Why Contracts Matter to Your Bottom Line

Despite the fact contracts ultimately govern a general contractor’s performance on a project, they often are not read carefully. Studies by the Construction Industry Institute and other groups demonstrate that allocating risk unfairly damages project results. According to a recent study examining just five clauses, owners wind up paying a 20 percent premium for risk contingencies. This is not a good investment because the owner pays regardless of whether the contingency arises.

An owner and those higher up in the contractual chain have the power to transfer risk to a weaker party. Generally, the stronger party can get a smaller party to sign a contract so it can get the job. However, industry-wide efficiency ultimately suffers. Contracts are part of the problem. 

The ConsensusDocs coalition of more than 40 leading organizations, including Associated Builders and Contractors, Construction Users Roundtable, Construction Owners Association of America and National Association of State Facilities Administrators, is committed to improving the contractual environment by identifying and publishing best practice contracts that are fair to all parties.

More than 100 standard contract documents address all major project delivery methods, including design-build, construction management at-risk, integrated project delivery (IPD) and agency construction management, in addition to the traditional method.

The purpose of the coalition is simple: Build a better way through better and fairer contracts. Rather than repetitively fighting over the same egregious contract clauses, the goal is to build a better contractual foundation from the national level, and then tailor it to each project’s needs.

The initial results using the contracts are promising, and usage continues to increase significantly, with 2015 showing the largest growth. One owner, the Department of Administrative Services (DAS) for the state of Iowa, switched to ConsensusDocs contracts from contracts based on American Institute of Architects (AIA) A201, along with making other improvements. Previously, DAS experienced formal claims on almost every single project. Since moving to ConsensusDocs contracts in 2011, DAS obligated under contract more than 120 projects and has not faced a formal claim.

Several general contracting companies, such as WAR Construction in Tuscaloosa, Ala., use the ConsensusDocs subcontract agreement and purchase orders as their company’s standard documents and issue an addendum for state- and company-specific provisions. They post the documents on a password-protected site and have used ConsensusDocs successfully on more than 1,000 projects.

Financial Information
Payment flow is the lifeblood of a contractor. Because margins are so thin, waiting until nonpayment to learn that project financing is gone is too late. ConsensusDocs contracts address this by allowing a contractor to request project financial information during the life of the job. The provision has teeth because the contractor may stop work if the owner doesn’t respond. Moreover, Guidelines for Obtaining Financial Information (ConsensusDocs 290) and a Standard Questionnaire (290.1) are available as an off-the-shelf solution to get needed information without hassling an owner. By comparison, the AIA A201 requires a contractor to make a showing to request financial information once dirt on a project is moved.

Retainage
Holding money on a project helps protect an owner from getting ahead of paying for work, but it shouldn’t be used as a hammer hovering over one’s head. Again, payment flow, and the cost of carrying increased capital expenditures, impacts the bottom line. Excessive retainage unnecessarily adds costs that have to be passed on to owners.

Under ConsensusDocs, no additional retainage is held once a project is 50 percent complete. Contingent upon the owner’s release upstream, early finishing trades receive released retainage rather than wait possibly years for final payment for their work. This is a great example of how offering fair contract terms really helps attract the best contractors and the best prices.

Change Orders
Contractors are in the business of building projects, not financing them. Construction is unique in that material changes are actually expected to arise before project completion. In construction, this doesn’t negate the contract. Unfortunately, other standard contracts place 100 percent of the financial burden of disputed change work upon the contractor. If an owner directs a change, but disputes that the work is out of scope, the contractor is stuck paying for materials and labor without any payment. Even the mere threat of this can intimidate a contractor on legitimate claims for changes in the work. It is extraordinarily hard to price out this kind of risk.

ConsensusDocs takes an even-handed approach to this difficult issue. The contractor gets paid half its estimate for the disputed change work and 100 percent of undisputed work. The owner retains its claim against disputed work and the contractor’s financial solvency is not sucked dry. Also, there is an obligation to convert directed changes into mutually agreed to changes as other change orders are processed.

Scope of Work
A fundamental issue in any contract is articulating the project scope in the contract and the contract documents. Contractors typically have an affirmative contractual obligation to review the plans and specifications, owner-provided information and apparent site conditions. However, the contract shouldn’t try to turn a contractor into an uncompensated inspector, nor a mind-reader of the designer of record. ConsensusDocs takes balanced approach of requiring the contractor to report errors it actually knows that are reasonably inferable, but doesn’t go down the fuzzy path of speculating on errors it should have discovered. Other standard contracts require the contractor to intuit an architect’s “intended results.” Pricing out the risk of someone else’s errors is close to impossible.

In addition, a good contract should help organize the interpretation of potentially conflicting contract documents by providing an order of precedence clause. Conflicting documents often impact project scope, and without a precedence clause, a contractor may unintentionally be following a modified golden rule (i.e., the one with the gold makes the rule, or whichever option is more expensive shall by required of the contractor). ConsensusDocs provides an order of precedence clause that generally gives more recently created contract documents precedence over older documents.

At the end of the day, the contract determines a company’s rights and obligations on a project. Neglecting to select the right standard construction contract and which clauses to negotiate will make the risky business of construction even riskier.  


Brian Perlberg is executive director of ConsensusDocs. For more information, email bperlberg@consensusdocs.org.