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Building a Better, Stronger Contract

WEDNESDAY, MAY 14, 2014

By FMI


More items for Good Technical Practice

Few industries require the use of contracts more than construction.

Contracts are much more than a promise. They promote economic efficiency by ensuring that agreements are completed, insulating parties from additional costs and providing remedies for any breaches.

Hardhat Standoff
© iStock / Lisa-Blue 

Few industries need strong contracts more than construction. Knowing the fundamentals will help secure your competitive advantage.

Understanding contract fundamentals is an important skill that construction leaders need to gain a competitive advantage.

Contract Fundamentals

A contract is commonly understood as an agreement by two or more parties that is enforceable by law. This is correct, but shortsighted.

A more technical definition would be: an agreement with specific terms by two or more persons or entities in which there is a promise to do something in return for a valuable benefit known as consideration.

What it Takes

The basic elements of a legally enforceable contract are an offer, acceptance and consideration.

  • An offer is a proposal to make a deal by promising to provide a service, purchase goods, abstain from conduct, etc. It includes terms that are useful in defining the scope of the agreement. These terms must be specific and definitive to sufficiently identify the promise and allow the offer to be valid.
  • Acceptance is an unconditional willingness by the recipient of the offer to be bound by the offer. The acceptance must comply completely with the terms of the offer without modification (known as the “mirror image” rule); otherwise, it is a counteroffer.
Waterproofing concrete
© iStock / BanksPhotos

Every contract requires an offer, an acceptance and consideration. Not all contracts are in writing.

  • Consideration is the bargained-for exchange between the parties and is the mutual exchange of value. It is the reason that parties create contracts. Most commonly, consideration takes the form of money, objects or services.

What Can Go Wrong

Most mistakes are made in the offer and/or acceptance.

These include misunderstanding specifications, incorrectly entered price quotes, or flawed time estimates.

(As a side note, the rule of thumb is that honest mistakes, such as mathematical errors, are often excusable and relieve the party of the contract.)

A common misconception is that contracts must be in writing and include a signature. This is not always true. Contracts may be oral. However, some contracts must be in writing to be enforceable. These include contracts:

  • That cannot be performed within one year;
  • For the transfer of an interest in land;
  • For the sale of goods priced at more than $500; and
  • When one party becomes a surety for another party’s debt.

Termination

A contract is terminated when the parties have completed full and satisfactory performance of their obligations, or when:

  • One party defaults, causing a breach of contract;
  • The parties mutually agree to terminate;
  • Unforeseen circumstances render it impossible for a party to perform the duties; or
  • The contract is terminated due to an operation of law.

Remedies

If a contract is terminated through one party's failure to perform, the other party will likely receive damages. These are primarily designed to provide the non-breaching party with the benefit that was lost or to “make the party whole.”

Deskwork
© iStock / canuzuner

Contract breaches can mean a variety of damages, from money to court-ordered changes in the terms.

The party may receive money damages, restitution, rescission, reformation or specific performance.

  • Money damages are designed to compensate for the value the party would have received if the contract had been fully performed, or the cost to complete the project after the breach.
  • Restitution, which may include money or property, restores the non-breaching party to a position before the contract.
  • Rescission allows a non-breaching party to terminate contractual duties if that party entered into the contract by mistake, fraud, undue influence or duress.
  • Reformation allows a court to change the substance of a contract to correct inequities suffered due to mistake, fraud, undue influence or duress.
  • Specific performance compels a breaching party to complete specific duties and is available usually when money damages are inadequate.

Special Clauses

Force Majeure. Often standard in construction contracts, the force majeure clause is used to free all parties of liability or obligation for extraordinary events that occur beyond their control. It would be relevant, for example, if flooding ruined the land on which Contractor XYZ was going to build a hospital.

Pay When Paid/Pay If Paid.  In the most common version of this clause, the subcontractor is not paid until the owner pays the general contractor. This clause is generally within the contract's standard terms and is largely enforceable, as long as the conditions are expressed clearly.

No Damages for Delay. Commonly added by the project owner, the NDFD clause bars a contractor’s attempt to recover payment or compensation due to delays, but allows completion of the project.

News on tablet
© iStock / hocus focus

The force majeure clause is used to free all parties of any liability or obligation for extraordinary events, such as natural disasters, that occur beyond the parties' control.

Indemnification Clauses. Indemnification expands the risk that a party will undertake and shifts liability to other parties. It usually applies to additional available remedies and obligates one party to certain damages for specific occurrences that happen related to the contract.

For example, if a personal injury occurs on-site related to a subcontractor’s services, the general contractor would likely succeed in shifting liability to the subcontractor.

Understanding these fundamentals will allow industry professionals to make better decisions and understand available options before signing on the bottom line.

However, this is only an introduction and is not intended to constitute legal advice. Consultation with an attorney specializing in construction law is highly recommended before engaging in any contractual agreement.

About the Author

Gregg Schoppman is a principal with FMI who specializes in productivity and project management.

Gregg Schoppman

He also leads FMI’s project management consulting practice. Email Gregg or call 813.636.1259.

ABOUT THE BLOGGER

FMI

“Building Success” is written by professionals at FMI, the world’s largest provider of management consulting, investment banking, and research for the engineering and construction industry. FMI serves contractors, building materials and equipment producers,architects and engineers,owners and developers,and others across the industry. Author information is available at the bottom of each blog entry.

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Tagged categories: Contractors; FMI; Laws and litigation

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