This article was taken from a webinar that was presented by SunRay Construction Solutions and Alex Barthet. Alex is a board-certified construction lawyer who serves clients in Florida. In this article we will discuss how to deal with material price escalation – a real problem that is affecting the construction industry.
1. Write it Down
You would be surprised to hear how many people have a contract dispute, but when asked for the contract, say that they do not have one. They have no written agreement at all, whether it is a proposal or quote.
So, the first thing you need to do is, whatever contract you have, that it is in writing. A short contract is better than no contract, and a lengthy contract is better than a very short contract. There are many other things that should be included in a contract, but having a written contract is very important.
Some people ask about whether or not a handwritten agreement is valid. It is absolutely valid. And it can also be electronic, like in an email where you outline the terms and conditions of your engagement. If the other person responds with a yes, that is considered a contract.
Also, it does not have to be an original. You do not have to have an original for there to be a valid contract. It also does not have to be notarized. In a case a few years ago, the judge found that an exchange via text message was enough to create a valid contract between two parties.
It does not take much, but obviously, the more formal the better. Just have a process or procedure in place and have the contract in writing.
2. Do Not Just Sign Their Contract
When you think back to the discussion above, about having the contract in writing, you should be concerned if someone hands you their contract, and you sign it. The reason is that more likely than not, their contract is designed to protect them over you. So, you are better off reviewing, understanding, and amending their contract than just signing it.
You do not want to go into blind. There are still a great number of people who have a contract and all they did was sign the one handed to them. Sometimes they do not even read it, which is very scary. You need to make sure that you read and understand the contract that has been given to you, and that you amend it to the extent that you have concerns with what is in it.
Now you should not just be worried about signing the contract that you are handed; you should also be concerned about signing what you believe to be standard contracts. There are two types of standard contracts.
One contract is when someone hands you one and says that it is their standard contract. You might believe it to be a fair contract and sign it without reading it, or you read and sign it anyway without making any changes.
The second type of contract is those produced by trade organizations. The most common is the American Institute of Architects (AIA). There are other bodies that produce similar documents, but while the AIA contract form, if unmodified is relatively fair to the parties in the transaction, it could still be made better. And you should not just sign that contract blindly.
3. Clearly Define Your Scope of Work
So now that you understand you need a contract and that it needs to be in writing, it cannot just be the other side’s contract. You need to define what the scope of work is that you will be providing, whether it is just materials, materials and labor, or just labor. You need to be very clear in how you define your work.
When someone is hiring you and they are giving you their contract, they typically want a very broad definition of the work that you are going to do. The reason they want that is they want to be able to have all the opportunities that may exist in the contract to say, “No this is within your scope even if it is somewhat vague.”
There is always a relatively a standard sentence that exists in the AIA contract and it would likely be in any contract that someone gives you for your work. And that is that you are responsible for all work that is shown in the plans and specifications as well as that which is reasonably inferable from there.
This means that you may not actually be on the plans and specifications, but if a reasonable person believes that it should be part of your contract, then a judge will determine that to be the case. So, that is one example of a contract provision that is a problem if you have it in your contract when someone is asking you to do the work.
Because that could expand the scope of work beyond what you understood it to be. Now, when you are hiring somebody, maybe you are subbing out some of the work. You want it to be as broad as possible in what you ask someone to do for you.
The other area where problems are seen, is when you look at the scope of work and the way it is defined is very broad, and it includes all of the pages of the plans and specifications. This is something that sophisticated owners and contractors like to do.
So, if a plan set includes plumbing, electrical, mechanical, and structural work, when they define your scope of work if you are just the electrician, you would like it to just be the electrical pages in the plans. So that is a very limited definition of your scope of work. But they would want you to be responsible for anything that is electrically related in all of the plans whether it appears on the structural pages or the mechanical pages.
So clearly defining your scope of work will make a difference. Because from the previous example, if something is left off the electrical plans, but was included in the mechanical plans as an electrical item, if you limited your scope of work to just the electrical pages, then you have a very good argument to say that anything else is not included in your price.
If it is the entire set of plans that relate to electrical work, then even though it appears on the mechanical set of plans, it would still be within your scope. You would likely have to do it for the same price.
4. List All Exclusions
There are things that you know you do, or that you do not do when you are in the scope of your work. So, if someone asks you to do extra work, you know it would be an additional price. When you go into a contract, you should have a list of exclusions ready to include in your own contract. Or when you are reviewing someone else’s contract given to you, you should have a list so that you can articulate to the other side, exactly what is not in your price or scope.
Where the problem arises here is when one party believes that something was within their scope and the other party believes that it isn’t. If you have a list of items that you know you do not perform or you will not provide within your contract price, you should have it ready. Any exclusions or limitations need to be part of this list, and you should include it as an exhibit to your contract.
5. Understand the Change Order Process
When you have to do extra work on a contract, there are typically several ways to go about this if someone asks you to do extra work, ideally, you will do that extra work only after there is an agreement on a change order. It has to be fully memorialized, signed with the change in the scope, price, and time, and approved before you do the work.
The reality is that that is not always the case. So, when you are looking through a contract that someone gives you, or if you generate your own contract, you need to make sure that you understand what the change order process is. And most importantly, you need to follow it.
For example, most general contractors who have their own form that they give to subcontractors or larger subcontractors who give to sub-subcontractors have a change order process that looks like this: it says you cannot do any work without getting a signed and approved change order in advance.
But if you are told to do other work, you agree to keep segregated records related to that extra work, submit the bill and then they will determine later whether in fact this was an extra and what the impact is on the schedule, as well as the cost. This cost is based on your separate records that you kept of labor and materials.
Now, let us say you undertake this work, and you get an emailing saying that they have included a change in the plans and that you should price and proceed with it. If you do not segregate your own records for the change order process you will be in trouble. You have your men in the field and should keep separate records associated with that change order work.
So, all of the materials and all of the labor associated with just that item of work are kept separate so that you can add them all up and submit them to the contractor. If you do not do this, it is going to be very difficult to submit pricing and submit a change order. But keep in mind you should demand the contractor or owner that if someone is asking you to do a change that they verify it is in fact a change.
Most contracts include what is called a change directive procedure through which you can do this. It means that a contractor or owner can direct you to do a change, but you want to get that written direction from them to work on the change. So ideally, they will tell you about a revised page in the plans.
But before doing the work, you should generate a change order, submit it to them, and have them either accept or reject it. If they reject it, then you need to tell them to issue you a change directive effectively. This ensures that you have the necessary paper trail associated with that change.
6. Verify the Schedule
As important as the price in your contract is, you also need to know the schedule and understand how quickly the work needs to be done. You need to check and see whether or not the agreement has any penalty associated with the failure to timely perform. So, you need to look at the schedule and make sure that it is doable.
Figure out if there are any liquidated damage provisions that exist in the contract, and if so, decide if they are reasonable and if you agree with them. You can try to add a buffer, for example, if there are liquidated damages, what the damages are typically per day, for your failure to timely perform your scope of work.
Maybe it is $500 per day or $1,000. Maybe you can add a buffer and say that those do not start to run until 30 days after the completion date. Know that if you have a contract and it does not have a liquidated damage provision. That does not mean that there are no damages for delay, it means that the damages you may be liable for, are the actual damages of the contractor and the owner.
For example, let us assume that you are a drywall subcontractor on a hotel. It is late in part because of failure to timely perform certain parts of your work. If that is the case and there is no liquidated damage in the contract, then the owner may be able to assess against the contractor and the contractor against you, their actual damages.
This means they may have had to hire employees and keep them on standby. They could not rent rooms and make that revenue. All of the actual damages that they suffered may be your responsibility even though there is no liquidated damage provision. So when you are reviewing the contract make sure that you review the schedule as well so that it is something that is achievable.
7. Refine the dispute resolution procedures
There are four types of dispute resolution processes that should be in your agreement.
a. Company executives should have a meeting
Number one, and always the first line of defense to avoid having a legal dispute, is that the executives associated with the companies should have a meeting. So, your agreement should say that within a week or two of a dispute, that the executives of each organization have to have an in-person meeting to attempt to resolve the dispute.
b. The parties should go to mediation
The second is if the first does not work. Then the parties should go to mediation, and mediation is a process in which both parties meet, split the cost of the neutral third party who is trying to facilitate a resolution between the parties. Usually, it is an attorney or a former judge, but it can be anybody. You can even define the person in your contract.
So, if you both agree, you can pick somebody. But if not, most people mention a mutually agreeable neutral third party in their contract. Once that is done and you have this meeting, the neutral third party may be able to bring the parties together to have a resolution for the dispute. And these disputes can happen during the course of the job. It does not have to be only at the end of the job.
c. The parties should go to litigation
The third and fourth ones are typically mutually exclusive, which means you can either pick one or the other. One is litigation where you take your case to a judge or jury and that judge or jury decides who is right and wrong. Your average legal case lasts between 8 and 24 months depending on how quickly things move and whether or not the parties can settle quickly or not. It is a very expensive process and as you can imagine, it takes a long time.
d. The parties should go to arbitration
The other way to deal with the dispute is what is called arbitration. Arbitration is effectively a private judge which the parties hire. This can be a contractor, architect, engineer, a former judge, or lawyer. That neutral third-party acts as a judge. You can either have one arbitrator or three arbitrators.
These arbitrators get paid like professionals, so they get paid anywhere from $150 to $450 an hour. Arbitration may be faster, but it is not tremendously faster. And there is an additional cost associated with arbitration because unlike litigation in court, where aside from paying a filing fee, you do not pay the judge. In arbitration, you have to pay all of the costs every time the arbitrator or arbitrators meet and try to decide something.
So that is the dispute resolution process, and you need to understand how it works before you blindly agree to one or the other.
8. Make Sure that the Winner Gets Their Legal Fees
Finally, make sure that the winner gets their legal fees. Many people ask about the likelihood that they are going to recover the legal fees that they may have to pay to an attorney for either prosecuting or defending their case. There are only two ways in the state of Florida to recover your legal fees. This typically applies in most states.
a. Someone is suing another person for violating a statute
The statute says that the winner gets their fees. A good example in construction is the lien statute and the payment bond statute. Typically in those cases, the winner gets their legal fees.
b. The prevailing party is entitled to recover their legal fees
If you have a written contract, and the contract says that the prevailing party is entitled to recover their legal fees, then you can. It is possible to have a written agreement that does not say that the prevailing party gets their legal fees, which means that unless you have another legal statute that says the winner gets their fees, even though you have a written contract, if it does not have the right language in it, then the winner will not recover their legal fees.
Because litigation is so expensive, you need to make sure that if you have to undertake the process and you have to go through all the way and spend lots of money with lawyers so that you are able to recover those fees if you win.