The Dotted Line: How to make sure a contract protects your money
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.
There are contractors who say they love the construction business so much that they would not do anything else for a living. But it's impossible to live on a business that doesn’t make money. Sometimes in construction, jobs get mired in delays, cost overruns, unexpected changes, late payments and even nonpayment, leaving contractors to salvage what they can.
However, one place where general contractors and subcontractors alike can help to prevent the bleeding of cash during the course of a project is in their contracts.
There are some obvious money-related provisions that should be in every construction agreement — e.g. contract amount, invoice due date, payment date — but some are more complicated and require a little extra review.
By the way, this is where an attorney comes in handy. Not only is it their job to make sure their clients’ contracts are fair, but the mandatory language of certain provisions and the validity of clauses vary from state to state, so an expert on local construction laws is invaluable.
These contingent or conditional payment clauses should be familiar to anyone who has performed work as a general contractor or a subcontractor.
These provisions allow a GC to withhold payment from subs until the GC receives payment from the owner for the subs’ work. A sub who signs a contract containing one of these clauses makes life down the road potentially harder for his or her company and gives an easy out to the GC if the owner cannot or will not pay.
In some states, these clauses are not enforceable, said Josh Leavitt, principal and chair of the construction law practice at Much Shelist in Chicago, and then other states will only enforce them if crafted to meet the wording of statutory requirements. Most states, he said, also have enacted prompt pay acts for public contracts, private contracts or both, so those laws come into play as well when figuring out if a GC is even entitled to hold back payment because of nonpayment by the owner.
Both GCs and subs, Leavitt said, need to be aware of how the pertinent statutes work together and determine if prompt pay protections can be waived by contract.
Even though these provisions can shift significant financial risk to the sub, many sign without question in order to secure the job.
But is there any negotiating room for subs when it comes to contingent payment clauses? Now that there is increased demand for a short supply of reliable subs that can man projects adequately and perform quality work, Holcomb said subs might have enough leverage to do just that.
“In an up economy,” said attorney Scott Holcomb, member at Dickinson Wright in Phoenix, “subcontractors have the upper hand. Subs could say ‘I don’t need this work’ and walk away.”
Justine Kastan, attorney at Rutan & Tucker in California, said complete elimination of a contingent payment clause is unlikely but added that the GC could be amenable to modifications such as adding a backstop date for payment or giving the sub the right to stop work in the event of late payments.
Kastan noted that in her experience, most GCs are willing to at least discuss reasonable requests in an effort to maintain good relationships with their subs.
Change orders are not simply documents that detail modifications to the work and alter the original contract price. These documents can change schedules and even modify terms of the original contract, so both subs and GCs need to examine them in detail before signing.
And, according to Kastan, GCs and subs want to shoot for the broadest possible change order clause, with the ability to be fully compensated for time, costs and profit for any work added to the original scope. Change order clauses in both owner-GC and GC-sub contracts usually end up being crafted more narrowly than that, but as a contractor, “that’s where you’re trying to go," she said.
Contractors also need to take the digital age into consideration. Holcomb said the Uniform Electronic Transactions Act has contributed to a big shift in the way communications are handled during the course of a project and potentially the way changes to the contract are considered “signed" and complete.
“Your contract can provide that all changes have to be written and signed, but if [the person authorized to sign] sends an email, that can give approval,” Holcomb said. Even a Microsoft Outlook email that has the sender’s name at the top can be equivalent to a wet ink signature when digital communications are part of the contract. So if the superintendent or project manager is authorized to approve changes but common practice within the company is to have upper-level management sign off first, that process can be sidelined if the super or PM have sent emails to the client agreeing to the changes or other alterations to the contract.
Another way contracts can be modified is through conduct, Holcomb said. “People focus on terms [of a contract], but what is more critical is what they do,” he said. Even if the contract states that all changes must be in writing, he said, and the first few changes are performed without written approval, Holcomb said, that is a good argument that the “in writing” requirement can be waived.
So if an owner denies a GC's request to be paid for extra work on the basis that there was no written change order as the contract prescribes, but has routinely approved and paid for changes requested verbally, then the owner could have to pay for the disputed changes anyway. This also applies to the GC-sub relationship.
Damages for delays
The owner can hold up a GC's progress on a job in various ways, just like subs can hold up each other’s work. But what are contractors’ rights when it comes to recovering damages for those delays? After all, when a project is running late, no matter the reason, contractors still have to keep paying for things like equipment rentals, insurance and jobsite trailers (general conditions).
“Owners will always want to put (into the contract) that remedies for delays are limited to an extension of time and no (financial compensation) for damages.” Holcomb said. But, again, in the current market, owners and GCs might be willing to negotiate.
And, according to Leavitt, courts have taken another look at what kind of delay damage claims owners and GCs can deny, leaning toward more reasonable terms.
Subs can minimize the chance of delays, Holcomb said, by making sure the clock on their schedule time begins when they start their scope of work. If not, significant delays due to problems with earlier trades can put them behind schedule before they even step one foot on the job.
It’s not unusual for owners to withhold a percentage from a contractor’s regular payments, a move meant to provide extra insurance that the contractor will stick around to make sure the project is completed satisfactorily. In turn, the GC also holds the same percentage, typically 5% to 10%, from subs’ pay.
Like other contract clauses, the amount of retainage allowed to be withheld and when it has to be paid varies from state to state. But the terms of retainage can be negotiated as well, especially if you’re an “early-in” sub like an excavation or foundation contractor.
On a large project, Holcomb said, retainage for contractors performing work on the first phases could be held for a year or more, since it's typically released after the project is 100% complete. Another issue with retainage is that the GC or a sub might have to pay in full for a very expensive custom item, and withholding a percentage of the reimbursement would impose a significant financial burden on them.
However, federal agencies, he said, and more private project owners are making efforts to reduce the financial pressure by cutting the percentage of retainage held at some point in the project, paying retainage to early-in subs and not withholding it all for some costly materials.
If contractors want to ensure they don't get shortchanged due to these provisions or other items during the course of a project, Holcomb said, it boils down to solid legal counsel and early discussions between the parties so that the details can be hammered out in advance of the project.
But contractors shouldn't expect a clean sweep, with their client agreeing to all their demands. "At some point," Leavitt said, "somebody has to take certain risks."
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