There are several big things in construction contracts that can get you into trouble if you do not know what to look for. Knowing what you are signing can be the difference between a very successful project and costly litigation — or worse. Because your bond company is guaranteeing the performance of your contract, they will also be very interested in the terms that you commit your company to. Watch out for these five contract clauses that can hurt your balance sheet.
Contractors should be very concerned with Consequential Damages clauses. These clauses make it difficult to evaluate your risk. Consequential damages are usually much larger than the contract itself, leaving your company with an inappropriate level of risk. Instead, the contractor should insist on a mutual waiver of consequential damages clause for any delay. It’s important to note that if the contract is silent on damages, consequential damages could still be assessed. A better alternative is a liquidated damages clause for delay because it allows you to calculate and fairly asses your risk.
The construction market changes quickly. Ask any contractor who survived the last recession. Guaranteeing a project for the long term is not something you or your bond company should want to do. Performance bond companies routinely see warranties of 2 years or less but will carefully scrutinize any warranty longer than 3 years. Additionally, long term guarantees on equipment or materials should be passed back to the supplier and not guaranteed by the bond.
Contract Termination Without Cause
If you are like most companies, a premature shutdown of your project will be costly. Not only will it cost you time, resources, profit and bond capacity that you committed to this job, but it will cost you time and resources to find work to replace the project. A much better solution would be to negotiate termination for specific causes (i.e. performance).
One word can be the difference between success and financial disaster. There have been no shortage of contractors burned by “pay if paid” language in contracts. The alternative is the “pay when paid”. Courts assume that “pay when paid” is a timing mechanism and the contractor will eventually be paid. This is not the case in “pay if paid” when the contractor assumes the ultimate risk of non-payment by the owner. Many states have made these provisions unenforceable as they are against public policy. Unfortunately Missouri and Kansas are not included in those states. These clauses are enforceable when written correctly. Contractors should always ask for evidence of owner financing and ask that any “pay if paid” clause be changed.
Flow down clauses are common in construction contracts and applies mostly to subcontractors. The purpose is to bind subcontractors to the same terms and responsibilities that the general contractor has with the owners. In reality, this makes a lot of sense and should be expected. However, we are seeing some troubling trends in the industry. First, we have seen that some general contractors are reluctant to share their contract with the owner and this is understandable. However, if the contract contains flow down clauses, you should always get a copy and review the contract before signing your contract. Otherwise you may find out later that you agreed to something you wished you had not. Secondly, be wary of any flow down provision that incorporates not only your scope of work but also includes the terms and conditions of the relationship with the owner and other parties. This could include many provisions such as financing, indemnification, design exposure and many agreements that may be unacceptable.
Construction can be a risky business and it’s virtually impossible to remove all risk. As a practical matter, almost every job will have certain terms that are unfriendly to contractors. However, it’s important to know your risks before signing a contract and to protect your company from unacceptable obligations. There are many good resources available to help identify these risks including your broker and construction bond company. When in doubt, consult an attorney. Although expensive, the upfront cost will seem slight in comparison to the cost to litigate later.
See more about performance bonds here.