What to look out for in construction contracts
Thursday, February 05, 2015
Construction contracts are often lengthy and complicated documents. Despite the fact that these agreements form the foundation for the relationship between the signing parties, the fact that they are so voluminous means that they are rarely thoroughly examined.
Further, even if the contract is examined, if the examination is performed by a non-attorney, there may be technical legal clauses or phrases that have profound effects, but that may slip by unnoticed. Since attorneys are expensive, and not every construction industry participant has in-house counsel, construction participants can help themselves by knowing some of the key things that they may wish to look out for.
Generally, pay-when-paid clauses are interpreted as a timing mechanism for payment rather than a risk-shifting clause. This means that the payment must be made within a certain reasonable amount of time, or put another way, contractual language stating that a contractor will pay a sub when payment is received from the property owner is not interpreted to mean payment can be avoided indefinitely. Even in the absence of payment from up the payment chain, payment down the payment chain must be made within a "reasonable" time.
It worth noting, however, that this type of clause can still delay payment. A "reasonable" time for payment is not defined as "upon invoice." Even if an invoice is due, a pay-when-pay clause may effectively slow down the obligation of the paying party to actually make that payment.
For example, the language of two common types of this clause can be seen below:
AGC 650 8.2.5: Progress payments to the subcontractor shall be made no later than seven (7) days after receipt by the contractor of payment from the owner. If payment from the owner is not received the contractor will make payment to the subcontractor within a reasonable time.
Payment will be made not more than thirty (30) days after the submission date or ten (10) days after the certification or when we have been paid by the owner, whichever is later.
On the other hand, however, pay-if-paid clauses are a specific attempt to shift the risk of nonpayment from one party to another. Most pay-if-paid clauses are viewed with disfavor by courts, but in some states they may still be enforced if specific language is used.
In order for a pay-if-paid clause to work as a condition precedent to payment, the clause must be extremely specific, and likely must contain some particular language — like "condition precedent" or "expressly agrees that the this clause shifts the risk of nonpayment" or "the party expressly assumes the risk of [some top of chain party's] nonpayment" or similar language.
If it does so, and the contract was for work performed in a state that allows such clauses, the burden of nonpayment is shifted to the lower-tiered party. Contracting parties, therefore, should be wary that in many states, while difficult to do, the risk of nonpayment may be shifted by the original contract between two parties.
Alternative Dispute Resolution Clauses
If a construction contract contains an Alternative Dispute Resolution (ADR) provision, there's a pretty good chance the language originally came from one of these three locations: (i) The American Institute of Architects (AIA) contract documents; (ii) The ConsensusDOCS; or (iii) The recommended provision from the American Arbitration Association (AAA).
Despite this, however, these provisions are commonly modified and altered by the company drafting the contract in a manner it feels better protects its interests. This means that a familiarity with the language generally contained in these provisions doesn’t allow a company to gloss over this part of the contract without examination — the provision may have changed from what it is used to.
The fairness of these provisions to various parties is debated by lawyers and construction industry participants, but in large part, the biggest potential benefit of these provisions is that they have been standardized and have reliable interpretations. In other words, in the case in which the provision has not been modified, the parties know what they’re getting into and can easily understand the provision and its impact.
The unfortunate reality, though, is that these clauses are too frequently edited, re-edited, or used as a springboard for a company’s own language for other companies to feel secure in knowing what they mean. This defeats the entire purpose of standardized contract sets.
The result is the creation and re-creation of thousands of different ADR provision variations; with each nuanced in a slightly different manner than the others. Even more importantly, these unique and company-specific custom provisions have not been interpreted by courts, which presents an enormous amount of uncertainty.
This means it’s incredibly important for construction parties to carefully read their contracts, and know what is required.
Construction contracts are complex and lengthy documents, but careful review is necessary, because they can substantially alter a company's rights. The above are just some of the provisions to which a company should pay careful attention, but provides a nice starting point for construction contract examination.
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