There are many different methods for the negotiation and execution of construction contracts. Although many parties approach construction contracting with a “the strong do what they will, the weak do what they must” or “take what you can when you can” attitude, that tactic is not always best in the long run.
Many problems may arise from a party exerting its leverage to get one-sided contract terms. Doing so may impede the ability to enter a contract with a preferred contractor or subcontractor and lead to higher bids from contractors taking on abnormally high risk.
Once the contract is executed, this over-leveraged position may set the stage for a contentious relationship during project execution and lead to disputes after completion. Additionally, making some contractual terms, such as liquidated damages or indemnification, too punitive may conflict with applicable law, rendering those provisions unenforceable. What good does a high per-day liquidated damages assessment achieve if that provision is later held an unenforceable penalty? It is easy to see why being too heavy handed may inadvertently create more problems in the future, but the other end of the spectrum, rolling over and not fighting for necessary contract edits or project-level adjustments, is just as dangerous. There are strategies to assist contractors in successfully entering contracts for and executing construction projects.
Eliminating all tension between parties to a construction contract is not possible. However, reasonable steps can be taken to reduce potential pitfalls and make both contract negotiation and execution more efficient and less contentious. One way is to approach contract negotiation with a focus on allocating risk to the party best able to control the work or activities potentially giving rise to that risk.
For example, it makes sense for a contractor to provide indemnification to the project’s owner for damages caused by the contractor’s subcontractors, because they are under the contractor’s control. It does not make sense for a contractor to provide indemnification for damages arising solely from the owner’s actions, because the contractor has no way to control the owner and, therefore, no way to manage that risk. As a side note, many states prohibit indemnification provisions that require one party to indemnify another party for damages arising solely from the indemnified party’s actions. When negotiating a contract and the other party attempts to place any and all project risk at your company’s feet, it is worth considering whether the risk is worth the potential reward.
Another method for effectively negotiating a construction contract is to look for opportunities to craft provisions that adequately protect both parties. Examples include a mutual consequential damages waiver, a termination for cause provision that provides remedies in the event a termination for cause is held improper, a mutually applicable force majeure provision, and liquidated damages that include a reasonable cap in relation to the overall contract value. Avoid clauses that give one party sole and exclusive discretion to determine an issue affecting both parties. Instead, give the deciding party the ability to act within its own reasonable discretion, which leaves decision-making power with the same party and gives the other party an avenue to challenge the decision if it is unreasonable.
Additionally, it is important to be realistic and flexible during negotiations. Just as an owner or contractor can use its position to force one-sided provisions on a lower-tier contractor, that lower-tier contractor can pick apart a contract and try to edit every provision it views as unfavorable. Even the most reasonable, fair-minded owner or contractor is not going to change every aspect of its contract, especially to meet the other party’s preferences or general practices. Additionally, returning a contract with most provisions redlined may dissuade the owner or contractor from working with the company. When reviewing a contract drafted by the other party, identify potential edits and ask what the purpose of each edit is. Is it to protect the company from undue risk, or is it an internal wording preference? If the former, great; include the suggested edit. If the latter, it is probably best to move on without mentioning it.
Also, consider internally categorizing requested edits as either “must have” or “nice to have.” There should be relatively few “must have” edits because, if the other side refuses to make the change, the requesting party may not be able to enter the contract. Examples of “must have” edits are an overall liability cap on damages arising from the project and a mutual consequential damages waiver. “Nice to have” edits would improve the requesting party’s risk position, but not changing the provision is not the end of the world, either because it does not create too much risk or the requesting party can effectively manage that risk. During negotiations, “nice to have” edits can be used as bargaining chips. The requesting party can use its willingness to give up one proposed edit as leverage to get something else it wants. However, simply horse-trading one provision for another is not always necessary. Try to understand the other party’s position and find a compromise that is mutually agreeable without necessarily giving anything up. Incorporating these strategies and a reasonable risk-allocation mindset during the negotiation phase should make for a smoother process.
But negotiating a contract that both parties will actually enter into is only half the battle. All that careful risk allocation and time-consuming negotiation can be undone if project teams do not understand and adhere to those carefully constructed provisions.
During project execution, one of the most valuable steps any party can take is to assign a contract administrator or project manager who is detail oriented to track and fulfill contractual obligations and manage risk under the contract. This goes well beyond delivering a final product that fulfills the project’s drawings and specifications. This person, as well as other project personnel, must understand and abide by the contract’s requirements in every respect, especially regarding notice, change order claims, payment applications and other typical project obligations. Fulfilling these requirements may be the difference between a contractor recovering substantial extra work costs or bearing those costs itself.
For example, some states strictly enforce compliance with contractual notice provisions and any time limits associated therewith. If a project manager provides actual notice of an extra work claim but does not timely submit the contractually required forms and documentation, the project manager’s company may end up footing the bill.
Finally, although no one enters into a construction contract expecting the project to go wrong and end up in a fight, it is always good to plan for the worst and hope for the best. For that reason, consistent and detailed project-level documentation is vital. As soon as an issue arises, it should be documented in writing. Verbal or handshake agreements between parties should immediately be commemorated in writing and in accordance with any other contractual requirements. All costs for extra or changed work, including man-hours, materials, equipment costs, etc., should be tracked contemporaneously, not estimated after the fact. Daily, weekly, and monthly reports should be prepared and submitted as their names suggest and, importantly, should be organized and saved on a shared project server of some sort rather than locally by a single person. Taking these and other similar steps will not only better prepare the company for a dispute that ends up in litigation or arbitration but also may help avoid that fight altogether. It is a lot harder to reject an extra work claim when a contractor or subcontractor is submitting contemporaneous project documents and communications, as well as thoroughly detailed costs records, as backup.
Although no construction project is perfect, these are steps all parties can take to avoid undue risk, protracted negotiation periods and back-end disputes.
