The Most Critical Clauses in Construction Contract That You Need to Know
The Most Critical Clauses in Construction Contract That You Need to Know

The Most Critical Clauses in Construction Contract That You Need to Know

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When working with a client for a construction project, it is essential to set the terms of the working relationship as soon as possible. Generally, this is done by entering into a construction contract, and there are many forms of project contract you can choose from. Some construction companies use a standardized form from a trusted association, such as the AIA (American Institute of Architects), while the others have their custom versions.

Either way, there are some critical contract clauses that you will want to pay attention to when you manage a project, as they set expectations and how your relationship with a client will develop throughout the project operations.

1. Contract Sum

The first clause you need to pay attention to in the contract is the contract sum. This section is where the contract price, aka the guaranteed maximum price, is indicated, depending on what project delivery method you are using. Hopefully, at this point, you have already come to an agreement on the final price of the work, so this shouldn’t be a shock.

Things get trickier when terms such as allowances, alternates, and unit prices are already involved in this clause. These can potentially add expenses to the contract value and should be carefully considered in the budget planning before anything even starts.

           a. Alternates

Alternates are options that you may or may not have discussed during the design phase with the client. For instance, the client may have had two flooring options in mind. One is part of the base contract and will be included in the total contract amount, while the other is an alternate. When alternates are involved in the contract, they can be considered a part of the total contract amount or added in the future through a change order. Always ensure that the contract is clear about whether the alternates are included in the base contract or not, as this could raise or lower the actual cost of the work.

           b. Allowances

Allowances are the “placeholder” cost when decisions haven’t been made on the final scope of work of the project. For instance, if the client hasn’t selected a specific color of exterior paint, you may put in an allowance of $30 per square meter as a placeholder in the construction contract. Once the client has decided on the exact color they want, that price will be lowered or raised depending on how the selection compares with the allowance cost. The contractor’s responsibility is to give reconciliation on the allowances at the end of the project. 

           c. Unit Prices 

Unit prices are used when the work is going to be contracted on a “per unit” basis. The unit price is multiplied by the number of units completed to get the total contract amount. This type of contract pricing is often used in public work construction and other infrastructure projects when a standard price for each unit of measure has already been established and mandated.

2. Payments

The next important construction contract clause is the payment terms. It is vital to include a detailed description of the payment process in the contract, including the documents required, timing, approval process, and the conditions of final payment.

This clause should contain a procedure about the percentage and how often payments are issued on an ongoing project. 

           a. Dates

Relevant dates, such as the invoice due date and when the payment due date, should also be part of this clause. These dates are critical for all parties to be aware of, as penalties like interest and lien rights are dependent on them.

           b. Documentation

Every project will have its documentation requirements when it comes to payments. Required documents might include cost back-up, subcontractor invoices, subcontractor and supplier lien waivers, payroll reports, and a list of subcontractors and suppliers and how much each is owed. A construction management software can enable you to keep all these critical documents in one place, to be accessed anytime and anywhere thanks to cloud technology.

           c. Approval

The process to get payment approved should also be included in the payment terms. This section will consist of who reviews and approves the payment request and how long they have to review it. 

           d. Final Payment

The process to release final payment is often complex and requires a lot of paperwork. Requirements from the project owner, lender (such as a bank), insurance company, and any other parties to the agreement should be included in this section. Documents for submittal typically include a Certificate of Completion (CoC), 

construction lien waivers from suppliers and subcontractors, operations manuals, as-built drawings, warranties, and a list of project stakeholders’ contact information. 

3. Changes in the Work

There are many changes in all construction projects, whether they are expected or not- how they are managed needs to be spelled out in the contract. Terms will include the general contractor and subcontractor markup on changes, how and when that notification about the changes will occur, and what to do if there is a disagreement between the parties.

There are two types of changes that can occur on a project: 

           a. Change Orders 

A change order may be suggested by the architect, project owner, construction manager, or the general contractor, which can be a change in materials or a change to the scope of work. Once the cost has been decided, and an agreement is reached, the scope is added or subtracted from the project.

           b. Change Directive

If an agreement cannot be achieved on the changes and how much it will cost, the designers or construction manager may step in and declare a change directive. A change directive orders the construction team to make the necessary changes and adjust the crew schedule as needed, determining the cost later. A change directive can prevent disputes over change order costing from holding up completion of the work.

4. Claims

When a dispute between the project owner, construction manager, or contractors cannot be settled, it usually escalates to a claim. Generally, a claim is a request for additional money or an extended construction schedule. The construction contract will detail the claims process, notice requirements, and timeline. It may also include the preferred approach of claims resolution.

The first party to review a claim is the designer or construction manager. They act as a neutral third party and help the owner and contractor come to a decision. If there isn’t a construction manager or designer on the project, or they cannot obtain a resolution, the claim then moves on to the next level of dispute resolution.

The last section of the claims clause will state how disputes are settled when the parties cannot work them out. There are three main categories are: arbitration, mediation, and litigation.

5. Dispute Resolution

The dispute resolution section determines how conflicts are settled if the concerned parties cannot come to an agreement. Arbitration, mediation, and litigation are the three main categories of dispute resolution that are common in construction contracts.

           a. Arbitration 

Arbitration resembles a court hearing since one or more deciding bodies hear both sides of the claim and attempt to settle it through resolving in favor of one party. It is less formal than a courtroom, but the process is still a very judicial one. The arbitrator is non-biased, selected by both parties, usually from a selection of available arbitrators familiar with construction.

           b. Mediation

Mediation is not binding and less formal than arbitration and is often a precedent to litigation if stated in the contract. Both parties meet with a neutral mediator who tries to help them reach their mutual agreement. The mediator doesn’t make the final decision but tries to get both parties to meet somewhere in the middle. In the construction industry, meditation is often successful in resolving the claim without the expense of litigation or arbitration, particularly if all parties are inclined to settle.

           c. Litigation

The most formal dispute resolution process is litigation which associates the party with the claim and the party receiving the lawsuit. A formal hearing will be scheduled, and both sides will give evidence and testimony presided by a judge. The judge or jury will together render a decision that is legally binding to both parties involved.

Conclusion

These five critical construction project contract clauses should be included in every contract. Consult your company attorney and review them carefully before signing any construction paper. 

Construction contracts act as the backbone between the relationship of the owner and the general contractor. They will usually play a role in determining the project’s success by properly laying out job responsibilities and expectations. All relevant parties need to be aware of construction job management, no matter what job they are working on the project, whether big or small, toward the project’s success. 

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