The Dotted Line: 5 of the most commonly misinterpreted terms in construction contracts
This feature is a part of "The Dotted Line" series, which takes an in-depth look at the complex legal landscape of the construction industry. To view the entire series, click here.
People are fallible, and misunderstandings are a part of life. Construction work is no exception. However, when it comes to construction contracts, time and money are at stake. A lack of legal background is, of course, one of the primary drivers behind misinterpretations, but there's also the fact that many contractors think they've seen and know everything based on experience.
"Most construction contractors follow custom and standard practice in the industry, or what they've always done in the past," said Chicago attorney Matthew Horn, a long-time construction law attorney and founder of Legal Services Link. "But when something goes wrong … that's when you get into litigation." Horn said that it doesn't even have to be a "newbie" in the construction business who gets it wrong. "It's not unusual for (experienced) parties to a construction contract not to fully understand what it says," he said.
Attorney Ken Perry, with Perry & Aronin in New York, said the degree to which contractors should worry about misinterpreting the terms in a contract often varies depending on how well they know the other party. He said it's always smart to scrutinize a contract no matter the source, but he added that the odds of a positive outcome in the event of a misunderstanding are always higher when doing business with a trusted partner. "Relationships are the most important consideration," he said. "Know who you're dealing with."
Attorney Daryl Williams, with Baird Williams & Greer in Phoenix, said, "There are some people who can work with others on a handshake, and that is the best type of relationship, but a contract with a new party … who will not consent to simple things — or demands extraordinary things — means you are in trouble." Williams said contractors, as well as other parties, enter into contracts for the protection they provide, so contractors need to pay close attention to any "form contract" from the other party. "You can count on the fact that the form produced by the other side is slanted it its favor," he said.
According to these legal experts, these are some of the most commonly misinterpreted clauses, phrases and terminology in construction contracts.
These are sections of the contract that make other documents part of an agreement. Horn said that for subcontractors, these clauses can often incorporate by reference the general contractor's agreement with the owner or a litany of other terms and conditions that don't have anything to do with the scope of the subcontractor's work.
No matter who the parties are, "If your contract has incorporation clause, your contract is not your contract," Horn said. "Your contract is your contract plus whatever else is incorporated into it." That's why it's critical, he said, to obtain all of the incorporated documents and review them before signing any agreement.
Perry said that paying attention to this clause is not just about making sure contractors don't agree to something they doesn't understand. It's also about ensuring that any proposals or extra terms that contractors have given the owner are incorporated as well.
Pay-if-paid vs. Pay-when-paid
These phrases in a contract indicate under what circumstances a contractor will be paid. Pay-when-paid is common industry practice and usually means that subcontractors won't get paid until the owner pays the general contractor. Pay-if-paid, however, puts the certainty of final payment up in the air. If the owner never pays the general contractor, the subcontractors will most likely never see a penny either.
Fortunately, many states have outlawed pay-if-paid contract terms, but, Horn said, neither of these terms are favorable for "downstream" parties like subcontractors. "If you are a downstream contractor, you want them removed from your contracts," he said.
Change orders and extras must be in writing to obtain payment
What could be hard to understand about something having to be in writing? According to Williams, change orders do not have to be in writing, even if the contract requires it, because the parties can alter the contract throughout the change order process. However, in the case of an oral agreement, he said, "You just have a proof problem."
Horn noted that many contracts stipulate that change orders must be in writing in order to guarantee payment, so if a contractor is directed to make changes, "it only takes a few seconds to send a text or email confirming an oral change or extra request in writing, so there is no excuse for not documenting an oral request."
Indemnify vs. defend
Both Perry and Horn said contractors often have a hard time distinguishing between these two terms. When a contract requires that a contractor indemnify either the owner or a general contractor, that means that if one of those parties, because of the contractor's wrongful conduct, has to pay a third-party judgment, the contractor will provide full monetary reimbursement in the amount of that judgment.
However, attempting to defend against the third-party lawsuit means that the contractor agrees to pay all the legal fees incurred by the general contractor or owner. Perry said many contractors don't understand either term, as "they just know it comes into play if there's a lawsuit."
Perry said mechanics' liens are the most misunderstood contract-related term he encounters. "Every contractor has a different understanding," he said. Some believe that filing a lien automatically means they'll get paid the full amount of what they're owed, and some misconstrue it as an order to pay.
"People are relying on word-of-mouth and sources who don't know what they're talking about," Perry said. Of course, the lien process varies from state to state and can be incredibly complicated. However, it is usually just the first step on a very long road to payment with no guarantees.
The importance of scrutinizing contracts
So what happens when there is a disagreement over the meaning of a contract term and both sides hold fast to their interpretations? "The fallout is simple," Williams said. "You end up in a lawsuit where the attorney’s fees can eliminate any profit."
To avoid ending up in court over these and other terms, Perry said it's important for contractors to sit down and thoroughly read their contracts. If they run across something that is ambiguous, then they should have an attorney read through it, or at the very least, sit down with the other party and try to hammer out any disagreements.
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