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October 8, 2020
(Editor's note: This is the second of a two-part series on residential construction contracts. Part one ran on Oct. 1.)
Drafting a contract is never fun. Reviewing one is often even less entertaining. So what happens when a homeowner is considering a significant remodel or building a spec home on a vacant lot? Typically, the relationship between the owner and the contractor is key. But these relationships can and do break down, especially in stressful times when various dates (commencement and completion) are often in a state of flux.
Below are the last five of 10 items every residential homeowner should look at in the contract with their contractor. The list is not in any particular order.
6. COSTS AND BILLING PROCEDURES
What is this? Generally speaking, there are two types of construction contracts, in terms of how the contractor will charge the owner. It will either be “fixed price” which is also known as “lump sum,” or it will be on a “time and materials” (T&M) basis which is sometimes called “cost plus.” Fixed price is essentially a black box or sticker price. If the contractor's actual costs are less than the sticker price, the contractor makes money. If the contractor's actual costs are more, the contractor loses. Typically this is the easiest kind of contract to administer for the contractor, as long as the interim milestones are clear. For example, 50% payment upfront, 25% upon completion of framing and 25% upon completion of the punch list. Under the fixed price method, time cards and receipts from suppliers and subcontractors are not relevant.
Why is this important? For contractors and owners, this is typically the primary concern: It's all about the money. Either method is fine. It varies significantly by the contractor's preference, the type of job (small or large), and any number of other factors. One key thing to keep in mind regarding fixed price contracts: Many owners assume that if the price is fixed this is a guarantee construction will not exceed this cost. This is a false assumption unless the contract also states that it is a “guaranteed maximum price” (GMP) or “not to exceed.” If these words are not in there, though the contractor should not go over the amount stated, it is not guaranteed. Changes are often the key reason, and the point below discusses changes. On the T&M side, it should be very clear how the contractor will be calculating the T (time), and whether the T will also be marked up or is all inclusive, meaning it will not be marked up again.
Takeaway. Get comfortable and confident in how the contractor will be billing the owner. Owners can and should be very candid at the outset about this. It helps the contractor and owner get on the same page.
7. CHANGES AND CHANGE ORDERS
What is this? The contract itself should spell out how changes will be initiated and paid by the owner. There may also be a change order form but the contract is the quarterback — it should discuss the process and can often help if the contractor provides a sample change order form at the outset so that the parties know more about the process.
Why is this important? This area is probably where most disputes occur, on both T&M and fixed price contracts. Owners typically request changes, but later owners will represent they did not know what the change entailed, why it would delay the project, or why it was so expensive, since — though they might have requested it — they did not budget for it.
Takeaway. First, the clause in your contract about changes and change orders should spell out how changes are initiated, how they are priced, when payment is due and any other issues that will allow everyone to be prepared since, as they say, change happens. One final note: change orders are different than a punchlist. It is good practice for the contractor to spell out the punchlist procedure at the end. This allows the owner to point out issues it would like corrected (such as fixing nail pops), when the issues are fresh. When owners start calling in warranties later, contractors often assume that owners may have caused the issue (such as a scratch) and disputes can arise over the condition that the contractor left the property. For contractors and owners, the best practice is to document everything during the project and particularly immediately before demobilization. Second, owners and contractors will want to make sure that the initial scope has enough detail to avoid “haziness” about what is or is not a change. These details should include specific information about quality, finishes, system details, tolerances, etc. Disputes, the next topic, almost always arise when the owner thinks he or she is getting a certain quality item, but the builder has budgeted something very different. Rarely are these topics spelled out with absolute specificity, but they should be. When they are not, which is where we see many disputes arise, there is an argument about whether there was a true meeting of the minds about various aspects of the project, leading to an expensive and fact-intensive arbitration or trial.
8. DISPUTES AND REMEDIES
What is this? The contract should spell out exactly what happens — and when — a dispute arises. How will the parties try to resolve it? The scope of this article is too general to get into specifics. But, the one key provision both parties should strongly consider including (though there are drawbacks too) is a prevailing party attorney fee clause.
Why is this important? This should help tamp down suits. Should is the key word. Nothing will stop a motivated party from suing. In the absence of such a clause, and absent a statute, both parties will pay their own attorney fees, win, lose, or draw. This is called the American Rule. For example, if the contractor sues, claiming it is owed $12,000, and the contractor gets $0, in the absence of a clause allowing the prevailing party to recover, the owner may pay $20,000 to defend, but get nothing back from the contractor.
Takeaway. To the victors come the spoils, as the saying goes. But, the flip side is this: If you lose, and you do have a clause stating the prevailing party is entitled to fees, in the example immediately above, the contractor may not only get $0, but have to pay $20,000 to the owners if the owners prevail.
What is this? Indemnification would mean that, if a contractor's employee is injured, and the employee sues you (alleging unsafe work conditions), if the contractor agrees to defend, it is then the contractor's issue also.
Why is this important? Indemnification is important because, if the owner had nothing to do with an injury, the owner should not be stuck defending. This can get complicated, but arises under RCW Title 51.
Takeaway. Due to the way Title 51 is drafted, employers (contractors) are “immune” from suits by their injured employees. However, with a properly drafted indemnity clause, if the contractor causes the injury, and the owner is sued by the injured employer, the contractor will have to address it. This topic also underscores point No. 1 (see Oct. 1 article) as well, providing an extra layer of protection in certain cases for owners.
10. LIEN WAIVERS/NOTICE
What is this? Lien waivers relate to the contractor and its subcontractors and suppliers agreeing they will not lien and have been paid during the project. A good contract will require all such waivers, supplied by the general contractor, prior to any interim payments. A lien notice is something a residential owner must sign prior to work starting. This is state law. If you do not get a “Notice to Customer” to sign, relating to liens, though this sounds promising (no one wants to be liened), this is a bad sign. The contractor has to provide this to you and obtain your signature prior to work starting. This does not mean you are being liened, it explains that if you don't pay, you could be liened.
Why is this important? Lien waivers are important because you do not want to be liened by a sub-tier later, even if you have paid the contractor. The final waiver from the contractor is also important for the same reason. You want finality when the job is done, from the contractor. Along the way (ideally with each payment on larger jobs), you will want to know that the money you are paying is going to the parties who are owed.
Takeaway. Avoiding liens (and conversely protecting the right to lien for a contractor) are key issues when it comes to payment. At a minimum, an owner will want to be fully educated on his or her rights and remedies. Education is the purpose of the “Notice to Customer,” so every owner should read it carefully before signing. Again providing the notice with the contract does not mean the owner will be liened. It simply outlines rights and remedies, and informs the owner about the contractor's bond and registration, which is important, and leads to the final point below.
ONE LAST TIP
Each of the above can make or break a project when the circumstances are “right” (meaning things go wrong unfortunately). But one last tip, which is not a contractual issue, but can often be more important: L&I record verification.
What is this? It is strongly advisable to check out the contractor's record on the Department of Labor & Industries' website, at https://secure.lni.wa.gov/verify/. It will show other pending cases involving the contractor's bond, it will show the amount of the bond (typically $12,000) and it will show any other infractions. It will also show the amount of the contractor's insurance (typically $1 million). This insurance would be what you are looking at, as a maximum, if you have to sue your contractor directly (versus being an additional insured; see point No. 1).
Why is this important? This will at least provide a general background of the contractor's record. Note that many outstanding contractors have multiple claims against their bonds, and some contractors who may not perform perfectly may have no claims. This point is made since, though it is important to verify the contractor is current with L&I, and the amount of its bond, suits often happen without justification, and though the case will ultimately show up as dismissed, it will still always show up on the contractor's L&I page.
Takeaway. Information is key. Too much can be a problem (there are always naysayers online, on other sites), but too little can be a major problem as well.
Seth Millstein has been practicing construction law in Seattle since 2004 and is a member of the Washington State Bar Association's Construction Counsel. Millstein founded Pillar Law in 2010, where he and Kerry Lawrence represent owners, contractors, suppliers and trades in construction matters.