Five Key Construction Contract Terms That Every Building Owner Needs to Negotiate

When a building owners hires a contractor to construct a building or other construction project, the contractor is often significantly more experienced when it comes to the ins and outs of the construction contract as well as the overall construction process.  Oftentimes, a building owner may simply accept the contract terms provided by the contractor, without realizing how critical the contract terms can be to the outcome of the project. Doing so can potentially be a very expensive mistake, as contractors may include contract terms that are very one-sided in favor of the contractor, and that can leave the owner in a very bad position if things go wrong during construction.  Savvy building owners know that there are certain provisions in a construction contract that need to be negotiated before the project starts when the owner has the most negotiating leverage.  This blog highlights five of the key construction contract provisions that every building owner needs to pay close attention to when negotiating with the contractor.  Other contract provisions are also important, so having an attorney experienced in construction law evaluate the construction contract on behalf of the building owner is recommended.

1. Construction Contract Scope of Work

The scope of work contract provisions are one of important areas of a construction contract for the building owner to pay close attention to and negotiate because those provisions describe the parameters of what the contractor is contractually obligated to build the owner in exchange for the contract price.  Anything not included in the scope of work may be considered an extra that could require the owner to pay additional money for the work and push out the completion date.  To try to avoid such scope gaps, building owners should insist on language in the contract requiring the contractor to construct the project in accordance with all requirements of the contract, plans, and specifications and reasonably inferable from them as necessary for the contractor to produce the results intended by the contract.  This type of “reasonably inferable” contract language requires the contractor to provide what is reasonably necessary to complete the work, even if something might not be shown specifically on the project plans.

Owners must also carefully review the terms of the scope of work provisions of the contract, as well as any documents attached to the contract or referenced in the scope of work provisions, such as drawings, plans, and specifications, as these are as binding as the contract terms.  Careful attention must be paid to any assumptions or exclusions that the contractor includes, as the owner may assume the contractor is providing certain aspects of work under the contract, but if it is excluded, the contractor is not obligated to provide it without additional payment.

Owners should also insist on a contract provision resolving discrepancies between contract terms, the drawings and specifications, and later modifications to the contract, such as change orders.  Typically, the later modifications should control over the base contract to the extent of conflict, and the owner should try to include language that to the extent of an unresolvable conflict between contract terms, plans, or specifications, the provision providing the most stringent standard or the best quality should control.

2. Payment Terms

The payment provisions of the construction contract are also critical because they govern how and when the owner must pay the contractor, and under what circumstances the owner may withhold payment.  The owner should only be obligated to make progress payments for completed work, and should insist on no more than monthly payment applications from the contractor.  The  payment applications must sufficiently describe the portions of the completed work for which payment is sought, and need to be accompanied by partial waivers of construction lien rights from the contractor and subcontractors through the date of the payment application in exchange for payment.  If the construction is being funded by a construction loan, the payment provisions must align with the funding terms of the building owner’s loan agreement with the lender.

The owner should also have the right to withhold payment for nonconforming work, delays, liens or the threat of liens.  The contract should require the contractor to continue to perform the work pending any such payment dispute, with the owner to continue to pay for undisputed work, and to release the withheld payments only upon contractor’s remedying the reason for withholding.  In addition, the contract should provide that at least 10% of each progress payment should be withheld by the owner as retainage until the work is substantially completed.  This retainage serves as a protection for the owner and as a financial incentive that the contractor will satisfactorily and fully complete the work.

3. Project Schedule

Other than the scope of work and cost, timely completion of the work is probably one of the most important aspects of the construction project for the owner.  Delays can be extremely costly not only in the form of delayed ability to use the construction project for its intended purpose, but also because delays often result in claims for additional costs by the contractor.

To protect the owner, the contract must provide that time is “of the essence” under the contract, and provide for a deadline for the contractor to achieve substantial completion of the work.  Without this, the contractor has no contractual obligation to timely complete the project by any certain date.  The contract should also require the contractor to provide the owner with a critical path schedule for the work showing substantial completion by the contract deadline, and the contractor should on a monthly basis provide the owner with updates as to the progress of the work in accordance with the project schedule.

In addition, the contract should provide that the contractor is obligated to pay the owner liquidated damages in an agreed daily amount for each day that the contractor is late in substantially completing the work, unless the delay is caused by the owner or another unforeseeable cause outside of the contractor’s control.  In the event that there is such a delay outside of the contractor’s control, the owner should try to have the contract provide that the contractor’s sole remedy for such delays is an extension of time, with the contractor not to also recover damages for delays in addition to time extensions.  Such no damages for delay clauses, while generally enforceable in Florida, may not be enforceable in some jurisdictions.  Delay claims by the contractor for events outside the contractor’s control should also be limited to events that delay the critical path on the agreed project schedule, and for delays that are not concurrent with delays caused by the contractor.

4. Change Orders

Changes are a common occurrence on construction projects.  The contract must therefore address in detail how changes will be handled in order to try to minimize disputes during the course of the project.  The owner should insist on the right to add or deduct from the scope of work under the contract through change order.  Even if the owner and contractor cannot agree on the price for the change order, the contract should provide that the contractor shall be obligated to proceed with performance of the changed work, with the pricing to be determined later in accordance with the contract.

The owner should also require that the contract provide that agreement on a change order shall constitute a final settlement of any and all claims by the contractor for additional cost or time extensions arising out of the change in the work.  In addition, the contract should provide that the contractor is only entitled to be paid for changed work if documented in a written change order signed by the owner and contractor, and that no course of dealing or oral communications shall entitle the contractor to a change order.

5. Claims and Dispute Resolution

As claims and disputes can sometimes occur on construction projects, the contract must address the manner for initiating claims, the type of documentation required to substantiate the claim,  and the timing and manner for decision on the claim.  In order to protects its interests, the owner should require that the contractor must provide timely written notice to the owner of any claim for delay or for additional cost within a set time period, usually between 7 and 21 days after the occurrence of the event giving rise to the claim.  The notice provision should also provide that the contractor’s failure to timely provide written notice to the owner constitutes a waiver of the claim by the contractor.  The purpose of such written notice provisions is to allow the owner a fair opportunity to determine whether there may be ways to mitigate the issue or otherwise avoid the added cost or delay, prior to the contractor incurring the additional costs.

On projects with an architect involved in administration of the construction, the owner should consider having the architect designated as an initial decision maker on claims, with such decision being binding unless either party pursues further dispute resolution procedures.  If there is no architect in a project administration role, the owner should reserve for itself the role of initial decision maker.

For disputes that cannot be resolved through this process, or through informal negotiation, the contract needs to address the formal dispute resolution procedures.  If the owner desires that disputes be resolved in arbitration rather than in court, the contract must provide for mandatory arbitration, and will need to address how the arbitration will be administered, typically through the American Arbitration Association or other third party administrator.  If the owner prefers litigation in court over arbitration, the contract should provide that the parties waive the right to a jury trial and should provide for exclusive jurisdiction with a court where the project is located.  In either event, the owner should include a prevailing party attorney’s fee provision so that it may recover its attorney’s fees from the contractor if it prevails in the dispute.  Without such a provision in the contract, the owner will likely not have the right to recover its attorney’s fees, even if it prevails.

Finally, whether arbitration or litigation is chosen for dispute resolution, the contract should also require mediation as a condition precedent to arbitration or litigation.  This requires that the parties engage in a mediation, which is a structured settlement conference with a third party mediator, prior to being able to file a lawsuit or arbitration proceeding.  This ensures that the parties make a significant effort at settlement prior to proceeding with costly and time consuming arbitration or litigation, the avoidance of which is usually in the best interest of the parties and the project.