Construction Contracts – Negotiate for Success

As an engineering or construction contractor, are you getting a fair deal in those contracts you sign with your customers?

 by Kit Werremeyer

President, Southernstar Consultants, LLC

There are many good reasons to negotiate changes to the commercial terms and conditions in the client’s proposed construction contract.  Two good ones are:  first, get a better financial deal for your company, and; secondly, lower your company’s commercial risk and exposure to unnecessary potential financial liability. 

Here are some suggestions on how to do this:

 Scope of Work

All time and effort put into carefully detailing and defining the scope of work will pay dividends in the form of less claims, better planning, and less disputes between parties to the contract. Take the time to: 

• Define what you are obligated to do.
• Define what the client is obligated to do.
• Define what the client’s engineer and/or project manager is obligated to do.
• Define what all third parties supplying permits, goods and services, or inspecting on behalf of the client are obligated to do.

 Include this detailed scope in the contract documents.

 Terms of Payment

 You are entitled: 

• To receive a downpayment.
• To be paid on time and in accordance with your payment terms.
• To not having to agree to allow the client to withhold retention from your payments.
• To be paid in full for all agreed upon changes, without retention.

Always negotiate favorable terms of payment.  You’re in the construction business, not in the charity business.

Schedule and Float

If you have any float (contingency schedule time) in the schedule you agree upon to do the project, it belongs to you, not the client.  If the client wants to own the float, negotiate some form of compensation for that privilege.

 Indemnification

The reason a client inserts an indemnity clause in a construction contract is to transfer the potential financial liability associated with certain of his risks to you, the contractor. 

These are the major risks and associated financial liabilities the client would typically like to transfer to you: 

• The financial liability arising out of damage to property caused by the client’s negligent behavior.
• The financial liability arising out of injury to a person(s) caused by the client’s negligent behavior.
• The financial liability arising out of death to person(s) caused by the client’s negligent behavior.
• Client’s defense costs associated with defending claims for the above noted negligent behavior.

You do not have to agree to be responsible for the financial liability that may arise on account of the negligent acts or behavior of your client.

The best indemnity is no indemnity.  There is no requirement for an indemnity clause to be included in a construction contract.  You are always going to be responsible at law for the financial liability that arises from your own negligent actions.  So should the client.  Actually, he generally is, unless you agree to contractually assume the financial liability for his risks under an indemnity clause in the construction contract.

An indemnity clause is a contractual land mine in a construction contract.  Try to get rid of it.   If the client insists on including an indemnity in the contract, defuse it by negotiating limits similar to the following: 

• Indemnify only the client and only to the extent of your negligence, not his.
• Limit the scope of the indemnity only to damage to property, injury or death to persons.
• Limit the time the indemnity applies to only the time you are physically located on the construction jobsite.
• Limit the indemnity to only those events occurring during the on-site performance of your work.

Indemnity clauses can be complex and difficult to understand.  Always work with someone who understands indemnities when negotiating changes to an indemnity clause.

Alternatively, you may want to have your insurance company provide contractual liability coverage under your General Liability policy for the financial liability you agree to assume under a client’s indemnity clause in the construction contract.

 Limitation of Liability

If you agree to an indemnity in a construction contract that obligates your company to be responsible for the financial liability caused by the negligence of the client, make sure you negotiate into the contract a separate limitation of liability clause.  This limitation of liability clause should limit your financial liability to some maximum dollar amount, or to the proceeds from certain types of insurance you carry.

 Insurance

Insurance is another form of contractual risk transfer.  Insurance provides you with a certain level of protection from financial liabilities that may arise from your construction activities.  With insurance you transfer a fixed amount of financial liability that may arise from certain defined risks to a third party, the insurance company, for a premium.

The types and amounts of insurance requested by the client should make sense for the value of the project.  For example, you are doing a $250,000 construction job, and the client requires $10,000,000 in General Liability insurance.  That’s probably excessive and it would be appropriate to negotiate a lower amount

Sometimes a client who is building a large project will provide at his cost a main project liability insurance policy and he will allow all the contractors working on the site to be covered by that policy as additional or added insureds.  In this case, understand who pays the policy deductibles and understand the provisions and exclusions of the policy.  You may find you still want to provide some insurance to fill in any gaps in the client-supplied policy.

Today, insurance is necessary and valuable protection for companies in the construction business.  It is a key asset or your construction business.  It pays to have a good working relationship with a professional insurance agent.

He can explain and guide you through all the complexities of insurance and assist with your contract negotiations for required insurance coverage.

 Additional Insured Status

When you contractually agree to add the client to your General Liability policy as an additional insured, he may have full access to all the benefits (like payment for legal defense) and financial limits of the policy.  In the event the client has a large claim against your policy and later you have a claim, there might not be enough money left on the policy limits to pay the full amount of your claim.

If the client has a large claim against your policy, guess what happens next time your policy is up for renewal?  Maybe it’s not renewed.  Or if it is, the premium for renewal may be significantly larger as your loss experience rating is not as good now.  The client’s claim goes against your loss experience because it’s your policy. 

Did the client pay you for this nice insurance?  Probably not.  You agreed in the contract to give him some free insurance by granting him additional insured status.  That’s a really good deal for the client.

Now here’s the best part.  It involves the indemnity clause you agreed to accept without changes in the client’s construction contract.

The insurance clause in the client’s construction contract requires you to add the client as an additional insured to your General Liability policy.  The clause also specifies that the policy must provide for contractual coverage.   What does contractual coverage mean?  It means that your insurance company agrees to provide coverage for the financial liabilities that may arise from your contractual obligations.  Remember, you agreed to be contractually responsible, under the provisions of the indemnity agreement in the contract, for the financial liability that may arise from your client’s negligent behavior.

Why would a client want your General Liability policy to provide him coverage for your contractual obligations?  Here’s why: 

• The client wants this coverage in the event your company is not capable of meeting the financial obligations in the indemnity.
• The client wants this coverage for your contractual obligations just in case a court won’t enforce the requirements of the indemnity clause in the contract. 

Let’s walk through what could happen: 

• The client is added to your General Liability insurance as an additional insured.
• The insurance clause in the contract requires your General Liability insurance policy to provide for coverage of your contractual obligations as well.
• In the contract, you contractually agree in the indemnity clause to assume the client’s financial liability that may arise from his negligence on the jobsite.
• During the course of construction a claim is made against the client for injury to a person that occurred due to some degree of the client’s negligence.
• You reject the client’s request to pay for the potential financial liability under the indemnity clause.
• The client now sues you and your insurance company to provide defense against the claim and to pay the claim.  The client can do this since he is an additional insured under your General Liability policy that also provides coverage for your contractual obligations.
• The court orders your insurance company to pay the claim.  It rules the insurance company agreed to provide coverage for the risk of the client’s financial liability that you agreed to contractually accept under the provisions of the indemnity agreement.
• The client, and his insurance company, escapes payment of the financial liability associated with his negligence that caused an injury to a person on the jobsite.

To add insult to injury, your insurance company may raise your future premiums on account of having to pay the client’s claim against your General Liability policy.

As far as the request for additional insured goes, you may want to reject the client’s requirement for additional insured status and negotiate with the client to buy a separate project specific General Liability insurance policy, or project specific Owners and Contractors Protective policy to meet his insurance needs. 

Also, talk with your insurance agent about how you can limit the financial exposure that may arise from your contractual obligations.  Your agent may be able to provide specific exclusionary and limiting wording in the policy endorsement that adds the client as additional insured for contractual coverage to your General Liability policy. 

Damages

If you fail to perform on a construction contract you may be exposed to liquidated damages.  The value of the liquidated damages is the client’s measure of how much he is financially damaged by your failure to perform.  If you encounter a liquidated damages clause in a construction contract, try to eliminate it, or if that’s not possible, try to minimize or cap the amount of liquidated damages you agree to accept.

Discuss with the client the fact that liquidated damages in a contract may create an adversarial atmosphere on the project as you will now insist that all changes, even the small ones, and especially those changes that effect the schedule, be recognized so that you are not improperly exposed to the liquidated damages.

Always negotiate the exclusion of consequential, indirect, special, and other similar damages, including loss of profit, in a separate contract clause.   Consequential damages must be specifically excluded in writing in a contract.  It is generally not sufficient to be silent in the contract on consequential damages.

 Warranty

Clients expect contractors to build their projects generally free of defects in design, materials, and workmanship.  That’s good; that’s what builds a contractor’s reputation of doing a good job.

A one-year warranty of the contractor’s work is nominal and expected.

Just be careful if a client wants an extended warranty; it could be used to have you provide free maintenance.  Maintenance is the client’s responsibility, not yours.

An extended warranty doesn’t have to free.  It’s appropriate to negotiate an extra charge for this extended contractual obligation.

Contract Changes

You are entitled to be paid for legitimate changes to your scope of work on a construction project.  You are also entitled to changes in your project schedule to accommodate changes in your scope of work.  Again, ask yourself if you are a construction company or a charity. 

If you are too busy to take care of changes as they occur, or if you reckon you can get fairly treated on changes at the end of the job by the client, then either the changes don’t amount to much or you really are a charity.

Stay on top of your contract changes.  Document, document, document!  Try to keep the changes on the table in front of the client until he settles fairly with you.

Make sure you negotiate a good change clause in the contract.  The clause should require both parties to settle changes as they occur, require proper documentation, and most importantly, require the client to approve the cost and schedule consequences in writing prior to performing the work involved with the changes.

 Disputes

Disputes are going to arise from time to time, and it’s important to have a procedure in the construction contract to resolve them.

A clear dispute resolution clause should be negotiated into all construction contracts.  The clause should require both parties to first try to resolve the dispute by negotiations with each other.  If that doesn’t work, then the clause should require the parties to use an Alternative Dispute Resolution process, or ADR.   Typically, ADR means using mediation or arbitration.  Make sure that the dispute clause requires any mediators or arbitrators to have construction backgrounds. 

 Finally….

Negotiating a fair construction contract with a client can be time consuming and frustrating to both parties.  If you have a good offer that is being considered by the client, odds are he will be willing to negotiate changes to his proposed construction contract.  Those changes will make the contract more fair to your company yet still remain a good deal for your client.