Have you reviewed your contract lately to make sure it is up to date and covers the key terms and conditions necessary to protect your company as much as possible? In the effort to sign up a new prospect and document a new project, contractors often pull out their usual form agreement that may well be outdated and passe. Sometimes, they will simply copy the one from the last job that may have negotiated away certain protections or assumed too much risk.<\/p>\n\n\n\n
It\u2019s helpful to recap what the whole point of entering into a contract achieves. The primary purpose of a contract is to create legal consequences. Contracts define the rights and obligations, enforceable by law, of each party. A well-drafted contract establishes clear terms and conditions, protects the parties\u2019 rights and objectives, clarifies their roles and responsibilities, manages their risks, and addresses the fair resolution of any potential disputes. Key terms in construction contracts beyond the more straight-forward ones such as scope of work, schedule and milestones, payment terms, and change orders, are the ones that allocate risk between the parties. The construction contract should always be drafted to manage the typical risks encountered in any construction project. Here are some major ones.<\/p>\n\n\n\n
Consequential damages are probably one of the biggest risks for contractors on a construction project and their potential waiver may be the single most critical provision in the construction contract for a contractor to consider. These types of damages can result in liability that far exceeds the original contract price. <\/p>\n\n\n\n
Direct damages are immediate, such as the cost of repair, the cost to fix defective work. Consequential damages in construction projects are damages (usually economic losses) that do not flow directly from a breach of the contract but are the result of the consequences<\/em> of the breach. They represent the indirect financial losses stemming from a breach, the losses that occur as a ripple effect of the direct damages. Typical examples of consequential damages include the owner\u2019s lost business profits, loss of use of the completed facility, increased financing costs, lost rental income, loss of productivity, increased overhead, additional construction and materials costs (to remediate errors, correct defects), property damage from construction errors, and damage to the owner\u2019s reputation. They are usually related to delays in performance or completion of the project.<\/p>\n\n\n\n A very well-known case actually became a catalyst for the American Institute of Architects (AIA) to change its standardized contracts to include a mutual waiver of consequential damages. Arbitrators had awarded a hotel and casino owner in Atlantic City over $14,500,000 in damages for lost profits as a result of the contractor\u2019s delayed completion of the project even though the contractor\u2019s fee for the work was only $600,000.<\/p>\n\n\n\n The consequential damages provision is usually heavily negotiated, and contractors must evaluate the risk on each project and check the language in the agreements they are signing very carefully, even on standard forms. The AIA now proposes a mutual waiver of consequential damages. In the AIA templates, the owner and the contractor each waive claims against each other for consequential damages arising out of the contract. <\/p>\n\n\n\n If a mutual waiver is not acceptable, there are potential carve-outs and limits that can be included. Consequential damages may be limited, for example, \u201cto the extent covered by insurance,\u201d or capped at a specific dollar amount or percentage of the contract price (typically ranging from 5% to 15%), or include only third-party claims for indemnity, or specific types of consequential damages may be excluded. The intent behind setting a cap is to limit the potential liability to the contractor\u2019s fee or profit to prevent the contractor from having to pay out-of-pocket for any such damages. There are also various strategies to limit the potential for such damages, such as clearly defining the scope of the project, ensuring the parties know their roles and responsibilities, developing a realistic schedule and set of milestones, and establishing clear and open channels of communication.<\/p>\n\n\n\n Liquidated damages are another way of limiting risk and typically replace consequential damages. Such damages are daily or weekly financial penalties deducted from the contractor\u2019s payment, agreed by the contractor and the owner in advance of commencement of the contract for construction. They represent a reasonable estimate of what the anticipated losses would be for delays in reaching the completion of a project and provide certainty in a contract rather than ensuring a lawsuit, with the challenges and costs of litigation.<\/p>\n\n\n\n Liquidated damages are not intended to punish the contractor but rather to compensate the owner for a loss. They are generally enforceable, especially in an arms-length negotiated contract, if the amount bears a reasonable relation to the damages the owner would suffer; otherwise they could be considered a penalty. As a result, it is important to document how the damage amount was calculated to reflect a reasonable estimate of likely damages so that the amount will be upheld in the event of a challenge.<\/p>\n\n\n\n A liquidated damages provision may include a grace period, or provide for a sliding scale \u2013 for example, one that increases after a certain period of time. Such a provision is often paired with an incentive or bonus for early completion. A contractor may wish to increase the contract sum to cover the additional risk and will want to include a cap to limit its total liability. In addition, a contractor should consider a waiver to the extent that the owner is responsible for, or contributes to, any delay as well as passing on a liquidated damages provision to its subcontractors.<\/p>\n\n\n\n Without a liquidated damages provision or a waiver of consequential damages, the contractor remains exposed to unlimited risk. Even with the inclusion of a provision for liquidated damages, a waiver is preferable. Liquidated damages usually end at substantial completion, while the risk of consequential damages continues after completion, such as damages from a breach of warranty. It\u2019s important to understand and evaluate the risk on every project, considering the complexity of the project, the plans and specifications, the aggressiveness of the schedule, and the ability to obtain extensions of time.<\/p>\n\n\n\n Disputes between contractors and owners are costly in terms of time, emotional energy, business relationships, and finances. It\u2019s preferable to plan for them upfront by including a provision for either litigation or arbitration, following a period of time attempting to resolve issues through mediation. The goal is to resolve disputes quickly, efficiently, and cost-effectively. After all, compromise usually signals sound business judgment rather than a desire and plan to win at all costs.<\/p>\n\n\n\n Mediation is a nonbinding method employing the assistance of a third-party mediator (preferably with expertise in the construction industry) to help the parties reach a settlement. The mediator\u2019s role is to ensure the parties understand each other\u2019s position and ask difficult questions to help them reach settlement. The mediator does not decide who is right or how much money should be exchanged; the mediator basically acts as a peacemaker and witness. Both parties must begin with a good faith intent to settle, though either party may walk away at any time. It\u2019s a less costly process than either arbitration or litigation and usually represents the first step before a binding dispute resolution procedure.<\/p>\n\n\n\n Litigation is a formal, structured, often lengthy process that resolves disputes through the state or federal court system. It is typically costly in terms of time and money, and time out of work, and is usually a slow and lengthy process. Judges and jurors are not usually knowledgeable about the construction industry or its standards. In addition, litigation is, by its nature, excessively adversarial. The most significant downside besides time and expense is the fact that litigation involves public disclosure of the dispute, with the complaint and discovery documents all available online.<\/p>\n\n\n\n Arbitration is a form of binding dispute resolution, generally private, in which an arbitrator (an impartial third party) makes a binding decision to resolve a dispute. The process is less regimented than the comprehensive procedures governing cases in court and provides flexibility to the parties to customize the applicable rules, timing, and location. The selection of an arbitrator is a key step, and the contractor and the owner may choose their arbitrator, usually selecting one with industry experience. In most cases, arbitrations tend to be less costly than traditional litigation. They are also most always decided on a faster, more streamlined, timeline, as the parties control the schedule, and discovery and expert testimony are limited. An arbitrator\u2019s award may be overturned in court only in exceptional circumstances, such as bias or fraud.<\/p>\n\n\n\n Each of the provisions in a construction contract can result in significant consequences for a contractor, and it\u2019s wise to check with an attorney experienced in drafting these types of contracts to make sure you are not assuming too must risk on any particular project.<\/p>\n","protected":false},"excerpt":{"rendered":" Have you reviewed your contract lately to make sure it is up to date and covers the key terms and conditions necessary to protect your company as much as possible? In the effort to sign up a new prospect and document a…<\/p>\n","protected":false},"author":7,"featured_media":4274,"comment_status":"closed","ping_status":"closed","sticky":false,"template":"","format":"standard","meta":{"_acf_changed":true,"footnotes":""},"categories":[184,178,185],"tags":[180],"class_list":["post-4278","post","type-post","status-publish","format-standard","has-post-thumbnail","hentry","category-construction-contract","category-construction-law","category-dispute-resolution","tag-construction-law"],"acf":[],"_links":{"self":[{"href":"https:\/\/www.apslaw.com\/construction-industry-advisor\/wp-json\/wp\/v2\/posts\/4278","targetHints":{"allow":["GET"]}}],"collection":[{"href":"https:\/\/www.apslaw.com\/construction-industry-advisor\/wp-json\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/www.apslaw.com\/construction-industry-advisor\/wp-json\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/www.apslaw.com\/construction-industry-advisor\/wp-json\/wp\/v2\/users\/7"}],"replies":[{"embeddable":true,"href":"https:\/\/www.apslaw.com\/construction-industry-advisor\/wp-json\/wp\/v2\/comments?post=4278"}],"version-history":[{"count":0,"href":"https:\/\/www.apslaw.com\/construction-industry-advisor\/wp-json\/wp\/v2\/posts\/4278\/revisions"}],"wp:featuredmedia":[{"embeddable":true,"href":"https:\/\/www.apslaw.com\/construction-industry-advisor\/wp-json\/wp\/v2\/media\/4274"}],"wp:attachment":[{"href":"https:\/\/www.apslaw.com\/construction-industry-advisor\/wp-json\/wp\/v2\/media?parent=4278"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/www.apslaw.com\/construction-industry-advisor\/wp-json\/wp\/v2\/categories?post=4278"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/www.apslaw.com\/construction-industry-advisor\/wp-json\/wp\/v2\/tags?post=4278"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}Liquidated Damages<\/strong><\/h3>\n\n\n\n
Dispute Resolution<\/h3>\n\n\n\n