Put it in Writing: Managing Risk with Construction Contracts

When beginning a new project or trying to close a deal, it can be tempting to rely on another party’s contract or use a form contract from a prior project.  It can also be tempting to avoid negotiating terms of a contract in an effort to move the project forward.  Unfortunately, if something goes wrong, most parties will be quick to point fingers, and the clarity of the contracts’ terms will suddenly skyrocket into critical importance. 

It is worthwhile to spend the time, and sometimes the money, to closely review and carefully negotiate the terms of the contract before signing, rather than litigating over those terms once a dispute arises. 

Even if each term is not negotiated to all parties’ satisfaction, a searching review of the contract before signing it can provide clarity on where their respective risks lie.

What follows are some key considerations to help you mitigate risk in construction contracts. While not an exhaustive list, it’s a good place to start when thinking about your next contract.

Use a Written Contract that is Executed by Both Parties

Parties can sometimes rely on oral agreements, letter proposals, or quotes to set forth the terms of an agreement, especially if there is a tight deadline to begin construction or the agreement is with a returning client.  The biggest danger in relying on an oral contract is that if a dispute arises, and the parties disagree over the terms of the agreement, the prospect of litigation escalates dramatically.  In this type of scenario, the outcome will depend entirely on oral testimony.  This creates a significant risk for each party because their claims will rest solely upon the credibility of their witnesses, who may not even be employees by the time trial comes around.  Therefore, regardless of the relationship between the parties, an agreement should always be in writing.

Although written proposals and quotes will serve parties better than an oral agreement, relying on these agreements can still create a substantial risk if the proposal or quote does not address essential terms.  Key terms may include a detailed description of the scope of work, when payment is due, handling of reimbursable expenses, insurance requirements, dates for substantial and final completion, notices for default/opportunities to cure default, changes in the scope of work or price, termination procedures, and the forum and process for dispute resolution.  This list is not exhaustive, but it does illustrate some of the detail necessary to protect a party’s interests and define the parties’ responsibilities for the project—something that’s difficult to accomplish in a one-page proposal or quote.  On a final note, because an agreement is much more easily enforced against a signatory to a contract, all parties should sign the agreement.

Use Detailed Consequential Damage Waivers

Consequential damage waivers have become more prevalent in the construction industry and work to define and limit the parties’ exposure for damages in the event of a breach.  Because there is some debate over the definition of consequential damages, parties should define these damages as much as possible within the contract.  From an owner’s perspective, these costs may include loss of use, business interruption, or lost profits.  For a contractor or subcontractor, consequential damages might include delay-related costs, such as loss of use of equipment, acceleration, or loss of productivity.  A specific definition within a consequential damage waiver may help in avoiding confusion for the parties because they will have an idea of the level of exposure in the event of a breach.

Supply a Framework for Termination

Termination is a drastic step and should be used, if at all, only after exhausting all reasonable attempts to find another solution.  Even though an owner has the common-law right to terminate a contract in the event of a contractor’s material breach, the parties will be well-served by including specific termination procedures—very much including notice and cure protocols, if any—in the contract.  A contract should also distinguish between terminations “for cause” and “for convenience.” Terminations for cause can usually only occur if a party cannot fulfill its contractual duties.  On the other hand, termination for convenience allows for termination in the absence of a breach.  Additionally, a contract can include a provision that converts a wrongful termination for cause into a termination for convenience.  These provisions are generally enforceable and give some latitude in deciding to proceed with termination on a “for cause” basis.

Evaluate the Amount of Liquidated Damages

Liquidated damages provisions frequently appear in construction contracts.  A liquidated damages provision in a contract will quantify the amount of damages a contractor will owe if it breaches a contractual obligation, such as a delay in reaching final completion.  From an owner’s perspective, liquidated damages may provide an incentive for a contractor to complete a project on time.  On the contractor’s side, liquidated damages may serve to limit liability.  Parties should, however, consider whether the liquidated damages are appropriate for the project at hand.  To protect themselves against under-compensation in the event of a delay, project owners should evaluate whether the liquidated damage amount is adequate to cover potential delay losses.  Similarly, contractors should also evaluate the amount of proposed liquidated damages to guard against potential over payment. And if you want it to be enforceable, do not call it a “penalty.”

Summary

A critical part of any construction project is the contract drafting and thorough understanding of the key terms of the contract.  There may be no single “right” clause for every construction contract, but every project deserves its own agreement—and understanding the major issues and resulting responsibilities will help the parties tailor contract clauses and improve clarity.  Thoughtful contract drafting is one of the most powerful vehicles available to allocate responsibilities and risks, so treat them accordingly.

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Nicholl Wade is a construction attorney at Allensworth & Porter where she helps clients across the construction industry solve problems and put disputes to rest.

This article was originally published in the February 2020 edition of Austin Construction News.