Construction contracts and risk mitigation

Submitted by digital on Thu, 09/10/2015 - 18:32
{"version":"0.3.0","atoms":[],"cards":[],"markups":[["strong"],["em"],["a",["href","http:\/\/","target","_new"]],["a",["href","http:\/\/\/2015\/09\/commercial-finance-701-construction-contracts-and-risk-mitigation\/","target","_new"]]],"sections":[[1,"p",[[0,[],0,"A commercial construction project is a multifaceted venture. The numerous parties, erratic pricing of materials, potential for defects, unpredictable local governments, tight profit margins, and vital financing all contribute to a challenging project. The parties need a well-drafted construction contract."]]],[1,"h3",[[0,[],0,"The Process"]]],[1,"p",[[0,[],0,"Reaching the point of actually needing a construction contract can be exhausting. Necessary steps include site selection, design concepts, plans and specs, value engineering, pricing, revisions, bidding, delays, and loan negotiations. Deal fatigue may set in even before the first draft construction contract hits the table. Stale bids, a slipping projected timeline, and resolute desire to break ground all may lead to a perilous rush to sign a contract. Our advice? Slow down."]]],[1,"h3",[[0,[],0,"What Could Go Wrong?"]]],[1,"p",[[0,[],0,"What could go wrong? In a word \u2014 everything. Improper zoning. Cost overruns. Boundary line disputes. Plans and specs revisions. Insufficient utility capacity. Delayed COs. Insolvency of a major player. Defaulted leases. Interest rate moves. Material shortages. Natural disasters. Lack of loan approval. An untimely recession. Construction is challenging."]]],[1,"p",[[0,[],0,"While the probability of any one particular thing going wrong isn\u2019t very high, the incident rate of one non-specific thing heading south approaches a near certainty. Generally, due diligence reduces risk and helps the parties avoid the untimely discovery of problems. Even without a lender\u2019s insistence, a developer should obtain a survey, title and zoning reports, soil borings, and utility company will-serve letters."]]],[1,"h3",[[0,[],0,"The Construction Contract"]]],[1,"p",[[0,[],0,"Now for the construction contract. The purpose of any contract is simple \u2013 to assign rights, duties and responsibilities and to provide specificity so as to reduce the risk of a misunderstanding. In the construction world, an ounce of prevention forgoes a ton of grief and attorneys\u2019 fees."]]],[1,"p",[[0,[],0,"Competing forms, in various degrees of neutrality, are ubiquitous. The American Institute of Architects publishes a frequently used series of contract documents, which it self-describes as \u201cThe Industry Standard.\u201d These architect-friendly documents leave little unsaid. One example is the AIA\u2019s A102-2007 form, known less succinctly as the \u201cStandard Form of Agreement Between Owner and Contractor where the basis of the payment is the Cost of the Work Plus a Fee with a Guaranteed Maximum Price.\u201d This 23-page contract incorporates by reference the 57-page ancillary A201-2007 General Conditions of the Contract for Construction, which contains a treasure-trove of detailed contract provisions."]]],[1,"h3",[[0,[],0,"Nuances and More"]]],[1,"p",[[0,[],0,"Aside from the obvious problem of contract nuance, some of the more critical issues stem from seemingly obvious provisions."]]],[1,"p",[[0,[0],1,"The Parties."],[0,[],0," Is the contracting party the same party with whom you have been negotiating? For good reasons, a developer might form a single purpose entity (SPE) for a transaction. A construction company might have specialized subsidiaries. Each entity could have a different performance record, net worth, bonding capacity, and ownership. Know your contracting party. XYZ Contractors, Inc. and XYZ Construction, LLC. aren\u2019t the same company."]]],[1,"p",[[0,[0],1,"Details."],[0,[],0," Do you have finalized plans and specs and a detailed budget? A contract that postpones finalization of key elements is more like a contract to contract and an open invitation for acrimony in the form of a biting change order. If the details are not finalized, you may be getting the cart before the horse."]]],[1,"p",[[0,[0],1,"Pricing and Scope."],[0,[],0," Typical pricing options include stipulated sum, cost plus, and the aforementioned GMP contract. Each involves a shifting of price risk, which naturally is factored into cost. This focal election necessitates a full understanding of the scope of the project. What is not included? Is this a turnkey project?"]]],[1,"p",[[0,[0],1,"Timelines."],[0,[],0," Read carefully the provisions on \u201ccontract time\u201d to \u201csubstantial competition.\u201d High-fives at contract execution can turn into clinched fists after the project misses a critical date. What if the opening of a new hotel in a football powerhouse college town slips from late August to mid-November?"]]],[1,"p",[[0,[0],1,"Retainage \u0026 Payments."],[0,[],0," Retainage is the portion of a payment held until work is substantially complete. Contractors hold retainage on subs. Developers hold retainage on contractors. Lenders hold retainage on developers. A comprehensive contract describes in detail the progress payment procedure. Retainage and payment provisions in a construction contract and loan agreement often differ \u2013 but shouldn\u2019t."]]],[1,"p",[[0,[0],1,"Payment \u0026 Performance Bonds. "],[0,[],0,"In the AIA series, a brief section at the end of the form references bonds. The placement and brevity of this section belies its importance. A developer, who foots the bill, tends to be less interested in a payment and performance bond than a lender. A payment bond, which grants payment rights to first and second tier subcontractors and materialmen, will go a long way in protecting the property from liens."]]],[1,"p",[[0,[0],1,"Law \u0026 Venue."],[0,[],0," Consider that innocuous law and venue provision with care. Do you really want to litigate in another state?"]]],[1,"h3",[[0,[],0,"Two Big Issues"]]],[1,"p",[[0,[0],1,"Timing."],[0,[],0," If we had to pick one \u201cwildcard,\u201d it is timing. Delays can be problematic and expensive. Depending on how many of the proverbial project ducks are in a row at the contracting stage, the adequacy of the contingency component may need special scrutiny."]]],[1,"p",[[0,[0],1,"Change Orders."],[0,[],0," Change orders are a fact of life. Still, executing a contract prematurely with the plan to change something is fraught with issues. Changes could ripple through cost estimates, timeline and permits. Also, substantive changes will likely require the consent of the bonding company and lender."]]],[1,"h3",[[0,[],0,"Non-Print Can Be Pitfall"]]],[1,"p",[[0,[],0,"While the fine print is important, the non-existent print can be devastating. What wasn\u2019t addressed? Using an industry standard contract may help eliminate that question."]]],[1,"p",[[0,[],0,"Naturally, the topic of construction contracts is considerably more complicated than we\u2019ve discussed. And we haven\u2019t even addressed subcontracts. The goal is to avoid a construction dispute by prudent planning and painstaking drafting. As Albert Einstein noted, \u201cIntellectuals solve problems; geniuses prevent them.\u201d"]]],[1,"h3",[[0,[],0,"About the Authors"]]],[1,"p",[[0,[1],0,"Ben Williams and Molly Jeffcoat Moody are attorneys in a commercial law practice at "],[0,[2],1,"Watkins \u0026 Eager PLLC"],[0,[],1,". Williams and Moody are both recognized by Chambers USA and Best Lawyers in America. Williams was selected as Best Lawyer\u2019s 2016 Project Finance Lawyer of the Year in Jackson, Mississippi."]]],[1,"p",[[0,[],0,"This article originally ran in the "],[0,[1,3],1,"Mississippi Business Journal"],[0,[],1,"."]]]]}
Commercial construction project is a multifaceted venture. The parties need slow down and create a well-drafted construction contract.
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