Three Types of Contracts Offer Different Benefits and Risks

For the first time in years, construction material costs are rising. In March, the Bureau of Labor Statistics reported numbers showing a 4.8 percent rise in material prices between February 2016 and February 2017.

For contractors who have been working on long-term projects, the price increases could mean lower profit margins, or even losses, as they complete their work. Contractors who are in the estimating, bidding, and contract negotiation stages for new projects will want to ensure profitability and manage risk where possible. In particular, selecting the best pricing system for a project and properly drafting the contract to reflect it is essential, especially during periods of material cost increases.

Three prevalent pricing mechanisms are fixed-price contracts, cost-plus contracts, and guaranteed maximum price contracts. Here’s the lowdown on each type and the benefits and risks with respect to cost changes.

FIXED-PRICE CONTRACTS

Fixed-price or lump-sum contracts are contracts where the parties, sometimes through extensive negotiation, agree upon a fixed sum for the labor and materials to be furnished. Typically, the contractor will prepare a schedule of values where portions of the work correspond with a certain percentage of completion, and pay applications are submitted for the appropriate percentages (often, minus an agreed-upon amount of retention). If the parties want to change the scope of work, a signed change order will be required, and the parties must negotiate and agree upon the change order pricing before signed.

Fixed-price contracts offer contractors limited protection—and in some cases, no protection—in the event of material price increases. Indeed, “the normal risk of a fixed-price contract is that the market price for subject goods or services will change.” (See Seaboard Lumber Co. v. U.S., a 2002 Federal Circuit Court opinion.) Many contracts contain force majeure provisions that excuse or absolve parties from performing their contractual duties in the event of unforeseeable circumstances that are beyond their control and that make performance impossible or commercially impracticable. Examples of such events include “acts of God” like floods, tornadoes, and earthquakes, as well as events such as riots, terrorist attacks, and labor strikes. However, force majeure clauses can be difficult to enforce, and most courts, like the Federal Circuit in Seaboard, view cost changes as a normal, foreseeable risk and not an event that will excuse contractors from further performance. Therefore, when negotiating a fixed price, contractors generally should plan to be held to that price.

However, properly drafted fixed-price contracts can give contractors options to mitigate potential losses arising from cost increases. One strategy is drafting the contract to read that the fixed price is based upon material prices as of the date of signing and that significant increases in material prices will or shall (not “may”) entitle the contractor to an equitable adjustment of the contract price through a signed change order.

Contractors should also be entitled to adjust the contract price or time of completion to account for other problems—like delays, material shortages, or other difficulties acquiring materials—that can occur when costs increase. Such provisions will have better chances of being enforced if the contract specifically defines what constitutes a “significant” percentage increase in price. Additionally, contracts should include provisions protecting contractors from liability associated with delays and shortages. Some fixed-price contracts also provide that in the event the parties cannot agree on a price for change orders, the change order work shall be paid for on a time-and-materials basis including overhead and profit. If contractors are unable to negotiate an equitable adjustment provision, a time-and-material measure for change orders can provide some protection.

COST-PLUS CONTRACTS

For contractors, while the above revisions to fixed-price contracts may be helpful, cost-plus contracts will provide the maximum protection against material cost increases. Cost-plus contracts—also known as time-and-material agreements—are agreements whereby contractors bill for the cost of the labor and materials, plus a fee that is either a percentage of the project costs or an agreed-upon flat fee. When invoicing, contractors include documentation of their payment to subcontractors, vendors, and material suppliers to provide proof of the cost. They then invoice for the cost plus the agreed-upon percentage of the cost.

Unlike fixed-price agreements, cost-plus agreements place the risk of cost overages and increases on the owner. If the contractor’s fee is a percentage of the labor and material costs, these arrangements also create potential for contractors to benefit from cost increases. However, they eliminate the need to negotiate a fixed price, they make change orders much simpler to implement, and in periods of cost decreases, they can benefit owners.

GUARANTEED MAXIMUM PRICE CONTRACTS

While some owners will be wary of cost-plus agreements—especially when material prices are on the rise—guaranteed maximum price (GMP) contracts may serve as a compromise that could help both contractors and owners mitigate risk. GMP contracts are a modified cost-plus option in that they function like cost-plus agreements—contractors invoice for the labor and material costs, plus their fee—but the contracts establish a maximum price for the entire project. Contractors invoice in the same manner they would for a cost-plus agreement, but once the owner has paid the maximum agreed-upon amount, the remaining costs are the contractor’s to bear.

Often, parties to GMP contracts also agree that if the sum of the cost of work and the contractor’s fee total less than the guaranteed maximum price, the difference in the cost and the agreed-upon maximum fee reverts to the owner or is split between the two parties. This makes some owners more amenable to these agreements than they would be to traditional cost-plus agreements, which can make project costs very unpredictable.

Whether parties decide that a fixed-price or cost-plus agreement is best for their needs, they should take care to draft the price terms clearly in order to avoid ambiguity and confusion. Generally, courts enforce contracts as written if they are clear and unambiguous, but if an ambiguity exists, courts will must look to extrinsic evidence to determine what the parties intended, leaving the fate of the dispute to a jury or fact finder. For example, in Rosa v. Long (a 2004 N.C. Court of Appeals opinion), a homeowner and contractor entered into a contract stating that the contractor would build a turnkey dwelling for the “sum of $193,662.60” but later stating that contractor would receive a commission in the amount of 10 percent of all materials, subcontracts, and labor obtained and expended by the contractor. Because these terms suggested that the contract was both fixed-price and cost-plus, a jury decided what the parties intended instead of a judge enforcing the terms as drafted. Clear, proper drafting is essential to increasing the parties’ chances of a predictable outcome in the event of a dispute.

NIBS States Proposed ABA Resolution to Make Codes and Standards Free Could Reduce Safety

The National Institute of Building Sciences issued an open letter to delegates attending the American Bar Association (ABA) Annual Meeting in August informing of the potential impacts if they vote to support a proposed resolution. The resolution—which advocates that copyrighted codes and standards incorporated by reference in legislation and regulation be made available for free—would alter the way codes and standards are developed in the United States.

In the U.S. construction industry alone, there are hundreds of copyrighted codes and standards that impact everything from seismic requirements and wind loads to water use and life safety. The standards developing organizations (SDOs) that develop these codes and standards have thousands of members, employees and volunteers that participate in the process to incorporate best practices and lessons learned to improve the standards. Each industry, from aeronautics and agricultural to electronics and telecommunications, has a similar structure and industry participation to address their specific needs. Such standards improve safety, drive innovation and improve commerce, both domestically and around the world.

The U.S. Government recognizes the benefit of private industry standards development, as directed by the National Technology Transfer and Advancement Act (NTTAA, P.L. 104-113) and Office of Management and Budget (OMB) Circular A-119.

If the ABA’s suggested resolution and related advocacy campaign is successful, private-sector-developed standards would be subject to new requirements due to their incorporation by reference in legislation and regulation, and the ability for SDOs to recoup development costs would change considerably.

The development of codes and standards is expensive. Today, the cost is born by those who are ultimately impacted by the standards (whether by participating in the process or purchasing the resulting document). By making such information free online, the ABA resolution would hamper cost recovery through such mechanisms. The result would be that private-sector organizations may no longer be able to invest in the development process, leaving existing standards to remain stagnant (and thus inhibiting innovation) and shifting the responsibility (and expense) of developing future standards to the government.

ABA’s proposed resolution attempts to mitigate any copyright concerns by encouraging government agencies to negotiate licenses with SDOs. However, this change would require agencies to hire staff and implement contracting mechanisms, making it necessary for tax payers to cover the cost of standards development.

The National Institute of Building Sciences—which was established by the U.S. Congress to work with both the public and private sectors to advance building science and the design, construction and operations of buildings to meet national goals of health, safety and welfare—is extremely concerned that the ABA is advocating a one-size-fits-all legislative vehicle that will alter the long-standing tradition of private-sector-developed standards in the United States. The result could reduce safety, increase costs and add a burden to the government and tax-paying citizens.

In lieu of moving forward with the resolution, the Institute suggests the ABA focus on engaging in a meaningful dialogue with the SDO community to help address the changing nature of access to copyrighted materials through the internet and other electronic sources, and, after taking the long-term goals and impacts into consideration, identify a mutually acceptable path forward.

Read the letter.

Fewer Contracts and More Coordination Point to Design-Build Becoming Even More Popular

When contractors and owners elect a certain project delivery method for their project, it can affect all aspects of the construction, including costs, time to complete the project and amount of exposure to liabilities for each involved party. Owners and designers have long viewed the “Project Delivery Method” as the comprehensive process including planning, design and construction required to execute and complete a building facility or other type of project. Choosing the right project delivery method is integral to a successful project. Currently, there are at least four types of common project delivery methods: construction management at risk (CMR), design-bid-build (DBB), design-build and multi-prime (MP). There is a growing trend showing the more traditional design-bid-build product delivery method is losing its appeal and other options, like the design-build delivery method, are taking its place.

To understand why the design-build process is growing in popularity, it is helpful to discuss three areas where the four processes are different: number of phases and essential parties, number of essential contracts and the liability exposure under the contracts within each method.

NUMBER OF PHASES AND ESSENTIAL ‘PRIME’ PARTIES

Traditional design-bid-build is the familiar, drawn-out process where the owner of the property contacts a designer to create plans and specifications. Once complete, the owner takes the plans and specifications and begins the bidding process. After a bid is accepted, only then can construction begin. The CMR and MP methods use similar processes, though the owners may contract to different parties instead of contracting with the general contractor (we’ll discuss this more later). Under design-bid-build, CMR and MP methods, a minimum of three players is necessary in every project: the owner, designer and the contractors in their various forms.

The design-build method uses an “integrated” process, whereby the designers and contractors are one-and-the-same entity. The process of designing and constructing occurs simultaneously and thus eliminates the lag time between an owner’s receipt of a design and the acceptance of a bid. Also, because there is only one entity performing the design and construction, the only two necessary “prime” parties are the owner of the project and the design-build entity.

NUMBER OF ESSENTIAL CONTRACTS

Another closely related factor to the number of phases and essential parties is the number of contracts created during the project. The traditional design-bid-build project first requires the owner to form a contract with a designer that will design the building or project in isolation and without any input from the construction team. CMR operates similarly again; however, it allows for input from the construction team as to what materials would be the most cost-effective and merchantable for the desired purpose. In these two processes, two contracts exist: one between the owner and designer and one between the owner and construction-management constructor.

MP requires the owner to contract directly with each contractor and subcontractor instead of with one general contractor. Under this process, a minimum of two contracts exists between the owner and the designers and contractors, likely increasing as the size of the project increases.

Conversely, the design-build process merges the designer and builder into one entity. Because the one entity handles both jobs, the contracting process is streamlined and results in only one contract between the owner and design-build entity.

LIABILITY EXPOSURE UNDER THE CONTRACTS

As the volume of contracts involved in the project increases, the more fragmented the liability exposure becomes. In the design bid-build, MP and CMR methods, the owner first secures the designs from the designing entity. When the owner hires the constructing entity, he or she warrants to the constructing entity that the designs and specifications are sufficient for its hired purpose. The designer and the contractors are independently responsible for their work product, but the owner is still held responsible for any representations made to either entity. Although the CMR method attempts to foster the communication between the designer and contractors, no contract exists between the two and, therefore, liability remains on the owner for all
representations made. Further, any change orders, which frequently arise, and any other “gaps” are solely the responsibility of the owner.

Design-build removes the wall that is frequently erected when construction projects go wrong. Frequently during litigation involving the design-bid-build process, designers will attempt to avoid liability by pointing the finger at the contractors and vice-versa. Design-build, by creating a merged entity including the designer and the contractor, places the responsibility of designing and constructing with that one entity, which facilitates problem resolution instead of gearing up for an adversarial proceeding. Therefore, the design-builder is responsible not only for designing the project so that it will satisfy the desired standards, but it must also complete the project required by the owner in the contract.

As for “gaps” with the design-build process, they are essentially eliminated. The entity is performing both roles. Should the owner provide the design-builder with prescriptive designs and specifications, however, the design-build contractor is the party
responsible for discovering any inconsistencies with the performance standards by which they are bound. Any consistencies found will be the financial responsibility of the owner.

FEWER BUMPS

It is easy to see why the design-build process is growing in popularity. Costs are decreased by streamlining the process in many ways: an overlapping process of concurrent designing and constructing, fewer required contracts, and the ability of the contracting entity to adapt to the changes in design and construction. Although liability exposure is more concentrated in the design-build entity than in the other methods, the benefits of coordination between the designer and contractor will surely outweigh its detriments.

In addition to making the project delivery process easier, fewer bumps along the way will surely decrease the time and costs associated with the completion of a project. As we follow the trend toward a more design-build-focused construction industry, we will likely experience a positive effect on the litigation process, where claims will arise only between two parties as opposed to the requisite three parties in a traditional design-bid-build-based action.

Expertly Negotiate Contracts

The National Roofing Legal Resource Center (NRLRC) has released its Roofing Contractors Introductory Guide to Reviewing Construction Contracts

The National Roofing Legal Resource Center has released its Roofing Contractors Introductory Guide to Reviewing Construction Contracts.

The National Roofing Legal Resource Center (NRLRC) has released its Roofing Contractors Introductory Guide to Reviewing Construction Contracts, which is designed to educate and assist roofing professionals in negotiating contracts. The rights and obligations of roofing contractors are governed by the terms of the contracts they sign. The guide discusses terms that frequently appear in contracts they are asked to sign and offers suggestions about how to revise provisions that may be disadvantageous if a problem were to develop. It is available electronically on NRLRC’s website.

Forum-selection Clauses and Their Impact on the Construction Industry

With the national housing market poised for slow but steady growth in 2014, U.S. contractors expect a good year for business, and the number of contracts and subcontracts for construction work is expected to increase. Many of these contracts will contain forum-selection clauses, and a recent U.S. Supreme Court ruling brings to light the importance of these clauses and coming changes in their enforceability.

WHAT IS A FORUM-SELECTION CLAUSE?

A forum-selection clause is a contractual provision in which the parties establish the place for specified litigation between them. These clauses have become increasingly common in construction contracts, particularly with general contractors who do business in two or more states. Often, general contractors have a form subcontract agreement they require or ask all subcontractors on a particular project to sign. If general contractors work in multiple states, forum-selection clauses can help them make potential litigation less costly and easier to manage by guaranteeing the litigation will take place in the company’s home state, where its executives and attorneys likely work.

An example is a general contractor based in New York but working on a North Carolina project and entering into a roofing subcontract with a North Carolina roofer. The general contractor can present the subcontractor with a forum-selection clause mandating any legal claims arising from the subcontract may only be brought in a New York court. For a North Carolina contractor, finding counsel and filing suit in New York will likely be more difficult and costly than doing so in North Carolina, especially when evidence and witnesses are located in North Carolina. In this example, the forum-selection clause makes litigation more predictable and cost-effective for the general contractor and also decreases the likelihood the subcontractor will actually be able to sue, so it most likely favors the general contractor.

To protect local contractors, many state laws have declared out-of-state forum-selection clauses unenforceable in construction contracts. These states include Arizona, California, Connecticut, Florida, Illinois, Louisiana, Minnesota, Montana, Nevada, New York, North Carolina, Ohio, Oregon, Pennsylvania, Tennessee, Utah, Virginia and Wisconsin. Additionally, state laws in Nebraska, Rhode Island, South Carolina and Texas make forum-selection clauses unenforceable in certain circumstances that sometimes, but do not necessarily, encompass construction contracts. In the first category of states, local contractors have been able to file suit locally despite forum-selection clauses because courts in these states can apply the state laws and disregard the clauses. However, the U.S. Supreme Court’s recent decision on these clauses will severely limit the reach of these laws and will ensure that forum-selection clauses are enforced in many more cases.

CASE BACKGROUND

In December 2013, the U.S. Supreme Court issued a unanimous decision in the case of Atlantic Marine Construction Co. v. United States District Court for the Western District of Texas. The court held that defendants in federal court can use forum-selection clauses to transfer their cases to the state specified in the clause, even if the suit is brought in a state with a law deeming these clauses unenforceable. Essentially, forum-selection clauses may be enforced by a venue transfer motion.

The case involved Atlantic Marine Construction (AMC) Co., a general contractor based in Virginia. AMC won a federal contract from the U.S. Army Corps of Engineers to construct a building at Fort Hood, Texas. AMC subcontracted with J-Crew Management, a local Texas company, to perform some of the work. AMC’s contract, which J-Crew Management signed, included a forum- selection clause dictating that any legal disputes between AMC and J-Crew Management arising from the contract had to be brought in state or federal court in Norfolk, Va.

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Five Ways Construction Professionals Can Protect Their Contractual Rights and Avoid Misunderstandings

If your company has recently been awarded a contract for construction work, congratulations! In finding the work and having your bid accepted, you’ve demonstrated your capability to efficiently furnish high-quality labor and materials. At this point, many contractors have no choice but to immediately proceed with reviewing the schedule, scope of work and specifications, as well as preparing to mobilize labor to meet time-related demands. With this flurry of activity, many contractors forget to reduce the agreements to writing, fail to sign written agreements, or—worse—sign contracts without reading all the terms and conditions. The following tips and information can help busy contractors prevent common pitfalls from occurring and offer guidance for those mired in contractual disputes.

1. Put everything in writing.

Most construction professionals would agree written contracts are essential for projects with new or relatively unknown clients, but many feel that long relationships with clients and mutual trust and respect eliminate the need for written contracts. In fact, some fear written agreements have the potential to offend other professionals with whom they have a positive past working relationship. However, written contracts are essential in today’s economic and legal climate and can be seen as a way to honor the mutual respect many feel toward past and repeat clients. The primary purpose of a contract is not necessarily to give one party an advantage over the other. Instead, the goal is for both parties to clearly delineate each party’s expectations from the other to avoid unwanted surprises. If both parties are aware of the duties, responsibilities, risks and rewards before the project commences, there will be less potential for disputes and misunderstandings than there will be without a written agreement.

2. Know that complying with licensing statutes is essential to preserving contract rights.

North Carolina and South Carolina, like most states, prohibit unlicensed contractors from enforcing the provisions of their contracts if a license was required for the contract in question. Additionally, North Carolina case law requires contractors to strictly comply with N.C. General Statutes Chapter 87, which contains specific provisions about the name in which contractors can lawfully hold a license. Failure to comply with the statutes will prevent contractors from enforcing the provisions of their construction contracts.

South Carolina has taken an even stricter approach. Pursuant to S.C. Code Ann. §40-11-370, it is unlawful to engage in construction under a name other than the exact name on the license issued to the contractor (if a license is required for the work), and an entity that does so may not bring an action in law or in equity to enforce the provisions of a contract. This means even a duly licensed contractor can be barred from any recovery for breach of contract, including lien and bond lawsuits, if the contractor’s name on a written contract is even slightly different from the contractor’s name on the contractor’s license. Although some states have case law adopting this principle, South Carolina appears to be the only state that has codified the rule. Therefore, it is imperative a contractor’s name on the contract is the exact same name as the name on any contracting license required for the work in question.

3. Assume no damage for delay clauses are enforceable.

Both North and South Carolina courts generally enforce “no damage for delay” clauses, which specify owners will not be liable for a general contractor’s damages arising from delay, disruption or interference—even if the owner is responsible. General contractors can enforce these provisions against subcontractors or suppliers, too. Often, the contract will provide that additional time—contingent on written approval by the owner, architect or general contractor—is the sole remedy for delay.

South Carolina courts have recognized some exceptions to these clauses’ enforceability, however. The South Carolina Supreme Court held in Williams Electric Co. v. Metric Constructors Inc. (1997) delay caused by fraud, misrepresentation or bad faith; delay caused by active interference; unreasonable delay giving rise to abandonment of the contract; or delay caused by gross negligence can give rise to recoverable damages.

Similarly, North Carolina courts have overlooked “no damage for delay” clauses and allowed parties to recover damages arising from delays that constitute abandonment of a contract; active interference with the contract; and delays resulting from fraud, bad faith or arbitrary action. Additionally, damages from delays not reasonably contemplated by the parties are recoverable.

Many delay provisions are accompanied by notice requirements, too. Most contracts that do allow parties to recover for delay related damages require the party claiming damages to give notice of the delay, or the source of the delay, as soon as they are aware of it. What constitutes notice and reasonable knowledge of the delay can be open to interpretation. Ambiguity is best avoided through specific provisions in the contract.

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