THE SEVEN CRITICAL PROVISIONS THAT SHOULD BE IN EVERY RESIDENTIAL CONSTRUCTION CONTRACT
An ounce of prevention is worth a pound of cure
In 1736, observing how vulnerable the city of Philadelphia was to a potential fire, Benjamin Franklin famously advised his neighbors that “an ounce of prevention is worth a pound of cure”. Preventing fires is cheaper and easier than fighting them.
With litigation, the same is true, particularly with contracts. A good contract is a fire prevention method that can save a tremendous amount of litigation cost down the road. Preventing litigation is cheaper and easier than litigating.
Rotten silk cannot be fixed
When my wife and I renovated our house fifteen years ago our builder sent us his proposed contract. I spent an hour trying to revise it before giving up and calling the guy on the phone.
“Hey ‘Sven’, where the heck did you get this thing?” I asked him.
“I don’t really remember,” Sven replied. “I think it was probably from the first guy I worked for when I got into construction. Is there something wrong with it?”
“Well,” I replied (trying to be diplomatic), “it has a whole lot of stuff in it that doesn’t matter and very little that does. I tried to fix it, but it’s like rotten silk—the more I sew, the more it tears.”
“Damn it,” Sven said with a laugh, “I knew I shouldn’t have agreed to build a house for two lawyers.”
“Not true my friend,” I replied. “Lawyers know the true cost of the failure to compromise. But look, no offense but this contract can’t be fixed. Let me just rewrite the thing from scratch. You need a new contract anyway.”
“Okaaaay, but how do I know you won’t screw me?” Sven asked.
“You don’t. So just take it to another lawyer and pay him to read it for you. It won’t even take an hour because this thing is going to be short.”
“Deal,” Sven replied.
So I rewrote Sven’s contract and he built our house and everything worked out fine. I don’t know if he ever took it to another lawyer, but he did become my client afterwards and he kept using that contract I wrote for him.
Unreasonable owners and incompetent builders are out there
Sven is typical of the residential general contractors I have encountered both as clients and adverse parties over the years. He was good at building a house but didn’t give much thought to his company’s legal needs. That works most of the time, but eventually every contractor is going to run into that unreasonable owner who doesn’t view the construction of a house as something done with human hands. For that type of owner, nothing the contractor can do will ever be fast enough, good enough or cheap enough. Without clear contractual provisions, a contractor can find himself in protracted and expensive litigation even though he built the owner a solid house.
The inverse is also true. Most owners will sign whatever contract the builder sends them without reading it or (if they do read it) without knowing what to look for. Most of the time, that will not result in disaster. But just as there is that unreasonable owner lurking out there to ruin a good contractor’s day, there are always a few incompetent and undercapitalized builders who may have been decent framers or roofers but lack the management skills to be a general contractor. Without clear contractual provisions, the owner may find himself in protracted and expensive litigation even though he paid all the contractor’s bills on time.
Whether you are the builder or the owner in a residential construction project, the best way to arm yourself against the unreasonable owner or the incompetent contractor (as the case may be) is to have a solid contract that contains a clear expression of these Seven Critical Provisions
1. Scope of the Work
The contract should start by identifying the property upon which the project is located (mailing address if fine), the general nature of the project (renovation, new construction etc.) and the specific work the contractor is agreeing to perform. Ideally, this is done by identifying a set of building plans that are made part of the contract. If there is no plan, then there should be a specific list of items—the more specific the better.
2. Completion of the Work
This provision should include three things: 1) a specific date by which the contractor is to substantially complete the project; 2) the definition of substantial completion; and 3) a process by which the date of substantial completion can be extended due to events that are outside of the contractor’s control, like adverse weather conditions (the most common reason).
3. The Contract Sum
There are essentially two ways a contractor can be paid by the owner in residential construction.
The first is by stipulated sum, which means the owner and the contractor agree on a single price for the work to be done and that price does not change regardless of how much it costs the contractor to do the work.
The other way is cost-plus, which means the owner pays the contractor for what it costs him to do the work plus a sum for his overhead and profit. Unlike stipulated sum, under cost-plus the price does change in relation to the contractor’s actual costs incurred. The more it cost the contractor, the higher the price will be for the owner.
Under most circumstances, I would not recommend cost-plus (a topic for another blog post), but regardless of which payment arrangement is agreed upon, there must be a specified methodology under the contract for both the contractor’s right to request payment and the owner’s obligation to make payment. Ideally, the methodology for both is simple and easy to understand.
4. Changes to the Work
Regardless of how carefully the plans are drawn and how much thought the owner has given to what he wants, there will inevitably be changes to the work that will require changes to the contract because a contract (once signed) cannot be altered—unless the parties agree that it can by change order.
This provision should include five things: 1) a definition of a material deviation from the work (generally requested by the owner) that requires a change order; 2) an identification of abnormal or unforeseen conditions that would entitle the contractor to a change order; 3) a provision governing the owner’s selection of materials (e.g., countertops) that exceed an allowance in the contract; 4) the methodology that the parties will use if a change order is required; and 5) a provision allowing the project to continue toward substantial completion in the event that the parties cannot agree on a particular change to the work.
5. Punch List
A punch list is a list of minor things that must be fixed by the contractor after he has substantially completed construction. For it to be effective (in the sense that it eliminates or shortens litigation), it must be made before the owner occupies the house.
I cannot count the number of residential construction cases that I have handled that arose primarily from punch list disputes where the contract either had no provision for final completion of the work or had a provision that was uselessly vague.
An effective punch list provision would have the following elements:
a. It would require the contractor to notify the owner (in writing) when substantial completion had been achieved;
b. It would require the owner to deliver to the owner a list of the items that that the owner contended needed to be corrected before the owner occupied the project and preclude the owner from adding to the last after he occupied the project;
c. It would give the contractor a set number of days to object to any item on the list;
d. It would give the contractor a set number of days to correct the items on the punch list to which he did not object;
e. It would define the hours during which the owner would make the project available for work to be done;
f. It would specify the amount (if any) that the owner is entitled to retain against the contractor’s completion of the punch list.
6. Scope of Warranty
Many states have common law and statutory warranties that govern residential construction. It is far simpler and effective (in limiting litigation) for the parties to agree to an express warranty limited to a year from substantial completion which warrants that the materials and labor comprising the work shall be of good quality and workmanship.
7. Suspension and Termination
The contractor should have the right to suspend its work if the owner fails to make the payments set out in the contract without having breached the contract by doing so. Likewise, there should be a provision allowing the owner to terminate the contract that specifies what entitlement to payment the contractor will have in the event the owner does so.
Whether you are the builder or the owner, make sure that you have these Seven Critical Provisions in your contract. If you are not sure, it would be worth an hour of lawyer time to find out before you stumble into a project that could result in lengthy and expensive litigation.
That hour would be a ounce of prevention against a ton cure.