Important Terms in Construction Contracts – Part I

Contracts signed in connection with construction projects allocate risk between and among the different parties to the construction process. Construction professionals who understand basic contract clauses are at less risk of signing off on poorly written contracts. The next two monthly bulletins will explain the most significant clauses in construction-related contracts.

Types of Construction Contracts

Construction projects can involve a number of contracts, including general contracts, subcontracts, purchase orders, owner/designer agreements, loan and security documents to some extent, and bonds and insurance policies. Several types of clauses can be found in most well drafted construction documents. Often the use of a single word, and sometimes certain punctuation, will make a huge difference in the meaning of a particular clause.  

Payment Provisions

Subcontracts frequently include a "pay-when-paid" or a "pay-if-paid" clause. The difference between the two is critical. "Pay-when-paid" clauses may allow the general contractor to delay payment to its subcontractors for a period of time. However, if the general contractor never receives payment from the owner, the contractor is still obligated to pay the subcontractor the amounts owed within a reasonable time. On the other hand, a "pay-if-paid" clause allows the general contractor to withhold payment from the subcontractor until the general contractor receives payment from the owner. This delay could be indefinite, and it also could be forever, if the general contractor never receives payment from the owner.

Incorporation by Reference (Flow-Down)

The "incorporation by reference" concept means that certain rights and obligations set forth in another contract or document are included in your contract. When another document is incorporated by reference, it is essential to obtain a copy of that document and thoroughly review it.

Notice

Construction contracts typically include a requirement that the contractor provide written notice to the owner of circumstances that may give rise to a claim. Failure to give the requisite notice can result in the denial of a request for an extension of time and/or denial of an equitable adjustment for delay-related costs. The contractor's failure to provide written notice of a potential claim may also operate as a bar to the claim. In order to give effective notice, a contractor should strictly comply with contractual requirements.

Indemnity

Construction contracts frequently require one party to "defend, indemnify and hold harmless" another party. The party providing the indemnity is the known as the "indemnitor," and the party receiving indemnity is known as the "indemnitee." Indemnity may require the indemnitor to pay the entire amount of damages to the indemnitee who has paid the judgment or settlement to the injured party. Under some circumstances the indemnitor may be required to pay to defend the indemnitee against the claims of a third party and to pay for the indemnitee's damages even if the indemnitee is itself partly or wholly responsible for them.

Liquidated Damages

Liquidated damages (LDs) are based on a contractual provision stipulating a certain sum as an approximation of the amount of damage a party will suffer if the other party breaches the contract. LD clauses are frequently used in an attempt to quantify the monetary risk associated with delays on construction projects. In order to be enforceable, LD clauses must satisfy numerous legal requirements. Although many contractors (and their sureties) try to avoid LD clauses, they can benefit both parties by obviating the time commitment, expense, and uncertainty that can exist if a dispute arises. 

A complete understanding of every construction contract is necessary, so be sure to consult with an experienced construction attorney when you have questions about the interpretation of contract provisions.