Construction Contracts Basics

Chapter 1: Contract Basic 1
Chapter 1
Contract Basics
The first chapter presents the basic information a construction
contractor needs to know about contract law. It describes contract
"Start with what characteristics including:
is right rather
than with what is ■ The four elements
acceptable." ■ Terms and conditions
Peter Drucker ■ Classifications of contracts
■ Breach
■ Damages
A contract should not be devised as an attempt to obtain unfair

advantage over another. Even if you were capable of gaining unfair
advantage over another, you could lose your legal standing. There
are legal principles that can be applied to rectify unjust situations.
Contract Characteristics
A contract is an agreement or promise between two or more parties
to do, or not to do, a specific act. A contract may be expressed in words
(oral or written) or implied (shown by acts).
A valid contract is one that has all of the four elements and is in the
proper form (written if mandated by law).
A valid contract is legally binding and enforceable in a court of law.

In a dispute, the court will first check for the validity of the contract.
2
Note
Each state will have slightly different laws affecting
contracts. The basics described in this chapter will apply
to all contracts.
Negotiation
The formation of a valid construction contract is the end product of
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2 Volume 1: Contract Law for Construction Contractors
the negotiation process between either:
■ Owner and general contractor

■ General contractor and subcontractors
However, not all aspects of the contract have to be determined as a

result of a lengthy negotiating process. Standardized contract forms
are available to help the agreement process. CONGRAM:
Contractor gram-
A typical construction contract uses both: mar which is
defined as the
■ Standardized terminology, also known as boilerplate imperfect past,
terminology the insufficient
■ Negotiated terms and conditions present and the
absolutely perfect
future.
Valid Contract Elements
Just because two people reach an agreement does not mean that a
valid contract has been made.
Regardless of the form of a contract (standardized or the customized),

a valid contract has to contain four elements to be considered valid.
A valid, or good contract has four elements:
■ Offer and acceptance

■ Consideration
■ Competent parties (legal capacity)
■ Legal purpose
Offer and Acceptance

The offer and acceptance element comprise the basic agreement of
the valid contract. Together, they represent the beginning and end
of the contract negotiation process.
Offer
An offer is a promise made by one party to do, or not to do, a specific
act. This promise is an offer when it defines the promised action
clearly enough to be easily understood.
A bid is an offer by a contractor to transact business. When the

contractor submits a bid, an offer is made. A legal offer fulfills the
following two conditions:
Advantage Contractor Business Success Series

■ The offer, expressed in reasonably definite terms, has to
have the effect of forming a legal relationship between
offeror (contractor) and offeree (owner). The offer has to
describe a duty or obligation for each party.
■ The offeree (to whom the offer is made) has to be clearly
identified.
Time Limitations
Most offers have a deadline for acceptance. In the proposal (and/or
bid) there is normally a specified time limit for the duration of an
offer (typically 30 days).
The law makes a fine distinction as to when such a 30-day limitation

would commence. It has to do with how the time limitation is worded:
■ If it states "This offer is good for 30 days," the time period

will commence as of the date of the writing.
■ If it states "You have 30 days in which to accept this offer,"
the time period will not commence until the offer is
delivered.
Even if no such limitation is made, an offer will terminate after a

reasonable time has expired. This reasonable time factor has no
specific length that can be applied to all circumstances. The courts
Any system that
tend to interpret time limits on a case-by-case basis.
depends on human
reliability is un-
In the case of a verbal contract, the offer is considered to terminate at
reliable.
the end of the conversation, unless otherwise stated.
An offer is normally revocable any time prior to an acceptance.
Firm Offer Rule

Often in Requests for Proposals (RFP), the customer requests that
a statement be made by the contractor to the effect that, "this offer
constitutes a firm offer, good for "x" number of days."
An offer, stated and presented in this way, becomes irrevocable for

the duration of the time noted. Irrevocable means that the offer has
to stand for the time stated and at the price quoted. Acceptance of the
offer obligates the offeror to the proposal.
If the firm offer does not stipulate a specific time frame, the reasonable
time usually cannot exceed three months.

I
Warning
When submitting a bid, you as a contractor are entering
into a binding contractual relationship as described by
your bid documents.
Acceptance
Typically, the owner (offeree) shows acceptance of the offer by
signing the contractor’s (offeror’s) proposal.
Often the owner is interested in doing business, but not under the
terms expressed in the original offer. When this is the case, a If the assump-
counteroffer can be made. tions are wrong,
the conclusions
Counteroffer aren't likely to be
A counteroffer has the effect of switching the roles of offeror and very good.
offeree.
A counteroffer is not an acceptance and does not in any way bind the
original offeror to the initial offer made. In essence, a counteroffer
nullifies a previous offer.
2
Note
Do not interpret all continued bargaining as counterof-
fers. Fine tuning a contract is not the same as nullifying
a contract. As long as the terms being discussed are
consistent with the original intent of the agreement,
there is no reason to consider fine tuning as jeopardizing
previous negotiations.
Consideration
Consideration is defined as the promised activity of each party in
completing the contract. All parties entering into a contract provide
consideration.
Consideration is the exchange element of a contract. Money is

exchanged for services; this is also known as Quid Pro Quo—
something for something.
Consideration greatly influences the enforceability of a contract

because it defines the values negotiated-for-exchange-of-values.

2
Note
Consideration should be clearly stated in the contract and
easy to determine. It can be money, property, or a promise
to do or not to do something.
In the typical construction contract, the consideration element can

involve numerous details, such as addendums, plans, and
specifications.
Payment
There are two standard methods used to describe the means of
payment in the contract:
■ The fixed-sum contract quotes one price (typically in the

bid) for everything.
■ In the cost-plus-fee contract, the contractor is not held to
a set price. Basically it is a time and materials provision.
The contractor will charge a fee for his services. This fee
might either be a flat sum, or a percentage of the project
costs.
Sometimes the contractor uses a combination of these two methods.

A set price is given in addition to the contractor’s fee. If the fee is
based upon a percentage, the total can vary depending upon change
orders.
Legally Sufficient
The consideration element of a contract has to be legally sufficient.
Legally sufficient consideration does not mean that the benefits

given in return for the promise have to equal a fair deal for both
"Law is often parties.
spoken of as un-
certain; but the The courts do not look for equity in the consideration element, but
uncertainty is not rather for evidence that there was a negotiated agreement to the
so much in the law consideration.
as in the evidence."
Tyron Edwards Under certain circumstances, the courts will interpret a contract as
unenforceable and/or void. Situations of fraud and gross inadequacy
may apply. (For definitions of fraud, gross inadequacy, and also
unconscionable, see the "Quick Reference Tool," at the end of this
course)

Competent Parties (Legal Capacity)

To be considered competent, parties have to be of sound mind. In
addition, parties have to have the authority to act for themselves or
another (agency). What's legal and
what's fair are not
For example, someone heavily under the influence of drugs or always the same
alcohol would be incapable of directing his or her own affairs and thing.
could be judged incompetent by the court.
Parties to a contract have to be of legal age (18 years or more in most

states).
2
Note
A contract between two minors is void. In addition, a
contract between a person of legal age and a minor is
voidable. (see "Status of a Contract" later in this section)
Someone may claim to have authorization to contract for another

person. You should get proof that the person claiming to have this
authorization actually has it. If the authorization does not exist,
you may not have a valid contract.
P Tip
Be especially aware of this possibility when dealing with
the remodeling of rental units. If someone has a history of
representation for another, then legal capacity can be
established.
For example, a son or daughter may be handling business

concerning an apartment building for their elderly parent,
who is the actual owner of the property.
Finally, all parties in a contract have to exist and be identifiable. For

example, one cannot enter into a valid contract with a deceased
person or dummy corporation.
Legal Purpose
A contract has to have legal purpose and be possible to perform. For
instance, a contract to kill or steal is clearly invalid.
A contract to build a structure that does not comply with building

codes also can lack validity. That contract, or part of it, could be
declared void by a court.
Verbal and Written Contracts

A contract does not have to be a formal document, but it does have
to adequately describe the intent of the parties. The dialogues below
are examples of verbal contracts or promises.
Example 1:
First Party: "I’ll have your $10.00 sirloin steak."

In every case of a
Second Party: "Coming right up."
person suffering
the penalty of the
Example 2:
law, is an instance
where the penalty
First Party: "I’ll charge you $2,400 to repair the broken section of
did not defer the
your driveway."
person from vio-
Second Party: "Shake. You’re on.”
lating the law.
Parties in the first example would probably not go to court over a
disagreement. However, parties in the second example would be
likely to settle their disagreement in court, or through some other
mediation, arbitration, or claims process.
P Tip
We urge you to put your agreement(s) in writing. How-
ever, if you choose not to, keep an accurate and complete
record of expenses. If there is a dispute, you will need the
following types of evidence to support your claim:
■ Receipts
■ Invoices
■ Canceled checks
■ Journal of your daily business activities
Written Contract Required

Certain important contracts have to be in writing, for example:
■ Contracts exceeding certain amounts

■ Contracts to sell real property
■ Contracts that will not be performed within one year

The purpose for having these contracts in writing is to prevent

perjury, forgery, and/or dishonest conduct when proving the
existence and terms of these contracts. You will find a complete list
of contracts that have to be in writing in the Statute of Frauds of
your state law.
Even though only certain contracts have to be in writing, you should make it a practice to put all of your
agreements in writing. There is simply no better way to prevent disputes. If an owner does not want a written
agreement, abandon the effort to bid the project. Let someone else get the problem.
Construable Terms and Conditions

A contract has to be construable. The terms, conditions, and clauses
have to be understandable. A vague contract, one with its terms,
conditions, and clauses missing or not clearly defined may be
unenforceable. If a court cannot clearly understand the contract’s
intent it will not enforce the contract.
Integration Clause
The integration clause is typically part of the general conditions of
a construction contract. It states that the agreement signed, and the
contract documents attached (integrated), constitute the entire and
only agreement.
Any modifications to the agreement would have to be done through "There are a
a proper procedure (for example, a change order) as described in the million things in
document. this universe you
can have, and
Terms and Conditions there are a million
Terms and conditions are stipulations within a contract document things you can't
that qualify the general terms of the contract. have. It's no fun
facing that, but
Specifically, each condition agreed on will have its own legal that's the way
significance within the context of the document. Some of these things are."
specific conditions will be covered in "Chapter 2: Your Construction Captain Kirk,
Contract." Star Trek
Conditions can be classified as either precedent or subsequent.
Condition Precedent
A condition precedent is something that has to happen first, before
an obligation can take effect.
An example of such a condition would be a guarantee of satisfaction.

Strictly speaking, if the customer is not satisfied, then the customer
is not obligated to pay.
Condition Subsequent
A condition subsequent is one that tends to free a party from
obligation. An example would be an insurance company denying
liability for damages resulting from an illegally installed wood
stove.
Ignorance of the
law is what keeps
our court sys-
tems busy.
Contract Classifications
Contracts are classified based on the following four criteria:
■ Creation of intent
■ Formation of the contract
■ Status of a contract
■ Enforceability of a contract
Creation of Intent
Intent is the heart of the contract. Courts will attempt to interpret
a contract based on the intent of the parties to the agreement. If the
intent is not discernible, the courts can consider the contract
unenforceable.
In a construction contract, the intent of the contract is made clear by

its components and/or contract documents. (Contract documents
will be defined in the following "Chapter 2: Your Construction
Contract").
The intent of a contract is created in three ways:
■ Expressed contract
■ Implied contract
■ Quasi contract
Expressed Contract
The terms and conditions of an expressed contract are clearly stated
in oral or written words. This should be the case for most construction
projects.
Implied Contract
An agreement between two parties can be implied from specific
circumstances. When requesting the services of a professional,

permission to proceed implies a promise to pay for services. This is

an implied contract.
For example, a homeowner requests the services of a contractor to

fix a leaky roof. The owner is at work and leaves a note describing
The law can stop
what needs to be done. The roofer fixes the leak. In this case, the
illegal actions once
owner owes the roofer a reasonable fee for services rendered.
they are
uncovered. The law
Quasi Contract cannot stop an
The quasi contract is sometimes referred to as a "contract implied illegal action from
in law." It is not a valid contract because one or more elements are occurring.
missing.
A quasi contract is a court remedy to prevent unjust enrichment.
An example of this would be a situation where a homeowner may be

required to pay the contractor for a deck the contractor built, even
though an initial valid contract did not exist. The homeowner would
be unjustly enriched if permitted to keep the deck at the total
expense of the contractor.
This concept would also hold true if the contract was made by a
contractor who was not correctly licensed or registered at the time
of the signing of the agreement. Under state law, where contractors
are required to be licensed or registered, a noncomplying contractor
gives up most of the normal remedies enforceable in court. A quasi
contract is one of the few benefits available. (For a related concept
see "Quantum Meruit," under "Damages" later in this chapter.)
I
Warning
A noncomplying contractor does not have the same pro-
tection under the law as a complying contractor. While
the contract may not be declared completely void, the
noncomplying contractor is normally not judged by the
court as a competent party to a construction contract.
They have not fulfilled the conditions of a contractor
under the law.
Formation of the Contract

Contract formation has to do with the manner in which an offer and
its acceptance are contingent on one another.

Bilateral Contract
A bilateral contract includes a promise given in exchange for
another promise. This is the case for most construction contracts. A
contract is formed at the signing (acceptance) of the document. The
contractor promises to build something of value and the owner
promises to pay something of value.
Unilateral Contract
A unilateral contract comes into being when one party’s acceptance
is contingent upon another’s action or restraint from action.
An example of this type of contract would be a reward offered for the

return of a lost dog. No contract exists until the dog is found and
returned.
Status of a Contract
The status of a contract is expressed as either executed or executory.
Executed Contract
An executed contract is one in which the performance of the
agreement has been completed. Sometimes the term "executed" is
used to denote a contract that simply has been signed.
Executory Contract
An executory contract is one in which there is still unfinished
business. The project is not finished and/or the final payment has
"Laws are never as not been made.
effective as habits."
Adlai Stevenson
Enforceability of a Valid Contract
An enforceable contract is:
■ Valid; it has the four elements

■ Clear in its intent
■ Construable; its terms, conditions and clauses are well-
defined
A court will enforce a contract if a party refuses to do a promised

activity that is clearly defined in the contract. Enforcement means
to impose the performance of promised duties in the contract on a
party who is not performing them now.

Void Contract
A void contract is a contract that is not legal (not valid). In essence,
there never was a contract in the first place because one of the four
elements was missing, or it was not in the proper form (written) as
required by statute.
Voidable Contract
A voidable contract indicates that one of the contracting parties has "There is no
a right to terminate responsibility regarding the agreement. country in the
world in which
For example, a minor would have the option to void a contract to everything can be
which he or she is a party. provided for by
the laws, or in
Unenforceable Contract which political
An unenforceable contract is one that does not meet some statutory institutions can
requirement, has non-definitive, non-understandable terms and/or prove a sub-
stitute for
intent, or is non-construable.
common sense
and public mor-
Promissory Estoppel Rule
ality."
Promissory estoppel is a rule of law that says that if a promise is
DeTocqueville
made and another person has been placed in a position of reliance
on that promise, the promisor is estopped (prevented) from denying
the responsibility of that promise.
This rule comes into play especially when dealing with subcontracts.
A general contractor who has used a subcontractor’s bid as a basis for
the contract price has established justifiable reliance on that
subcontractor’s bid.
The subcontractor could be estopped from denying liability of

performance and/or compensation to the general contractor.
Parole Evidence Rule

Parole evidence means outside evidence. Under the parole evidence
rule, a written contract shall be interpreted solely by what is in the
contract. Any intention or agreement outside of the written contract
shall not be permitted to change the terms of the written contract.
I
Warning
■ What you see (what you signed) is what you get!

■ Read the entire contract.
■ Negotiate changes as necessary, prior to
signing.

Breach
To breach a contract is to break a promise.
A contractual party is said to be in breach of contract when that

party fails to fulfill the obligations assigned by the terms and
conditions of the contract agreement.
Degrees of Breach
There are degrees of breach that determine if the breach is material
or nonmaterial.
A material breach is an action or lack of action that substantially

upsets the intent of the agreement. If a material breach can be
proven, rejection of the entire contract is possible. For example, the
contractor who did not complete the project or abandons the project.
A nonmaterial breach is an action or lack of action that does not

substantially change the intent of the agreement. For example, the
contractor did not finish by the time stated in the contract.
Claiming a Breach
A typical defense for breach of contract is to claim that the other guy
breached first:
I never was ruined
but twice: once I "He didn’t do what he was supposed to do, so I don’t have to do what
lost a lawsuit, and I’m supposed to do."
the second time
when I won a This may seem reasonable but remember two things:
lawsuit.
■ First, the burden of proof is on the party claiming breach
of contract. If you allege breach of contract and the other
party claims that there was no agreement to begin with,
then not only would you have to prove breach of contract,
but you would also have to prove the contract was valid.
■ Second, even if a breach exists and a valid contract has
been proven, the question still remains whether the breach
is a material breach.
I
Warning
Not all breaches of contract will free the offended party
from the obligation to perform what they promised.

A contractor who mistakenly walks off the job, thinking the owner
has materially breached, could instead find himself in material
breach. The courts could find the contractor liable for damages to
the owner.
P Tip
There are many legal avenues for litigating (to bring
court action against) breach of contract.
Before you decide to go to court, consider the fact that even if you
win, you may lose your shirt as far as money is concerned. You may
not recover all of your costs and the court process could take a very
long time to complete.
Consult with a qualified attorney before making such a decision.
2
Note
There are options to litigation. Negotiation and compro-
mise are a lot less expensive. Mediation and arbitration
are other options. See Chapter 4 of this course.
Damages
Damages are losses caused to one party of the contract as a result of
breach by the other party.
Damages awarded to a party are intended to be remedies to compensate

someone who has not received what he or she bargained for. The goal
is to award the party what they would have been entitled to (or a
reasonable equivalent) in the first place.
Damages depict the worst case scenario of a failed negotiation

process. However, the discussion of damage awards can be helpful in
developing insight into your rights and obligations as a contractor.
"All things come
to him that waits,
Categories of Damages even justice."
The three categories of damages are: Austin O'Malley
■ Punitive damages
■ Compensatory damages
■ Liquidated damages

Punitive Damages
Punitive damages have to do with a judgement against a person
who, through outrageous actions, has caused damage to another.
Punitive damages are awarded in addition to compensatory damages.
Compensatory Damages
Compensatory damages are compensation to a party deprived of
contracted-for-services and/or payment for services.
Compensatory damages are often referred to as difference-money

damages. This kind of damage is intended to reward the difference
No law has ever (in money) between what was promised and what was actually
been passed that received.
will keep a person
from acting like a For example, a general or primary contractor has a contract with a
fool. subcontractor for a particular project. The subcontractor completes
the job, but not to the standards as specified in the contract documents.
The problem has to be fixed at the general contractors expense. The

general contractor is then entitled to general compensatory damages
to cover the cost of doing the job right.
The two types of compensatory damages are general damages and

special damages.
General Damages
General damages are the money and/or service needed to make up
the difference between the performance promised and the
performance given.
Special Damages
Special damages are awarded on the basis of additional expenses
and/or loss of revenue incurred as a result of the inadequate
performance of another.
In assessing special damages, the concept of reasonable certainty

will be applied. Special damages are only recoverable if the losses
sustained were foreseeable and were a traceable result of the breach
of contract.
In the example above, where the subcontractor did not do an adequate

job, the general contractor could be entitled to special damages if, for
instance, the project suffered"down-time" as aresult of the inadequate
work. The special damages could also applyif the general contractor was

forced to pay liquidated damages to the owner for failure to complete

the entire project on time.
Liquidated Damages
Liquidated damages is a term associated with the timely completion
of a construction project. It comes into play when the contractor does
not finish the project. Liquidated damages are amounts of money
awarded as compensation for costs incurred by the owner as a result "You can have
of a project delay. anything you
want, but you
As a contractor, you will see and hear this term often. A clear can't have every-
understanding of the legal intentions behind the assessment of such thing you want."
damages will be of great value in your negotiation with the owner Wealth 101
and other contractors.
Most projects will require specific time frames to be incorporated

into the contract document that specify the anticipated start and
finish dates of the project. If the contractor fails to complete the project
on time, he or she could be subject to paying liquidated damages.
Often the amount of these damages will be predetermined within

the contract. The contract can stipulate a sum of money to be paid
if the project is not completed by the date specified in the contract.
Typically, the sum to be paid will accumulate for each day the
project is overdue.
Obviously, from a contractor’s point of view, this is not one of the

more favorable clauses in a construction contract. But often a
contractor has no choice but to agree to such a condition. Manytimes
it is the owner who is in a stronger negotiating position.
One thing that a contractor should be aware of is that the courts will
examine a liquidated damages clause very closely. They recognize
that unequal negotiating power can exist. Thus, the courts can
mandate that such clauses represent reasonable and fair conditions
for all parties of the agreement.
2
Note
The penalty stated in the contract has to reflect the degree
of damage.
The dollar figure of a liquidated damages clause has to be realistic.

It has to represent the actual financial loss sustained by the owner
should the project not be finished on time.

An excellent example of this would be a situation where a homeowner
is paying for a rental while a new house is being constructed. After
inexcusable failure by the contractor to complete the house by the
date promised, damages may be assessed on the contractor equal to
the amount of the homeowner’s rent.
In commercial construction, reasonable damages can be substantial.

Besides the additional rent paid or lost by the owner, unrealized
anticipated profits also can become the contractors liability.
Sometimes a delay in construction is not entirely the fault of the

contractor. Sometimes the owner may be partially to blame. In
situations such as this, the courts will tend to allow only an
appropriate allocation of award to the owner.
Courts may allow the owner to recover a percentage of the damages

based upon degrees of fault; or they may only allow recovery based
upon those damages for which the contractor is exclusively to
blame.
Are Liquidated Damages Penalties?

You may have heard liquidated damage clauses referred to as
penalty clauses. Liquidated damages are not penalties.
Penalties have to be based on realistic anticipated or actual damages.

Even if penalties are expressly written into the contract itself, the
enforceability of such a clause would be questionable.
In most states a commercial code expressly stipulates that liquidated

damage clauses that do not realistically reflect potential actual
"In law, nothing is damages would be void.
certain but the
expense." Time Is of the Essence
S. Butler When a timely performance is clearly indicated in the contract, then
compliance with the completion date is considered to be a condition
precedent of the contract.
If the time factor is not clearly indicated in the contract, then the
courts will determine whether such a condition actually exists in the
intent.
Inexcusable failure to complete a project on time would be considered

(in most instances) a minor breach of contract. The primary
agreement would maintain its enforceability.

The owner would not be able to negate any obligations to pay

because the project was not finished on time; but the owner would
have the right to demand appropriate liquidated damages.
P Tip
Because it is not always possible to refuse such time
penalty clauses, (even if you can, the courts may later rule
that "time is of the essence" was implied), then negotiat-
"Instincts are no
match for infor-
mation."
ing a time reward clause may be the next best option.
Harvey Mackay
A reward clause stipulates a bonus to the contractor if the project

should be completed ahead of schedule.
It is also possible that a "no damage for delay" clause could be

included in the contract. However, this may or may not be enforceable
if damages are indeed realized through the project’s delayed
completion.
2
Note
In public construction projects, "no damage for delay"
clauses would normally be interpreted as being contrary
to public policy and would be considered void and unen-
forceable.
I
Warning
If you are the primary contractor, a "no damage for delay"
clause may sound tempting. But there are two possibilities
in this clause. Consider the possible consequences if this
clause prevented you from recovering damages to you
resulting from delays caused by subcontractors.
Substantial Completion (Performance)

Typically when a project completion date is set, the date is not
referring to that moment when the project is 100 percent complete.
Instead, the completion date is in reference to when the project has
to be substantially complete.
Substantial completion refers to that point in a particular project

when the vast majority of the work has been completed. The only
remaining items to be done are of a minor nature (for example,
cabinet handles, paint touch-ups, etc.).

Your state's contract law statute will set a definition for substantial
completion in most cases. Substantial completion may occur at the
time of, but not be limited to, the first occurrence of any of the
following events:
■ Final inspection is completed

■ Certificate of Occupancy is issued
■ The structure, or a portion of the structure, is in a
habitable or usable condition
■ Most or all of payment is made
Perhaps the most useful determination of when substantial

completion has been reached is that point in time when the structure
may be legally owner-occupied and used in the manner intended.
2
Note
Because of such possible variations in the precise meaning
of substantial completion, this term needs to be defined
within the context of your contract to promote mutual
understanding of its meaning.
Substantial completion is a key determinant for assessing or not

assessing liquidated damages. Once substantial completion has
been attained, delay damages can no longer be imposed.
In addition, a contractor who has substantially completed the

project attains a more favorable position with the courts if other
claims of breach should arise.
Substantial completion determines other factors as well. Statutes of

limitations can begin to expire from the time a project is substantially
complete. The time allotted to file liens can also begin to elapse.
People buy on price
only when you
don't have any- Recovery of Damages
thing else to offer. Recovery of damages through a contract will always involve courts
and legal procedures. Your state's licensing or registration agency
may award damages to an owner after the investigation of a claim.
The award may end up coming from the contractor’s surety bond if
the contractor fails to perform as required by the terms of the
damage award.
The licensing or registration agency or the courts may require

repair or replacement as damages. Again, if a contractor fails to

repair or replace as required, the surety bond may pay to repair or
replace.
Little things don't
Finally, the contractor may have remedies under state law against
mean a lot, they
the owner when the contract does not serve to clearly state when
mean everything!
damages are due.
Licensing or Registration Agency

If your state licenses or registers contractors, they may have a
process to handle claims brought by the owners and subcontractors.
The claims process only deals with contractors and owners that
qualify. The cases include issues of:
■ Negligent work
■ Improper work
■ Breach of contract
This claim would have to qualify under the claim terms. Usually the
claim amount has to be under a certain minimum dollar amount
and subject to the decision of the agency arbitrator or hearings
officer. In most cases these claim processes are designed to resolve
smaller, less complicated disputes. Larger or more complex cases go
to a court of law.
2
Note
This is an important legal distinction. An owner’s claim of
breach may be handled by the licensing or registration
agency. However, claims by contractors against owners
are normally dealt with in court, as are liens and suits.
The only exception to this may be when a general contractor has a

claim against a subcontractor regarding lack of or negligent
performance.
Time of Limitations
Claims handled by the state licensing or registration agencies
usually require a quick disposition.
Regardless of whether the claim involves a new or existing structure,

if the owner files the claim because the contractor failed to
substantially complete the work, the agency must usually receive
the claim not later than one year after the date the contractor ceased
work on the structure.

If a licensed or registered contractor is performing work as a
subcontractor, the agency must usually receive the claim not later
than one year after the date the structure was first occupied or two
years after completion, whichever comes first.
Claims to be resolved through court action are subject to other time

limitations. These can range from one to six years depending on the
types of issues involved.
Owner’s Recovery of Damages

An owner’s claim of breach of contract is most often centered around
the issues of time delays, inferior work, and/or absence of work
promised.
Claims of this nature often arise from a lack of clarity within the
contract documents themselves. Unrealistic expectations by the
owners are usually the main culprit leading to claims of breach.
Another area where claims arise has to do with misappropriated

funds. This is typically in cases where the contractor fails to pay
suppliers and subcontractors after being paid by the owner for work
performed and materials delivered.
P Tip
Knowing in what way an owner is entitled to recover
damages is necessary in order to know your expected
responsibilities as a contractor.
An owner may claim breach of contract in regard to the quality and

functionality of the work. Statements such as, "All work will be done
in a professional manner," expressly give the owner such rights.
However, even without such wording, the owner will have implied
rights to reasonable work.
The only people who
enjoy hearing your Cost of Replacement or Repair Rule
troubles are When economically feasible, the owner is entitled to be reimbursed
lawyers, and they for the cost of replacing or fixing anything the contractor did not do
are paid to do it. properly.
However, when replacement or repair is not a practical solution, the

owner is entitled to the value difference between the project as it is,
versus its value if done properly (difference in value rule).

Contractor’s Recovery of Damages

Contractors wishing to litigate regarding an owner’s breach of
contract usually cannot use the services of the licensing or
registration agency for this purpose. However, the contractor has
many options to recover damages.
A lawyer is willing
to spend your last
These include exercising the right to lien on the owners property. (If
dollar to prove he's
you have an interest in lien law, the Academy offers the Advantage
Contractor Business Success Series course, Lien Law for Construction right.
Contractors.)
You also have the option of placing a mediation and/or an arbitration

clause in your initial contract. See Chapter 4 of this course.
If you choose court action, you may be able to use your state's small
claims process for disputes less than the minimum dollar amount
established by law. For action involving an amount greater than
the minimum, litigation would have to take place in a higher court
of proper jurisdiction.
I
Warning
Litigation would normally involve hiring an attorney. In
general, many state courts do not allow for the recovery of
the cost of attorney’s fees. The prevailing (winning) party
can recover costs of legal counsel only if it is stated in the
contract.
If an owner breaches a construction contract, the general contractor

could recover the cost to do the project as well as the cost to prepare
for doing it. Project preparation costs could include permit costs,
deposits for materials, or advance payments to secure services.
In addition to costs, the contractor is also entitled to recover any

profit that would have been made if the project had been finished.
This profit can be calculated by subtracting the contractor’s actual
and projected costs from the total price quoted in the contract.
Evidence is necessary for proving the actual costs of your performance

on a project. You may have intended to realize a $10,000 profit; or
you may have made that much on a similar project.
However, these criteria are not adequate evidence for proof of one’s
actual costs and profit. Details showing the reasonable certainty of
such lost profits would be required. A thorough and accurate record
keeping system would usually provide such evidence. (More

information on Accounting and Record keeping, is available in the
Advantage Contractor Business Success Series course, Record
Keeping for Construction Contractors.)
Many objections
to law arise from
the impossibility Quantum Meruit
of making the law The concept of quantum meruit translated means, "as much as he
apply only to the deserved." Quantum meruit comes into play in situations involving
other party. services and/or materials rendered by a contractor or subcontractor
for which the contract did not provide a means of compensation.
Suppose the contract was to build new steps to the front porch. The
owner has given the contractor the go ahead and tells the contractor
to do whatever it takes to get the project done.
The contractor discovers that half the porch is rotten. The owner is
now out of town. The contractor rebuilds the rotten porch to facilitate
the building of the steps.
If a dispute arises, under the principle of quantum meruit the

contractor would be entitled to obtain reasonable payment for the
work done.
I
Warning
Be aware that it is the contractor’s responsibility to prove,
with reasonable certainty, that the work performed was in
the best interest of the owner, and that the cost of the
additional work is reasonable.
Cardinal Change
The principle of cardinal change is similar to the concept of "as much
as he deserved."
Cardinal change refers to a situation where a construction project

has been so drastically altered that the original terms and conditions
Lawyers would no longer apply. The altered scope of the work is so profound that a
have a hard time change order system would not be adequate.
making a living if
people behaved For example, a painter contracts to paint a room. The owner keeps
themselves and adding room after room and before long the entire house becomes
kept their pro- the scope of the project.
mises.
In another example, suppose the homeowner continually changes
his mind about colors and the painter has to paint everything twice.
Even though the existing contract did not cover such drastic changes,

and no subsequent contract was made for the additional work, There are two
under the cardinal change criteria and the principle of quantum types of experts:
meruit, the paint contractor could claim entitlement to reasonable There is the expert
compensation for the work done. who can make
something happen,
Generally speaking, the intent of the law is just compensation for and there is the
work done. The key words are reasonable and certainty. expert who can tell
you what he or she
The value attached to the work in question has to be established thinks will happen.
with reasonable certainty. The evidence of lost profits has to be
reasonable in scope. Profits not realized from other projects "down
the road" typically are not recoverable as lost profits connected with
the project in question.
Avoidable Consequences
The sense of what is reasonable is contained in another concept of
law—avoidable consequences.
This concept establishes that a contracting party has an inherent

obligation to exercise reasonable effort and business sense to avoid
unnecessary loss as a result of another’s breach of contract. But this
avoidance of unnecessary damages is reasonable in its expectations.
The damaged party is not expected to take undue risk or spend
unreasonable amounts of money to curtail damages.
The Law of Gravity

Summary is the only law
observed by
This chapter presented the basic information a contractor needs to
everyone.
know about contract law. It described contract characteristics,
including:
■ The four elements

■ Terms and conditions
■ Classifications of contracts
■ Breach
■ Damages

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Chapter 1: Contract Basic 1

A contract should not be devised as an attempt to obtain unfair

A valid contract is legally binding and enforceable in a court of law.

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the negotiation process between either:

■ Owner and general contractor

However, not all aspects of the contract have to be determined as a

Regardless of the form of a contract (standardized or the customized),

A valid, or good contract has four elements:

■ Offer and acceptance

Offer and Acceptance

A bid is an offer by a contractor to transact business. When the

Advantage Contractor Business Success Series

The law makes a fine distinction as to when such a 30-day limitation

■ If it states "This offer is good for 30 days," the time period

Even if no such limitation is made, an offer will terminate after a

An offer is normally revocable any time prior to an acceptance.

Firm Offer Rule

An offer, stated and presented in this way, becomes irrevocable for

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Consideration is the exchange element of a contract. Money is

Consideration greatly influences the enforceability of a contract

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In the typical construction contract, the consideration element can

■ The fixed-sum contract quotes one price (typically in the

Sometimes the contractor uses a combination of these two methods.

Legally sufficient consideration does not mean that the benefits

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Competent Parties (Legal Capacity)

Parties to a contract have to be of legal age (18 years or more in most

Someone may claim to have authorization to contract for another

For example, a son or daughter may be handling business

Finally, all parties in a contract have to exist and be identifiable. For

A contract to build a structure that does not comply with building

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Verbal and Written Contracts

First Party: "I’ll have your $10.00 sirloin steak."

Written Contract Required

■ Contracts exceeding certain amounts

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The purpose for having these contracts in writing is to prevent

Construable Terms and Conditions

Conditions can be classified as either precedent or subsequent.

An example of such a condition would be a guarantee of satisfaction.

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In a construction contract, the intent of the contract is made clear by

The intent of a contract is created in three ways:

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permission to proceed implies a promise to pay for services. This is

For example, a homeowner requests the services of a contractor to

A quasi contract is a court remedy to prevent unjust enrichment.

An example of this would be a situation where a homeowner may be

Formation of the Contract

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An example of this type of contract would be a reward offered for the

■ Valid; it has the four elements

A court will enforce a contract if a party refuses to do a promised

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The subcontractor could be estopped from denying liability of

Parole Evidence Rule

■ What you see (what you signed) is what you get!

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A contractual party is said to be in breach of contract when that

A material breach is an action or lack of action that substantially