Fair is Fair…Right? Basic Principles of Risk Allocation in Construction Documents, Part 1, by Kevin O’Beirne, Chair EJCDC

Your mother probably taught you the original Golden Rule: “Do unto others as you would have them do unto you.”  Then when you were older you undoubtedly learned the real Golden Rule: “He who hath the gold maketh the rules.”  Unfortunately, the latter Golden Rule is usually a basic tenant of construction contract preparation, and it shouldn’t be.  (And no, some construction contractor didn’t pay me to write that.)

Basic principles of fairness are well-ingrained in most of us.  Anyone watching the classic, 1978 slob-comedy film Animal House gets the joke when the antagonist, Dean Wormer, bellows during a disciplinary hearing against an unruly fraternity, “I’ll tell you what’s fair!”  Despite everyone getting the joke, many owners and design professionals frequently write construction documents that have highly slanted risk allocations.

Both parties (owner and contractor) and other project stakeholders come out ahead when the construction contract is fair.  The contractor, subcontractors, and suppliers all like fair provisions because it improves their bottom line.  The owner benefits from fair provisions because it promotes an appropriate climate for business that will ultimately result in lower pricing bid or proposed to the owner.  The design professional prefers fair provisions because they contribute to a less-contentious project with fewer claims and a happier client.

Common Provisions that Allocate Risk

Provisions throughout the construction contract documents allocate various forms of risk, often without the owner and design professional fully realizing it.  Some of the most-obvious and common clauses that allocate important risks in almost every construction contract are:

  • Responsibility for pre-construction site conditions and provisions on differing site conditions discovered during construction. Optimally, the construction documents should fully-disclose all the information known to the owner and design professional, and indicate how bidders and the contractor may obtain such information, and indicate that information on which bidders and the contractor may rely.
  • Indemnification provisions. Such provisions should be reasonable and should cover only losses incurred due to the indemnifying party’s negligence.
  • Insurance provisions, including which entities are to be additional insureds, and a requirement for a waiver of subrogation by the insurance carrier(s).
  • Contract time provisions, including liquidated damages and bonus/penalty clauses. Many non-standard contracts contain “no-damages-for-delay” provisions (e.g., the contractor is not due additional compensation for delays caused by the owner) which are understandably disliked by contractors.  Some contracts include an escalating schedule of liquidated damages amounts, often for which there is no rational basis (other than punitive).
  • Clauses assigning responsibility for safety at the site.
  • Provisions on controlling the work. This is typically rightfully the contractor’s responsibility, but many non-standard contracts interject the owner into evaluating the contractor’s employees’ fitness and competency of subcontractors, judging the acceptability of the work on a continuous basis, and other items, which serves to transfer to the owner risks that are normally rightfully the contractor’s.
  • Payment terms, including retaining provisions (which are included in most construction contracts) and “pay-when/if-paid” clauses (common in subcontracts).

Examples of Actual Contract Language

Although project problems can be significantly compounded by poor construction contract administration by an owner or their design professional, the principal causes of inappropriate risk allocations arises from one of the following: 1) When standard contract documents, such as those by the Engineers Joint Contract Documents Committee (EJCDC), are edited for a given project by changing their risk allocations, and 2) When non-standard contract forms (e.g., prepared for and maintained by a project owner, without relying upon standard documents such as those of EJCDC) are used.

After reviewing more than 100 different owners’ sets of non-standard construction contract documents and their dazzling array of atypical and sometimes unfair risk allocations, a few examples from actual contracts used on public works projects are shown below.

  1. The apparent unfairness of this one is evident: “Contractor agrees that, in the event of any ambiguity or conflict in the Contract Documents, the language in the Contract Documents shall not be construed against the Owner.” Unfortunately, this type of provision is very common.
  2. The following makes the contractor, not the owner, responsible for all pre-construction conditions at the site (despite the owner having selected the site) and attempts to preclude claims for changed conditions. This owner’s documents also require all bidders to perform their own investigations of the site during bidding: “Contractor is responsible for all conditions that exist at the Site.  Contractor has represented in its Bid that Contractor has visited the Site and made a reasonable and thorough investigation of the Site.  Contractor has undertaken all studies, inspections, or other actions the Contractor deems necessary to discover any differing subsurface or physical conditions …, any Underground Facilities …, and any Hazardous Environmental Conditions…”  This certainly engenders contemplation that, if the bidder is supposed to do all those investigations during the short bidding phase, the owner or design professional could have evaluated the site during the six or 12 months it took to design the project.
  3. The following allows the contractor only three days to file the initial notice of a claim and just 15 days to submit all the information necessary to substantiate the claim; EJCDC and AIA documents allow 30 days for each (for a total of 60 days), and empower the entity determining entitlement in the claim to allow more time if necessary.  The following sample provision also bars all claims submitted later.  The purpose of these short time frames could be to preclude, based on lack-of-timeliness, otherwise valid claims.  Furthermore, in the following clause, the owner itself is the entity that determines entitlement on the contractor’s claims, which is like having a defendant serve as the only member of the jury at his own trial: “… Notices of Intent to Claim shall be given no later than three (3) days after the occurrence of the event giving rise to the potential Claim.  Notices of Claim shall be given no later than fifteen (15) days after Owner’s written determination in response to the relevant Notice of Intent to Claim submitted by Contractor.  If the Contractor submits a Combined Notice …, the Combined Notice shall be given at the time the Notice of Intent to Claim is required under the Contract.”  And, “Strict compliance with the provisions of this Article, including all Notice and submittal requirements, shall be a condition precedent to the assertion of any Claim, and any Claim not presented as required by the provisions of this Article shall be barred.”
  4. While there are many interesting examples of onerous indemnification requirements, the following stands out. In it, the contractor is responsible for, among other items, 1) the site’s pre-construction condition, 2) delays caused by force majeure events, and 3) for indemnifying the owner for the owner’s own negligence: “The Contractor shall take all responsibility of the work of his respective trade, said Contractor shall bear all losses resulting to said contractor on account of the amount or character of work, or because the nature of the land in or on which the work is done is different from the assumed or expected [conditions], or on account of the weather, floods, or other causes; and the said contractor shall at said Contractor’s own proper cost and expense assume the defense of and indemnify and save harmless the [Owner] and their employees, officers, and agents from all claims of any kind arising from the performance of this contract, whether or not any active or passive or concurrent or negligent act or omission by the [Owner] or any of their employees, officers or agents may have directly or indirectly caused or contributed thereto…”  The actual provision is twice as long as this excerpt.

These examples were selected because they are representative of provisions we have seen in many non-standard contracts.  Unfortunately, the above are hardly rare examples.

Such provisions are not exactly highlighted in the associated contract documents.  A careful, coordinated review of all the contract provisions is necessary to find them amongst scores or even hundreds of pages.  Although such reviews are time-consuming, they are a necessity both for contractors (because they will affect pricing) and design professionals (to control the design professional’s own risk exposure and to hopefully advise the owner on more-reasonable risk allocations).

How do such clauses get into an owner’s contracts?  The answer is twofold: 1) They grow like moss on a rock, as provisions are added and modified on an individual-paragraph basis as project experience is gained. 2) They are often drafted by the owner’s attorney, who is often not a “contracts attorney” and may not fully-understand the effects of such provisions; furthermore, attorneys are paid to represent their client in a partisan manner, and some owners’ attorneys appear to believe that lopsided risk allocations mean a contract that is better for their client.

Be on the Lookout for the Next Installment:  What’s a Contractor to Do?