Executives are frequently diligent and
detailed negotiators when consummating a real estate purchase contract or long-term lease. But even the most thorough
owners and tenants do not pay enough attention during the next phase, when construction or tenant improvement contracts need
review and approval. Many of these contracts begin as boilerplate documents created by construction-related associations and,
unless they are meticulously reviewed and
modified, owners may forfeit savings opportunities, sustain cost overruns and assume
financial liability for the contractor’s debts.
“Almost invariably, the contract presented
to the owner by the contractor is missing fundamental provisions required by law or good
construction practices to protect the owner
against preventable risks,” says Katherine M.
Knudsen, a construction litigation attorney
with Procopio, Cory, Hargreaves & Savitch
LLP. “If the contract does not provide adequate protection, the owner’s financial liability can quickly grow to hundreds of thousands of dollars due to delays, the contractor’s failure to pay its subcontractors or other
situations. To avoid or limit financial loss or
liability, owners should address and allocate
these risks in the contract.”
Smart Business spoke with Knudsen
about how to avoid the hidden pitfalls in construction agreements.
What is the first step in negotiating a construction agreement?
Before contract negotiations begin, owners
should check with the California Contractors
State License Board to verify the contractor’s
history and to make certain the contractor
has an active license. Also, an owner should
verify that the contractor has adequate insurance coverage, including comprehensive
general liability and workers’ compensation,
preferably from an A-rated carrier, and verify
the contractor’s ability to obtain payment and
performance bonds. Further, the owner
should check references and investigate the
contractor’s qualifications and experience.
Next, have a construction attorney review
the contract to protect the owner’s interests
and to make certain the scope of work, the
compensation and the schedule for performance are all spelled out in detail. It is imperative that the contract include a construction
schedule identifying completion dates for
each phase of the project so the contractor is
held to a timeline.
What else should be included in a contract?
Contractors should be required to provide a
schedule of values or a budget for the project
to help ensure that the contractor stays within the contract price and to guard against
overpayment. Further, the contract should
provide that the owner may withhold 5 to 10
percent from each progress payment until
the work is fully completed and inspected
and the time for subcontractors and suppliers to record mechanics’ liens has expired.
The contract should also have a clause providing the owner the right to receive timely
audits, a full accounting for the project and
documentation of expenses if the contractor
is being paid based on the cost of the work.
Are indemnification clauses and lien waivers
Owners should make certain the contract
contains an indemnification clause stating
that if the contractor fails to pay its subcontractors or suppliers, fails to keep the property free from liens, or causes injury or damage
to persons or property, then the contractor
shall indemnify the owner for all claims, lawsuits, losses, attorneys’ fees and costs. In
addition, the contract should also contain
language requiring the contractor and its sub-contractors and suppliers to execute conditional and unconditional lien waivers and
releases before receiving progress payments
and final payment, making it less likely that
any mechanic’s liens or stop notices will be
filed against the property.
How can construction delays be prevented?
The owner may consider including a ‘no
damages for delay’ clause to help safeguard
against a delay claim the contractor may
assert if the project is not completed within
the agreed-upon completion time. On the flip
side, the owner may want to consider the
inclusion of a liquidated damages clause entitling the recovery or withholding of a set
amount for each day the project completion
is delayed beyond the date set forth in the
contract due to the contractor’s fault.
What bonds should be required?
The general contractor should be required
to carry payment and/or performance bonds
on the project, although the premium for
such bonding is customarily borne by the
owner. Even with a competent, adequately
capitalized contractor and a well-drafted contract, unforeseeable difficulties may arise on
a project. Payment and performance bonds
offer additional protection to the owner.
Generally, a performance bond ensures that
the construction of the project will be completed if the contractor is unable to do so and
a payment bond ensures that the subcon-tractors and suppliers will be paid if the contractor fails to pay them.
These recommendations are just a fraction
of what owners should include in construction contracts. The main thing to remember
is that ‘contract due diligence’ should not end
when the lease or purchase agreement is
KATHERINE M. KNUDSEN is a construction litigation attorney with Procopio, Cory, Hargreaves & Savitch LLP. Reach her at
(619) 515-3206 or [email protected].