Construction Contracts: What You Should Look Out For Before You Sign
The following blog was written to summarize a Built with Billd podcast held in May 2020, in which we interviewed Ernie Adams of Southwest Construction Services. This article is not meant to serve as legal advice, and the opinions expressed are those of the interviewee.
Construction contracts are often crowded with legal jargon that can be difficult to understand. All the while, they house vital information like the scope of work, timeliness, and payment obligations. To protect their business, contractors need to familiarize themselves with the nuances of their contracts.
There are a number of clauses that can spell trouble for contractors. We’ve outlined what sections can be tricky, misleading, or demand careful attention, so that you know what to look out for.
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What Aspects of Construction Contracts Are Negotiable?
Ernie Adams of Southwest Construction Services puts it this way, “There’s not a contract that doesn’t deserve to have something marked up.” Many young contractors are unaware that the project scope is entirely negotiable—but only if you speak up. Payment, timeline and how change orders will be priced are likewise up for discussion. Don’t hesitate to delve into the nitty gritty of the contract, including provisions about how and when you will be paid.
A common mistake among subcontractors is not proactively amending their contract when there has been a change to the original scope. By not speaking up and properly documenting change orders, a contractor can find themself taking on extra work with no compensation.
“My advice: don’t be shy about saying ‘I don’t have that in my contract.’ Talk through pricing it out and adding it into the contract, because even if there’s a disagreement, there’s always room to negotiate,” suggests Billd CEO, Chris Doyle.
Contractors often walk a fine line between being perceived as “difficult” and doing their due diligence. But many project disputes can be avoided by thoroughly and accurately establishing the scope of work. Voicing your concerns is something you’ll ultimately grow more comfortable with over time.
Look Out For: Liquidated Damages Clauses
Among the clauses that contractors should be wary of, liquidated damages clauses rank high. Liquidated damages are an amount of money, agreed upon by whomever signs the contract, that can be recovered if one of the parties breaches it. They can usually be calculated using a formula, with variables like the total contract price, the cost per day, and any factor related to the contract breach.
While this is a good tool for owners, it’s not nearly as useful to contractors. Although they sound great in theory, these clauses are difficult to enforce. They’re loaded with vague language and make actual damages difficult to quantify. Many states have loose, generalized rules on how to enforce these clauses, which is why you’ll want to study them carefully before signing.
In particular, there’s one term you should militantly watch out for: indirectly. Contractors risk being held accountable for another team’s breach if they’re considered “indirectly” part of that team. According to Ernie Adams, by removing the term “indirectly” from a liquidated damage clause, you could potentially absolve yourself from having to eat the costs of another team’s mistake.
He goes on to say that removing the word “indirectly” is a common practice when reviewing this portion of the contract. This helps ensure he won’t pay for costs associated with unforeseen circumstances or events beyond his control.
Look Out For: “Pay if Paid” or “Pay When Paid”
The terms “Pay When Paid” or “Pay If Paid” are contractual red flags to watch out for. Also referred to as “contingent payment clauses,” both indicate that a subcontractor’s payment will in some way depend on when the GC gets paid by the owner. These phrases ultimately gauge who will take on the risk of the project: the contractor or the subcontractor.
Pay When Paid Clauses
If a Pay When Paid clause is present, the subcontractor is guaranteed payment. However, the timing will depend on when the contractor is paid. If their payment gets delayed, so will the subcontractor’s. Pay When Paid clauses only affect the timing of a payment that is otherwise guaranteed.
Pay If Paid Clauses
Pay If Paid clauses pose a much greater risk. These clauses state that if any disputes prevent the contractor from getting paid, the subcontractor may end up doing work for free. Pay If Paid clauses mean that the subcontractor is not guaranteed payment. They effectively shift the risk of nonpayment to the subcontractor.
If you’re not well capitalized, this could extend payment schedules, forcing you to pay for crew work and materials out of pocket, and potentially waiting a long time before you get paid yourself.
This is where your relationship with the general contractor becomes critical, especially if you intend to negotiate the removal of this clause. You should have a good understanding of the financial viability of the project well before you sign on. You may also want to research state laws surrounding these clauses. Some states don’t look favorably at “Pay If Paid” clauses and have a history of ruling in favor of the subcontractor in such cases.
If you suspect the owner may not follow through on payment obligations, this is an important time to ask for proof of their ability to pay. Put simply, it’s better to have hard conversations up front, rather than be burned by a lack of communication later.
Look Out For: Generalized Language
Keep a keen eye out for general language that could contractually bind you to work you weren’t prepared to perform. “Including but not limited to,” is an excellent example. To combat this issue, a subcontractor should meticulously outline what does and does not fall under their scope of work. This will come in handy if a change order arises and is outside the scope. Many construction contracts aim to limit the amount of money a subcontractor can charge for change orders, sometimes no more than 5% over the entire cost of the contractor’s work. This not only limits the amount of money a subcontractor can make, it exposes them to potential losses if change orders begin to mount.
If you spot generalized language in your contract, speak with other parties involved on the potential for cost run-ups. Address the fact that you can only absorb so much extra cost on your end. In addition, look for clauses in the contract stating that the subcontractor must continue working while pricing is being negotiated. You don’t want to end up completing the work only to be told you’ll be paid less than it cost you to complete it.
Soften the Blow of Contractual Disputes With A Flexible Payment Solution
Understanding your construction contract is critical to being a successful contractor. It’s simply a matter of knowing where to focus your attention and not being afraid to ask for changes to protect yourself. To learn more about this subject, check out the Built With Billd podcast where CEO Chris Doyle speaks with Ernie Adams, a contracting pro with years of experience on the subject.
Billd offers a funding solution to help you bypass the potential cash flow issues that come with late payments or contractual disputes. We partner with world-class suppliers to obtain your project materials up front. With our “bill me later” option, you can purchase your materials today and pay over time. Thousands of contractors have turned to Billd for our industry expertise, customer care, and flexible payment terms. If you’re ready to explore a game-changing funding solution, get in touch with Billd today.
About Billd: At Billd, we provide a payment solution that enables commercial construction contractors to free up cash for material purchases while enjoying the flexibility of 120-day payment terms. You get financing for commercial materials upfront with the freedom to pay it back at your own pace. Learn more about how Billd can help eliminate your company’s cash-flow problems so you can win more bids and grow your business.