Be Careful What You Sign: Construction Contracts
1, How The Issues Emerge
New construction, renovation and systems upgrade projects designed to improve operations and service delivery are critically important investments for local government entities and their taxpayers. Establishing need, options, support, funding and a team of reliable contractors takes an appreciable commitment of time and energy by both elected officials and staff. Reputable architects, engineers, environmental consultants and general contractors provide critical professional support and are very helpful to their clients. In the vast majority of projects, the parties are enthusiastic and aligned to complete the job successfully. Construction, however, is not without its difficult moments.
Awkwardly at some point, the form construction contract will beg the owner’s hurried endorsement. Various iterations of the form contract are used by architects, engineers and general contractors, and none are fully protective of the owner’s interests. On closer inspection, these agreements suggest competing interests and require the owner’s acquiescence to certain disadvantageous terms residing within the main document and its attachments, which may be incorporated by reference and obtainable only by request. Lawyers, when they observe the prejudicial terms, will object and edit the proposed documents. So begins an uncomfortable period of debate and disagreement over contract “boilerplate.” A common question arises, “Why can’t we just sign this contract so everyone can get back on track with the project?”
2. Risk Transfer
Local government officials have a duty of care in signing a legal instrument that defines the parties’ respective rights, remedies and liabilities in a construction project. Signing a construction contract without careful review and revision will likely place the owner at legal and financial peril if liability issues arise from some aspect of the project.
A contract can easily transfer limitless financial risk to an unsuspecting or disinterested party. Risk transfer clauses have become ubiquitous and are utilized extensively in the construction industry. Litigation experience informs us that the construction contract, because of its tendency to carefully structure and transfer financial risk, is the document that all interested parties, their attorneys and insurance carriers will study carefully and invoke against one another in the aftermath of a loss. In order to manage this exposure, it’s imperative for the owner to anticipate the risk and participate in the drafting and revision of the construction contract prior to the commencement of services.
The primary risk transfer devices used in these contracts include indemnification clauses (commitments to pay for another party’s legal fees, expenses and settlement/verdict costs), additional insured requirements (adding another party to your liability insurance even though they are already insured), waivers of subrogation (eliminating your insurer’s legal right to recoup losses caused by another party), and property coverage requirements (identifying who insures the work in progress and any existing structure). Particularly problematic are clauses that require the owner to indemnify and insure architects, engineers and surveyors because there is no coverage for these obligations. Similarly, any promise to indemnify and insure a party regarding pollution or hazardous waste liability is not supported by coverage and should be avoided. Subrogation waivers are equally troublesome. Primex3, through subrogation, pursues parties responsible for covered losses to recoup as much of the loss payment as possible. The recovery is applied dollar for dollar to the covered member’s loss run to reduce its claim history and premium impact. Because of the importance of subrogation, Primex3 members may waive it only with Primex3’s written consent.
Secondary clauses that bear indirectly on risk transfer include limitations on the owner’s remedies, jury trial rights and time in which to file claims. These provisions minimize the contractors’ financial exposure and effectively leave that exposure with the owner.
Owners should not only play good defense against adverse risk transfer, but they should also go on offense and use their leverage to impose risk transfer on their contractors. For example, contractors should agree to indemnify and additionally insure owners for claims arising from the contractors’ operations, acts or omissions. Mutual indemnification and reciprocal additional insured are sometimes proposed but are never truly advisable concepts because they defeat the purpose of risk transfer and cancel out the protection. These techniques are used as blocking maneuvers by parties reluctant to indemnify or additionally insure.
3. Insurance and Financial Responsibility
All contractors should carry appropriate insurance coverage. General liability, umbrella, business auto, professional liability/errors & omissions, workers compensation and employer’s liability are standard requirements. Amounts of coverage may vary with the project’s level of risk but are generally substantial for most projects. In some cases, pollution or other specialty lines of coverage may be warranted. The construction contract should require the general contractor to impose the same or similar insurance requirements on the subcontractors. Uninsured subcontractors pose a very serious and inadvisable risk to the owner’s interests.
New Hampshire law requires local government entities to secure a payment bond on all projects with a value of $125,000 or greater. RSA 447:16. For projects below this threshold, the bond is optional. The obligation to procure the payment bond should be passed off to the general contractor in the construction contract. A performance bond is usually sold with the payment bond and is recommended. In addition to the financial protection the bonds afford the owner relative to the project, the underwriting process is relatively rigorous and will screen out a contractor whose past or present circumstances make them ineligible for bonding.
4. Tips for Managing Contracts
Developing a simple contract management process is a great place to start. Identify who is authorized to receive, review, negotiate, approve and sign contracts. A very limited number of people should be given authority to approve and execute contracts, and they should be trained and given access to legal counsel. Primex3 offers training and insurance consulting on contract matters and is happy to help in these regards. Local legal counsel should always review the entire contract and should be involved from the outset with construction projects to help ensure compliance with municipal and regulatory laws. Primex3 members should submit the insurance, indemnification and subrogation waiver sections to Primex3 for review and editing to avoid unintended coverage issues.
It’s critical to negotiate the terms of construction contracts early on when the owner has more leverage. Trying to resolve terms several days before breaking ground invites resistance because the prospect of a last-minute delay increases the contractor’s leverage. It’s often effective to put expectations regarding important contract language issues in the RFP, or to make contract negotiation the first order of business after the selection of the general contractor.
Before signing the contract, legal counsel and the owner should carefully review it again to make sure all revisions have been correctly made. Often, one or more edits may be inadvertently omitted or jumbled in the rush to move forward.
The contracts and proofs of coverage related to the project should be maintained permanently. Litigation unfortunately can arise from a project many years down the road, and these documents will be central to the outcome.
By treating the construction contract and related documents as items of importance early in the process, the owner can more effectively consult advisors, work through issues and ensure it’s interests are adequately protected.
Mike Ricker is General Counsel with Primex3. Mike can be reached by email at email@example.com or by phone at 603.225.2841. Founded in 1979, the New Hampshire Public Risk Management Exchange (Primex 3) is a public entity risk pool organized and operating as a trust on behalf of member municipalities, schools, counties and other governmental entities.