Contracts… We Don’t Need No Stinking Contracts!

I recently gave a talk to the CPB on contracts.  I titled that presentation “Anatomy of a Construction Contract: Or ‘Contracts, . . ., We Don’t Need No Stinking Contracts!’.”  The secondary title was a bit tongue-in-cheek, but represents the attitude of many of my clients, over the years with the question of “Why do I need to have a written contract, isn’t my word good enough?!”

First of all, don’t misunderstand me, a person’s word should be his bond.  Our collective industries could not function without the integrity of their membership, period.  However, not everybody that you deal with views their calling in the same way.  

I cannot tell you the number of times that I have had clients who did not have a written contract, claim that a certain term was agreed to as part of the project; however, when we got into the meat of the case, like clockwork, one party or another just didn’t seem to remember that that they agreed to that specific term, or that “wasn’t really the way they remembered it.”

What is a contract?  A contract is an agreement between parties, typically an offer and an acceptance, bound by consideration, of some sort.

The two types of contracts important to homebuilders are those between themselves and their owners; and, between themselves and their subcontractors.

As between an owner and a contractor, there are generally two types of contracts:  Custom Contracts and Spec. Contracts.

A contract for the construction of a Custom home is between an owner and a contractor that relates to the actual design and construction of the house on a piece of property owned by one or the other.  These contracts fall into either one of two categories, generally: “Flat rate” or GMP (Guaranteed Maximum Price) contracts, or “cost-plus” or T&M (Time and Material) contracts. 

The contract for a Spec. house is really a “contract after the fact”–the owner has no, or little, input into the construction design, means, and methods, and is really just purchasing the house from the builder for a set price.  The contract for a Spec. house is a little less complicated than the contract for a custom house, and typically reflects more of a contract for the purchase of real estate.  Although this may be the case, the builder should be aware that he has certain protections available to him with this type of contract, that I rarely see used: These include provisions relative to dispute resolution (arbitration, mediation, attorney fees provisions, etc.); warranties and express warranties (and the limitation of same); soil and other liability disclaimers; notice and right to cure provisions; and waivers of consequential damage. All of these are  provisions which I view as necessary, which should be, but almost never are, contained in Spec. contracts.

With regard to Custom contracts, as I had mentioned earlier, these contracts are  more complicated.  They are there to govern a relationship, and deal with issues like who is responsible for the design, soil testing, change orders, payment and insurance, amongst other things.  Equally important in a Custom contract is the issue of warranties, and, as discussed above with Spec. contracts, dispute resolution and waivers.

Important in Custom contracts–that you don’t have with a Spec. contract–is the issue of getting paid.  That’s why we have two separate types of Custom contracts: Flat rate and cost-plus.  Flat rate contracts require the builder to build the house in accordance with the set of plans and specifications for a set price.   There are dangers with the flat rate contract.  If you are not a good estimator, you may be building the house for a loss.  If you are not a good plan or design reader, you may have agreed to build the house based on “plans and specifications” which contain items that you either never originally saw when you made your bid, or that your subcontractor just overlooked during the course of construction.   That means that if there was an item that was not constructed that falls within the plans and specifications, you cannot seek additional compensation to correct or add that item after construction; you are contractually bound to have done as a part of the “deal.”

This may seem to be a small item, but in a recent case that I had, which involved, thankfully, a cost-plus contract, not a flat rate contract, the plans called for a geothermal heating and cooling system, which would have cost several times more than the conventional system my client had installed.   Had that been a flat rate contract, my client would have been required to either remove the conventional system and install the geothermal system, or provide the necessary rebate in the form of the cost difference  to the owner from the fee that my client had already been paid.  

In contrast, the cost-plus contract merely provides that the builder will build the house for the “cost” of what the owner wants, plus a certain agreed-upon percentage.  Sometimes these percentages are capped at an amount, sometimes not.  This arrangement places the burden on the owner for any changes made in the contract documents (whether deductive or additive); whereas the flat rate contract requires greater attention to the plans and specifications, and more thought into change orders and the execution of change orders to protect the builder.   In a “cost-plus” arrangement, if the owner wants to make a change, while it is prudent to make sure that change is in writing, the contractor merely has to oblige, document the change, and then add on his agreed-upon percentage.  If an item is omitted, the owner, at law, cannot demand that the contractor perform the omitted work without first having paid the contractor for it.  To require otherwise would be what we lawyers call “betterment.”

Lastly is the subject of contracts between Contractors and their Subcontractors.  I cannot tell you how important these often omitted documents are.  The purpose of having a written agreement between a contractor and a subcontractor is several fold:   To set forth the subcontractor’s scope of work, to delineate the amount to be paid and the payment schedule, and to provide protection to the general contractor in the event that the subcontractor’s work is either deficient or defective.  From where I sit, the more important language in a subcontract agreement deals with the latter.  Indemnity language, insurance provisions (including, “additional insured” language), and dispute resolution mechanisms, which mirror those contained in the general contract with the owner, are essential.

Quite frankly, I could write a book discussing the importance of subcontracts between general contractors and subcontractors, and the various provisions that are necessary.  The law provides a benefit to general contractors who have written contracts with their subcontractors that it does not provide in their absence. The prime example is with indemnification.  Mississippi has a six-year statute of repose that provides that six years after substantial completion of a project, the owner is barred from suing the contractor for any defects caused thereby.  There are some exceptions, but that is the general rule.   The same statute also cuts off claims for indemnity between a general contractor and a subcontractor for defects, within that same six years.  Therefore, if an owner sues a general contractor for construction defect on year five, day 300, and the general contractor does not do the procedural things required to perfect his indemnity claim against the subcontractor whose work is at issue within that same six years, then the general contractor’s indemnity claim is lost and gone forever, even though the owner’s claim against the general contractor remains viable.  The exception to this Draconian rule lies if a written contract exists between them, then the statute specifically saves the general contractor’s right to seek indemnity against his subcontractor.

Of equal importance are contractual provisions between a general contractor and subcontractor for the naming of the general contractor as an “additional insured” to the subcontractor’s GL policy.  Such a provision negates the need for the general contractor to seek indemnity from the subcontractor, or even name him in a suit as a third-party defendant, because the provisions are intended to have the subcontractor’s GL carrier pick up the general contractor’s defense and indemnity.  The intent is to actually create harmony on the job site. 

Likewise, a written provision to waive subrogation claims between owner and general contractor and general contractor and subcontractor also accomplishes the same thing — harmony on the job site — by cutting off an insurance company’s right to seek subrogation against a contractor or subcontractor for defective work which causes damage to the structure resulting in a claim, either on a builder’s risk or similar policy.

And all these provisions can only be effectuated if they are in writing and signed between the parties, they cannot be on a hand shake.

A good contract is like a seat belt, you hope that you never ever have to rely on it, but when you do, and you have one, you are awfully thankful that you do.