Contract Provisions That Help Manage Risk on Long-Term Projects

Jason Lambert | Construction Executive

Few things can dampen the thrill and promise of a newly closed construction deal than the realization that it could quickly become a losing proposition for the contractor depending on economic and other conditions. In an era of instant information, constantly adjusting markets and political extremes, projects that start under one set of assumptions or conditions can occur or conclude under much different ones. While no one has a crystal ball, there are contractual provisions that can provide clear guidance in the face of many “what ifs” that can arise in construction. 

One of the chief concerns a contractor should have in a project lasting more than a few months is what impact price increases will have on the profitability of the job. On a true cost-plus project, this may be of little concern, but on any project with a limitation on costs or a guaranteed maximum price, contractors should insist on a procedure to revisit the limitation or price if certain conditions change. 

This can be as simple as allowing the contractor to receive an upward adjustment in the price if costs increase by more than a certain percentage. It can be as complicated as requiring multiple new bids and disclosures to the property owner, architect or project manager and allowing approval of new suppliers or subcontractors to limit cost increases to the cheapest increase. The protection—and certainty—to the contractor though, comes from having a process in the contract to address cost increases, whether it is simple or complex. 

In a similar vein, if seeking cost increases is not feasible or preferable, then it may make sense to include a provision that allows the contractor to terminate the contract if costs increase beyond a certain amount or certain percentage. Again, this may require a certain amount of disclosure to property owners or other third-parties to justify termination, but it may be preferable to exit a project at a break-even point or mild profitability rather than take it to conclusion and lose money. This option does not exist though, unless a contract between the parties expressly allows it. 

Shifting away from cost-focused provisions, another unpredictable problem can involve owner-caused delays. Typically, property owners have material selections to make or approve, change orders to authorize and other input to provide on the project. While eliminating delays entirely may be impossible, the best way to address them can be to incentivize timely performance, by, for example, providing for liquidated damages in the event the owner does not meet required deadlines. Another option could be to allow cost increases to be charged if they are the result of delays, and still a third option would be to allow the contractor to make the decision for the owner in the absence of timely input. Again, the specific method of allowing for additional costs or time in response to delays is less critical than having a procedure to do so that eliminate uncertainty from the future.

Another type of delay can arise from third-parties or events external to the project. Contracts commonly alleviate contractors from delays caused by natural disasters, strikes, war, etc., but most do not go the extra step of determining how the risk of those events are to be allocated among the parties or how the contractor is to be reimbursed for the consequences of them. One way to avoid this issue is to provide more specificity, especially in the face of known issues. 

A great example of this is hurricanes. Many projects along the U.S. Gulf Coast and Eastern Seaboard face the threat of hurricanes impacting the project sometime during the summer months, whether a hurricane actually strikes the project or simply strikes a manufacturing facility 100 miles away. Contracts for these projects should include specific hurricane mobilization and demobilization provisions, allocate the costs and delays associated with the same, and allow contractors to seek cost increases if material or subcontractor prices go up due to demand or scarcity. While the hurricane may never impact the project, if it does, the contractor will be able to rely on those provisions to protect its ability to perform the project or terminate it if necessary. 

Finally, contracts should require that contractors, subcontractors and material suppliers exercise their rights under relevant lien laws. This means ensuring the pre-lien notices or any pre-project notices are sent at the beginning of the project, even when things are going well and everyone is performing their contractual obligations timely. This is the only way to ensure that lien and other rights are preserved in the event of any “what ifs” that come to fruition. 

While these are only a few specific types of issues that can arise in the future and can be mitigated through contractual risk allocation, contractors can think through common problems that occur for their business or their region and craft contractual provisions that address what the contractor wants to happen if some foreseeable event in the future. While this may not prevent problems from arising, it certainly will keep those problems from derailing a project or company. 

Prior Material Breach May Excuse Performance, but the Factfinder Must Agree It Was a Material Breach

J. David Pugh, Ian P. Faria and Amandeep S. Kahlon | Buildsmart

In most jurisdictions, a party may be excused from any future performance under a contract by the prior material breach of the other party. A “prior material breach” is typically defined as conduct that deprives the injured party of the benefit that it reasonably could have anticipated from the breaching party’s full performance. This excuse may serve as a complete defense in a breach of contract action. It is a potent defense, but the devil is in the details: Was it a “material breach?”

Because determination of whether a breach is material is typically a question for the jury, or judge or arbitrators, depending on the forum, failure properly to raise the issue of “prior material breach” may invalidate an otherwise valid defense to a breach of contract action. A homeowner recently learned this hard lesson from the Texas Court of Appeals’ decision in Earth Power A/C and Heat, Inc. v. Page published on June 23, 2020.

In Earth Power, an HVAC contractor alleged a homeowner breached its contract for installation of a geothermal HVAC system by failing to make multiple progress payments. The homeowner asserted an affirmative defense of “repudiation” arguing that the contractor repudiated the contract by not installing the HVAC system in a workmanlike manner.

At trial, the jury found that both parties breached the contract, but that the contractor breached first. The jury also found that the homeowner’s payment obligations were not excused by any repudiation and awarded the contractor damages for nonpayment. The homeowner did not raise the affirmative defense of “prior material breach” or present to the jury the question of whether the contractor’s breach was material or whether the breach excused the homeowner from paying the contractor.

After the jury verdict, the homeowner moved to set aside the judgment and to enter judgment as a matter of law in its favor. The homeowner argued that the jury’s finding that the contractor breached the agreement first should be treated as a finding of “prior material breach,” and the court should vacate the jury award of damages. The trial judge accepted this argument and amended the final judgment in favor of the homeowner.

On appeal, the contractor argued that the trial court erred because there was no finding of “prior material breach” as that question was never properly raised before the jury. The Texas Court of Appeals agreed. The homeowner “failed to secure findings necessary to support the assertion that his failure to perform was excused” by the contractor’s prior material breach. According to the court, although the jury found that the contractor breached the contract first, it was not asked whether that breach was material, and the homeowner submitted no question or instruction to the jury regarding “prior material breach.” Under Texas law, the failure to request a jury question or instruction on “prior material breach” waived the homeowner’s affirmative defense.

An exception to this waiver rule applies if the affirmative defense is “conclusively established,” but the homeowner did not argue this exception on appeal. Absent a prior material breach, the contractor was entitled to recover damages for the homeowner’s failure to pay amounts due under the contract. The Court of Appeals, therefore, reversed the trial court judgment and ordered the homeowner to pay the contractor the damages awarded by the jury, plus attorneys’ fees.

What is the takeaway from this decision?

As we are sure you’ve heard, “it’s complicated.” Prior material breach is a common affirmative defense in construction contract disputes, but it requires more than a mere showing of which party was the first to breach an agreement. If the homeowner in Earth Power had properly submitted “prior material breach” as a defense for its non-payment to the jury, a finding in its favor would have likely survived appellate scrutiny.

However, when materiality is not proven, the party responsible for the first-in-time breach may still recover for subsequent (material) breaches by the other party to a contract. As stated above, this allegation, like the decision to quit performing a contract, may be a “nuclear option” in construction contracts. It should be approached with solid advice and with caution.

COVID-19 Language For New Construction Contracts: A Practical Approach

David A. Blake | Seyfarth Shaw

Introduction

Those entering into new construction contracts should include custom language addressing the parties’ respective rights and responsibilities related to COVID-19. Many articles and webinars have focused on how traditional contract clauses in existing contracts may respond to COVID-19 issues. The fit is not always clear. Some guesswork is involved and creativity is called upon as square pegs are coaxed into round holes. While there is a need to perform that retrospective analysis to assess how COVID-19 issues will play out under existing contracts, there is no need to propagate uncertainty in new contracts. Indeed, such uncertainty can cause parties to shy away from new contracts or include significant contingencies, neither of which supports an industry trying to recover from the pandemic.

This article addresses custom COVID-19 language for new construction contracts. The principles discussed can be applied to any construction contract. This article is based on two construction contracts for which I successfully drafted and negotiated custom COVID-19 language. One is a private project and the other is a public project. Some of the views expressed during those negotiations are weaved into the discussion to provide both sides’ perspective.

Contract Clauses and Issues

Definitions  

Just like a building needs a solid foundation, new COVID-19 language in a contract should start with key definitions on which the parties’ rights and responsibilities will be built. Four terms to define upfront are COVID-19COVID-19 Proclamations, COVID-19 Condition, and Unknown COVID-19 Condition.

Everything ties back to COVID-19, so define that term first. Consider a definition that includes both the virus and the disease it causes, such as: “The 2019 novel coronavirus and the disease it causes are collectively referred to herein as COVID-19.”

Next, pick a term, such as COVID-19 Proclamations, to capture the orders, directives and guidance concerning COVID-19 that have been issued, and which may be issued, by public bodies with jurisdiction over the project. Those orders, directives and guidance may require the project to shut down or otherwise increase the contractor’s cost or time of performance by calling for things such as social distancing and the use of personal protective equipment. Having a term for that collection of orders, directives and guidance is helpful when allocating the parties’ rights and responsibilities pertaining to them.

Finally, define a set of related terms, COVID-19 Condition and Unknown COVID-19 Condition. Define a COVID-19 Condition as something attributable to COVID-19 not caused by the contractor and beyond its control. The definition should list specific items, such as COVID-19 Proclamations and supply chain disruptions due to COVID-19, and include a catchall, such as, “other circumstances concerning COVID-19 not caused by the contractor and which are beyond its control.”

An Unknown COVID-19 Condition adds a time component. Define it as a COVID-19 Condition the contractor did not know about, and reasonably should not have known about, as of a certain time, such as when the contract or a guaranteed maximum price amendment is signed. Consider stating COVID-19 Proclamations issued at least X days before a contract or GMP amendment is signed are not an Unknown COVID-19 Condition. In other words, the contractor will be deemed to have knowledge of those COVID-19 Proclamations.

The nesting of the definitions, culminating in an Unknown COVID-19 Condition, is very important. As discussed in the following sections, in order to be entitled to any relief, the contractor must demonstrate an issue constitutes an Unknown COVID-19 Condition. This is based on the principle that if the contractor knew, or reasonably should have known, about the issue when it signed the contract or GMP amendment, then it should have accounted for it in the price and schedule. Tying into that principle, if a COVID-19 Condition arises after the contractor submits its bid or proposal, it should be allowed to revise the same due to that condition up until the time it signs the contract or GMP amendment. Language to that effect should be included in the contract and procurement documents, as appropriate.

Delay

In many construction contracts, one of the criterion for an excusable delay is it must be unforeseeable. Contractors may be concerned that in new contracts all delays related to COVID-19 will be deemed to be foreseeable because the parties were aware of the COVID-19 pandemic when they signed the contract. This is the type of uncertainty that can arise if standard clauses are not clarified. An equitable approach is to focus on the specific COVID-19 issue that caused the delay, rather than the pandemic as a whole. In that regard, clarifying language should be added to the contract stating, with respect to a COVID-19 Condition, only an Unknown COVID-19 Condition is deemed to be unforeseeable. That strikes a fair balance. If the contractor did not know about, and reasonably should not have known about, the COVID-19 Condition when it signed the contract or GMP amendment, it will be deemed to be unforeseeable and something for which the contractor can pursue a time extension. The owner is also protected because the contractor will not be able to seek a time extension based on a COVID-19 Condition it knew about, or reasonably should have known about, when it signed the contract or GMP amendment.

If the contractor is entitled to a time extension for an Unknown COVID-19 Condition, the next issue to address in the contract is whether that time extension is compensable. One approach is to treat this type of delay the same way the contract treats force majeure delay. For example, if the contract states only delays caused solely by the owner are compensable, then clarify that even if the contractor is entitled to a time extension due to an Unknown COVID-19 Condition, the time extension is non-compensable. On the flip side, if the contract affords the contractor compensation for force majeure delay, then clarify that if the contractor is entitled to a time extension due to an Unknown COVID-19 Condition, the time extension is compensable.

Owner Directed Suspension

The owner may want to suspend work at the project site due to COVID-19 health concerns even though the contractor is allowed to proceed with the work based on COVID-19 Proclamations. This may be more likely for sites partially occupied by the owner during the course of construction. If the contract provides the owner the right to suspend the work for its convenience, then one approach is to add language that describes this type of a suspension and states it will be deemed to be a suspension for the owner’s convenience with the contractor having the corresponding remedies stated in the contract for such a suspension. If the contract does not allow the owner to suspend the work for reasons other than the contractor’s breach, then consider adding a new section specifically addressing the owner’s right to suspend work due to COVID-19 health concerns and the relief to which the contractor is entitled for that suspension.

Compliance with COVID-19 Proclamations

Include a section that states the contractor is required to comply with COVID-19 Proclamations in the performance of the work. This is true irrespective of when the COVID-19 Proclamations are issued. The timing of their issuance (before or after the contract or GMP amendment is signed) will affect whether the contractor is entitled to an equitable adjustment for such compliance, but not whether compliance is required. 

Another issue to address in this section is whether, and to what extent, the contractor should be responsible for its subcontractors and suppliers complying with COVID-19 Proclamations. At a minimum, it is fair for the contractor to be responsible for its subcontractors and suppliers complying with COVID-19 Proclamations while they are on the project site. However, should it also be responsible for them complying with COVID-19 Proclamations while they are off-site? Consider a group of subcontractors who pool together and take a van to work in violation of applicable social distancing guidelines. One of those workers becomes infected with COVID-19 and comes to the site, resulting in a suspension of all site activity while a deep clean is performed. Should the contractor be responsible for that delay? How do we know if that conduct resulted in the worker becoming infected?

As a general principle, the contractor is responsible for the acts and omissions of its subcontractors and suppliers as it pertains to their performance of the work. Defective work is one example. Consider the van example above. However, instead of violating social distancing guidelines, the driver was pulled over for speeding and arrested, which resulted in a delay to the project because the workers never showed up at the site that day. Would the contractor be responsible for that delay resulting from off-site subcontractor conduct? A final example to consider is a contractor’s supplier whose factory is shut down because the workers in the factory were not following social distancing guidelines and became sick. The supplier is late in supplying the equipment the contractor ordered, which delays the project. Should the contractor be responsible for that delay because its supplier did not abide by COVID-19 Proclamations?

The extent to which the contractor should be responsible for its subcontractors’ and suppliers’ off-site compliance with COVID-19 Proclamations is an issue the owner and contractor may view very differently. Putting those differences aside, and even if one agreed in principle that the contractor should be responsible for such compliance, the impracticality of the contractor policing its subcontractors’ and suppliers’ off-site conduct may result in a significant increase to its price for that effort and risk. Therefore, the owner should perform a risk-reward analysis. The outcome might be that the price premium is not worth it. However that issue may be resolved, do address it in the contract. Wrestling with an issue upfront before the ink dries is better than first confronting it after the pages have curled with age.

Compensation for COVID-19 Costs

The last significant issue to address is the contractor’s right to be paid for COVID-19 costs, including, but not necessarily limited to, price escalation due to COVID-19 supply disruptions and the cost of complying with COVID-19 Proclamations. This critical language should strike a fair balance to achieve the twin goals of dissuading contractors from including excessive COVID-19 contingencies in their lump sum bids and GMP proposals, and encouraging lenders and owners to commit their funds to new projects.

First, identify the criteria for compensation. For example, the cost must: (i) be solely attributable to an Unknown COVID-19 Condition; (ii) be reasonable under the circumstances; (iii) not be the result of the contractor’s failure to comply with the contract documents or a COVID-19 Proclamation; and (iv) not be the result of a subcontractors’ or suppliers’ failure to comply with a COVID-19 Proclamation while on site (and, as discusses above, perhaps while off-site as well). You can refer to a cost that satisfies those criteria as an Unknown COVID-19 Cost. Second, state the owner will reimburse the contractor for costs attributable to COVID-19, and which are not included in the schedule of values, only if the cost is an Unknown COVID-19 Cost. As with a time extension for delay, this strikes a fair balance and hinges on what the contractor knew, and reasonably should have known, at the time it signed the contract or GMP amendment. Third, if your contract is based on a GMP that includes a construction contingency, you might address whether that contingency will be the first source of funds for an Unknown COVID-19 Cost, with a change order to follow only if there is a shortfall.

Organization of New Language

You have two options concerning how you organize the new COVID-19 language. You can disperse it throughout the contract on a topical basis. For example, you can include the COVID-19 delay language in the delay section of the contract. Alternatively, you can add a new article to the contract for COVID-19 and include all of the new language there. The second option is preferred for a few reasons. First and foremost, it is easier to comprehend and apply the language when it is in one place. This is especially true due to the nesting of the definitions. Further, from a drafting and negotiating perspective, it is more efficient to add the language in a new article, and it is easier to edit and pass drafts back and forth when the language is in one place. If your contract includes separate documents for the agreement and general conditions, include the new COVID-19 article in the document that has the higher priority in the order of precedence clause.

Conclusion

Owners and contractors should include new language in their construction contracts specifically addressing their rights and responsibilities concerning COVID-19. Doing so is a better option than wondering how standard clauses might apply to the pandemic. Further, with experienced counsel, the time investment to craft the new language is minimal. That investment should pay dividends for owners and contractors alike. The greater certainty created by COVID-19 contract language should reduce upfront pricing and schedule contingencies to the benefit of owners, and encourage the letting of new projects to the benefit of contractors.

Seeking Certainty in Uncertain Times: Employing Cost-Plus Construction Contracts in 2020

Janeia Brounson and Carl Pebworth | Faegre Drinker

With the uncertainty of COVID-19 impacting construction projects in new and unfamiliar ways, choosing the right construction contract format has never been more important. A cost-plus contract — also known as a cost-reimbursement contract — can offer an attractive project format in the current construction environment. Defining project costs and expense using projected and agreed upon costs can be particularly attractive for both owners and contractors in roiling social and economic circumstances.

A cost-plus contract requires the owner’s consent to pay the complete cost for material and labor in addition to the amount for contractor overhead and profit. Cost-plus contracts fall in two basic categories: cost-plus fixed fee contracts and cost-plus fixed fee agreements with guaranteed maximum price. In a cost-plus fixed fee contract, compensation is based on a fixed sum independent of the final project cost. The owner agrees to reimburse the contractor’s actual costs, regardless of amount, and, in addition, pay a negotiated fee independent of the amount of the actual costs. In a cost-plus fixed fee with guaranteed maximum price contract, compensation is based on a fix sum of money and the total project cost will not exceed an agreed upon upper limit.

Cost-plus contracts allow the contractor to be reimbursed for almost every expense incurred in a project. The cost-plus contract pays the contractor for direct costs (such as labor, materials, supplies and equipment) and overhead costs or indirect costs (such as business-related expenses) that are necessary to perform the contract. The contractor is also entitled to a pre-negotiated amount above the reimbursed amount considered a fee or profit.

Cost-plus contracts present several advantages on a construction project. Generally speaking, the contractor can focus on the quality of the project instead of the overall cost. Contractors can be less likely to cut corners or to use less expensive materials because the costs will be reimbursed. Cost-plus contracts also cover all expenses related to the project so there are no surprises. With this in mind, the risk is shifted from the contractor to the owner because all expenses are likely to be covered.

There are also disadvantages with a cost-plus contract format. Final costs cannot always be determined. Cost-plus contracts require that contractors reproduce and justify all related costs, which can be burdensome and time consuming. Disputes regarding expenses can also arise where a contractor feels a cost is justified while owner does not.

With stay-at-home orders, infection risks at job-sites, and project delays in the age of COVID-19, owners may want to negotiate a project cost cap or limit, and a contractor may find comfort in knowing that expenses will be covered. Under those circumstances, cost-plus contracts offer a comparatively safe and assuring construction format.

Michigan Federal Court Permits Subcontractor’s Quasi-Contractual Claims to Proceed Despite Existence of Express Contract Covering the Same Subject Matter

Anthony V. Finizio | Constructlaw

A Michigan federal court partially granted Consumers Energy Company’s (“CEC”) motion to dismiss P.A.L. Environmental Safety Corporation’s (“PAL”) complaint alleging numerous causes of action in connection with its suit against CEC and contractor North American Dismantling Corporation (“NADC”) for outstanding payment stemming from asbestos abatement work at a CEC-owned power plant in Essexville, Michigan (the “Power Plant”).     

According to the decision, CEC, as owner, and NADC, as prime contractor, entered into a written contract whereby NADC agreed to abate, dismantle, and demolish the Power Plant.  In turn, NADC subcontracted with PAL to perform abatement of all asbestos containing material at the Power Plant.  While the subcontract price was $7,996,331, PAL alleged entitlement to an adjusted price of $23,841,833 in unpaid labor and materials for its asbestos abatement work.  Specifically, PAL alleges that it performed additional work not accounted for in the subcontract including fly ash and coal dust removal, refractory brick abatement, and extra asbestos removal. 

While PAL’s complaint included numerous counts against Defendants NADC, CEC, and labor and material payment bond surety North American Specialty Insurance Company (“NASIC”), the opinion is most notable for its treatment of CEC’s motion to dismiss several counts against it including: (i) quasi-contractual claims; (ii) a third-party breach of contract claim; and (iii) a negligent misrepresentation claim. 

Unjust Enrichment & Promissory Estoppel

CEC’s Fed. R. Civ. P. 12(b)(6) motion argued that PAL’s quasi-contractual claims for both unjust enrichment and promissory estoppel were barred by the presence of a written contract as “[t]here cannot be an express and implied contract covering the same subject matter at the same time.”  Campbell v. City of Troy, 42 Mich. App. 534, 537 (Mich. Ct. App. 1972).  PAL countered that in order for an express contract to bar equitable claims, it cannot just cover the same subject matter, but must also be “between the same parties.”  Morris Pumps v. Centerline Piping, Inc., 273 Mich. App. 187, 194-95 (Mich. Ct. App. 2006).

The Court reasoned that although two express contracts existed with respect to demolition of the Power Plant, there was no contractual privity between CEC and PAL.  Accordingly, the Court declined to dismiss the unjust enrichment and promissory estoppel claims because PAL had no express contract with CEC and no other avenue to recover from CEC outside of equitable remedies.       

Third-Party Breach of Contract

PAL also alleged that as a third-party beneficiary of the contract between owner CEC and prime contractor NADC it was entitled to bring a breach of contract claim against CEC despite a lack of privity.  The Court first analyzed the contract to determine if a third-party beneficiary was intended, noting that “[a] third person cannot maintain an action on a simple contract merely because he or she would receive a benefit from its performance . . . ‘[t]hird party beneficiary status requires an express promise to act to the benefit of the third party; where no such promise exists, that third party cannot maintain an action for breach of the contract.’”  Kisiel v. Holz, 272 Mich. App. 168 , 171-72 (Mich. Ct. App. 2006) (quoting Dynamic Constr. Co. v. Barton Malow Co., 214 Mich. App. 425 , 543 (Mich. Ct. App. 1995)). 

The Court concluded that not only did the contract not include a direct promise to PAL, it explicitly stated that the contract did not create any third-party beneficiaries: 

2.8 Third Party Beneficiaries. Unless and except as may be specifically stated herein, nothing contained in this Contract shall create any contractual relationship, including but not limited to any third party beneficiary status, between or establish any rights or benefits in favor of, anyone other than the Owner and the Contractor.

Accordingly, the Court dismissed PAL’s claim concluding that any benefit PAL received from the contract between the owner and prime contractor was incidental, leaving it with no third-party rights to enforce.      

Negligent Misrepresentation

PAL’s final claim against CEC alleged negligent misrepresentation with respect to two key pieces of information surrounding its scope of work:  (i) the amount of asbestos containing material PAL would be required to remove and (ii) fly ash/coal dust removal prior to PAL commencing work. 

CEC moved to dismiss the claim as conclusory and barred by the parol evidence rule.  While the Court quickly concluded that PAL’s allegations of oral misrepresentation met the pleading threshold under Twombly and Iqbal, it engaged in a more protracted analysis of CEC’s argument that the claim was barred by the parol evidence rule and the integration clause in the contract between CEC and prime contractor NADC.  PAL argued that since it was not a party to the contract, the integration clause and the parol evidence rule did not apply to it.  The Court ultimately agreed, finding that an agreement between the parties is a necessary condition of the parol evidence rule.  Watkins & Son Pet Supplies v. Iams Co., 254 F.3d 607 , 612 (6th Cir. 2001); 70 A.L.R. 752 (2011) (“[w]hether the parol evidence rule applies depends upon whether there was an integration or a complete expression of the agreement of the parties.”).  Given that neither PAL nor CEC alleged the existence of an express contract between them, the Court found that the parol evidence rule did not bar CEC’s alleged misrepresentations to PAL.