A construction contract must spell out the various documents that make up the contract documents and incorporates them into the agreement. This is necessary because the agreement alone is not a complete contract and requires the other documents to be binding and inclusive. The contract must name the documents by their generic titles and list separately all of the items that are being incorporated into the agreement- the Conditions (General, Supplementary, and other), the drawings and specifications, any addenda issued prior to the formal agreement, and any other documents necessary to the particular project. The documents and the construction contract together constitute the entire contract and supersedes any other agreements or negotiations that may have occurred.
The owner must be sure that any issues discussed and resolved during negotiations are reduced to writing and included in one of the documents on this list, in order to have any legal effect. The owner also must be careful not to list conflicting or redundant documents.
The Work of the Contract.
The contract must the scope of work to be completed under the contract and any exceptions where necessary. Owners should be thorough and inclusive when defining the scope of work. The descriptions used must incorporate all work covered by the plans and specifications, plus any additional work, conditions, or responsibilities required to complete the job. The owner should state its plans to complete certain aspects of the project itself or with a separate contractor.
Date of Commencement and Substantial Completion.
The Date of Commencement is the start of the construction period but not always the start of construction. Although time is of the essence on most construction projects, the owner should be cautious in defining a specific start date at contract signing. Many things can happen to delay project construction, particularly on rehabilitation projects. Tenants may have to be relocated, authorization permits must be obtained, and financing must be put in place. These factors are not always under the direct control of the owner.
If a contractor is delayed in starting the project after an official start date is established, additional compensation may be required. Therefore, some form of flexibility is necessary to allow the owner to address last-minute changes and issues.
A useful tool for the owner to include in the agreement is a requirement of a Notice to Proceed letter. This document is issued to the contractor, after signing the contract, as notification that the conditions are correct to begin construction. This letter allows the owner to reduce its risk and to increase its flexibility as to timing of the work. The owner locks in the contractor to a stipulated sum as defined in the agreement, and thereby reduces the risk of a price change. In addition, the owner maintains the flexibility of starting the project only when all necessary conditions are met.
Contractors, for obvious reasons, dislike Notice to Proceed letters. These letters are perceived as risky by contractors because they give owners an open-end date to begin construction. Owners who want to utilize the Notice to Proceed mechanism must explicitly state that the start of construction will be determined by a Notice to Proceed letter. This gives the contractor fair warning of this condition.
The contract must also state the date and condition under which a contractor will have achieved “Substantial Completion.” This is a point in the construction process, defined and certified by the architect or construction manager, when the project is essentially suitable for occupancy in whole or in part. In addition to the conditions necessary for occupancy, the contractor must have secured government authority to occupy the property (a Certificate of Occupancy and similar documents) by the date of substantial completion.
If occupancy of the project by a certain date is critical to an owner, provisions should be made for penalties or incentives to induce the contractor to proceed diligently and to compensate the owner for possible damages that may be caused by delay. One form of inducement is the use of a liquidated damages clause. Liquidated damages are intended less as a penalty and more as a means of keeping the owner whole during each day that the contractor delays completion. Liquidated damages amounts, often calculated and reflected in the contract as a predetermined per-diem charge that is assessed against the contractor for every day that the project is delayed, should represent the owner’s estimate of potential damages (e.g., lost rental income, additional interest carry, and so on). Despite the owner’s attempt to base this per-diem charge on reasonable damages estimates, the establishment of a liquidated damages clause may be the most difficult issue that the owner and the contractor will have to negotiate. In addition to a liquidated damages clause, the owner should consider including an incentive clause in the agreement. An incentive clause commonly allows the contractor to share with the owner, in an agreed-on percentage, any cost savings resulting from completing the job ahead of schedule. When the project is completed and the owner is free to occupy all or some portion of the project, the responsibility for warranties, insurance, security, utilities, and damage may be shifted from the contractor to the owner. The manner and timing for this transition of responsibility should be carefully planned by the owner, the attorney, and the insurance representatives.
The Contract Sum.
The contract must stipulate the basic terms of compensation for completing the scope of work. The owner should define the lump-sum amount to be paid and any alternates that may be acceptable. If unit prices are to be used, they should be fully defined in the space provided. In addition, the owner should specify the time period during which all alternate and unit prices will be guaranteed by the contractor.
Progress Payments and Retainage.
The contract also establishes the procedures to be followed in making the periodic payments (often referred to as “progress payments” or “draws”) to the contractor for work completed. This is a prime responsibility of the owner, and careful coordination with the construction lender or lenders is required.
Timing of periodic payments—Contracts commonly call for the contractor to submit an Application for Payment on the 25th of the month. In many cases, the contractor will project its costs through the end of the month and include them in the application. This projection requires the owner, architect, and lender to guess whether the contractor’s estimate is accurate or not. To eliminate the projection problem, owners should consider stating that the payment period is one calendar month, beginning and ending on the 25th of each month.
Reviewing periodic payment requests—The construction lender’s standard procedures for reviewing the Applications for Payment and then issuing checks will affect the schedule of payment or the date when the contractor can expect to get paid after submitting a progress payment request. Lenders will require specific supporting documentation such as “lien waivers” and affidavits, as discussed below, before processing any payment requests. Where applicable, a list of the documentation that will be required from the contractor with each payment request should be provided to the contractor so all parties understand and agree to the procedures and schedule of payment.
A lien waiver is a document that the contractor receives from a subcontractor in order to certify that no liens have been or will be placed on the building or property because of non-payment. Lenders require these waivers to ensure themselves that the payments made to the contractor are being distributed to the subcontractors. Lien laws vary between localities, however, and contractors often submit lien waivers from subcontractors one payment period in arrears. In order for a contractor to submit current lien waivers for each period, the contractor would have to pay the subcontractor out-of-pocket or have the subcontractor forgo the lien rights prior to payment.
Owners must determine the best procedure for dealing with lien waivers based on local laws and the contractor’s financial strength. This issue must be carefully addressed in the agreement, to avoid delays in the project schedule due to litigation.
Determining the amount of periodic payment requests
The contract must also devise a formula for calculating periodic payments. There are essentially three factors in the calculation:
- The original contract sum plus or minus any adjustments due to change orders.
- The total payment earned for all work completed and stored to date minus any retainage.
- The total of all previous payments to the contractor.
The contract lays down the conditions and government approvals that a contractor must achieve in order to receive final payment for the project. For the owner, the Final Payment can be a nightmare! The project has taken a long time to plan, design, and build, and everyone is ready to finish the job. The problem is defining what is a finished job. The contractor has to move equipment and crew to a new job and does not have time to clean the building and property or complete the incidental items required by the owner. The owner has successfully marketed the project and wants to move the tenants in, but the building is dirty and the details haven’t been addressed. The Final Payment is the lever to move the contractor to complete the project to the owner’s satisfaction.
An experienced contractor with a good working relationship with the owner will send in the “punch list” crew to touch up, clean up, and tighten up everything the owner’s needs. Other contractors have drawn down all of their compensation in previous payments and will not be sufficiently induced to stay on the job. The owner cannot wait until the Final Payment to define how and when the job is complete.
The owner should coordinate a final inspection schedule and determine the conditions necessary for final payment with the construction lender. Reliance on a Certificate of Occupancy or other municipal authorizations is problematic in that the authorities’ concern is only for the health, safety, and welfare of the occupants, not the appearance, cleanliness, workability, or warranty of the project.
Subcontractors are specialized members of the development team. They can be hired for the project by the contractor, to supplement the trade experience of the crew; they can be hired by the owner, to work for the contractor; or they can be hired by the owner, to work for the owner directly. Elevator installation, electrical and plumbing work, and kitchen installations are just a few examples of the types of building trades hired under subcontracts. The construction contact can address this issue.
Unless the owner hires the subcontractors, there is no contractual relationship between the contractor’s subcontractors and the owner. This has advantages and disadvantages to the owner. Without a direct contract, the subcontractors must act through the contractor to resolve disputes on the job. As long as the contractor continues to obtain lien waivers from the subcontractors, the owner can be satisfied that no legal action against the property by a subcontractor will interfere with the construction progress.
If, however, a subcontractor’s performance on the job is not to the owner’s standard or satisfaction, it can be difficult to have the subcontractor replaced without the direct contractual relationship. The owner must act through the contractor to address complaints in this situation.
When the owner hires the subcontractor, it is usually done to decrease costs, especially on publicly bid projects, or to impose an element of control over the project. There is a disadvantage to this approach for the owner. Responsibility for the subcontractor’s work becomes blurred. Normally, the contractor is liable for the work of all subcontractors. If the owner hires the subcontractor and the subcontractor does not perform or causes delays, the contractor can claim damages. Attempts to modify the Construction Agreement to shift liability for this subcontractor’s work with disclaimers are common in the industry. The owner should weigh carefully the use of independent subcontractors on the job.
Seek the assistance of an expert
When you are entering into a contract with a contractor to construct a building on your property, speak to an experienced American Fork Utah real estate lawyer. The lawyer can prepare the construction contract for you.
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