The US has three branches of government: judicial, legislative, and executive. Each branch contributes to the body of law governing design and construction contracts. Those main sources of law are common law, statutory law, and regulatory and administrative law, described below. A construction project may be subject to different laws, depending upon, among other conditions, whether the project is private or public, the jurisdiction in which the project is located, and the nature of the project.
Common law, created by the judicial branch of government, consists of published decisions made by courts and certain other tribunals deciding disputes between parties. A judge charged with deciding a case is obligated to employ the same reasoning as previous judges who sat in superior courts within the same jurisdiction as the current case is being heard and must reach a decision consistent with what was decided in those former cases (decisions in cases that are not superior or are outside the jurisdiction may be persuasive but are not binding). This method of deciding a case, called stare decisis, creates a unified body of law referred to as common law.
Statutory law, created by the legislative branch of government, consists of laws made by legislatures at the national, state, and local levels. The resulting laws are referred to as statutes. A group of statutes on the same topic, for example, design or construction, can be grouped or arranged together, resulting in a ‘code’ or an ‘act’.
A legislature can create statutes for a multitude of reasons, including: to create new law; to change existing law; to supplement existing law; to shape emerging law, including law made by another branch of government; or to codify common law. If a dispute arises involving a statute that the parties cannot otherwise resolve, a judge from the judicial branch of government will interpret the statute and resolve the dispute based on common law.
Regulatory and administrative law, created by the executive branch of government, consists of rules and regulations made by governmental agencies at the national, state and local levels. The relationship between regulatory/administrative law and common law is similar to the relationship between statutory law and common law. If a dispute arises that the parties cannot otherwise resolve, a judge will interpret the rule or regulation and decide the dispute based on common law.
Last modified 22 Mar 2024
Professional and other licensing and permit requirements vary widely from state to state in the US. Moreover:
This is a highly detailed and regulated area of law that not only depends on the jurisdiction, but on the nature of the project being undertaken (eg construction of a facility, engineering of public works), the entities involved (eg individual, corporation, partnership), and the type of work being performed.
As only a very broad and generic overview, examples of licenses and permits that an engineer or contractor may be required to obtain to carry out construction work include:
Generally, an engineer or architect must possess a professional license to render services within the state where the project is located. In order to obtain the required license, the engineer or architect generally must attain a certain level of education, satisfy requirements for experience in the field, pass state-administered licensing examinations, and satisfy other requirements, such as residency, ethics and fee requirements.
Although not every state requires that a general contractor be licensed, several states have requirements that must be met. For example, a general contractor might be required to meet certain educational requirements, possess certain experience, and/or take and pass certain tests. This is critical because in some states unlicensed contractors are deemed to have forfeited any right to bring a legal action seeking payment for work performed and/or may be required to return all payments received for work on the project. However, even where such licensing is not required, a contractor likely will have to register to do business as a domestic or foreign corporation with the secretary of the state in which the project is located, obtain a tax identification number from the agency or agencies that collect state and municipal taxes, and procure a local business license.
Trade contractors may have to be licensed or registered, obtain bonding, or register with certain authorities. These requirements are particularly relevant to mechanical electrical and plumbing (MEP) contractors, those handling asbestos or other hazardous materials, or trades that require the handling of explosives etc.
The Federal Acquisition Regulations (FAR) serve as the primary regulations for US federal agencies acquiring services and supplies. FAR does not include any blanket federal authority that allows a contractor to perform work in a jurisdiction where it does not have a relevant authorization. According to FAR, the US federal government places the burden and expense upon contractors to obtain all necessary authorization to perform the work, including any authorization applicable in the state or other jurisdiction where the federal project is located.
Last modified 22 Mar 2024
The main agency in charge of enforcing federal safety and health legislation is the Occupational Health and Safety Administration (OSHA) in the US Department of Labor. Congress created OSHA to assure safe and healthful working conditions for working men and women by setting and enforcing standards and by providing training, outreach, education, and assistance.
The regulations and safety standards, known as the Occupational Safety and Health Act of 1970 (Act), regulate health and safety in the workplace. Some of the areas addressed by the Act with respect to construction are:
In addition, the federal Advisory Committee on Construction Safety and Health (ACCSH) has been in place almost 40 years to focus on construction standards and policy matters affecting federally-financed or assisted construction.
The US Environmental Protection Agency (EPA) also is charged with protecting human health and the environment and has promulgated many requirements and protections for the safety of workers on construction sites as well as those occupying buildings after construction. To name just a few, regulations include the discovery, handling, and remediating of hazardous materials on a site, the kinds of materials used in construction, pollution prevention, providing for storm water and drainage, and sustainability guidelines.
Both OSHA and EPA regulations address workers constructing buildings and occupying buildings. In addition to OSHA and the EPA, which are federal, most states also have enacted safety regulations. Safety regulations also can be and are promulgated at regional and local levels through codes, ordinances, rules, and regulations by other governing bodies.
Last modified 22 Mar 2024
Air quality is protected at the federal level by a wide range of legislation, the most prominent of which is the Clean Air Act enforced by the US Environmental Protection Agency (EPA). The Clean Air Act regulates, among other things, air emissions, acid rain, ozone depletion, toxic air pollution, and auto gasoline. With respect to construction, compliance with relevant standards of the Clean Air Act is meant to reduce construction-related health risks.
Air quality regulations also are promulgated at the state and local levels, such as laws common to many states prohibiting smoking in public areas or local ordinances prohibiting the burning of certain materials, including construction debris.
Water quality is protected at the federal level by a number of agencies and the military, including the
Depending on the site or type of construction, the regulations of any of these entities might be applicable.
Federal legislation addresses several issues that might be relevant to a construction project, including the integrity of the water supply, protection against flood and hurricane damage, pollution, surface and ground water, sewer discharge, levees, environmental restoration, protection of wetlands, dredging and filling etc. Specific legislation includes the Water Resources Development Act, the National Levee Safety Act, and the Flood Control Act. In addition, many individual states have similar legislation further protecting their own lakes, rivers and harbours.
A wide range of federal, state, and local legislation controls the generation, transportation, and disposal of waste, including hazardous waste and construction and demolition debris. The US Environmental Protection Agency (EPA) regulates hazardous waste, and the US Department of Transportation regulates the transportation of hazardous waste.
States are becoming active in legislating the generation, handling, and removal of demolition and construction debris, with a focus to reduce, reuse, or recycle it rather than place it in landfills. For example, CALGreen, a building code focusing on sustainability that was enacted in California requires the recycling of 65% of construction waste and in some instances the submission of a construction waste management plan or the utilization of a waste management company.
Both mandatory and voluntary sustainability building requirements are being legislated at state and local levels, including CALGreen in California (described immediately above). While 65% recycling of construction waste is mandatory under CALGreen, a higher percentage is preferred but voluntary. In addition, certifications evidencing sustainable green construction are available from third parties, including several universities. Perhaps the most well-known is LEED (Leadership in Energy and Environmental Design) offered by the US Green Building Council, which uses a rating system to certify a newly constructed or rehabilitated building as a sustainable green building.
Last modified 22 Mar 2024
Development incentives and infrastructure support provided by local authorities and utilities vary by jurisdiction and often, within the same jurisdiction, can differ from project to project based upon local need and other market forces. Counsel in the US can assist in assessing incentives or other arrangements available for a specific project.
Last modified 22 Mar 2024
Yes, numerous provisions are or can be implied in design and construction contracts by either case law or statute. These provisions vary from state to state; however, a few examples of implied obligations include:
While the owner, designer, and contractor are free to agree contractually on the standard of care by which the work will be performed, in most cases a standard of care will be provided by statute or common law if the construction contract is silent. While most implied standards will differ in some respects from state to state, the standards are reasonably similar and in some manner require proper workmanship or skill ordinarily used by members of the profession.
Setting forth the standard of care in the contract could be of benefit to either the owner or the design professional or contractor, depending on the standard of care agreed to and other circumstances. On the one hand, an owner may be able to negotiate a higher standard of care than common law or statute would provide. On the other hand, once agreed to by contract, the design professional or contractor may be able to avoid implied warranties that could heighten a standard of care or even punitive damages that could be awarded were the contract silent.
A design professional generally has a duty to design the project in accordance with applicable building codes.
Most US states (but not all) obligate the parties to a contract to act in good faith. The obligation of good faith also has been incorporated into the Uniform Commercial Code. Simply put, the covenant of good faith requires that people deal fairly with another.
Even in states where good faith is not universally implied in commercial contracts, a state may require good faith in specific instances. For example, a contractor may be obligated to comply with building codes, even though such compliance is not an express obligation in the contract.
Common law may, in some jurisdictions, allow a contractor additional compensation and/or time when encountering hidden, unexpected conditions on a construction site that a contractor should not have been able to discover during its examination of the site. The contractor may be entitled to additional compensation and/or time under certain circumstances even if the contractor agreed to perform the work for a lump sum, guaranteed a not-to-exceed price, or guaranteed a completion date the contractor cannot meet because of the differing site conditions.
Lien rights are provided by statute in all states; however, provisions and requirements vary. Stated broadly, a person who contracts to improve real property may have a legal right to encumber the property for the amount owed.
Some states require that the law of that state is applicable to any contract for construction in that state, despite the parties’ agreement otherwise.
See Limitation period.
Other provisions that may or may not be implied in a contract, depending on the jurisdiction in the United States, include copyright protection, impartiality of an architect, cardinal change, implied authority for a change order, implied contractual indemnity coverage, common law one-year corrective remedy, implied warranties of design and design adequacy, duty of cooperation, duty of disclosure, site investigation duty, duties regarding the handling and disposal of hazardous materials, implied inspection authority, doctrine of impracticability, anti-indemnity statutes, implied contractual indemnity, merchantability, strict compliance doctrine, implied warranty of habitability and consumer protection statutes.
Last modified 22 Mar 2024
The form of construction contract to use for a specific project can be selected in a multitude of ways. An architect, engineer, or contractor preparing a proposal for an owner may present the owner with a form document to consider. In those cases, the owner then may ask its lawyer to review and revise the document as appropriate. A proactive owner, however, may prepare a form of contract, preferably before the owner seeks bids, and then include that contract with a request for proposals. Owners that construct projects regularly may have their own original manuscript forms of contract, rather than relying on published forms.
Standard forms of contract are published and sold in the US by organizations associated with the construction industry. Among the most popular are the following:
AIA documents are by the American Institute of Architects. The AIA forms of agreement are the most widely used and the most heavily critiqued in the United States. Prepared by a professional association for architects, some perceive that the AIA forms allocate risk in favour of the architect and to the detriment of the owner. As a result, the AIA forms are generally modified by the parties before execution. The AIA provides a multitude of form contracts, however, they are most often used for general building and not heavy construction.
EJCDC documents are by a group comprised of the American Council of Engineering Companies, the National Society of Professional Engineers/Professional Engineers in Private Practice, and the American Society of Civil Engineers-Construction Institute. The EJCDC documents are most often used by construction projects driven by professional engineering, frequently called ‘horizontal’ projects.
ConsensusDOCS were created by a group comprised principally of general contractors and subcontractor groups, although they have been endorsed by some other groups. The ConsensusDOCS appeared in 2007 and purport to represent a consensus by all of the parties to a construction project, including those concerned with the allocation of risk in the AIA documents. ConsensusDOCS promote themselves as the successor to the Associated General Contractors of America documents.
FIDIC document are by the Fédération Internationale Des Ingénieurs-Conseils. Although well-known internationally, FIDIC forms of contract are rarely used in the United States.
Last modified 22 Mar 2024
Depending on the type of project, and the project delivery method selected by the owner, the main parties to a construction or engineering contract include the following:
A party who owns or develops a project, engages parties to design and construct the project, and compensates those parties for their services and work.
A party engaged by the owner to design the project. An engineer is required to design and engineer specialized projects, such as public works (eg bridges, highways) or plants (eg manufacturing facilities, utilities).
A general contractor is a party engaged by the owner to construct the project. The general contractor typically hires subcontractors to perform and complete separate parts of the project. Those subcontractors, in turn, may hire sub-subcontractors to perform a portion of the part of the project for which the subcontractor is responsible. A phrase commonly used to describe the subcontractor and its sub-subcontractors is ‘subcontractors of any tier’.
A party engaged by the owner to design and construct the project. A design-builder takes responsibility for both the design and construction functions, either with respect to the entire project or a portion of the project.
A party engaged by the owner, architect, engineer or contractor to render professional assistance regarding a particular aspect of the work. For example, an architect might hire a specialty engineer; a contractor might hire a remediation consultant; a design-builder might hire an MEP (mechanical-electrical-plumbing) engineer; an owner might hire a construction manager to oversee the entire project or a professional to provide expertise regarding a specialized project, such as a water park, golf course, or manufacturing facility. Several consultants may render professional services on a single project, each engaged by and responsible to a different party.
An entity from whom materials are obtained that will become part of the project; for example, those who supply the steel, cement, wood, glass, tiles, and electrical and plumbing fixtures.
While not parties to the design or construction contract or any subcontract, the following are key parties in the process:
An entity providing funds to the owner for the project, which funds the owner must repay. Depending on the size of the project, a single bank or a syndicate of banks could loan the owner funds.
The lawyers assisting each of the parties above with the negotiation and drafting of the contracts. In order to avoid a conflict of interest, a lawyer may only provide advice to one of the parties. Legal advice also may be provided for legal issues arising while the project is being constructed, such as delays, labour issues, or defective work. Finally, legal counsel may assist a party should dispute resolution become necessary, for example, by negotiating with the other party or parties to the dispute or assisting with mediation, arbitration, or litigation.
The insurers who provide insurance for the project in order to assist in managing risk. Contractors generally obtain coverage such as commercial general liability insurance, workers’ compensation, employers’ liability, and vehicle insurance. Owners may obtain property insurance, referred to as builder’s risk or all risk insurance.
A guarantor of the obligations of the principal – in this case, the contractor – in the event the construction contract requires the contractor to obtain performance or payment bonds. Subject to the terms of the bond, the surety guarantees to the owner that the contractor will perform and complete the project and pay for the labour, material, and other items the contractor is obligated to pay for under the contract. In the event the contractor fails to perform its obligations, the surety becomes responsible for the losses incurred by the owner to the extent those losses are covered by the bond. The surety then is entitled to obtain reimbursement from the contractor.
Last modified 22 Mar 2024
The allocation of risk depends on several factors, including, among others, the project delivery method selected and the manner in which the contract price is calculated.
If the project delivery method is a traditional design-bid-build – whose defining characteristics include: (a) three principal participants (owner, architect, and contractor) and (b) two separate prime contracts (owner-architect agreement and the construction contract) – the general contractor is responsible for construction of the project as depicted in drawings, specifications, and other documents prepared by the architect and design team. Accordingly, the general contractor depends on the architect for the design of the project and the quality of the documents the architect prepares. The general contractor has little opportunity for input during the design process with respect to matters in which it has expertise, such as value engineering, cost estimating, constructability, construction scheduling, labour and material market analysis, equipment availability, design of specialized equipment and proprietary systems, and other similar issues.
Depending on the type of contract negotiated, the general contractor also may bear responsibility to complete construction of the project within a certain price. If the general contractor has agreed to construct the project for a fixed price or has guaranteed a maximum, not-to-exceed price, then the cost overruns (with certain exceptions) become the risk of the general contractor. Accordingly, the contractor assumes the risk of volatility in labour and material pricing. Conversely, if the contract is cost-plus, then the general contractor’s compensation is comprised of the actual cost of construction the project – whatever that cost may be upon final completion – plus a fee. In such a case, the owner bears the risk of escalating costs.
The general contractor also may assume the risk of completing the project on time and obligate itself to complete the project by a specific date or prior to the expiration of a certain period of time. Achieving completion of the project on time may be necessary for the owner to meet its obligations with respect to financing or third parties (eg future tenants in the facility being constructed), take advantage of business or seasonal cycles, otherwise generate needed revenue from the project, or limit expenses so the project remains viable. If the general contractor fails to complete the project within the agreed-upon time, then the owner may suffer losses due to the delay. Accordingly, the owner may require that the contractor guarantee the time in which the project will be completed and assume the risk if it is not. For example, the contractor could agree to pay liquidated damages, if the project is not completed by the agreed-upon date of final completion as set forth in the contract.
Another risk assumed by the general contractor arises from the architect’s limited role in the design process in a design-bid-build project (the design is completed by the architect before the project is bid or the contractor selected) and the corresponding limited remedies available to the contractor against the architect. Because the owner enters into separate contracts with the architect and the general contractor, the general contractor and architect are not in privity, ie the general contractor and architect have no contractual relationship. Lacking privity, the contractor’s remedies against the architect are limited, depending on the economic loss rule law in the US state in which the project is located. The general contractor’s only option to pursue a claim might be to bring the claim against the party with whom it has a contract – the owner.
The spectrum of a construction manager’s risks and responsibilities is wide and filled with variations. At one end of the spectrum, the construction manager operates as the agent of the owner. At the other end of the spectrum, the construction manager is ‘at-risk’ and operates similar to a general contractor.
At the ‘agency’ end of the spectrum, the construction manager does not assume the traditional risks of a general contractor. Rather, the construction manager’s role is to act as an advisor to the owner while monitoring the project. The construction manager typically will attempt to minimize the owner’s risks while at the same time expediting the process – for example, obtaining bids before the design documents are 100% complete.
At the ‘at-risk’ end of the spectrum, the construction manager bears risks similar to the general contractor in the design-bid-build project delivery method. With respect to guaranteeing a price, an ‘at-risk’ construction manager may bear additional risk because the price it guarantees is an estimate based on incomplete drawings. Methods of mitigating this risk include factoring in a larger contingency in the guaranteed price or providing an estimate when the construction management agreement is executed, with provision for a guaranteed price only after the design documents are complete.
The body of law governing an at-risk construction manager is less than an at-risk general contractor or an agent construction manager. As a result, disputes may be more difficult and more expensive to resolve.
Under the design-build approach, a single entity undertakes to both design and construct the project, providing the owner with a single point of responsibility for the entire project. The entity bearing that responsibility is often the general contractor who either has in-house design expertise or takes responsibility for subcontracting with an architect for the design. As a result, some of the risk factors that an owner confronts in the design-bid-construct approach now belong to the design-builder with whom the owner contracts; and the owner is relieved of some of the challenges that accompany holding separate and independent contracts for the construction and design of the project.
Calculating the cost of the project and preparing a proposal presents a difficult exercise for a design-builder and, accordingly, a risk. In preparing a proposal, the design-builder faces a dilemma. The design-builder is arguably best served by developing the design to a point where the design-builder is reasonably confident in its ability to predict all elements needed to produce a final design. If the design builder is comfortable with the design, reasonable projections are possible for cost, time, performance, characteristics, and other matters. Therefore, the design builder can reduce contingencies accordingly and submit a more reliable proposal.
However, the design-builder’s effort to produce a more reliable proposal consumes limited resources and is very costly. For example, the design-build project may be structured as a two-step process, with a ‘go’ or ‘no go’ decision to be made at a certain point by the owner regarding whether to proceed with the design-builder or the project. If the owner decides not to proceed, then the design-builder will not recover those costs if another party is awarded the contract or if the project is abandoned. But, the alternative of putting forth only minimal effort in preparing a proposal is a risky venture. The resulting proposal may not be responsive to the owner’s needs and, therefore, a wasted effort. Moreover, the less-developed proposal may put the design builder at risk. The design-builder has made a wager that it will be able to complete the project for the cost and time proposed, although the design-builder may not have studied the project in detail and as appropriate to make such a judgment.
Force Majeure. The term ‘force majeure’ generally refers to an unexpected event of nature or civil unrest beyond the parties’ control, such as a flood, war, strike, or storm. A force majeure clause attempts to relieve the contractor of certain of its responsibilities for time and/or price upon the occurrence of a force majeure event, generally either by extending the time allowed to perform the contract or by increasing the price beyond the limit of any guarantee.
The extent to which a force majeure clause shifts risk from contractor to owner depends on how the term is defined in a contract and the specific provisions made for force majeure. The contractor will want the term defined as broadly as possible in the contract; the owner will want to narrow the definition. The contractor will want the delay caused by the force majeure event to be compensable, ie the contractor is entitled to claim both time and money. Conversely, the owner will want the force majeure event to be excusable, ie the contractor is entitled to claim only time – and then only if the force majeure event increases the critical path of the project.
Accordingly, the contract negotiated by the parties will determine what constitutes force majeure and how it shifts risk between owner and contractor with respect to a particular project.
Last modified 22 Mar 2024
Infrastructure projects can be delivered through the traditional design-bid-build delivery system or by other delivery methods more commonly used in the private sector; however, because of funding shortfalls and long-term objectives, methods used for private projects are not always viable or efficient in the public sector. Consequently, the public sector sometimes turns to more innovative approaches for the delivery of infrastructure projects, this often takes the form of public-private partnerships, sometimes referred to as ‘PPP’ or ‘P3s’.
Some of the first canals and commuter rail lines in the United States are examples of the private sector delivering infrastructure projects. Nonetheless, the P3 approach has been slow to catch on in the United States, and the US presents somewhat of an emerging market for public-private partnerships. P3 transactions are difficult to assemble and implement in the United States, even under the most favourable of circumstances. Moreover, P3 transactions are more common for major public improvement projects, which often:
In order to encourage the use of P3 transactions in the United States, the federal government has established programs to encourage the use of P3 transactions by making low-cost financing available for such transactions. Some of the more commonly used initiatives are:
Finally, although a collaborative endeavour with the private sector, a P3 transaction is a public-sector procurement. Therefore, another consideration is that the P3 remains subject to whatever rules govern the public entity in its procurement of improvements. A public entity cannot proceed with a P3 transaction unless the applicable statutory or legal framework allow procurement of a project by such a method. At this time, 37 states in the US, the District of Columbia, and Puerto Rico have enacted some sort of legislation to allow public-private partnerships. While initially limited to toll roads, P3 transactions now include power, water, light rail, airport, and government building projects.
Last modified 22 Mar 2024
Yes, parties can enter into a ‘fixed price contract’, often referred to as a ‘lump sum’ or ‘stipulated sum’ contract, for performance and completion of the construction work. However, although the price is fixed, the lump sum amount might be increased for certain reasons, including additional work that the owner would like the contractor to perform, differing site conditions (see Limitation period), or force majeure (see Allocation of risk).
Additional work causing an increase to a lump sum contract likely would be performed pursuant to a ‘change order’, which is an amendment to the contract signed by both owner and contractor providing for the additional work. Change orders should describe the change in the work and state any change in compensation or time as a result of the changed work.
In a lump sum contract, the contractor generally takes the risk of increases in the cost of labour and materials, but also benefits in the event of any decrease. In such a case, fluctuations in price or the labour force will not change the lump sum amount.
Absent the ability to add to or reduce the scope of work (and thereby increase or decrease the lump sum amount), an owner would not be able to make any material change to the project after execution of the contract, which is often too rigid for most owners. Thus, fixed price contracts generally have some mechanism where compensation can be changed under certain circumstances.
Last modified 22 Mar 2024
Each party to a design or construction contract should always confer and obtain advice from its own risk manager or insurance agent regarding the types and limits of insurance that will best protect the risks with respect to each project. Architects generally carry professional liability insurance. Both architects and contractors carry the following types of coverage:
In addition to the above, other requirements with respect to insurance may be desirable. Examples include:
Last modified 22 Mar 2024
Common forms of bonds that protect various parties to the construction process are performance bonds, payments bonds, and lien bonds. A contractor can post a performance bond whereby a surety guarantees to the owner that the contractor will complete the construction work. A contractor also can post a payment bond whereby a surety guarantees that the contractor will pay its subcontractors and suppliers. A lien bond protects the owner’s property from mechanics liens.
The contractor’s surety, however, not only shares some of the obligations of the contractor but also has the right to assert some of the contractor’s defenses. For example, if the owner does not pay the contractor and, in turn, the contractor does not pay the subcontractor, then the surety can assert owner’s lack of payment as a defense to the obligation to under the bond to pay the subcontractors.
A guarantee by a parent or holding company may be desirable, if the assets against which a party to the contract would make a claim are held by that parent or holding company.
Last modified 22 Mar 2024
Several payment methods exist in order to compensate the above-described parties. Some of those methods are described below.
For contractors and subcontractors, the most common payment methods are lump sum, cost plus a fee, and cost plus a fee with a guaranteed maximum price (known as GMP or GMAX):
Under a cost plus fee arrangement, the owner pays the contractor for the entire cost of the work, including, without limitation, the cost of engaging workers (including employee benefits), equipment, materials, supplies, supervision etc. The owner also pays the contractor a fee representing the contractor’s profit and other items, such as office overhead. The fee can be a percentage of the cost of the work or a lump sum. If the fee is a percentage, then the fee generally will increase or decrease as changes are made to the scope of the work through change orders or construction change directives (see variations). If the fee is a lump sum, then any additional fee will have to be provided for in the change order or the construction change directive.
A guaranteed maximum price is the cost plus a fee compensation structure (immediately above) but with a not-to-exceed price guaranteed by the contractor. If the cost of the project exceeds the guaranteed price, then contractor must complete the project and bear responsibility for such excess costs. If the cost of the project is less than the guaranteed maximum price, then the difference between the guaranteed price and the actual cost becomes savings and may be shared in an agreed-upon proportion between the owner and contractor.
Variations exist on the above as well. For example, under the cost plus a fee, the contractor might agree on a not-to-exceed price for the general conditions costs. Under any of the above methods, the contractor might agree not to charge a fee for changed work unless the changed work exceeds a certain dollar amount. In such a case, the contractor might agree that it is not entitled to a fee until the dollar amount of change orders exceeds a specific collar amount (called a ‘fee holiday’ or ‘dead band’).
A schedule of values also may be used to determine that payment remains on course during course of the construction loan. In such a case, a schedule of values listing the trades and other activities on the Project is made, together with the amount then due such parties.
For design consultants, payments are generally made periodically in accordance with a method agreed upon by the parties in the governing agreement. For design work, the phases of work might be assigned a certain value of the entire contract price (eg $X for the schematic design phase, $Y for the design development phase, $Z the construction document phase, $A for the bidding and negotiation phase, $B for construction administration phase, and possibly $C for sustainable design). Within a phase, the parties might agree that the design professional will receive a pro rata share of such value corresponding to the amount for that phase.
Last modified 22 Mar 2024
Yes, parties to a construction contract can fix the time/date to complete the entire project. In addition, they can agree to the time/date when a portion or portions of the project must be completed (usually called milestones), including fixed time/dates for both substantial completion and final completion.
A common method of dealing with delays is to provide for liquidated damages, often referred to as ‘LDs’. If the parties decide upon LDs, the contractor agrees to pay a certain sum for each day (or some other increment) of delay for each portion of the project and/or for the entire project not completed on time. Liquidated damages are often used where the amount of actual damages would be difficult to calculate and prove.
The sum determined by the parties should be an estimate of actual damages, not a penalty – a penalty is not enforceable under US law. As a result, it is important for the owner to perform the exercise of attempting to calculate what its damages will be if the project or any portion of the project is not finished on time (even if difficult or speculative). In addition, the liquidated damages must be the sole remedy available to the owner for delay, ie the owner cannot have the choice of demanding payment of liquidated damages or pursuing the actual cost of delay through litigation.
Last modified 22 Mar 2024
Generally, changes to the work can be made to the drawings and specifications by using one of three methods, as follows:
Construction contracts typically provide that the design professional may make minor changes in the work without change to the contract time or contract price. For example, the AIA A201 General Conditions of the Contract for Construction gives the architect the authority to order minor changes as long as those changes do not require adjustments to the contact price or contract time and are consistent with the contract documents. Changes meeting those criteria are binding on both owner and contractor.
If the change is more extensive than a minor change to the work, then the change can be made by a written amendment to the construction contract, known as a change order. A change order provides for variations in the work where the architect, owner, and contractor agree as to the scope of the changed work and any increase or decrease to the contract price or time. The compensation for changed work might be a lump sum agreed upon at the time the need for change in work arises, or unit prices already provided for in the construction contract, or the cost of the work plus a fee, which fee is a percentage set forth in the construction contract to be applied to the cost of the work. Generally, the architect prepares the written change order and all parties execute it. As stated in payment, the change order should set forth all of the details of the work, including the scope, cost, and time of the changed work.
If the parties cannot agree on the changed work, the owner may unilaterally order a change in the work by issuing a construction change directive signed only by the owner. The method of calculating the contractor’s compensation for changed work in the event the parties cannot reach agreement should be set forth in the contract and that calculation is then applied to the changed work should the need arise. For example, a common method of calculating compensation for changed work absent mutual agreement is to pay the contractor the cost of the work plus a percentage of such cost for profit and overhead. The AIA A201 General Conditions of the Contract for Construction uses that approach, providing that the contractor is entitled to the sum of the costs of the following: labor, equipment, material, supplies, supervision, premium for any additional insurance coverage required and additional field office costs. The contractor also is entitled to a percentage of the foregoing sum as compensation for profit and overhead.
Variations to specifications that far exceed the scope of the work are known as cardinal changes. A contractor cannot be forced to perform a cardinal change; rather, a cardinal change constitutes a breach of the contract. Whether a change is a cardinal change is decided on a case-by-case basis, but an example might be adding a fourth story to building that initially was to be three stories. The contractor generally cannot be forced to perform changed work that far exceeds the scope of the work.
Last modified 22 Mar 2024
The common law ‘doctrine of substantial completion’ provides that the project is substantially complete, if it is ‘nearly equivalent’ to what was bargained for. Ocean Ridge Develop. Corp. vs. Quality Plastering, 247 So.2d 72, 75 (Fla. 4th DCA 1971). Courts and the construction industry in the US generally interpret this to mean that the owner can use the building for the purpose intended. One of the significant indicators that a building can be used for the purpose intended is the issuance of a certificate of occupancy by the relevant authority stating that the building is ready to be occupied, with all mechanical, electrical, ventilation, elevator, safety and other systems and features in place and operational.
The foregoing aside, the parties to a contract typically define the term ‘substantial completion’ in the contract with greater specificity and include conditions that the contractor must meet in order to achieve substantial completion. For example, the parties might provide that substantial completion only can occur where the remaining work is comprised of minor punch list items and require that the architect must certify that substantial completion has been achieved.
The contract also should set forth the procedure for certifying that the project is substantially complete. If an architect performs construction administration for the project, the architect likely will certify substantial completion. However, the contract also might provide for input from the owner, such as requiring that the owner be satisfied with the work or requiring that defective work be corrected prior to issuance of the certificate of substantial completion.
If the owner does not engage an architect during the construction phase of the project, then the contract might provide that the word ‘architect’ refers to the owner’s representative.
The parties are free to negotiate many of these provisions privately. However, a certificate of occupancy generally, if not always, must be obtained from the relevant governmental authority after construction but before a building can be occupied and used. The requirements for such certificate of occupancy are determined by the issuing governmental authority, and the parties to the contract cannot vary or change those requirements.
Last modified 22 Mar 2024
The times within which a party to a contract may bring a claim generally are imposed by state statutes if the parties do not provide otherwise in their construction contracts. As such, the times differ from state to state in the US and there are different limitation periods for different types of cause of action.
For example, in Illinois, the statute of limitations for construction defects is four years (735 ILCS 5/13-214(a)) and the statute of repose is 10 years (735 ILCS 5/13-214(b)). Together, these Illinois statutes provide that a person must bring a claim within four years of learning of the defect (statute of limitations) but in any event must bring the claim within ten years of substantial completion of the project (statute of repose). The Illinois statute of repose also provides an extension: if the defect is learned of anytime within the 10-year statute of repose, then the entity still has four years to bring a claim from the time of learning of the defect, even if the 10-year statute of repose is exceeded. Not all states, however, permit extensions for late-discovered defects. As indicated above, the requirements vary from state to state.
Parties in Illinois also may agree to a different limitation period, as long as reasonable. To illustrate, AIA documents generally provide that construction defects must be brought within ten years of substantial completion, with no provision for an extension. Thus, if parties in Illinois use an AIA document and want to provide for the extension allowable by Illinois law, the parties could modify the applicable provisions in the AIA document. Absent modification, the parties to such AIA document would not be entitled to the four-year extension granted by the Illinois statute of repose.
No matter what the limitation period is, it is necessary to determine at the outset of any new claim whether the limitation period has expired. If it has, the claim will be barred, and the claimant may be prevented from bringing a claim against the alleged wrongdoer. The defendant will be able to plead the defence of limitation, and the claimant will have the burden of proving that the cause of action arose within the relevant statutory period.
Last modified 22 Mar 2024
The pursuit of claims against the developer by the end user of the facility for physical damage or economic loss, and how the developer can exclude those claims, depends on whether the developer is in privity with the end user, ie whether the end user and developer have entered into a contract. If they have entered into a contract, they are in privity, and the answer likely is found in contract law. If developer and end user are not in privity, the answer likely is found in tort law. The answer also depends on the economic loss rule in the state where the action is brought. Not only can the economic loss rule be complicated, it is applied differently from state to state.
In most states, claims for physical damage against the developer by those who ultimately use the facility but are not in privity with the developer would sound in tort, not contract. As a tort, the claim must satisfy four elements in order to be a viable cause of action: duty, breach, causation and damage. The developer would attack each of those elements in an attempt to exclude the claim. The developer also would attempt to assert affirmative defenses that might exclude the claim, eg an expired statute of limitations or repose (which likely is far less for property damage sounding in tort than for construction defects sounding in contract).
In its purest application, the economic loss rule provides that parties must be in privity in order for one of the parties to assert a claim against the other for purely economic loss. However, a claim for economic loss can be brought where there is no contract, if the economic loss arises out of physical damage to other property (ie to property not the subject of a contract). Again, the economic loss rule varies from state to state in the US.
Depending on the contract provisions, claims for physical damage and economic loss against the developer may be made by the end user, if the two parties are in privity and the contract so permits. The developer can limit its liability via contract provisions and insure for risks it cannot eliminate.
One method to limit liability is to negotiate a shorter liability period than allowed by the statute of limitations or repose in the state where the project is located (see limitation period). Another method, which may be beneficial to both parties, is to provide for delay damages via a liquidated damages provision; the liquidated damages likely will include economic loss by the end user (see delay).
Last modified 22 Mar 2024
The answer to this depends on whether the architect, other designer, building contractor, or subcontractor is in privity with the entity against whom the claim is to be made. With the exception of mechanics' liens, the answers will be the same as developer's liability to end user. To the extent the economic loss is non-payment for services and the unpaid party is not in privity with the developer (eg the subcontractor is only in privity with the contractor), then such unpaid party can claim a mechanics lien over the real property where the project is located; provided, however, a mechanics lien typically cannot be claimed on public property.
Last modified 22 Mar 2024
A contract may extend certain rights to third parties who are not parties to the contract. Such third parties are referred to as third-party beneficiaries, and both the third-party beneficiaries and the rights afforded the third-party beneficiaries must be provided for expressly in the contract. However, because third-party beneficiaries are not parties to the contract, they do not have corresponding obligations. Accordingly, third-party beneficiaries may enforce certain of the owner’s rights as expressly set forth in the contract, yet not be subject to claims.
A simple example is a right of the owner to audit contractor’s records. If the owner has the right to audit the contractor’s records under a contract, then a third-party beneficiary also has such right and could arrange directly with the contractor to exam the contractor’s records without first seeking permission from the owner.
A more significant example is the right of the third-party beneficiary to a warranty by the contractor; the third-party beneficiary could enforce a warranty against the contractor, even though the third-party beneficiary did not enter into the contract with the contractor and has no privity.
A contract also may provide specific requirements with which the contractor must comply in order to afford protections to a purchaser, tenant, or lender. For example, the contractor may be required to cooperate with a purchaser, not interfere with tenant’s business, cooperate with lender, enter into an escrow if requested by lender, and obey the landlord’s rules and regulations etc.
Last modified 22 Mar 2024
Generally, construction disputes are heard in the civil court of the state where the project is located. If the claimant asks for something other than damages, for example, a party requests an injunction or specific performance, then the case will be heard in the state’s equity court, often called chancery court. Otherwise, the case will be heard in a court of law.
However, construction disputes can be heard in federal court, if the resulting claim arises from a federal construction project, involves a federal question of law, or meets certain other criteria that allows the claim to be heard in federal court, such as diversity jurisdiction.
Final decisions of these courts generally can be appealed to an intermediary court of appeals. Any appeals thereafter to a higher court are at the discretion of the higher court.
Last modified 22 Mar 2024
In order for a dispute to be referred to arbitration, the parties to the dispute must mutually agree to submit their dispute to arbitration. The parties may do so when the dispute arises, or, more likely, the parties will have provided in their contract that any dispute will be decided by binding arbitration.
Arbitration and litigation are different in many respects. In arbitration, disputes are resolved in private; in litigation, the procedure is public, as are the documents and evidence filed by each of the parties. In arbitration, the parties generally have a voice in selecting the arbitrator or panel of arbitrators. However, in the court system, judges are assigned randomly to cases without any input from the litigants; in some jurisdictions, a litigant may (but may not) have the ability to strike one judge without a reason.
Although not always the case, arbitration is intended to be an informal and streamlined process when compared to litigation. Absent a mutual agreement by the parties, arbitration does not involve discovery – no interrogatories are submitted to the other side, no depositions are taken, and the rules of evidence are not applicable. Because of this, disputes generally can be resolved more quickly. However, once the arbitrator renders its decision, there is no appeal to a higher authority except under extremely narrow circumstances, such as fraud or conflicts of interest. Courts encourage private resolution of disputes by parties and will avoid setting aside decisions made by arbitrators. Although laws vary among states, arbitration decisions generally can be set aside only for a ‘manifest disregard of the law’ or if a party can prove the arbitrator was biased.
An analysis of the cost of litigation as against arbitration depends on the size of the dispute and other facts. The fee for arbitration generally is a graduated percentage of the amount in dispute; the court filing fee generally is nominal. The arbitrators are paid an hourly fee for preparation and study time, travel, attendance at the arbitration, and deciding and preparing the award. The judges, however, are not paid by the litigants. Lawyers’ fees may be less in an arbitration, depending on the nature of the dispute. Because the process is quicker, less lawyer time may be required.
Last modified 22 Mar 2024
Disputes generally are resolved by litigation unless the parties mutually agree upon an alternative method to resolve the dispute, which might include mediation, arbitration, or a combination of methods. However, even if a party commences litigation, a judge may require the parties to enter into mediation in an attempt to resolve the dispute without further litigation. In such case, the parties would return to court and pursue resolution of the dispute via litigation only if the mediation is unsuccessful and the parties fail to reach a consensus. While not altogether uncommon, such requirement by a judge for mediation as a condition precedent to further litigation in court is the exception rather than the rule. It likely is more often used in family court than in resolving construction disputes, although each state has varying requirements.
A recent trend in some US states is to require a form of mandatory ADR as part of a state’s construction law reform, but these requirements generally relate to disputes involving residential/condominium construction. Otherwise, there generally has been no mandatory alternative dispute resolution method required by law as a first step in the dispute resolution procedure. Parties mutually may agree to submit to mediation prior to arbitration or litigation, but this has been voluntary on the part of the parties, not a legal requirement. However, the AIA construction contracts (see industry forms of agreement), without revision, provide for mandatory mediation as a prerequisite to engaging in binding dispute resolution, such as litigation or binding arbitration.
Last modified 22 Mar 2024
What risks in a construction or engineering contract are normally borne by the contractor? To what extent is force majeure relevant in such contracts?
The allocation of risk depends on several factors, including, among others, the project delivery method selected and the manner in which the contract price is calculated.
If the project delivery method is a traditional design-bid-build – whose defining characteristics include: (a) three principal participants (owner, architect, and contractor) and (b) two separate prime contracts (owner-architect agreement and the construction contract) – the general contractor is responsible for construction of the project as depicted in drawings, specifications, and other documents prepared by the architect and design team. Accordingly, the general contractor depends on the architect for the design of the project and the quality of the documents the architect prepares. The general contractor has little opportunity for input during the design process with respect to matters in which it has expertise, such as value engineering, cost estimating, constructability, construction scheduling, labour and material market analysis, equipment availability, design of specialized equipment and proprietary systems, and other similar issues.
Depending on the type of contract negotiated, the general contractor also may bear responsibility to complete construction of the project within a certain price. If the general contractor has agreed to construct the project for a fixed price or has guaranteed a maximum, not-to-exceed price, then the cost overruns (with certain exceptions) become the risk of the general contractor. Accordingly, the contractor assumes the risk of volatility in labour and material pricing. Conversely, if the contract is cost-plus, then the general contractor’s compensation is comprised of the actual cost of construction the project – whatever that cost may be upon final completion – plus a fee. In such a case, the owner bears the risk of escalating costs.
The general contractor also may assume the risk of completing the project on time and obligate itself to complete the project by a specific date or prior to the expiration of a certain period of time. Achieving completion of the project on time may be necessary for the owner to meet its obligations with respect to financing or third parties (eg future tenants in the facility being constructed), take advantage of business or seasonal cycles, otherwise generate needed revenue from the project, or limit expenses so the project remains viable. If the general contractor fails to complete the project within the agreed-upon time, then the owner may suffer losses due to the delay. Accordingly, the owner may require that the contractor guarantee the time in which the project will be completed and assume the risk if it is not. For example, the contractor could agree to pay liquidated damages, if the project is not completed by the agreed-upon date of final completion as set forth in the contract.
Another risk assumed by the general contractor arises from the architect’s limited role in the design process in a design-bid-build project (the design is completed by the architect before the project is bid or the contractor selected) and the corresponding limited remedies available to the contractor against the architect. Because the owner enters into separate contracts with the architect and the general contractor, the general contractor and architect are not in privity, ie the general contractor and architect have no contractual relationship. Lacking privity, the contractor’s remedies against the architect are limited, depending on the economic loss rule law in the US state in which the project is located. The general contractor’s only option to pursue a claim might be to bring the claim against the party with whom it has a contract – the owner.
The spectrum of a construction manager’s risks and responsibilities is wide and filled with variations. At one end of the spectrum, the construction manager operates as the agent of the owner. At the other end of the spectrum, the construction manager is ‘at-risk’ and operates similar to a general contractor.
At the ‘agency’ end of the spectrum, the construction manager does not assume the traditional risks of a general contractor. Rather, the construction manager’s role is to act as an advisor to the owner while monitoring the project. The construction manager typically will attempt to minimize the owner’s risks while at the same time expediting the process – for example, obtaining bids before the design documents are 100% complete.
At the ‘at-risk’ end of the spectrum, the construction manager bears risks similar to the general contractor in the design-bid-build project delivery method. With respect to guaranteeing a price, an ‘at-risk’ construction manager may bear additional risk because the price it guarantees is an estimate based on incomplete drawings. Methods of mitigating this risk include factoring in a larger contingency in the guaranteed price or providing an estimate when the construction management agreement is executed, with provision for a guaranteed price only after the design documents are complete.
The body of law governing an at-risk construction manager is less than an at-risk general contractor or an agent construction manager. As a result, disputes may be more difficult and more expensive to resolve.
Under the design-build approach, a single entity undertakes to both design and construct the project, providing the owner with a single point of responsibility for the entire project. The entity bearing that responsibility is often the general contractor who either has in-house design expertise or takes responsibility for subcontracting with an architect for the design. As a result, some of the risk factors that an owner confronts in the design-bid-construct approach now belong to the design-builder with whom the owner contracts; and the owner is relieved of some of the challenges that accompany holding separate and independent contracts for the construction and design of the project.
Calculating the cost of the project and preparing a proposal presents a difficult exercise for a design-builder and, accordingly, a risk. In preparing a proposal, the design-builder faces a dilemma. The design-builder is arguably best served by developing the design to a point where the design-builder is reasonably confident in its ability to predict all elements needed to produce a final design. If the design builder is comfortable with the design, reasonable projections are possible for cost, time, performance, characteristics, and other matters. Therefore, the design builder can reduce contingencies accordingly and submit a more reliable proposal.
However, the design-builder’s effort to produce a more reliable proposal consumes limited resources and is very costly. For example, the design-build project may be structured as a two-step process, with a ‘go’ or ‘no go’ decision to be made at a certain point by the owner regarding whether to proceed with the design-builder or the project. If the owner decides not to proceed, then the design-builder will not recover those costs if another party is awarded the contract or if the project is abandoned. But, the alternative of putting forth only minimal effort in preparing a proposal is a risky venture. The resulting proposal may not be responsive to the owner’s needs and, therefore, a wasted effort. Moreover, the less-developed proposal may put the design builder at risk. The design-builder has made a wager that it will be able to complete the project for the cost and time proposed, although the design-builder may not have studied the project in detail and as appropriate to make such a judgment.
Force Majeure. The term ‘force majeure’ generally refers to an unexpected event of nature or civil unrest beyond the parties’ control, such as a flood, war, strike, or storm. A force majeure clause attempts to relieve the contractor of certain of its responsibilities for time and/or price upon the occurrence of a force majeure event, generally either by extending the time allowed to perform the contract or by increasing the price beyond the limit of any guarantee.
The extent to which a force majeure clause shifts risk from contractor to owner depends on how the term is defined in a contract and the specific provisions made for force majeure. The contractor will want the term defined as broadly as possible in the contract; the owner will want to narrow the definition. The contractor will want the delay caused by the force majeure event to be compensable, ie the contractor is entitled to claim both time and money. Conversely, the owner will want the force majeure event to be excusable, ie the contractor is entitled to claim only time – and then only if the force majeure event increases the critical path of the project.
Accordingly, the contract negotiated by the parties will determine what constitutes force majeure and how it shifts risk between owner and contractor with respect to a particular project.
Last modified 22 Mar 2024