Construction Contract General Conditions: Addressing Risk-Laden Clauses (Part 1)

Introduction

Construction contracts generally consist of the following documents:

  • The plans
  • The specifications
  • The contract: Agreement, General Conditions and Special Conditions

The plans and specifications focus on the specific technical requirements and quality of the end product. These technical requirements specify the nature of the materials, allowable tolerances and acceptable criteria for contract compliance. The plans (which provide the basis for quantity takeoffs) and the technical specifications typically form the baseline of a contractor’s bid. The all too often ignored General Conditions (GC’s) are frequently considered incidental to the work and, therefore, not given serious consideration. But the GC’s set forth the duties, responsibilities and risk allocations associated with the work.

Theoretically, the aim of a written contract is to define with certainty the obligation of each party, avoid ambiguities and preclude ultimate controversy. The GC’s define specific duties, obligations and responsibilities of each party.  Construction contracts, and specifically the GC’s, seek to identify risk and then, allocate the risk of specific contingent events to one of the parties. This is accomplished by including a clause in the GC’s that states the type of contingent event, the risk that is allocated, the conditions under which the risk is allocated and party to whom the risk is allocated.  If the contingent event occurs, the party that bears the risk absorbs the cost associated with the event.

Furthermore, supplemental conditions and/or special conditions may supplement or amend what is written in the GC’s, so it is important to also review and understand these documents and their relationship to the GC’s.

In today’s construction marketplace, most general contractors function as brokers of construction services.  The vast majority of construction is performed by subcontractors.  Most subcontract agreements contain flow-through clauses that bind the subcontractor to the terms of the owner-contractor agreement, such as:

“To the extent the terms of the prime contract between the Owner and Contractor apply to the work of the Subcontractor, then the Contractor hereby assumes toward the Subcontractor all the obligations, rights, duties, and redress that the Owner under the prime contract assumes toward the Contractor.  In an identical way, the Subcontractor hereby assumes toward the Contractor all the same obligations, rights, duties, and redress that the Contractor assumes toward the Owner and Architect under the prime contract.”

Therefore, the subcontractor has the additional burden of reviewing not only its subcontract agreement and GC’s but also the owner-contractor contract and GC’s to fully understand its risks, obligations and rights.

What are these risks? Although not complete, the following represents specific risks confronting general contractors and subcontractors:

  • Major project changes
  • Failure to obtain access
  • Delays in owner-furnished materials
  • Interference by owner or other contractors
  • Defective owner-furnished materials
  • Project funding problems
  • Delays in granting/issuing change orders
  • Exculpatory clauses
  • Inadequate tolerances in construction
  • Unusually severe or harsh inspection
  • Errors and omissions in plans and specifications
  • Slow shop drawing turnaround
  • Late release of construction drawings
  • Failure to cooperate and/or to coordinate
  • Ambiguous and/or conflicting plans and specifications
  • Labor strikes
  • Unusually severe weather, fires, floods
  • Differing site conditions
  • Government interference
  • Third party intervention and delays

This broad listing can be further consolidated by assessing the frequency by which each is contested in a dispute. In perhaps a subjective assessment, the following risks would appear to be most frequently contested:

  • Requests for time extensions and/or constructive acceleration
  • Following the “Changes” clause
  • Proceeding with disputed “Changed” or “Extra” work
  • Tight interpretation of plans and specifications
  • Exculpatory clauses
  • Site coordination
  • Getting timely answers

 

Focusing on Risks

While these items above identify risks, the GC’s provide the additional step of their respective allocation.  In a similar fashion, the most frequently sought after questions to “ask” of the GC’s are:

  • What does the contract allow for recovery of damages?
  • What are the notice requirements?
  • What form does a claim have to be in?
  • What are the scheduling requirements?
  • Does the contract contain a “no damages for delay” clause?
  • How are differing site conditions handled?
  • Is turnaround time for shop drawings addressed?
  • Is the project a performance or design specification?
  • What about variations in quantities?

With this background of generalized risk identification, a review of currently used clauses places these concerns in context.

 

Limitation of Recovery

While most construction contracts provide an equitable provision for contract adjustments, some contracts are not so lenient:

“In determining the amount of any adjustment to the Contract price under this Article 49, the Contractor agrees that the following items shall not be included in its claim and that in any court, arbitration or other proceeding, the award or verdict shall not include payment for the following items:

  1. Profit;
  2. Loss of Profit;
  3. Labor Inefficiencies;
  4. Cost of Idle Equipment;
  5. Project Overhead;
  6. Home Office Overhead; including but not limited to costs of any kind of home office personnel;”

While this language is heavily one-sided against the contractor, most contracts address limitations on a contractor’s potential financial recovery. The contractor’s financial recovery may barred for certain contingent events or recovery may be limited by other contract provisions such as predetermined unit prices or stipulated wage rates, equipment rates, overhead percentage and profit percentage to be used in pricing change orders.

 

Notice Clauses

Many clauses in the GC’s require the contractor to provide notice to the owner to perfect the contractor’s rights of recovery. The requirements for a contractor to provide timely notification extends to a variety of conditions – notification of claims, changes, time extensions, differing site conditions, etc. Failure to comply may waive the contractor’s rights to future recovery:

“It is an express condition of Contractor’s right to make a claim or to receive any recovery or relief under or in connection with the Contract, that Contractor submit a written Notice of Intent to Claim in accordance with the provisions hereof of this ArticleFailure to comply with the provisions hereof shall constitute a waiver by the Contractor of any right, equitable or otherwise, to bring any such claim. The Notice provided above shall be given within ten (10) days after the happening of the event or occurrence giving rise to the potential claim . . . .”

 

Notice requirements vary widely from contract to contract and a contract may contain multiple notice clauses:

 

Delay

If Contractor is delayed in the progress of the work . . . Contractor shall, within twenty-four (24) hours after the commencement of such delay, file with AGENCY a written notice of delay . . .

 Changes

The Contractor shall within five (5) days notify AGENCY in writing when the Contractor has received direction, instruction, interpretation or determination from any source which the Contractor believes may cause any change in cost or time required for the performance of the Work . . .

 

Changed Conditions

Contractor shall promptly, and before the conditions are disturbed, give a written notice to AGENCY of (1) subsurface or latent physical conditions at the Work Site which differ materially from those indicated in this Contract, or (2) unknown physical conditions at the site, of an unusual nature, which differ materially from those ordinarily encountered and generally recognized as inherent in work of the character provided in the Contract.”

The contract should be read carefully to determine the proper notice provision for each clause.  This is a relatively simple process but experienced contractors continually fail to issue timely, contract compliant notice, and thereby jeopardize otherwise meritorious claims.

Notice clauses are often interpreted by contractors as obstructive and punitive.  However, when a change, delay or impact event occurs, the owner must be given the opportunity to investigate and provide a suitable response.  The owner’s right to respond to and mitigate a potentially adverse and costly problem is the primary reason that notice provisions are included in construction contracts.  Therefore, a contractor who fails to provide notice is deemed to have denied the owner the opportunity to mitigate and may not prevail in its claim.

An owner’s first line of defense may be to reject the contractor’s claim for failure to provide timely notice, but lack of strict compliance with timely notice provision need not be fatal to the contractor’s position. Two real defenses are available:

Constructive Notice:  Demonstrate that the owner had the opportunity to mitigate its costs because it already knew, or should have known about the problem via meeting minutes, schedule updates, progress reports or other project documentation.

No Harm:  Demonstrate that the lack of timely notice did not prejudice the owner’s rights to mitigate its costs, because the contractor took the most effective course of mitigation and no possible action by the owner could have further reduced the incurred costs.

Despite these available defenses, a contractor’s claim always stands on firmer ground when notice was provided in accordance with the contract GC’s.

 

Conclusion

Considerable attention is typically given to the plans and specifications when a contractor prepares its bid.  Equally important to the financial bottom line of the project are the risks, duties, obligations and responsibilities defined by the GC’s.  Contractors should take care to understand the GC’s of their contracts.  When project issue arise, timely notice, in accordance with the contract requirements, is crucial for the contractor’s perseveration of rights to pursue additional compensation.

In Part 2, we will discuss inclement weather clauses, scheduling clauses, change clauses and multi-prime contractor coordination.

Construction Delays: Quantification of the Financial Impact

Introduction

During the construction of a project, there are few problems which have a more adverse, financial effect on a contractor or subcontractor than project delays.  Delays result not only in increased costs to specific items of work, but also frequently have concurrent disruptive effects on base contract work resulting in a protracted project completion.  At the heart of the factual evidence required by the contractor for proof of the impact of delays to individual activities is the construction schedule.

Whether a contractor is submitting a construction claim or defending against one, the element of proof is the same:

  • What was the cause of the problem (in this instance, the delay), and
  • What was the effect (the subsequent ripple to activities within the schedule network due to the delay)?

The process of establishing such direct causation can be complex.  Delays on construction projects can be caused by either the actions and/or inactions of entities (i.e., owner, contractor, vendor, etc.) or circumstances (i.e., abnormal weather, trade embargoes, etc.).

Broadly stated, the process of definition reveals three forms of delays:

  • Excusable and compensable
  • Excusable but not compensable
  • Non-compensable and non-excusable

Methods of Proving Delay and Impact

The availability of a detailed network schedule provides the parties with a means of establishing the effects of discrete delays. Such schedule usage provides the means by which time extensions due the contractor can be assessed. Equally important is the issue of concurrent delays.  Simply defined, during the course of construction, work may be proceeding on several activities simultaneously.  One of these activities may experience a compensable delay while, at the same time, a non-compensable delay may impact a parallel activity.  The concurrent delay issue is important because in such a situation damage recovery by the contractor may be precluded.

An evaluation of concurrent delays is necessary when establishing delay claims or, for that matter, when analyzing a contractor’s delay claim on behalf of an owner.  The initial step in the process is to establish the schedule baseline.  Depending on the circumstances, either the contractor’s as-planned schedule, preferably submitted shortly after the Notice to Proceed.  Then, a comparison between the as-planned and the as-built schedules should provide valuable insight into extended activity durations and changes in network logic.

This initial effort focuses on the identification of delay types and the methods available to establish proof of delay and schedule impact.  Performing that exercise establishes the cause of delay. The next step is to identify the effect – the resultant monetary delay damages.

Contractor Delay Damages

The major elements of a contractor’s delay claim may include:

  • Direct craft labor costs
  • Escalation costs
  • Jobsite overhead costs
  • Home office overhead costs

In the majority of construction claims, labor cost overruns are often the predominant element of damage.

Labor Damages

A contractor may have compensable labor damages in several categories:

  1. Increased labor hours required to perform a given task of work.
  1. Loss of production efficiency/productivity as a result of:
  • Out-of-sequence work
  • Impact of changes/disruptions/delays to unchanged work
  • Adverse weather
  • Acceleration – overtime, shift work or increased crew size
  • Trade stacking
  • Restricted access
  1. Labor escalation caused by compensable delays which precluded the performance of work in a lower wage period.

The labor damages identified by Item 2 can often be considerable when project delays are sustained. After initially establishing the basis of recovery for reduced labor productivity/inefficiency, the subsequent step is the actual quantitative assessment of such labor productivity loss. Substantiation of labor productivity loss can often be predicated on a schedule analysis. Delayed project completion need not occur for a contractor to have sustained these labor loss elements.  For instance, an early delay on a project may be completely overcome by an accelerated work effort.  The end result may be timely project completion at the expense of lost labor productivity.

Acceleration

Generally, acceleration occurs when the contractor is required to adhere to the original schedule completion dates despite the existence of compensable or excusable delay. A contractor can employ several means of accelerating the work.

Numerous industry studies have been prepared to assess the impact that various acceleration methods have on craft labor productivity. Figure 1 is illustrative of the cumulative effect that overtime has on productivity.  The data is extracted from a Business Roundtable study entitled “Scheduled Overtime Effect on Construction Projects.”

Cumulative Effect of Overtime on Productivity

50 and 60 Hours Work Weeks

Overtime

Figure 1

 

In addition, acceleration may take the form of increased crew size over what the contractor may have planned to be its optimum crew. Figure 2, based on a Corps of Engineers report entitled “Modification Impact Evaluation Guide,” evaluates the effects of increasing crew size:

“The optimum crew size (for any construction operation) is the minimum number of workers required to perform the task within the allocated time frame. Optimum crew size for a project or activity represents a balance between an acceptable rate of progress and the maximum return from the labor dollars Invested.  Increasing crew size above optimum can usually produce a higher rate of progress, but at a higher unit cost.  As more workers are added to the optimum crew, each new worker will increase crew productivity less than the previously added worker. Carried to the extreme, adding more workers will contribute nothing to overall crew productivity.”

Effect of Crew Overloading on Labor Efficiency

Overmanning

Figure 2

 

A third method of acceleration is the addition of a second shift. Figure 3, based on “Shift Work Impact on Construction Labor Productivity,” illustrates the effect of increased shift work on craft labor productivity.

Effect of Shift Work on Labor Productivity

Shift

Figure 3

 

Adverse Weather

If a contractor sustains a compensable delay which forces more of this work into adverse weather conditions, the loss of labor productivity that follows will likely be recoverable. It has been clearly recognized that work performed during winter conditions will be less productive than the same work performed during the summer.

Industry studies have established criteria by which loss of labor productivity could be correlated to adverse weather. Figure 4, based on the National Electrical Contractors Association data, is illustrative of such a correlation.

Temperature Effect on Labor Productivity

Temperature

Figure 4

 

If all or a portion of a contractor’s work is delayed by the owner, the increased direct costs of labor and material resulting from the delay are compensable.

The data required to calculate and prove a claim for labor escalation include:

  • The planned labor loading schedule
  • The actual labor loading schedule
  • The wage rate in force at the time of bid
  • The actual wage rates paid over the life of the project.

On union projects, the wage rates can be obtained from union agreements. On non-union projects, the information must be obtained from the contractor’s payroll records.

The rationale on material cost escalation is essentially the same except that the contractor must demonstrate that the owner’s delay caused the contractor to make purchases at a later date and at a higher cost. Owner delay may also impact the contractor’s ability to purchase in bulk, the costs of storing, handling and insuring materials.


 

Extended Jobsite Overhead

During bid preparation, a contractor will anticipate (and price) the required jobsite overhead required for the contract duration. Such jobsite overhead normally comprises those necessary field expenses not readily allocated to individual bid items such as:

  • Salary and expenses of superintendents, field engineers, clerks, etc.
  • Temporary site facilities such as office trailers, storage trailers and temporary utilities, among other costs.
  • Tools and equipment allocable to the entire project.

If the project is accelerated, the contractor may also incur incrementally increased jobsite overhead costs during the acceleration period.

Extended Home Office Overhead

Home office overhead consists of those expenses necessary for a firm (construction or other) to do business. Without such organizational structure, the normal course of running the business would be impossible. Because of that, in certain settings, some portion of home office overhead may be recoverable.  For the purpose of definition herein, it is necessary to explain the difference between “extended overhead” versus “unabsorbed overhead.”  These terms have their origins in construction and manufacturing, respectively.

Recoverable extended overhead damages focus on those home office costs that are normally incurred after the original contract completion date but which have been caused by compensable delays occurring during the original project duration. Unabsorbed overhead costs occur during the original contract duration and are costs which the contractor fails to earn because he is precluded from performing the original base contract volume.