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The 5 Most Important Construction Project Contract Clauses

Signing construction contract

When you are working with a general contractor, it is important to set the terms of your working relationship as soon as possible. Usually this is done by entering into a construction contract of some type. There are many forms a project contract can take. Some companies use a standardized form from an association, such as the AIA (American Institute of Architects), and others have their own custom versions. Either way, there are some important construction project contract clauses that you will want to pay attention to, as they set expectations and the stage for how your relationship will develop throughout the project.

Contract Sum

The first clause that you need to pay attention to is the contract sum. This is where the contract price, or guaranteed maximum price, is spelled out, depending on what project delivery method you are using. Hopefully you have already come to an agreement on what the price of the work is going to be, so this shouldn’t be a shock.

Where things get trickier is when terms such as alternates, allowances, and unit prices are included in this clause. Some of these can potentially add money to the contract value and should be considered in the budget before work even starts.

Alternates are options that you probably discussed during design or as the contractor was pricing the work, or the contractor may be bringing them up for the first time. For example, you may have had two different flooring options in mind. One is considered part of the base contract and will be included in the contract amount, and the other is an alternate. When alternates are included in the contract, they can either be considered a part of the agreed contract amount, or they can be added later through a change order. Make sure the contract language is clear about whether the alternates are included in the base contract or not, as that could raise or lower the actual cost of the work.

Allowances are amounts included in the contract as placeholders when decisions haven’t been made on the final scope of work. For example, if you haven’t selected a specific brand of carpet, the contractor may put in an allowance of $30 per square yard as a placeholder in the contract. Once you have selected the exact carpet you want, that price will be raised or lowered depending on how your selection compares with the allowance. It is the contractor’s responsibility to provide a reconciliation of the allowances at the end of the project. At that time a change order is generally issued to conform the budgeted allowances to actual costs.

Unit prices are utilized when the work is going to be contracted on a per unit basis. The unit price multiplied by the number of units completed equals the total contract amount due. This type of pricing is often used in road construction and other infrastructure projects when there is a standard price for each unit of measure completed.

Payments

The next important construction contract clause is payment terms. It is important to include a description of the payment process in the contract, including the timing, documents required, approval process, and the terms of final payment.

This clause should contain language about how often payments are to be made on an on-going project. Important dates, such as the invoice due date and when payment is due, should also be included in this clause. These dates are important for all parties to be aware of, as penalties such as interest and lien rights are dependent on them.

Every project will have its own documentation requirements when it comes to payments. Required documents might include cost back-up, subcontractor invoices, subcontractor and supplier lien waivers, payroll reports, and a list of subcontractors and suppliers and how much each is owed.

The process to get a payment approved should also be included in the payment terms. This section will include who reviews and approves the payment request and how long they have to review it. This process will tie into the dates provided in the timing portion of the payment clause.

The process to release final payment on a project is often complicated and requires a lot of paperwork. Requirements from the owner, lender, insurance company, and any other parties to the agreement should be included here. Required documents generally include a final certificate of project completion, final construction lien waivers from subcontractors and suppliers, operations manuals, warranties, as-built drawings, and a list of subcontractors and suppliers with contact information. Timing is very important here, as the date lien rights expire is determined by when workers were last on the job and when the job was substantially complete (all work done except punchlist items).

Changes in the Work

There are changes in every construction project, whether they are expected or not. How these changes will be handled needs to be spelled out in the contract. Terms will include details about general contractor and subcontractor markup on changes, how long the contractor has to notify the owner of any changes, how that notification is to take place, and what to do if there is a disagreement.

There are generally two types of changes that can occur on a project: change orders and change directives. A change order may be started by the architect, owner, construction manager, or the contractor, and can be a change to the scope of work or a change in materials. Once pricing has been determined and an agreement is reached, the scope is added or subtracted from the project.

If an agreement cannot be reached on the change and the price, the architect or construction manager may step in and issue a change directive. This document orders the contractor to make the change in the work, with the pricing to be determined later. A change directive prevents a dispute over change order pricing from holding up completion of the work.

Claims

Anytime there is a dispute between the owner and the construction manager or contractor that cannot be settled, it may escalate to a claim. Basically, a claim is a request for additional time or money regarding the project. The contract will detail the claims process, timeline, and notice requirements. It may also state the preferred method of claims resolution, which we’ll discuss in the next section.

In most contracts there is a time limit on when a claim can be brought forward. Usually it is so many calendar days from noticing the issue, or if it is regarding pricing extra work, before the extra work is completed (except in emergency situations). It is important to know what this timeline is because claims submitted after this time has expired are considered invalid and are dismissed.

Claims notices are usually sent in written form, both by regular and certified mail. Email correspondence may be acceptable if your contract allows it, but it is always good to follow that up with a formal notice of a claim.

The first party to review a claim is usually the construction manager or architect. They act as a neutral third party and try to help the owner and contractor come to an agreement. If there isn’t a construction manager or architect on the project, or they aren’t able to obtain resolution, the claim moves on to the next level of dispute resolution.

The next part of the claims clause will state how disputes are to be settled that cannot be worked out by the parties. There are three main options: arbitration, mediation, and litigation.

Dispute Resolution

The dispute resolution clause will determine how conflicts are settled if the parties cannot come to an agreement and the architect is not able to settle the dispute. Arbitration, mediation, and litigation are the three main types of dispute resolution used in construction contracts.

Arbitration is like a court hearing, in that there is one or more decision makers who hear both sides of the claim and attempts to settle the dispute through deciding in favor of one of the parties. It is slightly less formal than a courtroom but is still a very judicial process. The arbitrator is selected by both parties, usually from a pool of available arbitrators with experience in construction.

Mediation is generally not binding and less formal, and is often a condition precedent to litigation if so stated in the contract. The parties meet with a neutral mediator who attempts to help the parties come to their own agreement. The mediator does not make a decision but tries to get the parties to meet somewhere in the middle. In construction often meditation is successful in resolving the claim without the expense of arbitration or litigation, particularly if all parties are motivated to settle.

Litigation is the most formal dispute resolution process and involves the party with the claim filing a lawsuit against the other. A formal hearing will be scheduled with a judge, and evidence and testimony will be given by both sides. The judge or jury will render a decision that is legally binding to both parties.

Due to the expense of litigation, mediation and arbitration have become more popular and are the preferred ways to settle construction disputes. However, many construction attorneys believe that arbitration is virtually the same cost as litigation and has other disadvantages. In our experience, about half of the attorneys we work with prefer one or the other, but always with mediation as a condition precedent to either action.

Conclusion

These five essential construction project contract clauses should be included in every contract. Consult your attorney and review them carefully if you are a party to a construction contract. They provide the backbone of the relationship between the owner and the general contractor, and will often play a large role in determining the success of a project by properly laying out responsibilities and expectations. All parties need to be aware of their rights and responsibilities, no matter what role they are playing on the project.

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