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.
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.