Understand Construction Contracts to Lower Your Risk

Understand Construction Contracts to Lower Your Risk

Reviewing construction contracts carefully prior to signing can save your business time and money. Understanding common contract terms, along with the help of legal counsel, can help you analyze the commercial risks associated with construction contracts and protect your company’s assets.

Scope of the Agreement

Examine the definition of provided services to ensure the language is clear for an unrelated third party to understand the scope. The contract should include a service completion time frame and both parties’ rights and obligations should be clearly outlined. Any mechanisms to alter the scope of the contract or terms (if permitted), should be outlined within the contract.

Terms of Payment

Terms of payment should be clearly listed within the contract to clearly define the expectations of both parties. The contract should specify an agreed payment schedule for goods received.

Warranties

Two types of warranties, express and implied, are assurances regarding explicit issues. 

Express warranties are specifically defined in the contract. Implied warranties are based in statutory and/or common law based on your jurisdiction. They are two-fold, a warranty of merchantability requires that goods/services must reasonably conform to an ordinary buyer’s standards. A warranty of fitness for a particular purpose states a seller’s knowledge of the product or service’s intended purpose implies the act of selling fit for that purpose. 

Be aware of warranty disclaimers and understand how they limit your statutory rights. If all warranties, express and implied, are disclaimed, your will be limited to only remedies within the contract. Examine all disclaimers in the contract’s context. While it may require you to disclaim your statutory rights, other contract language may provide adequate rights and remedies in areas you are most concerned.

Damages, Limits of Liability & Indemnification

Within a contract, these interrelate areas are often in close proximity to one another. Damages are certain types of losses that could create liability under the contract. A limit on liability places restrictions on the amount of damages a party would compensate if found liable for such damages. This may also include a limit for indemnification.

Indemnification provisions allocate risk and cost between the parties. You should review whether the party assuming the risk also controls that risk.  A “limit of liability” is an indemnification that limits the negligence or specifies a dollar amount.

Insurance

Most contracts contain requirements of minimum bodily injury and property damage liability coverage the party must possess. It may also require the customer be covered as an additional insured.  

We caution you to examine the contract’s insurance coverage against the amount of liability exposure. Employ your broker to review all contracts prior to signing as they have extensive experience and familiarity with your policies and coverage.

Terms & Conditions

  • Governing Law & Jurisdiction — Review to verify your comfortability with the implication of the state law chosen by the drafter. This will impact the contract’s interpretation from warranties to indemnification.
  • Dispute Resolution — Requires knowledge and comfortability with the state laws/forum chosen by the drafter. Governing rules and regulations can impact the outcome of a dispute. You should also consider whether the dispute resolution fits your situation.
  • Intellectual Property — When disclosing and/or licensing intellectual property (trademarks, copyrights, patents), include a clause that recognizes the intellectual property owner and affirmatively states the agreement does not transfer any rights.
  • Standard of Care — May appear in certain types of contracts. The standard of care provided by the law should arrange for the minimum standard of care for the contract’s provision of services.
  • Term/Termination — Both parties should be provided the right to terminate the contract. Termination situations vary. Some contracts allow termination based on dissatisfaction while others permit with specific notice for no cause. Recognize specific instances where you would require the contract to be terminated.
  • Right to Cure — Some contracts, relevant to termination, will contain right to cure clauses that provides the defaulting party notice of a breach and a finite period to remedy such a breach.

Specific statutes or regulations referenced that statute or regulation is wholly contained within the contract itself. Read and understand that language prior to giving your consent.

Language should also be included to define the term of contract. This could include whether to use a finite term and availability for automatic renewals.

Standard Form Contracts

Construction is absent of a consistent set of laws like the Uniform Commercial Code or a federal statutory scheme. Contracts produced by professional and trade associations for architects (American Institute of Architects), engineers (Engineers Joint Contract Documents Committee) and commercial contractors (Associated General Contractors of America) can provide as a reference and benchmark in drafting new contracts.  As an expert industry source, they can reduce drafting and review time, essentially lowering overall transaction costs.

Use caution with the following when using a standard form contract:

  • Standard forms are written broadly to encompass many different contexts, require transaction-specific and jurisdiction-specific modifications.
  • Document changes including word or terms definitions may affect other areas that make reference to it.
  • Custom-drafted and industry-drafted forms are often incompatible. Even industry-drafted forms from different publishers can be unsuitable.
  • Standard forms always contain drafter bias. Use this to identify when to utilize various standard forms published by different industry organizations.

We're Here to Help

Reviewing general terms and features of construction contracts will help you grasp the consequences of its terms and conditions for your business. We urge all contracts to be reviewed by your legal counsel and insurance risk manager to ensure its completeness and accuracy.

For questions about how contracts impact your insurance policy and risk for your organization, please connect with a member of our team.

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