Construction Contracts 101: The Use of Standardized Contracts and Forms

On October 23, 2007 by

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.

On Oct 23, 2007

by