Overview of Construction Law - the Basics
This course is designed to review basic contract provisions uniquely encountered with construction projects, such as provisions regarding “pre-bid inspections and liabilities imposed,“ “no-damage-for-delay,” “pay-to-be-paid,” and scheduling issues. The course will also address common contract provisions, but in the context of a construction project, such as indemnification and insurance, scope of work, issues with privity of contract and pass-through provisions, issues with fixed-fee and cost-plus projects, termination and abandonment, and damage limitations. In addition to expressed provisions, the course will cover implied terms, such as workmanship and code compliance. The course is designed to alert an attendee of the various contractual issues experienced with construction projects and how to generally address the issues when reviewing or preparing a construction contract or litigating the contract. The course will be beneficial for both the attorney who only periodically works with construction projects, as well as more experienced attorneys. Case law is cited in the materials to assist in identifying issues and their resolution.
John Snow: Hello, my name is John Snow, and I'm an attorney with the law firm of Parsons Behle & Latimer. We have offices in Western states and one of the things that I do for a living is a construction litigation. And as a result, I do review a lot of construction contracts and in connection with that, I do from time to time review contracts for clients concerning specific issues. And I don't draft per se because I litigate and therefore I leave real lawyering to others, but I do review contracts for purposes of issues.
And in my experience, I have come across 12 or 13 fundamental issues that you encounter in a construction contract. And the purpose of this seminar is to give an overview of construction contracts and things to look for specifically whether or not your enforcing a contract through litigation or litigating a contract and some type of construction defect or for payment, whatever, or drafting. And we're going to just touch on some of the more frequent provisions so you understand how they work in relationship to one another and to some extent in the real world.
One of the things that's true with every contract and specifically true with construction contracts is that the contract is all about risk shifting. It's deciding who is going to bear what risk regarding the construction project. For example, who was going to bear the risk of an injury to a third party on the construction site? Is it going to be the owner? Is it going to be the general contractor? Is it going to be the subcontractor? Is going to be the vendor of machinery or materials that are going into the project?
These kinds of issues can be worked out before the project even starts. And as a result, you eliminate issues that could have been handled more easily if they had been addressed at the beginning of the project with a proper contract. You can see construction contracts that are hundreds of pages long and they still will not be able to cover every single issue that may arise. There is always an ambiguity, no matter how big the contract or how little.
Now, of course, the larger the contract, the more details that are covered, the less likelihood of confusion or ambiguity is less, of course. But nonetheless, it always exists. But going back to the purpose of a contract, it is to allocate risk, including risk of payment by the owner and the owner doesn't pay the general. Does the subcontractor to the vendors also assume some of that risk or not? It's all part of the contract. It's all part of the risk shifting. And we're going to talk about a few issues in that regard.
Now, the first issue that I look for in a construction contract is who is going to be bound by the contract. Now, you may say this is a no-brainer because it's the parties to the contract, but you'd be surprised how many times people who are not a party to the contract will sue in tort. For example, a subcontractor who was delayed on the project because of the owner's design people having provided faulty plans.
There's no privity of contract between the owner and a subcontractor, and therefore the subcontractor doesn't have a claim against the owner because there is no privity. Likewise, the economic loss rule can interfere with recovery on a negligence claim when there's a contract that's existing or covering the situation. So the idea here is when I talk about privity, I know who's the parties to the contract.
For example, the general contract is going to be between the owner and the general contractor. But frequently we'll include in construction contracts or drafters will include in construction contracts a pass through provision, so that it says that the owner has all of the contractual rights of the general contractor against all of the general contractors subs or vendors, suppliers.
And the reason for that is so that the owner can have a direct claim against those people in the event of a breach of some fashion. And you might want to have that if you have a contractor who perhaps is not fully capitalized and you want to be able, as the owner, to enforce those rights directly. Generally, you would not have a pass through provision specifically allowing the subcontractors to be in privity with the owner and sue for claims directly against the owner. And the reason for that is the owner doesn't want to have multiple lawsuits.
It has a single a party, and that's the general contractor. If a subcontractor is injured, it has to go through the general contractor. And one of the things that is done in this regard is that there are path through provisions included in construction contracts, that if the subcontractor is injured by actions of the owner or owner agents, such as the design professionals, the subcontractor could make the claim on the contractor and the contractor is then obligated to pursue that claim on behalf of the subcontractor against the owner.
And those types of pass-through provisions are functional and they provide a service, but frequently the general contractor is not all that wowed and does not necessarily want to sue the owner because the owner and the general contractor may have continuing business relationships and so may not pursue the claim as aggressively. But when you're looking at a construction contract, when you refer to privity, what you're really thinking about, or at least what I'm thinking about are in terms of, who has what rights to sue or make claims against which parties?
And the reason you want to know that is in part so that you have appropriate indemnification provisions and that you have appropriate insurance coverage or other protections that you may need in connection with the construction project. And then the reason why you would like to have a pass through provision as a subcontractor so at least you have some way to get to the owner or the owner's agents.
One of the things you might want to consider putting into those construction contracts, where you have a pass through provision though, is a specific statement that the general contractor has the duty, at least in good faith, to pursue those claims. There is some argument that the duty is actually a fiduciary duty that the general contractor has to the subcontractor to pursue a subcontractor's claim against the owner.
And although you may not think that arises on a regular basis, it does, where you have a subcontractor that has a contract with the general and the general has the contractor the owner and the owner is of school district. The school district hires the specific contractor on a regular basis. But the subcontractor may only be involved in one remodel of a school or some building of a school. And so would they want to make a claim against the owner of the project, the general contractor really doesn't want to interfere with its relationship with the school district so does not pursue the claim.
And that's why you want to put in, in a contract or look in the contract for specific provisions regarding the duty of the general to protect the interest of the subcontractors if a subcontractor has a direct claim. In the same regard, there's frequently provisions that say that the general contractor is not liable to the subcontractor, unless the general contractor recovers from the owner based on the claim. So that if you sue the general contractor for a deficiency in the plans and the general contractor sues the owner for the deficiency in the plans, but the general contractor does not recover, then the subcontractor does not recover either.
So that's why you look for priviting. And just so you know, some people seem to rely on a third party beneficiary concept, and as construction contract does not provide a third-party beneficiary relationship between the owner and a subcontractor because the subcontractor and the owner, depending on what side of the equation you're looking, is not the primary beneficiary of the contract. The primary beneficiary or purpose is the construction of the project, not for the benefit of a subcontractor to recover payment.
Another area you look to in a construction contract is pricing and payment provisions. I mean, this seems pretty obvious. But fixed price and cost plus, which are the two primary methods for compensation under a construction contract, have their own unique problems. First with respect to the fixed price contract, a lot of contractors are under the impression that when they agree to construct something, for a specific price, that they don't fully realize that they're assuming liability for unknown risks.
And even though the contract doesn't say otherwise, they just assume the general practice is, and there's a lot of basis for this because most contractor's construction contracts seem to have a sharing provision. If the contract does not specifically provide that if unforeseeable circumstances are encountered, then there will be an equitable remedy available. And I don't mean equitable remedy in the sense of litigation, but an equitable adjustment between the parties or a change order between the parties based upon the unforeseeable conditions to change the price of the fixed price contract.
Some general contractors just assume that exists. So when you're looking at these kinds of contracts, remember that the general contractor that has a fixed price contract has an obligation to perform the contract for that fixed price. Another problem that you've encountered with fixed price contracts is the scope of work. A scope of work is some times difficult to define. Now, you have the plans and specifications, so that should define the scope. But plans and specifications are never quite complete. Even though they go through the review process at 50%, at 95% and 100%, you can still find deficiencies in the plans and specifications.
So there is a difficulty in sometimes defining what is the real scope of the work. The more you can tie down the scope of work with the fixed price contract while representing the contractor, the better off the contractor will be. On the other hand, having a more generalized provisions may benefit the owner because you could make the argument and include a provision that the scope of work includes the plans and specifications and all foreseeable modifications, changes, or necessities to complete the project to provide.
And then if it's a performing performance facility, that can generate electricity of X amount or can store such and such or will have temperatures of such and such. But if you can put in performance specifications to define the scope of work, even though the plans and specifications may not be sufficient. Now, of course, when you're talking about insufficiencies in the plans and specifications, the question frequently is, who's responsible? And again, the subcontractors and even the general contractor do not have direct relationships with the general.
It's going to be between the owner and the general contractor. So therefore you need to make the better practices to have the scope of work clearly defined and inferences drawn from the plans and specifications clearly defined. The more narrow it is, the better off the general is as a general rule. And I made a comment a minute ago that the general contractor assumes risk of unforeseen conditions and that is in part based upon United States Supreme Court decision called Spearin.
Now, the Spearin doctrine is actually known for another purpose. But in the Spearin case, it does discuss the well-known concept that one who agrees to do for a fixed sum a thing possible to be performed, he will not be excused or become entitled to additional compensation because unforeseen difficulties are encountered. And so when you're drafting a contract, address whether or not unforeseen conditions are going to be addressed by the parties through a change order or who is going to be responsible for unforeseen difficulties.
One of the reasons why you do have an equitable adjustment provision in a contract when unforeseen conditions are encountered is to keep the price down. If a general contractor is assuming the risk for unknown or unsuspecting situations, they're going to put more money into the contract to cover those unknown conditions and may not even bid on the project. So to get bidders and not put all the risk on the general contractor, there's frequently provisions for equitable adjustment in the price or change order provisions that will apply to unforeseeable conditions that are encountered during construction.
Of course, when a general contractor loses money on a project, they always come back with there was unforeseen conditions. For example, in Wyoming, where there is severe, the general contractor is going to argue if they have to work through the winter months that the severity of the weather in Wyoming was unforeseeable. Well, the weather in Wyoming is always bad during the winter. So it's not going to be unforeseeable, but the general contractors will frequently make that claim that the weather was particularly bad.
But then you pull out the weather charts and you find out the weather was as typical as any other year. But it's an argument that is made. So the reason why I mention that is so when you're drafting one of these contracts or reviewing one of these contracts, define what an unforeseeable event is. Add that winter conditions have to be a percentage greater than normal or that the delay encountered has an increase in cost of X number of dollars. And then have ways to equitably adjust, meaning that one party doesn't bear all the risk, or by change order, based upon a cost of materials, labor and a percentage or a profit and overhead.
But there's ways to do that, that those are ways to do that. There's others depending on the circumstances of your construction contract. But nonetheless, that's something that should be reviewed. Now, with cost plus contracts, one of the problems that you have is, first of all, lack of inducement to work in an economic manner. Since everything is paid for, the general contractor will frequently, allegedly frequently, perform in a shoddy manner, increase the cost to increase their profit.
You don't find general contractors very often that actually do that, but they may not be the most efficient operators at all times. And so since there is no inducement in a cost plus contract for economies, one of the things you may want to consider in a cost plus contract is putting in a provision that incentivizes the general contractor to work in an economic manner. For example, having a provision that states that if the general contractor is able to figure out a way to reduce costs and presents it to the owner, that they'll share the cost savings. That it gives the general contractor inducement to try to save, but also share some of the savings with the owner.
And so you are able to still get a motivator or incentive to work in an economic manner. Another problem you have with cost plus is, what are costs? Frequently you'll see a cost plus contract and there is no definition of cost. And so the general contractor comes back and tries to charge the owner of the project generalized insurance, generalized overhead, and other non-essential costs related to the project. And if it's not defined clearly, it very well may be recoverable based upon some type of formula that is being used at any particular time.
There's a couple of formulas that are used from time to time based upon gross revenue of the contractor versus the revenue from the specific contract. So you come up with a percentage and you apply that percentage to all of the overhead of the general contractor. Well, again, the owner is not in control of those items. So you can include provisions in the contract as to what specifically will be considered as overhead or cost that can be included in the cost plus contract and those which can not be included. So that at least there is an expression of intent as to what the parties intend with respect to generalized costs like overhead general insurance provisions.
Let's see. There is some case law that we've cited here, and that is the party performing a cost plus contract, although maybe not per se a fiduciary to the owner, but there is an obligation to at least be able to account for your work. In a case I had a few years ago where the general contractor was building a dairy and had made representations that they had done it before. In fact, they really hadn't, although that was the representations. And they really did not know what they were doing and there were a ton of errors.
And as a result of those errors, there was not only deficiencies in the final product, but the cost of construction was a lot higher than it should have been because the general contractor did not know how to sequence the work correctly and had subcontractors and suppliers that really did not fully understand what the project was trying to achieve. Now, there was a performance provision in the construction contract. So we did have a way to quantify whether or not the facility that was finished actually met the specifications like a facility able to produce so much milk in such and such a time period with the base heard of X.
And so we were able to show that the project as completed did not meet the specifications. And that gave us a leg up on proving that there were significant deficiencies in both the plans with the general contractor was responsible for because it was a design build to an extent. So we were able to bootstrap the fact that the finished product was not compliant. But going back to what I was mentioning, or actually coming to a conclusion on that, the general contractor also was not a good record-keeper. There would be charges and no backup. And the general contractor basically was telling the owner, "Trust me, I'm being reasonable and fair."
Well, unfortunately, the owner wasn't all that good in reviewing the monthly invoices either. So they would get an invoice without backup and not look at it for three months. There was a provision in the contract that said you have 30 days to review the invoice and pay it. And payment constitutes waiver of any deficiencies in the construction. So those were some of the arguments. We were arguing in some instances that the deficiencies were hidden and not fully disclosed in the invoices and there was no waiver.
That was an arbitration and ended up the arbitrator did split the baby somewhat. But we did get a leg up on the general contractor because of the poor record keeping system that they had. So my point here is if you're representing the general contractor in a cost-plus construction project, make sure that they know they have a duty to keep records and costs and properly allocate costs. Let's say another problem with any contract for a subcontractor is the pay of paid provision.
And then this is now a pretty common provision in construction contracts, that the general contractor only agrees to pay the subcontractor if the general contractor is paid by the owner. So the subcontractor is assuming some of the risks, the financial risk of the project. And this can be a big deal for a subcontractor because all of the risks that the financial risk the general would be assuming is passed on to subcontractors and the general contractor only has minimal exposure, whereas the subcontractors are assuming most of it.
One of the things that you need to put in a provision or consider in a provision, if paid provision, is that the subcontractors have a right to demand and receive assurances of performance, not only from the general, but from the owner. That they, like the general, would be entitled to financial information of the owner to evaluate the risk. Another thing when you're taking on that kind of a provision is make sure that there's a payment bond. Make sure that your lien rights are protected, although lien rights can be totally meaningless in a lot of cases because the subcontractor really cannot afford to buy the facility and assume the loan and keep it current.
So the subcontractors, to protect themselves, need to make sure that there are guarantees such as payment bonds or that the general contractor and the owner are capable of performing their financial obligations. Another thing to consider with a pay-when-paid or pay-if-paid provision is that if it's not a condition to payment by the general to the subcontractor, that is considered just a tiny device and the subcontractor can still pursue the general for nonpayment. So the general contractor needs to include in their construction contracts with their subs that provision that says the payment to the subcontractor is a condition precedent to payment to the subcontractor.
Otherwise, the subcontractor can demand payment and at some point a reasonable time period, but they are not precluded from recovery. Another issue with respect to bonds is some bonding companies have successfully argued that if the owner didn't pay the bomb to the general contractor for the benefit of the subcontractors, it also doesn't kick in because the bond is guaranteeing payment by the general, and since the general wasn't paid, it has no obligation to pay the sub and therefore it's not obligated to pay.
There are actually a couple of cases that have agreed with that reasoning. But in my view, the majority rule is that the bond is a separate, independent contractual obligation. And whether the pay-to-be-paid provision is enforced in effect in the contract between the general and the subs, the subs can still make a claim against the payment bond. However, this is an issue. You should make sure that the contract you're reviewing or drafting or litigating is in a jurisdiction that recognizes the rule that the bond is a separate obligation, not dependent upon or subject to the condition precedent of a pay-when-paid provision. Wow, that was a mouthful.
Going on. By the way, there have been some states that have legislatively done away with a pay-to-be-paid provision because of the deemed unfairness to subcontractors. So you do have some legislature on that. You also have some court decisions that state that the pay-if-paid provision is against public policy. I only know of a couple of cases and those cases very well may have been changed by now by legislation. And then also the case that said the materials Clarke Corp versus Safeco, where California Supreme Court held that the payment bond was an independent obligation. And even though there was a pay-to-be-paid provision in the contract between the general and the sub, the sub still had a direct claim against the bond.
Another item we've been talking about, and I'm going to go back to now, is scope of work. One of the things to make sure regarding the scope of work is that there is indeed an integration clause. One of the things that will come up in a construction contract is somebody will inevitably say, "Yeah, that was our contract, but we also agreed, or they also represented, or we also discussed and agreed." And the reason for the integration clause is not just scope of work, but primarily for scope of work, but it can also do with means and methods.
And an example of that is where there was representations during bidding that fill for the project could be obtained from a site just a couple of miles away. And that the field from the site was suitable for the project. Well, as it turns out, the borrow site did not have soil that was appropriate for the construction project. And so materials had to be brought in from 20 miles away, and there was a significant amount of materials. And so therefore, there was significant cost increase for the hauling of the soils.
Now, there was an integration clause of sorts in this contract, but the court, to circumvent the unfairness or its perceived unfairness, argued that it was a misrepresentation of fraud. That this borrow pit could be used and that the bidders, including the bidder who was selected, had a right to rely on the representation, even though there was provisions in the contract that says you can't rely upon anything that's not in writing, et cetera, et cetera, et cetera. But you do run into those kinds of problems where you can get around integration clauses.
But by and large, having an integration clause will generally circumvent the arguments that we also agreed, or we had a side agreement. And a typical integration clause is contained in the outline. Basically it's the contractor and owner acknowledge that there are no covenants representations, warranties agreements, or conditions expressed or implied, which in any way affect or correlate to this agreement, except for those expressly set forth herein. That's a typical integration clause.
However, you then need to go on and say, that cannot be changed, modified, or altered, except in writing. Now, there is case law that says, even if you have that kind of a provision, you can still amend the agreement orally after the fact. However, there's also cases that say that to do that you actually have to agree to waive the integration clause and then enter into the oral agreement. That analysis has been applied in a number of cases. But it's, again, a warning not to rely on oral representations. If you're representing a contractor whose argument is they were told and there's an integration they were told dot dot dot, and there's an integration clause, you obviously have an uphill battle.
But the case law does provide you some means and arguments to circumvent the restrictions on the integration clause. Another problem that you can encounter with construction contracts is the duty to investigate, pre-bid or pre-contract. Frequently in the bidding documents and in the contract itself, it'll state that the general contractor has an obligation to inspect the site. And that's fine and dandy. I mean, a contractor who did not probably has some issues. But knowing the site, investigating the site, getting data related to the site, such as soils, reports and those types of things is the prudent thing to do.
But then the question is, what kind of shifting of risk does that entail? Well, infrequently in these contracts that says the contractor will investigate the site and make sure that the site is buildable with the design drawings, case law has stated that is not sufficient to shift the risk of the suitability of the drawings for the site merely because the general contractor has an obligation to investigate with the idea of reviewing the plans and specifications to make sure they're suitable for the site.
If there's not something that's open and obvious to a reasonable general contractor, that's not going to make the contractor a guarantor essentially of the plans and specifications. However, if it is something that could be seen and known by a reasonable general contractor investigating the site and the drawings and plans, then they are assuming the risk for those types of things. But they are not necessarily assuming risk for unforeseen or unknown conditions or conditions that we require having an engineer on their general contractor staff to review the plans and specifications.
The risk is shift based upon compliance with the standard of a reasonable general contractor. And I've mentioned this a couple of times about the duty to investigate. Here there's a clause in the materials about an unknown or unforeseen site conditions and it says contractor assumes all risks associated with or relating to the project site and subsurface conditions regardless of the condition cause, event or effect, then the contractor shall remain responsible and obligated to complete the project work provided in the contract documents without extension or increase in the contract time or contract sum.
That is somewhat of a draconian provision, but that provision is not uncommon in construction contracts. I don't mean it's in all the contract because a lot of owners want to share the risk so they get somebody to bid on the contract. But you'll see contracts where this is included in it. And the contractor is assuming all of the risks of unknown and unforeseen conditions. Under those circumstances, even if the general contractor inspects the site but doesn't say anything of concern, they are still obligated because they have contractually agreed to all unknown and unforeseen conditions at the site.
And I've cited a couple of cases in the materials that confirm that notion based upon what the Supreme Court has stated. And these are more recent cases. For example, one stays Costello agreed in the parties contract that the construction documents were complete and sufficient for bidding, negotiating, costing, pricing, and construction of the project. These standard provisions are not enough to shift the risk, but the provision that states that the general contractor is assuming that risk directly and specifically that does shift the risk.
Let's see. Okay. Another big issue with construction projects is indemnification and insurance. Indemnification in any contract of any size is always addressed. But lawyers sometimes forget that indemnification provisions come in a lot of different shapes and forms and sizes. And they are also governed in a lot of states by statute. For example, a statute in some states specifically states that a contractor cannot indemnify the owner for the owner's own negligence. In some states, it actually is held that an obligation to provide insurance, which is another form of indemnification, may be voided by that provision.
Although most states that have addressed this issue either by statute or by court decision have stated the obligation to procure insurance for a risk is not a violation of the anti-indemnification provision. So there could be a provision in the contract that says the general contractor will indemnify the owner from all risks associated with the project, including the owners own negligence. That provision may not be enforceable in some states. However, a provision that says the general contractor will procure insurance that covers all risks associated with a project, including the negligence of the owner, that would be enforceable.
So you have not non indemnification provision, but an obligation to provide insurance. And if the general contractor does not provide the insurance, then they would be in breach of the contract. And presumably the damages for the indemnification would be exactly the same as for the failure to obtain the insurance policy. Insurance is a big deal on any construction project and who gets it, how's it allocated, that's always a significant issue. Most lawyers do not have the background in insurance per se to actually make sure that all risks are being covered by the policies.
Insurance brokers that specialize in construction or at least have construction background can actually provide a better product than the lawyers merely reviewing. Now, I'm not saying lawyers shouldn't review the policies or make sure that the policies are in place to protect the client, whoever it might be, but make sure that somebody who actually knows insurance is involved in evaluating the general contractor's obligations regarding insurance and coverage. This also applies to the owner or a subcontractor.
But you'll generally see the general contractor, especially in more recent time, getting the insurance for the entire project and then having the subcontractors contribute to the cost of insurance based upon their respective contract amounts. There are various forms of indemnification, as I indicated. This first one that I want to talk about is contractor shall indemnify the owner from any and all claims asserted by third parties against the owner arising out of, related to, or in any matter connected with the project.
Well, that seems pretty straight forward, but it doesn't specifically state that the contractor will indemnify the owner for the owner's own negligence or fault. And as a result, it will not be interpreted to do so. The courts will not interpret that type of provision to protect a negligent party or a wrongdoer from their own fault, only from third parties. Another one example is a vendor shall defend, indemnify, and hold harmless the customer from any and all claims arising out of, related to, or in any manner connected with the vendors services, but only to the extent caused by vendors negligence.
Well, okay, in this instance, it's more limited. It's only limited if it's only going to cover the owner or protect the customer where the vendor is at error, not anybody or any thing that may cause harm. Another example is a contractor shall indemnify the owner from all claims for nonpayment brought by contractors, subcontractors, or suppliers. The reason why I mention this, this is a direct claim or a direct dispute type of indemnification. This is probably sufficiently addressed in the contract itself where it provides that the contractor must and shall pay the subcontractors in a timely manner.
And the failure to do so is a breach of the contract, which actually operates somewhat the same as the indemnification provision. However, there are greater remedies to subcontractors in some states when the general contractor fails to pay. And so the indemnifying the owner may give broader coverage. And furthermore, belts and suspenders approach to drafting of contracts is not all that bad, in some instances. And then the broader form, contractors shall defend, indemnify, and hold harmless the owner, the architect, the owner's mother, the owner's lender, the owner's pet dog.
I mean, you have a very broad class of people protected by the indemnification. And it says from all claims involving bodily injury or property damage. But one thing it doesn't cover is economic loss necessarily. And then it also goes on except for claims caused by the indemnities sole negligence. So what do we have here? We have a situation where the owner was partially negligent, but not solely negligent. Under those circumstances, the indemnification would still apply, even though some of the negligence was a partial cause to the harm. You could have an all-day seminar on indemnification and insurance.
But the idea here is when you're looking at indemnification clauses, they're not all the same. Some are broader, some are narrower, some are controlled by statute, some are controlled by common law to some extent. So when you're looking at indemnification provisions, make sure it is suitable that the party you want to indemnify will be indemnified. And another thing with the indemnification is that they are pretty much worthless if the person who is giving the identification doesn't have the backing.
So you see identification clauses together with an insurance provision going hand and glove. And the reason for that is insurance will actually give some assurance that the indemnification will occur because the indemnitor may simply not have the ability to respond. And also you'll notice in some of these, I talked about the contractor shall defend or the indemnitor shall defend and others that was not there. The duty to defend is separate and apart from the duty of indemnification. Indemnification is the agreement like insurance to indemnify somebody against loss or harm.
But to defend means that you'll actually provide the defense for that person if they're sued or the indemnity if they're sued or a claim is asserted against them. And if you don't have that provision, it's a separate duty. It doesn't exist. So you have to expressly state defend. And then when you're going to defend, there's all sorts of other provisions that could come into play on the indemnification. For example, do you provide your own lawyers? Do your lawyers get to be included?
Do the indemnities lawyers get to be included and paid for under the indemnification provision? What about settlement provisions? If the indemnity does not want to settle or does settle or wants to settle, how do you address that under the duty to defend? Those are all issues that you need to consider or think about when you're looking at an indemnification provision? Another item that comes up with construction contracts, although it's not one of the specific provisions, but it's the implied provisions.
Remember that there's an implied obligation of workmanship and code compliance. Even though you do not expressly state that in the contract or it may not be expressly stated in the contract, there is still an implied obligation to do the work in a workman-like manner and that you have complied with code regulations that are applicable to the structure. If you want to change that or modify it in any way, it has to be addressed. Obviously expressed provisions in a contract supersede the implied provisions.
Now, why would you want to do that? Well, because sometimes when you're following the plans and specifications as a general contractor, it will result in substandard work because there's deficiencies in the design. And so you might want to put in a provision or at least think about including a provision that says something along the lines that as long as the contractor has complied with the plans, specifications, and the drawings for the project, there is no implied obligations. Yeah, implied obligations, including implied workmanship or implied code compliance because you're relying on the plans and specifications and the drawings.
But that's something you can think about. It's something that you should be aware of when you're litigating or drafting or reviewing a construction contract. Of course it goes without saying that the implied obligation of good faith and fair dealing is also an implied provision in the contract. And one of the ways that comes in to play, and we're going to talk about this in a minute, is with scheduling. The owner of the project or the general contractor, generally the general contractor who's in charge of scheduling, may schedule things or move schedules around that impact negatively one of the subcontractors.
Because they sequence their work in such a fashion that complies with the original schedule. But now the schedule is modified, their sequencing no longer works and additional costs will be incurred. Sometimes you'll see an argument that the scheduling provision was not exercised in good faith because of harm to subcontractor. Well, the case law is pretty strong on this, that the right to do scheduling is an absolute right. And if there's a good business reason or any business reason for doing it the way they did it, they are not limited, they meaning the owner or the general contractor is not limited in changing or modifying the scheduling.
The implied covenant of good faith and fair dealing does not come into play under those circumstances unless, of course, the general contractor in switching the scheduling around was specifically trying to harm one of the subcontractors. Change orders. Change orders is an area where you'll find in smaller projects that the general contractor and the subcontractors or the general contractor and the owner kind of just do the work and don't really care about change orders, even though there is a change order provision in the contract.
And then when things go south in the relationship and the general contractor wants to be paid and goes to the owner and says, "Hey, pay me for all that extra work, but there's no change orders in place." And the owner says, "Oh, that's too bad. We never got change orders on that. So sorry for you, general contractor." Now, the contracts where there is change order provisions will inevitably say that unless a change order is in place, either before or sometime after the work is performed, then there will be no compensation.
You do run into the situation and projects where it says there'll be no compensation unless there's a change order in place, but the work has to be done immediately or it's going to screw up the sequencing for the entire project. And so the owner wants the general contractor to go ahead and perform without a change order in place. In a relaxed relationship, they may not get a change order in place, but that is a bad practice because frequently things go wrong. And when things go wrong, there is no documentation. And therefore who wins that argument? The one without. If the contract provides there has to be documentation and there isn't, you lose.
So point here is that when you have a situation and you're looking at a contract that has requirements for change orders, make sure your client understands you need to have change orders, even though you might have a good relationship with the owner or the general contractor or whoever you're getting change orders with. The fact of the matter is good relationships go bad. So comply with the contractor. Or alternatively, at least document that you are not compliant with the change order provisions.
Now, you can do it through documentation and on occasion you can also get a way through course of dealing. If at no time the change order process is followed during the construction project, then perhaps you have a waiver of compliance with the change order provisions. But that is a more difficult argument to show waiver of those provisions or course of dealing to change the terms of the contract. The better practices to what a provision in the contract regarding change orders and then fall following them.
Again, this is a very basic provision in a construction contract and one that the lawyers should be familiar with and that the party the lawyer is representing needs to know it as well and they need to be told. There is a case here, the Hawkins contractor's court case, where the contract said, unless the claim is expressed, the authorized under this agreement is made in accordance with the following procedures, then there's no compensation. And those procedures included change orders.
And then in this case, the court just simply said that the contractor simply has not met his burden of showing that the custom practice and conduct of the parties was that the written request would only be made once oral approval had been received and there was no other basis for a finding of waiver. We agree. The idea here is that it's always easier to prove a case in writing as opposed to relying upon course of dealing or some other type of unwritten waiver.
I've talked about pass-through provisions earlier when I was talking about privity. But that's, again, something to remember, that pass-through provisions are common in the R.E. Monks contractor's case. There is some case law about the fact that pass-through provisions have been recognized by the court and are effective and are a way to circumvent the lack of privity. And so because of time, I'm going to move on a little bit. Another common provision in a construction contract is the no damage for delay provision.
And this can be an incredibly painful provision for any contractor, where the owner has not gotten all the necessary permits for the construction to start and the general contractor is ready to go. But because of the delay by the owner in getting the permits, the general contractor now has to work during winter conditions, which increase the cost of construction. This is just an example. But the contract specifically states no damage for delay and the delay in getting the permits, although they were working in good faith to get the permits, is not something that the contractor can be compensated for.
Another problem you can have with no damage for delay provisions is the delay can be forever. And I don't mean literally, but seem like forever. It can be a delay of several months while permits are being obtained from the various environmental agencies, for example. And as the result, the contractor is giving up other work, the subcontractors are giving up other work. The contractors have labor standing around. The general contractors already invested in equipment that is being financed, but not being paid for because the construction project has not started.
There can be significant ramifications for the delay. So when you see these kinds of contracts, if you're drafting the contract, modify the no damage for delay provision and put in a period of 30 days or 15 days or two months or something that is reasonable under the circumstance for your client, and then let the other side worry about it. But there are ways to circumvent, again, by case law, the no damage for delay provisions, like it was not foreseeable, it was unreasonable. They were not in good faith.
There are various misrepresentations. That there was an implied term that they would have the permits by the time of start. That at the time they selected the start date, they did not have a good faith basis for believing that it would be commenced on that date. And no damage for delay clauses are construed strictly against the owner of the project or at least the party asserting the no damage for delay provisions. So there is case law that gives some benefit or some avenue to circumvent the effect of a no damage for delay provision. But when you see them, be aware of the fact that they can be devastating.
Scheduling. I've talked a little bit about scheduling in connection with the implied obligations. The McPhee case just merely notes that the party with the power to modify the schedule has the power to modify the schedule. And that in this case, the subcontractor failed to show that the contractor acted wrongfully or unreasonably in fulfilling it's obligation to schedule, sequence and coordinate the work. In any construction project, much like war, much like trial, things change as you go along and you have to adapt. And that's why you have scheduling changes if it doesn't suit the subcontractors or even the contractor.
And there's a scheduling provision, as there will be, you have to live with it. Again, like with no damage for delay provisions, you may want to include a provision for additional compensation if the schedule is materially changed or has any impact on you. There's also acceleration claims where it can be an actual or expressed acceleration where the owner is actually required you by scheduling, not you, but the contractor to work at a higher rate of work. And as long as it was not at the fault of the contractor, it may be a compensable accelerations.
And then there's the elements of constructive accelerations, where there was no excusable delay by the party claiming the acceleration. The party requested an extension, but was denied the extension, but they complied with the contract in any event. Termination provisions is another area where owners can take advantage of contractors and contractors, subcontractors, where they can terminate for default. I get it. The downstream contractors are not compensated if there's a default. That makes sense.
But where you have the provision of discretion, where the owner has the right to terminate the contract based on their own needs, under those circumstances, you may want to consider having the contractor more than compensated for the work performed to date, because they've actually given up other projects to form on this contract or that they have now have labor force standing around or new equipment that's not being used. There are additional costs, and they've lost the benefit of the bargain by not getting their profit out of the project.
Although most contractors will front end load the profit, the argument still exists that you did not get all your profit out of the project because of the discretionary determination. So when you're representing a party in connection with terminations, for convenience, consider adding additional benefits to the general contractor or the subcontractors who may be harmed by an early termination of the contract. And then the last topic I want to talk about or our last two topics are damages.
In most construction contracts now, you do see a waiver of consequential damages, but not always. Consequential damages are anything that's foreseeable. And if a contractor is building a hotel and runs into a problem and the hotel opens up six months after it should have, there could be significant consequential damages allocated to the general contractor for the delay. So by waiving consequential damages, you're protecting probably the general contractor, although there's occasions where I suppose general contractors would have consequential damages against the owner.
But by and large, it's going to be the owner that sustains the consequential damages. A substitute for consequential damages is liquidated damages. And in most states, I think still the rule is that the liquidated damages have to be a reasonable forecast of actual damages and has to approximate your actual damages that are incurred. Now, that rule varies from state to state. Other states are now going to the proposition that you can put in any amount, as long as your actions are not unconscionable. It's just a matter of right of contract.
If you contract for a million-dollar penalty a day, that's outrageous. But you agreed to it, and it's not unconscionable. It very well may be enforced. The advantage of liquidated damages, although contractors will generally bristle at this, is that you actually know what your loss is going to be by delay and you can judge your project accordingly.
If you're willing to take a hit for some delay because you have another project that is more demanding or has a higher liquidated damages clause or has other needs, you're going to adjust your schedule to deal with it. And also it still provides compensation for the delay to the owner, but it allows the general contractor some assurance of what their damages will be ultimately. So with that, the presentation on basic construction contract provisions has been covered. And thank you very much for listening. Goodbye.