A well-drafted construction contract clearly sets out the work to be done, the price to be paid for the work, and the terms and conditions of payment. The contract should also allocate various foreseeable risks between the parties. When the parties allocate a list of potential risks, the contract becomes longer, but it reduces the potential for disagreements in gray areas that are not addressed, assuming that both parties take the time to read and understand the lengthy document. Of course, failure to read a written agreement is not a valid defense.
Because the subject of contracts is covered in depth elsewhere, the fundamentals of contract law are not addressed here, but contractors should be aware that all of the requirements of basic contract law must be met for a construction agreement to be valid. This article focuses on construction-specific applications of contract law.
Construction contracts are often formed through the bidding process. The owner requests a quote or issues a more formal request for proposals, and contractors wishing to perform the described work respond with the price that they would charge. The contractor’s bid constitutes a binding offer, which if accepted, results in a legally enforceable contract. The acceptance of a bid is generally referred to as an award of the contract.
In the case of private construction contracts (as opposed to government contracts), the property owner requesting bids is generally free to accept or reject any bid, regardless whether the bid is the lowest or most responsive one. In the case of public contracts, however, the bidding process must follow strict rules set forth in federal, state, and local laws and regulations.
Construction contracts consist of terms of agreement ranging from price and description of materials to be used to an agreement that any disputes will be resolved through arbitration. Courts are reluctant to imply terms that are not expressly part of the contract, but courts may look to local custom if the contract is silent on a disputed material issue.
- Example: Under local custom, the contractor had to obtain a certificate of occupancy before final payment. But the written agreement in question had no clause requiring the contractor to furnish the certificate of occupancy. The court found that the local custom was part of the agreement by implication.
Parties to a construction contract generally select from one of several traditional methods by which the contract is priced. The following are among the most common:
- Lump sum. The owner agrees to pay a specific dollar amount for whatever is required to complete the job, such as an agreed fixed fee of $3,306 to install a new hardwood floor. If the contractor makes a mistake in the estimate for labor or materials, the contractor bears the loss.
- Unit price. The contract is priced by the number of units delivered multiplied by a set rate per unit, such as an agreed rate of $6.39/square foot for installing a hardwood floor. Contractors bear less risk under unit price contracts because an error in estimating the size of the job does not stick the contractor with overages.
- Cost plus a fee. Under this arrangement, the contractor agrees to keep records of the costs for labor and materials. The owner agrees to pay for all the submitted costs plus a markup, which can be expressed either as a percentage or as a lump sum, such as an agreement that a contractor will install a hardwood floor and charge the actual cost of the materials plus 35%.
If there is a dispute regarding the price, courts will first attempt to determine which type of pricing scheme the parties agreed to use, determine which party assumed risk of error or contingencies, and finally determine which party bears financial responsibility.
Ten Things to Think About Before Signing a Contract
At some point, you will probably find yourself wondering whether you should really sign the contract in front of you. If you order items from a door-to-door sales representative, hire a contractor for a home improvement project, or go to work for someone as a consultant, you will be faced with a document that is designed (hopefully) to protect both you and the other party. Ideally, a contract allows the parties to define, in specific terms, the extent of their obligations to each other relative to the delivery of products or services and payment terms. When the contract is signed, it generally cannot be changed unless both parties agree. Consequently, it is important to protect yourself prior to signing a contract by understanding exactly what it is you are committing yourself to. Use the following list as a general guide. Make sure that contract terms are workable for you. If they are not, attempt to negotiate terms that are more reasonable.
- Time Frame. The agreement should have a time frame if any aspect of your transaction will occur in the future. If you are the party delivering the services or goods, make sure that you are allowing yourself enough time to complete the job. If you are the party receiving the goods or services, make sure that the delivery schedule conforms to your needs. If you want to contract for month-to-month services, make sure that you are not signing an agreement that obligates you for a longer period.
- Prices. The agreement should clearly state prices. Be wary of additional charges that you have not discussed with the other party. For example, when you contract with a professional, you will often be quoted an hourly rate that will not include additional charges for things like photocopying and postage. Make sure you know what the additional fees are and ask for an estimate.
- Payment Method. Determine the terms of payment and whether it is appropriate to your financial situation. For example, the contract may call for payments at the end of the month when the majority of your bills are due. You may also be able to negotiate installment payments if you cannot afford a lump sum.
- Payment Penalties. Determine whether there are late payment penalties and if they are reasonable.
- Material Terms. If you and the other party have an understanding about the goods or services, make sure that the particular terms are in the contract. For example, if you have agreed to make a collection of dresses out of silk-like polyester, then it should be in the contract. This will help you make your point should the buyer demand that the dresses were supposed to be made of silk.
- Transaction Rules for Particular Industries. Particular industries have rules by which transactions are governed. If you see something in a contract that makes an assumption of following a particular industry procedure, but doesn’t set out the procedure in the contract, make sure you know what the industry procedure is before you sign.
- Inability to Agree. If you need to have work started immediately, but cannot come to an agreement on the final terms of an agreement, you need to make sure that you are signing a contract that is not going to be enforceable as a permanent agreement. You can accomplish this by adding language such as:
- This interim agreement is in effect only until a more permanent agreement can be negotiated by both parties.
- Resolution of Anticipated Disputes. No matter how careful you are or how good your relationship with the other party, a dispute may arise. Many contracts include an arbitration clause, which means that a dispute must be settled in arbitration as opposed to in court. Arbitration is generally less costly and less formal than court, but if you sign the contract with the clause intact, you have probably waived your right to take the matter to court.
- Anticipated Problems. The party with whom you are contracting may have had prior experiences that have led it to add particular methods of resolution to the contract. Those ideas may be perfectly agreeable, but they could also be unfairly beneficial to the other party. Analyze whether these terms will benefit you.
- Attorney’s Fees. Determine whether you will be charged for the other party’s attorney’s fees if you breach the contract and lose the case that will probably arise to enforce it. If you are prone to breaching contracts, this is the kind of clause you should avoid.
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