Ten Tips for a Successful Construction Contract

TEXAS  LAWYER                                                                       APRIL 21, 1997  VOL. 13, NO.6

Ten Tips for a Successful Construction Contract 


1. Check the Financial Stability of Contracting Parties
The most obvious, yet often disregarded, consideration of a construction contract is the financial stability of both the owner and the contractor. A financial analysis of the owner is absolutely necessary even when the contractor knows that the owner is financially stable or, more importantly, the construction project is one that is being financed by a third patty through a loan.
Since most construction contracts provide for periodic payment and some withholding, the owner wants to ensure that the contractor has the financial capacity to keep the project going. If the contractor does not have the financial wherewithal to fund the project for at least 30 days at a time, the contract cannot be successful unless the owner steps in to manage the finances.
It is the owner’s responsibility to make sure that the project is completed and that all subcontractors and suppliers are paid. Other than a financial analysis of the contractor, which can be done through credit reports, financial statements and other credit investigation, the owner can protect himself in one of two ways: a performance bond or a payment bond. When a contractor defaults under a performance bond, the bonding company steps into the shoes of the contractor and actually performs the balance of the contract if the conditions of the bond are satisfied. Under a payment bond, the bonding company ensures that bills f rom subcontractors and suppliers are paid, but the company does not complete the construction project itself

2. Closely Review Indemnity Agreements
One of the primary functions of a written construction contract is risk allocation. A normal construction contract provides for casualty insurance and an indemnity provision in which the owner and contractor allocate risk of loss for such things as job-site injuries. An owner should draft the provision broadly enough to prevent responsibility for injuries to the contractor’s employees. Because an employee’s recovery is limited against the contractor by workers’ compensation, workers have long sought the deep pockets of the owner under premises liability theory.
Most indemnity provisions now would indemnity the owner from the consequences of the owner’s own negligence so that the contractor would be entirely liable. An indemnity agreement placed on the reverse side of a sales order in the fairly common small and light print does not provide fair notice of indemnity. The indemnity language should be in a fairly conspicuous place to afford fair notice.

3. Obtain Product Notebooks and Review Manufacturers’ Representations with the Contractor
A normal construction project allows the contractor to select the products to be used because the contractor generally has more expertise in this area than the owner. However, by creating an intermediary between the owner and the product’s supplier or manufacturer, the owner can lose remedies in the event of a defective product.
A primary example of this recently came out of the Texas Supreme Court. The manufacturers of a polybutylene plumbing system argued successfully in a DTPA case that their liability did not extend to all entities in the chain of distribution when none of the alleged misrepresentations made by the manufacturers ever reached the consumer. This ruling effectively cut off the home owners direct remedy against the pipe manufacturer because the alleged misrepresentation had been made to the middle-man contractor.
Hence, an owner should insist upon reviewing the contractor’s complete file of all significant or new product brochures to be used, from the cement and bricks to the roofing materials. In addition, owners should get the contractor to repeat all verbal representations made by the manufacturer. This step enables the owner to delegate the selection of products to the contractor, yet the owner is aware of all of the representations made by the manufacturer.

4. Conduct Environmental Surveys
&n bsp;    Environmental liability is one of the most devastating – yet avoidable – liabilities. Insist on a proper investigation of the construction project’s environmental impact. These liabilities can stem either from the construction project itself or from prior use of the property and can arise in both the front and back end of the project. At the front end, there is compliance with federal and state statutes that require permitting pollution programs under the Clean Water Act, Safe Drinking Water Act and hazardous waste under the Resource Conservation and Recovery Act. At the back end is potential liability under the Comprehensive Environmental Response, Compensation and Liability Act, commonly referred to as Superfund.
To limit exposure, an owner should investigate the historical applications of the property going back at least 50 years and should cover such areas as petroleum storage tanks, asbestos and manufacturing usages that may have involved dangerous chemicals. Lenders on most construction projects now require that the owner or prospective borrower conduct a complete environmental audit of the property. Further; most real estate contracts require inspection of the property for environmental liabilities as a condition of the closing.
Underground storage tanks in particular must be researched. The seller should be able to represent and prove that all regulated tanks have been registered under Texas law.

5. “I thought we were insured for that!”
The most common liability policy today is a commercial general liability policy that automatically should include contractual liability, personal-injury liability and broad-form property damage liability, among others. A comprehensive general liability policy does not provide the same coverage. The product/completed operations coverage also should be endorsed on the policy to cover products liability or exposures after the project’s completion.
In addition, the contractor should be listed as an additional insured on the subcontractor’s policy. If for some reason the indemnity provision is held to be unenforceable, the contractor and owner are covered under the subcontractor’s policy anyway.
The general contractor’s standard contractual indemnity provision may impose greater liability requirements on the subcontractor than may be covered by the subcontractor’s insurance. Further, particularly in the personal-injury context, the contractor may hire certain subcontractors whose contracts require that the subcontractor be indemnified. Unless the endorsement has been obtained for contractual liability; there would be no insurance coverage for such an indemnity clause.
Another very important factor is whether or not the subcontractor has opted out of the Texas workers’ compensation program. It can be bad enough to be dragged into an injury lawsuit as the general contractor with the deep pockets, but far worse to discover that the subcontractor does not have the proper insurance and coverage isn’t applicable except for the general contractor’s own policy

6. “But I had the first lien!”
Since most construction contracts involve financing, it is extremely important to determine which lien will have priority, from the owner, the contractor and the financing standpoint. A bank or a mortgage company financing a construction contract will require that it have a first lien position. An owner should have the contractor and all subcontractors subordinate their liens to the construction financing. Contractors, on the other hand, do not want to subordinate their liens because they might have their lien rights cut off by a foreclosure of the financing deed of trust.

7. Provide for Liquidated Damages for Delay, a/k/a “Delay and You Pay”
A provision that can be utilized effectively to keep contractors on schedule is the liq uidated damages provision for delay of the work. This provision applies to work stoppages that are within the control of the contractor, such as the failure to properly coordinate subcontractors. These provisions also can be applied when a guaranteed date of completion is to be made with so many days allowed for rain and other “act-of-God” situations. it is critical that the amount of the penalty, which is usually imposed on a daily basis, be reasonably related to the cost of the delay.
Another underused contract provision is the bonus provision for early completion. An award to the contractor for completing the job early is entirely appropriate if in fact there is a penalty provision for delaying the job. Furthermore, utilizing such a bonus provision gives credence and validity to a penalty-for-delay provision.

8. Do Not Allow the Ground to Swallow You Up
Any contract that requires subsurface work, whether at the beginning or to repair existing infrastructure, can have a gaping hole that literally can swallow up the owner or the contractor. Who bears the risk?
Under the American Institute of Architects form contracts, as well as the Engineers Joint Contract Documents Committee, form documents under the conditions of contract allow a price adjustment for unforeseen subsurface conditions. Unless the owner modifies the contract, the owner bears the risk. One option is to provide in the contract that all bidders may have access to subsurface information and soil reports; however, the owner disclaims responsibility for their accuracy. A provision of this type may place the onus on the contractor to review both the subsurface information and soil reports and to investigate their validity.

9. Limit Exposure to Damages and Attorneys’ Fees
Contracts allocate risk. Two of the largest risks involved in any business transaction arise when the transaction goes sour and parties are exposed to damages and attorneys’ fees. The first method of limiting exposure to both risks is to employ a means of alternative dispute resolution in the contract. Arbitration and mediation are effective means to this end.
The parties also can consider a contractual limitation on damages. Language having the effect that the parties agree that the seller shall not be liable for damages and/or additional damages beyond the amount paid for the product, when properly drafted, may be effective to limit liability to the amount of the purchase price. Such provisions have been upheld and are not considered to be waivers of rights under the warranty or the DTPA.

10. Investigate How the Land Can be Used
This tip would appear to be common sense, but is frequently overlooked. Follow a simple checklist to review the presence of utilities, the status of zoning, requirements for wastewater, the presence of wetlands and any local requirements for signage. There have been numerous occasions when an owner contracted for and built a dock or other infrastructure, only to discover that the Army Corps of Engineers greatly objected to the filling in or destruction of wetlands.
Simple examinations of current-use and prescribed-use zoning is extremely important. From a practical standpoint, it is also a good idea to find out if there is residential zoning use near the property and if there is an active neighborhood association or a historical neighborhood association that could affect development. Checklists for due diligence of land use and environmental purposes are available.


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