It’s construction contracting 101: get the contract signed before the shovels hit the dirt.
But, too frequently, a signed agreement becomes secondary to starting work. This is understandable. For both owners and contractors, starting on time is critically important. So there are times when business reasons dictate starting construction before a final contract is negotiated and signed.
Nonetheless, it is important to revisit the reasons why it’s prudent to have an executed contract before work starts. Here are five of them:
Negotiation takes time
Oftentimes, parties are willing to set aside the negotiation of a contract until after construction starts because there’s a shared assumption that they will be able to quickly agree on contract terms in the days thereafter. But even when an owner and a contractor have an established relationship, this may be an unreasonable expectation.
Sophisticated owners and contractors are bound to have significant disagreements. Negotiations that drag on while construction is under way can distract a project team. And both parties may lose influence over important matters. Meanwhile, the longer that work proceeds without a contract in place, the greater the risk to both parties.
Adequate insurance cannot be assumed
Insurance is one of the principal project assets that both owners and contractors rely on to manage risks that arise both during construction and in the years after work is completed. But neither owners nor contractors should assume that whatever party they are working with has adequate insurance.
Owners will want to ensure that contractors have adequate liability coverage to protect themselves against losses during construction, as well as “completed operations” coverage that takes effect after contractors’ work is finished (not to mention workers’ compensation, employers’ liability and commercial auto, among other common coverages). And because subcontractors typically perform the bulk of the work on a given project, owners will also want to require that these companies maintain appropriate coverage.
Although often owners provide “builder’s risk” coverage that protects work during construction, the parties could agree that the contractor is to obtain the builder’s risk policy. When work begins before these responsibilities are contractually established, there is an increased risk that coverage will be inadequate or that there will be gaps.
Compensation is more than a number
During bidding or a proposal process, the bulk of attention, appropriately, is usually paid to the price for which a contractor will agree to build a project. Generally speaking, it’s not until people start negotiating final contracts that owners and contractors deal with specific terms governing owners’ obligation to make payments to contractors.
These negotiations include matters such as procedures for submitting and approving payment applications, the documents required by an owner as a condition for making payments (e.g., lien waivers from the contractor and all subcontractors?), whether retainage will be deducted from progress payments, the amount of interest to be paid on payments that are late and conditions for final payment. An agreement on an initial contract price does not deal with ways to adjust prices (or schedule) in response to changes in the scope of work or problems encountered during construction. Ideally, these issues are settled before work begins.
The earlier a prime contract is signed, the easier it is to ensure key requirements flow down to subcontractors
A general contractor’s agreements with its subcontractors typically include standard flow-down language that incorporates the terms of the prime contract. Nonetheless, the prime contract also frequently requires that specific provisions be expressly stated in subcontracts.
For instance, when an owner and general contractor agree that disputes between them are to be resolved by arbitration, they will often also agree that a general contractor’s agreements with its subcontractors and suppliers should include identical language binding subcontractors to arbitrate disputes in a consolidated proceeding. If a prime contract is executed after certain subcontracts or supply agreements are executed, then a general contractor may need to amend those agreements to include required language.
A contractor’s bid may include terms that are not acceptable to an owner
A contractor will typically prepare a bid that describes a scope of work, sets forth “assumptions” on which the bid is based, and contains other “exclusions” and “clarifications.” The assumptions, exclusions and clarifications frequently contain legal terms and disclaimers that many owners might find objectionable (for example, limits on liability or waivers of consequential damages) and would never accept in the ultimate contract.
But if a contractor’s bid is the last writing between parties before work starts, a contractor may have reason to later insist that such objectionable terms were a material part of the contractor’s proposal as accepted by the owner – even if the owner orally expressed an objection to such terms before work started. Having a signed agreement before work starts, one that expressly excludes such objectionable terms, obviously avoids these pitfalls.
Of course, there may be instances where an owner and a contractor have no choice but to start work before a contract is completed. In those cases, it may be preferable to execute a letter agreement that contemplates the execution of a superseding formal contract at a later date.
Zachary Davis is an attorney in Stoel Rives’ construction and design practice group. Contact him at 503-294-9410 or firstname.lastname@example.org.