While there is no way to eliminate all of an owner’s risks on a construction project, the most important, and often most overlooked, tool to minimize those risks is the construction contract. Proper negotiation, drafting and administration of a construction contract can provide a plethora of protections to an owner, ensuring, among other things, that an owner: (1) will not pay twice for the same work if a mechanics’ lien is filed; (2) has the full range of remedies available to it in case of a contractor’s breach; (3) is protected in case of payment or performance failures by its contractors, subcontractors and suppliers; and (4) enjoys all of the warranties for which it has bargained.
1. Make sure that all subcontractors and suppliers are made aware of the total contract price and the time for payment.
Under Pennsylvania’s Mechanics’ Lien Law, 49 P.S. § 1101 (Lien Law), an owner can be compelled to pay twice for the same work and materials when its general contractor fails to pay its subcontractor or supplier for such work or materials. But that possibility can be eliminated if an owner takes one of two easy steps. Under Section 1405 of the Lien Law, an owner can limit its liability to the amount unpaid on its contract, if, before a subcontractor or supplier performs any services or provides any materials, the subcontractor or supplier is either: (1) made aware of the total amount of the owner’s contract with its general contractor and of the time of payment under that contract; or (2) if the owner files the pertinent part of its agreement with its general contractor with the prothonotary of the court of common pleas of the county in which the project is located. Typically, an owner accomplishes this by requiring its general contractor to include within its subcontracts the relevant payment provisions of its contract with the owner. It is good practice to require that the general contractor provide proof that it did so before work begins or materials are provided for a project.
2. Make sure to require and obtain partial and final lien waivers and claim releases for all payments.
Although the good old days where all mechanics’ lien claims could be waived at the outset of a project are no longer (unless a contractor posts a bond guaranteeing payment for labor and materials provided by subcontractors), an owner can still contractually require that its general contractor provide partial lien waivers for all payments received and claim releases (releasing any and all potential claims up to the date of payment), and that its general contractor, in turn, contractually require its subcontractors and suppliers to do the same. If all parties do so, and withhold subsequent payments until partial lien waivers for the prior payments and claim releases are received, an owner can, even if it did not make the subcontractors and suppliers aware of the payment terms, limit the potential of double payment to a single pay period.??
3. Think about requiring payment and performance bonds.
On large projects or on projects with contractors with which an owner does not have much prior experience, an owner can require — albeit generally at the owner’s expense — a contractor to obtain payment and performance bonds from a surety. A payment bond guarantees that a contractor will make all required downstream payments on a project and permits the filing of an advance global lien waiver on commercial projects, and a performance bond guarantees that a contractor will complete all obligations under its contract with the owner. So, on a fully bonded project, if a contractor stops making payments to its subcontractors or suppliers, or simply walks off the job, the owner can call upon the surety to make the missed payments or complete performance of the contract (either by retaining its own forces to complete the work or by reimbursing the owner for the costs incurred in completing the project with a different general contractor). While the cost of bonding a project is often an unwelcome one at the outset of a project, an owner will be glad to have incurred that cost if problems ensue on a project.
4. Require retainage.
In all construction contracts, it is good practice for an owner to require that retainage be withheld from all progress payments and released on the date of final acceptance (and not substantial completion). Withholding retainage helps ensure that a contractor will complete all work and punch list items on a project, as opposed to moving on to the next project prematurely. On larger projects, it is not unusual to agree to release a portion of the retainage when the project is substantially complete and/or to reduce retainage at the midpoint of a project (from 10 percent to 5 percent, for example).
5. Watch out for the Contractor and Subcontractor Payment Act.
Like most states, Pennsylvania has a Contractor and Subcontractor Payment Act, 73 P.S. § 501 (CASPA). CASPA provides a powerful remedy for a contractor against an owner for payment failures. Under CASPA, an owner is subject to 1 percent interest per month for all overdue payments, and, if a contractor substantially prevails in litigation against an owner, the owner is subject to a second 1 percent per month penalty, plus attorney fees. CASPA provides that, unless the contract says otherwise, an owner’s payment is due on the later of 20 days after the end of a billing period or 20 days after an invoice is delivered. So, if an owner wishes to extend its payment deadlines beyond 20 days, it must do so by contract. More importantly, and often overlooked, if an owner wishes to withhold payment because of a deficiency in the work provided by its contractor, CASPA requires the owner to notify the contractor within seven days after the invoice is received. As a result, it is critical for an owner to provide prompt written notice of any amounts withheld from a contractor.??
6. Make sure that the owner is an additional insured.
While most construction lawyers will require that a contractor have proper and sufficient insurance coverage, it is important that the construction contract require that the owner be named as an additional insured on such policies. This eliminates potential arguments from carriers that an owner is not entitled to receive insurance payments where appropriate.
7. Do not waive consequential damages.
Most lawyers who represent contractors will seek mutual waivers of consequential damages in contracts with owners. This is so because in actuality, it is the owner — and not the contractor — that is likely to incur consequential damages on a project. For example, if an owner is constructing a dormitory, and it waives consequential damages, it will not be able to recover damages such as the cost of housing students if construction is late. Likewise, having waived consequential damages, an owner that is constructing a widget factory with contracts to deliver a million widgets by a certain date will not be able to recoup its damages for breaching those contracts if the factory is not completed on time. So, it is important for an owner — to the extent possible — to refrain from waiving consequential damages, and, when using American Institute of Architects forms, to be sure to cross out the mutual waiver of consequential damages clause that is a standard provision in those forms.
8. Properly define the terms "substantial completion" and "final acceptance."
Substantial completion is an important milestone that generally triggers transfer of property to an owner. In most standard construction contracts, substantial completion is loosely defined, and sometimes its definition is limited to a date. This is a mistake. An owner should insist on a rigorous definition of substantial completion that includes certain requirements, including the issuance of a certificate of occupancy, and the functionality of major systems such as HVAC (heating, ventilation and air conditioning).
Likewise, in most standard construction contracts, the definition of final acceptance is so loose that it is of limited value to an owner. An owner, therefore, should require a more rigorous definition of what constitutes final acceptance and what must happen before that milestone can be met. Thus, to provide adequate protection to an owner, a construction contract should require that the following occur at final acceptance of a project: (1) all claims, including disputed change orders and delay claims, be resolved; (2) all warranties and guarantees be delivered; (3) final payment resolves all of a contractor’s claims and lien rights; and (4) all as-built drawings and specifications are certified by the contractor as complete and accurate.??
9. Make sure that all preconditions of any warranties have been met.
Most construction contracts will require the contractor to warrant its work and to provide manufacturers’ warranties for many of the materials used and construction elements completed, such as roofs, windows, doors and HVAC systems. Most warranties, however, contain preconditions that must be met in order for the warranty to be valid. These preconditions often include pre- and post-installation manufacturers’ inspections, notice provisions and regular maintenance requirements. The failure to comply with any of these conditions can void a warranty, so an owner must carefully read and comply with all such conditions.
10. Document all problems and communicate them to your contractors.
One of the most common mistakes made by an owner on a construction project is the failure to document problems as they occur and to communicate them to its general contractor. Not only will proper documentation and quick communication help address and head off problems while they are manageable, but if the problems are resolved in court, the difference between winning and losing often comes down to the party that has properly documented and communicated the problems. This is so because proper documentation and communication show that the owner gave the contractor a chance to address the problem before heading to court, and provides the best evidence of the problems and a contractor’s failure to address those problems.¢