Negotiating and Drafting Construction Agreements

Category | Briefing Papers

The Golden Rule or the Plumber’s Credo

It is often said that the negotiation of construction contracts is governed by the “Golden Rule.” That is, the one with the gold, rules. It is certainly true that the economics of a transaction can be the driving force behind any negotiation, be it Tiger Woods’ contract to hype a product or your contract to design and construct an ethanol plant. Another way to look at construction contract negotiation is through the use of an old plumbing adage: **** runs downhill. To put it more politely for this “erudite” publication: power runs from the top down. The project owner has a project to be built and many contractors who want to build it. So, the owner’s desire to fully insulate itself from any liability that might befall the project tends to trump the contractor’s expectation that it will be liable for only those things caused by its wrongful conduct. Following the economic chain, the design professional or contractor who is awarded the project has many subconsultants and subcontractors to choose from, so the original design professional or prime contractor’s interests tend to prevail over the lower tier consultants or subcontractors. The first tier consultants and contractors attempt to beat the lower tier consultants and subcontractors into submission to protect what little is left of his rights after being whipped by the owner.

But just as human drama is far more complex than the stories you read about in the newspaper or hear about on television, negotiation and drafting of contracts involves a dynamic that requires more thought and finesse than a simple resort to economic power as an excuse for dictating the terms of an engagement.

Negotiation Strategies

There are many approaches to negotiation of any agreement. People make a living espousing theories like “win-win negotiation,” “power negotiation,” or “don’t take no for an answer negotiation.” While all of these approaches may have some value, using any one approach to the exclusion of others would be foolish. One size does not fit all. After all, what is more important to you: getting the job, or obtaining the contract that protects you the most? Do you anticipate a long term relationship with your client, or is this a one time project? Is this a publicly or privately bid project? While we may not consciously analyze the answers to questions like these during the negotiation phase of a contract, the answers to questions like these are key to determining the best method for negotiating your construction agreements. Defining the nature of the parties’ relationship and identifying and ranking your ultimate goals will provide valuable structure to your negotiations. Boundaries and goals will illustrate why you should not use one negotiation strategy for every situation. Identifying what is really important from what is marginally significant will avoid your applying a square peg solution to a round hole condition.

Determining a Hierarchy of Importance

I have always maintained that there is little difference between negotiating a construction project and bidding a construction project. Both tasks are all about identifying risks, assuming risk in return for money, and passing off risk to others. In other words, as you bid a project, you will determine what could happen to increase your costs, what might happen, whether you can effectively prevent costly over-runs from occurring, whether you can pass the risk of some disaster onto the other party to the transaction or a subcontractor, and whether you can obtain insurance to protect you against the consequences of risk. All of those factors should affect your price.

From the owner’s perspective, the analysis should be much the same. The more risk the owner wants the contractor to take, the higher the price it should, in a perfect world, pay. (Unless it takes a bid from someone who does not appreciate the risk or has not analyzed it correctly; also known as the bidder who made the biggest mistake.)

Before you can decide what might be important to a particular project contract negotiation, you have to analyze what risks are likely to arise, what the consequences of those risks might be, whether there is anything you can do to prevent a risk from occurring, whether there is another party who can prevent or control the risk, and finally, whether you can insure against the risk. In an ideal world, you would negotiate your construction agreement in such a manner as to put the consequences of risks squarely on the entity that has the most control over the chances that risk will rear its ugly head; you would share the consequences of the risks that you and others caused according to your degree of fault; and you would insure the risks that no party to the transaction can influence or control.

While you can analyze this with a microscope, it is not practical. You must separate out the “meat and potatoes” from the “side dishes.” A hundred objections to a contract form, no matter how legitimate, will be received with much skepticism by the other party to the transaction. Therefore, you need to make your stand on what is most important to you and not “fly speck” every word in a contract proposal.

The Use of Industry Forms

To standardize and simplify the process of contract negotiation and to avoid having to re-invent the wheel over and over again, industry groups have written standard form agreements to fit various construction situations. The American Institute of Architects (“AIA”) has an extensive set of construction industry forms. The Engineers Joint Contract Documents Committee (“EJCDC”) has a less extensive set that are used frequently in projects where the design professional is an engineer rather than an architect, such as the water and wastewater treatment construction industry. The Associated General Contractors of America (“AGC”) also has a set of construction contract forms. The list goes on and on. From my perspective, each industry group’s forms tend to favor the membership of the group and their clients. Thus, the AIA documents will protect the architect first and then the owner; the EJCDC will protect the engineer and then the owner.

Each industry group’s set of documents has good and bad points from the perspective of everyone else who are not a member of the group. In fact, books have been written on standard modifications to these sponsored forms. Standard changes favoring the contractor, standard changes favoring the owner, and standard changes favoring the subcontractor are offered in a variety of construction treatises. Some contract negotiations in which I have been involved have produced lists of changes to the standard forms that are, in length and breadth, as extensive as the standard general conditions themselves.

Consensus Documents

This year, a set of documents styled as ConsensuDOCS has been released for use in the construction industry. The seventy (70) plus form set was produced with input from over 20 construction industry and owner groups, including:

· American Subcontractors’ Association (ASA)
· National Association of State Facilities Administrators (NASFA)
· Construction Owners Association of America (COAA)
· Associated General Contractors of America (AGC)
· The Construction Users’ Roundtable (CURT)
· Associated Builders and Contractors, Inc. (ABC)
· National Electrical Contractors Association (NECA)
· Construction Industry Round Table (CIRT)

The group purports to have a set of documents that owners, contractors, subcontractors, designers, and sureties could all agree was fair to all parties, thus making lengthy negotiations over contract terms unnecessary. Whether anyone will agree with that statement remains to be seen. The documents were released on September 28, 2007, and I have not yet seen them in use. The forms are expensive and as one might expect, some industry groups such as the AIA, who already have an extensive set of contract documents, were not interested in participating.

Manuscript Forms

Many sectors of the construction economy do not use standardized forms. Monopolistic industries, for example power and communications companies, use construction documents drafted by owners’ attorneys that tend to favor the owner over the contractor. (That might be a little of an understatement.) The larger the project or the owner, the more economic “weight” the owner can wield and all the less likely one will be able to negotiate terms. This is an economic reality that cannot be ignored.

Implied Obligations

In addition to the written terms of the contract, every contract is read against a backdrop of judge-made law. Courts have placed certain obligations on contracting parties regardless of which contract form one uses. For example, an owner generally is said to warrant site access to the construction contractor such that if the contractor cannot obtain access to the site through no fault of its own, the owner has breached an implied term of the contract.

Similarly, many courts hold that the owner impliedly warrants the accuracy and adequacy of the plans and specifications so that if the contractor builds it pursuant to plans and specifications, it is not responsible for the results obtained.

Additionally, courts imply an obligation of good faith and fair dealing in most contracts. If one of the contracting parties intentionally acts in a way that is unreasonable, on a subject that is not already specifically covered under the contract, there will be a breach of the obligation of good faith and fair dealing.

Important Clauses

Whatever contract form is used, you should pay particular attention to the following clauses:

· Incorporation by Reference Clauses. What exactly are you agreeing to and do you have all of the documents that are incorporated into your contract by reference?
· Flow-Down Clauses. Are you undertaking duties that are not explicit in the contract but are based on some “upstream” entities contractual duties?
· Differing Site Conditions and Site Investigation Clauses. Does the contract provide relief if conditions turn out to be different from what everyone believes the conditions are at the time of the bid?
· Indemnification Clauses. Are you being asked to assume the risk of another persons’ mistakes? If so, can insurance be purchased to cover those risks?
· No Damage for Delay Clauses. Are you limited in your remedy for delays caused by the other party, or a third party, to a mere extension of time?
· Paid-if-Paid Clauses. Is your right to payment conditioned on the other party’s receipt of payment from someone else?
· Dispute Resolution Clauses. Do you have to arbitrate, mediate or litigate and what are the conditions of each? Where will they take place and who can be joined in the proceedings? Are the other parties equally bound to the requirements?
· Termination Clauses. Who can terminate, for what reason, and how is it accomplished?
· Change Clauses. How will changes to the design and specifications be made? How will you be able to ensure that you are compensated for the change?
· Standards of Performance Clauses. How is your work judged and by whom? Who is liable for the acceptance of defective workmanship?

Conclusion

Remember that even if the other side seems to have all the negotiating leverage, you still have tremendous power. The only way to obtain favorable terms is to first request them, then insist on them based upon logic and reason. First draft contracts often represent the highest hopes of the drafter and may include requirements that are not crucial. Only through communication will you discover which terms the opposing party is willing to alter and which are “deal breakers”. If the terms of the deal are too one-sided, you can always, using the phrase coined by Nancy Reagan, “just say no.”

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