Trust us: Construction contracts eliminate surprises
Thinking about renovating a building? Expanding your facilities? Improving infrastructure?
Be sure to button up a solid construction contract before you start, or you may wind up with an $8-million surprise.
That’s what happened to one industrial manufacturer in Michigan who was in such a hurry to construct its new facility to meet customer demand that it made a few basic — yet costly — mistakes. For starters, it hired a contractor who promised to get the project done on time and within budget, yet was vague on the specifics.
The contractor blamed the tight labor market when subs failed to show up — or worse, did shoddy work that required a lot of rework. The owner agreed to pay on a time-and-materials basis instead of demanding a guaranteed maximum price. With the clock ticking, the price tag soared $8 million past the original budget — and all because the owner’s haste made him forego standard project protections.
What should the owner have done instead?
Insist on a construction contract with a detailed scope of work and services. You can have a contract that spells out the price but don’t gloss over the actual scope of work. Be sure to include project drawings and specifications that describe the specific work to be done so you don’t get burned. If something wasn’t spelled out in this scope of work, then it will be outside the agreed-upon price — and that means change orders. And those mean money.
Be skeptical if a contractor says “trust us.” Get it in writing. The Michigan economy is percolating right now, and there’s a scarcity of skilled construction labor. When everyone is working at a fast pace, it may be tempting to settle for a handshake but don’t. Paying attention to details upfront will prevent unpleasant surprises down the road.
Retain a qualified architect or construction consultant. This expert should review and approve the progress of work and require the contractor file a standard application for payment before cutting a check.
Require a retainage on all progress payments. The owner should hold back 10 percent of each progress payment until completion of the project as an incentive for the contractor to perform construction properly — and on a timely basis.
Get the right insurance. Be sure you and the contractor and subs have the proper type, level and amount of insurance in place. For starters, this should include builder’s risk insurance. Be sure you as the owner are named as an additional insured — and that any indemnification obligations under the contract do not impair the insurance obligations.
Require a schedule of values from the contractor. This breaks down progress payments on a percentage of completion of the project. Monitor the disbursements to make sure they match that percentage.
File a notice of commencement. Also, require the applicable notices of furnishing, sworn statements and lien waivers will be provided throughout the process to avoid construction liens being filed against the property. Make sure whoever is doing the work follows this process. As draws are done, make sure you get a sworn statement, and lien waivers acknowledging the contractor or subs who have done work have been paid in full. This ensures your contractor is paying subs, and the subs won’t turn around and file a lien.
Retain a title company to provide monthly progress payments. This should include the title company obtaining sworn statements and waivers of liens from the contractor and subs, as well as issuing construction draw title endorsements through the date of such progress payments. The title company can issue an endorsement on the title policy that ensures work has been done to date — and prevents a lien from being filed. The larger the project, the more important this step is.
Provide for final sign-off. Insist on a final inspection period and create a punch list that identifies minor construction items to be completed within a short period after the issuance of a certificate of occupancy. Final payment should be conditioned on the issuance of a certificate of occupancy and assignment of all manufacturer and contractor warranties.
Require the contractor to provide a detailed warranty for all work. This should include having the obligation to continue to correct any issues that arise prior to the standard one-year warranty period.
David C. C. Eberhard is a partner with Warner Norcross & Judd LLP who specializes in construction and real estate matters. He can be reached at email@example.com.