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InfoPAKSM

Understanding Construction Contracts

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2 Understanding Construction Contracts

Copyright © 2008 Womble Carlyle Sandridge & Rice, PLLC and Association of Corporate Counsel

Understanding Construction Contracts

August 2008

Provided by the Association of Corporate Counsel1025 Connecticut Avenue, NW, Suite 200Washington, DC 20036Tel 202.293.4103Fax 202.293.4701www.acc.com

This InfoPAKSM is written to inform the average in-house counsel of the general construction process. It is presumed that the average in-house corporate attorney will represent the party desiring to build new construction or modify an existing building. This document is an attempt to clarify the terms and performance of construction with the target audience of in-house at-torneys.

The information in this InfoPAK should not be construed as legal advice or legal opinion on specific facts, and should not be considered representative of the views of Womble Carlyle Sandridge & Rice, PLLC or of ACC or any of its lawyers, unless so stated. Further, this InfoPAK is not intended as a definitive statement on the subject and should not be construed as legal ad-vice. Rather, this InfoPAK is intended to serve as a tool for readers, providing practical informa-tion to the in-house practitioner.

This material was compiled by Womble Carlyle Sandridge & Rice, PLLC.

For more information about Womble Carlyle Sandridge & Rice, PLLC, please visit their website at www.wcsr.com or see the “About the Author” section of this document.

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For more ACC InfoPAKs, please visit http://www.acc.com/legalresources/publications/infopaklistings.cfm

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Contents

I. Introduction ........................................................................................5

II. Background Information ..................................................................5

A. The Construction Process . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 51. Due Diligence2. Cost Estimating3. Value Engineering4. Bidding5. Contracts6. Schedule7. Changes in the Construction Industry8. The Big Picture

III. Contracts .............................................................................................13

A. Standard Contracts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13B. Types of Contracts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13

1. Contract with Designer2. Contract with General Contractor3. Basis of Payment to Contractor4. Stipulated (“Lump”) Sum5. Unit Price6. Cost Plus Fee – With or Without a Guaranteed Maximum Price7. Design-Build

C. Obligation of Good Faith and Fair Dealing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17D. Contract Ambiguities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17

IV. Key Contract Terms ..........................................................................18

A. Scope of Work . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 181. Specifications

B. Payment Terms . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20C. Insurance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20

1. Builder’s Risk Insurance2. Statutory Workers’ Compensation and Employers’ Liability3. Automobile Liability4. Comprehensive General Liability (“CGL”)5. Umbrella Liability Coverage6. Additional Insured Endorsements7. Professional Liability (“Errors and Omissions”) Insurance

D. Bonds . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 231. Performance Bond2. Payment Bond

E. Indemnification . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 24F. Schedules/Liquidated Damages . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 24G. Delays . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 25H. Adverse Weather . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 26

1. Permitting DelaysI. Changes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 26

1. Contract Provisions



2. Differing Site Conditions3. Plan and Quanity Errors4. Mechanics’ Liens5. Prime Contractors’ Liens6. Subcontractor/Supplier Liens

V. Intellectual Property Rights ............................................................31

A. Copyright . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 32

VI. Disputes ................................................................................................32

A. Notice/Claims . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 32B. Construction Claims . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 32C. Right to Repair Laws . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 33D. Mediation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 35

1. The Phases of the Mediation Process2. Timing of the Mediation3. The Initial Joint Session4. The Caucus5. Closure and Formalizing the Agreement

E. Arbitration . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 381. Why Arbitrate?2. Select the Language in the Arbitration Agreement3. Selection of the Arbitrator & Advocate

F. Dispute Resolution Boards (“DRBs”) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 411. Use of DRBs2. Advantages of DRBs

VII. About the Authors .............................................................................43

VIII. Endnotes ..............................................................................................45


Introduction/Background Information 5

I. IntroductionConstruction has existed since humans have constructed dwellings. The first written laws, The Code of Hammurabi (created around 1792 B.C.), include construction law and building standards. The Code of Hammurabi said that if a builder builds a house that collapses and kills the owner, the builder shall be put to death. Fortunately construction means and standards have evolved and substantially improved since Hammurabi’s time. Similarly, construction laws have evolved. Significant improvements in construction means have led to significant changes in construction law. Construction law has evolved into a specialized area of law, with specialized terms. As a company grows, it may need to build or renovate a building, requiring construction and a construction contract.

II. Background InformationMany attorneys think the American Institute of Architects’ (“AIA”) documents are reliable because they are widely used. However, the AIA documents are written by architects and tend to protect architects from both the owner and the contractor. This is problematic because the average in-house attorney repre-sents the owner and could be using a document that is disadvantageous to their client. The AIA documents were the first standardized documents, and as the first, they gained popularity, soon becoming the industry “standard.” However, the AIA documents are builder-friendly, failing to protect the owner, who is usually the in-house attorney’s client. Nevertheless, these documents continue to enjoy wide usage, largely because the construction industry’s familiarity with them reduces the transactional costs involved in “custom-drafting.” With ap-propriate modifications, the AIA documents can adequately protect the owner’s interests.

A. The Construction Process

Construction typically begins with a party desiring to construct a project. For example, an owner 1 wishes to construct a building on her property. The owner hires a design firm to create building plans for the project.

1. Due Diligence

The design firm will often perform due diligence on the property to make sure it is a suitable site for the project. This due diligence can include verifying that the anticipated use is compliant with the property zoning. The design firm may need to study the impact of the proposed project to obtain building ap-proval. This is known as an “Impact Study.” The Impact Study may include, for example, a traffic study to see the effect the project will have on traffic patterns. It can also include environmental impacts. Fire protection requirements may



require verifying appropriate water pressure in the existing municipal water sys-tem. For these reasons, it is useful for the design firm to have a local presence or affiliate with a local design firm where the project is located.

The owner should exercise great care in selecting an appropriate design firm because the owner will be liable to a contractor for defects in or changes to the plans and specifications, once the contractor and owner have agreed on a price to build the project. This is known as the Spearin Doctrine, a notion that the owner warrants that the building plans are constructible, and assumes all liabil-ity if they are not.2

The owner may separately hire a land surveyor to survey the property; however, many design firms have surveyors on staff, or can retain them as a sub-consul-tant and will attempt to bundle the survey services within its design package. Although slightly more expensive, bundling the services together is usually worthwhile because one party will be responsible for any errors in design and surveying, rather than responsibility being spread among several different par-ties. Compared to the total cost of the project, surveying should be a minor cost. If there is an error that could be either a survey or design error, having the same party performing both functions will simplify the “blame game,” so that the parties can rectify the problem and avoid delays.

There are two consultants that are primarily hired by the owner, rather than the design firm: the geotechnical and the environmental consultants. The geotech-nical consultant studies and categorizes the subsurface materials, determining such things as load-bearing capacities of the soils, and makes recommenda-tions for footings, foundations, and the like. The environmental consultant may perform what is commonly known as a “Phase I” environmental investigation, consisting of a visual inspection of the site and a review of the property records to determine whether it is likely that there is environmental contamination on the site. If there is a risk that the site is contaminated, the consultant performs a “Phase II” environmental investigation. This phase consists of invasive testing to determine whether any environmental remediation is necessary prior to the beginning of construction.

The design firm usually consists of civil engineers, architects, and surveyors. Civil engineers include structural engineers that design structural components of buildings. For complex projects, the design firm may hire additional special-ty consultants, such as a mechanical engineering firm to design heating, ventila-tion, and air conditioning (HVAC). Mechanical engineers would also design plumbing systems. Electrical engineers may be needed to design the electrical and lighting portions of the project.


Background Information 7

2. Cost Estimating

The owner often has the design firm perform a cost estimate of the project. The design firm typically has little or no experience actually building projects, so the cost estimate is only a ballpark figure. Architectural design firms typically estimate costs on a square foot basis using such publications as MEANS COST DATA. Engineering design firms may quantify the various units of items that need to be constructed, such as linear feet of piping, square yards of concrete, etc. The design firm will multiply the units by the closest unit price that the de-sign firm can find. The design firm will estimate other materials’ costs and the cost of labor based on availability and pricing in the relevant market. Since the design firm usually has little experience in actually building projects, the design firm’s estimate can be very inaccurate. For a more realistic outlook, expect the cost to be 20% higher or lower than the stated estimate.

The time period available to construct the project may also affect construction costs. If it is a rush project, the cost of construction likely will increase because the contractor must employ additional resources to accelerate the construction schedule. If construction must occur during winter weather, construction costs also tend to increase.

3. Value Engineering

The owner will often hire a third party—a second design firm, a construction management firm, or a general contractor—to perform a “constructability re-view” of the project. This third party will have a fresh look at the building plans and specifications and make recommendations for changes that will reduce construction and life cycle costs. This process is known as “value engineering.”

The owner should be aware that value engineering recommendations that are accepted can occasionally be used against the owner. Third parties who suffer injuries as a result of construction defects can allege deficient design by com-paring the original plans to the value engineered plans. Similarly, the contractor can use the value engineered plans compared to the original plans to show in-adequate design if there are construction delays, construction defects, or design deficiencies.

4. Bidding

When the plans and specifications are complete, the owner is ready to engage a contractor. Based on the building plans and specifications, interested contrac-tors will compile bids for the project. The bid is an offer for the owner to accept. Depending on the size and complexity of the project, the bidding contractor may include in its bid a variety of specialty (sometimes called “trade”) contrac-tors to help construct a portion of the project. In layman’s terms, these “trade” contractors are called “Subcontractors.”



For public projects (projects owned by a governmental entity), the plans and specifications must go out for competitive bidding, where any qualified contrac-tor can bid on the project. The governmental body will publish notice of the public bid, often including a budget for the project. The qualifications for bid-ding the project will vary based on the size of the project and the governmental entity. Typically, the public body is required to accept the lowest bid from a responsible bidder if the bid is lower than the budget for the project. The low bid requirement was created to prevent “cronyism,” where public officials give projects to their friends. Public projects often require substantially more testing during the construction to verify quality of construction, since the lowest bid-der is constructing the project.

For private projects (projects by private companies), bidding is by invitation only. In this situation, the owner invites contractors to bid on the project. Un-like public bodies, private owners are not obligated to accept the lowest bid. The private owner can choose to only deal with one contractor.

5. Contracts

After accepting a bid, the owner will sign a contract with the successful bidder—the “contractor.” The contract between the owner and contractor is known as the “prime contract” or “principal contract.” In addition to defining the scope of work, the prime contract sets out numerous terms and conditions for the work, typically including a deadline for achieving substantial completion of the work (“substantial completion”). Substantial completion means the time when the owner can occupy and use the project for its intended purposes.

Frequently, the prime contract contains a liquidated damages provision requir-ing the contractor to pay the owner damages if substantial completion is not achieved on time. Liquidated damages are generally enforceable if the amount established at the time of entering into the contract is a reasonable estimate of the owner’s damages due to the project’s delay. For example, the prime contract might provide that the contractor must pay the owner $1,000 for each calendar day that the contractor misses the date for substantial completion. This pro-vision is not a penalty; instead, it is a reasonable estimate of the damages the owner would suffer for delayed completion. During the course of construction, the contractor may encounter unforeseeable delays beyond its control. If this occurs, the contractor may seek a claim for additional time which pushes back the date after which the contractor may be exposed to an assessment of liqui-dated damages.

The prime contract, as well as the subcontracts, normally contain “time is of the essence” provisions. In construction law, this provision means that a failure of the contractor to adhere to the contractual deadlines, unless such failure is permitted by another contractual provision, is a material breach. The prime


contract often requires the contractor to pay a surety to post two types of bonds in favor of the owner: 1) performance bond and 2) payment bond. With a performance bond, the surety agrees to step into the shoes of the contractor and complete the project under the principal contract if the contractor defaults. (See Section IV.D.) With a payment bond, the surety agrees to pay subcontractors if the contractor defaults in its payment obligations to them.

The contractor enters into one or more subcontracts with a subcontractor to perform specified portions of the work (the “subcontract”). The subcontract will often include a flowdown provision, where the terms of the principal con-tract flow down into the subcontract, so that the subcontractor is liable to the contractor for the same things for which the contractor is liable to the owner.

6. Schedule

Almost every prime contract requires the contractor to prepare a construction schedule for the work. For complex projects, the contractor will typically pre-pare a Critical Path Method (“CPM”) schedule, also known as a PERT Schedule. For simpler projects, the contractor may use a Bar Chart schedule, also known as a GANTT Chart, which uses horizontal bars to track the time of individual tasks, but lacks the complex sequencing of tasks that exists in CPM schedules. The CPM schedule is a more precise scheduling method and requires substan-tially more preparation.

It is typically created using powerful scheduling software. The type of schedul-ing method should match the type of project.

The cost of using a CPM schedule may outweigh the benefits for simpler proj-ects because scheduling software can be expensive. CPM schedules can be shown in a GANTT Chart format, by using arrows connecting the bars as shown in the diagram below, which shows some precedence activities:

G A NT T C hartG A NT T C hart




Based on the same activities as the GANTT Chart above, the following is a more developed CPM Schedule illustrating the critical path:

C P M (C ritic a l P ath Method) S c heduleC P M (C ritic a l P ath Method) S c hedule

7. Changes in the Construction Industry

The construction industry has undergone significant changes in the past few decades. At least once each year, Engineering News Record (“ENR”), a leading publication in the construction industry, publishes a list of the largest design firms and largest contracting firms in the country, as well as the types of projects in which the firms specialize. The ENR lists can be useful for selecting design firms and contractors.

In recent years, Design-Build project delivery and Public-Private Partnership projects have significantly changed project delivery and the construction field. Also, in just the past year, several industry organizations have published new standard form contracts. These changes are discussed in the sections below.

Design-Build ◾

Design-Build is a project delivery method in which one entity (the “design-builder”) is responsible for both designing and building the project. Most often, the contractor will be the design-builder and will engage the archi-tect as a subconsultant, but sometimes the architect is the design-builder and engages the contractor as a subconsultant. Either way, the design-builder is responsible for any errors in the construction process, whether it be a design error or a construction error. The diagram below illustrates a Design-Build Project Delivery Method.


Design-BuilderDesign-Builder

ContractorContractorDesigner

( A rc h itec t o r E n g in eer)Designer

( A rc h itec t o r E n g in eer)

SubcontractorSubcontractor SubcontractorSubcontractorSubconsultantSubconsultant SubconsultantSubconsultant

Des ign-B uild P rojec t Delivery

Design Contract Construction Contract

OwnerOwner

Design-Build Contract

Design-BuilderDesign-Builder





Des ign-B uild P rojec t Delivery


OwnerOwner

Design-Build Contract

Design-Build project delivery has both benefits and costs. With Design-Build, there is likely a sole source of responsibility when things go wrong in the construction process. This benefits owners because many of the risks inherent in construction are shifted to the design-builder. However, because these risks are shifted to the design-builder, the owner may pay a higher price for the project than with other project delivery methods.

In a Design-Build project, the owner often hires a design firm to produce a program which may include performance specifications (sometimes called “outline specifications”) for the project. The owner uses the outline speci-fications to define the project for the design-builder. The design-builder then assembles a construction team, including a design firm. The design firm uses the owner’s outline specifications to create a set of construction drawings and specifications to build the project. If design errors occur in the construction drawings or specifications, the design-builder resolves the issues with the design firm. Design-Build projects are frequently done on what is called a “fast track,” where the design firm is literally designing the project at the same time that it is being built. Design-Build can be a good solution for time-sensitive projects.

Public-Private Partnerships ◾

Public-Private Partnerships (also known as “PPP” or “3P”) dramatically changed the construction field. PPP projects create a partnership between private and public entities. For instance, a public entity may lease land to a private enterprise, which builds and owns a facility that is then leased to the public entity.




PPP projects, in essence, require a private company to finance the entire project and then recoup the investment over a long period; thus contrac-tors in PPP projects require significant financing infrastructure. PPPs have existed in Europe for some time and many large European contractors have created the appropriate financing infrastructure to build PPP projects. This existing infrastructure often makes European contractors more competitive for projects in the United States than their U.S. competitors. In the United States, PPP projects began with toll road and turnpike projects, but are gaining in popularity for many other types of projects, including mixed-use residential, commercial and institutional projects.

PPP projects tend to be large scale projects, in the many millions or billion dollar range. The size of PPP projects, combined with the complex financ-ing arrangements necessary to carry them out, limit the number of con-tractors that can bid on these projects; some large PPP projects may only have one bidder. The long-term ramifications of PPP projects in the United States are yet to be determined.

8. The Big Picture

Understanding the owner’s and contractor’s goals will make finding win-win solutions and drafting construction contracts easier for the in-house attorney.

In the big picture, the owner usually has the following three primary goals:

Constructing the project to meet the owner’s needs;1.

Controlling the project cost; and2.

Completing the project on time.3.

In the big picture, the contractor usually has the following three primary goals:

Construct the project profitably;1.

Construct the project safely; and2.

Ensure long-term profitability and preserve reputation by properly construct-3. ing the project.

The contractor must balance five factors when constructing a project:

Profitability/Cost 1.

Time2.

Quality3.

Safety4.

Litigation Avoidance5.


Contracts 13

A contractor can focus on the time element to accelerate the construction; how-ever, that may affect the project’s cost, quality, and safety. Similarly, a contractor can focus on the quality element, in which case, time and profitability may be affected. Ultimately, the project’s success will depend in large part on the extent to which the owner’s and the contractor’s interests can be aligned within the construction contract.

III. Contracts

A. Standard Contracts

Several organizations have created standard form contracts to facilitate the construction negotiation process. These organizations include: Association of General Contractors (“AGC”), American Institute of Architects (“AIA”), En-gineers Joint Contract Documents Committee (“EJCDC”), and Design Build Institute of America (“DBIA”). Most of these organizations draft the forms in part to protect the parties that they represent. Review the composition of the organization’s board of directors for an indication of its representation.

It is essential to note that standard form contracts often favor the authoring party. The existence of a standard form contract does not mean that the form is “good” for your client. In fact, if your client is the owner, most standard form contracts will not be good without at least some modifications to better pro-tect your client’s interests.4 From an owner’s perspective, any time a standard form agreement that is published by an industry group is used, the owner needs to be certain that the owner’s interests are sufficiently protected, and this will frequently mean that the standard form agreement needs to be modified. In particular, provisions dealing with payment methods and procedures, insurance and indemnity need to be carefully scrutinized.

Great care should be taken when using standard form agreements because sometimes the forms contain provisions that are invalid in certain jurisdictions. For example, some states prohibit certain kinds of contractual indemnifica-tion obligations, and some states also have statutes governing payment (usually called “Prompt Payment Acts”). If the contract provisions contradict a statute, the offending provision becomes void and unenforceable.

B. Types of Contracts

In a typical construction project, the owner will have at least two contracts: 1) a contract with the designer to prepare the building plans and specifications, and 2) a contract with the general contractor to build the project according to the building plans. Typically, both the designer and the contractor will have their own standardized forms that highly favor themselves. Rather than starting



the negotiation with forms that favor other parties, the owner should start the negotiation with a form that favors the owner. The following diagram illustrates the traditional Project Delivery Method:

OwnerOwner





T raditional P rojec t Delivery


OwnerOwner





T raditional P rojec t Delivery


1. Contract with Designer

Owners whose businesses are heavily involved in construction tend to have their own standard forms that highly favor the owners. Examples of such owners include land developers and real estate investment trusts, retailers who construct their own buildings, and government entities. Additionally, owners typically use a standard form agreement for smaller projects. For vertical construction, where an architect is the lead designer, the most common standard form agreements are those published by the AIA. For horizontal construction and facilities such as wastewater treatment plants, an engineer is the lead designer and owners typically use the standard form agreements published by the EJCDC.

The two major areas covered by design contracts are 1) the actual design of the project and the preparation of the plans (drawings) and specifications necessary for the project to be constructed, and 2) construction administration services during the construction. Sometimes an owner will engage a designer for only one of these roles; for example, an owner may have construction administration expertise in-house, and use the designer only to prepare the plans and specifications. All design contracts should require that the designer carry professional liability (errors and omissions) insurance in addition to the customary comprehensive general liability, automobile liability, and workers’ compensation insurance. (See Sections IV.C.4, IV.C.3, and IV.C.2.) Professional liability insurance protects the owner against damages resulting from the architect’s negligent errors and omissions.

Under any of the standard form agreements, the designer’s compensation to perform an agreed scope of services can be based on a lump sum or on a percentage of the cost of the project. If the designer performs services outside


of, or in addition to, the agreed scope of services, the “additional services” or “changed services” are commonly compensated on an hourly basis in accordance with an hourly rate schedule. It is very important for the owner and the designer to have a detailed scope of services included in the contract so that there will be no misunderstanding about what constitutes additional services.

2. Contract with General Contractor

In contrast to design contracts, it is not unusual for an owner to use a customized construction contract. Still, it appears to be fairly common for the owner and contractor to enter into a standard form agreement published by one of the major industry groups. If the owner’s lead designer is an architect and the project is a building–and particularly if the designer assists the owner with the contracting process–the construction contract will likely be an AIA standard form agreement. If the owner’s lead designer is an engineer and the project is not a building, the construction contract will likely be an EJCDC standard form agreement. Governmental entities sometimes create their own contracts to better protect their interests.4 Similarly if the contractor gets the opportunity to present the owner with a contract form, it may well be the standard form agreement published by the AGC. However, since the AGC forms tend to be balanced, many contractors create their own forms to better protect their interests. Examples of areas on which to focus are scope of work, payment terms, time for completion, responsibility for correcting defective work, warranties, insurance, indemnification, and the contract price.

The old saying “you get what you pay for” often applies to construction. A large portion of construction costs is for materials and equipment; it is not a high–profit industry. If a contractor’s price is significantly below its competitors, there is probably a reason for it. The likely reason is that the contractor misunderstood the scope of work or intends to make-up the cost by “change ordering” the owner excessively. If, in fact, the contractor misunderstood the scope of work, the obligation of good faith and fair dealing prevents the owner from taking advantage of the contractor’s misunderstanding.

3. Basis of Payment to Contractor

The basis of payment to a contractor will dictate in many respects the type of contract that should be used and the terms that are appropriate. The five methods of payment set out below are the most common.

4. Stipulated (“Lump”) Sum

The contractor agrees to construct the project for a sum certain in accordance with the contract terms, including completing the project within the period of time required by the contract. In agreeing to a lump sum, the contractor necessarily will have included in that sum a certain amount of money as a

Contracts 15



contingency to cover unanticipated costs. In addition, under a lump sum contract, any work that is performed outside of the scope of work set out in the contract is considered to be “changed work,” and the contractor will be entitled to a change order for more money. Similarly, if there are delays on the project that are not the contractor’s fault, the contractor will be entitled to a time extension for completion of the project, and in many cases, to more money for the extra costs it incurs because of the delays.

5. Unit Price

Unit price contracts are used most frequently for horizontal construction (for example, roads, water, sewer lines) and for site preparation contracts, where payment is based on the quantities needed. For example, if laying pipe, the contract might specify a certain dollar amount per linear foot of pipe needed. For site preparation contracts, the basis of payment might be a lump sum for excavating and moving up to a certain number of cubic yards of dirt, and then a certain dollar amount for every cubic yard moved above that amount. Building construction is generally not performed on a unit price basis, with the exception of the site preparation costs, for which unit prices are commonly given if quantities of dirt beyond those anticipated have to be moved and disposed of.

6. Cost Plus Fee–With or Without a Guaranteed Maximum Price

Contracts in which the basis of payment is the actual cost of the work (as defined in the contract), plus a fee to the contractor for the contractor’s overhead and profit, are often favored by owners because the contractor does not have to include a large contingency to cover all unanticipated costs, as is necessary with a lump sum contract. The contractor’s fee is usually a percentage over and above the cost of the work. In addition, the owner usually wants to know its maximum possible cost exposure under the contract. In most cases, the contract establishes what is called a “Guaranteed Maximum Price” or “GMP.” The GMP is calculated by adding the estimated cost of the work (the contractor’s estimate of what the actual costs will be to construct the project based on the plans and specifications) plus the contractor’s fee.

If it turns out that the project is more costly than the contractor estimated, the contractor must pay the additional costs, because the GMP is the owner’s maximum exposure under the contract. On the other hand, if it turns out that the project costs less than the contract’s GMP, the owner and contractor often share the savings. When entering into a GMP contract, owners need to understand that the GMP based on the scope of work set out in the contract and any changes in that scope (including delays that extend the project completion date) may entitle the contractor to an increase in the GMP. On rare occasions it is appropriate to enter into a cost plus contract without a GMP. An example might be a renovation project where there are likely to be hidden


conditions.

7. Design-Build

Design-build contracts can follow any of the above bases of payment. A cost plus with a GMP is a very common basis for a design-build agreement. The design portion of a design-build contract is usually excluded from the cost of the work and is paid on a lump-sum or an hourly basis with a not-to-exceed maximum. When the design is sufficiently complete to estimate the cost of the work, the owner and design-builder agree on a GMP.

C. Obligation of Good Faith and Fair Dealing

Every contract has the obligation of good faith and fair dealing, which basically means that a party cannot interfere with the other parties’ performance of the contract. In construction law, the good faith and fair dealing obligation creates duties for owners and contractors. In construction law, the owner has: (a) an implied obligation not to do anything to hinder or obstruct performance by the other person; (b) an implied obligation not to knowingly delay unreasonably the performance of duties assumed under the contract; and (c) an implied obligation to furnish information which would not mislead prospective bidders.

Many contracts contain a “no damage for delay” provision that prohibits a contractor from filing a claim for delays caused by the owner. There is a risk that the owner’s agents will take such provisions literally and actively breach the obligation of good faith and fair dealing. Such actions by the owner’s agents will set the owner up for a costly claim or lawsuit. Since the owner will be liable for its agent’s actions, the owner should proactively control its agents to ensure they do not breach the obligation of good faith and fair dealing.

D. Contract Ambiguities

Construction contracts often incorporate drawings and specifications, which can cause ambiguities in the contract itself. By definition, if a document can have two reasonable interpretations, it is said to be ambiguous. Since the drafter of the contract can remove ambiguities, contract law construes all ambiguities against the drafter, in favor of the non-drafter. Owners should be aware that to the extent any ambiguity exists in the interpretation of the contract, it will be strictly construed against the drafter. Owners should attempt to work as a team with the contractor to resolve ambiguities in a fair manner, and to prevent delays that may give rise to a delay claim for such things as idle equipment, idle labor, home office expenses, field office expenses, and so forth. Many contractors will forego a claim for minor delays if the owner works with the contractor to timely resolve problems.

Contracts 17



IV. Key Contract TermsThe single most important provision in the contract is the one that sets out the scope of work. The price, schedule, and other variables are all affected by the scope of work.

A. Scope of Work

The scope of work should define precisely what the owner wants the contractor to build. Too often, parties begin workign on other provisions of the contract without clearly defining the scope of work. This is a mistake because the scope of work can and will affect the other provisions. The scope of work should be defined in narrative form only, but usually, the scope of work is defined by combining a narrative describing the project, with the actual plans and specifi-cations for the project.

1. Specifications

There are four specifying methods used to specify requirements in the project manual: (1) Proprietary; (2) Descriptive; (3) Reference Standard; and (4) Per-formance. To get a flavor of each of these four specifying methods, let’s use a hamburger as an example. The following are examples of a hamburger specifi-cation:

a. Hamburger

Proprietary Specification: ◾Hamburger shall be “Big Mac” manufactured by McDonald’s (add “or equal” to change from Closed/Restrictive to Open/Non-Restrictive).

Descriptive Specification: ◾Ingredients: Two all beef patties, special sauce, lettuce, cheese, pickles, onion on a sesame seed bun Nutrition: Calories 540 kcal; Cholesterol 80 mg; Sodium 1.01 g; Total carbo-hydrate 47 g; Dietary fiber 3 g (14%); and Protein 25 g. Size: X.X inches wide by X.X inches high Net Weight: X.XX ounces Execution: Chop lettuce, cut bun, etc.

Reference Standard Specification: ◾Hamburger shall meet the following industry standards and governmental regulations: National Restaurant Association, Standard XXX U.S. Department of Health and Human Services, Code XXX, Ch. X.X(x) U.S. Department of Agriculture (USDA), X CFR XXX.X(x)(x), XX Food and Drug Administration (FDA), Rule XXX, § XX.X(x)(x)….

Performance Specification: ◾Hamburger to look tall, be liked by majority of children and adults, smell


good, have 540 kcal of Calories and 25 g of protein….Moving from hamburgers to construction, here are examples of a window specification:

b. Window

Proprietary Specification: ◾Windows shall be “InfoPak Residential Window”, Series XXX-1234, manu-factured by InfoPak Window Co. (add “or equal” to change from Closed/Re-strictive to Open/Non-Restrictive).

Descriptive Specification: ◾Type: High performance residential aluminum clad wood windows with divided lites. Material: Aluminum clad wood Glass Type: 7/8” Insulating Low-E coating: Yes Condensation Resistance Factor (CRF): >60 U Value: <0.50; R Value (1/U): >2..00 Execution: Install window units according to manufacturer’s instructions.…

Reference Standard Specification: ◾High performance residential aluminum clad wood windows shall meet the following industry standards and governmental regulations: ASTM E XXXX: Specification for Sealed Insulated Glass Units. ASTM C XXXX Standard Specification for Flat Glass. WDMA XX: Industry Standard for Water Repellent Preservative Treatment for Millwork. AAMA XX.X(x)(x): Voluntary Specification for High Performance

Performance Specification: ◾Windows to be attractive colonial style, residential grade, low maintenance and top ten percent in industry for energy efficiency.

It is not uncommon to use a combination of specification methods; however, it must be done with caution, due to the possibility of redundancy or contradic-tion.

When building according to proprietary, descriptive, or reference standard specifications, the contractor must comply strictly with the requirements—but that is the extent of the contractor’s obligation. If the specifications are defi-cient in some way, the contractor is not responsible for fixing the defect, as long as the specifications were followed. In contrast, performance standards set out how the finished project must perform. The contractor has the flexibility, within certain parameters, to use whatever materials and equipment the con-tractor chooses, as long as the performance standard is met.

Key Contract Terms 19



B. Payment Terms

Most contractors submit monthly invoices for payment. In most cases, these in-voices take the form of an “Application for Payment,” which is an AIA standard form (AIA G702 and G703). If the architect is providing construction adminis-tration services, the contractor submits its Application for Payment to the archi-tect. Based on the work quality and quantity, the architect certifies for payment the amount the architect deems to be due the contractor. The AIA documents provide that once the architect has certified payment, the owner is obligated to pay the contractor the amount certified by the architect.

In most construction contracts, the owner is entitled to withhold from the con-tractor some portion of each progress payment (the “retainage”) to protect the owner in case the owner needs to finish incomplete work or correct defective work. The traditional amount of retainage is 10% of each progress payment, until the project is 50% complete, and then no retainage after the halfway point so that at substantial completion of the project, the owner is retaining 5% of the amount due to the contractor. At substantial completion, the retainage is frequently released to the contractor, less the estimated cost as determined by the owner or architect to complete any “punch list items.” Punch list items are normally defined as things needing completion or correction that do not inter-fere with the owner’s use and enjoyment of the project.

C. Insurance

It is imperative that all of the parties working on a construction site carry ad-equate insurance. The owner normally carries builder’s risk insurance, which is the type of property/casualty insurance that applies to projects under construc-tion. The architect, contractor, and all subcontractors need to carry workers’ compensation, comprehensive liability, and automobile liability insurance. In addition, the architect needs to carry professional liability (Errors and Omis-sions) insurance.

1. Builder’s Risk Insurance

Construction projects involve unique risks of loss. Structures under construc-tion are much more subject to damage from natural elements, such as fire, wind, rain, hail, and the like, than are completed structures. The construction contract will specify who is responsible for purchasing builder’s risk insurance, and in most cases, the contract will place this responsibility on the owner. Re-gardless of whether the owner or the contractor purchases the policy, all parties with an “insurable interest” in the project will have their interests covered.

The changing value of the structures under construction is also relevant to this issue. Likewise, the value of projects under construction is constantly changing. At the beginning of construction, the value is minimal, but it increases with the


progress of construction and is highest when the structure is complete. Finally, property to be incorporated into the construction may be owned by many dif-ferent parties (contractor, subcontractor, suppliers) and be in transit, in off-site storage, or on the project site. This insurance should be written on an “all-risk” basis, which means that any risks, other than the named exclusions, are cov-ered for loss from any cause. The insurance policy should also be written on a completed “value form,” meaning that the coverage limit is the estimated value of the completed project. The premium is based on that estimated completed value, and then adjusted according to the actual completed value.

2. Statutory Workers’ Compensation and Employers’ Liability

In most states, employers are required to carry workers’ compensation insur-ance to protect their employees. Specific coverage requirements and benefits vary by state and are set by statute. In most states, workers’ compensation insurance is the exclusive remedy for work-related injuries; however, sometimes there are damages arising out of work-related injuries that are not covered by the statutory benefits. For that reason, it is important for the employer also to carry employer’s liability insurance, which responds to claims that do not fall within the statute’s purview. This insurance requirement often appears in con-struction contracts with language requiring “the contractor to carry workers’ compensation insurance as required by statute and employer’s liability coverage of $1,000,000.” 6

3. Automobile Liability

All parties who may be traveling to the construction site must be required to maintain automobile liability insurance covering owned, non-owned, and hired vehicles. This coverage is usually written with a combined single limit, mean-ing that the full policy limit is available for the payment of any covered claim. The limit applies per accident, with no annual aggregate. Common language for this coverage requires the contractor to carry “automobile liability insurance with a combined single limit of $1,000,000 covering owned, non-owned and hired vehicles.”7 The contract should require the contractor’s insurance to name the owner as an additional insured under the contractor’s and subcontractors’ automobile liability policies. (See #6 below for additional information)

4. Comprehensive General Liability (“CGL”)

The main coverage types under CGL insurance are for bodily injury and prop-erty damage for which the insured is legally liable. Every party involved in the project should be required to maintain CGL insurance at least until the comple-tion of the project, and the contractor should be required to maintain one part of this coverage, “products and completed operations” beyond completion (see below). Most CGL policies are written on an occurrence basis, which means that coverage is triggered by the occurrence of a covered injury or damage dur-




ing the policy period, not by when a claim is made. Thus, under an occurrence policy, a claim can be made many years after the policy term’s expiration, as long as the claimed injury or damage occurred during the policy term. Gener-ally, owners prefer CGL policies written on an occurrence basis. It is common for the construction contract to require that the contractor carry CGL insur-ance that includes coverage for: “XCU (explosion, collapse, and underground property damage), products and completed operations, and contractual liability. Products and completed operations coverage shall be maintained for (one or two) years after final completion [of] the project.” 8

The amount of required liability coverage depends on a variety of factors, including the size and value of the project, the size of the contractor’s opera-tions, the complexity of the construction, and the anticipated risk of injury to third parties or the property of third parties. Commonly required limits are $1,000,000 per occurrence with a $2,000,000 annual aggregate, with umbrella liability coverage of at least $5,000,000 (see #5). The owner should be named as an additional insured under the contractor’s and subcontractors’ comprehensive general liability policies.

5. Umbrella Liability Coverage

Umbrella liability insurance provides additional coverage limits over the limits provided in the CGL policy. In addition, umbrella policies typically broaden the scope of coverage, picking up some forms of liability that are not covered by the CGL policy. Normally, the owner should require that the contractor carry umbrella liability insurance with coverage limits of at least $5,000,000. For some projects, higher limits may be in order, for example, if the project involves dangerous work or is in an urban area that is highly populated with heavy traf-fic around the construction site. The owner should be named as an additional insured under the contractor’s and subcontractors’ umbrella liability policies

6. Additional Insured Endorsements

Additional insureds have the same rights as the named insured, including the right to defense from the insurer and the right to file a claim directly against the insurer. Typically, an additional insured is covered for liability arising out of the named insured’s work performed on behalf of the additional insured. The construction contract should require that the owner be named as an additional insured under the contractor’s comprehensive general liability, automobile li-ability, and umbrella liability policies.

7. Professional Liability (Errors and Omissions) Insurance

All design professionals should be required to carry professional liability insur-ance. Professional liability insurance covers negligent acts and omissions of de-sign professionals. It does not cover intentional wrongdoing, nor does it cover


breach of warranty. This insurance is written on a “claims made” basis, meaning that a claim must be made during the policy period in order to be covered. At least $2,000,000 of coverage is typically required of design professionals, and higher coverage should be required for large or complex projects. It is not ap-propriate for the owner to require additional insured status under professional liability policies. Construction managers who provide value engineering ser-vices or constructability reviews also should be required to carry this insurance, which may be added by endorsement to their comprehensive general liability policy.

D. Bonds

Most public projects and many private projects require the contractor to obtain performance and payment bonds. Generally speaking, these bonds guarantee the contractor’s performance of the construction contract and if the contractor defaults, the surety that has issued the bonds is obligated to the owner for the costs of completing the project in accordance with the construction contract, up to the amount stated in the bond (known as the “penal sum” of the bond). The parties to a bond are: (1) the surety company (“surety”); (2) the contractor (“principal”); and (3) the owner (“obligee”). The principal owes the primary duty to the obligee and the surety’s liability is only secondary, triggered upon the principal’s default.

1. Performance Bond

The performance bond guarantees the performance of the construction contract to the obligee. The construction contract is incorporated into the bond, so the two documents must be read together to understand the surety’s exposure and potential liability. The penal sum of the bond should be the full contract price or GMP, as applicable. The surety has no duty to complete the project itself, or to arrange for its completion, but it must pay up to the penal sum of the bond for the completion of the project if the contractor defaults.

It is important to remember, however, that the surety will be able to assert any defenses under the construction contract that the contractor could have assert-ed against the owner to avoid liability under the bond. In addition, the surety may assert any defenses available to it under the bond itself, such as untimely notice or notice not given in accordance with the requirements of the bond. Finally, there are certain principles of surety law that may help the surety avoid liability. For example, if the owner has paid the contractor more than the value of the work performed at the time the contractor defaults, the surety may be able to argue successfully that it should not be liable for the full amount of the costs to complete the project.




2. Payment Bond

The surety normally issues a payment bond simultaneously with the perfor-mance bond. The payment bond protects subcontractors and others who supply labor and materials to the project and assures the owner that they will be paid in case the contractor fails to pay them. A payment bond also helps to keep the project free from mechanics’ liens (see below). Although the payment bond names the owner as obligee under the bond, the bond really runs in favor of and for the benefit of subcontractors and other suppliers of labor and materi-als to the project. The owner has no direct rights against the surety under the payment bond.

E. Indemnification

The indemnification (sometimes called “hold harmless”) agreement is a con-tractual device used to transfer risk from one party to another. It is commonly used in construction contracts to transfer risks inherent in the construction process from the owner to the contractor. The contractor, in turn, transfers those risks to its subcontractors by including an indemnification agreement in its subcontracts. Indemnity agreements can take many forms and can be classi-fied as: (1) Broad, where the indemnitor agrees to hold harmless the indemnitee for all liabilities arising out of the indemnitor’s work, regardless of which party was at fault; or (2) Limited, where the indemnitor agrees to hold the indemnitee harmless for only those liabilities that are the indemnitee’s fault.

Many states now have construction anti-indemnity statutes which render unen-forceable as against public policy those indemnification provisions that require indemnifying a party for its own negligence. Many of the state statutes will completely void the indemnification provision, rather than limit the indemnifi-cation provision. As a result, indemnification provisions are increasingly writ-ten on a limited, or comparative fault, basis. In an effort to comply with state law, sometimes indemnification provisions include limiting phrases such as, “To the fullest extent permitted by law, X shall indemnify Y….”

One of the most commonly used indemnification provisions comes from the AIA Document A201, the General Conditions of the contract for construction, and has served as a model for owners, contractors, subcontractors, and their lawyers. The AIA indemnification provision is based on comparative fault, and obligates the indemnitor to hold harmless the indemnitee for liability attaching to the indemnitee only “to the extent caused by the negligent acts or omissions” of the indemnitor.

F. Schedules/Liquidated Damages

From the perspective of the owner, every construction contract should con-tain a “time is of the essence” provision. This makes strict compliance with


the completion schedule an essential term of the contract, and any unreason-able delay in completion is deemed a breach of contract. Similarly, the owner’s timely payments and responses to contractors’ requests to clarify and correct plan errors can be a breach of the contract.

The contractor typically is required to provide the owner with a construction schedule at the beginning of the project, demonstrating that substantial comple-tion will be achieved within the time set-out in the contract (i.e., the “contract time”). Unless a delay is excused by one of the reasons permitted under the contract (e.g., unforeseen events beyond the control of the contractor, abnormal weather, force majeure, etc.), the contractor will be liable to the owner for any damages suffered by the owner if the project is not completed on time.

It is common in the construction industry for the owner to “liquidate” those damages at the time of entering into the construction contract. This is accom-plished by putting into the contract a liquidated damages provision that pro-vides certainty to the contractor as to its exposure and also relieves the owner of the obligation to prove its actual damages, if indeed the project is completed late. Liquidated damages provisions are enforceable, provided they are based on the owner’s reasonable estimate at the time of entering into the contract of what its damages would be if project completion were delayed, and are not so high as to constitute a penalty to the contractor. Generally, if the owner stipulates to an amount of liquidated damages that are lower than what is later determined to be its actual damages, the owner has forgone the right to pursue a claim for actual damages. Therefore, in this situation, the owner is limited to his/her original stipulation. Liquidated damages provide the contractor a limit to its per day exposure for delay damages.

G. Delays

There are progress delays in almost every construction project. Some delays are not the contractor’s or owner’s fault, like those caused by adverse weather, natu-ral disasters, and the like. Such delays are said to be “excusable.” Other delays could have been prevented by the contractor and are said to be “inexcusable.” Adverse weather is generally considered an excusable, but non-compensable delay (no extra money to the contractor). An example of a compensable delay (the contractor gets extra money) would be where the owner actively interferes with the contractor’s work or where the plans and specifications are defective, except on a design-build project, where the design-builder is responsible for the accuracy of the plans and specifications.

The construction contract should specify what delays are excusable and com-pensable, what delays are excusable but non-compensable, and what delays are inexcusable. Owners should be aware that provisions limiting contractor’s compensation for delays are still subject to the obligation of good faith and fair dealing.




H. Adverse Weather

Rarely does a project have good weather throughout the entire construction process. The question is: How bad does the weather have to be before it entitles the contractor to a change-order extending the contract time or increasing the contract sum? That answer depends on the terms of the construction contract. The General Conditions of the Contract for Construction (AIA Document A201) contains the following language: “If adverse weather conditions are the basis for a Claim for additional time, such Claim shall be documented by data substantiating that weather conditions were abnormal for the period of time, could not have been reasonably anticipated, and had an adverse effect on the scheduled construction.” This language can be strengthened by adding the requirement that acceptable data for substantiating a claim based on adverse weather should be the records of the National Oceanographic and Atmospheric Administration (NOAA) for the prior 5 years.

Some owners require that the contractor build an agreed number of “adverse weather days” into the project schedule, so that no time extensions can be claimed unless and until those days are exceeded. Owners should require the contractor to show that the delay directly impacted critical path activities. For example, if the building is 95 percent complete and dried in, an abnormal rain should not justify an extension of the contract time.

1. Permitting Delays

Governmental authorities operate on their own schedules, and are notorious for issuing permits slowly. Sometimes a construction contract will provide that the work must achieve substantial completion “within X calendar days of the date the building permit is issued.” This is a sensible approach to the building permit. However, there are other permits that may be necessary, depending on the nature of the project and the jurisdiction in which the construction is tak-ing place, that may also create delays in the anticipated progress of the work. If these delays are due to the slow permitting authorities, this will be an excusable delay and will entitle the contractor to an extension of the contract time. A mi-nor permitting delay created by governmental authorities is not the fault of the owner, and therefore should be non-compensable. However, major delays af-fecting the work that require demobilization and remobilization of the contrac-tor’s forces, delays compelling a contractor to construct during winter, or other delays that significantly increase a contractor’s cost of construction may entitle a contractor to compensation for the delay, especially if the owner’s agents con-tributed to the delay.

I. Changes

Changes in the work of the project (the “work”) are an inevitable part of a construction project. Changes can be occasioned by unanticipated weather, site


conditions, design errors or omissions, installation problems or errors, coor-dination problems in the work (for example, the parts of the work do not fit together as shown on the plans), or simply changes to the owner’s program that necessitate a change in the project. It is important to manage changes carefully and consistently.

1. Contract Provisions

The construction contract should provide that changes to the work can only be made in writing through a formal document (a “change order”). The change order must be signed by the owner, the architect, and the contractor. The three signatures indicate that all parties approve the work change, including the con-tract sum adjustment, if any, and the contract time adjustment, if any. The contract should also identify the representative of the owner, and who is authorized to make changes in the work and sign change orders. If there is a limitation on the dollar amount of change orders that the owner’s representa-tive may approve, that dollar limitation should be expressly stated. On a siz-able project, owner’s representatives are frequently given authority to approve change orders up to $25,000 without seeking higher approvals.

Most construction contracts also provide a mechanism for accomplishing changes in the work in the absence of an agreement between the owner and contractor on what the adjustment in the contract sum or contract time should be. If the owner desires to make a change but cannot agree on the terms of that change with the contractor, the owner can issue a “Construction Change Direc-tive,” ordering the contractor to perform the desired change. The construction contract obligates the contractor to make the change if it receives a Construc-tion Change Directive, and the contract spells out how the adjustment to the contract sum and the contract time is to be calculated. Under most construc-tion contracts, the architect makes that calculation in accordance with those terms. Several change circumstances that arise frequently in the course of construction are described below.

2. Differing Site Conditions

As discussed in the previous section on “Due Diligence” (see Section II.A.1), before beginning a construction project, the owner engages a geotechnical consultant to investigate the subsurface conditions at the desired building site—what types of soil exist, what the load bearing capacity of the soil is, whether there is rock and if so, how prevalent, and what kind, etc. The owner may also engage an environmental consultant to determine whether underground envi-ronmental contamination exists at the site. Each of these consultants prepares a report that is available to the contractor for its review prior to the contrac-tor’s submitting a bid for the project, and the contractor will be deemed to have taken this information into account in submitting its bid.




It is not unusual for the contractor to encounter something unanticipated under the ground that slows up its work and requires it to do some things it had not planned to do, based on the information contained in the contract documents. For example, the subsurface report may have identified a small amount of rock in one area of the site, but in fact there was rock under the surface in several other places as well, and it was rock that was very difficult to extract, delaying the progress of the work and making it more costly for the contractor to pre-pare the site for the building. This would be an unanticipated or “differing” site condition, because it differed from the information contained in the subsur-face report, and the contractor would be entitled to a change order increasing the contract time and the contract sum. This is called a “Type 1” differing site condition.

There is also a “Type 2” differing site condition that entitles a contractor to a change order. In a Type 2 differing site condition, the contractor encounters a subsurface condition that ordinarily it would have no reason to suspect existed at the site. For example, it is possible to uncover an area of the site that was once a dumping ground for debris of all kinds, when there was no history that the site was used as a landfill. While the geotechnical investigation might iden-tify that condition, it might not, particularly on a large tract of land.

There are also “hidden conditions” that may occur above the site. Renovation projects are particularly susceptible to hidden condition situations, where there are conditions in the structure to be renovated that cannot be known until the contractor begins its work. An owner undertaking a renovation project where there may be hidden conditions should build into its budget a substantial con-tingency to cover these situations.

3. Plan and Quantity Errors

There is no such thing as a perfect set of plans. Hypothetically, if the plans were perfect, the plans would be so voluminous that contractors may become ner-vous and bolster bid proposals with large contingencies. In areas that are not critical, it is better to leave some discretion to the contractor. When there is an error by omission, a contractor may be justified in making a claim for addition-al money because it should only be responsible for bidding on what is specified or shown on the plans. As protection from error by omission claims, owners and architects sometime include default contract language requiring the con-tractor by inference to include all incidental items necessary for a sound, secure and complete installation.

When there is an error by conflict, either in another plan detail or a specifica-tion, a contractor typically can claim that its bid only included the least ex-pensive of the conflicting requirements justifying a claim. As protection from error by conflict claims, owners and architects might include default contract


language requiring that the contractor provide the more expensive or higher quality of the conflicting requirements. In addition, the contract may include an order of precedence clause where, for example, a large scale detail will take precedence over a smaller scale detail. Finally, the plans may simply, have an error by mistake, in which case the contractor may be entitled to a claim. When an owner has to pay a contractor extra costs for a plan error by the architect, the owner may justify a claim against its architect if the error rises to the level of negligence. If the error is not severe enough to meet the negligence threshold, the owner pays.

Architects typically do not include quantities or a bill of materials in its plans and specifications; therefore, the risk of quantity errors generally falls on the contractor. Occasionally, the architect may catch a contractor’s quantity error in reviewing shop drawings. However, standard form architect contracts gener-ally include language providing that architectural review is not conducted for the purpose of determining the accuracy and completeness of details such as dimensions and quantities, and that the architect’s approval does not relieve the contractor of its responsibility for such errors in shop drawing submittals.

4. Mechanics’ Liens

Each state has enacted a mechanics’ lien statute to give security to those who provide labor or materials to improve someone else’s real property. Lien statutes vary greatly from state to state in terms of who they protect, under what con-ditions they protect, what labor and materials are protected, what procedures need to be followed to take advantage of the protection, and under what con-ditions the protections may be waived.9 You must consult the mechanics’ lien statutes of the state in which the project is located if a lien claim or issue arises.

Mechanics’ lien statutes in general apply to private property. Most public property is exempt from lien statutes and therefore cannot become subject to a claim of lien. The security for those providing labor and materials on public projects is a payment bond (see “Payment Bond,” Section IV.D.2). Some juris-dictions, however, allow a claim of lien on funds to be asserted against a public owner (see “Subcontractor Liens,” Section IV.I.6 ). In most jurisdictions, those providing services (e.g., architects, engineers, land surveyors, etc.) are covered, as well as those providing the labor and materials that are directly used in the construction. However, most issues and lien claims arise from prime (general) contractors and subcontractors.

5. Prime Contractors’ Liens

The lien rights of prime (general) contractors vary greatly from state to state and can only be ascertained by studying the mechanics’ lien statutes of the state in which the real property being improved is located. However, in most juris-dictions, prime contractors can assert a claim of lien directly against that real




property for labor and materials furnished on the property and not paid for by the owner. The claim of lien must be filed in the property records of the county in which the property is located. This puts everyone with an interest in that property on notice that there is a claim of lien against it. Filing a claim of lien in the property records may be the only notice required to be given to the owner, depending on the pertinent statutory requirements. After filing a lien claim, all jurisdictions require that the lien be “perfected” in some way, which generally means that the contractor must file a lawsuit against the owner to enforce the lien within the time required by the statute. Statutory time requirements gener-ally are strictly enforced and an otherwise valid claim of lien can be lost if not timely perfected.

A multi-count lawsuit filed against an owner will demand that the owner pay the contractor the amount owed under the claim of lien (with interest and at-torneys’ fees if allowed by the applicable statutes) or, in the alternative, that the land be sold and the proceeds paid to the contractor up to the amount owed. Sometimes a contractor will improve land under a contract with a lessee of the real property. In that case, a contractor normally can assert lien rights against the leasehold interest. Whether the lien rights can extend to the owner’s fee interest in the property is governed by the lien statutes of the state in which the real property being improved is located. In almost every jurisdiction, lien rights can be waived under certain circumstances; commonly, when the owner receives payment. In many, if not most jurisdictions, it is against public policy to require a contractor to prospectively waive its lien rights as a condition of securing a contract.

6. Subcontractor/Supplier Liens

Subcontractors and suppliers generally have contractual and lien rights against the prime (general) contractor with which they have a contract. Subcontractors and suppliers are not in privity of contract with the owner of the real property they are improving so they do not have direct lien rights against the real prop-erty. However, as with prime contractors, lien rights of subcontractors and sup-pliers vary greatly from state to state and can be ascertained only by reference to the mechanics’ lien statutes of the state in which the property being improved is located.

Under some mechanics’ lien statutes, subcontractors and suppliers can assert a lien against funds owed by the owner to the prime contractor, and in that way obtain some security that they will be paid. For example, in some jurisdictions a subcontractor can serve a notice of claim of lien on funds on the owner in the same way that it would serve a lawsuit. After receiving such a notice, the owner must retain from its payment to the prime contractor at least the amount of money stated in the notice of claim of lien in order to provide security of payment to the subcontractor. If the owner does not retain at least the amount


of money stated in the notice, the owner could become personally liable to the subcontractor for that amount. Then, the subcontractor may be able to directly file and perfect a lien against the owner’s property similar to the prime contrac-tor’s lien, depending upon the specific provisions of the applicable mechanics’ lien statute. In some states, a subcontractor or supplier can also serve a notice of claim of lien on funds against a public owner, and the public owner must retain the amount stated in the notice from the prime contractor, even though the public property itself is not lienable.

Some lien statutes require an owner to pay twice for the same improvements, if the contractor fails to pay its subcontractors. This provides an incentive to the owner to ensure that the contractor pays its subcontractors and suppliers. If the owner pays the contractor, but the contractor fails to pay its subcontractors, the owner could be required to pay the subcontractor directly. Generally, language in a contract waiving lien rights is unenforceable. As a precaution, because the owner is making progress payments to the contractor, the owner should require the contractor to submit partial waivers of liens for the work already performed. This helps to ensure that subcontractors are paid and avoids subcontractor or supplier lien problems later.

A lien attaches to the improved property, much like a mortgage that clouds the real property title. The lien can be foreclosed upon, often requiring sale of the real property at public auction to the highest bidder. The proceeds from the auction are used to satisfy the lien, with the remainder going to the owner. It cannot be emphasized enough that mechanics’ lien statutes vary so greatly from state to state that one should never assume knowledge about a specific lien right or issue without consulting the applicable state’s mechanics’ lien statute.

In addition to the lien statutes, some states recognize equitable liens or common law liens. Equitable liens require the owner to treat subcontractors and suppliers fairly. If the owner has not paid the contractor, the subcontractor and suppliers can seek an equitable lien to obtain a judgment against the property and sell it at public auction. Unlike statutory liens, which may require an owner pay twice if the contractor does not pay its subcontractors, equitable liens only require an owner to pay once out of fairness.

V. Intellectual Property RightsHistorically, the designer creates and transmits most intellectual property on paper to the owner, the general contractor, and others involved in the project. In today’s world, as more project data is created and transmitted by parties other than the designer, and in digital form, intellectual property rights and interests are extending beyond the owner, designer, and general contractor; ideally, these intellectual property rights and interests must be considered more

Intellectual Property Rights 31



broadly. Several industry organizations have responded to this phenomenon by creating standard form documents to govern the ownership, use and transmis-sion of digital data, and these documents will probably come into common use before long.

A. Copyright

Drawings, specifications, and other design documents are frequently referred to as “Instruments of Service.” Normally, the designer retains copyright own-ership in the Instruments of Service, and the owner is granted a license to use the Instruments of Service for purposes relating to the project; but the owner cannot use the Instruments of Service on any future projects. While the de-signer retains the copyright ownership in the Instruments of Service, the owner frequently prohibits the designer from using them on any other project. Occa-sionally, the owner will insist that the designer create the Instruments of Service as “works for hire” so that the owner retains all rights to them, including copy-right.

VI. Disputes

A. Notice/Claims

Many construction contracts require that a contract provide the owner notice of intent to file a claim, known as a “NOI.” The NOI provides the owner the op-portunity to track and document costs as well as causes for delay. Some con-struction contracts limit a contractor’s ability to recover unless the contractor provides the owner with reasonable notice specified in a contract. The amount of notice may vary with the type of claim; for instance, a notice provision for additional work may require notice to owner before contractor begins the ad-ditional work. In comparison, claims for delay may require 10 business days notice after the start of the delay. Courts will invalidate unreasonably short notice requirements, such as 24 hours notice.

B. Construction Claims

Construction claims are a contractor’s request for additional payments for unforeseen conditions, delays, additional work, or other issues that the contrac-tor believes entitles him to additional payment. The contract will often specify the claims procedure for the contractor to follow. If the contractor believes the claim procedure is unfair and the amount in controversy is significant, the contractor will likely sue the owner in court. The suit can include a breach of contract as well as an equity claim.


C. Right to Repair Laws

The rise of so-called “Right to Repair” or, as referred to in some states, the “Right to Cure” laws were a response by legislatures to fix an avalanche of construction defect lawsuits that negatively impacted residential construction. Typically, Right to Repair laws are designed to require builders and claimants to participate in a presuit dispute resolution and discovery process, giving them an opportunity to attempt to settle before entering the court system. As of 2007, there were 31 states with Right to Repair laws which typically allow for 60, 90, or even 120 days to pass before a claimant may file a lawsuit.10 The rise of Right to Repair laws, beginning in 2000, was consistent with a marked increase in construction activity in the U.S.—most significantly in the Southeast and Western portions of the country. According to the May 2008 U.S. Census Bu-reau statistics, the number of privately owned housing went from 19,180,000.00 units in the year 2000 to a height of 25,291,000.00 in 2005 to 16,673,000.00 in 2007.11 In Florida, despite a slow down in construction beginning in 2006, in the first quarter of 2008 there were 8,205,085.00 square feet of office space and 12,465,718.00 square feet of industrial space under construction.12

The expansion of construction activity has increased construction defect claims. Construction defect claims are problematic because there is no uniform defi-nition of what constitutes a construction defect. Alleged defects range from problems that threaten the structural integrity of buildings (such as improper materials, drainage, earth movement, structural collapse, complex foundation, and framing issues) to aesthetic issues (such as improperly painted surfaces and deteriorating wood trim around windows and doors). To put the scope of the problem in perspective:

In the January 2004 issue, Consumer Reports noted that approximately 15 ◾percent of all new homes built each year have serious problems most due to failure to follow applicable building codes or installation instructions which means that using the U.S. Census data for 2007 for residential housing, there should be 2,500,950.00 homes with serious construction related problems.13

The three most common types of construction defects consist of: (1) plumb- ◾ing and draining leaks (21%); (2) building structure (19%); and (3) infra-structure (17%).14

It should not be a surprise that builders and insurers view the consequences of increased construction defect suits differently than do condominium and homeowner associations or trial lawyers. According to a 2002 study by the University of California on condominium related construction in California, both builders and insurers were of the opinion that “frivolous” construction defect lawsuits not only stopped project production, but also led to construction insurance premiums skyrocketing.15 On the other hand, condominium and ho-meowner associations, along with trial lawyers, argued that construction defect

Disputes 33



litigation was caused by poor building practices and refusals by the builder to correct mistakes. They also asserted that insurance is a small percentage of the sales price of a condominium or single family home. 16

According to insurance professionals, based upon loss experience data and a legal environment conducive to a large number of claims resulting in expensive settlements or judgments paid by contractors or their insurance carriers, insur-ance carriers classified risks of a construction related lawsuit in the following states higher than in others. This translated into higher premiums for con-tractors. Below is an outline of the states with the highest to lowest insurance premiums:

1st tier – CA ◾

2nd tier – AK, AZ, CO, FL, HI, MN, NJ, NV, NM, NC, OR, SC, TX, WA ◾

3rd tier – All other states. ◾ 17

In response to the increase in construction defect related suits, states sought to diminish the number of suits by requiring Right to Repair laws that aim to reduce or prevent litigation by forcing compliance with a statutory wait-ing period. Such waiting periods are designed to encourage negotiation and to facilitate settlement. Although most Right to Repair laws do not enumerate the specific defects covered, which is one of the many difficulties in dealing with construction defects, California’s Right to Repair statute (California Civil Code § 896), gives lengthy definitions for the types of defects it covers and purports to limit the builder’s liability to damages for violation of these standards. Only the defects considered in § 896 are actionable. In order for a homeowner to make a claim for violation of these standards, the homeowner needs only to demon-strate that the home does not meet the applicable standard, subject only to the affirmative defenses specified by the statute.18

Another state that has taken a different turn is Florida. Although most Right to Repair laws are limited to residential construction, Florida amended Chapter 558 of the Florida Statutes in 2006, to substitute references to “real property” for references to “dwellings”, and appurtenances and attachments thereto” throughout the section and substituted “property owner” for “homeowner” and substituted the definition of “Real property or property” for the definition of “Dwelling.” Therefore, Chapter 558 is now applicable to all improvements to real property, not just dwellings, and includes public projects. All Right to Re-pair laws typically provide that if the contractor fails to comply with the “right to cure” provisions, the claimant may sue at an earlier time.19

Although statistics on the success of Right to Repair laws are difficult to find, in Colorado during the five years prior to the 2003 passage of the state’s right to repair legislation, 556 construction defect lawsuits were filed including 140 in 2002 and 80 in the first four months of 2003.20 In Colorado, the number of


lawsuits filed annually by the state’s top construction defect law firms fell dra-matically to just 22 in 2004.21

D. Mediation

Mediation is a process in which a neutral third party helps the parties reach a mutually acceptable settlement.22 The mediator does not decide what is “fair” or “right”; rather, the mediator acts as a catalyst between opposing interests by defining issues, eliminating obstacles to communication, moderating, and guid-ing the process to avoid confrontation and ill will. The mediator will, however, seek concessions from each side during the mediation process.23 Mediation can benefit all parties, including the court system, by reducing or eliminating pretrial motions, trials, and expert witness fees, making efficient use of compa-ny resources, avoiding interruptions to business operations, and increasing the parties’ satisfaction because both parties are intrinsically involved in crafting the outcome.24 Because participation in the process is voluntary, either party may disregard the mediator’s recommendations.25 According to the American Arbitration Association (AAA), perhaps the most important benefit of media-tion is that mediation works. Statistics show that 85% of commercial matters and 95% of personal injury matters end in written settlement agreements.26

1. The Phases of the Mediation Process

Selection of the Mediator ◾Because of the often complex relationships that exist in the construction industry where time is money and most contracts are fixed cost contracts, the parties should choose a mediator with industry experience whose mediation style is evaluative. A more aggressive, involved mediator is more likely to move the proceedings forward towards a resolution particularly when deal-ing with construction disputes that typically involve projects in the millions of dollars that have tight deadlines, to delay damages and avoid short tem-pers.27 Choosing a mediator with industry experience is easier when you rely on organizations such as the American Arbitration Association28 or JAMS,29 which have developed a roster of industry professionals with a track record that can be examined by the parties.

The Preparation Stage ◾ Thorough preparation is key to a successful mediation. Although mediation is not a trial or arbitral proceeding, in order to have the best chance of suc-cess, all parties must be ready and able to present their case with the same care as if they were going to try the case or present it at arbitration. One rule of thumb is that preparation for mediation should take at least 80% of the total time allocated for the mediation.30 The elements of a successful media-tion include:

Defining Your Objectives. ◾ Criteria should be both legitimate and prac-

Disputes 35Disputes 35



tical. Scientific findings, professional standards, or legal precedent are possible sources of objective criteria. One way to test for objectivity is to ask if both sides would agree to be bound by those standards.31

Choosing Who Should Be Present. ◾ Nothing will stop mediation faster than not having a necessary decision maker physically present in the mediation. In Florida, Rule of Civil Procedure 1.072(b)(1) requires that a party having full power and authority to settle must be present at the mediation. This means that the party present at mediation cannot be running to the phone every time an offer or counter offer is made. Nev-ertheless, because mediation is a dynamic process, even without a court order or rule, it is imperative that a true decision maker be present in order to make the tough decisions.32 Additionally, if insurance is part of the claim, representatives of the primary carrier and excess carrier should be present as well.33

Utilizing Discovery. ◾ A common mistake that advocates make is to accept what the clients tell you or what they show you at face value, particularly since the persons who are providing you with the informa-tion may be the very same people who may have created the problem in the first place.34 Your best practice is to seek the same information from multiple sources. For example, a party may fail to provide information regarding a counterclaim because that party was in charge of the phase of the project that caused the counterclaim. After lengthy litigation, in-formation about the counterclaim may surface and lead to a settlement. It is imperative for advocates to inspect relevant documents and speak to parties such as supervisors, field personnel, design professionals, and engineers in order to make an independent assessment of each party’s strengths and weaknesses.35 The parties should also strongly consider involving experts at the mediation. Because disputes in the construction industry typically involve multiple parties, crafts, and disciplines, they are well suited to the involvement of an expert in the mediation process. The expert can educate the advocates, parties and mediator as to the crux of the dispute and available remedies.36 Even though it may appear at first that experts are diametrically op-posed based upon their conclusions, if the experts can meet to discuss common solutions, candid discussions may lead to a common approach to a problem.37 For example, in a dispute between a landowner and builder, the owner’s hydrologist expert and the expert on behalf of the builder were able to develop a solution. Because the two parties were openly discussing the issues, they were able to determine that the land-owner’s property was subjected to flooding from improvements made to the adjoining land parcel.

Actively Preparing. ◾ The advocates and parties must commit to making


the mediation work by being well prepared. Parties must know what the issues are and be ready to address the problems with viable proposals at mediation.38 Even if the mediator is well grounded in the construction industry, it is important to educate the mediator about the dispute to enable the mediator to engage in “reality testing” with each side so that they can evaluate offers and counter offers.39

2. Timing of the Mediation

The timing of mediation, whether it should be early or late in the process, is a hotly debated topic. One opinion is that it should be early in the process to avoid having the parties dig in to a position, while others believe that the par-ties need to engage in discovery, such as taking depositions, so that each party’s relative strengths or weaknesses are clear.40 Based upon my experience in participating in numerous mediations, I believe that early mediation is more ef-fective because as one observer noted, each party probably has 95% of the infor-mation it needs from its own files or personnel in order to effectively mediate41; waiting until each party undergoes the expense and annoyance of depositions, interrogatories, and document productions merely causes the parties to commit to a battle out of financial considerations. One participant in a court-ordered mediation clearly epitomizes this idea, stating, “We have already paid most of the costs so what do we have to lose?” Granted, things can always get worse, but after a party has seen its case move though the court system for years, while paying thousands or even millions of dollars to litigate it, there is very little mo-tivation to settle for less than what it has already spent.

3. The Initial Joint Session

The initial joint session is used by the mediator to educate the parties about the mediation process; the parties take this opportunity to educate the mediator and the opposing party about their respective claims.42 The initial joint session is also important because it is one of the few times that all the “players” are in one room and can directly address each other. Even though it is unlikely that one side will simply agree with the other side, sometimes forcing the decision makers to “look each other in the eye” is just the needed impetus to put them on a path toward resolving the dispute.

4. The Caucus

Once the mediator has gained the confidence and trust of the parties, he or she will typically meet with each party in a series of frank, confidential meet-ings.43 The caucus is considered the most effective and beneficial aspect of the mediation process because it allows the mediator to identify possible trade offs and solutions to the parties and to crystallize possible areas of agreement before bringing the parties together again.44 In effect, the caucus is where the media-tor can “test drive” solutions to the dispute with each party prior trying to close

Disputes 37



the deal.

5. Closure & Formalizing the Agreement

Closure is the portion of the mediation process where the mediator “closes the deal” by striving to keep the parties focused on the closeness of their positions rather than their differences.45 Once the parties agree orally on the terms of the agreement, the mediator should reduce it to writing at the mediation session to avoid backsliding or outbreaks of hostility.

E. Arbitration

Arbitration is defined as a process that provides for the submission of a dispute to an impartial third party for a decision that is final and binding on the par-ties. Arbitration is contractual and the parties are subject to statutes such as the Federal Arbitration Act or state arbitration laws. One important advantage of arbitration over litigation is that the parties can select the person who will decide the dispute based on that person’s qualifications.46 Arbitration proceed-ings are private and confidential. The arbitrator is chosen by the parties, and the decision of the arbitrator is enforceable in a court of law.47 Arbitration is not new. In fact, when George Washington drafted his will, he stated that any dispute regarding the will was to be decided by arbitration.48

Arbitration can produce inconsistent results if used improperly; for instance, if some parties are required to arbitrate and others are not. Since construction in-volves multiple parties, a party should consider whether all parties will agree to arbitration. Arbitration may create inconsistent results if some parties arbitrate and other parties litigate in court. For instance, if the owner and designer are required to arbitrate, but the contractor is not required to arbitrate, the contrac-tor can go to court instead of arbitration. With different tribunals deciding the case, there is a risk of inconsistent results. Similarly, if a subcontractor or sup-plier is not required to arbitrate in their contract with the contractor, the owner could be pulled into that dispute in court while simultaneously fighting a case with the contractor in arbitration. Thus, an owner should only require arbitra-tion if all of the parties are required to arbitrate.

1. Why Arbitrate?

The arbitration process has come under increasing scrutiny due to cases high-lighted in the media where arbitration’s advantages have been overshadowed by problems that developed in the arbitration.49 Most in-house lawyers have either experienced or heard of a “horror story” involving arbitration in a com-mercial setting. These “horror stories” usually involve cases where the arbitra-tion has become more like litigation.50 For example, the author was involved in an complex arbitration involving the construction of a power plant project in South America. A panel of three neutrals in New York caused unnecessary


expense and delay to the parties by considering a “motion to intervene” in the arbitration by a non-party. This led to months of delay and the expense associ-ated with the advocates and neutrals.

Arbitration has suffered from a perception by some lawyers (particularly those without experience in arbitration), the public, and some elected government officials that arbitration is “unfair” because parties no longer have a right to a trial in a court of law.51 Despite the horror stories, if parties carefully draft the agreement giving rise to arbitration and carefully choose a neutral they will find that arbitration is an efficient way to resolve their dispute.

2. Select the Language in the Arbitration Agreement

The parties must tailor the language of their arbitration agreement to their par-ticular needs. Simply adopting the AAA Construction Industry Rules (“Rules”) without limitation is not a good idea since they allow the arbitrator to grant “any remedy or relief that the arbitrator(s) deems just and equitable within the scope of the parties’ agreement.” Further, the Rules are silent as to liability for attorney’s fees and costs. Without limitation, the arbitrator may fashion an award that could even include punitive damages.52 Thus many advocates believe it is imperative to limit the arbitrator’s authority. Suggestions for doing so include:

Eliminate punitive or consequential damages including but not limited to ◾delay damages, prejudgment interest, and attorney’s fees and costs.

Although widely discussed among advocates, parties, and arbitrators, the ◾agreement should require a reasoned award. Even though some believe that a reasoned award might encourage appeal, experience shows otherwise. Most parties who have no reasons for the award are inclined to appeal it and often attach some nefarious reason for the arbitrator’s decision. Also, in light of the U.S. Supreme Court’s ruling53 eclaring that the Federal Arbitration Act provides the exclusive grounds for vacating and modifying arbitration awards, it appears that there are less reasons for a party to successfully file an appeal modifying or vacating an award.

The parties must also be aware of the latest changes to the American Institute of Architects’ (AIA) contract documents. In the latest version of A201, the AIA decided to make arbitration an elective process rather than making it the default. A member of the AIA committee involved in making the changes to A201 stated that the AIA did not reject arbitration, but simply recognized that some parties may prefer to litigate. Some clients simply refuse to arbitrate claims unless there is no alternative because of a “bad” arbitration experience, and there is nothing that will change their view on this subject.

Disputes 39



3. Selection of the Arbitrator & Advocate

Because the arbitrator is going to be the fact finder and adjudicate the parties’ dispute, choosing an arbitrator and advocate that has knowledge of the subject matter is even more critical than with mediation. Many architects, engineers and neutrals have “war stories” of being involved in an arbitration where an advocate has little understanding of the subject matter and literally causes the entire arbitral process to grind to a halt. That is why sufficient time should be devoted to selection of the neutral. Despite the horror stories, arbitration is usually a more efficient way to resolve a dispute for the following reasons:

Speed & Cost ◾According to the AAA, the average federal jury or non-jury case takes nearly two years and the wait time in state cases can be much longer depending on the jurisdiction.54 Complex construction litigation and the no holds barred approach that litigators take result in high costs associated with multiple de-positions, document productions, and hearings. Although statistics compar-ing the costs are hard to come by, one observer noted that a case in New York involving $200 million in claims took six years and $7 million in attorney fees.55 In arbitration, discovery rights are much more limited.56 However, where there is a need to obtain documents or testimony from third parties residing outside the state, arbitration has a grey area that paradoxi-cally, may result in litigation. There is a split among circuits regarding the enforceability of non-party subpoenas of out of state residents. The Eighth Circuit allows subpoenas to non-parties residing outside the state where the arbitration is being held while the Third and Second Circuits allow a hearing for document production purposes. The Fourth Circuit held that an arbitra-tor may not compel a third party to comply with pre-hearing discovery ab-sent a showing of special need or hardship.57 Realistically, however, it is rare for the parties to be unable to access the documents they need and if neces-sary, the parties can have a hearing in the state where the non-party resides.58

Finality ◾ Part of the reason why arbitration is more efficient is because the arbitra-tor’s decision is final unless there are very unusual circumstances such as an arbitrator’s manifest disregard for the law, fraud, or corruption.59 Addition-ally, where there is an award, courts are very reluctant to stay enforcement of that award. In one case,60 Duke Capital hired Wartsila, a Finnish company, to construct a power plant in Guatemala. The project was to be completed in four phases and after the inevitable payment dispute, Wartsila initiated arbi-tration for payment of disputed invoices after the completion of phase three but prior to the completion of phase four. During the course of the arbitration, both Wartsila and Duke Capital with-drew certain claims from the pending arbitration in anticipation of a contin-


ued arbitration following completion of phase four. After an arbitral award was entered on behalf of Wartsila in the amount of $757,000.00, Duke Capital refused to pay and filed a new request for arbitration, claiming it had a right to withhold payment to protect itself against a potential breach by Wartsila, as well as to offset amounts it would later seek in its withdrawn claims. The Fifth Circuit disagreed with Duke Capital and held that, rather than support-ing Duke Capita’s ability to set off future claims, the arbitration panel tailored the award to resolve the dispute immediately before it and issued a final award compelling monetary payment with no strings attached. The Court also noted that the panel had considered Duke Capital’s deductions when calculating its award. It held that the District Court did not abuse its discre-tion by refusing to grant Duke Capital’s stay of enforcement.

F. Dispute Resolution Boards

Dispute Resolutions Boards or DRBs are a form of collaborative dispute resolu-tion, which consists of one to three members or experts selected by the parties before the start of the job and meets at the jobsite periodically.61 Typically, there are four meetings per year where the members review progress since the last meeting, the project schedule, discuss potential dispute and observe the work in progress.62 The Board is usually formed by the owner selecting a member for approval by the contractor, the contractor selecting a member for approval by the owner, with the two thus chosen selecting the third to be ap-proved by both parties. The three DRB members then select one as chair with the approval of the owner and contractor.63

DRB members are provided with the contract documents, become familiar with the project procedures and the participants, and are kept abreast of job progress and developments. The DRB meets with owner and contractor representatives during regular site visits and encourages the resolution of disputes at the job level. The DRB process helps the parties head off problems before they escalate into major disputes.64

When a dispute flowing from the contract or the work cannot be resolved by the parties, it can be referred to the DRB. The Board review includes a hearing at which each party explains its position and answers questions. The hearings do not involve lawyers, they are non-adversarial, and informal. There is no discovery or cross-examination. In arriving at a recommendation, the DRB, considers the relevant contract documents, correspondence, other documenta-tion, and the particular circumstances of the dispute.65

The Board’s report consists of a written, non–binding recommendation for resolution of the dispute. The report includes an explanation of the Board’s evaluation of the facts, contract provisions, and the reasoning that led to its conclusion. Acceptance by the parties is facilitated by their confidence in the

Disputes 41



DRB in its members’ technical expertise, first-hand understanding of the project conditions, practical judgment, and by the parties’ opportunity to be heard.66 While the DRB recommendation for resolution of a dispute is non-binding, the DRB process is most effective if the contract language includes a provision for the admissibility of a DRB recommendation into any subsequent arbitration or legal proceeding.67

1. Use of DRBs

In the U.S. and Canada, DRBs have been used extensively with much success, primarily in large projects.

Project values have ranged from: one project over $1 billion, a hundred ◾projects under $5 million, and six projects under $1 million, averaging $42 million each project.

58% of the projects were “dispute free”– No disputes requiring hearings were ◾brought to the DRB.

98.7% of the projects were completed without resorting to subsequent dis- ◾pute resolution methods. This has been referred to as the “success rate” of the DRB process.68

2. Advantages of DRBs

DRBs work because they encourage claim resolution: The DRB becomes part of the project team and problems are resolved in real time.69 However, as noted in the statistics regarding the use of DRBs, due to the high cost of the DRB, it may be cost efficient only in projects of a dollar value of $50 million plus.70


VII. About the AuthorsMark W.S. Young is counsel, Construction Divisions, for a private conglomer-ate of construction, mining, and energy divisions that includes an ENR Top 200 contractor with over 1,600 employees. Any views or opinions expressed are solely those of the author and not necessarily the opinions of his employer. Mark is a civil engineer/attorney. Mark has a BS in Civil Engineering from Rose-Hulman Institute of Technology and a Juris Doctor and Masters in Busi-ness Administration from the University of Utah. As an engineer, he designed roadway, airport, municipal, government, commuter train, and land develop-ment projects. Mark is licensed as an attorney in FL, PA, NJ, TX and USPTO. His construction law work concentrates on construction claims, construction litigation, and construction contract drafting and negotiating. Mark works on private and governmental construction projects.

Karen Estelle Carey is a construction lawyer and a member (partner) at the law firm Womble Carlyle Sandridge & Rice, PLLC, with eleven offices through-out the Southeast and Mid-Atlantic. Karen has a JD from Duke University School of Law and over twenty years’ experience practicing construction law. She represents primarily large owners -- in the health care, educational, gov-ernmental, commercial and industrial sectors -- but sometimes also represents design-builders, construction managers and contractors. Karen has spoken and published widely on construction law topics, and is an experienced construc-tion arbitrator. She serves on the National Panel of Construction Arbitrators of the American Arbitration Association. Karen is an experienced advocate in mediation, arbitration and litigation, but spends most of her time on the “front end” of projects, assisting owners in drafting and negotiating design and construction contracts and trouble-shooting on behalf of owners during the construction process. Feel free to contact Karen Carey with any questions: (336) 721-3536; [email protected].

Kenneth R. Michael is both an attorney and a registered architect at the law firm Womble Carlyle Sandridge & Rice, PLLC. Prior to attending law school, he practiced as a registered architect for over eight years, involved in all archi-tectural phases of a variety of commercial, governmental, institutional, health care and residential projects. Most of his construction law practice involves representing owners during contract negotiations and other construction phases. He also advises owners, developers and construction firms on project delivery choices in construction. Ken focuses on resolving disputes through ne-gotiation and mediation, but also is an experienced advocate in arbitration and litigation. He is licensed as an attorney in NC and FL, and is a member of the American Institute of architects (AIA); National Council of Architectural Regis-tration Boards (NCARB); and is a Certified Construction Specifier. Feel free to contact Ken Michael with any questions: (336) 721-3644; [email protected].

About the Authors 43



Jose M. Chanfrau IV is the general counsel for Downrite Engineering Corp. and its affiliates employing over 700 employees specializing in commercial and residential infrastructure construction, land development, paving, blasting, excavation, installation of sewer & water systems, hauling construction waste, landfill operations, electrical contracting, and landscaping in south Florida. Mr. Chanfrau has extensive experience in areas such as mergers and acquisition, ar-bitration, construction and real estate, management of outside counsel, worker’s compensation, employment, managing insurance claims, employee health and safety, FLSA, ADA, OSHA, MSHA and litigation cost control.

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VIII. Endnotes1 This party is typically referred to as the “owner,” regardless of whether the party actually owns the property undergoing construction. 2 United States v. Spearin, 248 U.S. 132 (1918).3 Project Management, Powerpoint Presentation, avail-able at www.cba.nau.edu/facstaff/williams-s/BA%20301/Slides/Project%20Management.ppt. 4 In 2007, in order to address this issue, a coalition of construction industry groups issued a new, com-prehensive set of standard form agreements called ConsensusDOCS in an attempt to address this issue. 5 Just as with standard form design agreements, the owner will normally want to modify whatever standard form construction contract is being used to protect the owner’s interests adequately.6 The quoted text is an example of typical language used in a construction contract regarding workers’ compensation.7 The quoted text is sample language from a construc-tion contract regarding automobile liability insurance.8 The quoted text is sample language for a CGL cover-age requirement in a construction contract.9 For that reason, only the most general statements can be made on this subject in this InfoPAKSM.10 Examples of “Right to Repair Laws” are: FLA. STAT. § 558.004 (2008); GA. CODE ANN. § 8-2-35 et seq. (2008); IND. CODE § 32-27-3-12 (2008); NEV. REV. STAT. 40.646-667; W. VA. CODE § 21 (2008).11 U.S. Census Bureau, www.census.gov (May 2008).12 CB Richard Ellis Group, Inc., http://www.cbre.com (first quarter 2008).13 RISK MONITOR Vol. 3, No. 1.14 California Department of Real Estate (“DRE”), http://www.dre.ca.gov.15 Cynthia Kroll ET AL., The Impact of Construction-Defect Litigation on Condominium Development, Uni-versity of California Policy Research Center: CPRC Brief, Vol. 14, No. 7 (Oct. 2002), available at http://www.aia.org/static/state_local_resources/liabilityre-form/Defect_Litigation_Effects.pdf. 16 Id.17 Ronald T. Kozlowski, Presentation, Understanding

and Analyzing Construction Defect Claims, Finance 431: Property-Liability Insurance, College of Business, Department of Finance, University of Illinois (Apr. 2008). 18 Construction Defects Litigation and the “Right to Cure” Revolution, Construction Briefings (Thompson West Mar. 2006).19 National Association of Home Builders (NAHB), http://www.nahb.org. 20 INS. J. (Nov. 4, 2004). 21 Id.22 MANUAL FOR LABOR ARBITRATION ADVO-CACY, American Arbitration Association (“AAA”) (2002-2006), http://www.adr.org/index.asp.23 See Mediation Defined, JAMS, available at http://www.jamsadr.com/mediation/defined.asp.24 A Guide to Mediation and Arbitration for Business People, American Arbitration Association (2007), available at http://www.adr.org/sp.asp?id=29195; Report by the Judicial Council of California, Ad-ministrative Office of the Courts, Mediation Week: Resolution Recognizing the Benefits of Mediation and Court Mediation Programs (Feb. 6, 2008), avail-able at http://www.courtinfo.ca.gov/jc/documents/reports/022208mediationweek.pdf; Robert B. David-son, Strategic Mediation Advocacy in Complex Cases, JAMS (Jan. 23, 2007).25 Id.26 Guide to Mediation and Arbitration for Business People.27 Richard M. Shusterman, Mediation: An Effective Process to Resolve Complex Commercial Disputes, avail-able at http://library.findlaw.com/1998/Dec/1/126711.html. 28 American Arbitration Association, www.adr.org.29 JAMS, http://www.jamsadr.com/index.asp.30 MANUAL FOR LABOR ARBITRATION ADVO-CACY. 31 Roger Fisher and William Ury, Getting to Yes: Negotiating Agreement Without Giving In (New York: Penguin Books 1983). 32 William A. Blancato and C. Allen Gibson, Jr., Presentation, Controlling Your Own Destiny, The 2008 AAA Construction Conference: ADR Works (May 30, 2008).

Endnotes 45



33 Robert B. Davidson, Strategic Mediation Advocacy in Complex Cases, JAMS (Jan. 23, 2007).34 Controlling Your Own Destiny. 35 Id.36 Id.37 Id.38 Kent B. Scott and Cody W. Wilson, Questions Cli-ents Have About Whether (and How) to Mediate and How Counsel Should Answer Them, DISP. RESOL. J. (May-June 2008).39 Id.40 Margaret S. Herman, The Blackwell Handbook on Mediation: Bridging Theory, Research and Practice (Blackwell Publishing 2006). 41 Controlling Your Own Destiny.42 MANUAL FOR LABOR ARBITRATION ADVO-CACY. 43 Id.44 Id.45 Id.46 Donald L. Carpenter and John B. LaRocco, What Parties Might be Giving Up and Gaining When Deciding Not to Litigate: A Comparison of Litigation, Arbitration and Mediation, DISP. RESOL. J. (May-June 2008). 47 Id.48 Elkouri & Elkouri, How Arbitration Works (BNA Books 1973).49 William R. Joyce, Returning Arbitration to an Effec-tive Process in Construction Contracts, DISP. RESOL. J. (May-June 2008).50 Id.51 In the context of consumer and employment dis-putes, arbitration has been criticized as being “unfair,” which has led members of congress to “fix” arbitra-tion by proposing mandatory arbitration be void under those circumstances. See Arbitration Fairness Act of 2007, S. 1782, 110th Cong. (proposed July 12, 2007) available at http://www.opencongress.org/bill.-10-s1782/text (introduced by Senators Feingold and Durbin July 12, 2007).

52 ADR Works, The 2008 AAA Construction Con-ference, The Dispute Resolution Board Foundation (“DRBF”), http://www.drb.org/index.htm (May 30, 2008). 53 Hall Street Associates, L.L.C. v. Mattel, Inc., 2008 WL 762537 (Mar. 25, 2008).54 Construction Industry: Arbitration v. Mediation, American Arbitration Association. 55 Id. 56 See Comsat v. National Science Foundation, 190 F.3d 269 (4th Cir. 1999) (holding that limited discovery was a hallmark of arbitration and was necessary to its efficient operation).57 See Leslie Trager, The Use of Subpoenas in Arbitra-tion, DISP. RESOL. J. (Nov. 2007–Jan. 2008). 58 Id.59 Id.60 Wartsila v. Duke Capital LLC, 518 F.3d 287 (C.A. 5, Feb. 20, 2008).61 The 2008 AAA Construction Conference. 62 Id. 63 Id.64 Id. The Benefits of DRBs, DRBF PRACTICES AND PROCEDURE MANUAL, § 1.3 (Apr. 2007), available at http://www.drb.org/index.htm.65 Id.66 Id.67 Id.68 Id.69 The 2008 AAA Construction Conference. 70 Id.