Construction Contracts: Beware of Certain Clauses

A well-drafted construction contract will outline all the obligations, liabilities, and procedures needed to protect your rights and your money. Those who have been in business for a few years have fine-tuned their contracts to their company’s specific needs. Here are a few of the more pertinent contractual provisions you should review – and consider revising.

Learn more: The Contract Review Checklist

1. No-lien clauses

In general, no-lien clauses are looked upon with disfavor, and many states have specifically and forcefully disallowed their inclusion in contracts, and their enforcement, by statute or through court decisions.

A “no lien clause” is simply a clause within a construction contract, or a lien waiver document signed before the furnishing of work, whereby a party preemptively waives its right to later file a mechanics lien on the project. In other words, the waiving party agrees (whether they know it or not) to perform the work without the security of a potential mechanics lien claim against the improved property if they end up not getting paid for their work.

In general, these types of agreements are unenforceable. While the “freedom of contract” doctrine generally allows parties to contract between themselves as they wish, contracts must not run afoul of the state’s public policy. For example, you can’t contract to do something illegal, or against what the legislature and courts have determined to be the public good.

Accordingly, in many states, you can’t contract around the state’s interests in protecting construction participants against non-payment through the mechanics lien right.

Note, however, that while this is generally the case, it is not universally always true in practice. While there may be a technical difference between a no lien clause in the original contract and a preemptive waiver of lien rights prior to furnishing labor or materials to a project, there is no practical difference. Both result in a loss of lien rights for the potential claimant. Some states let parties waive lien rights prior to performance, subject to certain rules, and some don’t — so be careful.

2. Subordination of mechanics liens

Even in situations where a pre-work waiver of lien rights is not allowed, it may not be the end of the story. In some cases, the subordination by contract of the mechanics lien to some other security interest is perfectly fine, sometimes even in states that disallow the advance waiver of the right to file a mechanics lien.

Subordination of a mechanics lien relates to a lien’s priority, which is what may ultimately determine who gets paid first (or at all) in the event of an enforcement action and foreclosure on the property. While lien enforcement or foreclosure proceedings are not frequent, they do occur, and being at the end of the priority line can mean that a party doesn’t get paid – even if they have a valid filed lien.

Subordination of a mechanics lien, then, takes a lien from its place of higher priority, and moves it behind another interest in the property that originally would have been lower on the priority ladder. Often times, these subordination clauses are contained within lending agreements, so that the lenders can claim priority for their deed of trust over mechanics lien claims that may have otherwise had priority.

It is important for construction parties to examine contracts for lien subordination clauses, because even if a “no-lien” clause may not be enforceable, a lien subordination clause may be – and unfortunately for would-be lien claimants, it can have the same ultimate result.

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3. Delay and disruption damages

The COVID-19 pandemic demonstrated the tenuous nature of the construction economy. State governments intervened to halt progress on many projects, and This is why it’s so critical to review the clauses in your contract related to delay claims and disruption claims.

These clauses will determine which types of delays and disruptions are excusable and inexcusable. Once that’s established, be sure to the clauses detail if and when a party will be entitled to an increase in the contract price or an extension of time.

If a delay is incurred, project managers should avoid trade stacking and other attempts to catch back up to the initial schedule. Compensation and time should be fairly allocated to ensure the project is completed safely and efficiently.

Also, keep an eye out for a no damages for delay clauses, also referred to as a “no pay for delay” clauses. These clauses are typically inserted by higher-tiered parties to reduce or eliminate their liability to pay for delays. Essentially forcing a subcontractor to absorb the additional costs of delays caused by others on the project. If there is one in the contract you’re about to sign, it would be wise to negotiate around it.

4. Force majeure clause

Also known as the “Acts of God” clause, a force majeure clause is meant to excuse non-performance for delays caused by circumstances that were unforeseeable and well beyond the contractor’s control.

Depending on the language in the clause, this could be a viable defense if a delay is caused by a force majeure event. Consider adding language specifically tailored to disease, pandemics, and quarantines that may impact the progress of the work.

5. Notice provisions

Notice provisions aren’t necessarily a specific clause. Often, notice provisions are spread throughout a construction contract. Many of your rights and obligations under a construction contract require some sort of notice. Notices may be required prior to claims for delay damages, an extension of the contract time, change orders, stop-work requests, and terminations.

Learn more: The Complete Guide to Construction Notices

It’s almost a guarantee that all of these necessitate sending a notice within a certain timeframe in order to exercise or invoke these particular rights. Be sure you familiarize yourself with all of the details, such as when a notice is required, who they should be sent to, and the time period in which they need to be sent. Failing to do so could result in forfeiting claims or taking money out of your pocket.

6. Termination clauses

The termination clauses in your contract will also be particularly relevant during the pandemic. This is understandable from both angles. A property owner or a project manager may want to terminate a contract, or the project as a whole.

Contractors need to review the agreement clauses that clearly outlines the circumstances, notice requirements, and other relevant procedures to execute a termination for convenience.

7. Escalation clauses

Material supply chains continue to experience interruptions, leading to material shortages and price volatility.

This could entail requiring contractors and subs to secure more than one vendor, or at the very least one back-up. In addition to that, including an escalation clause could also help control cost overruns due to supply chain disruptions. When volatile market conditions and material shortages are factors, this clause helps protects contractors from price fluctuations for raw materials.

It shifts the burden of increased costs from the contractor to the client, to ensure they’re not the ones left with an inflated tab.

8. Mobilization costs

Some form of mobilization costs are included in a typical construction contract. These can be structured in a number of different ways. It can be a flat fee for costs, based on a percentage of the contract price, and can be paid out in advance or follow a draw schedule.

Whether a project is temporarily shut down due to a pandemic or recessionary pressure, contractors may be forced to de-mobilize and re-mobilize more than once. Contractors should be careful to review their contractual rights to recover mobilization cost, and potentially include the right to request additional compensation.

9. Insurance requirements

Construction contracts should also require some sort of insurance policy coverage for all parties involved. This can include a number of different types of policies. Contractors or subs who let required coverage lapse could find themselves in breach of contract.

Additional resources

These are just a few of the more pertinent sections and clauses that contractors should review going forward, but a full review of your contract is highly recommended. And keep in mind, this doesn’t just apply to your contracts — be sure to thoroughly review your vendor contracts as well. Everyone needs to be proactive and prepared.

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Construction Contracts - Beware of Certain Clauses
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Any attempt to preemptively limit the right to file mechanics liens becomes a battle between the right of freedom of contract on one side, and centuries old public policy on the other. How that battle shakes out can depend on many different factors.
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levelset
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