Central Washington Homebuilders Association - Full Article: Construction Contracts

Construction Contracts

Before proceeding with construction of your new home or remodeling project, you will need to prepare and sign a contract with your contractor. The purpose of the contract is to carefully identify the scope of work and the terms and conditions of construction. You also need to anticipate the variety of problems that can arise during the course of construction and carefully address their resolution. Just ask your-self "what could go wrong in terms of the contractor's performance or financial stability?" Then make appropriate provisions in your agreement with the contractor.

The following questions are the ones most frequently asked and addressed by owners contemplating either new construction or remodeling projects.

Q   Is there a standard form of agreement that would be in the best interest of an owner to sign?

A   There is no standard form of agreement, although the American Institute of Architects publishes a series of owner-contractor agreements which are both detailed and comprehensive. These agreements state that the owner's architect will administer the contract, provide onsite observations, certify applications for payment, issue certificates of substantial completion, etc.

Q   What is the difference between a contract and the project drawings and specifications?

A   The contract is a legal document. The project drawings and specifications are architectural documents. The contract simply refers or incorporates the drawings and specifications by reference and obligates the contractor to proceed with the work in accordance with the drawings and specifications as referenced in the contract. The contract does not attempt to fully describe or detail the scope of work to be performed by the contractor. It simply identifies those particular drawings and specifications upon which the contractor has based his price and commitment to perform the work.

Q   How should the contractor be paid?

A   There are different ways of compensating the contractor. The first way is agreeing to pay the contractor a fixed price for the work. The contractor submits a bid, there is some negotiation over the price, and a fixed dollar amount is agreed upon between the owner and the contractor. This amount will include the contractor's overhead and profit. A second way of compensating the contractor is on a "cost-plus" basis where the contractor proceeds with the work and submits all of his bills and invoices to the owner. The owner reimburses the contractor for construction costs incurred by the contractor together with either a contractor's fee for supervision, over-head and profit, or a percentage mark-up on the contractor's costs for supervision, overhead and profit. Some-times "cost plus" contracts have guaranteed maximum amounts beyond which the contractor agrees that the owner will not be responsible for cost reimbursement to the contractor.

Q   How should payments be made to the contractor?

A   On projects taking less than thirty days, the contractor is typically paid a down payment, with the balance due upon completion and acceptance by the owner. On projects taking more than thirty days, payment to the contractor generally involves progress payments made to the contractor each month based upon the progress and value of the contractor's work, with the final payment being made following completion of the work and the owner's acceptance. If the owner is financing the project through a commercial lending institution the lender will likely visit the site each month, certify the progress of the work, calculate the loan disbursement payable to the owner, and issue a check to the owner which will then be signed over to the contractor.

Q   What is retainage?

A   Retainage is a holdback from the progress payment and/or the final payment in an amount, generally about 5 percent of the contract price. The purpose of the retainage is to leave enough money in the contract for the owner to complete any uncorrected or uncompleted work in the event that the contractor fails to do so within a reasonable time.

Q Can the work be redesigned or altered after the contract is signed?

A   Once construction has begun, owners generally do request changes in the work. That's just human nature. The handling of these change orders needs to be addressed in the contract, and is typically addressed with a provision that change orders need to be agreed upon in writing before the contractor proceeds with the work. The written change order should address issues of price increases or decreases and impacts on the construction schedule.

Q What is an allowance?

A   An allowance constitutes a dollar value of the contract price which has been set aside for the purpose of financing a distinct portion of the work, such as light fixtures, floor coverings, etc. For example, if the owner has not quite made up his or her mind about selection of floor covering, bathroom fixtures, or kitchen countertops, the contractor will plug a figure (i.e. an allowance) into the contract to allow for the labor and materials associated with installation. If it turns out that the owner selects bathroom fixtures costing more than the allowance, the owner is obligated to pay the contractor for the excess. And, of course, it works vice versa.

Q   What kind of warranty should the owner request?

A   The owner should request a warranty from the contractor that states all work will be performed in a commercially reasonable manner and that there will be no defects in the labor or materials furnished to the project by the contractor. The warranty should be for a period from one to six years, depending upon how much the owner is willing to pay for the warranty. Typically, contractors will issue a one-year warranty. The owner should request the contractor to provide to the owner all written warranties for all manufactured or consumer products which are installed during the course of construction such as roofing materials, appliances, windows, heating and mechanical systems, etc.

Q   If there is a problem, do we have to go to court in order to resolve it?

A.    No. Since 1975, our state laws have provided for mandatory arbitration on all disputes under a certain dollar limit, generally $25,000. In your contract, you should state that if the parties cannot resolve a dispute or disagreement among themselves, and a third party is required to make a decision, those disputes or disagreements will be decided according to the mandatory arbitration rules regardless of the amount in dispute. A useful option is to agree in the contract that the award of the arbitrator shall be binding.

Q.   Should the contract contain a liquidated damages clause?

A.    Perhaps. A liquidated damages clause generally provides that the contractor must pay the owner a certain per diem dollar amount for each day of work beyond the scheduled completion date. For example, if a liquidated damages clause provided for a $50 per day per diem payment to the owner, and the contractor was 15 business days late in completing the work, then the contractor would be obligated to pay or refund $750 to the owner. Liquidated damages clauses are common, and are usually associated with corollary clauses which provide a certain per diem bonus to the contractor in the event that he completes the work ahead of schedule. Liquidated damages clauses are useful when it is very important for the contractor to finish on a certain date for reasons such as the owner's prior residence both scheduled to close on or near that date, or the owners are scheduling their move into the new residence on a certain date, etc.

Q    Are there certain clauses of special concern?

A.    Yes. One clause typically found in contracts which should be of special concern to the owner is a clause that states that all prior negotiations, understandings or agreements no matter what may have been discussed or agreed upon previously and orally with the contractor, are not part of the contract unless they are stated in writing within the terms of the contract. Another clause that should especially concern the owner is a clause that provides the contractor is not responsible for unforeseen circumstances. This clause is very common in remodeling contracts. It means if the contractor encounters difficulties on the job which he did not anticipate, the owner may be required to pay an additional amount of money to the contractor to cover these unforeseen events. A third clause that should be of particular concern to the owner is a clause in the contract which recites the contractor's registration number. In order to verify the contractor's registration and bonding status, the owner should call 1-800-647-0982, number 3 to verify:

  1. The registration status of the contractor;
  2. Inquire about prior claims against the contractor's bond, if any; and
  3. Make sure the contractor executes the contract under the same name in which he or she is registered as a contractor with the Washington State Department of Labor and Industries. 

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