Building Blocks Of Construction Contracts

Megan K. George and Rebecca M. Wichard | Stites & Harrison | February 14, 2019

This article highlights common, but often overlooked, terms routinely found in construction contracts. Understanding how each clause operates is critical to protecting your rights and interests on every project. Because courts generally assume that parties to a contract read, understood, and agreed to its terms and will typically enforce them as written you should consult with an attorney to ensure you understand your contract and that it comports with applicable law.

Sample Incorporation by Reference: “In addition to this Agreement, documents forming this Subcontract include the Contract Documents identified in the prime contract between Contractor and Owner, which are incorporated by reference…”

Subcontracts routinely incorporate the prime contract and include “flow down” provisions, which bind subcontractors to the terms agreed to between the general contractor and owner. Examples of commonly incorporated terms include general conditions, plans, and drawings. By incorporating these terms and including “flow down” provisions in the subcontract, the subcontractor is bound to the prime contract terms as if it was also a party to that agreement, regardless of whether the subcontractor actually read (or received copies of) the prime contract.

Sample Pay-If-Paid Language: “Receipt of payment by Contractor from Owner for Subcontractor’s work is a condition precedent to payment from Contractor to Subcontractor.”

Sample Pay-When-Paid Language: “Payment to the Subcontractor for satisfactory performance of the Work shall be made seven days after receipt by Contractor of payment from Owner for Subcontractor’s work.”

“Pay-if-paid” clauses generally obligate the contractor to pay subcontractors only if the contractor receives the owner’s payment, while “pay-when-paid” clauses are typically interpreted as a timing mechanism, requiring the contractor to pay subcontractors within a specified timeframe after it is paid by the owner. While they seem similar, the difference in how each clause is interpreted is significant. In many states, “pay-if-paid” clauses are enforceable. When enforced, the clause shifts the risk of owner’s nonpayment to the subcontractor and, in the event of owner’s nonpayment, the contractor is not obligated to pay the subcontractor for its work. On the other hand, “pay-when-paid” clauses are interpreted requiring payment to a subcontractor within a reasonable time, and will not completely shield the contractor in the event of the owner’s nonpayment.

Sample No Damages for Delay: “If Contractor is delayed in performing the Work by any cause, regardless of whether the delay is caused by Owner or an event beyond Contractor’s control, Contractor’s sole and exclusive remedy shall be an extension of time.”

These clauses typically limit the contractor’s remedy for delay to an extension of time and prohibit it from seeking monetary damages, even if the delay is caused by the owner. Including a “no damages for delay” clause in an agreement could force the contractor to absorb all costs (including extended general conditions, overhead, etc.) of the delay, regardless of who was actually at fault for the delay. While some jurisdictions prohibit or limit the applicability of these clauses viewing them as violating the contractor’s right to recover damages due to it many jurisdictions permit and enforce them.

Sample Liquidated Damages: “Time is of the essence. Contractor’s failure to complete the Work within the Contract Time will cause Owner to incur substantial damages which are difficult to ascertain. The parties agree liquidated damages represent a fair, reasonable, and appropriate estimate of the losses Owner will incur if completion is delayed…”

These provisions permit an owner to recover against the contractor, or a contractor against lower-tiered contractors, for losses incurred due to delays. Liquidated damages are a predetermined (typically per day) amount, reflecting a reasonable pre-estimate of damages the non-breaching party anticipates it will suffer as a result of delay. Courts tend to review liquidated damages provisions with some scrutiny to avoid the imposition of an impermissible penalty on the breaching party. Notably, while some jurisdictions enforce liquidated damages provisions despite the omission of a “time is of the essence” clause, the vast majority require this language for a non-breaching party to recover liquidated damages for delay.

Sample Waiver of Consequential Damages: “Contractor and Owner hereby waive all claims for consequential damages arising out of this Agreement, including but not limited to: overhead or principal office expenses, lost profits…”

Consequential damages are generally understood as indirect or unanticipated damages suffered by a party as a result of the other party’s breach, and parties often fear that permitting their recovery may open the door to exorbitant (and potentially uninsurable) claims. As a result, many contracts include a mutual waiver of consequential damages, meaning the parties waive the right to recover these additional indirect damages from one another for breaches of the contract. Notably, waivers of consequential damages can preclude recovery of damages stemming from any number of breaches.�

Sample Waiver of Subrogation: “Owner and Contractor waive all rights against each other for damages or other causes of loss, to the extent those losses are covered by property insurance…”

Another common, and often overlooked, provision is the mutual waiver of subrogation, under which the parties waive the rights of their own insurers to seek repayment for losses covered by insurance, but which losses are not due to the fault of the insured. Waivers of subrogation may relate only to specific types of coverage or broadly waive all subrogation rights. Typically, insurance carriers will not object to pre-loss waivers of subrogation, but it is important to confirm with your carrier before agreeing to such terms.�

CONCLUSION

It is important to understand how these provisions operate and how they are enforced in your particular jurisdiction. While this article may help you identify these provisions in future agreements, it is important to check with a locally-licensed attorney to determine the contract terms best suited to your business’s particular needs.

Contractual Waiver of Consequential Damages

David Adelstein | Florida Construction Legal Updates | December 1, 2018

Contractual waivers of consequential damages are important, whether they are mutual or one-sided.  I believe in specificity in that the types of consequential damages that are waived should be detailed in the waiver of consequential damages provision. Standard form construction agreements provide a good template of the types of consequential damages that the parties are agreeing to waive. 

But, what if there is no specificity in the waiver of consequential damages provision? What if the provision just states that the parties mutually agree to waive consequential damages or that one party waives consequential-type damages against the other party?  Let me tell you what would happen.  The plaintiff will argue that the damages it seeks are general damages and are NOT waived by the waiver of consequential damages provision.  The defendant, on the other hand, will argue that the damages are consequential in nature and, therefore, contractually waived.   FOR THIS REASON, PARTIES NEED TO APPRECIATE WHAT DAMAGES ARE BEING WAIVED OR LIMITED, AND POTENTIALLY THOSE DAMAGES NOT BEING WAIVED OR LIMITED, WHEN AGREEING TO A WAIVER OF CONSEQUENTIAL DAMAGES PROVISION!

Interestingly, this issue appeared in the recent case, Keystone Airpark Authority v. Pipeline Contractors, Inc., 43 Fla. L. Weekly D2601d (Fla. 1stDCA 2018).   Here, a plaintiff sued a contractor and engineer for defects to an airplane hangar and taxiways.  The plaintiff claimed the engineer’s negligence through its failure to supervise the work as contractually required which resulted in defective construction.  The plaintiff claimed that the engineer was responsible for the costs to repair the airplane hangar and taxiways.   The engineer argued under a waiver of consequential damages provision that read:

“Passero [engineer] shall have no liability for indirect, special, incidental, punitive, or consequential damages of any kind.”  

The engineer argued that the damages the plaintiff was seeking due to its failure to supervise was excluded under the waiver of consequential damages provision in the contract.  The plaintiff argued that such damages are general damages and not barred.  The trial court, as affirmed by the appellate court, held that the damage was barred because the damage was consequential.  In doing so, the court examined the definitions of the types of damages:

General damages are ‘those damages which naturally and necessarily flow or result from the injuries alleged. . . . General damages  ‘may fairly and reasonably be considered as arising in the usual course of events from the breach of contract itself. Stated differently, [g]eneral damages are commonly defined as those damages which are the direct, natural, logical and necessary consequences of the injury.

In contrast, special damages are not likely to occur in the usual course of events, but may reasonably be supposed to have been in contemplation of the parties at the time they made the contract. They consist of items of loss which are peculiar to the party against whom the breach was committed and would not be expected to occur regularly to others in similar circumstances.  In other words, general damages are awarded only if injury were foreseeable to a reasonable man and . . . special damages are awarded only if actual notice were given to the carrier of the possibility of injury. Damage is foreseeable by the carrier if it is the proximate and usual consequence of the carrier’s action.

[C]onsequential damages do not arise within the scope of the immediate buyer-seller transaction, but rather stem from losses incurred by the non-breaching party in its dealings, often with third parties, which were a proximate result of the breach, and which were reasonably foreseeable by the breaching party at the time of contracting. The consequential nature of loss . . . is not based on the damages being unforeseeable by the parties. What makes a loss consequential is that it stems from relationships with third parties, while still reasonably foreseeable at the time of contracting. 

Keystone Airpark Authority, supra (internal citations and quotations omitted).

Based on these definitions, the court agreed that the repairs to the hangars and taxiways were not special damages as “[i]t cannot be said that repairs stemming from improperly supervised construction work are unlikely to occur in the usual course of business.”  Keystone Airpark Authority, supra.   Such damages did not involve special circumstances for which the plaintiff would be required to give the engineer actual notice. 

BUT… these damages were CONSEQUENTIAL:

[T]he cost of repair here did not constitute general damages, either, because the damages were not the direct or necessary consequence of Passero’s [engineer] alleged failure to properly supervise the construction work.  The contractor could have completed the job correctly without Passero’s supervision.  Thus, the need for repair did not arise within the scope of the immediate transaction between Passero and the Airpark.  Instead, the need for repair stemmed from loss incurred by the Airpark in its dealing with a third party – the contractor.  While these damages ‘were reasonably foreseeable,’ they are consequential and not general or direct damages.

The appellate, however, certified the following question of great public importance:

WHERE A CONTRACT EXPRESSLY REQUIRES A PARTY TO SUPERVISE CONSTRUCTION WORK AND TO DETERMINE THE SUITABILITY OF MATERIALS USED IN THE CONSTRUCTION, BUT THE PARTY FAILS TO PROPERLY SUPERVISE AND INFERIOR MATERIALS ARE USED, ARE THE COSTS TO REPAIR DAMAGE CAUSED BY THE USE OF THE IMPROPER MATERIALS GENERAL, SPECIAL, OR CONSEQUENTIAL DAMAGES?

Thus, there could be a ruling in future from the Florida Supreme Court relating to construction industry, specifically relating to the damages associated with a supervising architect or engineer.

Massachusetts SJC Clarifies “Strict Compliance” Standard in Construction Contracts

Jacob Goodelman | Construction Law Blog | November 27, 2018

In Massachusetts, it is well established that a contractor cannot recover damages from a construction contract without first showing that the contractor completely and strictly performed on all of the contract’s terms. Recently, the Massachusetts Supreme Judicial Court narrowed the rule by concluding that complete and strict performance is only required for contract terms relating to the design and construction itself. The high Court explained that non-design / non-construction contract terms are governing by “ordinary contract principles, including the traditional Massachusetts materiality rule.”1

In the case – G4S Tech. LLC v. Mass. Tech. Park Corp. – G4S Tech. LLC (“G4S”) brought suit against Mass. Tech. Park Corp. (“MTPC”) alleging MTPC owed G4S $4 million of a $45 million contract after G4S completed the build of a fiber optic network in western and north central Massachusetts.2 MTPC maintained that they withheld the $4 million because of substantial delays in the project.3 MTPC in turn brought counterclaims against MTPC alleging fraud and violations of the Massachusetts Consumer Rights Act. Specifically, MTPC maintains that G4S fraudulently and intentionally delayed payments to subcontractors in violation of the construction contract.4 The SJC held that the contract provisions dealing with the “timing of payments to subcontractors and the documentation concerning those payments” is not a contractual term relating to the design or the construction of the fiber optic cable itself.5 Thus, the SJC analyzed the alleged violations under the Massachusetts materiality standard as opposed to the strict and complete performance standard.6 In general, a material contract breach (i.e., a breach concerning an essential and inducing feature of the contract) may discharge the non-breaching party from performing on the contract while a minor or ancillary non-material breach generally does not discharge the non-breaching party (but may warrant monetary damages). Here, the SJC decided that the fraudulent recording of subcontractor payment did constitute a material contract breach.

The SJC’s holding in G4S Tech. LLC v. Mass. Tech. Park Corp. is significant for future construction contracts because it shapes different standards and effects for different categories of contractual terms. That is, to the extent a contractual term relates to the design or construction itself, a contractor is required to strictly and completely comply with such terms. The Court reasoned that strict compliance is required to ensure that the “construction itself is done safely and correctly according to design specifications.”7 However, if a contractor fails to strictly comply with a non-design / non-construction term then a court must analyze whether the non-compliance constitutes a material breach or merely a non-material breach and the effect thereof.

Moving forward, Massachusetts contract drafters, contractors, and owners should pay close attention to terms relating directly to the design or construction of a particular project. Interestingly, the SJC chose not to consider the consequences of contract provisions “that are subsidiary to or supportive of the design and construction, but do not directly involve the design and construction itself.”8 As such, future litigants may attempt to argue that particular provisions are merely “supportive” to a project’s design and construction and thus doesn’t require strict compliance. That being said, best practices for contractors remains the same – strictly and fully comply with all terms.
_______________________________________________________________________

1 G4S Tech. LLC v. Mass. Tech. Park Corp., 479 Mass. 721, 723 (2018).
2 G4S Tech, LLC, 479 Mass at. 721.
3 Id.
4 Id. at 723.
5 Id. at 733.
6 Id. at 734-24.
7 Id. at 731.
8 Id. at 732.

Allocation of Risk in Construction Contracts – 2018 Update

Ellis Baker, Luke Robottom and Anthony P. Laver | White & Case | December 14, 2018

Risk in construction contracts

‘Risk’, in a project delivery context, can be defined as ‘an uncertain event or set of circumstances that, should it occur, will have an effect on the achievement of one or more of the project’s objectives’.1 Risk exists as a consequence of uncertainty, and, in any project, the exposure to risk produced by uncertainty must be managed.

Construction projects are often complex, highly technical and of high value, and can have construction periods that may span a number of years. Common risks prevalent in construction projects include weather, unexpected job conditions, personnel problems, errors in cost estimating and scheduling, delays, financial difficulties, strikes, faulty materials, faulty workmanship, operational problems, inadequate plans and specifications, and natural disasters.3 Projects will also have additional specific risks, dependent on the nature of the project and its surrounding circumstances.

Although the volume and nature of contractual documentation for a construction project will vary as a consequence of the nature of the project, its scale and the procurement methodology adopted,4 a construction contract may be simply described as a contract between a contractor and an employer whereby one person (the contractor) agrees to construct a building or a facility for another person (the employer) for agreed remuneration by an agreed time.5 A construction contract will include a compact of rights and obligations6 between the parties by which the parties pre-allocate responsibilities between themselves in respect of certain risks that may transpire during the contract’s execution. In doing so, the parties define the impact of such risks on the three key elements of the construction: the product or facility that is to be constructed by the contractor, the time at which the product or facility must be completed by the contractor and the amount the employer is obliged to pay the contractor. The collective allocation of such risks in a construction contract represents its ‘risk allocation’.

 

Pursuit of a ‘fair and equitable’ allocation of risk

Typically, in preparing the contract document bid package, the employer will be in a position to decide on its intended risk allocation. While there may be, in such circumstances, a temptation to allocate major risks to the contractor, this must be tempered by an understanding of the adverse consequences of unilaterally assigning risk where doing so may preclude the submission of bids or result in such an increase in cost that the project is no longer financially viable.7 Improper risk allocation may also result in prolongation of construction completion times, wastage of resources and increased likelihood of disputes. As Shapiro states, ‘proper risk identification and equitable distribution of risk is the essential ingredient to increasing the effective, timely and efficient design and construction of projects. If the parties to the construction process can stop thinking in an adversarial manner and work in a cooperative effort towards obtaining an equitable sharing of risks based upon realistic expectations, the incidence of construction disputes will be significantly reduced.’8

While it is possible for parties to negotiate the terms of a construction contract individually, the possibility of unwanted variance and scope for abuse of bargaining power on both sides has led to a number of standard form contracts being developed by various entities, and it is now common in major projects for one of these standard forms to be used as the basis for the final construction contract.9 One of the pervasive features of standard form contracts is an attempt to produce a ‘fair and balanced’ allocation of risk.10 The rationale for pursuing this is that doing so will provide the best chance of successful project delivery. Echoing Shapiro, Lane notes that, ‘[a] contract which balances the risks fairly between a contractor and an employer will generally, in the absence of bad faith, lead to a reasonable price, qualitative performance and the minimisation of disputes.’11

Abrahamson suggests that to achieve a fair and equitable allocation of the risks inherent in construction projects, a risk should be allocated to a party if:

  • the risk is within the party’s control;
  • the party can transfer the risk, for example, through insurance, and it is most economically beneficial to deal with the risk in this fashion;
  • the preponderant economic benefit of controlling the risk lies with the party in question;
  • to place the risk upon the party in question is in the interests of efficiency, including planning, incentive and innovation; and/or
  • the risk eventuates, the loss falls on that party in the first instance and if it is not practicable, or there is no reason under the above principles, to cause expense and uncertainty by attempting to transfer the loss to another.12

Commenting on this, Bunni notes that, while the principle of control of a risk is a powerful method in the determination of risk allocation, it is not comprehensive and other principles must be utilised to address adequately the allocation of risk in a construction contract.13 For example, ‘acts of God’ or ‘force majeure’ cannot be controlled by either party, and, instead, the consequences of such risks must be assessed and managed. Consequently, Bunni proposes that the following four principles are used for allocating risks in construction contracts:

  • Which party can best control the risk and/or its associated consequences?
  • Which party can best foresee the risk?
  • Which party can best bear that risk?
  • Which party ultimately most benefits or suffers when the risk eventuates?

The question of what is a ‘fair’ risk allocation is, ultimately, a subjective one; in deciding how it wishes to procure a project and the way it seeks to allocate risks, an employer will need to weigh up the theoretical efficiency of the risk allocation with political and market dynamics and the needs of the particular project.

A Case Against One-Size-Fits-All Construction Contracts

Chris Bailey, Oliver McEntee, James Castello, Adrian Cole, Mike Stenglein, Simon Dunbar and Jia Lin Hoe | King & Spalding LLP | November 29, 2018

Project development involves careful planning and clear contractual requirements on the front end to help ensure that the project is completed on time and within the budget. Key components of any successful construction project are selecting an experienced and capable contractor and entering into a well written and thought-out construction contract. In this article, we focus on the need to tailor a construction contract to the requirements of the particular contract by reference to the American Institute of Architects (AIA) forms of contract.

The importance of a well-drafted construction contract

From a developer’s perspective, a good construction contract should define the standards of performance expected of the contractor; present the developer with tools to measure performance to determine whether those standards are met; and effective remedies in the event they are not. A construction contract should also provide the developer advance notice of issues with progress of the work and costs. The best construction contracts motivate the contractor to perform in a timely, efficient and costconscious manner by aligning the contractor’s interests with those of the developer to the greatest extent possible. If it makes sense commercially, a developer may offer bonus compensation structures to encourage ontime and under budget performance. The imposition of liquidated damages for delay can also help ensure the project is completed on time and help compensate the developer for costs associated with delay that it might not otherwise be able to recover, such as lost revenue.

If the project goes smoothly and contractors and subcontractors encounter no major problems, a project can likely succeed with or without a good construction contract. It is when problems do arise (as they often do in construction) that a carefully drafted contract becomes important. A developer can do much to ensure its latest project is a success by devoting serious attention to its construction agreements. Without such attention, a developer may find itself, to one extent or another, at the mercy of the contractor.

Prior to engaging a contractor to perform construction work, a developer will often have already engaged an architect to start design work. Often, this “architect” does much more than design the aesthetics and architecture of the project. It also provides other design services ranging from civil and structural engineering to landscape design to permitting support services.

The developer relies on the expertise of the architect for advice in developing, designing and ultimately managing the construction of its project. This reliance often leads the developer to follow its architect’s guidance and advice in selecting a form of construction contract to use with a selected contractor.

The perils of using unamended standard-form contracts

Architects and engineers will often point a developer to a suite of form documents published by the American Institute of Architects (commonly referred to as “AIA” documents), which are advertised as the most widely used construction contracts in the United States. Though these contracts are drafted by architects, they are reputed by the AIA to address commentary from all the major players on a construction contract, including contractors, subcontractors, developers and owners.

While the AIA markets their forms as a balance of the interests of the owner and its contractual counterparties, and can provide a framework on which a good construction contract may be built through modifications, the AIA’s one-size-fits-all approach often does not adequately protect the developer when issues arise on a construction project. Many issues can and do arise from either misusing or overusing AIA forms. We touch on just a few of those issues here.

One of the biggest problems a developer faces in using the AIA forms is selecting the proper form for its project. Often when we discuss the project delivery system with our clients on the front end, we find that the contract provided to them is not well suited to what they envision. The AIA suite of documents provides dozens of construction contracts designed to be used for different project delivery systems. Commonly, whether through the advice of an architect or at the suggestion of a contractor, developers are presented with a draft agreement using an AIA form that does not align with the appropriate project delivery system.

If the “wrong” AIA form is ultimately used, confusion can ensue and the owner can be saddled with additional and unexpected costs. One common example of this is related to the A102 form, a form construction contract in which the contractor is compensated on a reimbursable basis with a cap on such reimbursement referred to as a “Guaranteed Maximum Price” or “GMP.” The idea of a “guaranteed” maximum price is enticing to many, including financiers of projects, and under this project delivery system the developer may maintain all or a significant portion of the cost savings, while the contractor bears the risk of completing the project within the GMP. However, an A102 form is appropriate only if the architectural drawings and specifications have been finalized or are nearly-finalized at the time the construction contract is being developed. If such documents have not been fully developed as of date of execution of the contract (which is often the case), then the GMP will have to be developed at a later date. If this is the case, an A133 form is more appropriate than an A102 form.

Additionally, a fixed price contract may actually best serve the developer’s interests and needs, in which case an A101 is more appropriate. Another common pitfall is using a form designed to be used between an owner and general contractor in a transaction between an owner and a different project participant, such as a project manager. The ensuing confusion is easily avoidable.

Separating the design and construction packages

Another item for the developer to consider prior to selecting a contracting form is whether to separate contractual responsibility for design services from contractual responsibility for construction. There are design-build AIA forms that hold the contractor responsible for both the design and construction, while most other AIA forms separate the design and construction responsibilities on a project. This is a commercial or risk allocation decision on which the developer should make an intelligent and fullyinformed choice. While separating design from construction may be familiar to many developers, this option often leaves the developer in the middle of two disputes (one with its contractor and the other with its architect) if a defect in the work arises later on. By making one contractual counterparty responsible for both design and construction, the owner can often avoid significant additional costs and the distraction of an expensive legal battle. At the same time, it can be significantly more expensive to use a design- build or similar approach and it may be difficult to find a contractor willing to bear such risk. Alternative approaches may also be considered, such that the conceptual design is performed by the architect, but the design-builder assumes full responsibilities for any errors or omissions in the drawings and specifications. The correct choice depends on the circumstances.

Apart from these high-level concerns, developers must be equally aware of the language in its form contracts. Often that language does not fulfill the developer’s vision for the management of the project and creates unwanted scenarios when disputes arise. This is particularly true where a developer uses the AIA form documents without much thought towards tailoring the form language to its interests.

Specific issues arising under the AIA forms

For one example, the unmodified AIA form contracts place the architect in the role of an “Initial Decision Maker.” The practical implication of this is that the developer must turn to the architect in often critical situations prior to making important decisions. One example is if the contractor makes a claim against the developer for additional costs or schedule relief. Under form AIA language, if a contractor submits a claim, the architect must first review and decide upon its validity without “partiality” to the developer or to the contractor. While the developer may expect the architect to be devoted to the developer’s interests, placing the architect in the role of initial decision maker creates the opportunity for a conflict of interests. This is especially problematic if the basis of the dispute is the architect’s own faulty design. If the architect is at fault, it may be inclined to accept the contractor’s claim in order to avoid additional costs under its own architect agreement. This automatic third-party review by the architect also increases the time required to submit disputes to formal dispute resolution procedures and introduces a third party into the claims process with its own time commitments, schedule constraints, and (potentially) its own biases. All of this leads directly to additional costs. Architects are also typically paid on a reimbursable basis without a cap, meaning the developer will incur expenses for these services without a contractual limit.

The contractor’s scheduling obligations

AIA form documents also do not include detailed submission requirements for construction schedules (i.e., critical path method schedules) as construction progresses. Without modification, the AIA form documents merely require a contractor to submit a construction schedule at the beginning of the work (without any specified level of detail required) and do not include requirements to update that initial schedule. Without detailed schedules, if claims arise with respect to a delay, the developer will be left in an inferior position to the contractor to reject such claims because it will not have the information necessary to truly evaluate the merits of the claim. To avoid being left at a serious disadvantage, a developer should ensure its construction contracts include detailed asbuilt and look ahead schedule submission requirements. While most contractors of any level of sophistication keep schedules to track their work, construction schedules can often be influenced and (to varying extents) manipulated later in an attempt to justify a claim. Requiring the contractor to submit detailed schedules at regular intervals preempts such gamesmanship and can provide significant leverage in a schedule-related dispute down the road. In short, detailed schedules reduce the potential of incurring additional costs or delays.

Broad termination rights

Another pitfall is that the AIA forms provide the contractor with broad termination rights, broader than the contractor actually needs. These unnecessary termination rights only provide the contractor additional bargaining power when making and negotiating claims later for additional costs. For example, the AIA contracts permit the contractor to terminate its construction contract if work is stopped for 60 days, regardless of the length of the project or whether the contractor is actually impacted by the stoppage. This could occur if the developer is unable to get a certain land permit in place by a certain period of time (a situation over which the developer has relatively little control). This could leave the developer with two unwelcome choices: either retain a replacement contractor at the last minute, likely at a significant premium over the negotiated contract price, or adjust the contract price through a change order to keep the contractor at bay, knowing the contractor still has a right to terminate. Either choice will lead to unrecoverable and significant additional costs.

Broad rights to change orders

Another key shortcoming of the AIA forms is that they do not include an exhaustive or exclusive list of situations in which the contractor may be entitled to a change order. Instead, the AIA forms leave openended the circumstances in which a contractor can make change order claims, effectively allowing contractors to bring claims for almost any reason. At a minimum, this drives up administrative costs and burdens associated with directing the construction contract.

Other weaknesses of AIA forms include:

AIA forms require the developer to release one hundred percent of any withheld retainage at substantial completion. A better approach is to retain some portion of the withheld retainage until final completion, to motivate the contractor to complete its punchlist work in a timely fashion and to protect the developer in the event such punchlist work is delayed or left incomplete. Releasing retainage at final completion also gives the developer some leverage in ensuring that warranty work is completed diligently. While that leverage lasts only until final completion, it can still be helpful as many defects appear shortly after substantial completion.

AIA forms restrict the developer’s right to withhold payment to the reasonable judgment of the architect. If left unmodified, AIA forms provide that a developer may only withhold payment “to such extent as may be necessary in the [a]rchitect’s opinion to protect the [o]wner from loss for which the [c]ontractor is responsible.” A developer’s right to withhold should be based on its own reasonable judgment. AIA forms also restrict withholding rights to “repeated” failures of the contractor to carry out its work in accordance with the contract, among other situations, but do not include withholding rights for any other breach of the contract. Broad withholding rights are one of the developer’s most effective tools to motivate timely and efficient performance.

AIA forms make the owner, not the developer, responsible for paying deductibles on the builder’s risk insurance policies. This creates an incentive every developer should hope to avoid, where the party in the best position to prevent damage to the work, the contractor, is not financially responsible at all for damage to the work caused by accidents or outside forces. Without an incentive directly affecting the contractor’s bottom line to protect the work, the developer will end up paying out more on its builder’s risk policy than it otherwise would.

Conclusion

This very short list alone should be cause for concern for developers planning to use an AIA form, or any other standard form contract, for their latest construction endeavor. Without careful thought and modification to standard forms, developers can find themselves in a difficult position in a delayed and overbudget project, even if developers signed a contract with a “guaranteed maximum price.” Project development requires detailed attention to all aspects of your latest construction agreement.