work;
  • Violating applicable codes and regulations; and
  • Making errors in design or requiring excessive change orders.

Decisions will also need to be made regarding which overall contractual arrangement is best for the situation. For example, larger projects may be better suited to a series of overall agreements, dividing the project into phases. One set of documents will apply to the first phase; another set to the second phase; etc. This is a common preference in the construction of school buildings and college campuses, as well as other multi-structured projects.

Furthermore, decisions will be needed on the contractual arrangements that will exist between the various parties: should the same type of contract be used for everyone? Often, the parties find it best to have one type of contract between the owner and the general contractor and another between the general contractor and all the sub-contractors.

Common types of construction contracts include:

  1. Lump Sum. In lump-sum contracts, one party agrees to provide certain, named services for a set price; the other party agrees to pay that price either upon completion of the work or pursuant to a schedule. If chosen between an owner and a general contractor, the owner will pay a set amount. The general contractor takes the risk of loss if there are unexpected expenses and the possibility of gain if the project comes in under-budget.
  2. Unit Price. Unit price contracts breakdown the work to be performed into parts with a set price for each portion. These agreements are common among subcontractors who take the risk of loss and the possibility of gain, while the general contractor (or the owner) pays the set, agreed-upon price.
  3. Cost Plus. Cost-plus agreements have the general contractor’s profit defined in the contract itself, as well as the estimated construction expense. If the actual expenses come in lower than the estimate, then the owner reaps a savings. Cost overage, and the owner has to pay more for the project. These contracts place the risks of cost overruns upon the owner, not the general contractor, who enjoys the security of knowing his exact profit. The general contractor may have little incentive to be efficient on-site, but the owner has the satisfaction that the ultimate project will be to his exact standards even if the expenses run high.

Standardized forms cannot address the needs and wants pertaining to an individual project: the templates will call for some revision in order to meet the requirements of the particular parties involved in each construction project. Moreover, the templates themselves cannot predict which set of forms best meets the needs of the individual parties. In addition to overall risk allocation, things like unique project delivery methods and systems must be considered; provisions included for specific insurance and indemnity issues; and dispute resolution methods outside of a formal courtroom negotiated and properly implemented.

Standardized forms do help. They assist in the creation of solid construction contracts which successfully do their job: defining who bears the brunt of the unexpected events or the unforeseen mistakes that naturally occur during the course of construction. The forms introduced by www.consensusdocs.org have the added benefit of authorship derived from all those involved in the process – from owner to subcontractor to surety – as opposed to those offered by one organization or group, which have lent themselves in the past to criticism that their language is slanted to favor their membership.

However, reliance upon any standardized form without molding its language to fit the needs and wants of the individuals involved in a specific project is foolhardy; failing to obtain expert legal assistance in the process is unwise. These forms should never be considered as replacing the assistance of legal counsel; instead, they should be seen as tools to better effect a harmonious and efficient construction process.

For example, of particular concern in each individual instance is the choice of law for the particular project. What state law controls the interpretation of the agreement can be key in determining which party bears the financial burden of a realized risk: for example, is there an indemnity clause, and will the state law respect that language?

Contractual provisions cannot trump the law: parties cannot contract around state legislation established in the public interest and attempts to do so are invitations to a time-consuming and expensive litigation process. However, contracts can realign risks in a manner that the law will allow in instances where the parties’ rights to determine their own course is respected.

Different state laws can define this boundary between the parties’ free will to contract and the need to protect the public interest in different ways. One state may allow a provision that another state will not (such as indemnification). Standardized forms cannot address issues to this level of detail.

For all those involved in construction but particularly small businesses, as well as residential contractors and home owners, the standardized form is an especially tempting danger as well a terrific tool, depending upon its usage. Without the input of a knowledgeable construction lawyer, these templates can open a Pandora’s box of problems for the parties involved in the construction process, and a high risk of litigation expense — if only to have a court’s assistance in determining the parties’ contractual intent. With the assistance of expert legal counsel, these forms offer a means to circumvent many pitfalls as well as decreasing an otherwise lengthy contract expense.