By their very nature, construction projects are complicated and risky. The work is typically performed not just by a single contractor, but by a number of contractors, often by a general contractor who holds the prime contract with the owner of the project and a crew of subcontractors who hold contracts with the general contractor. Often, there are multiple tiers of contractors, with subcontractors awarding contracts to sub-subcontractors.
If one contractor fails to do its work properly or on time, it can affect the work of other contractors and, ultimately, the schedule and cost of the overall project. In addition, costs and schedules can be affected by events that are largely or entirely out of control of the general contractor, with weather and availability of materials being two of the most common. And, of course, construction work can be relatively dangerous, with accidents always a possibility.
The general contractor, or sometimes a construction manager, is responsible for obtaining permits, scheduling the delivery of materials, coordinating the work of all the other contractors, and enforcing good safety practices and procedures to see that the work is completed on time, within budget, and without personal injury. Nonetheless, there are significant risks of accidents, delays, cost overruns, and flaws in design or workmanship. Ideally, those risks are fairly and appropriately allocated among the contractors, the architects and engineers, the construction manager, the insurance underwriters, and the owner. That’s where lawyers come in.
Our lead business law attorney, Michael Smith, gained a significant amount of experience with construction contracts during his years as in-house counsel responsible for Eli Lilly and Company’s engineering, procurement, and construction components, experience that helps him to protect the interests of his clients involved in construction projects, whether they are contractors, subcontractors, suppliers of materials, architects and engineers, construction managers, or owners of construction projects, both in writing and negotiating contracts and in resolving disputes. He has experience in all of the following, and more:
- Design Contracts: Architects and engineers take the project from its basic conceptual stage through the creation of final drawings and specifications that are used to bid the work and ultimately to construct the final project.
- Construction Management Contracts: Professional construction managers are hired by the owner to oversee the execution of the project. The difference between a construction manager and a general contractor is that a general contractor is also responsible to the owner for the actual construction, while a construction manager is not.
- Construction Contracts, including:
- Fixed Price contracts in which the contractor agrees to do the work for a specified price, which protects the owner from cost overruns. If the contractor can manage to do the work more efficiently than was assumed in arriving at the fixed price, the contractor stands to make more profit. However, if the contractor experiences cost overruns, the contractor’s profit can suffer, even to the point of losing money.
- Time-and-material (or T&M) contracts in which the contract agrees to do the work in exchange for a fee calculated from the price of the materials the contractor buys, plus a markup, and a specified schedule of hourly labor rates. The contractor is generally protected from cost overruns, which are borne by the owner (or, perhaps, by another contractor at a higher tier).
- Cost-plus contracts in which the contractor is paid an amount equal to its cost of labor and materials plus an additional fee for overhead and profit. Sometimes the fee is calculated as a percentage of the contractor’s labor and materials costs; sometimes it is a fixed amount regardless of the underlying costs.
- Unit price contracts are those in which the work can be quantified by some sort of unit measure – such as the number of cubic yards of concrete poured by a concrete contractor – with the price specified as a number of dollars per unit. Pure unit price contracts are relatively rare, but unit prices are sometimes incorporated into T&M or cost-plus contracts.
- Guaranteed Maximum Price contracts protect the owner against unexpectedly high costs that can be associated with T&M or cost-plus contracts. The contractor agrees to do the work on either a T&M or cost-plus basis are subject to a guaranteed maximum amount that the contractor will be paid for full performance of all the work. Contractors often see straight guaranteed maximum price contracts as unfair because the contractor bears the risk of going over the maximum price but does not get any of the benefit for completing the project under budget.
- Shared-savings contracts are a way address the potential unfairness of guaranteed maximum price contracts. In a shared savings contract, the contractor agrees to perform the work on a T&M or cost-plus basis, with a cap on the total amount the owner has to pay for complete performance, but if the contractor completes the project for less than the guaranteed maximum price, the owner pays the contractor a percentage of the difference (i.e., a share of the savings). Ideally, the share of the savings is calculated so that the contractor makes at least as much profit – and preferably a bit more – by reducing the cost to the owner than by increasing the cost to the owner. For example, if the underlying cost structure is cost-plus with a percentage fee, the contractor should get a slightly higher percentage of the savings than the percentage of the contractor’s fee, so the contractor has an incentive to save the owner’s money rather than to spend it.
- Design-build contracts are intended to reduce the time required to go from basic concepts to finished project by eliminating the middle step of the usual design-bid-build sequence of events. While design-build contracts can produce substantial benefits for the owner, particularly when time is extremely important, writing and negotiating design-build contracts to fairly allocate risks between the design-build contactor and the owner requires knowledge, experience, and frankly a high degree of trust between the contractor and the owner.
Note that, in all of the types of contracts described above, allocation of risk is an important factor. Sometimes that risk is allocated directly, for example by indemnification clauses. Sometime the parties to a contract pay a third party – an insurance underwriter – to assume some of the risk. In other instances, the risk is allocated indirectly, primarily through the compensation structure. In every instance, the advice of a lawyer who understands construction contracts can be invaluable.