By Martha Perkins
Whether you are a bond producer, owner, contractor, or subcontractor, success in the construction industry is largely an exercise in risk management—and construction contracts serve as a powerful tool to allocate those risks across parties. That is why it is so important to understand their intricacies. We asked Scott Walters, an attorney at the law firm of Smith, Currie & Hancock LLP and a participant on the NASBP Attorney Advisory Council, to weigh in on common risk-shifting provisions within construction contracts. Here are five clauses he said sureties and contractors should look out for in construction contracts:
1. Notice Provisions. Walters said notice provisions in contracts are “critically important” and can potentially put a surety at risk. “I’ve been seeing a lot of notice provisions that clearly are an attempt to shift significant risk from the owner to the contractor and, potentially, the contractor’s surety, if proper or timely notice is not given,” Walters said.
For example, if a contractor believes work is being delayed — such that it is taking more time to do the work and costing more to use resources longer — but the contractor doesn’t provide timely notice of that delay, ultimately the contractor could be deemed responsible for the delay under some contract provisions. “It could be a way of limiting the surety’s ability to recover certain time or costs back against the owner if the surety takes over or performs the work,” Walters said.
2. Indemnification Language. This type of clause is used to shift potential risk from one party to another and often applies when dealing with claims made by third parties. For example, a person visiting a job site may slip and fall, resulting in a claim against the owner. If there is an indemnification clause in the contract, the owner may be able to then shift the risk to the general contractor. These types of scenarios may well affect a surety that is guaranteeing performance of a project and stepping in fulfill an obligee’s responsibilities.
Such clauses may also include sole negligence exclusions where damage caused solely by an owner’s negligence will not lead to indemnification. “What’s reasonable is a contributory type of scenario, where I indemnify you for any negligent acts and you indemnify me for your negligent acts,” Walters said.
3. Limitation of Liability Provisions. Walters said these clauses allow parties to contractually limit exposure to damages. “As a rule, I advise clients to negotiate in their contracts an overall cap on damages,” he said.
Parties may also come to an agreement regarding the type of damages that can be covered. For example, a party may choose to waive rights for damages that are consequential to a particular breach of contract, or both parties may choose to mutually waive consequential risk.
Walters said these limitation of liability provisions often benefit all parties, including sureties, “because they know the scope of damages they will be responsible if they have to step into the shoes of and perform the obligee’s responsibilities.”
4. No-Damages-for-Delay Provisions. These clauses protect owners from damages caused by time extensions, sometimes even when the delay was caused by the owner. “Construction contracts are almost always one party contracting with another for a certain period of time for a fixed price,” Walters said. “If a project is delayed or extended, there are more costs associated with the added time to complete the work.”
Ultimately, a no-damages-for-delay provision shifts responsibility for delay-related costs back to the contractor, adding a significant amount of risk for the contractor and its surety.
5. Conditional Payment Provisions. Also known as “pay-if-paid” clauses, these provisions generally arise in contractor/subcontractor relationships. If such a provision is enforced, a general contractor may avoid its payment obligation to a subcontractor in the case that the owner fails to pay the general contractor.
“It shifts the risk of owner non-payment from the general contractor and puts that risk entirely on the subcontractor,” Walters said.
In cases involving public owners, sureties likely cannot rely upon conditional payment provisions as a defense to a valid payment bond claim. For cases involving private owners, sureties may be able to rely on conditional payment provisions as a defense to payment bond claims. That said, in some states (such as North Carolina and Ohio), conditional payment clauses are void altogether.
Of course, for all these provisions, there is generally no uniform law from state to state. “These provisions and how enforceable they are will depend on the law governing the underlying contract,” Walters noted.