Smart Business: Killer Contract Language
Left unstated was that the best of all worlds would be to sign a good contract with a good person. In any case, everyone in the contracting business ought to be on the lookout for red flags in contract language.
A seminar on construction law doesn't make for the most enjoyable afternoon, but I attended one several years ago by Chicago construction attorney Stanley Sklar that was good enough to keep my eyelids pried open for four hours. Sklar is a straight shooter. "If you are looking for a fair subcontract, it does not exist," he told the audience. "Nobody wants to accept project risk. Everyone is looking to shift it downstream, and subcontractors are at the bottom of that stream. The best you can hope to look for is a subcontract where you know the risks."
This seminar took place shortly after the unveiling of a new standard subcontract form jointly negotiated by the Associated General Contractors and American Subcontractors Association. It was supposed to be the final word in fairness. According to Sklar, GCs won't use them precisely for that reason. "Of some 50,000 copies sold so far, about 49,000 have been purchased by attorneys who lecture on their use," he said of the AGC/ASA forms. Mainly this is due to their removal of conditional payment terms that held GCs accountable to pay subs only if or when they get paid by their clients.
Due DiligenceSklar emphasized that the greatest opportunity to eliminate risk occurs during the "due diligence" phase of contracting before the documents are signed and irrevocable commitments made. Among the areas he addressed:
- Money matters. "If the job is underfunded, it doesn't matter what kind of contract you sign," Sklar said. Under the widely used AIA subcontract form, GCs have the right to seek reasonable financial information from owners demonstrating their ability to pay. If not asked, owners aren't obligated to provide any information. So it is up to subs to push GCs to ask.
- Payment bonds. Find out what kind of bonding the GC has. A performance bond is irrelevant to a subcontractor. You need the GC to be covered by a payment bond guaranteeing sub payments in the event of default.
- Caustic clauses. Your cash flow can receive a big hurt with the wrong kind of contract language. Watch out for 60-day payment terms. That's 60 days after the GC gets paid by the owner, meaning it may be 90 or 120 days before you see your money.
- Excessive retention. Is the GC withholding a greater amount from you than the owner retains from him?
- Restrictive claims. Contract language may require claims to be filed within as little as 48 hours. At the least, said Sklar, seek language that ties the period to business days rather than hours.
Contract PitfallsThe deck is stacked against subcontractors. For example, the GC is not obligated to give you the job he promised based on low bid. He is free to shop around. The GC, however, can hold you to the price you submit.
Therefore, it is important to avoid big mistakes in your bid proposal. Watch out for problem areas such as:
1. Unrealistic time expectations. Just because the owner specifies he wants the job completed in a given time frame doesn't mean it can be done.
2. List contract forms. When submitting a bid proposal, list not only unit prices but also the contract forms you intend to use.
3. Give a time frame. Specify how long your bid price stays open.
4. Scope of work. "You live or die here," said Sklar. He cited three phrases in particular that could be the death knell for a particular project: "strict compliance," "exact compliance" and "reasonably inferable."
The way to carve out wiggle room is to have contract language refer to substantial compliance with plans and specifications. To illustrate how self-serving contract language can get, Sklar told a story about a GC who tried to get a sub to pay for the GC's business license owing to a scope provision fixing responsibility for all licenses and permits. "Say, ‘as it pertains to my work,'" the attorney advised. Also strike the word "all" wherever it rears its troublesome head.
5. Changes. A provision you want to incorporate is that "all change orders must be in writing." Be sure you identify who is authorized to direct change orders, and specify who on your staff is authorized to accept them.
In the real world, some verbal change orders are unavoidable, Sklar acknowledged. You don't, for instance, want to be accused of holding up a job waiting for routine paperwork. In those situations, just make sure to uphold the stated change authority and immediately afterward write a letter documenting the authorization and stating that your costs are in the process of being compiled. "Never wait till the end of the job to file a claim," warned the attorney.
6. Condo liens. On condo work, the cost to effect a lien is prohibitive because of multiple owners. Sklar said that the way to deal with a condo project is to contract with the condo association and put the lien on its special assessment fund.
7. Warranties and guarantees. Try to get warranties to start when the owner begins "beneficial occupancy." Otherwise you may find the period extended when, for instance, the job gets completed in November but the water doesn't get turned on until April.
Watch out for restrictive repair language, such as "defects must be repaired within seven days." What if a part takes 30 days to arrive?
8. Insurance. The easiest way to lay off risk on a project is by buying insurance, claims Sklar. "Additional name insured" (as opposed to "additional insured") parties may be added to most policies without extra cost. Sklar recommended exchanging "additional name insured" coverages with the GC.
9. If ... when ... who cares! Throughout my industry career I've read dozens of articles by lawyers and legislative specialists about the finer points of "if ... when" contract clauses. Subs were to strive for "when paid" language, which supposedly gives them greater assurance of payment than "if paid" clauses.
Said the 30-year veteran of construction law: "The [if-when] distinction is lost on me."
Sklar added that he's "gotten nowhere negotiating this clause," and that when he represents general contractors, "I hold firm" keeping the language in. "Both sides are right," he stated. Subs have every right to expect payment if and when the GC gets paid. On the other hand, if you were a GC, would you want to promise payment to subs even if you got stiffed by the owner? This is why Sklar emphasizes the due diligence stage as the best time to reduce risk, by checking owner financial stability.
10. Hazardous exclusions. Be sure that any agreement you sign excludes you from obligation to work when you encounter hazardous material of any kind, including asbestos, underground fuel tanks, etc. The contract language should give you the right to stop work upon encountering EPA-designated hazardous materials.
11. Letters of credit. Sklar does not regard a bank's letter of credit as a suitable substitute for a bond. "A bonding company will resist and work with you if you have a case," he explained. "A bank will just pay up on demand."
12. Attorney fees. In some states, the party who pays attorney fees is designated by statute. Where it is specified by contract, contract language frequently calls for the "prevailing party" to be awarded attorney fees.Problem is, the "prevailing party" is not easy to determine in disputes involving settlements or split judgments. Sklar recommends language to the effect that a "court or arbitrator shall have the right to award attorney fees as he or she sees just or equitable."
"It's better than spending $5,000 determining which is the ‘prevailing party' in the event of a settlement," he reasoned.
13. Arbitration. Sklar declared himself a fan of alternative dispute resolution, sneering at "Rambo lawyers" who will not approve arbitration. One of the bad raps against arbitration is the widespread belief that arbitrators are too inclined to split the difference. However, he cited an American Arbitration Association study finding that 80 percent of decisions result in clear winners. One precaution - "spend time negotiating the selection of arbitrators, if possible."
In the real world, subcontractors frequently aren't able to negotiate contract language that protects their interests. In such cases, "you must learn to say no to a job," said Sklar.
In the end, the best legal protection any subcontractor can have is a good faith working relationship with GCs they know and trust. Sklar urged subcontractors to "prequalify" the general contractors they do work for the same way GCs prequalify subs.
For more information, contact Stanley Sklar, Bell, Boyd & Lloyd, Three First National Plaza, 70 West Madison St., Suite 3300, Chicago, IL 60602-4207; 312-372-1121; email@example.com.