10 Key Points to a Construction Contract

Here at GreatBuildz, a free service that connects homeowners with reliable general contractors, we know the importance of a good construction contract – that’s why we asked two experienced attorneys to share their perspective on the most important aspects of a contract.

The purpose of this article is to identify those elements, terms, and provisions that an owner should look for and/or include in any construction contract entered into with a general contractor and/or a subcontractor.

By the time you have reached the point that you are ready to execute a written contract, it is assumed that you have already gone through the necessary steps to ensure that your contractor is licensed, bonded, competent to perform the work in which you are engaging him and reasonably priced. Once the pre-contract background checks have been completed, it is imperative that the construction contract contain certain critical terms and conditions so that all parties understand their rights, duties and obligations pursuant to the contract.

Please keep in mind that if you fail to specifically set forth a term in your contract and a dispute arises in the future, such ambiguity may ultimately be determined by the Court in the event of a lawsuit. Any and all agreements or understandings reached between the owner and the contractor should be placed in writing. Memories have a tendency to fade and be blurred over time; therefore, oral promises by the contractor to perform certain work that is not specifically written into the contract may provide an escape clause for the contractor in the future.

Often parties will use forms from the American Institute of Architects (AIA). These are well-established forms which have various options depending on the type, size, etc. of the job. Generally, you need the form agreement, a general conditions package, plus some modifications to make it applicable to your situation.

The following terms, conditions, and provisions should generally be included within the contract:

Type of Contract

There are several types of contracts and depending on what you choose will affect risks and costs.

A “Fixed Cost Contract” is where all described work is to be performed for a specified amount of money.

A “Time and Material” contract is one where the contractor charges a certain rate for all labor, time, material, and surcharges.

Between these two, a fixed cost contract may be more beneficial to an owner due to the fact that the contract amount is specifically known, as opposed to a time and material contract being based upon the speed and efficiency of the contractor.

Other types of contracts include “Cost Plus”, i.e., the actual cost of work plus a fixed percentage. A “Guaranteed Maximum” contract sets a ceiling for the cost of the work with provisions for the contractor to obtain competitive bidding for subcontractors. This may also include a cost savings provision. Regardless of the type of construction contract, it must be reviewed carefully so that the owner understands what they are entering into.

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Scope of Work

The construction contract should specifically set forth the job description of what the contractor has agreed to perform. In addition, the contract should identify the specific materials or named brands of materials to be used if applicable. As an example, a contract with a plumber should include the location (e.g. bathroom) that is to be plumbed, as well as specific brand identification for fixtures.

Further, the contract should specifically state those items that are not included within the contract. As an example, a concrete contractor who has not contracted to place a waterproofing membrane between a topping slab and a structural slab should specifically state that the contract excludes a waterproofing membrane.

Also, contracts should state that the contractor will comply with all plans, specifications and building codes. By specifically setting forth within the contract the scope of the work of the contractor and exclusions, discrepancies in the future as to the duties and obligations of the contractor will be greatly minimized.

Time is of the Essence

Generally, owners have a specific time frame during which they expect the work to be commenced and completed. This is especially true when the work that is to be performed is structural or waterproofing in nature, as opposed to merely cosmetic. As an example, a contract to have a new roof installed on a building will generally require completion prior to the commencement of the rainy season.
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Thus, a specific completion date is necessary. Also, by including a “time is of the essence” clause, the contractor is advised at the commencement of the contract that he will be obligated to provide an ample crew to perform his task timely.

Liquidated Damages

The purpose of a liquidated damages clause is to place an agreed amount of money in the contract that the owner can receive in the event that the contractor fails to timely complete his work.

This provision ties directly into the time are of the essence clause and basically states that if the work of the contractor is not completed by a specified date or within a certain number of days from the date of commencement the contractor will be either obligated to repay a certain sum of monies to the owner or forfeit a certain amount of money for each day beyond the original completion date of the construction contract.

Often a construction contractor will agree to liquidated damage provisions if the owner agrees to an incentive provision for early completion.

Insurance and Performance Bond

The contract should include provisions for both insurance and a performance bond. The contractor should be properly insured, including Workers Compensation Insurance and General Liability Insurance.

It is essential that the contractor’s insurance specifically insures the contractor to work on the project. For example, if the work is on a condominium in a multi-family dwelling/common interest development, there are often times exclusions for such work.

“The contractor should be properly insured, including Workers Compensation Insurance and General Liability Insurance.”

Further, it is generally advisable to have the contractor have the owner and/or Homeowners Association, if applicable, named as an additional insured. By being named as an additional insured, the owner and/or Homeowners Association would have direct contractual rights with respect to the insurance policy in case of damage or injury.

In addition, for approximately two (2%) percent of the contract price, the contractor can also obtain a performance bond which will cover the owner and/or Homeowners Association if the contractor does not perform his work completely. Thus, the performance bond is in essence an insurance policy that allows an owner to have the work completed by another construction contractor if the original contractor fails to perform.

Indemnity

Due to the litigious nature of the society in which we live, it is important to have an indemnity provision within the contract. An indemnity provision generally states that the contractor will hold the owner harmless and agree to defend and indemnify the owner as a result of any acts and/or omissions on the part of the contractor that gives rise to damage or injury to the project or individuals.

This provision is extremely important in circumstances wherein a general contractor performs significant renovation to a project which has the potential to damage other property, homes, or condominiums which could lead to neighboring owners suing the owner for the damage caused by the contractor.

By having a properly drafted indemnity provision, the owner could then tender the defense to the general contractor, who would then be obligated to defend and indemnify the owner against the claim. An indemnity provision can be found unenforceable if it attempts to indemnify a party for gross negligence or willful misconduct.

Payment Schedule

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The contract should set forth when payments are to be made. In California, a contractor cannot require more than ten (10%) percent of the contract amount upfront or one thousand ($1,000.00) dollars whichever is less.

In addition, the payment schedule should be phased in and should never be ahead of the actual work performed. It is not recommended to pay for work that has not yet been performed.

Further, the owner should always attempt to retain a minimum of ten (10%) percent retention until the job is totally completed and accepted by the Owner. To the extent that the Owner can increase the retention it should. The greater the amount of the retention, the better the leverage the Owner will have to have the work performed properly. Always obtain lien releases, both partial and final.

Warranties and Statute of Limitations

Any warranty provided by the contractor should be specifically set forth and identified. One should also determine whether or not the statute of limitations as to a claim based upon breach of warranty is being limited by the contractual terms to less than three (3) years.

Termination Clause

Construction contracts will often include a termination provision.

This needs to be viewed in several parts:
(1) who is the terminating party (owner or contractor), and
(2) is it for cause or without cause.

Generally, an owner should attempt to limit any termination fees to simply the value of the work performed at the date of termination. Again, the methodology of termination and the fees are negotiable.

Mediation/Arbitration and Attorney’s Fees

Parties to a contract may wish to have a provision stating that disputes or claims arising from the contract or the work will first be submitted to Mediation prior to filing a lawsuit or demand for Arbitration.

Mediation is a process involving a third party mediator who attempts to facilitate a resolution. The mediator does not issue a decision and it has no binding effect unless an agreement is reached.

Instead, the mediator attempts to bring both sides to a resolution by discussing the risks of the matter if it proceeds through litigation and ultimately trial. Mediation is used frequently and may be a contracted pre-requisite to filing a lawsuit. The mediator charges hourly typically for such services.

“Mediation is a process involving a third party mediator who attempts to facilitate a resolution.”

By way of binding arbitration, which is conducted without a jury, it is not appealable, except for very limited reasons. Also, the arbitrator has wide latitude in making their decisions.

The contract should also contain an attorney’s fees provision which states that if a dispute arises as a result of the work that is to be performed under the contract, that the prevailing party in any such dispute is entitled to the recovery of reasonable attorney’s fees and costs. This provision provides a heavy hammer that can be used to try to force the non-complying party, whether it be the contractor or the owner, to comply with the contract.

In summary, by including the above-referenced terms, conditions, and provisions, the contract will be clearer and more comprehensive with all parties understanding their rights, duties, and obligations.

Disclaimer: This article is for informational purposes only and does not provide legal advice, nor does it create an attorney-client relationship with you or any other reader. It is recommended that you consult an attorney prior to entering into a construction contract.

David A. Loewenthal and Michael D. Attar are Esquires of Loewenthal, Hillshafer & Carter, LLP, a boutique law firm serving individuals and businesses located in Woodland Hills, California (http://lhclawyers.net).