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January 2016 Newsletter Article
Written contracts are useful tools for any business, and construction companies are no exception. In fact, contracts can be both practically useful and strategic in the construction industry. This newsletter will introduce some of the practical benefits of getting contracts for your projects and then discuss some key provisions of construction contracts. Understanding these provisions will help you to manage risk through careful scrutiny of contract terms and knowing when to call on counsel for assistance in negotiating and drafting contract provisions that fairly allocate risk among the parties.
Taking the time to negotiate contracts will yield at least three distinct benefits. The first benefit, which may be obvious but still merits mention, is that well written contracts give both sides of the agreement useful guideposts to help navigate important aspects of the project. Among them, the time and manner of payment, project milestones, and which party bears the risk of various issues that cause increased costs or other unexpected eventualities. Absent clear written agreement before the project begins, both sides will be left scrambling-and often disagreeing-about how to handle problems or even customary matters like payment. In addition to protecting your interests, avoiding misunderstandings that may lead to major disputes with the other party should also be a major goal when drafting and negotiating a contract.
The second benefit of securing written agreements is that they will indicate when you actually do not have a deal. When a true meeting of the minds happens, both parties will tend to agree on the basics of the agreement and put it in writing quite easily. If the other party moves quickly on the fundamental terms and you are able to establish those terms without too much trouble before tackling the more peripheral details, you can rest assured that you and your counterparty are on the same page. However, when that portion of the contracting process fails, it becomes obvious that there is no deal.
The third practical benefit of contracting is that it will give you key insights into the integrity of the other party. It is especially worthwhile to get a sneak peek at whether the counterparty will keep its word. Thankfully, you do not have to visit a fly by night fortuneteller to discover this information. Negotiating a contract will give you the preview you need. Observing how the other party deals with contracts will reveal their general method of handling business affairs. A company that agrees to pay within 30 days after the job ends, but then rejects firm language requiring payment in 30 days or requiring interest if payment is made later than 30 days is probably not committed to paying on time. If you encounter this scenario, then remember that sometimes, the best contract you ever negotiate is one that you never sign!
The benefits extend beyond these three areas. The specific provisions you agree to will impact the bottom line of your business over time. Well drafted contracts are a key factor that determines survival and profitability in the construction industry. Such contracts lay the foundation for a healthy working relationship and a profitable job by defining key terms and issues, including the scope of work to be performed, the price, the terms and conditions of payment, and the allocation of any foreseeable risks.
Although all portions of a contract are important to understand before you sign and accept, the remainder of this newsletter will introduce nine of the most significant aspects of a construction contract. These provisions comprise the core of the agreement.
#1 - Scope of work: the general purpose of the scope of work is to establish the duty owed by the party delivering or performing the work to the party paying to receive the work. This is the very heart of a construction contract. Without a scope of work, a contractor's duty and liability cannot be determined. Similarly, brief or vague scopes of work create doubt and uncertainty as to when a contractor has fulfilled its performance obligations. A well written scope of work is crucial to avoiding disputes.
#2 and #3 - Price and method of payment: the purpose of the price and method of payment terms is to establish when and how the contractor will be paid for work completed. Usually a schedule for specific pieces of work will be included. As those work items progress, the contractor will attest that a percentage of the work has been completed and will become entitled to payment.
#4 and #5 - Project changes and change order requests: the provision allowing project changes and change order requests will typically address the allowed method for submitting, evaluating and approving any changes to the work plans or specifications of the project after the project has begun. In the case of fixed-price contracts, careful structuring of this section is very important to ensure the contractor is empowered with substantial discretion to block unnecessary or non critical changes.
#6 - Delays: the provision addressing delays is designed to determine the impact on the contract and performance in the event of project delays. Often, delays will be divided into two categories and addressed separately. For delays due to reasons within the contractor's control (or assumed to be within that locus of control), the contract might provide an allowance of a certain number of days before any penalties apply. For delays due to causes outside the contractor's control, the contract usually explicitly disclaims any liability or penalty to the contractor, making it clear that the contractor will not owe any damages. A contractor may also demand language imposing penalties and automatic damages for reimbursement of its costs resulting from project delays for reasons outside its control. From the contractor's viewpoint, the contractor's resources are valuable and time wasted on project delays might otherwise have been used to generate revenue from another project.
#7 and #8 - Suspension and termination: the provision addressing suspension or termination of the contract specifies the circumstances by which the contract may be suspended or cancelled for whatever reason, including if the contractor fails to perform as agreed. This section gives the owner enforceable rights to end the contract for failure of the contractor to uphold its end of the bargain. Typically, only substantial or material breaches that go to the heart of the contract will trigger a suspension or termination right.
However, contracts drafted by the owner are likely to contain language that allows the owner to invoke suspension or termination for a multitude of reasons, including seemingly trivial matters tangential to the broader purpose of the contract.
#9 - Disputes: the provision addressing how disputes between the parties are handled should not be overlooked because the parties need to decide how they must proceed in the unfortunate event of a major dispute over the contract. Some construction contracts will contain mandatory arbitration clauses that compel the parties to resolve their dispute before an arbiter rather than a judge in a state or federal court. In Texas, arbitration clauses are generally enforceable, so contractors should carefully consider whether they want to surrender their right to pursue contract claims in court.
Thoroughly negotiated and well-conceived construction contracts will be lengthy and complex. That is a necessary consequence of bringing clarity to material terms and creating a fair allocation of risk. Seeking legal counsel to negotiate the terms of a contract is a great way to ensure that your contract is clear, fair, and does only what you want it to do. Experienced counsel will also often have valuable wisdom about how to strategically structure certain terms in the contract to maximize the value to your business.