The Dotted Line: Do lump sum contracts create a simple agreement or potential minefield?

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.

Lump sum — or stipulated sum  construction contracts are one of the most common types of industry contracts and are typically cut and dried. While there may be certain allowances or contingencies built in, these contracts typically are the "vanilla" type in the industry  one price, a lump sum, for a specific scope of work. However, just because it's a simple concept doesn't mean things can't get complicated down the road.

"It's a single price for everything," said John Patrick Curran, partner at Sive, Paget & Riesel. Curran said one of the biggest benefits to contractors using this type of agreement versus, for example, a cost-plus, is that the project is "closed book," meaning that the owner is not entitled to audit the contractor's books, and any cost savings are the contractor's alone.

This contract type is also ideal if the owner wants to simply establish a budget and "not have to worry about it. You're going to get, for the most part, what you pay for at a single price," Curran said.

Issues arising from blind lien waivers

But even though the owner is not entitled to view a contractor's accounting, issues can still arise around payment and lien waivers. Curran said a contractor will often want to provide "blind lien waivers," or statements of payment from material suppliers and subcontractors that don't have the actual dollar amount on them.

"From the contractor's perspective," he said, "it's none of the owner's business how much it's costing him. They have an agreement. Our lump sum agreement says I'm going to build your building for X dollars. So when I give you lien waivers from my subcontractors … it's simply going to be an acknowledgment that they've been paid up to (a certain) point."

This can create an area of dispute, Curran said, because the owner wants to make sure everyone is being paid the proper amounts in comparison to the work being done and what they paid the general contractor.

John Agliano, of Bajo Cuva Cohen Turkel attorneys in Florida, said blind waivers are still common in Florida, but approximately 15 years ago, the state Legislature revised the law so that anyone executing a lien waiver cannot waive their lien rights in advance. This means that if the payment is not honored or the general contractor was able to get a subcontractor to sign one based on a promise of future payment, the lien could be invalid.

Questions of accurate bidding

However, Agliano said the real issues around lump sum contracts are rooted in the accuracy of the bidding process. "You are effectively guaranteeing your price," he said. In addition, any requests for additional money or time via a change order is determined based on the original scope of work in the contract.

A well-defined scope of work, Curran said, protects both the owner and the contractor. "If you go to a contractor with a somewhat amorphous design or design that lacks clarity, then the argument becomes whether something is within or outside of the contract," he said. "That is one of the most common areas of dispute."

However, if contractors do leave something out of their bid, and it's not in the plans, that doesn't necessarily mean they'll be entitled to a change order down the road. This all comes back to being accurate in all phases of the bidding and estimating process, according to Agliano. "The idea of a lump sum contract is that you're quoting the entire scope of work," he said. "One of the terms usually used in the contract is that you're contracting for anything that's 'reasonably inferable' from the plans."

"Reasonably inferable," he said, includes any equipment, tools, and supplies that are necessary to build according to the scope of work to which the contactor has agreed. In an extreme example, if a contractor submits a bid for an office building and there is no electrical plan as part of the bid documents, the fact that the building will need electrical is "reasonably inferable" and would be assumed included in the bid. Work that is not reasonably inferable, Agliano said, includes things like unforeseen site conditions, but only in certain situations.

"If there's no allocation of risk in the contract for what's underneath the soil, and you start building a foundation and you hit a sink hole, something like that would not have been reasonably inferable from the plans," Agliano said. However, he added, if a soil test indicated those conditions, then that would place the burden squarely on the contractor. Further, Agliano said, soil tests could be considered something the contractor should have requested before even submitting his bid, thereby placing the issue of a sinkhole, for example, also in the category of "reasonably inferable."  

"It would be incumbent upon the contractor to ask for any information that could ultimately result in a change of scope, cost or time because what the owner is expecting is that he's going to pay (the contractor) a lump sum for a finished product and that the contractor has assumed all the risk," Agliano said.

Standard commercial contracts, like those created by the American Institute of Architects and the Associated General Contractors of America, normally allocate a variety of contractual risks between the owner and the contractor, Agliano noted. "It's when the risks aren’t allocated that you run into problems," he said.

Lump sum complications among subcontractors

While lump sum contracts are often a popular choice for the general contractor and owner relationship, trade contracts, or subcontracts, will almost always be a lump sum, no matter what type of contract exists between the owner and general contractor, according to Curran. In fact, that's how the general contractor usually gets his bid for the project ready in the first place, he said.

"They get lump sum proposals and contracts for each one of the trade line items," such as plumbing, electrical, and drywall, Curran said.

One contractor who is not a fan of the lump sum contract, though, is Anthony Sierra of JP Sierra, Inc., in Tampa. Sierra said it's common practice now for lump sum contracts to exclude once-standard items like architectural and engineering approvals. Sierra said it's a combination of liability and the owner's attempt at cost cutting so that he can get plans into permitting as quickly as possible. As a matter of routine, he sees contracts that require major trades to get their own shop drawings examined and stamped by a second engineer.

If contractors aren't aware of this when they sign a lump sum contract, Sierra said, it can wind up costing thousands in engineering fees. "So your lump sum contract is no longer a lump sum contract," he said.

As if the additional engineering costs weren't enough, Sierra added that if the second engineer requires additional materials or a more costly approach to the work, "that is actually an extra, but in your contract … you're supposed to cover the engineering for this. But how are you going to know what your engineer's going to do unless you pay for it at bid time? If you do, your bidding costs on a big job could end up being $4,000 to $5,000 more for engineering charges, and you may not even get the job."

In response, he said, subcontractors have started adding engineering fees as an exclusion on their bids. If they don't know to do that, however, they're stuck with the cost.

"Lump sum contracts on simple projects … usually don't develop into a big problem, but when you have these other clauses and all these other disclaimers on them, you can run into some negotiations that can pretty much knock you out of the park," Sierra said.

Are lump sum contracts on the way out?

Curran, Agliano and Sierra agreed that the once-simple lump sum contract can be a minefield for contractors if they do not read it in full and have an attorney review it as well. The days of the lump sum contract being the simplest, most straightforward type of arrangement, Sierra said, are gone. "It's pretty much a fantasy," he said.

"It's never in anybody's interest for either party to sign something they don't realize they're signing," Curran said.

The Dotted Line series is brought to you by AIA Contract Documents®, a recognized leader in design and construction contracts. To learn more about their 200+ contracts, and to access free resources, visit their website here. AIA Contract Documents has no influence over Construction Dive's coverage within the articles, and content does not reflect the views or opinions of The American Institute of Architects, AIA Contract Documents or its employees.

Follow on Twitter

Filed Under: Legal/Regulation
Top image credit: Fotolia