Projects Success can Lie in the Contract's Details
By: Robert (Bob) H. Voelker
Dallas Business Journal
June 18, 2007
Construction contracts are frequently treated like step-children at the end of the development process -- a necessity but a nuisance.
Contractors and architects typically want to use a standard American Institute of Architects construction contract with very few revisions. Agreeably, the AIA contract is familiar to all the parties and has wide industry acceptance. However, experienced developers understand the adage that money is made in development but lost in construction. As long as the construction process proceeds as planned and there is an open working relationship with the contractor, form or "boilerplate" construction contracts work well, but when a project goes sideways or faith in the contractor is lost, time spent up-front in attending to construction contract details puts the owner in a much stronger position to proactively resolve construction problems.
The top five owner areas of concern in negotiating construction contracts are:
- Delivery of the project on time. If the project is delayed, the owner faces loss of tenants or end buyers, subcontractor cost increases, additional interest carry and loss of rate of return on equity. Owner delays and force majeure (unexpected or uncontrollable event) delays need to be narrowly tailored to cover only those areas where the owner should be responsible. Weather delays need to consider local weather patterns and should only affect the project schedule if the delays affect the critical path of construction.
In addition to a final completion date, the project schedule should contain interim milestones to keep the contractor on pace to meet the final delivery date, allowing interim steps to accelerate construction if the contractor falls behind. - Delivery of the project on budget. Managing cost overruns is critical to the economics of the transaction. The schedule of values (budget) for the project should be attached to the construction contract and should contain a detailed breakdown of development costs in the same format and detail that the owner and the lender will require for construction draws. The contractor's general conditions (basically the contractor's overhead) line items should be detailed by categories and the contractor's supervisory staffing for the project should be broken out person-by-person.
The schedule of values should provide a methodology for determining percentage of completion of the work to avoid arguments between owner and contractor as to the progress of the project and the amount to be paid to the contractor. - Inclusions/exclusions from cost of the work. Construction involves a long list of cost factors, from hard costs (materials, labor) to soft costs (supervision, home office accounting). Determining what can and can't be charged to the project is pivotal to the overall project budget.
Some of the issues that arise:
When does a delay in construction result in the contractor no longer being entitled to charge additional general conditions to the job ( the contractor bears its own overhead for the delay)?
To the extent the development experiences savings, how does the owner monitor the addition of supervisors to the job so that the contractor does not allocate its corporate overhead costs to absorb the owner's share of savings?
To the extent that the contractor is assisting subcontractors in providing bonding or insurance on the project under the contractor's bonding or insurance policies, what charge can the contractor make to the project and how is this charge impacted by end of the job insurance/bonding audits and rebates to the contractor? - Change orders. Determining proper cost of work items and having a detailed project budget reduces, but does not entirely eliminate future change orders. A change order process should be clearly outlined in the construction contract and the contractor profit percentage for change orders should be determined. The process should provide for a line item budget of each proposed change, along with supporting documentation from subcontractors and suppliers, and require owner approval and architect review for consistency with the plans and specifications before the contractor can start the work.
- Use of contingency. The contractor has a duty to review the project site, environmental reports, soil reports and the plans and specifications to become familiar with the site and the scope of work. The construction contractor should represent that it has evaluated the nature and location of the project site, the general and local conditions and limitations under which the work is to be performed. The contractor also should evaluate the equipment, facilities, manpower, materials and services necessary to complete the work based on the construction schedule and the quality of the work. The contractor also should state that it has made diligent inquiry of the architect and other design professionals in establishing the contract price and schedule.
These affirmative statements will assist in reducing change order claims and requests for use of the contingency based on unforeseen circumstances. The contingency should then be available for such items as concealed conditions, unforeseen costs of the work, gaps in scope and errors in performing the work that were not caused by the contractor's or subcontractors' failure to properly investigate the work and the site.
Negotiations with the contractor will occur over whether other items should be covered by the contingency.
The relationship between owner and contractor is a marriage, where both parties have to learn to compromise and get along to accomplish common goals -- and like marriages, most disputes are over time and money.
Addressing the areas outlined above will reduce strain on the owner/contractor relationship and provide the owner with solid tools to manage the time and cost of the project.
