Both property owners and contractors should invest in a quality construction contract before work commences. This article details some of the most important provisions that are typically found in a construction contract.
Models For Determining Cost
One of the most important features of a construction contract is the way that it determines the owner’s costs. There are two primary methods for calculating a project’s cost: The “Cost Plus” method, and the “Guaranteed Maximum Price” method.
Under a “Cost Plus” contract, the owner pays the actual cost of the work, plus a fee to the contractor calculated based on a percentage of the cost. Cost Plus contracts usually require the contractor to operate on an “open book” basis, where the owner is entitled to see all invoices and statements for the project.This method is sometimes preferred by sophisticated property owners who have the resources to closely monitor a contractor’s costs for accuracy and reasonableness. The down side to this method is that an owner will not know the final cost until the project is nearing completion.
“Guaranteed Maximum Price” contracts are more common. Under a GMP contract, the contractor simply guarantees that the project will be completed for either a fixed price or that the cost will not exceed a given amount. The price includes the contractor’s overhead and profit, and likely includes a cushion of extra cost. This pricing method provides predictability because the price is certain.
A Clear Definition of The “Work”
A construction contract must clearly define the scope of work being performed by the contractor. If a contractor is building a new home, the contract might define “Work” as “all materials, labor, and supervision necessary to construct the home depicted in the Contract Documents.” The “Contract Documents” should be defined as including the relevant architectural plans, specifications, and any subsequent change orders. If architectural plans aren’t being used, then the definition of the “Work” should describe in detail the work being performed.
The Contractor’s Responsibilities
The contract should clearly list the contractor’s responsibilities. A contractor’s responsibilities usually include:
- Supervising subcontractors
- Ensuring that the quality of workmanship is as expected
- Paying subcontractors and material suppliers (once payment has been received by the owner)
- Procuring insurance to protect the project (although the owner should also provide property insurance)
- Cleaning up the project site
- Procuring appropriate permits for the work
The Owner’s Responsibilities
Property owners also have responsibilities that should be defined in the contract. Owners obligations might include:
- Payment and financing
- Warranting site conditions
- Providing site and staging access
- Providing plans
- Making selections
The owner’s obligations, and deadlines for making selections, should be well-defined in the contract.
The contract should spell out when the owner is required to make payments, and what documentation the contractor must provide before payment is due. Most construction contracts require “progress payments,” meaning that payments are made in installments as certain portions of the project are completed. Minnesota Statute 337.10, Subd. 4(a) provides that, unless the contract provides otherwise, owners are obligated to make progress payments on a monthly basis based on an estimate of the percentage of work completed. The parties to a construction contract, however, can agree to less frequent progress payments.
Some contracts provide for “retainage,” where a certain percentage of each progress payment is withheld from the contractor until the end of the project. Minnesota Statute 337.10, Subd. 4(b) provides that retainage cannot exceed five percent.
Prior to receiving a progress payment, construction contracts typically require the contractor to provide documentation evidencing the appropriate disbursement of prior payments and showing the percentage of work that has been completed. These documents often come in the form of sworn construction statements and mechanic’s lien waivers.
Most construction contracts provide for written change orders as a means of agreeing to any increased cost or extension of time resulting from agreed-upon changes to the work. Some contractors charge an administrative fee to process change orders.
Most construction contracts contain an agreement between the parties about how disputes will be resolved. The most common methods of dispute resolution are mediation, arbitration, and litigation. Mediation is a process where a neutral person (usually a lawyer) assists the parties in negotiating a resolution. Arbitration is much like going to court, but its not open to the public and a decision is made by a neutral lawyer who acts like a judge. The key benefit to arbitration is that finality is achieved sooner because, typically, parties agreeing to arbitration waive their rights to appeal. The parties should decide on which dispute resolution method is best suited to their needs.
Most contracts contain provisions concerning how, and under what circumstances, a contract can be terminated. Usually, the contract permits the owner to terminate the contractor for default. These provisions may also spell out the remedies available to the parties in the event of a termination.
Both contractors and owners should have their construction contract reviewed by a Minnesota construction attorney. From time to time, the laws governing Minnesota construction contracts change, and it’s important that construction contracts keep pace with those changes. Furthermore, a lawyer reviewing a contract before a project commences can suggest changes to avoid costly problems down the road. An ounce of prevention is well worth the pound of cure.