Craig Ledet, Martha Buttry Daniels, Scott A. Greer and Mike Stenglein | King & Spalding LLP | September 11, 2018
Contracts and performance
Standard contract forms
What standard contract forms are used for construction projects in your jurisdiction? To what extent do parties deviate from these standard forms?
U.S. construction projects do not rely on one standard contract form. In fact, even when a form is used, the parties often make revisions. The most commonly used forms are those developed by the American Institute of Architects (AIA) and the American Society of Civil Engineers (ASCE), or are state-specific. AIA forms are popular in commercial real estate and are considered architect-friendly, so owners and contractors often push for a negotiated AIA. ASCE forms are more common in the industrial context. Residential construction contracts, such as for single-family homes, often rely on forms established by individual states. While forms from the International Federation of Consulting Engineers are popular in Europe, they are typically not used in the United States.
For larger projects, the parties often find it advantageous to negotiate their own contract, without relying on a standard form.
Definition of ‘construction work’
How is ‘construction work’ legally defined?
There is not one single definition for ‘construction work.’ Generally, individual states’ lien, anti-indemnity, or other construction-related statutes define construction broadly. The scope of work is usually defined by contract and will vary in specificity from project to project.
Governing law
Are there any rules or restrictions on the governing law of construction contracts?
Many states have ‘home court’ rules specific to projects constructed in the respective state. While the language in each statute differs, the general rule is that a provision in a construction contract is void or voidable if it requires litigation to occur in, or be subject to the laws of, another state. To get around the venue rules, parties may agree to arbitrate, rather than require litigation in a specific court system. That said, any contractual provision purporting to require the application of the laws of a state other than the state where the project is being built could still run afoul of the home court rules. These governing law restrictions can be complicated when horizontal construction occurs across borders, such as a pipeline running through different states.
Formalities
Are construction contracts subject to any formal requirements?
Construction contracts are subject to state-specific requirements. Many states have requirements on issues such as retainage, anti-indemnity provisions, prompt payment, and waivers of negligence or gross negligence—to name a few. These requirements often differentiate between the type of project: residential, commercial, or industrial. When drafting a construction contract, the best practice is to review the contract law of the relevant state.
Mandatory/prohibited provisions
Are there any mandatory or prohibited provisions in relation to construction contracts?
Whether a construction contract has prohibited provisions is subject to state-specific requirements. Every state has some restrictions on risk-shifting, but the extent of those restrictions varies. Similarly, the states scrutinize waivers of rights and responsibilities, as well as limitations of liability. Some states also restrict or prohibit the use of design-build delivery systems for public projects, although this method is becoming increasingly more popular in the public space. While there are restrictions, the states do not have mandatory contract provisions. When drafting a construction contract, the best practice is to familiarize oneself with the relevant state’s contract law.
Implied terms
Can any terms be implied in construction contracts?
The terms most commonly implied in construction contracts are warranties, which are subject to state law. Both owners and contractors may be subject to implied warranties. Under the Spearin Doctrine—effectively adopted by all 50 states—there is an implied warranty of accuracy for any information that the owner shares with the contractor. This can be critical for engineering, procurement and construction (EPC) contracts, but the majority of states allow the parties to waive this implied warranty. Various implied warranties apply to the contractor’s work, such as the implied warranty of merchantability and the implied warranty of fitness for a particular purpose.
In addition to implied warranties, state-specific products liability and consumer protection laws may be implied by law into contracts.
Risk allocation
How are risks typically allocated between parties to construction contracts?
The contract delivery strategy dictates how liabilities are handled. A traditional design-bid-build model is one liability set that consciously separates the liabilities (e.g., the construction contractor is not responsible for design errors unless the contractor discovers the error and fails to report it). In the EPC context, greater risk falls on the EPC contractor. There are many ways to allocate risks between parties to construction contracts (e.g., indemnities, limitations of liability, risk of loss provisions, performance guarantees, etc.), and that allocation often depends on the parties. The liability structures also depend on the industry, what is being built, who can bear the risk, each parties’ financial wherewithal, economic undercurrents, geography, issues with union labor, and political considerations.
Limitation of liability
How and to what extent can parties to construction projects contractually limit or exclude their liability?
There are many ways to contractually limit or exclude liability, through clauses such as limitations of liability, risk of loss provisions, waivers of consequential damages, and waivers of implied warranties. The states have their own restrictions on such limitations. For example, most states will enforce a limitation of liability provision only if it is explicit, prominent, clear, and unambiguous. Indemnities are also used to limit liabilities, but the drafter should take into account construction anti-indemnity statutes. Because each state has its own requirements, one should always analyze the relevant state-specific rules when drafting a construction contract.
In addition to the aforementioned mechanisms to limit or exclude liability, the parties may also shape their liabilities with warranties and representations, as well as contractual limitations on when and how relief may be sought.
Liquidated damages
How are liquidated damages typically calculated and to which liabilities are they usually applied?
Liquidated damages are traditionally used as a remedy for delay (including the contractor’s failure to mobilize or failure to complete its scope of work by a specified date), but they may also address performance elements. Interim liquidated damages can be based on delivery dates for multi-prime coordination.
Most states have specific case law on how liquidated damages should be determined and when they will be held unenforceable. Generally speaking, most states require liquidated damages to be calculated based on a genuine pre-estimate of what the party believes its damages would be in the event of breach by the other party. The damage amount may consider lost profits related to failure to start up. For commercial real estate, it may be calculated based on lost real estate rental income. Liquidated damages amounts can also take into account debt service and the extension of corporate and on-sight overhead.
Force majeure
How are force majeure clauses treated in your jurisdiction? Is there a legal definition of force majeure events?
There is not a single legal definition of force majeure events in the United States, as these clauses are analyzed on a state-by-state basis. As a general rule, a force majeure event must be beyond the reasonable control of the party, or unforeseeable at the time the parties entered into the contract. Force majeure typically allows only for schedule relief, rather than cost relief.
The parties may choose to define force majeure in the construction contract as they see fit, and they may agree that cost relief will be available in certain limited circumstances. Force majeure is negotiated differently depending on the industry, location, what is being built, and how the parties want to handle risk. In many contracts, the parties will negotiate and agree upon an exclusive list of events that qualify as a force majeure event, rather than relying upon a general definition.
General performance obligations
What are the general performance obligations of contractors and employers?
The parties’ general performance obligations depend on many factors, including what is being built, how the delivery system is set up, the expectations for the project, and the express terms of the contract.
Construction professionals are subject to various ethical and professional obligations. For example, engineers generally have a duty to perform to the standard of a reasonably prudent engineer, although the relevant contract may establish an even higher standard. For example, if the contract is an EPC contract, the standard in the industry is that there shall not be any defects in design or engineering, rather than relying solely on the standard of a reasonably prudent engineer. Contractors may also be subject to agency rules and fiduciary duties.
Project delays
How are project delays typically handled? Do any set rules, restrictions or procedures apply in this regard?
Project delays are one of the most commonly litigated construction issues in the United States. Well-drafted contracts establish clear grounds for entitlement to relief for delay. Disputes often arise regarding who caused the delay and how to calculate the relief for such delay. The modern trend in most U.S. jurisdictions is to allow apportionment of fault for delays. Additionally, contractors often challenge liquidated damages for delay as unenforceable penalties. To overcome that challenge, the party seeking to recover liquidated damages must generally be able to show that the amounts were a genuine, good-faith pre-estimate of the damages that would be incurred in the event of delays.
Contract variations
To what extent can the parties make variations to the contract? Do any set rules, restrictions or procedures apply in this regard?
A well-written contract will prohibit contractual variations unless it is done through a formal amendment or approved change order. Contract provisions are often found ambiguous, though, in which case most courts will allow some extrinsic evidence to resolve the ambiguity. In practice, this sort of evidence can change many core components of the parties’ arrangement. For this reason, even if the contract seems perfect, parties to a construction contract must stay engaged and ensure that the trail of paperwork properly reflects the contractual intent. The rules on contract variations exist on a state-by-state basis.
Termination
What are acceptable grounds for the termination of a contract?
Typically, a contract may be terminated for convenience or cause. Termination for convenience is common in construction contracts and is usually available only to the owner. When properly described in the contract, it allows an owner to terminate its contractor at will, and pay for costs incurred by the contractor up to the termination date. These costs largely depend on the industry and contract.
The contract should also define when an owner may terminate a contractor for cause. Termination for cause can be for many reasons, including, but not limited to, the contractor’s failure to perform the work, refusal or failure to supply enough skilled workers, failure to pay its subcontractors, and insolvency. Sometimes the owner may replace the contractor for safety reasons or because the contractor has repeatedly disregarded applicable laws.
The contractor can also terminate the contract for default, but that right is typically narrower. Justified reasons for doing so generally include the owner’s failure to pay undisputed amounts under the contract after a grace period has expired.
Remedies for breach
What remedies are available for the breach of construction contracts?
The owner generally has several different remedies for the contractor’s breach, including liquidated damages, termination of the contractor (for convenience or cause), and withholding payment. In certain circumstances, the owner may also pursue injunctive relief or specific performance. Under express and implied warranties, the owner can require the contractor to correct defects to its work, or pay for a third party to do so, then pass that cost on to the contractor.
The contractor’s remedies are often more limited, but may include termination for cause if the owner defaults. The contractor’s primary remedy is an entitlement to additional cost or schedule extension when an owner breaches its obligations. In the event of non-payment, the contractor may also lien the project. This often requires the contractor to satisfy specific requirements, defined by each individual state.
Either party may proceed under standard breach of contract theories. All of these remedies should be defined by the contract and may be addressed more generally by state law.