Construction Contracts: Terms & Issues
By Seth Millstein, Pillar Law PLLC
- What is this? By contract, owners often require contractors include the owner as an additional insured (“AI”) on their insurance policy.
- Why is this important? If your work causes an issue that causes another party (such as a neighbor) to sue the owner, the owner can then turn around and look to your insurance, as an AI, and seek defense and indemnity from your carrier.
- Takeaway. If, for example, a contractor cuts down a neighbor’s tree by accident, and if the owner is sued by the neighbor, your contractor’s policy should kick in. This is not a substitute for “builders risk” or other policies that may protect against issues such as fires. AI coverage only kicks in if another party sues the owner and the claim relates to the contractor’s work. Typically, unless required, a contractor will not offer such coverage. If an owner requires it, first check with your carrier to see if it is possible and if so, it is difficult to refuse.
- What is this? Generally speaking, a warranty relates to what happens when the work proves to be less than perfect and the owner requests a repair. In general, an owner will want to tie the contractor’s work to a specific performance threshold. Some of this depends on how specific the work is. If, for example, it is for painting only, the PDCA has specific guidelines that the painter’s work should meet or exceed. If the work is more general (i.e. a remodel), the owner should require that it meets or exceeds one of several standards.
- Why is this important? Most consumers (and contractors) think there is an automatic “1-year” warranty on a contractor’s work in Washington. This is false. Having a strong warranty is a great way to avoid litigation though. It typically demands that the workmanship issues are addressed, at no charge by the contractor, and can hopefully allow everyone involved to perform as promised.
- Takeaway. Without a specific warranty provision, which outlines what the standard is the contractor promises to meet or exceed, an “over-eager” owner can cause unlimited call-backs, making a profitable project unprofitable.
SUIT LIMITATION PROVISIONS
- What is this? In Washington the “rule” regarding filing suit is simple for a written contract: suit must be started within 6-years from the date of substantial completion or termination, whichever is later. There is no requirement that the contract be a written contract in Washington. Typically it is. If it is verbal or oral, the limitation period is only 3-years. Most contractors will try to reduce the window for suits to 1 or 2 years. Note that this is different than “warranty” provisions, since an underlying “breach” of the contract may go beyond “warranty” issues, so this area can get confusing, quickly, for both contractors and owners.
- Why is this important? Assume the owner receives a draft of the contract from the contractor that says ‘all suits arising out of this agreement must be filed within 1-year.’ But some defects are “latent” rather than “patently” obvious, meaning some may take some time to surface. A well-counseled owner will want more time. A well-counseled builder can increase the price or offer other types of assurances. It is also important to examine and define “trigger” dates for when this 1-year period starts and if it can “restart” if the contractor performs repairs in the interim.
- Takeaway. If there is no “suit limitation” clause, then the outer window for suing under a breach of contract in Washington is likely 6 years.
- What is this? This is an amount the owner can “retain” or hold back from payment. For example, the parties may agree that, until the project is completed, the owner will retain 5% from every payment.
- Why is this important? This can allow the owner to gain leverage at the end of the job.
- Takeaway. On most “private” / remodel projects, this can be a very touchy subject for contractors, since contractors are typically not interested in allowing for the owner to withhold “retainage.” Contractors tend to believe owners will use retention as a means of finding excuses in an effort not to pay the full final amount. But, this right appears on the lien form that must be provided prior to commencement of construction, and it is therefore an option our legislature chose to inform owners of the ability to contract to withhold.
CHANGES AND CHANGE ORDERS
- What is this? The contract itself should spell out how changes will be initiated and paid by the owner. There may also be a “change order form” but the contract is the “quarterback” here, and the contract should discuss the process and it can often help if the contractor provides a “sample” change order form at the outset so that the parties know more about the process.
- Why is this important? This area is probably the area where most disputes occur, on both T&M and fixed price contracts. Owners typically request changes, but later owners will represent they did not know what the change entailed, why it would delay the project, or why it was so expensive, since — though they might have requested it – they did not budget for it.
- Takeaway. First, the clause in your contract about changes and change orders should spell out how changes are initiated, how they are priced, when payment is due and any other issues that will allow everyone to be prepared since, as they say, change happens. One final note: “change orders” are different than a “punchlist.” It is good practice for the contractor to spell out the “punchlist” procedure at the end. This allows the owner to point out issues it would like corrected (such as fixing nail pops), when the issues are “fresh.” When owners start calling in “warranties” later, contractors often assume that owners may have caused the issue (such as a scratch) and disputes can arise over the condition that the contractor left the property. For contractors and owners, best practice is to document everything during the project and particularly immediately before demobilization. Second, owners and contractors will want to make sure that the initial scope has enough detail to avoid “haziness” about what is or is not a “change.” These details should include specific information about quality, finishes, system details, tolerances, etc. Disputes, the next topic, almost always arise when the owner thinks he or she is getting a certain quality item, but the builder has budgeted something very different. Rarely are these topics spelled out with absolute specificity, but they should be. When they are not, which is where we see many disputes arise, there is an argument about whether there was a true “meeting of the minds” about various aspects of the project, leading to an expensive and “fact intensive” arbitration or trial.
DISPUTES AND REMEDIES
- What is this? The contract should spell out exactly what happens – and when – a dispute arises. How will the parties try to resolve it? The scope of this article is too general to get into specifics. But, the one key provision both parties should strongly consider including (though there are drawbacks too) is a prevailing party attorney fee clause.
- Why is this important? This should help tamp down suits. “Should “is the key word. Nothing will stop a motivated party from suing. In the absence of such a clause, and absent a statute, both parties will pay their own attorney fees, win, lose, or draw. This is called the “American Rule.” For example, if the contractor sues, claiming it is owed $12K, and the contractor gets $0, in the absence of a clause allowing the prevailing party to recover, the owner may pay $20K to defend, but get nothing back from the contractor.
- Takeaway. To the victors come the spoils, as the saying goes. But, the flip side is also true: if you lose, and you do have a clause stating the prevailing party is entitled to fees, in the example immediately above, the contractor may not only get $0, but have to pay $20K to the owners if the owners prevail.
- What is this? Indemnification would mean that, if a contractor’s employee is injured, and the employee sues you (alleging unsafe work conditions), if the contractor agrees to defend, it is then the contractor’s issue also.
- Why is this important? Indemnification is important because, if the owner had nothing to do with an injury, the owner should not be stuck defending. This can get complicated, but arises under RCW Title 51.
- Takeaway. Due to the way Title 51 is drafted, employers (contractors) are “immune” from suits by their injured employees. However, with a properly drafted indemnity clause, if the contractor causes the injury, and the owner is sued by the injured employer, the contractor will have to address it. Obviously, this is not something a contractor would offer without being asked for it by a well-counseled owner.
Seth Millstein has been practicing construction law in Seattle since 2004. He founded Pillar Law PLLC in 2010. Seth is the Vice-Chair of WSBA’s Construction Council. Together with Kerry Lawrence, Pillar Law primarily represents owners, contractors, suppliers and trades dealing with a range of construction matters.