Construction Contracts - Negotiate for Success
As an engineering or construction contractor, or a materials
supplier to construction projects, are you getting a
fair deal in those contracts you sign with your customers? By Kit Werremeyer
President, Southernstar Consultants,
LLC
Here are some suggestions on how to do this:
Scope of Work
All time and effort put into carefully detailing and defining the scope of work will pay dividends in the form of fewer claims, better planning, and fewer disputes between parties to the contract. Take the time to:
- Define what you are obligated to do.
- Define what the client is obligated to do.
- Define what the client’s engineer and/or project manager is obligated to do.
- Define what all third parties supplying permits, goods and services, or inspecting on behalf of the client are obligated to do.
- Include this detailed scope in the contract documents.
Terms of Payment
You are entitled:
• To receive a downpayment or an early payment.
• To be
paid on time and in accordance with your payment terms.
• To
not having to agree to allow the client to withhold retention from your
payments.
• To be paid in full for all agreed upon changes,
without retention.
Always negotiate favorable terms of
payment. You’re in the construction business, not in the charity
business.
Schedule and Float
If you have any float
(contingency schedule time) in the schedule you agree upon to do the
project, it belongs to you, not the client. If the client wants to
own the float, negotiate some form of compensation for that
privilege.
Indemnification
The reason a client inserts
an indemnity clause in a construction contract is to transfer the
potential financial liability associated with certain of his risks
to you, the contractor.
These are the major risks and
associated financial liabilities the client would typically like to
transfer to you:
- The financial liability arising out of damage to property caused by the client’s negligent behavior.
- The financial liability arising out of injury to a person(s) caused by the client’s negligent behavior.
- The financial liability arising out of death to person(s) caused by the client’s negligent behavior.
- Client’s defense costs associated with defending claims for his above noted negligent behavior.
You do not have to agree to be responsible for the financial liability that may arise on account of the negligent acts or behavior of your client.
An indemnity clause is a contractual land mine in a construction contract. Try to get rid of it. If the client insists on including an indemnity in the contract, defuse it by negotiating limits similar to the following:
- Indemnify only the client and only to the extent of your negligence, not his.
- Limit the scope of the indemnity only to damage to property, injury or death to persons.
- Limit the time the indemnity applies to only the time you are physically located on the construction jobsite.
- Limit the indemnity to only those events occurring during the on-site performance of your work.
Indemnity clauses can be complex and difficult to understand. Always
work with someone who understands indemnities when negotiating
changes to an indemnity clause.
If you have to agree to an indemnity in a construction contract that obligates your company to be responsible for the financial liability caused by the negligence of the client, make sure you negotiate into the contract a separate limitation of liability clause. This limitation of liability clause should limit your financial liability to some maximum dollar amount, or to the proceeds from certain types of insurance you carry.
InsuranceInsurance is another form of contractual risk transfer. Insurance provides you with a
certain level of protection from financial liabilities that may
arise from your construction activities. With insurance you transfer
a fixed amount of financial liability that may arise from certain
defined risks to a third party, the insurance company, for a
premium.
The types and amounts of insurance requested by the
client should make sense for the value of the project. For example,
you are doing a $250,000 construction job, and the client requires
$10,000,000 in General Liability insurance. That’s probably
excessive and it would be appropriate to negotiate a lower amount.
Sometimes a client who is building a large project will provide at his cost a main project liability insurance policy and he will allow all the contractors working on the site to be covered by that policy as additional or added insureds. These are often called "wrap-up" policies. In this case, understand who pays the policy deductibles and understand the provisions and exclusions of the policy. You may find you still want to provide some insurance to fill in any gaps in the client supplied policy.
Today, insurance is necessary and valuable protection for companies in the construction business. It is a key asset for your construction business. It pays to have a good working relationship with a professional insurance agent or broker. He or she can explain and guide you through all the complexities of insurance and assist with your contract negotiations for required insurance coverage.
Additional Insured Status
When you contractually agree to add
the client to your General Liability policy as an additional
insured, the client will have full access to all the benefits (like payment
for legal defense) and financial limits of the policy. In the event
the client has a large claim against your policy and later you have
a claim, there might not be enough money remaining on the policy limits
to pay the full amount of your claim.
If the client has a large claim against your policy, guess what happens next time your policy is up for renewal? Maybe it’s not renewed. Or if it is, the premium for renewal may be significantly larger as your loss experience rating is not as good now. The client’s claim goes against your loss experience because it’s your policy.
Did the client pay you for this nice insurance? No, he did not. You agreed in the contract to give him some free insurance by granting him additional insured status. That’s a really good deal for the client.
Now here’s the best part. It involves the indemnity clause you agreed to accept without changes in the client’s construction contract.
The insurance clause in the client’s construction contract requires you to add the client as an additional insured to your General Liability policy. The clause also specifies that the policy must provide for contractual coverage. What does contractual coverage mean? It means that your insurance company agrees to provide coverage for the financial liabilities that may arise from your contractual obligations. Remember, you agreed to be contractually responsible, under the provisions of the indemnity agreement in the contract, for the financial liability that may arise from your client’s negligent behavior.
Most General Liability insurance policies provide for contractual liability coverage as a component part of the policy. However, it is best to check your policy provisions for this coverage.
Why would a client want your General Liability policy to provide him coverage for your contractual obligations? Here’s why:
- The client wants this coverage in the event your company is not capable of meeting the financial obligations in the indemnity.
- The client wants this coverage for your contractual obligations just in case a court won’t enforce the requirements of the indemnity clause in the contract, but will allow insurance to cover the obligations.
Let’s walk through what could happen:
- The client is added to your General Liability insurance as an additional insured.
- The insurance clause in the contract requires your General Liability insurance policy to provide for coverage of your contractual obligations as well.
- In the contract, you contractually agree in the indemnity clause to assume the client’s financial liability that may arise from his negligence on the jobsite.
- During the course of construction a claim is made against the client for injury to a person that occurred due to some degree of the client’s negligence.
- You reject the client’s request to pay for the potential financial liability under the indemnity clause.
- The client now sues you and your insurance company to provide defense against the claim and to pay the claim. The client can do this since he is an additional insured under your General Liability policy that also provides coverage for your contractual obligations.
- The court orders your insurance company to pay the claim. It rules the insurance company agreed to provide coverage for the risk of the client’s financial liability that you agreed to contractually accept under the provisions of the indemnity agreement.
- The client, and his own insurance company, escapes payment of the financial liability associated with his negligence that caused an injury to a person on the jobsite.
To add insult to injury, your insurance company may raise your future premiums on account of having to pay the client’s claim against your General Liability policy.
As far as the request for additional insured goes, you may want to reject the client’s requirement for additional insured status and negotiate with the client to buy a separate project specific General Liability insurance policy, or project specific Owners and Contractors Protective policy—an OCP—to meet his insurance needs.
Also, talk with your insurance agent about how you can limit the financial exposure that may arise from your contractual obligations. Your agent may be able to provide specific exclusionary and limiting wording in the policy endorsement that adds the client as additional insured for contractual coverage to your General Liability policy.
Damages
If you fail to
perform on a construction contract you may be exposed to liquidated
damages. The value of the liquidated damages is the client’s measure
of how much he is financially damaged by your failure to perform. If
you encounter a liquidated damages clause in a construction
contract, try to eliminate it, or if that’s not possible, try to
minimize or cap the amount of liquidated damages you agree to
accept. The most common exposure to liquidated damages arises out of the
contractors failure to complete the project on time.
Discuss with the client the fact that liquidated damages in a contract will create an adversarial atmosphere on the project as you will now insist that all changes, even the small ones, and especially those changes that effect the schedule, be recognized so that you are not improperly exposed to the liquidated damages.
Always negotiate the exclusion of consequential, indirect, special, and other similar damages, including loss of profit, in a separate contract clause. Consequential damages must be specifically excluded in writing in a contract. It is generally not sufficient to be silent in the contract on consequential damages.
Warranty
Clients expect contractors to build their projects generally free of defects in design, materials, and workmanship. That’s good; that’s what builds a contractor’s reputation of doing a good job.
A one-year warranty of the contractor’s work is normal and expected.
Just be careful if a client wants an extended warranty; it could be used to have you provide free maintenance. Maintenance is the client’s responsibility, not yours.
Make sure your warranty includes for specific exclusions, like corrosion.
An extended warranty doesn’t have to be free. It’s appropriate to negotiate an extra charge for this extended contractual obligation.
Contract Changes
You are entitled to be paid for legitimate changes to your scope of work on a construction project. You are also entitled to changes in your project schedule to accommodate changes in your scope of work. Again, ask yourself if you are a construction company or a charity.
If you are too busy to take care of changes as they occur, or if you reckon you can get fairly treated on changes at the end of the job by the client, then either the changes don’t amount to much or you really are a charity.
Stay on top of your contract changes. Document, document, document! Try to keep the changes on the table in front of the client until he settles fairly with you. In today's modern world of computers, and project management software, it's not too difficult to require your project manager or project superintendent to file a daily log of jobsite activities.
Make sure you negotiate a good change clause in the contract. The clause should require both parties to settle changes as they occur, require proper documentation, and most importantly, require the client to approve the cost and schedule consequences in writing prior to performing the work involved with the changes.
Disputes
Disputes are going to arise from time to time, and
it’s important to have a procedure in the construction contract to
resolve them.
A clear dispute resolution clause should be negotiated into all construction contracts. The clause should require both parties to first try to resolve the dispute by negotiations with each other. If that doesn’t work, then the clause should require the parties to have a senior executive from each party try to resolve the dispute. If that doesn't work, then the clause should require the parties to go to mediation.
Arbitration and litigation are other resolution choices—very poor choices—but using these means both parties have failed in their other efforts to resolve the dispute.
Finally….
Negotiating a fair construction contract with a
client can be time consuming and frustrating to both parties. If you
have a good offer that is being considered by the client, odds are
he will be willing to negotiate changes to his proposed construction
contract. Those changes will make the contract fair to your
company yet still remain a good deal for your client.
Copyright © Kit Werremeyer March 2002. Revised November, 2002; March, 2005. January 2014.
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