No construction contract is standard — terms matter

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In 20-plus years of navigating construction contract negotiations and disputes, I have reviewed for clients a number of terms overlooked at signing that carry significant importance when a dispute arises: materials warranties limited to replacement costs (no tear-out, no install) and a 60-day notice period; limitations of liability clauses that cap damages significantly below insurance coverage the owner paid for; and, in perhaps the most egregious example, an attorney’s fees clause written in reverse that had the winner pay the loser’s legal fees!

Whether developing a skyscraper, renovating an existing commercial space, or building a dream vacation home, one rule should remain constant: no construction contract is standard. Construction contract terms (almost) always lean in favor of the party that drafted them. Legal interpretations of important terms also vary considerably from state to state. This consistent inconsistency makes it prudent to carefully review terms at contract formation to manage the risk inherent in blindly agreeing to default form contract language. One often overlooked term – the third-party beneficiary (TPB) clause – provides a prime example.

A TPB is a person or entity who, though not a party to a contract or subcontract, stands to benefit from the contract’s performance. Typically, the TPB is expressly named in the contract from which it stands to benefit. For example, if the contractor and a subcontractor agree to a subcontract that specifies the subcontractor will render performance to a project for the express benefit of an owner as a TPB, then that owner is a third-party beneficiary of the subcontract, even though it is not a signatory or party to the subcontract. TPB status may exist both up and down the contractual chain of a project.

TPB status carries substantial benefits. In the example above, the owner may assert claims directly against the subcontractor for breach of the subcontract, breach of warranty, negligence, or other claims arising out of the subcontracted work for the project. This allows the owner flexibility to pursue the potentially liable parties rather than having to first seek recourse from its prime contractual partner, the general contractor. These direct rights can also help avoid an economic loss rule defense by the offending party (the economic loss doctrine generally provides that a party cannot recover in negligence for purely “economic loss” – i.e., without personal injury or property damage). There are risks, however, because if not drafted correctly, a TPB clause could grant unintended rights, such as direct claims against the owner or a project lender.

“Standard” contract language is limiting on the TPB issue. The American Institute of Architects’ default forms provide that unless otherwise stated they do not create a TPB relationship and can act as a potential waiver of a party’s rights. Other construction industry contract forms don’t do much better. This often means the parties are left to the applicable law of the place in which the project is located, which can vary considerably from state to state.

Legal interpretations vary and no construction contract is standard. The oldest piece of advice remains the best: if you want something done right, do it yourself. When negotiating your next construction contract, consider adding your own TPB clause. Clarify that the upstream parties benefiting from the work have direct rights of action against downstream parties in order to equitably hold each party accountable. Protect your rights and do not leave your contracts open to default form terms and the law of unintended consequences.