Negotiating a Construction Contract:
Tips and Reminders
With construction activity in the Phoenix area and across Arizona gradually rebounding, now is a good time to brush up on contract provisions that, if overlooked, could stall your comeback
This article appeared in the March 2012 issue of "The Construction Advisor"
published by Lang & Klain, P.C.
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Before You Contract
Be sure you hold the correct license.
Unlicensed contractors cannot lien or sue for payment.
Check the general
contractor’s license at
Causes for concern include a suspended license, no license, or
Check out the owner: In Maricopa County, find liens and judgments
at the County Recorder's
Recorded Document Search page,
and find lawsuits at the
Superior Court website.
Also, ask other trades on the
project about payment.
Secure your lien rights by
sending a pre-lien before starting work. If a tenant is making the improvements, you
typically have lien rights only against the building, not the land. If the property is owner-occupied, you
have lien rights only if you contract directly with the owner (A.R.S. §
33-1002[B]). If you have
orders, remember to amend your pre-lien.
Determine whether the
project is bonded, and ask for a copy of the bond. (More about
public project bond claims and
private project bond claims.)
AIA Standard Forms vs. Privately Drafted Contracts
There are advantages of using AIA (American Institute of
Architects) forms: They are the industry standard and are commonly
used. They are also very thorough (and the most litigated), so
interpretation is generally not an issue, and you don't have to hire
a lawyer to draft it. There are also disadvantages: AIA forms
are very long and relatively difficult to understand, and they are
Non-AIA (i.e., privately drafted)
contracts are cheaper, shorter and less formal and generally include
only essential terms. If you decide to use a privately drafted
contract, make sure it contains all of the minimum
elements of a contract required by the ROC (A.R.S. § 32-1158) and all
of the terms to which you and the other party (owner, general contractor
or subcontractor) agreed.
Beware of Certain Contract Clauses
Integration or Merger
What It Does. Bars parties to a contract from later claiming that the
contract does not reflect their entire understanding, was changed by a
subsequent oral agreement, or is inconsistent with prior agreements.
Sample Language. "This Agreement
and the exhibits attached hereto contain the entire agreement of the
parties with respect to the subject matter of this Agreement, and
supersede all prior negotiations, agreements and understandings with
respect thereto. This Agreement may only be amended by a written
document duly executed by all parties."
What to Do. Make sure that all promises and agreements are actually
included in the written contract, as otherwise it may be impossible to
enforce those unwritten promises.
What It Does. Passes through to a subcontractor the risks and
obligations assumed by general contractor in the prime contract (i.e.,
the general contractor’s obligations to the owner under the prime
contract "flow down" the contractual chain through the general
contractor to its subcontractor).
Sample Language. "The Subcontractor
shall be bound to the Contractor by all the terms of the Contract
Documents, and to assume toward the Contractor all the obligations
and responsibilities, including the responsibility for safety of the
Subcontractor’s work, which the Contractor, by these Documents,
assumes toward the Owner and Architect."
What to Do. If you are a
subcontractor, try to strike this type of clause unless you review the prime contract and you
accept all of the general contractor’s obligations to the owner.
What It Does. Requires the subcontractor to indemnify the general
contractor against claims arising from the work, sometimes regardless of
whether the subcontractor is at fault. Under many prime contracts, the
general contractor is required to extend the same indemnity to the owner
(another reason that subcontractors should be wary of "flow-through" clauses).
In Arizona, clauses requiring a subcontractor to indemnify the
general contractor against claims arising from the general
contractor’s sole negligence are illegal, pursuant to
Pioneer Roofing Co. v.
Mardian Const. Co., 152 Ariz. 455, 459, 733 P.2d 652, 656
(Ct. App. 1986).
Sample Language. "The subcontractor
agrees to indemnify and hold harmless the contractor against loss or
threatened loss or expense by reason of the liability or potential
liability of the contractor for or arising from any loss or damage
that may be occasioned by or through the acts or omissions of other
persons or contractors at the Project site subcontractor’s
performance of the work."
What to Do. Subcontractors should
seek to strike the clause to the extent it requires them to
indemnify the general contractor for anything other than the
subcontractor's own acts.
Waiver of Subrogation
What It Means. "Subrogation" means a party has the right to "step
into the shoes" of another party for the purposes of bringing a claim
for damages. Where an insurer has reimbursed its insured for loss, a
"waiver of subrogation" clause prevents the insurer from stepping into the
insured’s shoes and suing the party who caused the loss.
Sample Language. "To the extent
damages are covered by insurance during construction, the Contractor
and the Subcontractor waive all rights against each other and
against the contractors, consultants, agents and employees of the
other for damages, except such rights as they may have to the
proceeds of such insurance."
What to Do. Clear it with your
insurance carrier before you agree to it.
"Pay If Paid/Pay When Paid" Clause
What It Does. It conditions a
general contractor's payment to a
subcontractor on whether the general contractor has been paid by the
owner for the subcontractor’s work. In Arizona, the language of a "pay
when paid" must be very narrow to be enforceable, per L. Harvey Concrete, Inc.
v. Agro Const. & Supply Co., 189 Ariz. 178, 939 P.2d 811
(Ct. App. 1997).
Sample Language. "The total price
paid to Subcontractor shall be [contract price], no part of which
shall be paid until five days after payment is received from owner,"
or "… the Contractor shall pay the Subcontractor each progress
payment and final payment ... within three working days after he
receives payment from the Owner …"
What to Do. Subcontractors should
seek to strike this clause. (More about
pay-when-paid, pay-if-paid clauses.)
"Time Is of the Essence"
What It Does. It may support an action for breach of contract where the
contract is not completed within a reasonable (or specified) time.
Sample Language. "Time is of the
essence for the completion of the work described in this contract.
It is anticipated by the parties that all work described herein will
be completed within two (2) weeks of the date of execution, and that
any delay in the completion of the work described herein shall
constitute a material breach of this contract."
What to Do. Be sure you can complete the schedule milestones
within the agreed-upon timeframe.
Liquidated Damages Clause
What It Does. A liquidated
damages clause specifies damages that the general contractor may claim
against the subcontractor for failure to meet schedule milestones. Usually,
they are per diem amounts that are assessed for the total number of days
the project is delayed.
Sample Language. "If the
Subcontractor fails to complete the work within the contract time or
fails to achieve any of the contract milestones, the Subcontractor
agrees to pay the Contractor $______ per day as liquidated damages
to cover losses, expenses and damages of the Contractor for each and
every day which the Subcontractor fails to achieve completion of the
milestone work or the entire project."
What to Do. Be sure that (a) you can complete the schedule
milestones within the agreed-upon timeframe, and (b) the
specified damage amount is reasonable.
Dispute Resolution Clause
What It Does. A dispute
resolution clause sets forth the procedure for resolving disputes between the
parties related to the contract or the project.
Sample Language. "If any disputes arise between the parties, the parties
shall submit the dispute to a mutually agreed-upon mediator. If the
parties are unable to resolve the claim[s] through mediation, the
dispute shall be resolved by litigation in a court of competent
jurisdiction in the State of Arizona, unless the parties mutually
agree to binding arbitration, in which event such arbitration shall
be conducted pursuant to the Construction Industry Arbitration Rules
of the American Arbitration Association unless otherwise agreed upon
by the parties."
What to Do. Generally, this is a desirable provision for all
parties, as it can lead to cheaper and quicker dispute resolution.
However, beware of clauses that require the parties to submit disputes to
the American Arbitration Association (AAA) or similar organizations, as they
can actually be more expensive than litigation. It is better to simply
hire a local construction arbitrator and agree to abide by AAA rules.
What It Does. This type of
clause allows the general contractor to terminate the subcontract
without cause. Typically, the general contractor still must pay
the subcontractor for work performed, costs incurred because of termination,
and profit and overhead on work not performed.
Sample Language. "Contractor may, at any time, terminate the Contract for
Contractor’s convenience and without cause. In case of such
termination, the Contractor shall be entitled to receive payment for
work performed, and costs incurred by reason of such termination, along
with reasonable overhead and profit on the work not performed."
What to Do. This contract provision is generally acceptable
for subcontractors, but only if it does not require the
to waive payment for work performed, costs incurred because of
termination, and profit and overhead on work not performed.
Waiver of Consequential
What It Does. It is a waiver, usually by both parties, of claims for
any damages that are not directly related to the contract (i.e., cost to
repair or complete, rental expenses, loss of use, loss of financing,
lost profit, etc.).
Sample Language. "The parties waive claims against each other for
consequential damages arising out of or relating to this Contract or
What to Do. If you are a
subcontractor, no action is required, as this waiver is generally