Negotiating a Construction Contract: Tips and Reminders

Before you contract, be sure you hold the correct license. Unlicensed contractors cannot lien or sue for payment. Also, check the general contractor’s license at www.azroc.gov. Causes for concern include a suspended license, no license, or numerous complaints. Similarly, check out the owner: In Maricopa County, find liens and judgments at the County Recorder's Recorded Document Search page, and find lawsuits at the Superior Court website. Also, ask other trades on the project about payment.

Secure your lien rights by sending a pre-lien before starting work. If a tenant is making the improvements, you typically have lien rights only against the building, not the land. If the property is owner-occupied, you have lien rights only if you contract directly with the owner (A.R.S. § 33-1002[B]). If you have change orders , remember to amend your pre-lien.

Determine whether the project is bonded, and ask for a copy of the bond. (More about public project bond claims and private project bond claims.)

AIA STANDARD FORMS VS. PRIVATELY DRAFTED CONTRACTS

There are advantages of using AIA (American Institute of Architects) forms: They are the industry standard and are commonly used. They are also very thorough (and the most litigated), so interpretation is generally not an issue, and you don't have to hire a lawyer to draft it. There are also disadvantages: AIA forms are very long and relatively difficult to understand, and they are copyrighted.

Non-AIA (i.e., privately drafted) contracts are cheaper, shorter and less formal and generally include only essential terms. If you decide to use a privately drafted contract, make sure it contains all of the minimum elements of a contract required by the ROC (A.R.S. § 32-1158) and all of the terms to which you and the other party (owner, general contractor or subcontractor) agreed.

BEWARE OF CERTAIN CONTRACT CLAUSES

Integration or Merger Clause

What It Does. Bars parties to a contract from later claiming that the contract does not reflect their entire understanding, was changed by a subsequent oral agreement, or is inconsistent with prior agreements.

Sample Language. "This Agreement and the exhibits attached hereto contain the entire agreement of the parties with respect to the subject matter of this Agreement, and supersede all prior negotiations, agreements and understandings with respect thereto. This Agreement may only be amended by a written document duly executed by all parties."

What to Do. Make sure that all promises and agreements are actually included in the written contract, as otherwise it may be impossible to enforce those unwritten promises.

"Flow-through" or "Flow-down" Clause

What It Does. Passes through to a subcontractor the risks and obligations assumed by general contractor in the prime contract (i.e., the general contractor’s obligations to the owner under the prime contract "flow down" the contractual chain through the general contractor to its subcontractor).

Sample Language. "The Subcontractor shall be bound to the Contractor by all the terms of the Contract Documents, and to assume toward the Contractor all the obligations and responsibilities, including the responsibility for safety of the Subcontractor’s work, which the Contractor, by these Documents, assumes toward the Owner and Architect."

What to Do. If you are a subcontractor, try to strike this type of clause unless you review the prime contract and you accept all of the general contractor’s obligations to the owner.

Indemnification Clause

What It Does. Requires the subcontractor to indemnify the general contractor against claims arising from the work, sometimes regardless of whether the subcontractor is at fault. Under many prime contracts, the general contractor is required to extend the same indemnity to the owner (another reason that subcontractors should be wary of "flow-through" clauses). In Arizona, clauses requiring a subcontractor to indemnify the general contractor against claims arising from the general contractor’s sole negligence are illegal, pursuant to Pioneer Roofing Co. v. Mardian Const. Co., 152 Ariz. 455, 459, 733 P.2d 652, 656 (Ct. App. 1986).

Sample Language. "The subcontractor agrees to indemnify and hold harmless the contractor against loss or threatened loss or expense by reason of the liability or potential liability of the contractor for or arising from any loss or damage that may be occasioned by or through the acts or omissions of other persons or contractors at the Project site subcontractor’s performance of the work."

What to Do. Subcontractors should seek to strike the clause to the extent it requires them to indemnify the general contractor for anything other than the subcontractor's own acts.

Waiver of Subrogation Clause

What It Means. "Subrogation" means a party has the right to "step into the shoes" of another party for the purposes of bringing a claim for damages. Where an insurer has reimbursed its insured for loss, a "waiver of subrogation" clause prevents the insurer from stepping into the insured’s shoes and suing the party who caused the loss.

Sample Language. "To the extent damages are covered by insurance during construction, the Contractor and the Subcontractor waive all rights against each other and against the contractors, consultants, agents and employees of the other for damages, except such rights as they may have to the proceeds of such insurance."

What to Do. Clear it with your insurance carrier before you agree to it.

"Pay If Paid/Pay When Paid" Clause

What It Does. It conditions a general contractor's payment to a subcontractor on whether the general contractor has been paid by the owner for the subcontractor’s work. In Arizona, the language of a "pay when paid" must be very narrow to be enforceable, per L. Harvey Concrete, Inc. v. Agro Const. & Supply Co. , 189 Ariz. 178, 939 P.2d 811 (Ct. App. 1997).

Sample Language. "The total price paid to Subcontractor shall be [contract price], no part of which shall be paid until five days after payment is received from owner," or "… the Contractor shall pay the Subcontractor each progress payment and final payment ... within three working days after he receives payment from the Owner …"

What to Do. Subcontractors should seek to strike this clause. (More about pay-when-paid, pay-if-paid clauses.)

"Time Is of the Essence" Clause

What It Does. It may support an action for breach of contract where the contract is not completed within a reasonable (or specified) time.

Sample Language. "Time is of the essence for the completion of the work described in this contract. It is anticipated by the parties that all work described herein will be completed within two (2) weeks of the date of execution, and that any delay in the completion of the work described herein shall constitute a material breach of this contract."

What to Do. Be sure you can complete the schedule milestones within the agreed-upon timeframe.

Liquidated Damages Clause

What It Does. A liquidated damages clause specifies damages that the general contractor may claim against the subcontractor for failure to meet schedule milestones. Usually, they are per diem amounts that are assessed for the total number of days the project is delayed.

Sample Language. "If the Subcontractor fails to complete the work within the contract time or fails to achieve any of the contract milestones, the Subcontractor agrees to pay the Contractor $______ per day as liquidated damages to cover losses, expenses and damages of the Contractor for each and every day which the Subcontractor fails to achieve completion of the milestone work or the entire project."

What to Do. Be sure that (a) you can complete the schedule milestones within the agreed-upon timeframe, and (b) the specified damage amount is reasonable.

Dispute Resolution Clause

What It Does. A dispute resolution clause sets forth the procedure for resolving disputes between the parties related to the contract or the project.

Sample Language. "If any disputes arise between the parties, the parties shall submit the dispute to a mutually agreed-upon mediator. If the parties are unable to resolve the claim[s] through mediation, the dispute shall be resolved by litigation in a court of competent jurisdiction in the State of Arizona, unless the parties mutually agree to binding arbitration, in which event such arbitration shall be conducted pursuant to the Construction Industry Arbitration Rules of the American Arbitration Association unless otherwise agreed upon by the parties."

What to Do. Generally, this is a desirable provision for all parties, as it can lead to cheaper and quicker dispute resolution. However, beware of clauses that require the parties to submit disputes to the American Arbitration Association (AAA) or similar organizations, as they can actually be more expensive than litigation. It is better to simply hire a local construction arbitrator and agree to abide by AAA rules.

Termination for Convenience

What It Does. This type of clause allows the general contractor to terminate the subcontract without cause. Typically, the general contractor still must pay the subcontractor for work performed, costs incurred because of termination, and profit and overhead on work not performed.

Sample Language. "Contractor may, at any time, terminate the Contract for Contractor’s convenience and without cause. In case of such termination, the Contractor shall be entitled to receive payment for work performed, and costs incurred by reason of such termination, along with reasonable overhead and profit on the work not performed."

What to Do. This contract provision is generally acceptable for subcontractors, but only if it does not require the subcontractor to waive payment for work performed, costs incurred because of termination, and profit and overhead on work not performed.

Waiver of Consequential Damages

What It Does. It is a waiver, usually by both parties, of claims for any damages that are not directly related to the contract (i.e., cost to repair or complete, rental expenses, loss of use, loss of financing, lost profit, etc.).

Sample Language. "The parties waive claims against each other for consequential damages arising out of or relating to this Contract or Project."

What to Do. If you are a subcontractor, no action is required, as this waiver is generally favorable.