It is construction contracting 101: get the contract signed before the shovels hit the dirt. But too frequently the signed agreement becomes secondary to starting work. This is understandable. For both owners and contractors, starting on time is critically important, particularly in the Pacific Northwest where Mother Nature is often the biggest impediment to getting a project completed on time and on budget. Thus, there are times when business reasons dictate starting construction before a final contract is negotiated and signed.
Nonetheless, it is important to revisit the reasons why it is prudent to have an executed contract before work starts. Here are five of them:
1. Negotiation takes time. Often the parties are willing to set aside negotiating a contract until after construction starts based on their shared assumption that they will be able to quickly agree on contract terms in the days after construction is started. But even when the owner and contractor have an established relationship, this may be an unreasonable expectation. Sophisticated owners and contractors are bound to have significant disagreements. Negotiations that drag on while construction is underway can distract the project team. And the parties may both lose leverage on important issues. Meanwhile, the longer that work proceeds without a contract in place, the greater the risk to both parties.
2. Adequate insurance cannot be assumed. Insurance is one of the principal project assets that both the owner and contractor rely on to manage risk that manifests both during construction and in the years after work is completed. But neither the owner nor the contractor should assume that the other party’s insurance is adequate. The owner will want to ensure that the contractor has adequate liability coverage to protect against losses during construction, as well as “completed operations” coverage that takes effect after the contractor’s work is finished (not to mention workers’ compensation, employers’ liability, and commercial auto, among other common coverages). And because subcontractors typically perform the bulk of the work, the owner will also want to require that subcontractors maintain appropriate coverage. Though often the owner provides “builder’s risk” coverage that protects the work during construction, the parties could agree that the contractor is to obtain the builder’s risk policy. When work begins before these responsibilities are contractually established, there is an increased risk that coverage will be inadequate or that there will be gaps.
3. Compensation is more than a number. During the bidding or proposal process, the focus is appropriately on the price for which the contractor will agree to build the project. Generally speaking, it is not until they start negotiating the final contract that the owner and contractor address the specific terms governing the owner’s obligation to make payments to the contractor. These negotiations include issues such as the procedure for submittal and approval of payment applications, the documentation required by the owner as a condition for making payment (e.g., will the owner require lien waivers from the contractor and all subcontractors?), whether retainage will be deducted from progress payments, the amount of interest to be paid on payments that are late, and conditions for final payment. Relatedly, the agreement on an initial contract price does not address the manner for adjusting the price (or schedule) based on changes in the scope of work or problems encountered during construction. Ideally, these issues are settled before work begins.
4. The earlier the prime contract is signed, the easier it is to ensure key requirements flow down to subcontractors. A general contractor’s agreements with its subcontractors typically include standard flow-down language that incorporates the terms of the prime contract. Nonetheless, the prime contract also frequently requires that specific provisions be expressly stated in the subcontracts. For instance, when the owner and general contractor agree that disputes between them are to be resolved by arbitration, they will often also agree that the general contractor’s agreements with its subcontractors and suppliers are to include identical language binding the subcontractors to arbitrate disputes in a consolidated proceeding. If the prime contract is executed after certain subcontracts or supply agreements are executed, then the general contractor may need to amend those agreements to include the required language.
5. The contractor’s bid may include terms that are not acceptable to the owner. The contractor typically prepares a bid that describes a scope of work, sets forth “assumptions” on which the bid is based, and contains other “exclusions” and “clarifications.” The assumptions, exclusions, and clarifications frequently contain legal terms and disclaimers that many owners find objectionable (for example, limitations of liability or waivers of consequential damages) and would never accept in the ultimate contract. But if the contractor’s bid is the last writing between the parties before work starts, the contractor may have a basis to later insist that such objectionable terms were a material part of the contractor’s proposal as accepted by the owner—even if the owner orally manifested an objection to such terms before work started. Having a signed agreement before work starts that expressly excludes such objectionable terms obviously avoids such pitfalls.
Of course, there may be instances where the owner and contractor have no choice but to start work before a contract is finalized. In those cases, it may be preferable to execute a letter agreement that contemplates the execution of a superseding formal contract at a later date.
Originally published as “Five reasons to get a contract signed before construction starts” on April 18, 2019, by the Daily Journal of Commerce.