Contracts can take a number of forms. The simplest, but least enforceable, contract is the verbal agreement. While verbal agreements can be highly efficient in terms of transaction costs and are frequently used among business managers who have long-standing relationships, the risks for property owners are typically too great to suggest their use to the same degree in construction. Moreover, with the advent of fax machines, there are fewer and fewer occasions when verbal agreements (e.g., to facilitate an emergency purchase) are absolutely necessary to get the work done in a timely manner. “The law has yet to catch up with the routine use of fax machines, making it questionable whether a contract is binding if its documents were sent and received by fax. Most cases have held that fax signatures are binding”. To say that all or nearly all contracts let property owner should be written is not to suggest that these written contracts should take the form of an elaborate document complete with seals and notarization or one that is finalized with a signing ceremony. In cases where the product or service being purchased is fairly standard and where nondelivery will not result in extensive damage to operations or service delivery, contracts can be as simple as a purchase order or a letter of intent or letter of agreement.
Purchase orders are entirely satisfactory if they are used with merchants who are making an offer of goods or services at a certain price. They may be less enforceable when used to purchase services from a consultant who may not be set up as a formal business.
Letters of intent can be used when the property owner is anxious to get to work on a project but has not yet completed the contract negotiations. A letter of intent is written by the property owner. It states the intent to award a contract if the parties can come to agreement on terms, payments, and conditions. It then sets forth a statement of the work that will be done prior to the completion of the contract terms and the payments that will be made for this initial work. Such letters of intent will also tend to formalize the right of the property owner to terminate the letter of intent under certain conditions. With these minimum conditions in place, initial work on a project can proceed with both the property owner and the service provider understanding the limits of the agreement. In essence, a letter of intent is a minicontract that outlines the basis on which a larger contract will be forged. While letters of intent allow a project to get started, they can potentially disadvantage the property owner in the ensuing full contract negotiations. This is particularly the case when the technology or service methods used by the provider are unique to that provider. When this is the case, it becomes much more difficult and costly for the property owner to consider switching to another contractor.
If service providers know this to be the case, they may choose to demand higher payments or other premiums during the contract negotiations. When the particular service technology or method used by the intended contractor is not unique, letter of intent agreements can advantage the property owner, particularly in cases where the property owner is unsure about the quality of work of the selected contractor. In this instance, a letter of intent arrangement can work similarly to an employment probation period. If the quality of the work is not satisfactory during the period when the letter of intent is in force, the property owner may choose to take a more demanding position during the contract negotiations.
Though they may not appear as formal contracts, letters of agreement or letter contracts are complete and enforceable contracts–once the letter has been acknowledged and accepted. The letter is typically initiated by the purchaser and sent to the provider or contractor along with a copy of the letter that has a place for the provider to sign and date a statement of acknowledgment and acceptance. This acceptance copy is then sent back to the property owner. Because the contract is in effect from the time that the acceptance copy is signed and dispatched, one of the responsibilities of the property owner is to follow up on letters of agreement that have been sent out but not returned within a reasonable amount of time. If a letter has been lost in the mail or misplaced in a property owner office, the property owner may nevertheless be constrained by the terms of the contract. With regard to this same issue, property owner should consider including in each letter of agreement that is sent out an expiration date on the offer being made. This provision is particularly important when the service or goods to be provided have a high level of cost or price volatility.
Letters of acceptance are typically used in conjunction with requests for proposals. Each of the proposals the property owner receives is essentially an offer or promise to do work upon notice that the property owner has accepted a particular proposal.
Formal contracts are typically used when the value or complexity of a service or product makes it necessary to build in a higher level of understanding between the property owner and the service provider. What distinguishes formal contracts from letters of agreement is both a higher degree of formality in the design and signing of the document and the presence of a number of legal clauses that tend to place special duties on one or more of the parties to the contract. It is the presence of such clauses that makes it advisable for the property owner to engage the services of an experienced Layton Utah real estate lawyer in the development and review of the contract.
Constructing a Formal Contract
All construction contracts be written and concluded in the form of a contract. One method that has proven successful in this regard is to have prototype or boilerplate contracts that include all the mandatory language, terms, and clauses that an experienced Layton Utah real estate lawyer has advised. Typically, property owners will develop some boilerplate language that will satisfy all conditions
Protective contract language and risk management
While boilerplate contracts can be used successfully in the majority of construction situations, use of protective contract language can also be taken too far. This is particularly the case when predicting and addressing every possible contingency for every possible outsourcing situation than with the efficiency and effectiveness of the outsourcing process. Part of the contract management process is to assess the risk that a contract will be breached and to identify the most cost-effective means of handling this level of risk. The property owner’s use of risk-management mechanisms can differ substantially from the results of an attorney’s desire to create air-tight contracts. This is the case because many of the clauses that an attorney may desire to include in a contract involve both direct and hidden costs. If these costs are not assessed and weighed against the expected benefits, property owners may pay substantially more than would otherwise be necessary to receive the benefits of the contract.
Good contract management requires that the property owners take certain steps.
Determine if the Risk Involved in a Particular Contract Is Substantially above Some Risk Standard
A typical standard might be the risk involved in purchasing a good from a reputable local merchant. Purchasing a good or service from a local merchant who has been in business for years, has numerous local customers, has a good credit record, and who has no outstanding complaints regarding the goods or services provided is generally a low-risk contracting activity. As such, one would probably not require any particular risk-management terms or conditions in the contract over and above the protections provided by standard contracting language and the Uniform Commercial Code.
Determine Whether Particular Risk-Management Clauses Are Appropriate to Particular Contracts
Risks can be grouped into two categories: risks related to inappropriate contract awards or award challenges and risks of the contractor failing to perform as expected.
In assessing a contract, the property owner will also want to review the contract and the contractor’s qualifications to determine the level of risk of a contract breach that the property owner will be taking on in outsourcing with a particular firm. By assessing the contract for specific types of risk, it becomes possible to begin to craft an appropriate set of contract conditions to address the type of risk foreseen.
Contract Provisions for Addressing Risks That the Contractor Will Not Perform as Desired
Warranties extend the time period in which a seller, supplier, or service provider agrees to assume responsibility for what has been provided as part of a contractual exchange. Standard commercial codes will often provide consumers some level of warranty. In many cases, this implied warranty will be sufficient for a property owner, but not always. For example, if the property owner intends to purchase a recycling truck with a loader that has been modified to handle special recycling bins, knowing that the seller must deliver a loader that is fit “for the ordinary purpose for which the goods are used” would not be satisfactory. An additional guarantee that the product or service will perform or provide service in a particular manner or be suited to the intended purpose may be desirable. Such a warranty can be added to the contract, but the contractor may not be willing to have such a clause added without some additional compensation.
Besides extending the implied warranty to intended, rather than ordinary, purposes, warranties can be used to extend the guarantee of serviceability beyond the delivery date, guarantee certain technical specification, or guarantee a replacement or repair in cases where defects are found. Here are some things to look for in warranty clauses:
• Time limits on the warranty.
• The “as is” clause. Be wary of this clause as it can essentially eliminate all warranties–including the implied warranty provided by states that have adopted the Uniform Commercial Code.
• A specification that the defect must be of a certain size or cost before the warranty can be triggered. Used judiciously, these clauses can lower the total cost of contract management. Because the buyer will not constantly be invoking a warranty clause over small defects, the contractor should be able to provide the goods or services for a lower price. This is the case because the contractor will not have to add staff to handle and check on numerous small warranty claims.
• Warranties for only a part of the product or service–such as a warranty of parts but not labor, or the drive train but not the rest of the vehicle.
• Required records. Some warranties will allow the buyer to have the good repaired or the service delivered by another vendor, but will require certain types of records before authorizing warranty payments. More often, record-keeping requirements are left unstated, but will still be necessary to make a claim.
• Repair sites. Some warranties require that the product be repaired only at an authorized site. This requirement can be crucial in cases where the authorized repair site is inconvenient or has a large backlog of work orders.
• Timing of claims. Sometimes warranty clauses require the buyer to notify the contractor within a short period of time after discovery of the defect. If this is the case, property owners need to keep track of this and to make sure that those who are likely to discover a defect will, if a defect is discovered, promptly communicate this fact to the property owner.
Indemnification clauses require the contractor to protect the property owner against losses or damages caused by the contractor. Indemnification can include protection against losses that are caused by the contractor when the contractor is working according to the specifications provided by the buyer. Indemnification basically shifts the burden of accountability to the contractor. The basic consequence of such a shift is that if the property owner is sued as a result of some activity that is covered by an indemnification clause, the vendor or contractor, not the purchaser, will have to pay damages if damages are assessed. Indemnification terms typically will include language related to loss, claims, damages, actions, and liabilities related to the work conducted as part of the contract.
Key phrases to look for in indemnification clauses include:
• Any and all claims –this term obviously tends to expand the scope of the indemnification.
• Bodily injury claims only –this term limits the indemnification claims to personal injury. However, as injury claims are likely to be the most substantial type of claim, the limitation may not be that substantial.
• Sole negligence –indemnification clauses can be triggered by the degree to which negligence is shared by the parties to the contract. For example, if the property owner wanted a very strong indemnification clause–one that would protect it against most claims–it might ask that the contract indemnify or hold harmless the property owner in all cases except for when the property owner was solely negligent. That is, the contractor would essentially take responsibility for damages or losses where there was some shared negligence.
• Expense limits –indemnification clauses will often be limited to a set amount of damages or to the limit of the contractor’s or property owner’s insurance.
• Obligation to defend –sometimes indemnification clauses will place an obligation on the indemnifying party to defend claims made against the party being indemnified.
• Expense deductions clauses –expense deduction clauses allow the indemnified party that has been sued to deduct the expenses for its defense from the payments that would otherwise be due to the other party or contractor.
• Subrogation or waiver of subrogation –subrogation refers to the substitution of one creditor for another. Sometimes indemnification clauses will include a waiver of subrogation which can have the effect of limiting the liability of the party being held harmless by the indemnification. Subrogation typically occurs when an insurance company pays off a claim. That is, in return for paying off the claim the insurance company will (according to the terms of the policy) gain subrogation right or the same rights as the policy holder would have to sue other parties that might have been responsible for the loss.
A good rule of thumb for property owners is consult with an experienced Layton Utah real estate lawyer whenever a complex indemnification clause is proposed by a contractor.
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