Contracts: What You Need to Know
” The basics”
As I attempt to assist various general contractors, owners, construction managers, etc. with completion of their projects, it becomes apparent that elementary, contractual requirements, methods and procedures are either totally absent, or incorrectly implemented . It has now become common, for a general contractor to negotiate a contract with an owner, commence the work, and not be able to finish the project.
The lack of simple, basic, construction management is overwhelming, and in most cases, this is the reason that the completion of the projects becomes so tedious, and the final outcome disastrous.
This webpage is intended to briefly summarize the basics of proper subcontract negotiations and development, to ensure that, at least, the formal, legal aspects of the journey leading to a successful project are accomplished.
1.) Initial negotiations and proper subcontractor selection;
a.) There is no such thing as something for nothing. Isn’t this a lesson that is taught very early in life? If the price is too enticing, there must be a reason. This realization is especially important during the initial review of a subcontractor’s scope and proposal value. There is a balance of scope and value that underlies the success of any agreement. Yes, there are contractors that are more competitive within their portion of the work, due to proper management, more efficient labor forces as well as greater purchasing ability within the marketplace. These are the criteria for selecting a successful, efficient and economical contractor. The contractor that claims they have all the required scope of work, for a ridiculously low value, is NOT the contractor that they claim, nor the contractor that you want to hire!
After over 40 years of experience, I can basically guarantee, there is no such thing as something for nothing!
b.) Due diligence is required to qualify contractors for the project. Research and investigation regarding equipment capabilities, labor tenure and quality, as well as financial history, are all important elements in contract decision making. These abilities and values form the foundation for the proper and professional selection of the most efficient and economical contractor for the project. There must be a legitimate reason that a contractor has the most inclusive scope of work, for the most economical practical price, and it is the responsibility of the general contractor to determine that reason.
c.) Recommendations from their peers as well as a legitimate project history, are also important elements that must be identified and verified, prior to making a selection of the proper contractor. The resume of a contractor is as important as the resume of your new project manager. It is critical that the contractor being selected, has a history of success, a good reputation, and a resume that includes project completion and satisfaction. Do not hesitate to contact references and spend the time necessary to fully understand the relationships between the contractor and their references. Ask the difficult questions and do not shy away from the direct approach. Remember, it is important to try and find references that have not been suggested by the contractor you are considering. Much more honesty will be revealed if you can find a party that can verify a relationship, instead of one that has already agreed to provide a good reference.
d.) Projects under contract. It is vitally important that the general contractor analyze the contractors current ” projects under contract”. No matter how qualified the contractor may appear for your project, if the burden of existing work currently under contract, is too much for the contractor to manage and sustain, your new project will suffer. It is extremely important that the subcontractors work load is understood and managed and that they have the facilities as well as the ability to perform on your project also.
2.) Scope review;
a.) The scope of the work is a comprehensive list of activities that the contractor will be responsible for. This list must reflect an accurate and thorough identification of all contract requirements for the specific discipline being vetted. It is vitally important that the scope of work be carefully developed to ensure that the minimum of missed items, resulting in change orders, is presented and acknowledged during contract negotiations. You will miss items of scope, however, the intent is to not miss any of the primary ones.
There is an attitude, out in the industry, that if the subcontractor has not excluded the work item, they have included it. This does not work! This position will cause the relationship between the contractor and the subcontractor to quickly dissolve and will delay the project. I can guarantee this! The negotiated scope of work must include a comprehensive and complete listing of all work activities that the contractor is expecting the subcontractor to perform. There are NO shortcuts to this.
b.) Never should the contractor’s scope sheet listed on their proposal be used to determine the required scope of work for the contractor. The general contractor must identify the REQUIRED scope and negotiate this scope with the subcontractor. This review must be done in person, over a set of contract documents. It is recommended that this scope review be audio taped for inclusion in the formal contract.
c.) A full comprehensive, detailed scope review must be managed and formally summarized. As I recommended in ( item b. ) I have known contractors to actually make an audio tape of the scope review, for inclusion within the contract documents. In this manner, there will be no discrepancy regarding the conversations, agreements and discussions that occurred during the scope review meeting.
3.) Proposal value review;
a.) Once the scope has been clearly identified and negotiations have been completed, the final aspect of the general contractor / subcontractor agreement must be finalized, the value of the contract.
b.) The general contractor must develop a cost leveling sheet, that identifies each scope item and their inclusion within the proposal, for every contractor negotiating the work. This is a mandatory step that will ensure that the general contractor has professionally managed and coordinated the scope verses value, for each subcontractor. This leveling sheet should be the final basis for selecting the final successful subcontractor. A professional leveling sheet is one that the general contractor can understand. The necessity to create an excel spreadsheet will mean nothing if the scope items and their values are not understood. It is important that the general contractor understand the trade that they are negotiating with as well as a general idea of the individual values of the specific scope activities. Without this understanding, the most professional and computerized leveling sheet will mean nothing.
c.) Upon selection, based upon the leveling sheet, a final scope review must be done that summarizes all of the negotiations, discussions and mandatory inclusions that will be included in the final contract. It is basically up to the general contractor, whether the comprehensive scope review should be conducted prior to the formal value analysis, or after. In many cases, the leveling sheet can be used to determine the inclusion of scope for each subcontractor, and the value selection made at that time. Once the subcontractor has been selected based upon value, the comprehensive scope review can be performed. In this manner, the time expended for scope review, is singled out on the anticipated successful subcontractor, and not all the bidders for this one particular scope of work.
4.) Special provisions;
There are several special provisions that must be discussed and included within the contract. This is not an all inclusive list of special provisions and care must be taken to customize each contract with special and specific special provisions that pertain to the specific project being contracted for.
a.) Payment clauses.
Pay when paid; this is the famous and heatedly discussed provision in the contract, that identifies the obligation of the general contractor to pay the subcontractor only upon payment by the owner. General contractors will always insist that there is a pay when paid clause included within the contract. Basically this assures that the general contractor is only obligated to pay the subcontractor upon receipt of the money from the owner, developer or whoever is obligatory on the general contractor’s side of the agreements. Subcontractors will fight this clause and duly so. A pay when paid clause, causes substantial misunderstanding as well as ill will on the behalf to the subcontractor. The subcontractor may have performed all of their work perfectly during the month and another subcontractor has performed terribly. The owner is not paying the monthly requisition due to the unacceptable work of a subcontractor that has nothing to do with the perfect one. However, the sub that has performed perfectly must wait for their payment due to the delay from the owner. Although the general contractors love the clause, the subcontractor will take it on the chin for signing a contract with the pay when paid clause is involved.
Payment cycle; When, during the month, will the payment invoices be required to be submitted to the general contractor, what type of invoice or requisition will be required, and what are the payment terms to be followed. The payment cycle is a very important part of a successful contract negotiation. A subcontractor will be very interested in the time of the month that the project work will commence in relationship to the timing of the first requisition or invoice. For example, if the work commences on the first day of the month and the output of financial burden is substantial by the subcontractor, the billing for this work may not be submitted for almost a full month from the initiation of the work. If that is the case, the actual payment for the material, labor and equipment could be over 60 days from work initiation. Care must be taken to establish a schedule that is beneficial and acceptable to both parties. This is easier said than accomplished in most negotiations.
Payment terms; This identifies the scheduling of the payments. For example, many general contractors will try to extend the time required to make a payment to the subcontractor, for at least a 60 day period, and formally establish this timing within the contract. This 60 days can be stipulated to commence upon the contractor’s receipt of the payment invoice or requisition, or it can commence from the date that the general contractor has been paid by the owner. This payment clause within the contract, will always be a difficult negotiation, due to the fact that the contractor would like to delay the payments to the subcontractor for as long a period as possible, and the subcontractor would like the payment as soon as possible. Depending upon which side of the negotiation you are representing, will influence whether an increase or a decrease in time of payment is argued.
Retainage; Retainage is a percent of the total invoice that is held back from each payment, as a form of guarantee that the work will be 100% completed and satisfactory to the owner, or whoever is paying the bill. This retainage value could be as low as 2.5%, or as high as 10%. There are special clauses that can be negotiated that would require retainage of 10% for 50% of the project, with no additional retainage being held after the 50% completion. This would result in 5% of the total value of the contract, being held by the general contractor, at 100% completion. This negotiation is open ended, and can result in many different scenarios for retainage withheld.
Final payment; The final payment is a customized negotiation, specific to the project, and is normally not received until all aspects of the contract have been fulfilled. These final requirements should include the total completion of the punchlist, the submission of all final documents such as as-built drawings, warranties and guarantees, as well as items such as final lien waivers, final certification of specification compliance, etc. Final payment is not an easy process on most construction projects, and the final individual subcontractors payments, in many instances will rely on the compliance of all other subcontractors on the project.
The ability to achieve final payment has become almost an art form within itself.
b.) Change directives;
The contract must contain specific information regarding additional work or change directives.
Procedure; It is imperative that a specific procedure be identified within the contract, to identify the process for properly identifying and managing changed or additional work.
Change directive notification; The required notification period, must be identified and properly described, to ensure that the contractor has a clear understanding regarding changed work and the procedure for administration of this changed work. ( See Change Orders, on this website for additional information )
Implementation ; The implementation of change orders is always an important aspect of the management and communication between the general contractor and the subcontractors. Implementation of the change order work must be clearly and professionally identified, to ensure that there is a clear understanding of the process.
The formal procedures to be put in place for communication protocol between the general contractor and the subcontractors is important for the professional and efficient management of the project. The time required for notification, the time allowed for decision making, and the time allowed for implementation of the communication, is all essential and should be professionally managed and documented within the contract.
What items specifically require formal notification?
1.) Commencement to proceed with work ( Contractor to subcontractor )
2.) Schedule compliance ( Contractor to subcontractor )
3.) Manpower compliance ( Contractor to subcontractor )
4.) Approval of Change Order work ( Contractor to subcontractor )
5.) Request to accelerate ( Contractor to subcontractor )
6.) Request to decelerate ( Contractor to subcontractor )
7.) Notification of contract change of scope ( Subcontractor to contractor )
8.) Change Order initiation ( Subcontractor to contractor )
These are only some of the notifications that will occur as the project advances. The entire objective of the notification clauses within a formal contract, is to establish the number of days that various notifications are required to be made. In addition, the time allowed for notification response is important to establish, allowing both parties the opportunity to officially and unfortunately legally respond.
Specified time periods are important to allow official legal avenues to be formally taken.
As a summary to this brief review of contract basics, the establishment of an accurate and meaningful contract, together with various specific attachments, is essential to the proper management of the project. Construction is difficult enough and creates its own conflicts, delays, disagreements and general havoc between the contractors involved, without incomplete and mismanaged contracts.
The more precise and coordinated the construction contract between contractors, the less disagreements and misunderstood conflict will occur.
If you perform due diligence in the initiation of the contract, it will promote a sense of professionalism, that will generate coordination and problem solving throughout the project. Lack of effort and professionalism in the beginning of a project, will simply cause repeated issues in the field as well as schedule delays and increased costs, as the project attempts to limp towards completion.
I make my living by picking up the pieces of projects that have not been professionally managed nor initiated. If you perform your due diligence, and spend the time to professionally identify the scope, the schedule, as well as any anticipated issues prior to their full blown development, the project will run much more efficiently and the costs will remain within budget.
Good luck, and please write a good contract!