Key Construction Contract Provisions

by Barbara R. Gadbois, Esq.

and Sara H. Kornblatt, Esq.
Gibbs Giden Locher Turner Senet & Wittbrodt LLP

Clearly understanding key construction contract terms is essential to the success

of any construction project. Construction professionals should routinely refresh
their knowledge on the all-important four Rs of a construction contract: The
definition of the parties’ Relationship, Rights, Responsibilities and Risks. Below is a
review of key contract provisions that everyone needs to understand in order to
fulfill their contract obligations.

Contract Price

Most construction contracts are classified according to the method of pricing

and payment for the work: lump-sum/fixed price; unit price; and cost plus (with
or without a guaranteed maximum price).

Lump-Sum Contract

The lump-sum contract is the most common type of construction contract. In

this type of contract, the contractor agrees to complete a definitive scope of
work described in the contract documents for the agreed-upon price. With a
lump-sum contract, the contractor bears all risks and benefits of the cost to
complete the work. If costs exceed the lump sum, the contractor is responsible
for absorbing the excess costs, and is obligated to complete the work for the
fixed price. If costs are less than anticipated, the contractor is still entitled to
receive payment of the entire lump-sum amount, with the savings increasing the
contractor’s profit. Lump-sum contracts are often competitively bid and are
very common on public projects. On competitively-bid projects, bidders
typically have no opportunity to negotiate contract terms, and must include all
contingencies (e.g., cost escalation, delays due to labor strife, etc.) in the lump-
sum bid price. Furthermore, the contractor must have a clear understanding of
the risks allocated to him (such as liability for unforeseen conditions) when
calculating the lump sum.

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Unit-Price Contract

A unit-price construction contract establishes unit prices for specified

components of work and, in most instances, estimated quantities for such work.
Unit-price contracts are commonly used in situations where the scope of the
work is known and the quantities are easily measured (such as a volume of soil
or rock to be excavated), yet the exact quantities to complete are
undetermined. In a unit-price contract, the owner pays only for the actual units
(or quantities) that are installed by the contractor.

Cost-Plus Contract

Cost-plus contracts are often used when the scope of work is not fully defined,
or certain elements of the work are hard to determine. In a cost-plus contract,
the owner pays for the actual cost of the work plus either a fixed fee or a fixed
percentage of the construction costs. The owner only pays for the work that is
actually performed, and avoids paying for contingencies that do not
materialize. The contractor, however, has little incentive to minimize costs. As a
result of this concern, the cost-plus contract with a guaranteed maximum price
(“GMP”) emerged.

Cost-Plus Contract with a Guaranteed Maximum Price (“GMP”)

The cost-plus contract with a GMP is almost identical to the cost-plus contract --
with one significant exception: the risk of excess costs shifts to the contractor if
the costs exceed the Guaranteed Maximum Price. This arrangement gives the
contractor a strong incentive to perform within the GMP. Additionally, this kind
of contract frequently provides that the parties share savings when the cost of
the work is less than the GMP … an additional incentive to the contractor to
keep costs within the owner’s budget.

Contract Payment Provisions

Contract payment provisions define the form of the request and documents
(e.g. lien releases, schedule updates) required from the contractor. They
determine when a contractor is entitled to request payment, how the amount of
the payment will be computed, who will review the request, when the payment
will be made, and what rights and remedies (e.g., interest, penalties, the right to
stop work) the contractor will have if payment is not received when due.

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Construction contracts typically provide for payment of the contract price
through progress payments during the course of construction. In lump-sum
contracts, payments are typically calculated based upon the overall
percentage of completion of all work in place, or upon a predetermined value
when designated milestones are completed (e.g., foundation, framing, roofing,
etc.). In cost-plus contracts, the contractor is required to submit records of
actual costs incurred, and is also entitled to overhead and profit, typically
calculated as a percentage of costs.

Most construction contracts permit the owner to withhold retention, which is a

percentage of the amount due the contractor for each progress payment.
Retention payments are used as a type of security for the contractor’s
completion of the work, and to satisfy potential lien claims of unpaid
subcontractors and suppliers. Final payment of retention is made when all work
is complete and all closeout documentation has been submitted.

Contract Documents and Order of Precedence

The contract documents are a compilation of separate documents, including

the agreement, general conditions, special conditions, drawings, specifications,
addenda and amendments. These documents collectively form the contract
for construction; therefore, it is important that the agreement list all contract
documents and, in the case of a conflict between the documents, which
document will take precedence over the others.

Contract Time

The contract time clause establishes the duration or deadline for completion of
the work. This time period may be expressed by a number of days from a
“Notice to Proceed”, or in terms of a fixed calendar date. Contractors should
be wary of clauses with a fixed calendar date for completion, especially when
contract negotiations are protracted, design is incomplete, or there is some
constraint on commencement (e.g., permit pending).

When reviewing provisions for time extensions, contractors should analyze what
events are listed as grounds for a time extension (an excusable delay), and

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what procedures must be followed to submit the request for a time extension
(notice provision). Likewise, the contractor must consider whether the contract
includes a “no damages for delay” clause or a liquidated damages clause. If
these clauses are included, the contractor may be responsible for extra non-
compensable expenses, such as extended job site general conditions costs, if
the duration of the contract is extended -- even assuming that a time extension
is granted. Furthermore, the liquidated damages clause will obligate the
contractor to pay a predetermined amount to the owner if a contract milestone
completion date is not met. These potential costs must be carefully evaluated
by the contractor to estimate the total cost of performance.

Changes
The changes clause in construction contracts is unique to the industry, because
this clause allows the owner to make unilateral changes to the scope of work
without invalidating the contract. Further, the contractor must perform the
changed work, provided it is within the general scope of work contemplated by
the contract.

It is essential that the owner has the right to make changes in the work, so he
can deal with the issues that occur on a daily basis on almost every project. If
the changed work is outside the general scope of the original contract, or if the
owner issues numerous changes resulting in the final work being significantly
different than described in the original contract, the contractor may file a claim
that such changes represent a “cardinal change” or an “abandonment” of the
contract. The contractor does this to avoid the risk that is inherent in a fixed-
price or guaranteed maximum price contract, and recover damages based on
a total cost.

Construction contracts normally allow the terms within the contract only to be
modified through an approved change order, made in writing and signed by
the owner or the owner’s representative. It is important that the contractor
request a written change order for any work not specified in the contract.
Proceeding with a change prior to actually receiving the change order places
the contractor at risk of not receiving payment.

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If the owner and the contractor cannot agree on a price before the contractor
must perform a change, the contract should specify an alternative method for
determining the compensation to be paid (e.g., time and materials) to the
contractor for the added or changed work (and/or the credit for deleted work).
The contract should also require that the contractor maintain daily records of all
labor and material costs for the changed work, segregated from the base
contract work. The owner usually has a contractual right to issue a unilateral
change directive if the parties are unable to agree on the terms of a change
order, and to direct the contractor to proceed with the work pending the
resolution of any dispute.

Insurance and Indemnity

The insurance and indemnity provisions of the contract may weigh heavily on
the practical outcome of a dispute between the parties. At a minimum, the
insurance provision in a contract should set forth the types of insurance required,
the minimum coverage amounts, the maximum deductible amounts, the form
of endorsements, and the length of time each type of coverage must be
maintained.

The additional insured endorsement requirement affords the owner additional

insurance protection by making him an insured party on the contractor’s and/or
subcontractor’s policy. This is very important if the owner has a significant
deductible or self-insured retention in his own general liability policy. Since
insurance is a very specialized area, the insurance requirements in a contract
should also be reviewed and approved by the contracting party’s insurance
adviser and risk manager.

In its simplest form, the express indemnity clause in a construction contract

creates a contractual arrangement which obligates the contractor to protect
and indemnify the owner from the legal consequences of an action (or
inaction) on the part of the contractor or some third party. Most contractual
indemnity provisions require the contractor to defend the owner or pay for the
cost of the owner’s defense. The scope of contractor’s defense and indemnity
obligations is often limited by statute, and varies depending on whether the
project is public, private or residential. Moreover, the specific language of
indemnification provisions in construction contracts varies widely, and should be
carefully examined by the party’s legal counsel and risk manager.

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Termination of Contractor

Construction contracts typically give the owner broad authority to terminate the
contractor either for convenience or for cause (i.e., default). The “termination
for convenience” clause permits the owner to terminate without a reason, and
specifies the method of calculating the amount due the contractor. Typically,
termination for convenience allows the contractor to be compensated for the
contract value of the work in place, overhead and profit on work performed,
and costs of demobilizing and canceling subcontracts.

Whether or not a contractor will be entitled to receive profit on work not

performed is typically the subject of negotiation, with owners viewing profit on
work not performed as an unreasonable windfall to the contractor, while
contractors view this as payment for lost business opportunities.

The “termination for cause” provisions in the construction contract afford the
owner the right to terminate the contractor upon certain events such as: failure
to supply enough skilled workers or proper materials; failure to pay
subcontractors and suppliers; disregard of applicable laws; or substantial breach
of a provision of the contract.

After written notice of the grounds for default and contractor’s failure to cure,
the owner may terminate the contractor. The owner then may enter the site,
exclude the contractor from the site, and take possession of the contractor’s
tools, equipment, and material. Once the contractor has been terminated for
cause, he is not entitled to receive any further payments until the work is
complete. The owner is allowed to offset any amounts owed to the contractor
by the costs incurred in completing the work. If the cost to complete the project
exceeds the unpaid contract balance, the owner can recover the excess as
damages from the contractor.

Summary

The importance of careful contract drafting and thorough understanding of the

key terms of the construction contract is a critical element to any construction
project. This article touches on just a few of the many key provisions inherent in
most contracts. While there may be no single “right” clause for every contract,

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understanding the key issues and resulting responsibilities and risks will assist the
parties in tailoring contract clauses to clearly guide the parties through the
project.