Key Construction Contract Provisions

by Barbara R. Gadbois, Esq.

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

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

Contract Price
Most construction contracts are classified according to the method of pricing and payment for the
work: lump-sum/fixed price; unit price; and cost plus (with or without a guaranteed maximum
price).

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

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

Cost-Plus Contract
Cost-plus contracts are often used when the scope of work is not fully defined, or certain
elements of the work are hard to determine. In a cost-plus contract, the owner pays for the actual
cost of the work plus either a fixed fee or a fixed percentage of the construction costs. The owner
only pays for the work that is actually performed, and avoids paying for contingencies that do

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not materialize. The contractor, however, has little incentive to minimize costs. As a result of
this concern, the cost-plus contract with a guaranteed maximum price (“GMP”) emerged.

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

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

Contract Payment Provisions

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

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

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

Contract Documents and Order of Precedence

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

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

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

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

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

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

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

Insurance and Indemnity

The insurance and indemnity provisions of the contract may weigh heavily on the practical
outcome of a dispute between the parties. At a minimum, the insurance provision in a contract
should set forth the types of insurance required, the minimum coverage amounts, the maximum

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deductible amounts, the form of endorsements, and the length of time each type of coverage
must be maintained.

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

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

Termination of Contractor
Construction contracts typically give the owner broad authority to terminate the contractor either
for convenience or for cause (i.e., default). The “termination for convenience” clause permits the
owner to terminate without a reason, and specifies the method of calculating the amount due the
contractor. Typically, termination for convenience allows the contractor to be compensated for
the contract value of the work in place, overhead and profit on work performed, and costs of
demobilizing and canceling subcontracts.
Whether or not a contractor will be entitled to receive profit on work not performed is typically
the subject of negotiation, with owners viewing profit on work not performed as an unreasonable
windfall to the contractor, while contractors view this as payment for lost business opportunities.

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

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

Summary

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The importance of careful contract drafting and thorough understanding of the key terms of the
construction contract is a critical element to any construction project. This article touches on just
a few of the many key provisions inherent in most contracts. While there may be no single
“right” clause for every contract, understanding the key issues and resulting responsibilities and
risks will assist the parties in tailoring contract clauses to clearly guide the parties through the
project.