Understanding Construction Contracts

Protecting Yourself When You Build a New Home

For many, it’s the dream of a lifetime…designing and building a home that’s just right for you. But that dream can turn into a nightmare when your contractor doesn’t do what you ask or expect. That’s why it’s so important to have a clear agreement, a construction contract that identifies the rights and responsibilities of all parties.

What Is a Construction Contract?

A construction contract is a legally enforceable agreement that identifies the obligations and rights of parties involved in the construction of residential or commercial structures. Some states require construction contracts to be in writing, but many states allow the enforcement of oral construction agreements. To enforce a construction contract in a court of law, you must show:

• An agreement—There must be a valid offer by the contractor to perform the work, and the offer must be accepted by the homeowner.
• Consideration—Each party must give something of value or promise not to do something they have a legal right to do.
• Contractual capacity—All parties must have the mental state of mind to understand that they are entering into an agreement, as well as the terms of that agreement.
• Volition—The parties must enter into the contract knowingly and voluntarily, and not because of fraud, misrepresentation, duress, or undue influence.
• Legal subject matter—The courts will not enforce an agreement to perform an illegal act.

How Is Construction Work Legally Defined?

The precise definition of “construction” varies from state to state, based on both statutory and common law interpretations. Generally, construction refers to any physical activity on real property involving the erection of a structure, including the demolition of existing buildings, the construction of new buildings, additions or renovations to existing buildings, and any labor involved in those activities. It includes furnishing labor, materials, supplies, or equipment to a project, whether used in the design, construction, repair, alteration, maintenance, or renovation of a structure.

What Are the Key Provisions of a Construction Agreement?

The key elements of an enforceable construction contract include:

• Identification of all parties—The contract should include names, addresses, phone numbers, email addresses, and signatures of all parties bound by the agreement. It should also include the license number of the contractor.
• Scope of work—The agreement should clearly describe what the parties promise to do, including the full range of services provided, all work to be completed, and any specific materials provided or required. The agreement should also state that the contractor will obtain all necessary permits.
• Financial arrangements—The contract must identify the total cost of the project (or how it will be calculated, if there are contingencies), how much is to be paid up front, and when any installment payments will come due. The agreement should clearly state what the identified costs cover (or do not cover).
• Work schedule and timetable for completion—The agreement should set forth the schedule of work (e.g., will work be done on evenings, holidays or weekends?) and also identify when the project will start, when certain milestones must be met, and when it must be completed. The contract should include any required inspection approvals and also identify what penalties or sanctions will be imposed if deadlines are not met.
• Warranties—Make certain that all parties—contractors, subcontractors, vendors and suppliers—provide reasonable warranties on materials and labor.
• Special instructions—If the project involves anything out of the ordinary, put it in writing.
• An identification of who has decision-making authority—Will the general contractor have final authority? When will the general contractor need to obtain approval from the owner?
• Dispute resolution—Whether the parties agree to mediation, arbitration, or some other form of alternative dispute resolution (ADR). Owners should be careful to note whether the agreement requires binding arbitration. Such clauses are standard in most construction contracts, but by signing, the owner relinquishes their right to litigate any dispute in court.
• The process for amending or changing the scope of the agreement—The contract should identify how change orders are submitted and approved.

What Are the Different Types of Construction Contracts?

Builders take a variety of approaches when erecting a structure:

• Lump-sum agreements—This is essentially a fixed-fee contract. The most common of construction agreements, this type of contract identifies a specific price to complete the job. These types of agreements can be risky for builders if cost projections are understated, but they also provide the potential for greater profits through efficiency.
• Time-and-materials contracts—With this type of construction contract, the builder simply charges an hourly rate for labor and submits all materials costs to the owner for reimbursement. Time-and-materials contracts are advantageous to the builder when the scope of construction is vague.
• Cost-plus construction agreements—In some situations, the builder may agree to reimbursement of all materials costs, plus a fixed fee for the profit on the job. This type of arrangement allows for flexibility should material prices go up dramatically, but still allows the builder to make a profit.
• Unit-price contracts—If the project involves clearly distinct and separate units or phases, the builder may enter into separate “unit” contracts for each part of the construction.
• Guaranteed-maximum-price (GMP) agreements—This simply means that the builder promises that the owner won’t have to pay more than an agreed-upon sum, even if material prices go up.

What Documents Are Typically Required as Part of a Construction Contract?

To fully protect yourself when entering into an agreement for the construction of a residential or commercial structure, you want more than just the construction contract. The bundle of documents covering the project should include the following:

• A statement of the “General Conditions”—Often an addendum to the construction contract, this identifies the roles and responsibilities of all parties, including the change order process, submission and approval of payments, suspension or termination of work, any notice requirements, and whether disputes will be submitted to arbitration or other alternative dispute resolution.
• Any “Special Conditions”—This document identifies any work or activity that varies from the General Conditions.
• The “Scope of Work”—This document sets forth, in detail, exactly what the contractor will do or is permitted to do.
• Project drawings—The agreement should reference blueprints or drawings prepared by an architect and/or engineer, which should be provided to the contractor/builder before the project begins.
• A statement of “Construction Specifications”—This document contains all the technical information for the project, including quality standards, approved materials, and any required quality control testing or other measures.

Protect Yourself Against Potential Liens

If the general contractor or a subcontractor obtains supplies from a vendor, uses them on your project, but then does not pay for them, you could be subject to a mechanic’s or materialman’s lien. If the amount is substantial, the creditor could force the sale of your home. There are ways to avoid this:

• require the contractor to secure a payment bond
• make checks payable to the contractor and subcontractor jointly
• require the general contractor to get a release of all liens before you make final payment
• include a retention of funds provision, essentially a set-aside to cover potential liens

Your Right to Cancel a Construction Contract

Under federal law, if you sign a construction contract to build or remodel your primary residence, you have the right to cancel the agreement for any reason within three days.

Examples of Construction Contracts

Construction contracts take many different forms:

• A general contractor may enter into an agreement for the erection of a new residential or commercial structure, such as a home or office complex.
• A tradesperson, such as a painter, electrician, plumber, or carpenter, may enter into a contract to complete a specific job.
• A builder may agree to design and construct a house or commercial structure.
• A demolition company may agree to dismantle/remove an existing structure.

Summary

If you are planning on building a home or business structure, it’s essential that you put a valid and enforceable construction contract in place. Key components include an identification of the parties, a detailed description of the work to be done, the financial arrangements between the parties, how the agreement may be amended, and how disputes will be resolved.