The Best Laid Plans: Contingency in a Construction Contract Part II

Samantha Schact, Katesha Long and Josh Levy | Construction Executive

This is the second article in a three-part series on construction contingencies. The first article is The Best Laid Plans: Contingency in a Construction Contract.

WHO CONTROLS THE CONTINGENCY?

Construction contingencies can be an excellent tool to help plan for the unexpected on construction projects, but only if the project stakeholders are aligned on how the fund should be used and who controls the use of the contingency funds. Determining who should control the contingency and how the contingency should be used are topics that are the frequent source of disagreements, and even disputes, between owners and contractors. While two primary schools of thought exist—with contractors siding with one approach and owners siding with the other—there really are no right or wrong answers to these questions. However, like many project decisions, there are benefits and drawbacks to each approach. 

Generally speaking, contractors prefer to have broad discretion to use the contingency fund for anything that is considered an allowable cost, without the need to obtain owner approval of the use of the contingency fund. This approach is beneficial, because it enables the contractor to freely move money from the contingency line item to other line items as overages in other line items occur without the delay. If every charge to the contingency fund requires owner approval, the parties can get bogged down with paperwork for minor cost items that likely are not controversial. In today’s world where every project seems to be fast-tracked, the benefit to the owner of closely monitoring a fund that the is designed to make up for potential gaps in the contractor’s budget due to a variety of causes may be outweighed by the benefit of a contractor’s discretionary use of contingency. The relaxed oversight can help to keep the work moving and foster the spirit of cooperation. 

On the other hand, the contingency fund is the owner’s money. Margins in project budgets are often razor thin, and perhaps there is no other fund to draw from once the contingency fund dries up. In that case, the owner may determine that it is critical that it has the ability to exercise strict control over this fund to ensure that it does not become a contractor mistake fund. Even if money (or the lack thereof) is not the most critical concern, for some owners the idea of paying for costs such as subcontractor defaults and estimating mistakes is not consistent with the perceived responsibility of the contractor to bear the risk of these kinds of losses. In this case, the owner may want to approve all charges against the contingency fund before they are made or establish strict guidelines over what kinds of costs the contractor can charge to the fund.

Ultimately, there is no “one size fits all” approach. Determining who should control the contingency and what costs can be charged to the fund will be a project-specific determination and will depend on the needs of the project and views of the project participants. A collaborative approach will take into consideration common contingency use issues such as the completeness of the design, the potential for adverse weather, the risk of material shortages or delays and the myriad other challenges projects face every day. It is critical that the parties work through any disagreements over how the contingency fund should be controlled and spent before starting the project and clearly set forth the rights, duties and responsibilities of each party with respect to this fund in the construction contract.

Part III of the series will lay out the primary drafting considerations for contingency clauses in construction contracts. 

Recommendations and Drafting Considerations for Construction Contingency Clauses Part III

Samantha Schacht | Construction Executive

The best contracts provide the parties with a clear allocation of risks and responsibilities, and a process for handling inevitable project challenges. Contract negotiations can enable parties to have the difficult conversations allocating risks before the start of a project. An effective negotiation, in turn, aligns the parties’ expectations and helps avoid costly disputes born out of misunderstandings of the parties’ respective rights and responsibilities on the project.

This final installment of a three-part series on contingencies in construction contracts addresses factors that should be discussed and considered when drafting a contingency clause in a construction contract with the goal of helping to set clear expectations and avoid disputes. Part I The Best Laid Plans: Contingency in a Construction Contract explained what a construction contingency is and Part II The Best Laid Plans: Contingency in a Construction Contract discussed the two primary schools of thought on how a construction contingency fund should be used and managed.

The vast majority of owners or contractors use one of the industry standard construction forms. While these forms are a great starting point, most parties modify provisions in these forms to best suit their specific needs and risk profiles. The contingency clause is no exception. In fact, the construction contingency is one issue that most of the standard form agreements do not address in detail, and, as such, the modification or addition of a contingency clause is one of the more common changes made to these standard forms (particularly on guaranteed maximum price contracts). 

For example, the AIA A133-2019 –Agreement Between Owner and Construction Manager as Constructor where the basis of payment is the Cost of the Work Plus a Fee with a Guaranteed Maximum Price addresses the construction contingency in Section 3.2.4: 

In preparing the Construction Manager’s Guaranteed Maximum Price proposal, the Construction Manager shall include a contingency for the Construction Manager’s exclusive use to cover those costs that are included in the Guaranteed Maximum Price but not otherwise allocated to another line item or included in a Change Order.

The ConsensusDocs equivalent of this form, the ConsensusDocs 500, has no provision that addresses whether or not a contingency will be included or how it will be administered. 

A sufficiently detailed and well drafted contingency clause is critical for avoiding disputes related to the fund’s administration over the course of the project. At a minimum, a contingency clause should address each of the following: 

  • Is there a contingency? If yes, what is the amount of the contingency? 
  • What costs can be charged to the contingency? Will there be specific categories of allowable cost items (ex. material price escalation, scope gaps, and adverse weather), or will the contractor have broad discretion to use the contingency to pay for the cost associated with the project?
  • Who approves the use of contingency funds? Can the contractor freely allocate contingency funds to other line items in the schedule of values (subject to any limitations on allowable cost items) or do all costs require prior authorization by the owner?
  • Whether or not prior owner approval is required, is the contractor required to report on its contingency spending at certain intervals? If yes, what should those reports include?
  • Can the contractor add to the contingency fund by realizing savings elsewhere?
  • What happens to unused contingency at the end of the project? Is it included in any shared savings that the parties agreed to distribute at the end of the project if the project cost is less than the Guaranteed Maximum Price or does it revert back to the owner?

Here is an example of a contractor’s contingency clause that provides flexibility and the need for notice to the owner (as opposed to approval):

Construction Manager shall include a contingency in the Guaranteed Maximum Price for the Construction Manager’s exclusive use to cover those costs that are included in the Guaranteed Maximum Price but not otherwise allocated to another line item or included in a Change Order, provided that Construction Manager shall not use the Construction Manager’s contingency for (i) costs attributable to Construction Manager or its Subcontractors’ negligence or misconduct, or (ii) costs which are covered by insurance required by the Contract Documents, or (iii) costs that are recoverable from Subcontractor(s) using reasonably diligent efforts, short of litigation. The Construction Manager shall provide the Owner with written notification and justification for utilization of the Construction Manager’s contingency on a monthly basis.

Some developers see the contractor’s contingency as a sunk cost and would rather provide for limited owner control than inject a clumsy approval process. Many of these developers believe that the offer to share the savings provides enough incentive to avoid contractor abuse. The goal of this series will be fulfilled if the parties simply discuss these issues so their contact clearly sets forth their intent and adequately covers the likely project challenges.

Given the varying perspectives on each of these considerations, contingency clauses may need to be modified on a project-by-project basis. Return back to this series for the list of considerations when modifying preferred contingency clauses as a guide through the drafting process and help ensure that the project is a success.

If one of your cases is in need of a construction expert, estimates, insurance appraisal or umpire services in defect or insurance dispute – please call Advise & Consult, Inc. at 888.684.8305.