Top 4 Big Issues in Construction Contracts
Contracts are usually designed to manage risks and allocate risks. In other words, contracts define who is financially responsible for things. Construction contracts are your best tool for a contractor. They can shift risks to varying parties. However, shifting risks can cause adverse owner-contractor relations. The most common disclaimer clauses cover uncertainty of work conditions, delaying events, indemnification, liquidated damages, and sufficiency of contract documents. This is why it’s important to know what’s in a contract, and what can be done to mitigate visible and not so apparent risks.
1. Construction Contracts Allocate Risks to Control Them
Construction contracts are about ensuring the work is performed and reducing risk. This is why it’s important to note what risk is assigned to which party. It instills accountability. An owner or architect isn’t likely to take on injury risk, so most likely they will try to assign that to a contractor or subcontractor. And a subcontractor or contractor won’t want to take the risk for a bad design. The whole point is to ensure that the assigned responsible party can limit and reduce risks in a specific field.
The first thing in any risk allocation scenario is to check whether it is reasonable or not. You should know exactly which risks they’re assigning to you and your company before signing. That way you can negotiate any risk allocation that doesn’t make sense. Many contractors, when the risk is shifted to them, will add a contingency to the bid price, so that they’re partially covered if something happens.
2. Allocating Risks Through Indemnity Provisions
Indemnity provisions are another way of allocating risks. Indemnity is the security or protection against losses and financial burdens. These provisions are important in construction contracts because they obligate one party to pay for the losses incurred by another party. Sometimes they even require one party to defend another party, so after risks have been allocated to each party the next step is the indemnity provisions. An Indemnity provision means a contractor or subcontractor could be financially responsible for and obligated to defend the owner, but these would only be in limited cases.
For example, a subcontractor might be financially responsible for bodily injury or property damage claims because of negligence. If a worker accidentally breaks something on the site, the subcontractor could be financially responsible for the damage. However, if the site is full of hazardous waste, the owner would be responsible for any bodily injury or illness because this is a risk that a contractor or subcontractor can’t control.
3. Insurance is How to Minimize Risk & Loss
Insurance can minimize risk and loss in construction contracts. Some owners require contractors and subcontractors to have insurance to cover these potential issues. There are a variety of insurance options for contractors and subcontractors to help:
Liability Insurance – Liability insurance covers injuries, accidents, and property damage that happens on the job.
Builder’s Risk Insurance – It pays for damages up to the limit. Which could be the total completed value of the structure or another figure.
Natural Disaster Insurance – Weather can be a big factor in construction and some projects can benefit from a flood, fire, or other natural disaster insurance.
4. Surety Bonds
Surety bonds work to promise owners that a contractor or subcontractor will complete the construction contract. It is designed to prevent loss rather than compensating an insured person for an unforeseen circumstance. They protect owners against contractor default when it happens and can establish credit for contractors. There are many different types of surety bonds, but but the three most common are:
Bid Bonds – Which assure a bid was submitted in good faith and can provide the services outlined in their proposal.
Performance Bond – a performance bond protects an owner from financial loss if a contractor or subcontractor can’t perform their duties.
Payment Bond – this one assures that contractors will pay their workers, subcontractors, and suppliers.
Surety bonds can help contractors get jobs because there is a third party guaranteeing the work and some owners won’t work with people unless they have some sort of bond. The bonds can help contractors and subcontractors as well because the workers are guaranteed wages, and more likely to be willing to work with the contractor. Surety bonds also help contractors because it gives them a line of credit they can use in emergencies or when immediate cash is need.
Construction contracts can be a contractor and subcontractor’s best tool in projects. They not only help define the scope of the work, but they are what brings in money. This is why it’s important to know what the risk allocations are with the project and how to protect yourself from financial repercussions from those risks.