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General contractor agreements for construction projects contain many provisions subject to negotiation between the owner and the general contractor based on the specifics of the project and the relative negotiating power of each party. The purpose of this article is to explain the most critical clauses in general contractor agreements for construction projects. We will explain the purpose of each clause and negotiation considerations between the owner and the general contractor.
Scope of Work
The "scope of work" clause lays out the work the contractor is responsible for delivering in exchange for payment. An essential consideration in a scope of work clause is minimizing ambiguity to avoid future litigation. The primary issue in negotiations between the contractor and the owner is determining to what extent the contractor will be responsible for work that can be reasonably inferred from the architect's plans. Usually, this issue is resolved by defining reasonably "inferable work" as all work reasonably expected by other contractors exercising care, skill, and diligence in the geographical area in which the work is to be performed. For more information, read our article on What Clauses an Employer Should Include in a Contractor Agreement.
There are several standard methods used to establish a contract price:
- Lump Sum: A flat fee that does not take into consideration the actual cost of the work. This provides certainty to the owner and an opportunity for additional profit to the contractor in return for the contractor taking on additional risk if costs exceed expectations.
- Unit pricing: The parties agree to flat fees for various components of the work.
- Cost of Work Plus Contractor's Fee: The price takes into account the actual cost of work plus a fee for the contractor's labor, which can either be a flat fee or a percentage of the cost of work. In Cost of Work Plus Contractor's Fee contracts, the parties may agree to a cap on the total contract price and a bonus for the contractor if the price is below this cap.
- Time and Materials: The price equals the actual cost of materials plus an hourly rate for the labor.
Time to Complete the Project
It is crucial that the contractor and owner have an explicit agreement on the deadlines associated with the project and the consequences for the contractor failing to meet these deadlines. A contractor's failure to complete the project on time is one of the significant sources of a potential dispute between the owner and the contractor.
Typically, deadlines are set for both "substantial completion" and "final completion" of the project. Owners often want to set additional milestone completion dates for measurable portions of the work to ensure that the contractor is on track to complete the project on time. The contract should clearly define "substantial completion." Generally, "substantial completion" means that the project is fit for its intended purpose, usually occupancy.
A project may be substantially complete even when there are minor incomplete or incorrectly performed items to be corrected. These are typically called "punch list" items. Upon substantial completion, the owner, the architect, and the contractor will walk through the site to determine what remains to be completed or corrected and repaired and create a "punch list" listing these items. "Final completion" occurs when the contractor completes the items listed on the punch list. The contract will provide a deadline for the contractor to complete the punch list items after the date of substantial completion, typically 30 days.
The deadlines can be based on time periods from the date of the contract execution, or they may be based on triggering events such as the number of days from the date that the building permit is issued.
It is vital for owners to include language stating that "time is of the essence." This makes it clear that failure to meet the deadlines in the agreement constitutes a material breach of the contract, which will entitle the owner to damages.
The contract will often provide for "liquidated damages" to be paid by the contractor to the owner if the contractor fails to complete the project on time. If the contractor fails to meet its completion deadline, the owner will be entitled to damages for any financial injury resulting from the delay. However, traditional damages can be challenging to estimate and prove. This can lead to difficulty in the settlement between the owner and the contractor and subsequent litigation.
"Liquidated damages" provide a fixed dollar amount of damages for any delays. In order to be enforceable, liquidated damages must be a reasonable estimate of the actual damages that the owner would suffer due to a delay and cannot be intended to be a penalty to the contractor. Liquidated damages can be a lump sum, but they typically accumulate based on the length of the delay. The parties may agree to a cap at which the damages stop accumulating, usually limited to the amount of the contractor's fee over-and-above materials.
The parties may also agree to a bonus to the contractor for early completion.
Allowances are amounts set aside as part of the contract price for work that requires further plans or specifications from the owner. If the actual cost of the item is less than the agreed-upon allowance, the owner will usually get a credit for the difference. If the cost is more than the allowance, the contractor will typically be paid the difference over-and-above the contract price. In order to avoid disputes, it is essential that the contract be specific as to what is covered by the allowance and what materials or labor are instead factored into the rest of the contract price.
Usually, materials will be part of the allowance, but labor or the contractor's profit will not be part of the allowance and will be baked into the rest of the contract price. If the actual cost of the material is different from the amount of the allowance, the contract should require that the contractor submit a written change order to the owner in order to keep a clean record of the difference between the original contract price with allowances included and the credits or payments to the owner or contractor after the allowances have been resolved.
Schedule of Values and Contingencies
General contract agreements usually require the contractor to prepare a "schedule of values" that breaks down the total price of the contract and assigns values to various parts of the work in order to determine how periodic payments will be made to the contractor. The schedule of values will often contain a "contingency" amount that is part of the overall contract price that can be used by the contractor to cover unforeseen issues that arise in the construction. Which party will control how the contingency amount is spent is a negotiating point.
Typically, the more considerable the contingency amount relative to the total contract price, the more leverage the owner will have in negotiating for control over how the contingencies are used. Because the owner will usually get any unused portion of the contingency amount back at the completion of the project, the owner typically wants to prevent the contractor from using the contingency to cover the contractor's mistakes or other items that could have been anticipated by the contractor. The contractor, on the other hand, will want to control the contingency in order to protect itself from the risk of genuinely unanticipated conditions or issues that add cost to the project.
Timing of Payments
The owner and contractor will usually agree that periodic progress payments be made to the contractor based on the completion of the work shown on the schedule of values. The contractor will submit an application for payment to the owner, after which the architect will walk through the site with the contractor, review the contractor's work, and agree to any adjustments to the payment application.
The payment application usually includes the contractor's sworn statement identifying any subcontractors who worked on the project, as well as lien waivers from both the general contractor and any subcontractors used for the work in question. The parties will agree in the general contractor agreement as to who will review the payment application (e.g., the architect, the lender, the owner) and the standard upon which the application can be accepted or rejected.
However, the parties may agree that, instead of progress payments, the contractor's entire fee will be paid upon final completion or substantial completion of the project or that the owner will make a down payment before work begins and pay the balance upon completion.
The primary issue for negotiation is what percentage of the payments will be retained by the owner (called a "retainage") until final completion in order to safeguard timely and competent completion of the project. Owners will typically want to withhold the payment of some or all of the retainage until all of the contractor's obligations under the contract have been completed. Some owners may negotiate to withhold the retainage until the contractor's warranty period has passed to ensure that the contractor meets any obligations to correct defects found in work after completion.
In the course of the construction project, owners will often want to make changes to the project specifications. A change order is a written agreement between the contractor and the owner to adjust the contract price or the completion deadlines based on these changes. The contract should set forth a process for the contractor to submit a change order and for the owner to approve it. The contract should also establish how the contractor will charge the owner for any changes. The contractor's fee for changes is typically a percentage of the cost of materials.
It is crucial to establish the contractor's fees for changes at the outset because once the contractor has begun work, the leverage for negotiation of the contractor's fees shifts to the contractor. The contract should also address what happens when a "cardinal change" occurs, meaning that the changes to the original work are so numerous or fundamental that the project becomes substantially different from the project agreed upon in the contract. Disputes tend to arise when the contract is ambiguous as to whether the work requested in a particular change order falls within the scope of the original contract or whether it requires additional payment to the contractor.
Payment Bonds and Performance Bonds
Sometimes the owner will require the contractor to provide payment bonds or performance bonds. A payment bond is issued by an insurance company to insure against the contractor failing to pay its subcontractors. It prevents owners from having to pay both the contractor and the subcontractor for the same work. A performance bond ensures against the contractor's failure or inability to complete the project and will pay for another contractor to finish the project if the original contractor fails to do so.