Laurie A. Stanziale | Construction Executive
Mitigation of risk and costs in a construction project are always priorities for owners. In some contracts, in particular, Guaranteed Maximum Price contracts, some of those monetary risks are shifted to the contractor. Contingency is important because it allows for money to be in the budget for the unexpected and to keep the project moving, which benefits everyone.
Contingency is an amount of money built into the contractor’s price to complete the project to address unforeseen (although sometimes very common) costs that arise. This sum of money is generally referred to as the contractor’s contingency. The amount of the contingency is a balance struck between having money on hand to address the unexpected while also not unnecessarily tying up money that could otherwise be used for the project. Contingency is typically 5-10% of the hard costs. However, how the money is actually allocated during the project is not always well thought out, which can be the source of problems during the project.
The contractor’s contingency is not to be confused with an owner’s contingency (or reserve) which is outside of the contractor’s budget and generally used for owner driven changes to the project, such as changes to scope, design and schedule.
WHO OWNS (FUNDS) THE CONTINGENCY?
In a fixed-fee contract, the risk represented by the contractor contingency is the contractor’s. The owner typically is not involved in setting or accounting for contractor contingency in a fixed-fee contract. Unless the contingency is disclosed in the schedule of values, the owner may not even know that a contingency exists. Any money left unused in the fixed-fee contract contingency simply becomes profit for the contractor at the end of the project. In this scenario, the contractor controls the contingency and essentially owns and funds it from the contractor’s profit built into the contract price. This scenario, however, could lead to contractors cutting corners when problems arise in order to save money, which presents risks to the owner.
Contractor contingency in cost-plus-fee contracts, with or without a GMP, are where many disputes arise. Contractor contingency is a disclosed budget line item. In such a scenario, the owner funds the contractor contingency, from which costs arising from the enumerated risks are drawn until the contractor contingency fund is exhausted, at which point costs that exceed the GMP that do not constitute a change order, are the contractor’s responsibility. Even in a contract without a GMP, the contractor may be responsible for costs that exceed the contingency.
WHAT COSTS CAN BE PAID FROM THE CONTINGENCY?
Failure to clearly set forth in the contract the permitted uses of the contingency can lead to disputes, which can lead to delays. Some common contingency uses in contracts include the following:
- abnormal weather caused delays;
- cost overruns where the actual cost of an item exceeds the amount allocated to such item in the GMP;
- incomplete designs or design errors;
- minor changes in the work;
- concealed conditions;
- regulatory change;
- unanticipated price of materials or interest rate increases;
- overtime and premium time or multiple shift or weekend time not due to unexcused delays of contractor or its subcontractors;
- scope gaps between trade subcontractors;
- costs of completing the work of a bankrupt or insolvent subcontractor or supplier in excess of the subcontract price where such subcontractor or supplier has not provided surety bonds;
- costs incurred due to force majeure delays to the extent that such costs are not reimbursed by Change Order;
warranty costs prior to final completion;
- costs to address safety items;
- cost overruns of general conditions;
- contractor coordination issues and errors; and
- costs incurred to repair defective, damaged or non-conforming work executed by the contractor or any of its subcontractors which are not otherwise reimbursable.
There are certain of the foregoing which can lead to debate during contract negotiations. For instance, design errors could be argued by the contractor to be an owner cost to come from owner’s reserve. Whereas, defective work of the subcontractors could be argued by the owner to be squarely the responsibility of the contractor and not a use for contingency.
Further, items on the list are sometimes qualified by whether they arise due to the negligence of the contractor or its subcontractors and sometimes the frequency of the cost or amount is qualified. For example, if the same trade commits safety violations repeatedly, which result in regulatory violations causing additional safety procedures and fines, the owner could provide a “free pass” on the first or second occurrence (i.e. contingency can be used) but thereafter it is a not reimbursable and comes out of the contractor’s pocket or they have to figure out a way to charge it back to the subcontractor.
Contractors may argue that no project or contractor is perfect and there will be errors that should be paid from contingency while owners may argue their money should not pay for the contractor’s or its subcontractor’s negligence. The list of uses, any qualifications to such uses and, at times, express provisions of items for which contingency cannot be used can be contentious, but flushing them out in the contract, as best as possible, will benefit all.
WHAT NOTICE AND APPROVAL ARE NECESSARY?
The contract should also be clear as to how a contingency request is made, the owner’s timing for review, approval or rejection and the method for dispute resolution. It is not uncommon that the architect acts as the initial decision maker of a dispute (as is standard in an AIA document) but whomever the arbiter of disputes, it should be clear what the process is for submitting a dispute and whether that decision will be binding. Like all disputes, it is always preferable to keep the project moving, so some potential options (similar to disputes over change orders) are that:
- the contractor continues to work, provided the owner pay the undisputed sums;
- the owner escrows the disputed amount so the contractor has comfort that the money will be available should they be found to be correct about the use of the contingency; or
- the owner pays the full contingency request to the contractor and if the funds are found not to be due, the amounts can be withheld from a future payment.
Even with the delineation of the uses in the contract, in most instances, use of the contingency still requires the owner’s approval, which is often qualified by not being unreasonably withheld. In some instances, a certain amount that the contractor can use before requesting approval is set in the contract, requiring the contractor only to advise owner of the use, but not seek approval.
WHAT HAPPENS IF ALL OF THE CONTINGENCY IS NOT USED?
Any unspent contractor contingency funds at the end of the project either:
- revert to the owner;
- there is a sharing of savings between the owner and the contractor; or
- as an incentive to the contractor, all savings go to the contractor.
Whether there are savings is dependent on the proper uses along the way but also whether the contractor can move savings from one line item to another during the project or if those savings go into the contingency, where the owner may get the money back. Owners at times attempt to restrict the contractor’s ability to move money among the line items in the schedule of values, but ordinarily the contractor can use those cost underruns to fund cost overruns in other line items without the owner’s prior approval.
At least one court has acknowledged that the GMP equals all line items listed in the schedule of values as a whole, not that each line item is a separate GMP, effectively allowing the contractor to shift savings to an overrun item to maintain the aggregate GMP (and avoid saving pour over into the contingency). In the case of Nason Construction Co. v. Bear Trap Comm., LLC, 2008 WL 4216149, (not reported in A.2d)(Del. Super 2008), the developer was withholding payments due and owing to a contractor, arguing that each line item in a GMP is its own GMP and money could not be shifted. The court disagreed with the owner and held that the GMP is viewed as a whole, which enables a contractor to shifts savings from one line item in the schedule of values to another. This ability to shift savings and avoid pour over into the contingency can help the contractor to stay within the GMP.
Proper drafting of the contingency clause is critical and should not be overlooked. Best practices are to clearly delineate:
- the permitted or prohibited uses of contingency;
- whether owner approval is required and how obtained;
- how to resolve disputes; and
- what becomes of contingency savings.