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Managing Risk Starts with Contract Negotiations

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Construction Business Owner Magazine - July 2015

By: Lane Kelman & Lori Wisniewski Azzara

Understand contract terms to position your team for success

Success on a project is often dependent upon risk management, and managing that risk starts with contract negotiation. Contractors must recognize the implications of the contract provisions and review standard forms with a critical eye. Fully understanding and properly negotiating your contract terms will position you and your project management team for success. Of course, every construction contract needs to be modified to address the nuances of the particular project because every project is different. Understanding the enforceability and import of a contract's clauses is a fundamental step toward the successful completion of a project. The clauses discussed below are only a few examples of contract provisions that deserve specific attention.

Getting Paid: If vs. When

Construction contracts generally contain one of two types of payment provisions: pay-if-paid or pay-when-paid. Pay-if-paid clauses make payment from the owner to the contractor a condition precedent to payment from the contractor to the subcontractor. In other words, the contractor is not obligated to pay the subcontractor unless and until he/she first receives payment from the owner. This type of clause pushes the risk of the owner's nonpayment onto the subcontractor. If you are a subcontractor, negotiate to replace the pay-if-paid language with alternate terms that don't put the risk of nonpayment on you.

A pay-when-paid clause is often a middle ground, but far from ideal if you are a subcontractor. Pursuant to a pay-when-paid provision, the contractor is obligated to pay the subcontractor within a defined period of time after payment is received from the owner, or within a reasonable time, whichever is sooner. When proposing a pay-when-paid provision, all attempts should be made to define "reasonable time" (i.e., 60 days). If the reasonable period of time isn't defined within the contract, the courts will make that determination for you. By including a pay-when-paid provision, a subcontractor can allocate the risk of the owner's nonpayment back to the contractor.

It is important to note that the legality and enforceability of both payment provisions vary from jurisdiction to jurisdiction. Depending on the governing law, the protection of either clause may not actually exist. You should also consider, where payment bonds exist, whether the surety can rely on the contract's payment provision.

Know Your Notice Provisions

Understanding the requirements contained in a contract's notice provisions is critical to protecting your rights during construction, particularly if you need to submit a delay or impact claim. Notice provisions, if properly drafted, can protect the interests of both parties to the contract and provide guidelines to initiate a claim or request a change. While notice provisions can vary from contract to contract, the underlying principle is generally the same: a contracting party should notify the other parties when a potential cost or time impact occurs.

Notice provisions generally require an explanation of the delay event and its cost and time impact, along with supporting documentation. Unfortunately, notice provisions can often be difficult. Contractors should avoid provisions requiring notice within an unreasonably short period of time. For example, a provision requiring notice of a delay event within two days of the occurrence should be modified to five or 10 business days, if possible. Contractors should also avoid notice provisions that require a cost and schedule impact analysis accompanying the notice because it is costly and may not be possible to calculate the consequences until the work is completed.

Subcontractors should be aware of the contractor's notice provisions contained in the contract with the owner. Often times, the subcontractor is required to give notice within enough time to allow the contractor to comply with its own notice obligations to the owner. Depending on the law that controls the contract and the surrounding circumstances, failing to strictly comply with the notice requirements can potentially bar a claim for additional costs. Therefore, understanding the requirements, providing timely notice and taking steps to preserve your potential claim outside of formal notice requirements is critical to preserving your claim.

Protect Your Right to Get Paid

Changes—whether by design or not—happen on every project. Regardless of whether the change is elective, for missed scope, or due to a design error or incomplete construction documents, understanding and complying with the change clauses in the contract is important. Notice of a potential change and the risk of proceeding with extra work without a change order should be defined in the contract. Increasingly, contracts require a contractor to price not only the change, but also its full cost and time impacts of the changed work on the project's schedule. This can be difficult, as some impacts may not be known until completion of the work. Contractors should negotiate this requirement out of the contract whenever possible or take steps during the project to preserve their claims for unknown costs. Otherwise, the contractor risks waiving any claims for impacts caused by the change, discovered after the changes were made. Additionally, the contract should address allowable markup and disputes regarding either the scope or value of the work. Above all, a contractor's project team must be familiar with the change provisions contained in the contract so that the team can preserve the ability to recover costs for additional and/or changed work during the project.

No Damage for Delay?

Too often, contractors allow limitations to be placed on the types of damages they can recover in the event that their work is delayed or impacted. Contracts typically only allow for a time extension if a "force majeure" delay occurs (i.e., an event that is beyond the control of either contracting party, such as a natural disaster, union strike, war, etc.). These delays, as well as delays caused by the owner or other contractors, are often noncompensable and are included under a "no damage for delay" provision in the contract. Under a "no damage for delay" provision, the contractor's sole remedy for delay is an extension of time. It is important to note that the law varies from state to state as to the enforceability of "no damage for delay" provisions. Contractors should understand the viability of the clause when negotiating a contract.

"No damage for delay" clauses should be stricken when possible and instead include language that allows for an equitable adjustment to the contract for a delay event.

Regardless, preserving claims for delay or inefficiency are crucial. This requires providing notice and making sure that the project team does not formally waive any delay claims by unknowingly executing waivers.

This article was originally published in the July 2015 issue of Construction Business Owner Magazine.