Construction contract provisions
By Michael L. Fortney
Contents
- Is an indemnification clause enforceable?
- Can a contractor waive his right to file a mechanic's lien?
- Typical schedule provisions
- No damage for delay clauses
- Liquidated damages
- Suspension or termination provisions
- Changed work or extra work provision
- Pay when paid, pay if paid provisions
Is an indemnification clause enforceable?
Clauses in construction contracts where the promisor indemnifies "against liability for damages arising out of bodily injury to persons or damage to property . . caused by the negligence of the promisee" are against public policy and void. Ohio Revised Code §2305.31.
Accordingly, an agreement between an owner and a contractor, whereby the contractor agreed to indemnify the owner for any claims related to the contractor's work, was void and did not require a contractor to indemnify an owner against a claim by the contractor's employee against the owner for injuries suffered on the job allegedly caused by the owner's negligence. Kendall v. U.S. Dismantling Co., 20 Ohio St. 2d 61 (1985).
The Cuyahoga County Court of Appeals has interpreted the statute to prohibit requirements in a construction contract that the contractor name another an additional insured on his CGL policy to insure against the owner's negligence. Buckeye Union Ins. Co. v. Zavarella Bros. Constr. Co., 1997 Ohio App. LEXIS 2934 (July 3, 1997).
The statute also invalidates any requirement for the contractor to pay the owner's attorneys fees and costs in a lawsuit arising from the contractor's work for the owner, if such a requirement is contained within a void indemnification clause. Moore v. Dayton Power & Light Co., 99 Ohio App. 3d 138 (1994).
Can a contractor waive his right to file a mechanic's lien?
An owner in Ohio may have a contract provision providing that a contractor may not file a lien on a project. The enforceability of such a provision is questionable. However, some Ohio courts have upheld such "no lien" provisions against contractors that sign them. Seveco, Inc. v. C&G Investment Associates, 1977 LEXIS 7341 (Franklin Cty. 1977).
If a contractor agrees to a no lien provision, the contractor must put the same language in any contracts he enters into with lower tiered contractors or material suppliers.
Typical schedule provisions
The schedule for completion of the contract work is an essential component of the contract, and a frequent focus of construction litigation. In a perfect world, the contract will incorporate a detailed computer generated completion schedule, with milestone dates for the essential tasks, and the schedule will be updated periodically to reflect changes in the schedule to reflect changes and progress.
At a minimum, the prime contracts should include a date of commencement of the work, a project duration (the time that the prime contractor agrees to reach substantial completion of its scope of work), and a definition of substantial completion.
The date of commencement is subject to change, based on several factors. The most common factors affecting the date of commencement influenced by the owner are owner funding, the delivery of final plans and specifications, the availability of the building permit. Changes in the date of commencement change the date of substantial completion.
The project duration is measure either in calendar days or working days, and is based on the number of days that the parties predict it will need to complete the project. Project duration is subject to lengthen based on several factors: changes directed by the owner, unforseen conditions, force majeure, weather, contractor issues.
No damage for delay clauses
The Fairness in Contracting Law prohibits no damage for delay clauses when the reason for the delay is the result of the owner's [or contractor's] act or failure to act. Ohio Revised Code §4113.62. Defective plans and specifications are the leading reasons for owner-caused delay damages and time extensions in Ohio. To recover delay damages, a contractor must establish that (a) the owner breached the contract, (b) the breach caused a delay to the contractor's performance, and (c) the contractor was damaged.
Liquidated damages
Liquidated damages clauses are generally enforceable. Courts consider liquidated damages to be appropriate for remedying delays in the construction industry.
To be enforceable, the owner must establish (a) the actual damages would be difficult to ascertain, (b) the liquidated damages bear a reasonable relationship to the actual damages, and (c) the contract provision evidences that the parties intended to consider and adjust the damages that might occur from delays or other breaches. Courts will invalidate any liquidated damages clause that is deemed to be a penalty.
Suspension or termination provisions
Contracts typically provide that owners have the right to suspend work on the project or to terminate a contract “for convenience.” Some compensation for the suspended or terminated contractor is in order in these circumstances.
Contracts may typically be terminated by either party based on the default of the other party. Such terminations are normally subject to notice and cure requirements under the contract.
Changed work or extra work provision
The changed work provision is a mechanism to allow the project to continue despite unanticipated circumstances or changes in the construction process or plans and specifications. The change provision allows the owner to demand changes without requiring a new negotiated agreement with the contractor. Changed or extra work may result in the adjustment of the contract price – either resulting in additional money and/or time to complete the project or a deduct in the price. Reasons for contract changes include:
• owner initiated changes in the plans and specifications
• unforeseen site conditions and weather conditions
• direction is necessary to remedy design deficiencies
• contractor initiated changes, “value engineering”, accepted by the owner
• changes in the material quantities from estimate
Typically, contracts permit owners to unilaterally change the plans and specifications and direct the general contractor to perform the changed or extra work. Similarly, contracts permit the general contractor to identify instances of changed work and request an adjustment to the contract sum or time for completion. The general contractor is typically required to proceed with the changed work pending the resolution of any claim regarding the appropriate contract adjustment.
If the “change” or “extra” work involves work that is outside of the general scope of the contract, the change is not necessarily subject to the administrative remedy provided by the contract, and the contractor may refuse to perform the work pending resolution of the terms of the contract adjustment. Such changes are commonly referred to as a cardinal change.
To determine if a change is a cardinal change, look to the following factors:
• the impact of the change
• degree of added complexity and difficulty of the contract work
• disruption caused to the contractor’s performance
• impact on the contract sum and time for performance
Pay when paid, pay if paid provisions
One of the greatest concerns and risks on a construction project is payment by the owner. Once the contract work has been fully performed, everyone wants to be, and should be, fully paid. One of the risks of nonpayment is the owner's potential inability to pay. Contractors need to agree on who bears the risk of nonpayment – the general contractor or the subcontractor.
Contractors routinely try to shift the burden of nonpayment to subcontractors. "Pay when paid" and "pay if paid" provisions are popular. Most pay when paid clauses only serve to delay the time for payment to the subcontractor, whereas a properly worded pay if paid clause may actually shift the burden of nonpayment to the subcontractor.
Typical pay when paid clauses provide something like:
The total price paid to [subcontractor] shall be [contract price], no part of which shall be paid until 5 days after payment is received from owner.
or
. . . the Contractor shall pay the Subcontractor each progress payment and final payment . . . within three working days after he receives payment from the Owner . . . .
In Thos. J. Dyer v. Bishop International Engineering Co., the Sixth Circuit U.S. Court of Appeals refused to enforce a pay when paid clause. In Dyer, a general contractor was not paid on a project after the owner declared bankruptcy. The general contractor, in turn, did not pay its subcontractor for the work it performed.
The Sixth Circuit held that conditions on payment are enforceable, so long as such conditions are clearly expressed. In construing the clause that "no part [of payment] shall be due until five days after the owner shall have paid the contractor", the court decided that the clause was sufficiently ambiguous to require examination of the parties' intent.
In examining the parties' intent, the court noted that general contractors normally bear the risk of nonpayment due to insolvency. The court held that this normal relationship could be varied only with clear and unequivocal language.
Accordingly, the court held that the pay when paid clause was only effective to delay payment "for a reasonable period of time after the work was completed, during which the general contractor would be afforded the opportunity of procuring from the owner the funds necessary to pay the subcontractor."
Ohio courts have followed the Dyer rule. In Power & Pollution Services, Inc. v. Suburban Power Piping Corp., the Cuyahoga County Court of Appeals reversed the trial court's dismissal of a subcontractor's claim against a general contractor after the owner, LTV Steel, declared bankruptcy. The subcontract contained the language that the general contractor "shall not be required to pay such monthly billing of the subcontractor prior to the date Company receives payment of its corresponding monthly billing from the Owner."
How do contractors shift the burden of nonpayment by the owner? Say it clearly in a contract provision.
What should be said? The contract should state that
- the subcontractor is paid only if the general contractor is paid, (or the subcontractor will not be paid unless the general contractor receives payment from the owner); and
- the subcontractor assumes the risk of nonpayment by the owner due to insolvency or other inability to pay.
Such contract language has been held by many courts to sufficiently shift the burden of nonpayment to the subcontractor.
Some states, however, have held that such risk shifting violates public policy. The California Supreme Court has ruled "pay if paid" clauses are unenforceable as a violation of California’s public policy. The court noted that a "pay if paid" clause is an indirect forfeiture of a subcontractor’s constitutionally protected lien rights. The New York high court has likewise concluded that "pay if paid" clauses are void as against public policy.
