Key Construction Contract Provisions

II. KEY CONSTRUCTION CONTRACT PROVISIONS

The key provisions of a construction contract relate to the scope and quality of the work, the price to be paid for the work, and the time of performance. This section discusses the central issues relating to those issues, as well as a handful of other heavily negotiated construction contract provisions.

A. Price

The four traditional methods of pricing construction contract work are lump sum, cost-plus, cost-plus subject to a guaranteed maximum price, and unit prices. Also relevant to pricing construction work and related payment issues is the obligation of the party paying for the construction to provide financial assurances of its ability to pay.

1. Lump sum

A lump sum construction contract provides for payment of a stipulated amount in exchange for performance of the work. Usually, the work is paid monthly based upon the percentage of the work that the contractor has completed. The contractor's monthly payment application typically divides the work by subcontractor trade and reflects a percentage of completion for each part of the work. That percentage then is multiplied by the total amount allocated for each part of the work (called a schedule of values) to arrive at the total amount earned by the contractor. Payment typically is a percentage of the amount earned with the balance (usually between 5% and 10%) being withheld as retainage until the work is substantially complete.

2. Cost-plus

A cost-plus construction contract provides for payment of a contractor's costs, which are defined under the terms of the contract, plus a percentage of the costs as the contractor's fee. Significantly, there is no cap on what the contractor is entitled to be paid in this arrangement, and great care must be taken by the owner to both define the reimbursable costs and monitor the progress of the work and costs incurred. This usually is done with contract provisions requiring the contractor to provide the owner with a budget or cost estimate for the work, obligating the contractor to update the budget frequently, and often requiring prior notice to and consent from the owner if the contractor expects the budget may be materially exceeded. Cost-plus contracts are rare in commercial construction and usually only are used where the design is not yet sufficiently developed for the contractor to provide a lump sum or guaranteed maximum price. In such instances, the contract typically requires the contractor to provide a guaranteed maximum price once the design is completed. Cost-plus pricing also is used frequently in high-end residential construction.

3. GMP

A cost-plus construction contract which is subject to a guaranteed maximum price (GMP) is like a cost-plus contract except that the costs and fee are limited to a certain amount and the contractor agrees to bear any costs exceeding that amount. Typically, when a construction contract contains a GMP, it also contains a clause providing for the parties to share in any savings under the GMP (i.e., the amount by which the sum of the costs and fee total less than the GMP). The so-called "savings clause" provides an incentive to the contractor to keep costs down. The parties negotiate the split of savings between the owner and contractor. Frequently, the owner retains a larger share of the savings than it pays to the contractor, but sometimes the parties agree to split the savings equally.

4. Unit prices

Construction contracts that base compensation on unit prices tie specific prices to the quantities of materials installed. Unit prices are used as a basis of compensation in contracts consisting mostly of material installation such as highways, pipelines, and utilities. For example, in a pipeline contract based upon unit prices, the contract entitles the contractor to a certain amount per lineal foot of installed pipe.

5. Financial assurances

The need for financial assurances in construction contracting has been more acute during the recent difficult financial times. Architects and contractors seek assurance that the owner has the ability to pay the amounts promised under their contracts. Industry form contracts typically require the owner to provide assurances of its ability to pay when requested. Owners typically try to restrict such requests to the outset of the project or eliminate the right to make them altogether.

The most recent version of the AIA General Conditions of the Contract for Construction Document A201™-2017 (AIA A201), for example, restricts the owner's obligation to provide financial assurances largely to the period prior to when the work commences. A prior version of AIA A201 (1997 version) allowed the contractor to request assurances both prior to start of the work "and thereafter," and conditioned the obligation of the contractor to "commence or continue" the work upon the owner providing such assurance. The current version gives the contractor the right to request assurances prior to the start of the work but only allows such requests thereafter if:

(1) the owner fails to make payment as required by the contract;

(2) a change in the work materially changes the contract price; or

(3) the contractor identifies in writing a reasonable concern regarding the owner's ability to make payment when due.¹⁹

B. Scope of Work

1. Definition

The most fertile area of dispute in a construction contract lies in defining the scope of work. The vast majority of disputes between an owner and contractor concern whether the scope of work (often referred to as the construction documents) includes a particular item of work or whether the work described in those documents changed. A change or addition to the work may entitle the contractor to additional compensation or time to complete the work. Even disputes over the time of performance often come down to disputes over whether certain work was in or out of scope.

2. Plans and specifications

Key to effective contract drafting is precisely defining the scope of the work. Usually this is done either by listing the drawings and specifications in the contract, attaching a list of them as an exhibit, or, depending upon volume, actually attaching them to the contract as exhibits. Care must be taken to list the most current version of the drawings and specifications because documents change during the design process. Also, the design is not always complete at the time of contracting. In such cases, the contract should provide pricing for the current design and spell out how adjustments to that price, if any, will occur to account for the additional development of the design.

Even where the drawings and specifications are properly identified in the contract, disputes can occur over what those drawings and specifications provide. Thus, well drafted construction contracts require the contractor to build everything shown in the drawings and specifications as well as everything "reasonably inferable" from them.

3. Changes

A change is any alteration of a construction contract that changes the scope of work, the contract price, or the contract time. Typically, construction contracts require changes to be accomplished only by a written change order or other written directive. For example, A201™-2017 § 7.1.1 provides that "Changes in the Work may be accomplished after execution of the Contract, and without invalidating the Contract, by Change Order, Construction Change Directive or order for a minor change in the Work." Each of these must be in writing.²⁰

a. Additional work

An essential part of a construction contract is the owner's ability to make changes in the work. Often such changes result in additional work, although in some instances changes can reduce the scope of work. Without such a provision, the contractor would not be obligated to perform the changed work.

The owner usually initiates the change by requesting a change in the work. The contractor prices the change, and then the owner and contractor negotiate the time and money associated with the change. Where they are unable to agree on the terms of the change order, the contract typically enables the owner to direct the contractor to perform the work—by issuing a construction change directive—and entitles the contractor to an equitable adjustment of the contract price and time of performance. For example, AIA A201™-2017 § 7.3.1 provides that "[a] Construction Change Directive is a written order prepared by the Architect and signed by the Owner and Architect, directing a change in the Work prior to agreement on adjustment, if any, in the Contract Sum or Contract Time, or both." Section 7.3.2 provides that a Construction Change Directive "shall be used in the absence of total agreement on the terms of a Change Order." This enables the owner to keep the project moving while protecting the contractor's entitlement to be paid for additional work. After issuance of the directive, if the parties remain unable to agree on the terms of a change order, the contractor may make a claim for additional compensation or time under the claims procedures outlined in the contract.

Good change order provisions spell out in as much detail as possible how to calculate compensation for changed work. This can include unit prices, equipment, and labor rates (including burden), general conditions, overhead, and profit.²¹

b. Differing site conditions

Some changes in the work result from changed circumstances surrounding the project or because the expectations of the parties at the outset of the contract turn out to be incorrect. Differing site conditions are a prime example. Most construction contracts address the possibility of the contractor encountering subsurface or otherwise concealed conditions differing materially from those indicated in the contract documents or from the physical conditions ordinarily found to exist where the project is located.²²

Two distinct types of differing site conditions exist. "Type

...