5. Owner–Construction Contractor Prime Contract “Red Flag” Clauses

Key Words and Concepts

  • “Red flag” clause
  • Dispute resolution clause
  • Sovereign immunity
  • Changes clause
  • Differing site conditions clause
  • Delays and suspensions
  • “No-damages-for-delay” clause
  • Default terminations
  • Convenience terminations
  • Time provisions
  • Notice to proceed provisions
  • “Stepped” notices to proceed
  • Single completion time
  • Milestone completion times
  • Liquidated damages provision
  • Actual damages
  • Availability of the site
  • Restrictions to site availability
  • Payment provisions
  • Payment frequency
  • Payment for materials and fabricated items
  • Retention
  • Mobilization allowance
  • Final payment
  • Exculpatory clauses
  • Disclaimers
  • Attitude of courts to disclaimers
  • Present trend on underground construction
  • Geotechnical design summary report
  • Geotechnical baseline report
  • Insurance requirements
  • Surety bond requirements
  • Indemnification
  • Basis of quantity measurement
  • Variation in quantities clause
  • Equal employment opportunity/disadvantaged/women-owned business requirements
  • Escalation provisions

Before preparing a cost estimate and submitting a competitive bid for a contract, a contractor must first be sure that the various sections of the contract documents are complete. Chapter 4 identified the major categories of typical contract documents and discussed the general nature of each.

Once this first step has been completed, a prudent contractor bidder will do much more before making a decision on whether to proceed. It is imperative to know what kind of a contractual situation will be encountered if a bid is submitted and the contract awarded. Will the contract be fair, or will it be heavily biased in favor of the owner? Aside from the financial “risk of performance” associated with the actual construction work, what contractual risks lie buried in the contract language?

It took a wrenching personal experience for this author to appreciate the true consequences of failure to identify properly and answer these questions at the time of bidding for a large bridge substructure project. In that instance, the fact that the owner, a state department of transportation, was shielded by the doctrine of sovereign immunity applying to all contracts with that state was not discovered until long after the project was bid, the contract entered into, and major disputes had developed in the course of the work. The eventual resolution of the contractor’s claims, which was not appealable, was not obtained until 16 years after the completion of the work.

So, the lesson to be learned from this chapter is how to avoid unknowingly assuming the risks inherent in such situations.

Threshold “Red Flag” Clauses

An old adage states: “Do not sign a contract until you have read and understood every word.” Today, literal compliance with this rule is not practical, even if one wanted to do that. Reading contract language is a tedious, sleep-inducing activity, and most people hate to do it. Also, there is an obvious difference between signing a contract and committing to the preparation of an estimate and bid. However, submittal of a bid places the contractor in a position where failure to proceed with signing the contract and completing the project according to the contract terms can become extremely costly. This is true because bid security is normally required in the case of fixed-price construction contracts. Further, the preparation of a cost estimate for a fixed-price construction project is time consuming and expensive. Although a potential bidder can always drop further consideration of a project after work on the estimate has begun, the time and money expended up to that point is lost, and failing to proceed after starting can be destructive to a construction organization’s morale. So the old adage might just as well be stated: “Do not undertake a cost estimate and start bid preparation until you have read and understood the potential contract.” How can one approach this ideal? One good way is to seek out, carefully examine, and understand the provisions of certain key contract clauses, often referred to as “red flag” clauses. Generally, these clauses tell bidding contractors the kind of contractual situation they will encounter if they are successful in securing that particular contract.

Experienced construction executives probably would agree on the choice of clauses included in this chapter even if they did not agree on the precise “pecking order” in which the clauses are listed. Each “red flag” clause will be discussed from the standpoint of what the clause typically provides and why it is important. In this discussion, clause titles are generic. Actual titles may vary from contract to contract.

Dispute Resolution and Governing Law Clause

Bidding contractors need to be aware of the contract dispute resolution provisions. If disputes arise, who will resolve them and by what set of rules?

A well-drafted dispute resolution clause spells out precisely what steps the contractor and owner are required take to resolve disputes between them, usually defining time limits within which various procedural steps must be initiated. Some contracts specify straightforward and reasonably simple procedures, whereas others are excessively complicated and time consuming. In extreme cases, the contract states that the architect/engineer’s or owner’s decision is final and binding, ostensibly leaving the contractor no recourse in the event of disagreement with that decision. Usually, such A/E and/or owner decisions will be binding on the contractor on matters having to do with the standard of acceptability of the performed contract work. Whether such decisions will be supported by the courts with respect to “questions of law” depends on whether the work is public or private and on the law of the state in which the project is located. Federal contracts do not contain clauses providing that the engineer’s decisions are final and binding.

A well-drafted dispute resolution clause also states the means by which the dispute will eventually be resolved if the parties cannot come to an agreement. The normal possibilities are arbitration (usually under the auspices of the American Arbitration Association), submittal to an administrative board of the owner-agency involved, submittal to a specially appointed contract disputes review board, or a formal trial in a court-of-law. In the latter case, the contract may specify the particular court that will try the case. Of special concern from the contractor’s standpoint are the contract provisions in the few states that have not waived sovereign immunity (see the introduction to this chapter). In these instances, the contractor may not sue the state in a court-of-law on a matter arising from the contract. The only procedure open to the contractor is referral to a claims court, controlled by the state with whom the contractor has the dispute. There is no appeal. If a monetary award is made to the contractor, the state may not be required to make payment until and unless the state legislature passes a specific bill appropriating the necessary funds.

Finally, a well-drafted clause states what legal rules will apply—that is, what the governing law will be. The federal government contract clause states that disputes will be settled in accordance with the Contract Disputes Act of 1978, a federal law. The AIA contract clause states that the law of the state where the contract is performed will apply. The importance of this clause cannot be overemphasized because the laws of different states vary considerably.

The subject of dispute resolution is more fully discussed in Chapter 23.

Changes Clause

Every construction contract today contains a changes clause. However, the detailed provisions of the clause vary from contract to contract. The clause generally defines the owner’s right to change the contract unilaterally, places limitations on that right, establishes the contractor’s duty to perform the change, and the contractor’s right to be paid for performing the change. These details range from the provisions of the changes clause in the federal government contract, which are broad and evenhanded, to provisions in some contracts that are grossly unfair and which place the contractor at a distinct disadvantage when the owner makes changes. Chapter 14 focuses exclusively on the detailed provisions of the changes clause.

Differing Site Conditions Clause

The differing site conditions (DSC) clause is probably next in importance. Not all construction contracts contain a DSC clause. Many contractors put this clause at the head of the “red flag” list and will not submit a bid if the contract documents do not include a fair and comprehensive DSC clause. This clause is sometimes called a “changed conditions” clause. In the case of the AIA contract, the clause is called “concealed conditions.”

The relevance of this clause to underground construction is discussed in Chapter 4. This clause also normally applies to any physical site condition found during contract performance that materially differs from those indicated in the contract documents or from conditions normally encountered in the type of work of the contract. The detailed provisions range from the DSC clause in the federal government contract, which is comprehensive, fair, and serves as a model clause for the industry as a whole, to contracts with clauses containing less explicit language, to contracts containing no DSC clause at all. Chapter 15 is entirely devoted to the subject of differing site conditions and the operation of this clause.

Delays and Suspensions of Work

Another important “red flag” clause deals with delays and suspensions of work. There are several important aspects of this subject. First, construction contracts usually impose severe liabilities on the contractor because of generally stringent requirements for work to meet narrow technical standards within fixed time requirements. Such is the nature of construction contracting. However, both owners and contractors understand that certain conditions may occur under which the contractor’s failure to perform within the required time limits will be excused. Such conditions are sometimes called conditions of force majeure and normally would include acts, or failures to act, by the owner or others and “acts of God” that delay or prevent the contractor’s performance. The delays and suspension of work clause usually carefully enumerates what constitutes a reason for excusable delay for that particular contract. Bidding contractors need to know that this list is broad enough to include situations that the contractor knows from past experience may occur.

 

Again, the federal contract provisions are broad and fair and afford contractor’s time relief for delays that are truly beyond their control. Other contracts may designate far fewer situations for which relief will be granted, and some even require the contractor to complete the work by a certain stated date, called a “date certain” under any and all circumstances—in other words, the contractor is granted no relief whatsoever.

A second question arises regarding responsibility for extra costs arising when the owner either delays or suspends the work. Who pays? The federal suspension of work clause and other similar clauses contain provisions that are complete, explicit, and generally state that the government pays if the government causes a delay that damages the contractor. Other contracts range from some that are completely silent on the subject, to those containing “no-damages-for-delay” clauses, which state that a contractor’s relief for an owner-caused delay to the contractor’s operations is limited to an extension of time only. Some contractors will not bid on contracts containing a no-damages-for-delay clause. No-damages-for-delay clauses are further discussed in Chapter 16.

Terminations and Partial Terminations

An important “red flag” clause closely related to the delay and suspension of work clause is that dealing with terminations and partial terminations. Here, we are talking about the owner’s right, not to delay the work, but to unilaterally terminate all of the work of the contract or to terminate some divisible part of the work. Most construction contracts give the owner this right, usually under each of the following circumstances. First, the owner may terminate the contract when the contractor’s performance is either (1) far behind a reasonable time schedule or (2) results in work that fails to meet contract quality requirements or (3) when the contractor becomes financially insolvent. Second, the owner may terminate the contract without disclosing any reason.

The first set of circumstances constitutes a default of the contract by the contractor. Most contracts give the owner broad powers in these circumstances to remove the contractor from the site, to take over the equipment and materials on the site (whether paid for or not), and to complete the work or cause it to be completed by others. If the owner’s costs in completing the work exceed the unpaid portion of the original contract price, the difference must be paid by the contractor. Such terminations are called default terminations.

The second kind of termination is called a termination for the convenience of the owner or, more simply, a convenience termination. Contracts differ greatly in regard to this kind of termination. The difference is not in providing the right of the owner to effect such terminations (almost all present-day contracts provide for this), but in the provisions dealing with the final payment that the contractor receives if the owner does decide to terminate the contract or part of the contract short of completion. Many thorny questions arise. The contractor may be heavily committed to the project when suddenly, without warning, the contract is terminated. The contractor normally will have ongoing commitments in the form of purchase orders and subcontract agreements that must also be terminated and for which the contractor will incur unavoidable costs. The owner is undoubtedly due a credit for the value of the uncompleted work, but how large a credit? Is the contractor entitled to anticipated profit on the uncompleted work? Resolution of these and many similar questions never comes easily. Many contracts are completely silent on determination of a fair and equitable settlement in the event of a convenience termination, in essence leaving the parties to “fight it out.” On the other hand, the federal contract and other similar contracts deal more or less effectively with this subject, depending on the particular contract. Since a convenience termination is an act completely beyond the contractor’s control and must be regarded as a definite possibility, the detailed provisions dealing with payment are vitally important. Chapter 16 deals with some of the unique problems associated with both default and convenience terminations.

Other Important “Red Flag” Clauses

By the time that a contractor understands the threshold “red flag” clauses just discussed, he or she will have a fairly good indication of the type of owner and type of contract involved with the project. If the contractor is still interested in submitting a bid, the balance of the “red flag” clauses provide further critical information. These clauses-some general and others highly project-specific-include the following:

  • Tune provisions
  • Liquidated or actual damages for late completion
  • Site availability and access to the site
  • Payment and retention provisions
  • Reports of physical site conditions
  • Exculpatory clauses
  • Insurance and bond provisions
  • Indemnification clauses
  • Measurement and payment provisions
  • Variation in quantities
  • Equal employment opportunity and disadvantaged business assistance requirements
  • Escalation provisions

The detailed provisions of many of these clauses are complex and their potential impact on the contractor’s cost of performance can be enormous. Each will be discussed in some detail.

Time Provisions

The time provisions are project-specific and are much broader than simply a statement of how much time that the contractor has been given to complete the work. Contractors should look for at least the following additional information:

  1. What are the notice to proceed (NTP) provisions? Will the contractor receive NTP reasonably promptly after signing the contract, or does the owner have the right to delay giving NTP, perhaps indefinitely? In some instances, a delayed NTP may be an advantage to the contractor, but normally, once the contractor is committed to the project, starting work as soon as possible is to the contractor’s advantage and delaying it is a great disadvantage. Many contracts provide that NTP will be given within a specifically stated number of calendar days from the bid date or from the date of execution of the contract, whereas others are silent on this point. Another question is whether the contract provides for more than one, or a series of “stepped” NTPs, each NTP releasing only limited parts of the project or limited activities that the contractor may perform under that particular NTP. Many difficult contractual problems can ensue when stepped NTPs are used or when the owner issues NTPs that are qualified. Both practices severely limit the contractor’s flexibility.
  2. What is the time period after NTP within which the contract work must be completed? The bidder should not simply assume that the time period stated in the contract is necessarily reasonable. The contractor will normally be held to that period whether it is reasonable or not, so if the stated period appears to be insufficient, the bidder had best not proceed further unless extra costs are included in the bid estimate to meet the required schedule. Otherwise, the bidder should expect to pay liquidated damages for late completion. Some contractors will not submit a bid if they believe that the time allowed for contract performance is unreasonably short.
  3. ls a single completion time for the total project specified or is a series of “milestones” listed that must be met within specified time limits, each milestone completion time pertaining to a discrete part of the contract work? Contractors frequently find that they can meet the final completion deadline without undue difficulty but that intermediate milestones prove difficult and costly, particularly when very early milestone dates are specified. If milestone dates are specified, bidding contractors must take note and analyze them carefully.

Liquidated or Actual Damages for Late Completion

Closely related to the time provisions are other project-specific provisions stating the type of contractor liability that will result in the event of late completion. If the required contract work is not completed within the stated period, the contract has, in effect, been breached by the contractor, entitling the owner to be paid damages. The monetary amount will be determined in one of two very different ways.

  1. Most construction contracts include a liquidated damages provision. This provision states that, for every day the project work remains uncompleted beyond the time allotted for contract performance, the contractor shall pay the owner a stated dollar amount. The concept of liquidated damages is that the true or actual damages suffered by the owner are often difficult to determine accurately. Therefore, to obviate the need for making this determination, the owner and contractor agree at the time of contract formation on a dollar amount per calendar day that will be accepted by both parties as proper and appropriate recompense for any delay in contract completion. If the contractor completes the work late, the owner does not have to prove that any damages were thereby suffered but is entitled to the liquidated damages figure stated in the contract. If the contract provides for milestone completion dates in addition to the final completion date, liquidated damages may apply separately to each milestone date, with the total liquidated damages liability of the contractor being cumulative. Obviously, the magnitude of the stated daily liquidated damage figures may be of great concern to bidding contractors. In the writer’s experience, these have varied from less than $50 per day to over $50,000 per day.
  2. Monetary damages due the owner in the event of late completion may also be determined by proof of actual damages. If the contract does not contain a liquidated damages provision, the owner is entitled by application of common law principles to be paid the actual monetary damages suffered due to late completion. Although a contractor may finish a project late but pay nothing because the owner suffered no consequential damages, the owner’s damages in the event of late completion are sometimes immense and can be proven in court. Such contracts can represent a far greater financial risk to the contractor than if the contract provided for liquidated damages, depending, of course, on the stated daily liquidated damages figure. Thus, the absence of a liquidated damages provision in the contract is not necessarily beneficial from the contractor’s standpoint. If a liquidated damages provision is not included, bidding contractors would be well advised to determine the potential magnitude of actual damages the owner might suffer in the event of late completion before proceeding further. Liquidated damages are discussed in further detail in Chapter 17.

Site Availability and Access to the Site

Another project-specific matter concerns the availability of the site to the contractor. An implied obligation of the owner in every construction contract is to make the project site and reasonable access to it available to the contractor at the time of notice to proceed without restrictions unless the contract contains provisions to the contrary. Some contracts do contain such provisions to the contrary by placing restrictions to the site, either on the availability of the site or on the means of access to it. The restrictions can either state that the entire site, or separate portions of the site, will be made available at a time considerably later than the date of notice to proceed and/or that the contractor must complete the work and relinquish the site or sites by stipulated dates that are earlier than the final completion date of the contract.

A large contract for rapid transit construction in Atlanta in 1968 illustrates the problems inherent in stepped or phased construction site release dates. In that case, the bid documents provided for a highly fragmented schedule of release dates for construction work areas due to difficulty encountered by the Metropolitan Atlanta Rapid Transit Authority (MARTA) in obtaining title to the property involved. Included in these stepped work area release dates were specified dates for three areas contiguous to the main underground subway station-one area for ventilation ducts and the remaining two for auxiliary entrances to the station. All three were to be released to the contractor at dates stated in the contract that were considerably later than release of work areas necessary for the construction of the main underground station itself. After construction started, MARTA’s difficulties continued, delaying release of these three areas beyond the dates stated in the contract that created great uncertainty in scheduling and executing the contractor’s work activities. For many months, it was not known when, or even if, these three areas would be released. After delaying station construction significantly, the area for the ventilation ducts was eventually released, but the two areas for auxiliary station entrances were never released and eventually were deleted from the contract. The end result of delay and uncertainty of release for these three areas was that the project was in a continual state of flux for a considerable period of the contract, which seriously affected the contractor’s ability to schedule and carry out the underground station work. Considerable extra costs were generated which, fortunately, were eventually recognized and reimbursed by MARTA.

Another Georgia project involved the construction of 16 freeway bridges for the state department of transportation. Each bridge occupied an individual work site that the bidding documents indicated would be released to the contractor for bridge construction at stated dates. The contractor’s bid was prepared in anticipation that the individual sites would be released for construction in the order and by the dates stated in the bidding documents. After submitting the low bid and entering into the contract, the contractor commenced construction according to the bid plan, which relied on the bridge site release sequence and dates stated in the contract. Only two of the 16 bridge sites were released by the dates stated, the remainder being released from one to nine months late. The contractor’s planned work schedule and sequence of crew and equipment movement from site to site were totally disrupted, forcing the contractor to build the job on a continually changing schedule as first one and then another of the bridge sites were released late and out of sequence in a completely unpredictable pattern. The contractor filed claims for the greatly increased performance costs due to disruption and delay to the planned work program upon which the bid was based. The claims were denied, and the contractor sued in the Georgia courts.

Unfortunately for the contractor, the Georgia Court of Appeals reversed a trial court jury verdict that awarded the contractor substantial breach of contract damages for the state’s failure to release the bridge sites as stated in the contract.[1]

Apparently, in Georgia, contractors are not entitled to rely on these types of representations in bidding documents. Aside from the correctness or the incorrectness of the Georgia Court of Appeals decision, this case dramatically illustrates the risk posed to bidding contractors when the bidding documents indicate that the work site will be turned over to the contractor for construction in a piecemeal fashion.

Another form of site availability restriction is limiting the contractor’s right to occupy the site to certain days and to certain hours of the day, often to periods in the middle of the night. Such provisions are common for contracts for work in city streets, such as underground utility work or paving work. Similar restrictions may be placed on the availability of the means of access to the project site or sites, even to the extreme of stating that the contractor must make their own arrangements for access to the site. Another common form of restriction is to limit the hours in the workday during which certain kinds of construction activity, such as operating heavy haulage equipment or conducting blasting work, are allowed.

These and similar restrictions can affect the contractor’s cost of performance enormously. Such restrictions may not be immediately apparent when a bidder skims through a set of contract documents. However, a contractor bidding on a project must examine the documents carefully and clearly understand any restrictions to avoid later misfortune.

Payment and Retention Provisions

The general importance of the payment provisions is obvious. However, several specific aspects are somewhat less so. All large construction contracts call for successive progress payments to be made to the contractor, each based on an estimated value of the work satisfactorily completed during the progress payment time period. The important issues here are what is the duration of the progress payment period and how long after the end of the payment period can the contractor expect to receive payment? Provisions vary. A monthly period for payment frequency is common as is the provision that the contractor receives payment within 30 days from the date that the owner’s architect or engineer certifies the correctness of the estimate of work completed. In extremely large projects, a two-week progress payment period may be stated. Less obvious provisions govern the extent to which payment for the value of materials and fabricated products, such as structural steel and precast concrete procured and paid for by the contractor but not yet incorporated into the work, are made. Many contracts include the value of such items in progress payments, usually at less than their full value, with the balance of the contractor’s purchase price to be paid when the materials have been fully incorporated into the work. More restrictive payment terms do not recognize any value of such materials until they have been fully incorporated into the work.

A good example of the impact that payment for fabricated materials stored on site can have on a contractor’s cash flow is afforded by the Bolton Hills Tunnel Contract constructed for the Maryland Mass Transit Administration in the late 1970s. That contract involved $12 million worth of fabricated steel segmented liner plate to be procured by the contractor and installed as the tunnels were excavated. Fabrication and delivery to the site had to occur a number of months prior to payment being received for the installed plate in the tunnels. The fabricator required payment on delivery to the contractor’s storage yard at the site, and the contractor would have been badly strapped for cash had the contract not provided for partial payment upon delivery of the fabricated liner plate to the job site. Had the contractor been required to carry the full investment of the value of the liner plate until payment on installation, the bid would have been higher.

Another key issue is the retained percentage provision. Retained percentage or retention is a deduction made from each progress payment prior to paying over the balance to the contractor. The owner holds these retained monies until after satisfactory completion of the contract and acceptance of the work to provide a fund to remedy nonconforming work that the contractor may refuse or fail to remedy, as well as to provide some protection to the owner if the contractor falls in default of the contract and/or abandons the contract. After the satisfactory completion and acceptance of all contract work by the owner, the retained funds, less any amounts used to correct defects or satisfy other unpaid obligations of the contractor to the owner, are paid over to the contractor, constituting final payment of the contract price.

A common retention percentage is 10%, meaning that the contractor will receive only 90% of the value of each progress payment. Thus, when the contractor has fully completed all contract work, the owner will hold 10% of the contract price up until the point of final payment. On many types of work, the prime contractor’s markup on the estimated project cost will be less than 10%, meaning that, unless the contractor has retained 10% from all payments made to the material suppliers and subcontractors, the contractor could well be in a negative cash flow position at the completion of the contract work, even though the contract will eventually be profitable once the owner makes final payment. Under these circumstances, the point at which the final payment is made becomes increasingly important.

A more reasonable approach that has gained popularity in recent years is for the owner to retain 10% for the first 50% of the contract, then cease further retention, if the contractor is performing satisfactory work and is conforming to an agreed-upon project progress schedule. Further, at some subsequent point when most of the work has been completed, say, 90-95% of the total, and the contractor’s performance continues to be satisfactory with respect to quality and schedule, the retention is reduced to 200% of the estimated value of the uncompleted work. The remainder of the retention is then paid over as the final contract payment on completion and acceptance of all the work. Another popular approach is for the owner to deposit the retainage in an escrow account for which the interest is payable to the contractor. The owner may also permit the contractor to pledge interest-bearing securities or provide an irrevocable letter of credit in lieu of retention.

The retention provisions in a particular case can have a significant effect on the contractor’s cash flow, resulting in more or less investment of the contractor’s own funds in the project. This becomes even more of a concern in the case of major projects for heavy engineering civil works construction, significantly affecting the amount that bidding contractors include in their cost estimates for the cost of money, which in tum affects the total cost that the owner pays for the project.

Many heavy construction projects require large investments of capital before the work of the project can begin. These early cash outlays are required for the purchase of construction equipment, freight and assembly of the equipment at the work site, and installing extensive plant facilities such as temporary utility distribution systems, batch plants, material handling systems, and heavy-duty repair facilities. If not provided for separately in some manner, these large early expenditures can only be recovered through progress payments as the permanent work of the project is put in place.

Such projects may extend over several years, resulting in large investments tied up in the project for some time before being recovered. The time value of these invested funds is considerable and raises the bid price that the owner pays for the project. Another effect is to eliminate otherwise qualified bidders who may not have the financial strength to afford the initial high investment. Even if they have the necessary funds or the credit line to borrow them, they may wish to employ these resources elsewhere. Further, large public owners frequently can borrow at lower rates of interest than contractors.

For all these reasons, projects of this type frequently contain a lump sum bid item called a mobilization allowance, usually fixed by the owner in the bid form at a finite number of dollars. The project specifications make clear the kinds of costs that the mobilization allowance is intended to cover, and the contractor may immediately bill these large early expenses against the mobilization bid item. This lowers the contractor’s investment expense considerably and thus lowers the bid price to the owner in the same manner that favorable retention provisions and other favorable payment terms lower the bid price. Therefore, the presence or absence of the mobilization payment provision is important to bidding contractors. Otherwise, the bid must contain large interest charges as a necessary cost.

The importance of the time when final payment is made was previously mentioned, especially when the total retained funds are sizable. Some contracts contain straightforward procedures for contract closeout and release of final payment to the contractor. Others result in final payment months after completion and acceptance of the work. Contracts with a high retained percentage and with difficult and time-consuming closeout procedures obviously are not desirable from the contractor’s standpoint and therefore usually carry a much higher bid markup.

Reports of Physical Site Conditions

As mentioned in Chapter 4, it is important to determine precisely which documents comprise the contract and whether the contract documents include reports of physical conditions at the site, particularly for projects involving underground construction.

If such reports are included, are they to be considered part of the contract documents? Practices vary. Some owners make it very clear that the material has been included for the use of bidding contractors with the understanding that bidders shall consider it accurate and rely on it in determining their bids. Under these circumstances, the information implicitly is part of the contract documents. This fact will usually also be stated explicitly.

In contrast, other owners seek to limit or to avoid completely the liability that would ordinarily flow to them if physical site conditions data they furnish proves to be incorrect. They usually do this by means of a clause stating that the data is not part of the contract documents and that the owner and the architect/engineer bear no liability for any errors or inaccuracies that may later be found. Such a clause is one example of a type of clause called a disclaimer, and although not generally favored, may be recognized by the courts, provided that it is prominent and unambiguous and does not conflict or fly in the face of other contract provisions. On the other hand, many courts are reluctant to give this type of disclaimer full force and effect. They reason that if the owner does not want bidding contractors to use the information and rely on it in formulating the bid, then why include the information with the contract documents? Better to let the bidders make their own investigation of the site conditions. A problem with this approach is that the bidding period is usually too short to permit bidders to make in-depth investigations of physical site conditions, particularly underground conditions.

Good examples of courts’ reaction to the enforceability of disclaimers is afforded by the following two cases. In the first, a South Dakota State highway contract requiring borrow excavation contained the following disclaimer:

The information covering the pit for the project is given to you for informational purposes only. The Department of Transportation does not guarantee the quantity or the quality of the material listed in the above information. Interested contractors should investigate the area before considering it for bidding purposes.

The successful bidder had received the bidding documents including the borrow pit data only two weeks before bids were due. The borrow pit data proved to be grossly inaccurate and, after submitting a claim which was denied, the contractor sued to recover the increased cost of performance due to the inaccurate borrow pit information. The Supreme Court of South Dakota ruled against the contractor saying:

The unambiguous language of a contract defeats an implied warranty claim. There is no ambiguity in this case as to the parties’ intentions. The burden was placed on Mooney’s by expressed contract to determine the nature of the material in the pit. It appears that Mooney’s would now try to escape this contractor responsibility through use of an implied warranty.

Thus, the disclaimer was enforced.[2]

The opposite ruling resulted in a Maryland case where Baltimore County took bids for underwater repairs to the concrete piers for a bridge. The contract required the contractor to build sheet pile cofferdams around the piers, then dewater and excavate the bed of the river inside the cofferdams, exposing the piers. Once the piers were exposed, the contractor was required to chip away and replace deteriorated concrete, which was represented in the bidding documents to average approximately six inches in thickness.

The bidding documents contained a disclaimer to the effect that the site data included was for information purposes only and did not purport to represent actual conditions and did not relieve bidders of the obligation to verify independently all such data before submitting a bid.

During actual construction, the river bed was found to consist of hard material that was difficult to excavate, instead of the soft material represented in the bidding documents, and it contained numerous large boulders interfering with the cofferdam construction. The contractor incurred large cost overruns in performing the work. Further, only two inches of deteriorated concrete was found on the surface of the piers instead of the six inches stated in the bid documents. This resulted in the contractor being compensated for only 114 cubic yards of concrete removed instead of the 230 cubic yards that was calculated in the bid. The contractor sued to recover these large losses.

On appeal from an adverse lower court decision, the Court of Special Appeals of Maryland ruled for the contractor, stating that reliance on the data in the bidding documents was justified because there was no possible way that bidders could verify the data or otherwise obtain other more accurate data. The court further stated that the county’s data published in the bidding documents resulted from four years of periodic underwater inspections that could not possibly be duplicated by bidding contractors in the short period allowed for bidding.[3]

A more modern view for projects involving significant underground construction has resulted from the work of the Technical Committee on Contracting Practices of the Underground Technology Research Council sponsored jointly by the American Society of Civil Engineers and the American Institute of Mining, Metallurgical and Petroleum Engineers.[4] This approach requires that the owner have an adequate geotechnical investigation carried out pre-bid and include the engineer’s analysis of the data resulting from the investigation in the form of a geotechnical “baseline” report that the bidders may use in the preparation of their bids. Depictions of the logs of the actual soil borings and data recorded from various physical tests performed on materials at the site may or may not be included as part of the contract documents, but the engineer’s geotechnical baseline report including a summary of the analysis of all the detailed data and the engineer’s conclusions will be included as part of the contract. This engineer’s geotechnical evaluation is frequently called the geotechnical design summary report (GDSR) or, more recently, the geotechnical baseline report (GBR). If geotechnical conditions actually encountered during construction are more adverse than described in the geotechnical baseline report, the contractor is afforded relief for any ensuing loss of time or money through the provisions of the differing site conditions clause of the contract. This latter clause will be examined in detail in Chapter 15.

Exculpatory Clauses in General

Exculpatory clauses or disclaimers were discussed above in connection with their use in limiting the owner’s liability for inaccurate or otherwise misleading reports of physical site conditions. This is but one example of such clauses. Today, many knowledgeable persons, including contractors, owners, and architect/engineers, oppose the use of this type of clause, and many courts are reluctant to enforce them. However, their use persists. Bidding contractors who encounter them in contract documents and assume they will not be enforced do so at their peril. In any contract bidding situation, all exculpatory clauses must be identified and their potential impact evaluated.

Insurance and Bond Provisions

Insurance and bond provisions, briefly mentioned in previous chapters, are of paramount importance and could probably be considered a threshold matter. Ordinarily, bidding contractors will be able to meet the insurance requirements, provided they are not so stringent or unusual that the required policies are not available in the insurance market. The question then becomes one of insurance premium cost. Sufficient money must be included in the bid cost estimate to pay the required policy premiums for the life of the project. The advice of insurance specialists is usually needed to assure this; therefore, the insurance requirement provisions of the documents should be reviewed pre-bid by either in-house specialists on the contractor’s staff, an insurance broker, or both.

The contractor’s situation with regard to the surety bond requirements is considerably different. Here, cost is not the only question, although the premiums for the required package of bonds can be a substantial sum that must be included in the bid cost estimate. The major question is whether the contractor will be able to obtain the bonds at all. The answer depends on the relationship between the particular contractor and the surety companies. This, in turn, depends on the contractor’s financial strength and performance record on past contracts, the likely contract price for the project under consideration, and the contractor’s backlog of bonded work.

The key bond is the performance bond. If the contractor’s surety commits to furnishing the performance bond, the other normally required bonds (the bid bond and the labor and materials payment bond) will also be furnished by the surety. The surety’s agreement to provide the required project bonds must be secured very early in the bid preparation process. Without this commitment, the contractor cannot sensibly proceed, unless there is reason to believe that some development occurring during the bid preparation period will cause the surety to commit to furnish the required bonds. Chapter 8 is devoted to the subject of insurance contracts and Chapter 9 to surety bonds.

Indemnification Requirements

Many construction contracts require the contractor to “indemnify and hold harmless” the owner and the architect/engineer from all losses that they may suffer arising from any act or failure to act of the contractor in the performance of the contract work. Such indemnification usually extends to providing the legal defense in court for the indemnified parties if they are sued by persons or entities who allege they have been damaged as a result of the contract work and, if a judgment is obtained against the indemnified parties, to pay the judgment.

An indemnification clause imposes serious potential liabilities on the contractor. Many cannot afford to accept this risk unless the risk is insurable. A serious problem arises when the indemnification requirements are unreasonably broad and the contractor finds that they cannot be covered by insurance. For instance, such requirements have sometimes gone to the extreme of requiring the contractor to indemnify the owner and architect/engineer for the self-inflicted consequences of their own negligence. Therefore, before proceeding very far in pursuit of a potential contract, it is essential that contractors find out what the indemnification requirements are and determine whether they are insurable.

 

The federal government has not waived sovereign immunity with respect to tort liability. Neither have many of the individual states. These entities are thus protected from lawsuits by third parties arising from any act or failure to act on the part of their contractors. Construction contracts with these entities may not contain an indemnification clause.

Measurement and Payment Provisions

In the case of schedule-of-bid-items contracts paid on the basis of unit prices for measured quantities of work put in place which are common in engineered construction, the basis of quantity measurement and the exact rules determining which items of work will be separately paid and which will be included in the payment for other items are very important. Usually, the answers to both questions will be found in the measurement and payment language of the specifications. Contractors may well make the decision on whether to bid or decline to bid a job on the basis of the measurement and payment provisions if they have been so unclearly or unfairly written that they impose risks on the contractor that cannot be evaluated. Although detailed discussion of this subject is beyond the scope of this text, suffice it to say here that the measurement and payment provisions must be carefully examined and understood to avoid later unpleasant surprises.

Variation in Quantities Clause

The variation in quantities clause is also important in contracts for heavy engineered construction paid on a unit price basis, particularly those where the estimated quantities are large and can potentially underrun or overrun. The bid unit prices on such contracts normally contain one component to cover the contractor’s direct costs of performing the work and a separate component to cover the distributed portion of the contractor’s total job overhead and general and administrative expense. These latter costs are more or less fixed and independent of the final quantity of work done under the various bid items. An underrun in quantity will mean that the contractor will not recover all necessary fixed costs for the job, thereby suffering a loss. On the other hand, if the quantities overrun, the contractor will recover more than the fixed costs and reap an unexpected financial gain. The contractor will also experience a loss or reap a gain separately with respect to the profit and contingency components, which are also included in the bid unit price.

One widely used form of the variation of quantities clause provides that the bid unit price on any bid item in the job applies for all actual measured final quantities of work that fall within 15% under or over the estimated quantity shown on the schedule of bid items (the bid quantity). If the actual measured final quantity turns out to be less than 85% of the bid quantity, the unit price will be renegotiated upward if necessary to enable the contractor to recover the distributed fixed costs that would otherwise be lost. Similarly, if the actual final quantity turns out to be over 115% of the bid quantity, the unit price will be negotiated downward if necessary to prevent the contractor from over-recovering fixed costs.

Some clauses provide that the adjustment will “be based upon any increase or decrease in costs due solely to the variations above 115% or below 85% of the estimated quantity.” Under this form of the clause, the manner in which the contractor distributed the fixed general costs and profit to the various bid items is left unaltered when unit price adjustments due to quantity variations are considered. Unless the contractor’s actual costs of performing the work are directly affected solely by the increase or decrease in the quantity of work actually performed (either over 115% or under 85% of the bid quantity, respectively), there will be no unit price adjustment.

Under either form of the clause, the actual percentage figures controlling when the clause becomes operative may vary for particular contracts, but the principles of operation remain as explained above.

Equal Employment Opportunity and Disadvantaged/ Women-Owned Business Requirements

Equal employment opportunity requirements and disadvantaged/women-owned business subcontracting requirements that are frequently included in contracts in the public sector were briefly mentioned in Chapter 1. These requirements usually take the form of specifying goals by trades for

  1. The percentage of the contractor work force that should be filled by women and/or members of ethnic minorities; and
  2. Specifying a percentage of the total contract price that should represent either materials purchased from, or services subcontracted with, disadvantaged person-owned enterprises (DBEs) or women-owned enterprises (WBEs).

Ordinarily, the requirement for stated percentages of women or minority employees is seldom a problem in today’s contracting world, but there has been a great deal of trouble and litigation concerning the requirement for purchasing materials from, and subcontracting with, DBEs and WBEs. The issues involved are socioeconomic and often highly charged politically and emotionally. They are beyond the scope of this book. Suffice it to say that bidding contractors must know what the DBE and WBE requirements are and follow the stated instructions to the letter when submitting bids. Significant costs may be involved, which must be included in the bid price.

Escalation Provisions

Escalation provisions can be important in long-term contracts spanning a number of years. The essential idea of an escalation provision is that, in order to induce a lower bid price, the owner agrees to take the risk or part of the risk of increases in the cost of labor and key construction materials above the levels that existed at the time bids were taken.

Such contracts normally include a schedule of the labor hourly rates and the unit costs of key materials existing at the time of bid upon which the contractor’s bid was based. The contractor’s certified payrolls and paid invoices for all materials, maintained during contract performance, determine the actual manhours worked, labor rates paid, actual quantities of materials purchased and actual prices paid, all of which establish a basis for computing escalation costs. The contract will provide that the owner pay the contractor for all or a stated percentage of the escalation cost, in addition to the normal contract price determined by the bid.

The majority of contracts do not contain escalation provisions. However, when escalation provisions are present, the contractor is relieved of considerable risk, which will result in a lower bid price to the owner. Since the owner, not the contractor, is taking the risk, the owner will be the beneficiary of any savings when anticipated escalation does not occur, which would otherwise have been included in the bid price and thus paid by the owner even though these costs were not incurred by the contractor.

Conclusion

This chapter concluded the focus on prime construction contracts by first explaining why contractors must understand the implications of potential contracts for construction work by seeking out the “red flag” clauses and thereafter looking at the details of the clauses themselves.

The following chapters will shift emphasis from the prime construction contract to some of the prominent secondary contracts that are closely related to prime construction contracts, starting with Chapter 6 on the subject of labor agreements.

Questions and Problems

  1. Why is it important for bidding contractors to search out and become familiar with the “red flag” clauses discussed in this chapter? At what point in the bid preparation process should this be done?
  2. Why is important for a bidding contractor to know that an owner may be protected under sovereign immunity?
  3. What point does this chapter make concerning the treatment that a contractor can expect under the federal contract in contrast to other contracts with respect to disputes, changes, differing site conditions, delays, and terminations?
  4. What are the five threshold “red flag” clauses discussed in this chapter?
  5. What are the three separate aspects of time provisions that were discussed?
  6. What are liquidated damages and actual damages? Does the contractor normally have any input to the amount of a contractually provided liquidated damages daily figure? Why or why not? Which is preferable from the contractor’s standpoint—liquidated damages or actual damages? Of what significance is the contractually stipulated liquidated damages daily rate?
  7. What is meant by the phrase “conditions of force majeure”? Cite examples. In what way is this subject of concern to bidding contractors?
  8. What is the significance of site availability provisions? Discuss the several aspects of such provisions.
  9. What are four important aspects of payment provisions discussed in this chapter?
  10. What is the difference in the problem created for bidding contractors by the insurance provisions and the bond provisions of typical contract documents? Which is more likely to present a difficulty to a bidding contractor? Why?
  11. What are the two contrasting attitudes of owners toward inclusion of reports on physical site conditions as part of the contract discussed in this chapter? What is an exculpatory clause or disclaimer? What is the attitude of the courts regarding disclaimers of the accuracy of reports of physical site conditions? What is the modern view of how owners seeking bids on underground projects should handle disclosure and intended bidder reliance on reports of geotechnical investigations? Do you think it makes sense to expand this view to other types of projects as well?
  12. What is meant by indemnification? How do bidding contractors normally protect themselves from indemnification clauses? What is the general concern that may arise with indemnification requirements?
  13. Why is a variation in quantities clause important? How does a typical variation in quantities clause work? Would such a clause apply to the type of contract where the contract price was bid as a single lump sum? Why or why not?
  14. Which group of clauses included in equal employment opportunity or DBE/WBE requirements is likely to cause the most difficulty for contractors?
  15. What are escalation provisions? How do they work? Do all contracts contain them?

  1. Department of Transportation v. Fru-Con Corporation, 426 S.E.2d 905 (Ga. App. 1992).
  2. Mooney's, Inc. v. South Dakota Department of Transportation, 482 N.W.2d 43 (S.D.1992).
  3. Raymond International, Inc. v. Baltimore County, 412 A. 2d 1296 (Md. App. 1980).
  4. See Avoiding and Resolving Disputes During Construction, published by the American Society of Civil Engineers, 345 East 47th St., New York, NY 10017-2398.

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