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Contents
Acknowledgments
About the Author
Preface
Disclaimer
Introduction
The Goals of This Book
What Are the Benefits of This Book?
Contractor & Owner Conventions
Private Contracts or Government Contracts?
Key Contracting Concepts
Two Types of Commercial Terms & Conditions
The Most Important Commercial Terms & Conditions
The Contracting Process
Excuses for Not Negotiating Better Commercial
Terms & Conditions
The Concept of Risk Transfer
This Is a Book Developed Just for Contractors
Three Final Suggestions
Chapter 1: Contracts: Basic Training
What Is a Contract?
The Steps to a Contract
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1
1
1
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2
Coming to the Party?
The Starting Point
3
“Here’s My Proposal”
4
“Consideration,” or Something of Value
5
The “Happy Test”
5
“Can That Person Sign This Contract?”
6
Call in the Enforcer to Close the Breach!
6
A Contract Example
8
Strange Words & Long Paragraphs
10
11
Contracting Myths
Contract Negotiations
12
Chapter 2: Types & Forms of Contracts
15
Fixed Price & Fixed Schedule Contracts
16
Reimbursable Type Contracts
16
18
Combined Fixed Price & Reimbursable Contracts
20
Cost Plus Fee Contracts
Guaranteed Maximum Price Contracts
21
Target Price Contracts
21
22
Contracts with Performance Incentives
Form of Contracts
23
30
Some Final Contract Housekeeping—­Definitions
Conclusion32
Chapter 3: Scope of Work
33
37
The Scope of Work Matrix
Scoping Drawings
39
Conclusion40
Chapter 4: Terms of Payment & Cash Flow
41
Cash Flow
42
44
Interest Rates
Periodic Progress & Milestone Payments
45
Conclusion59
Chapter 5: The Schedule
61
Float62
Time Is of the Essence
64
Extra Time, but No Money
66
Conclusion68
Chapter 6: Assurances of Performance
69
Guaranties & Bonds
70
What Does “Failure to Perform” Mean?
72
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72
What Is a Bond?
Forms of Assurances of Performance
73
Surety Companies
78
Some Language Considerations on Guaranties & Bonds
82
Types of Performance Assurances
82
Conclusion101
Chapter 7: Insurance
103
What Is Insurance?
104
Claims Made vs. Occurrence
105
Types of Insurance
106
Important Issues Associated with Insurance
112
120
Additional Insured Status
Additional Insurance Basics
121
A Typical Insurance Clause in a Construction Contract
134
Safety140
Chapter 8: Indemnity
141
142
Insurance & Indemnity
Indemnity Definitions
142
143
Transferring the Owner’s Risks to Contractors
Fairness Is Not a Consideration
143
Is an Indemnity Required in a Construction Contract?
144
144
Anti-­Indemnity Legislation
Examples of Indemnification Clauses
150
Indemnification, Additional Insured Status, &
Contractual Liability Insurance
157
Owners Love CLAIMS!
161
Negotiating Indemnity Clauses
162
Knock-­for-­Knock Indemnities
165
Conclusion166
Chapter 9: Changes
169
Some Ground Rules
170
Protecting the Project Manager
170
Owners’ Directives
171
Constructive Changes
171
Payment for Changes
172
Sample Change Clauses
172
Major Contract Changes
178
Negotiating Change Clauses
179
Conclusion180
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183
Chapter 10: Disputes & Their Resolution
What’s a Project Manager to Do? A Short Story to Start With
183
Disputes—­The Construction Contract’s Bad Actor
184
An Ounce of Prevention
186
Dispute Resolution Options
186
The Folks who Negotiate, Mediate, Arbitrate, & Litigate
188
Dispute Resolution Clauses
189
Conclusion192
Chapter 11: Damages
193
194
Breach of Contract/Failure to Perform
Contractors’ Financial Exposure
194
Actual Damages—­A Silent Risk?
194
Liquidated Damages
196
Consequential Damages
204
Conclusion206
207
Chapter 12: Warranties
A Workable Definition of Warranty
207
Warranty Issues
208
214
The Uniform Commercial Code
When Is No Warranty Appropriate?
217
219
Extended Duration Warranties
Limiting Provisions in Warranties
221
Pass-­Through Warranties
221
222
Latent Defects & Warranty
A Sample Warranty
224
Conclusion224
Chapter 13: Termination & Suspension
227
Termination for Cause
228
229
Termination for Convenience
Suspension232
Cancellation236
Conclusion236
Chapter 14: Force Majeure
239
Negotiating Clauses
239
Sample Contract Language
240
Conclusion244
Chapter 15: Other Contract Clauses
245
Site Conditions
246
Use of Completed Portions of the Work
251
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252
Patent Indemnity
Secrecy & Confidentiality Clauses & Agreements
253
Owner’s Right to Inspect
254
Independent Contractors
257
Assignment258
Acceptance & the Punch List
260
Advance & Partial Waiver of Liens
262
265
Final Waiver of Liens
Audit Rights
268
Severability or Validity Clauses
269
269
Venue & Applicable Law
Florida Civil Code Chapter 47 Venue
270
Texas Business & Commercial Code
Annotated §272.001
271
Venue and Choice of Law State Statutes
271
271
Contractual Rendition?
272
Changes in the Law
Some Interesting Clauses to Close
273
Chapter 16: A Construction Contractor’s
Contract Checklist
275
Chapter 17: International Contracting
283
284
International Contracts
The U.S. Foreign Corrupt Practices Act
285
286
Letters of Credit
Split Contracts: Onshore & Offshore Contracts
288
289
Political, Religious, & Economic Risks
Overseas Private Investment Corporation (OPIC)
290
Legal Systems in Foreign Countries
290
Local Employees, Partners, & Agents
291
Offshore Companies
292
Currency Risks
293
Applicable Law
297
Joint Ventures
299
Joint Operations
299
Import & Export Considerations
300
Understanding INCOTERMS
302
The Export‐­Import Bank of the United States
305
Where to Get Some Help—­Ask the U.S. Government
306
Lastly, Use the Right Paper Size!
307
Conclusion307
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Chapter 18: What’s It Take to Do Business
in Southeast Asia?
Patience Is Golden
Walk the Talk
Time and Money
The US Foreign Corrupt Practices Act
Center for Strategic and International Studies
Trans Pacific Partnership (TPP)
Backdoor to China and India
SPECIAL SECTION—­The Socialist Republic
of Vietnam (Vietnam)
Resources for Business in Southeast Asia
Chapter 19: Some Final Thoughts on Negotiating Contracts
Why Negotiate?
The Concept of Standard Terms & Conditions
Risk Transfer Item 1: Get Rid of the Indemnity Clause!
Risk Transfer Item 2: Don’t Provide Additional
Insured Status
Risk Transfer Clauses, Insurance, & Safety
How to Say No without Aggravating the Owner
The Worst Contracting Word: “Reasonable”
The Best Contracting Word: “Notwith- standing”
Win-­Win & Lose-­Lose in Contract
Negotiations—­Fairy Tales?
Is There a Price for Bad Commercial Terms & Conditions?
Terms of Payment
Some Tips on Successful Negotiating
Three First (and Final) Suggestions
Resources
Glossary
Index
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310
310
311
312
313
314
314
316
317
319
320
320
322
323
323
324
324
325
326
327
327
328
328
329
333
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Acknowledgments
I am grateful to the following people who, by sharing their long-­term
experience in working with construction contracts, added
significantly to this book.
John T. (J.T.) Wodarski and Joseph J. Newman Jr., each of whom has
over 30 years of valuable experience in negotiating commercial terms
and conditions of engineering and construction contracts, provided
many suggestions for improvements in how the issues were covered
in this book. Neither of these two friends (and tough negotiators)
hesitated to challenge me to clarify or expand on some of the
contracting and negotiating guidance I drafted. The results were
significant improvements to the content of the book.
Robert W. Wolfe Esq. has negotiated and reviewed many large and
small domestic and international engineering and construction
contracts from a legal standpoint for more than 25 years. He kept me
straight on the many legal fine points associated with the riskiest
commercial terms and conditions found in contracts. He is the most
practical and effective lawyer I have ever had the opportunity to deal
with in the engineering and construction business.
Bruce Wilkinson Esq. has been working with a wide variety of
contracts for over 35 years. He provided many insightful and useful
comments and suggestions on construction contract commercial
terms and conditions.
Gwen A. Schroder and Ed Jacobs shared their extensive knowledge of
the insurance industry to help guide me through the technical issues
associated with insurance for construction projects.
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And my wife, Marilyn, a former teacher, reviewed every word in the
book at least twice and made every effort to ensure my spelling and
grammar were generally correct. While she did an excellent job, she
told me she never again wants to read anything about indemnities.
Amen.
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About the Author
Kit Werremeyer is the owner and president of Southernstar
Consultants LLC, of Valrico, Florida, a company that provides
training in the understanding and negotiating of construction
contracts. The company also offers a broad range of other
professional services to United States and international engineering
and construction companies.
Mr. Werremeyer’s experience includes more than 30 years of sales,
contracting, claims settlement, dispute resolution, and EPC project
development, including work for a broad range of major U.S. and
international companies, such as Bechtel; Kellogg, Brown & Root
(KBR); Fluor; J.A. Jones; Black & Veatch; DuPont; Shell Oil; Caltex;
Exxon/Mobil; BP/Amoco/ARCO; Air Products and Chemicals; Koch
Industries; Florida Power and Light; Chiyoda Corporation (Japan);
Japan Gasoline Corp.; Mitsui (Japan); Mitsubishi Heavy Industries
(Japan); Petronas (Malaysia); Thai Oil Company; Pertamina
(Indonesia); SINOPEC (Peoples Republic of China); Voest-­Alpine
(Austria); Daelim (Korea); and Hyundai (Korea).
Among prior positions, Mr. Werremeyer served as vice president and
area director of sales and marketing in Asia for Chicago Bridge &
Iron Company, an international engineering and construction
company. This position included responsibility for contracting and
the general management of area subsidiaries.
He is a graduate of the University of Illinois at Urbana-­Champaign,
Illinois, with a master’s degree in mechanical engineering.
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Preface
In 1977, I entered a year-­long sales training course presented by my
company, Chicago Bridge & Iron Company (CBI), an international
engineering, procurement, and construction contractor founded in
1889. CBI believed that all of its salespeople must have a strong
foundation in understanding, evaluating, and negotiating the
commercial terms and conditions typically found in engineering and
construction contracts. Specifically, the course was to prepare its
future salespeople to provide clients with “one-­stop shopping.” This
meant being able to work out all the technical and constructability
details of the contract with the client, and then negotiating
appropriate commercial terms and conditions without necessarily
having to go back to CBI’s legal department for advice.
This extra capability—­evaluating and negotiating commercial terms
and conditions for construction contracts—­was designed to give us a
clear edge over our competitors. We could work closely with the
client on all aspects of the project—­both technical and commercial—­
and then close the deal commercially without ever leaving his side or
making an outside telephone call.
The sales training program included a lot of classroom time on such
seemingly routine contractual considerations as terms of payment,
scope of work, schedule, claims and disputes, termination and
suspension, and warranties.
It also introduced us neophyte contractors to such new and
mysterious contractual terms as indemnity, additional insured status,
force majeure, advance waivers of rights, specialty insurance
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coverage, and assurances of performance. The instructors told us
horror stories about the financial consequences that arose out of
accepting a client’s risky commercial terms and conditions for
engineering and construction contracts.
This training course set the path of my career as, for the next
25 years, I worked in several different sales offices located on the
East Coast and the Midwest of the U.S. and for 13 of those 25 years,
in Southeast Asia. I participated in and/or managed the negotiations
of the commercial terms and conditions for hundreds of engineering
and construction contracts ranging in value from small $50,000
repair projects, to major engineering, procurement, and construction
(EPC) projects worth over $100 million. Clients ranged from small
owners to major international oil, gas, chemical, and petrochemical
clients, and major domestic and international EPC contractors from
the U.S., Europe, and Asia.
There were a huge variety and complexity of commercial terms and
conditions in all these contracts over those 25 years. Every owner or
EPC contractor had their own favorite idea of what constituted
acceptable commercial terms and conditions. Negotiating acceptable
terms and conditions for CBI projects was always a challenge;
nothing ever was the same. On a few occasions, the client’s
commercial terms and conditions were so one-­sided and
unacceptable, and the client was so reluctant to change them, that the
only thing left to do was close the file and walk out the door. It was
time to let some other poor contractor suffer with those lousy
commercial terms and associated risks.
When I retired in 2001 after 32 years with CBI to form my own
company, I looked back at all the diverse practical negotiating
experience I had with engineering and construction contracts in the
U.S. and internationally and felt it was important to write a practical,
user-­friendly, and non-­legalistic book about this subject. It is my hope
that my own experience will help contractors, regardless of the size or
sophistication of their companies, to negotiate better and less risky
commercial terms and conditions for construction contracts—­and
thereby better protect their assets.
I hope that contractors can learn something from this book and use it
as a practical desk reference. If by reading this book, they learn
nothing more than to be able to better identify, understand, and
evaluate risky commercial terms and conditions, and then negotiate
or otherwise seek help to resolve them, I have succeeded.
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Disclaimer
During the course of writing this book, I was reminded on several
occasions by my good friends and excellent reviewers that I needed to
include a written disclaimer regarding the reader’s use of the
contracting and negotiating guidance provided—­as it is impossible to
anticipate all the circumstances that may arise in a construction
contract. I have tried my best to provide what, in my experience and
opinion, is practical information gained from my over 30 years in the
engineering and construction business. My hope is that this book will
help contractors and subcontractors understand, evaluate, and
favorably negotiate construction and construction-­related contracts
and thereby help protect their assets.
I do not provide any express or implied warranty on the use of any of
the information contained in this book as it may be applied to
understanding, evaluating, and negotiating construction contracts.
Readers should consult, as needed, with professionals on their
particular contracts and circumstances.
– Kit Werremeyer
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Introduction
There is no price for bad terms.
~ Construction contractor from Toledo, Ohio
The Goals
of This Book
This book was written with three important goals in mind:
1. Assisting contractors in improving their abilities to identify,
understand, and evaluate certain high-­risk commercial terms
and conditions typically found in all construction contracts.
2. Providing contractors with negotiating suggestions on how to
lower or eliminate the risk associated with commercial terms
and conditions.
3. Providing straightforward information in as uncomplicated and
non-­legalistic a manner as possible.
The book will help contractors in their effort to negotiate favorable
commercial terms and conditions for their construction contracts. By
doing so, this will help lower their commercial risk; assist in
improving their terms of payment; and reduce their exposure to
claims, disputes, and unnecessary or inappropriate risk transfer and
its associated potential financial liability.
What Are
the Benefits
of This Book?
Contractors must be able to identify, understand, and evaluate all the
commercial risks that are accepted by agreeing to an owner’s
proposed contract. They must then be able to effectively minimize
and manage those commercial risks—­mitigating or eliminating them
through negotiations—­and thereby lessen their exposure to any
potential financial liabilities. This will ultimately protect the assets of
their companies. This is the primary benefit of this book.
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Contractor &
Owner
Conventions
This book refers to contractors and owners—­both in the general
sense, and capitalized in actual sample contract clauses. “The
contractor” refers to you, the reader of this book—­whether general
contractor or subcontractor—­working hard in the construction
business trying to make a living. “The owner” refers to the company
that the contractor is providing construction work for, and with whom
he will sign a construction contract. (Note that throughout this
book, the masculine singular “he” is used, for simplicity only, and
to avoid the more cumbersome “he/she”/“his/her” construction.)
Also for simplicity, the book refers to the construction contract
between the owner and contractor. Often, however, the contractor
will have a contract with another construction company who works
for the owner, perhaps in the role of the owner’s project manager, or
the owner’s main contractor. In this case, the contractor would
typically be considered a subcontractor, and his construction contract
would likely be called a subcontract with the owner’s project manager
or main contractor. It doesn’t matter whether the contract is made
directly with the owner, or whether it’s a subcontract with the owner’s
PM or main contractor—­the information contained in this book
about understanding and negotiating construction contracts applies
equally to all of these contracting relationships.
Private
Contracts or
Government
Contracts?
The contracting concepts presented in this book apply to contractors
working with private U.S. owners, and not federal or state government
owners. Construction contracts with U.S. federal, state, and local
governments may have different commercial contracting challenges.
Sometimes, for instance, government contracts are, by law,
nonnegotiable with respect to the types of commercial terms and
conditions a contractor must accept. However, the concepts and
suggestions in this book can be used to help better understand and
manage similar commercial issues in government construction
contracts, and can assist the contractor, particularly in those situations
where negotiation is an acceptable part of the government’s contracting
process. In Chapter 16, “International Contracting,” the additional
concepts presented also apply to contracts between a private
contractor and a private owner. Contracting with foreign governments
and their various departments often presents exceptional contracting
challenges that are beyond the scope of this book.
Key Contracting
Concepts
Throughout this book, two key contracting issues with construction
contracts are discussed:
• Commercial Risk: The risk associated with the potential for the
contractor to be harmed in some way by accepting the wording
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in an owner’s construction contract’s commercial terms and
conditions.
• Potential Financial Liability: The possibility of having to pay
money, which would arise from the obligations that a contractor
agrees to accept in the owner’s construction contract’s
commercial terms and conditions, and that might arise also from
the contractor’s common law obligations. Common law is the
body of law that develops out of decisions made by courts—­
called precedence—­rather than law that is created by statute.
Examples of Commercial Risk
Commercial risk creates an exposure to the potential for financial
liability and flows directly from the commercial terms and conditions
contained in the owner’s construction contract. Commercial risk is
probably the risk a contractor finds most difficult to understand and
manage. Some typical examples of a contractor’s exposure to
commercial risk found in a construction contract’s commercial terms
and conditions are:
• Exposure to the financial liability to pay liquidated damages or
other consequences of contractor’s late performance.
• Exposure to the financial liability to pay for damages that are
caused by the owner’s negligence.
• Not being paid for legitimate changes for additional work.
• Not being able to settle legitimate disputes in favor of the
contractor.
• Exposure to an owner cashing in a contractor’s performance or
payment bond without legitimate reasons.
• Exposure to the financial consequences—­not enough cash to pay
bills—­of not being paid by the owner on time for progress
payments.
• Exposure to the financial liability that may arise out of lengthy
warranty periods or requests by an owner to perform warranty
work that is really not warranty work.
• Exposure to the financial liability that may arise out of other
risks encountered on a construction project, such as differing
site conditions and force majeure.
Two Types
of Commercial
Terms &
Conditions
The commercial terms and conditions typically found in a
construction contract can be split generally into two categories:
• Administrative terms
• Financial liability terms
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Administrative terms are those commercial terms and conditions
that have a low probability of creating a significant financial
liability for the contractor. Financial liability terms have a high
probability of doing so. The focus of this book is to improve the
contractor’s ability to understand and evaluate these financial
liability terms and conditions and learn ways to lower or eliminate
the commercial risk associated with them through effective
negotiations.
A typical construction contract can be divided between
administrative and financial liability terms as shown in Figure 1.
This book will discuss only those commercial terms and conditions
that tend to create a high probability of financial liability for the
contractor. This doesn’t mean, however, that other terms and
conditions should be ignored or taken lightly. It just means that if the
contractor has to focus his effort primarily on one of these sets of
commercial terms, it should be on the commercial terms that have
the greatest potential for harm.
Figure 1: Types of Contract Terms
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The Most
Important
Commercial
Terms &
Conditions
The Contracting
Process
The three most important commercial terms and conditions
contained in all construction contracts are:
1. Scope of work
2. Pricing and terms of payment
3. Schedule
These commercial terms are the three foundation stones of all
contracts, as shown in Figure 2.
Here’s a bold statement: There is no difference between a
construction contract for a new one-­story office building worth
$500,000 and a new grassroots oil refinery worth $1 billion. Think
about this for moment. The contractor for each project must have a
written construction contract to perform the work described. Each
contract will have a scope of work section, terms of payment, and a
schedule. Further, each contract will likely have contractual
obligations for insurance, warranty, changes, dispute resolution,
termination and suspension, damages, indemnity, and assurances of
performance.
Certainly, the complexities of the two projects are significantly
different, but the contracting process of understanding and
negotiating commercial risk issues and potential financial liability
issues are the same, and must be properly dealt with by each
contractor in order to protect the assets of their companies.
Excuses for Not
Negotiating
Better
Commercial
Terms &
Conditions
What are the typical excuses given by contractors when faced with
the prospect of having to try to negotiate better commercial terms
and conditions in the owner’s construction contract? Some of the
most common:
• “It’s too hard to deal with the owner and his lawyers.”
• “The owner will disqualify me if I take exception to his terms
and conditions.”
Figure 2: Three Foundation Stones of a Contract
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• “I don’t understand the terms and conditions well enough to
negotiate better ones, and I don’t want to hire a contracts expert
or a lawyer.”
• “The competition accepts the owner’s terms and conditions all
the time, so I don’t have much of a chance.”
• “I don’t like to negotiate. Maybe the best thing to do is just sign
the contract, put it in the bottom drawer of the desk, and hope
nothing happens.”
The last excuse basically says this: “sign, do nothing, and pray for the
best.” This strategy works fine as long as nothing goes wrong during
the execution of the contract. However, things often do go wrong
during the course of executing construction contracts!
Let’s say the owner creates lengthy delays to the construction schedule,
refuses to acknowledge his fault, then penalizes the contractor by
imposing liquidated damages for late performance. Once something
like this happens to a contractor just once in his lifetime, he will wish
he had made the effort to negotiate more favorable commercial terms
and conditions prior to signing the contract.
One good reason to negotiate changes to the owner’s commercial
terms and conditions is simply to improve the contract for the benefit
of the contractor, and to lower the contractor’s exposure to potential
financial liability at the same time.
For example, creating a detailed scope of work document that carefully
outlines what the contractor, owner, and all other parties involved in the
contract are obligated to do will always serve to minimize
misunderstandings and disputes over the scope of work. Often the
contractor has the best experience and background to assist the owner
with developing a detailed and comprehensive scope of work document.
The Concept
of Risk Transfer
Another contracting concept that will be discussed throughout the
book is the concept of risk transfer. Commercial terms and conditions,
such as those associated with insurance and indemnity clauses,
transfer the risk of potential financial liability for certain events from
one organization to another. Insurance transfers the risk of certain
potential financial liabilities from the contractor—­the named
insured—­to the insurance company in return for the payment of a
premium. An indemnity clause in a construction contract can transfer
to the contractor the risk of certain potential financial liabilities that
may arise due to the negligence of the owner—­in return for nothing!
Contractors must understand the consequences of accepting risk
transfer clauses in a construction contract. Negotiating changes to
risk transfer clauses can significantly lower exposure to the possibility
of unnecessary or unwarranted financial loss.
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This Is a Book
Developed Just
for Contractors
Before the contractor
signs the contract, he
needs to understand
the commercial
risks and their
possible financial
consequences. The
contractor’s assets
are at stake.
This book is not
designed to be antilawyer or anti-owner.
It is designed to be
pro-contractor.
Every attempt has been made to write this book in as non-legalistic a
manner as possible. It was written for those contractors who have no
legal training in contract law and are simply in business to engineer,
procure, and safely build construction projects.
Anyone who is willing to take the time to understand the basic
concepts of construction contracting can become effective in
understanding, evaluating, and managing commercial risk and
negotiating more favorable commercial terms and conditions. Can a
lawyer who specializes in construction contracting help a contractor
understand and negotiate a construction contract? Certainly he can,
but that assistance, and cost, is not always necessary.
The book features samples of actual contract language—both the good
and the bad, the fair and the unfair. Each chapter contains these easyto-understand clauses, in boxes for quick reference, which show
contractors the kind of language that should be used, as well as jargon
and unreasonable terms that should be avoided. Having a good
working knowledge of the major commercial issues involved in
construction contracting will help a contractor understand what he is
getting into, the risks he is taking, and the risks he doesn’t want to take.
Is the contractor agreeing to a fair contract, or taking on a lot of
unnecessary responsibilities and commercial risks? Will he get paid
on time? These are the types of questions a contractor will be able to
answer and resolve after reading this book—before signing a
construction contract.
It may appear when reading through this book that owners are cast in
a bad light, and that all too often they demand unacceptable
commercial terms and conditions. This is not true. Some progressive
owners have, or will negotiate, commercial terms and conditions that
are fair and balanced for both parties—the owner and the contractor.
The contractual issues covered in this book are meant to raise the
awareness of contractors to worst-case situations that can arise from
accepting certain commercial terms and conditions in a construction
contract—and how to edit and reword unfair clauses.
Three Final
Suggestions
Finally, contractors should remember these three important things:
1. Read and understand everything in the construction contract.
2. Negotiate better commercial terms and conditions with the goal
of reducing commercial risk and the associated exposure to
potential financial liability.
3. Get all agreements in writing from an authorized representative
of the owner!
xxvii
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Chapter
1
What Is a
Contract?
The Steps to a
Contract
Contracts:
Basic Training
This isn’t a trick question, and it doesn’t have a complicated
answer. For the purposes of this book, the following definition will
be used:
A contract is a written agreement that clearly defines the
responsibilities and obligations of each included party, is legally
enforceable, and is dated and signed by an authorized representative
of each party.
A contract may also be called an agreement. The term contract will
be used throughout the book.
1. Receive an inquiry or request for proposal (RFP) from the
owner.
2. Prepare a proposal for the work and submit it to the owner.
3. Negotiate all the details of the contract with the owner.
4. Sign the contract.
Understanding and Negotiating Construction Contracts: A Contractor’s and Subcontractor’s Guide to
Protecting Company Assets, Second Edition. Kit Werremeyer.
© 2023 John Wiley & Sons, Inc. Published 2023 by John Wiley & Sons, Inc.
1
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It doesn’t appear to be too complicated, does it? However, there are
hundreds of issues—­small and large—­to consider and things to do
during the process of responding to an owner’s RFP. The contractor
must:
• Review and analyze all the written bid documents, including any
attached plans, drawings, and specifications.
• Resolve questions about the scope of work.
• Visit the site.
• Assess the physical and commercial risks.
• Select subcontractors and suppliers.
• Prepare an estimate and proposal.
• Review and comment on the commercial terms and conditions.
• Sort out insurance details.
• Negotiate improvements to the contract.
This chapter covers the basic concepts of contracting and explains
some of the terminology contractors most often encounter.
Coming to
the Party?
So who is a party to a contract? In almost all construction
contracts, there will be at least two parties. One is the contractor
(who is going to build something), and the other is the owner (who
has a need for what is being built). If the owner hires a project
manager to manage all the contractors on the project, then the
owner’s project manager would also be considered a party to the
contract.
All persons or organizations that have not signed the contract are
called third parties.
Some typical third parties a contractor might see at or near the
project job site are:
1. The owner of the commercial property and buildings adjacent to
the project site.
2. An OHSA safety inspector making a visit to the job site.
3. Another contractor, his subcontractors, and their personnel who
are also working for the owner on the project site.
4. Subcontractors working for the contractor who are not signatory
to the contract with the owner.
5. Local private homeowners or small business owners and tenants
adjacent to the site.
6. Environmental protection groups.
7. The general public, who may wander onto the job site.
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The Risk Associated with Third Parties
What’s all the fuss over this business of third parties? The actions of
these people or organizations can create serious commercial risks
and potential financial liability for both the contractor and owner.
Contractors must manage a multitude of job site safety issues in order
to avoid employees’ injuries.
Damage to a third party’s adjacent property or injury to a third-­party
individual, such as a member of the general public, exposes both the
owner and the contractor to lawsuits, legitimate or otherwise, that
could financially ruin either or both of them.
Much of the concept of commercial risk transfer involves
transferring risk from the owner to the contractor. Risk includes
potential financial liability associated with damage to property
belonging to third parties and injury to or death of third-­party
individuals, regardless of any contributing fault or negligence of the
owner. This transfer of risk is accomplished mainly by the use of
indemnity and additional insured clauses. (These topics are covered
in detail in Chapters 7 and 8 of this book.) So although the contract is
between the contractor and the owner, the contractor has to
recognize that individuals or organizations not associated directly
with the contract—­third parties—­may have an impact on the contract
risk.
The Starting
Point
The starting point for a construction contract is when an individual
or company decides to construct a new facility to meet its needs.
An Example
Wilson Properties conducts a search of local building contractors
and finds several that are qualified, including National
Construction Company.
Wilson Properties prepares a written inquiry, or as it is commonly
called, a Request for Proposal (RFP), and sends it out to several
contractors for competitive bids. The RFP would typically include:
• A description of the scope of work
• Some idea of a schedule
• The plans and specifications prepared by a design team and
approved by the building department
• Applicable codes and standards
• Commercial terms and conditions the owner expects the
contractor to accept
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The RFP might also require the contractor to indicate in writing
whether he will provide a proposal for the work by the time specified
in the inquiry, or whether he will decline to bid.
“Here’s My
Proposal”
The written proposal, such as prepared by National Construction
Company, to perform the work is called an offer and is the first half
of the contracting concept of offer and acceptance. The offer will
include the contractor’s price and schedule to perform the work and
may contain responses to information requested by the owner’s
inquiry. It may also address specific work scope and commercial
clarifications, as well as any other concerns of the contractor.
An Example
Offer and acceptance
is the technical term
used to test whether
a contract has been
arrived at or not. A
more workable and
practical definition
of the offer and
acceptance process
is successful contract
negotiations.
4
National Construction Company may propose a different
completion schedule than required by Wilson Properties’ RFP
documents, technical substitutions, or other cost- or time-saving
alternatives. National Construction Company may also propose
changes to the commercial terms and conditions that were included
in the Wilson Properties’ RFP documents.
“And I accept, but. . .”
Wilson Properties receives the proposal (offer) to perform the work
from National Construction Company, reviews it for general
compliance with the RFP, and decides that it is a good offer and that
they would like to award the project to National Construction
Company.
However, Wilson Properties has some issues with the schedule, the
price, and the clarifications to the commercial terms and
conditions proposed by National Construction Company. Wilson
Properties has National Construction Company come to their
office to negotiate and tells them, “We would like to accept your
offer, but. . .” The two companies then proceed to negotiate a
mutually agreed-on schedule, price, and set of commercial terms
and conditions.
The acceptance of the offer in this instance is actually a process.
Wilson Properties and National Construction Company negotiate
back and forth until they reach a mutually-agreeable deal. The
final offer is defined through the negotiations, and both parties say,
“Okay, we agree. We have a deal.” This back and forth negotiation is
the contract negotiation process.
All of the negotiated changes to Wilson Properties’ original RFP are
documented in writing. The best way to do this is to make the
appropriate changes in the body of the signed contract. An alternate
way is to document all the changes in a separate letter signed by
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both parties noting that the changes agreed on supersede and take
precedence over the contract and any similar or conflicting
provisions.
Wilson Properties then advises National Construction Company in
writing that they have been awarded the project, referencing the
original RFP and the letter documenting all the negotiated changes
to the RFP.
This written notification by Wilson Properties signifies their
acceptance of National Construction Company’s offer, as was
revised and agreed on through the two companies’ negotiations.
These are the first two key steps taken in the process of arriving at a
contract: offer and acceptance.
“Consideration,”
or Something of
Value
Each party to the contract must receive something of value in order
for the contract to be legally enforceable. In the previous example, the
contract calls for Wilson Properties to receive a new office building
that will be built in accordance with the RFP—­and the changes to the
RFP mutually agreed to in writing by both parties. The finished
building that Wilson Properties will receive is referred to as
something of value.
National Construction Company receives the agreed-­on contract
price to construct the building for Wilson Properties. The money—­
contract price—­that National Construction Company receives is also
considered something of value. Both parties to the contract receive
something of value, also known as consideration.
The “Happy
Test”
Both parties must mutually and freely agree to all the conditions
spelled out in the contract. In order for the contract to be legally
enforceable, neither party can use coercion to get the other party to
sign. A contract cannot obligate one party or the other to do
something illegal. An illegal obligation would cause the contract to be
unenforceable.
For example, if one party to a contract brings in a group of armed
thugs and says to the other party, “sign, or else,” then that clearly is
coercion, and the resulting contract would not be legally enforceable.
This is an extreme example, but it makes the point.
If the written conditions in the contract require one of the parties to
have the responsibility of periodically bribing the local customs
official (an illegal act) in order to have him under-­apply import
duties, then the contract would not be enforceable. There can be
nothing in a contract that requires one party or the other to do
something illegal. The best advice is: when in doubt, don’t agree
to do it.
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“Can That
Person Sign
This Contract?”
There are two issues here: the first one involves the competency of
the person signing the contract, and the second one involves whether
that person has the authority to sign. Both parties signing the
contract must be competent. If the person signing the contract is
under the influence of drugs or alcohol, or has a serious mental
incapacity, then that person probably does not have the competency
to sign the contract. The contract would likely be legally
unenforceable. A more common concern is whether the person
signing the contract for one of the parties has the authority to do so.
An Example
A contract may be
unenforceable if it is
signed by someone
who does not have
the proper authority
to commit the party
he represents to the
requirements in the
contract.
A young employee of the owner who has just graduated from college is
getting ready to sign a high-value EPC contract on behalf of the owner
for a major expansion to a complex petrochemical plant. The contractor
for the expansion questions the young person’s authority to sign the
contract. The contractor is accustomed to having much more senior
representatives of the owner sign contracts for such major projects.
In a situation like this, the contractor might request that the
proposed signer of the contract produce a power of attorney
document from the company president, or some other senior officer,
granting specific authority to sign the contract. This is a simple
solution to resolving the issue of proper authority.
It’s not too unusual for the owner’s RFP to require the contractor to
have an officer of the company sign the contract. If someone other
than an officer of the contractor’s company plans to sign the contract,
then he must present to the owner an appropriate power of attorney
document giving the signer the authority to sign contracts and
commit the resources of the contractor.
Call in the
Enforcer to
Close the
Breach!
What does the term legally enforceable mean? A legally enforceable
contract exists when:
1. A written contract has been negotiated (offered and accepted),
without any coercion, between the owner and the contractor.
2. There is nothing illegal contained in the contract.
3. The contract has been signed by representatives of the
owner and the contractor. The contractor and owner (or
representatives) have the authority to commit the resources
of their companies.
If a contract is legally enforceable, the owner can, if necessary, sue the
contractor in court to make him live up to his agreed-on obligations
as defined by the contract. Likewise, the contractor can, if necessary,
sue the owner in court to make him live up to his agreed-on
obligations. The court can act as an enforcer of contract obligations.
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Into the Breach!
If the owner or the contractor does not abide by his respective
obligations as contained in the contract, then he may be
determined to be in breach of contract. This just means that
someone who is party to the contract is not living up to what he
has contractually agreed to do. Breach of contract is also
commonly called failure to perform. It’s mentioned here only
because the issue rears its head all the time. How many times have
contractors heard it said that, if you don’t do this or that, you are in
breach of the contract?
There is no reason to get excited; the term is overused to exert
leverage on the contractor and is subject to far too many personal
interpretations.
An Example
If an owner agrees in the contract to pay the contractor’s payment
invoices 30 days from the date of each invoice, and does not pay
until the 32nd day, then the owner technically has committed a
breach of contract. The owner may have a variety of reasons—­
legitimate or otherwise—­why he didn’t pay the contractor on time
as required by the contract, but he is still technically in breach of
contract. Unfortunately, the contractor would have to go to court to
have it determined that the owner was actually in breach of
contract. It’s always better to find a way to resolve the issue with the
owner to get him to live up to the terms of payment he agreed
to accept.
The court acts as an enforcer in breach of contract disputes by
compelling the party who has failed to perform to live up to his
contractual obligations, or else pay monetary damages to the other
party.
Sometimes a contractor will hear the owner use the term
material breach of contract. Like many things in a contract, this
term is open to much interpretation. In general, a material breach
of contract is a failure to perform a contractual obligation, and
the failure is extremely serious and damaging to one or both
parties.
In the previous example, the owner paid the contractor on the 32nd
day and so was two days late. That probably would not stand up to
the test or interpretation of what constitutes a material breach of
contract. However, if the owner paid the contractor 60 days late and
did not have a legitimate reason for the delay, it would certainly have
a much better chance of being deemed so.
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A Contract
Example
The following is an example of a simple “supply and install”
construction contract that illustrates contracting basics.
An Example
National Construction Company responds to Wilson Properties’
RFP for a new office building, negotiates the details (offer and
acceptance), and enters into a construction contract, agreeing to
supply and construct the office building (something of value for
Wilson Properties) in accordance with the drawings and
specifications contained in the RFP.
National Construction Company also agrees to perform the work
within a fixed time period and for a certain fixed price (something
of value for National Construction Company). National
Construction Company is to receive a downpayment from Wilson
Properties prior to starting the work, and will receive the balance
upon satisfactorily completing the building.
No coercion was used by either party regarding the terms of the
contract, and the contract does not include any illegal requirements.
The contract document is signed by Wilson Properties’ President
and by National Construction Company’s Project Manager
(competent parties with authority).
In written form, the contract would look something like this:
Article 1 – Scope of Work and Price
National Construction Company agrees to supply and build a one-story
office building on a site provided by Wilson Properties strictly in accordance
with the attached Plans and Specifications for a fixed, lump-sum price of
$250,000.
Article 2 – Schedule
National Construction Company agrees to complete the one-story office
building within one year from the date of this Contract.
Article 3 – Terms of Payment
Wilson Properties agrees to pay National Construction Company $50,000
as downpayment immediately upon the signing of this Contract, and the
balance of $200,000 immediately upon the completion of the one-story
office building.
Dated: January 1, 2007
Signed:
8
Wilson Properties
National Construction Company
__________________
_________________________
President
Project Manager
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This is an example of a legally enforceable construction contract in its
simplest form. But that’s all that’s actually required. It includes all the
basics:
1. National Construction Company made an offer.
2. Wilson Properties accepted the offer.
3. National Construction Company provides something of value:
the one-story office building.
4. Wilson Properties also provides something of value: the
payment of $250,000.
5. The contract document is signed by a representative of each
company who is competent, and who also has the authority to
commit the resources of the company.
6. No coercion was used and no illegal activities are required.
This sample contract is extremely simple, but it would be perfectly
legal and enforceable. However, almost all construction contracts will
very likely be a lot more complex and will have numerous additional
clauses to cover a variety of commercial terms and conditions, such
as insurance, indemnity, performance and payment bonds, changes,
dispute resolution, safety requirements, and schedule and progress
reporting requirements.
This example could have been expanded to include an additional
clause requiring National Construction Company to provide
Workers’ Compensation insurance and other types and amounts of
insurance, which would read as follows:
Article 4 – Insurance
National Construction Company will provide statutory Workers’ Compensation insurance in accordance with state laws, Comprehensive General
Liability insurance in the amount of $1,000,000, and Automobile insurance
in the amount of $300,000.
These insurance requirements are typical. Most states require
contractors to participate in a Workers’ Compensation insurance
program, and owners typically require contractors to also
provide General Liability and automobile insurance at a
minimum.
All the clauses in a construction contract are collectively called the
commercial terms and conditions. Commercial terms and
conditions define all the responsibilities and obligations of each party
to the construction contract.
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Strange Words
& Long
Paragraphs
There are no requirements—legal, cosmic, religious, or otherwise—
for Latin terms to be used in a contract. For example, the Latin term
inter alia, which pops up all the time in construction contracts,
simply means “among other things.” It’s perfectly okay to say “among
other things” if necessary for clarity. Use English! Using only English
terms in a simple and concise manner is a much better way to write a
clear and understandable contract.
Also, there are no requirements, legal or otherwise, for the use of
complicated and abnormally lengthy sentences or paragraphs, or
any other confusing language that could lead to
misunderstanding.
The following is an example of an unnecessarily wordy, complex
contract clause stating that a contractor has to complete the work in
accordance with the contract documents.
Article 25 – Contract Completion by Contractor
In consideration of all the mutual and independent agreements set forth on
the part of the Owner in the Contract as contained herein, Contractor shall,
without exception, construct, complete, and maintain the Work in absolute
full conformity and in all respects with any and all the provisions of the
Contract and Contractor will perform, fulfill, comply with, submit to, and
observe all and singular the provisions, conditions, stipulations, and
requirements and all matters and things expressed or shown in or
reasonably to be inferred from the Contract and which are to be performed,
fulfilled, complied with, submitted to, observed by, or on the part of
Contractor.
Here’s how this clause could be revised to simplify the usual
obligation of the contractor to complete the work in accordance with
the contract documents:
Article 25 – Contract Completion by Contractor
Being clear, concise,
and specific is
the preferred
way to write a
contract, so that all
those individuals
responsible for
executing the
contract understand
what they have to do.
10
Contractor shall complete all the Work in full conformity with Owner’s
Contract documents.
Clear and concise English is the best way to write a construction
contract! Being as specific as possible in writing the commercial
terms and conditions is okay, too. Broadly worded commercial terms
and conditions are subject to broad interpretation, usually to the
detriment of the contractor. If there is a dispute over what the
language in a particular commercial clause means, the more specific
and concise the language, the better the chances are of resolving the
dispute.
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One thing to remember is that if a contractor ends up in a contract
dispute, and a third party, like a court or an arbitration panel, reads
the commercial terms related to the dispute, there is no assurance
that they will interpret the clause the way the contractor believes it
should be interpreted. Be as specific as possible so that the
interpretation of the wording is clear to everyone.
If a contractor does not understand a paragraph in a proposed
contract because of its length, construction, or use of legal terms,
then he should negotiate a revision to it so that everyone responsible
for actually executing the contract can understand and interpret it,
too.
Contracting
Myths
One myth to dispel about construction contracts is that of the so-­
called standard construction contract. There is no such thing as a
standard construction contract. There can’t be. There’s no such thing
as a standard construction project.
This “standard construction contract” approach is sometimes used as
a negotiating tool to get one party to the contract to accept
unnecessary and/ or onerous commercial terms and conditions that
are in favor of the other party. Owners will often insist on using their
preferred, standard construction contract as a barrier, or stonewall, to
try to stop the contractor from negotiating more favorable, less
onerous commercial terms and conditions. Their tactic is something
like this, “These standard terms and conditions are well established
and can’t be changed.”
On the other hand, legitimate attempts have been made to try to
standardize construction contracts so that the commercial terms and
conditions they contain have some balance, are easier to understand
and interpret, and are seemingly fair to all parties. This is admirable
in its intent, but can lead to laziness in addressing issues unique to
individual construction projects, and it may actually increase the
commercial risk assumed by one or both of the parties to the
contract. Caution should always be taken whenever a “standard
contract” is suggested.
Examples of standard commercial terms and conditions for
construction contracts are those published by the American Institute
of Architects (AIA) and the Associated General Contractors of
America (AGC). Other options include standard forms from the
Engineers Joint Contract Documents Committee (EJCDC) in the U.S.
and the International Federation of Consulting Engineers (FIDIC) in
Switzerland.
There are certainly opportunities to use these standardized terms on
construction contracts, but contractors must read them carefully and
11
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understand how they apply to the specific project. If some of the
standard terms don’t apply, or tend to create excessive commercial
risk, then the contractor should modify them or delete them. These
standardized terms are not cast in stone, despite the impressiveness
of the contract’s appearance.
A Second Contracting Myth
Another myth to dispel is that only lawyers can write construction
contracts. Once a contractor has an understanding of the risk and
consequences of accepting certain commercial terms and conditions
that can create a potential financial liability for his company, he can
negotiate favorable changes to any offending commercial terms and
conditions and better protect the assets of his company.
Contract
Negotiations
One important thing to remember about construction contracts is
this: all the wording of all the commercial terms and conditions in a
proposed contract is negotiable. This is especially so if the
contractor’s proposal for the work contains a good price, an
achievable schedule, and is technically solid. As long as what the
contractor is trying to achieve by changing or modifying the language
in a proposed contract is not illegal, then all the commercial terms
and conditions that may create a potential financial liability for the
contractor are fair game for change.
As noted earlier, many owners will have standardized wording for
most all of the commercial clauses in a proposed construction
contract. They would like for this wording to be accepted by all
their contractors. That’s fine, as much of the standardized wording
can probably be classified as administrative terms, or, as it is
sometimes called, boilerplate, and may not impose any additional
or excessive commercial risk and potential financial liability on the
contractor.
However, a conscientious and careful contractor needs to make sure
he carefully reads the contract terms and conditions and understands
all the commercial risk associated with accepting the owner’s
standard contract wording. If the commercial risk is unacceptable,
then negotiations are necessary in order to change the wording to
lower or eliminate the risk.
An unfortunate caution: some owners have been known to insert
unrelated high-­risk terms and conditions within what might be
considered administrative terms, perhaps hoping the contractor will
overlook them. A final waiver of mechanic’s liens, for example, is a
fairly normal requirement for the contractor to provide to the owner
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There is no substitute
for reading and
understanding
the contract. It is
probably the most
important part of
the contracting
process. Of equal
importance is the
ability to successfully
identify and then
negotiate changes
to any commercial
terms and conditions
that can create
unnecessary
commercial risk and
financial liability.
at the conclusion of a construction contract. The owner may even
have a standard form for this. Sometimes that final waiver of liens
also contains extra language that waives all of the contractor’s rights
to claim legitimate extras that are outstanding. This is unfair, but it
does happen, so be careful.
After the basics of contracts are understood, the next step is
developing an understanding of the general types and forms of
contracts that contractors will commonly encounter. This is
discussed in the next chapter.
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Chapter
2
Types & Forms
of Contracts
Construction contracts do not come in all shapes and sizes. They
conform to a fairly well-­defined set of types and forms. Seven
common types of construction contracts are:
1. Fixed price and fixed schedule
2. Reimbursable (unit rate and cost plus)
3. Combined fixed price and reimbursable
4. Cost plus fee
5. Guaranteed maximum price
6. Design build
7. Design-­bid-­build
Two additional types of contracts that are commonly encountered are
similar to the seven listed above, but with an added twist:
1. Target price contracts
2. Contracts with performance incentives
Understanding and Negotiating Construction Contracts: A Contractor’s and Subcontractor’s Guide to
Protecting Company Assets, Second Edition. Kit Werremeyer.
© 2023 John Wiley & Sons, Inc. Published 2023 by John Wiley & Sons, Inc.
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Fixed Price &
Fixed Schedule
Contracts
All well-defined
work that can be
accurately estimated
and planned is a
candidate for a fixed,
lump-sum price and
schedule contract.
These are the most common types of construction contracts. The
contractor submits a fixed, lump-sum price for the owner-provided
scope of work, as well as a finite completion time schedule. This type
of contract can be used for small projects, such as a $5,000 addition
to a single-family house, to large contracts, such as a petrochemical
manufacturing facility worth hundreds of millions of dollars. An
example of this would be when a contractor submits a fixed, lumpsum price of $1,000,000 to an owner, with a firm schedule of 52 weeks
to complete an office building.
In a fixed price contract, the contractor must have the ability to
accurately estimate the costs and time required to perform the work.
The contractor also must have the capabilities to execute the contract
for the price and schedule as promised. This type of contract requires
the owner to provide a comprehensive and accurate definition of the
scope of work.
For the owner, this type of contract will likely provide the lowest cost
or best schedule (or both) to get the work done, since he will
probably have asked several contractors to compete for the work and
provide a formal bid. Having a fixed price and firm schedule allows
the owner to plan better for scheduling and for financing or paying
for the project.
For the contractor, this type of contract requires estimating and
execution skills. It also requires him to make a judgment on how high
to price the work to compete with other contractors. One good thing
about fixed price and schedule contracts is that, if the contractor
performs well against his costs and schedule, it’s likely he will have
savings and thereby increase his estimated profit, and there’s nothing
wrong with that! On the other hand, if the contractor overruns his
estimated costs and/or schedule, it’s unlikely he will get much
sympathy—or money—from the owner.
Reimbursable
Type Contracts
There are two common and similar types of reimbursable contracts:
• Unit rate
• Cost plus
Unit Rate Contracts
The contractor submits a menu of prices for materials, labor, and
equipment to the owner. These prices include all of the
contractor’s costs and markups, including profit, for the respective
items listed.
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An Example
The owner wants to install approximately one mile of 24" diameter
underground cast iron pipe in a 6' deep trench. The contractor
provides the following example menu of prices to the owner:
• 24" diameter cast iron pipe: $50/linear foot delivered
• Project foreman: $75/labor hour worked, no overtime
• Laborers: $35/labor hour first 40 hours per week, $55/labor
hour overtime
• Backhoe: $175/hour fueled and operated
• Side-­boom tractor to lay pipe: $175/hour fueled and operated
• 12" rock backfill over pipe: $30/cubic yard delivered
• Miscellaneous expendables: $250/day
At the end of each week during the project, the contractor adds up
the length of pipe installed, the labor hours worked by the foreman
and laborers, the time of use for the backhoe and the side-­boom
tractor, the amount of rock backfill, and miscellaneous expenses.
The contractor then applies the reimbursable rates to each, sums
them up, and sends the owner a bill.
Cost Plus Contracts
In a cost plus construction contract, the contractor submits a menu
of direct costs and associated markups for materials, labor,
subcontracts, and equipment to the owner. The markups (the “plus”)
include all of the contractor’s overhead and profit applied to the
respective items in the menu.
An Example
The owner wants to install approximately one mile of 24" diameter
underground cast iron pipe in a 6' deep trench. The contractor
provides the following menu of costs and markups to the owner:
• All pipe materials delivered to site: direct invoice cost plus 20%
• Project foreman: $45/labor hour worked, plus 50% fringes and
20% overhead and profit
• Laborers: straight time, first 40 hours/week: $23/hour, plus
35% fringes and 20% overhead and profit
• Laborers: overtime, after first 40 hours/week: $34/hour, plus
25% fringes and 15% overhead and profit
• Backhoe: $145/hour, fueled and operated, plus 20% overhead
and profit
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• Side-­boom tractor to lay pipe: $145/hour, fueled and operated,
plus 20% overhead and profit
• Rock backfill over pipe delivered to site: direct invoice cost plus
20%
• Subcontracts: cost plus 15% overhead and profit
• Miscellaneous expenses: direct invoice cost plus 20%
At the end of each week during the project, the contractor adds up
the invoice costs of all materials delivered to the site, the labor hours
worked by the foreman and laborers, the time of use for the backhoe
and the side-­boom tractor, the amount of rock backfill, and
miscellaneous expenses. He then applies the noted markups to each,
sums them all up, and sends the owner a bill.
For the owner, these types of reimbursable contracts are useful where
the scope of work and schedule are difficult to define. Maybe there’s
some rock in the ground, or the terrain is difficult, or the weather is
really lousy—­and trying to determine a fair fixed, lump-­sum price
might prove difficult or turn out to be very expensive, as the
contractor will load up his contingency costs.
For the contractor, these types of reimbursable contracts allow him to
take on a job without having to provide a large contingency cost for
unknown conditions and schedule delays. The contractor probably
has to compete with others to get the work, so he’s careful about the
level of his reimbursable pricing and the time he estimates it will take
to complete the work.
On all reimbursable contracts, the contractor should expect that the
owner will want to audit his work records for the labor hours billed,
the time the equipment was used and billed, and for any other
reimbursable work item.
Combined
Fixed Price &
Reimbursable
Contracts
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As the name suggests, this contract is a blend of the two types of
contracts. It tends to be used where some of the work is well-­defined,
and some isn’t.
An Example
An owner wants to build a standard-­design, 300-­foot-­tall radio
relay tower on the top of a 10,000-­foot-­high, heavily-­wooded
mountain. There isn’t anything special or unique about the
engineering effort required or the supply of the materials for the
tower. However, getting the materials from the base of the mountain
to the top on an unimproved roadway, and then installing them, is
not conducive to a fixed price, as too many undefinable work and
schedule issues are involved.
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The owner ends up with the following example contract pricing
format:
• Engineering: $20,000 lump sum
• Radio tower material supply: $80,000 lump sum
• Transport materials to base of mountain: $5,000 lump sum
• Mobilize crew and equipment at site: $5,000 lump sum
• Project manager: $100/labor hour worked
• Project superintendent: $75/labor hour worked
• Steel erectors: $45/labor hour
• Clearing and installation labor: $30/labor hour
• 10-­ton mobile crane: $125/hour fueled and operated
• 5-­ton special transport: $85/hour fueled and operated
• Excavation: $5/cubic yard excavated and removed
• Portable air compressor and generator: $45/hour fueled and
operated
• Small tools and expendables: $200/day
• Demobilize crew and equipment from site: $3,000 lump sum
The contractor bills the owner for the stated lump sums for the
engineering costs, supply of materials, transport, mobilization, and
demobilization. These scope of work items were well-­defined by the
owner in his inquiry documents, and thus are conducive to fixed,
lump-­sum pricing.
The field installation work proceeds on a “best effort” basis, given
the adverse and difficult-­to-­estimate working conditions. The
contractor bills the owner for the work performed based on the
menu of reimbursable prices provided, just like in the reimbursable
contract example.
For the owner, this type of contract is useful where some aspects of
the scope of work and schedule are easy to define, but some of the
work is difficult to define. Trying to get a fair lump-­sum price for the
entire project might prove difficult, as the contractor will feel the
need to load up his contingency costs for the difficult field working
conditions.
For the contractor, the combined fixed price/reimbursable contract
will allow him to take on a job without having to include a large
contingency cost for unknown field working conditions and any
delays in schedule. He probably will have to compete with others to
get the work, so he’s careful about the level of his fixed, lump-­sum
pricing, the level of the reimbursable pricing, and the time he
estimates it will take to complete the work.
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Cost Plus Fee
Contracts
A cost plus fee construction contract format is often used for large,
complex projects. Typically, these projects require a significant
amount of conceptual and design engineering, along with a major
effort to procure a lot of expensive equipment and materials. These
projects also require construction services, including a large and
diverse project management staff and a multi-­disciplined craft labor
force. There might be a completion schedule of several years or more.
In this type of construction contract, the contractor provides, for
example, all permits, studies, design services, detail engineering,
major equipment, materials, and field construction management and
labor, often in a joint effort with the owner. The contractor then bills
the owner for the actual costs, and, in addition, bills the owner a fixed
fee, which would typically include the contractor’s project
management costs, overhead costs, and profit.
All the actual costs associated with engineering, procuring, and
constructing the project are billed directly to the owner for payment,
or reimbursement if the contractor is paying the bills in the first
instance as part of the contract with the owner. In addition, the
owner will pay the contractor the agreed-­on fee on a prorated basis
based on the physical or cost progress of the project.
Many cost plus fee contracts have a provision in them to increase the
fee should the estimated costs or scope of work exceed a certain
amount, or if the estimated schedule extends beyond what was
originally estimated.
For the owner, a key benefit of this type of contract is that it allows
him to build a project on a fast-­track basis. He can negotiate a
contract with a specialized and experienced contractor for the project
and proceed immediately with conceptual and detailed engineering
and procurement of major, long-­lead-­time pieces of equipment. The
owner avoids the lengthy fixed-­price process of selecting a main
contractor, then going through the development of engineering and
the production of bid documents, the bidding and bid review, and
final contractor selection process. The owner might expect to save up
to a year or more on the completion schedule of major projects with
this contracting approach. This type of contract requires full
participation of the owner in the cost control and subcontractor
selection process.
For the contractor, this approach allows him to be reimbursed for all
costs associated with the project and provides him with a fee to cover
project management, overhead, and profit for the project. If the
project expands beyond what was originally expected, then the
contract should allow for an adjustment to the contractor’s fee.
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In this type of contract, all reimbursable actual cost records are
auditable by the owner. In addition, the owner might expect to
negotiate the amounts in the fee for the contractor’s project
management, overhead, and profit.
Guaranteed
Maximum Price
Contracts
This type of contract would likely be a reimbursable type, or some
combination of reimbursable and fixed price contracts. The
distinguishing feature of this type of contract is that the contractor
would agree with the owner that the final price to the owner would
not exceed a fixed, certain value. In other words, the contract would
have a guaranteed maximum price.
This is a risky agreement for contractors. If the contractor’s cost of
the project exceeds the guaranteed maximum price, then that’s too
bad for the contractor. The extra money comes out of his pocket. It is
especially risky if the scope of work is poorly defined, and if external
factors like weather or labor conditions create expenses that he
cannot recover through claims or changes to the contract.
For owners, this type of contract is useful where he may, for example,
have to fund the project with outside financing and want to cap his
exposure to project costs.
Target Price
Contracts
A target price contract is one where the contractor and the owner
agree on a certain fixed, lump-­sum price, the target price, and the
contractor tries to execute the contract at or below it.
One unique feature is that the contractor shares all the costs in the
estimates, including his markups and expected profit, with the owner. The
owner understands the contractor’s estimating process and supports it.
In a target price contract, both parties agree on the level of costs and
contractor markups and profit. This type of contract also requires the
contractor and owner to have a working relationship based on a high
degree of trust.
In the event the contractor completes the project below the estimated
cost, there will be a cost savings, and the contractor and owner will
share that savings in a previously agreed-­on proportion. In the event
the contractor overruns the project costs, then the contractor and
owner will share the expense of the overrun in a similar fashion.
An Example
A contractor and owner agree on a price of $3,500,000 to build a
new, concrete marine cargo unloading jetty for the owner’s ships.
After finishing the project, the contractor manages to save $100,000
on his estimated costs and shares that information with the owner.
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The contract between the owner and contractor calls for any savings
against the target price to be split 50-­50. Therefore, the owner ends
up paying $3,450,000 for the project, and the contractor ends up
with an additional $50,000 profit.
In this type of contract, both the owner and contractor have a strong
incentive to work closely together and pool their talents and
resources to find legitimate ways to reduce costs and safely expedite
the overall project schedule.
Design Build Contracts
In this type of construction contract, the Owner signs a single-­source
contract with a Contractor that will cover all the aspects of the design
and construction for the project. The theory is that this will eliminate
multiple contracts and subcontracts for the Owner, find cost and
time savings, reduce paperwork, and streamline the overall bidding
and completion schedule.
Contractor led design-­build contracts can be considered where the
selected contractor has demonstrated engineering, design, and
construction strengths in the type of project being proposed. For
example, a refinery or petrochemical plant.
Architect-­led design-­build contracts can be considered where the
project has some complex and nuance design issues. For example, a
hospital or custom home. The contractor for the construction
might be part of the architect’s organization or perhaps a joint
venture partner.
Design-­Bid-­Build Contracts
The difference between this type of contract and a design-­build
contract is that the Owner issues a separate contract to an architect
for the design of the project and a separate contract for the
construction of the project.
In a design-­bid-­build contract, the construction contractor does not
participate in the project’s design.
An example of this type contracting process might be a single-­or
multistory commercial building.
Contracts with
Performance
Incentives
22
Any of the above-­mentioned types of construction contracts can have
performance-­based incentives included. Some typical performance-­
based incentives are:
• Safety: such as an incentive bonus for no lost time or recordable
accidents.
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• Quality: such as an incentive bonus for achieving 98% or better
flawless x-­rays on all full-­fusion welds in high-­pressure piping.
• Subcontracts: such as an incentive bonus for utilizing a certain
percentage of minority-­owned subcontractors or suppliers.
• Schedule: such as an incentive bonus for finishing ahead of
schedule.
Performance-­based incentives can play a strong role in achieving
certain goals for the owner. For example, if the owner’s company
assigns utmost importance to safety, then the owner should be willing
to “put his money where his mouth is” by making a pool of extra
money available to those contractors on the project who achieve
exemplary safety records.
On the flip side of this issue are those contracts that contain certain
performance disincentives. An example of this may also involve job
site safety, a common performance-­based incentive. In addition to the
pool of extra money that might be available to the contractor for
exemplary safety, the contract may also provide for the contractor to
put, say, 2% (or more) of his contract price at risk for poor safety. If
the contractor doesn’t meet the project’s minimum stated safety goals
for his portion of the work, then the owner has the right to deduct
some or all of the 2% from the contractor’s contract price.
One common disincentive that can be used by the owner is the
imposition of liquidated damages when the contractor fails to meet
or beat the contractual schedule. (Liquidated damages and how to
deal with them are covered thoroughly in Chapter 11.)
Form of
Contracts
Like the types of contracts, the form that a construction contract
takes is fairly standard, too. Organization is typically as follows:
1. Preamble
2.
3.
4.
5.
6.
General contract and the commercial terms and conditions
Special terms and conditions
Attachments incorporated by reference
Signature block
Order of precedence
Preamble
Most contracts begin with what is called a preamble, used to
specifically identify the parties to a contract. This is an excellent
convention to use, as owners may have many different, independent,
and separate business units, both U.S. and foreign subsidiaries, that
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have the ability to enter into construction contracts and commit the
use of corporate resources.
Preambles are straightforward in their structure and typically read as
follows:
This Contract is between Wilson Properties (Owner), an organization
registered in the State of Florida and having its registered office at 3160
Ponce DeLeon Way, Orlando, Florida, and National Construction Company
(Contractor), an organization registered in the State of Delaware and having
its registered office at 125 East Orange Street, New York, New York.
Note the convention of capitalizing and putting “contractor” and
“owner” in parentheses after they are identified as a party to the
contract. This is done to define important terms to be used
throughout the contract. It’s also a simplifying procedure. Rather
than using “National Construction Company” to define the
contractor throughout the contract, the capitalized term “Contractor”
is used. Defined terms and additional examples are more thoroughly
discussed later in this chapter.
Recitals
Often following the preamble in a contract is something called
recitals. Recitals typically begin with the word “Whereas,” or
“WHEREAS,” or “WITNESSETH.” A recital typically states facts,
issues, or conditions related to the contract and may read similar to
the following:
WHEREAS: Owner has decided to build a new 10,000 square foot
warehouse on property located in Orlando, Florida.
WHEREAS: Contractor warrants that it is qualified, experienced, and competent
to perform the work.
WHEREAS: Contractor has agreed to do the work subject to the terms and conditions of the Contract.
The recitals section ends with the following, or similar, sentence:
NOW, THEREFORE, IT IS HEREBY MUTUALLY COVENANTED AND
AGREED AS FOLLOWS:
What follows is the body of the construction contract. The recitals
section is an old, and some might say, antiquated practice that doesn’t
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