Construction Law

Hiring a Contractor

Contracting construction work typically involves either the direct hiring of a contractor or competitive bidding among different contractors. Government contracts differ from nongovernment contracts in that private sector contracts have few constraints, while public sector contracts involve extensive regulations imposed by the government.

Private sector construction contracts may either be directly hired or bid upon. The direct hiring of a contractor is the hiring of a contractor at the individual's own discretion. Competitive bidding gives all contractors a chance to bid on the construction contract and allows the individual to hire the lowest bidder.

Public sector contracts involve competitive bidding. Since the government is a major employer and is political in nature, there is an assumption that there may be impropriety and that the government cannot be trusted to meet and negotiate suitable terms without at least the appearance of impropriety or special favor. Thus, competitive bidding serves the dual purpose of safeguarding against favoritism toward a particular contractor and giving all a fair opportunity to participate.

Bidding Procedure

Bidding Issues

Cases that involve fraud or ill repute in contract bidding usually nullify the contract. For example, if a city or county lacks the statutory authority to enter into a particular contract, the contract is void and the contractor may not recover for work performed. Cases that involve bad faith or bribery are also nullified, with the contractor receiving nothing.

However, accidental bidding discrepancies sometimes occur. The nature of the bidding process means that bidders sometimes miscalculate their bids. Relief is typically granted when the mistake was an honest error in mathematics or a clerical error but the courts have refused to grant relief for errors of judgment. The Illinois courts also have allowed rescission of contracts when enforcement of the contract would be unconscionable or when unforeseen circumstances render the contract unenforceable. In cases of unconscionability, courts either will grant relief to the bidder, a refund of the bid deposit, or an action for rescission of the contract.

When the bidding contract involves a prime contractor and a subcontractor, a subcontractor generally may not hold the prime contractor liable for the prime contractor's use of the subcontractor's bid unless there was an agreement stating otherwise. Thus, if a prime contractor uses a subcontractor's bid, the prime is not compelled to use the subcontractor if the prime is awarded the project; similarly, a prime contractor may not hold a subcontractor liable for the subcontractor's bid unless there was substantial reliance on this bid by the prime contractor in making his or her bid, in which case the court may impose the doctrine of promissory estoppel and hold the subcontractor liable for its bid. Further, Illinois law requires that any person or business entity who enters into a contract for consultant swerves with a State agency shall state in the contract whether the services of a subcontractor will be utilized, along with the subcontractors' names, addresses, and fees charged thereby.

CONSTRUCTION CONTRACT PROVISIONS

Payment Methods

Lump sum payments are found in fixed-price contracts and provide that upon completion of a contract, the contractor is paid the amount due. Cost-plus contracts provide that a contractor will be paid for all costs, plus a percentage or fixed amount for profit and overhead. The unit price method is used when the same project will be completed several times; e.g., a development project where many houses are being built. A unit price contract would provide a certain amount of houses and a certain price per house, and the contractor would be paid in increments upon the completion of each house.

Once the payment method is determined, the next step is to calculate the terms and conditions for payment. A relic of the English legal system under Oliver Cromwell, performance contracts have typically required performance of all labor before any payment is requiredabsent an agreement to the contrary. However, progress payments are instituted in most construction contracts to provide relief to ease the contractor's financial burden of having to finance the entire projectincluding labor, supplies, and credituntil its full completion. Progress payments are partial payments for work completed at a particular stage of the project and ameliorate the problems of payment collection.

Substantial Performance

Contractual Clauses

Since there are as many "standard" construction contracts as there are contractors and subcontractors, generalizations concerning standard contracts can be perilously misleading. However, the Association of General Contractors has provided "neutral" contract provisions that construction contracts should contain to prevent potential problems.

The Changes Clause

Unexpected delays or scheduling problems can require last-minute modifications in the work assignments of subcontractors and should be considered when forming the contract. Changes clauses are a standard in virtually every construction contract because they allow modifications in the design, specifications, and timing of a project as the desire or need for such modification becomes apparent during construction. Typically, the owner may initiate these changes, or must approve changes which the contractor indicates are necessary. The owner is then responsible for the additional costs associated with these changes. This clause allows changes to be made in the construction of the project without completely stopping work on the project altogether, and is normally construed to require prompt performance on the part of the contractor and subcontractor, with expedited consideration from the owner because of any dispute involving the terms of the change.

The Scope of Work Clause

Before work on the project begins, each party should be clear as to its duties and obligations; i.e., the work and the costs involved. This is contained in the Scope of Work Clause, which defines the labor, materials, services and costs involved in the project. Contractors should be careful to avoid dragnet or all-inclusive clauses with boilerplate terms like "all work necessary to complete said project," "all related items" and "all work normally undertaken in this type of trade." Indeed, since the scope of work is often defined in various documents, each Scope of Work Clause should be "identified and incorporated" as such into the general agreement.

Flow-Down and Flow-Up Clauses

Virtually all contracts contain a clause that allows incorporation of a clause into the general agreement; in construction contracts, these are typically called Flow-Down and Flow-Up Clauses (also known as "Conduit Clauses").

A Flow-Down Clause provides that all duties and obligations the contractor owes the owner are owed by the subcontractor as well. Similarly, the Flow-Up Clause ensures the owner's obligations and duties to the contractor will also be owed to the subcontractor.

Retention Clauses

Illinois (together with Wisconsin, Texas, and Arkansas) statutorily requires that certain public owners must retain ten percent from the contractor's pay. Illinois Statute (121/5-409 [1993]) requires partial payments on contracts let by a county for highway work may be made as the work progresses, but no payment in excess of 90 % of the value of the work then completed may be made until 50% of the work has been completed. However, retention of the 10% may terminate once 50% of the construction work is completed. Of all states with a statutorily mandated retention clause, only Illinois has a statute which requires the retaining of contractor sums in a pure trust account. (There are, however, states that require the establishment of an escrow account.) This trust is put into an Illinois bank of the contractor's choice, is subject to the approval of the State agency, and all interest from such trust is to be paid to the contractor.

Other Standard Clauses

Parties should devote attention to Payment Clauses, which set forth a schedule of payment that is contingent on the general contractor getting paid before there is any payment to the subcontractor. Further, Safety Clauses are often standard and require subcontractors to observe basic safety requirements on the job site. For projects involving many subcontractors, Scheduling Clauses are often included in each subcontract to ensure that neither party will incur liability in the event that a third-party subcontractor's performance is delayed.

Modification of the Contract

Once the contract is executed, it may be modified only if both parties mutually assent to the modification. Agreement of both parties is required since the modification is seen as a new contract, and therefore the contractual requirements of offer, acceptance and consideration (typically money or another benefit) apply. Illinois courts have stated that furnishing additional labor and construction project materials in exchange for more money is adequate consideration. Written modifications are not required unless the Statute of Frauds or the contract itself necessitates a writing.

Concealed and Changed Conditions

A frequent problem on construction projects is the discovery of a previously concealed condition that makes the work more difficult, more expensive, or perhaps impossible to perform. These discoveries typically result in a need for additional time, contract revisions, or even rescission of the contract. Therefore, flexibility to make changes is an important part of construction law. In Illinois, the two most common types of clauses used to deal with concealed or changed conditions are the Site Investigation Clause, and the Changed Conditions Clause.

The Site Investigation Clause allows the contractor to make a claim for any condition not reasonably discoverable by an investigation of the site. However, the Site Investigation Clause has proven to be one of the general contractor's worst enemies. It is often asserted by the owner as a defense to the contractor's claim for "extras" since some Illinois courts have ruled that the contractor "could or should have anticipated the extra from a reasonable site inspection." While the Site Investigation Clause is a common construction contract disclaimer, by far the more common contract disclaimer is the Changed Conditions Clause.

There are two types of Changed Condition Clauses: the first addresses the contractor encountering a condition that is at variance with the conditions already documented in the agreement, and the second deals with the discovery of conditions or situations that are anomalous or incongruous with the type of work provided for in the contract. In Changed Condition Clauses, custom in the trade is often the standard for recovery, which is typically allowed unless the contractor knew or should have known of the conditions.

Damages in the Event of a Delay

Most construction contracts involve time restraints and many involve "time is of the essence" provisions. However, delays in the completion of a project sometimes happen, and a delay claim for damages is essentially a claim that the contract has been breached. However, in contract law, a breach of contract must be a material breach to file a claim for damages. Tardiness in completion alone is usually not part of the basic exchange of values in a construction contract, and thus not a material breach. Consequently, a construction contract should specify whether damages are recoverable if one party fails to perform. The "substantial factor test" is often applied to subcontractors. Here, courts will hold subcontractors liable for damages cause by delayeven though other subcontractors may contribute tot he delayif the subcontractors conduct is a substantial factor in the project's delay.

Three kinds of clauses are generally used to ensure indemnification in the event of a delay: Actual Damages Clauses, Liquidated Damages Clauses, and No-Damages-For-Delay Clauses. Actual Damages Clauses provide that a delay is a breach of the contract, and that the breaching party must pay money damages equal to the amount of damages suffered. Liquidated damages set an agreed-upon amount for damages to be paid in the event of a breach. No-Damages Clauses contractually limit liability to provide no relief in the event of a delay.

CONSTRUCTION DEFAULT

Mechanic's Liens

A mechanic's lien is a security device by which unpaid contractors, subcontractors, and suppliers may enforce payment for services and materials through the lien process. To acquire a mechanic's lien, a claimant must fall into one of state-protected classes of lienors, including: contractors, subcontractors, suppliers, laborers and mechanics. Mechanic's liens are typically statutory, so claimants must observe state regulations in strict obeisance. Substantial performance and proof of use of the materials into the construction project are required before the lien will attach. In most states, evidence that materials were delivered to the site is sufficient proof that materials were used in the construction project. However, once a lien is attached to the property, the courts will liberally interpret the lien requirements in order to accomplish the parties' objectives in completion of the project. In the event that the parties' objectives (presumably, completion of the project) cannot be met, courts have allowed the claimant to use the remedy of repossession. Proceedings for repossession are quite similar to proceedings used to foreclose a mortgage, and are subject to time constraints imposed by either the mechanic's lien statute itself, or by the statute of limitations.

Defenses to mechanic's liens are found in common and statutory law. An owner may defeat a claim for a mechanic's lien by proving the lienor's failure to comply with the statutory requirements (failure to prove that the materials in dispute were used in the construction project, for example), or by proving contractual provisions showing waiver of the lien or lien preclusionprovided the language of the waiver or preclusion is clear and unambiguous. Further, if the holder of the lien gave false, misleading, or inflated price information, any mechanic's lien will be rendered null and void. Illinois law provides that the prevailing party in a mechanic's lien foreclosure will recover reasonable attorney's fees in an amount to be determined by the court. However, once the U.S. Supreme Court held that public property was exempt from mechanic's liens, surety bonds for construction projects became an established practice in construction law.

Bond Coverages

Surety bonds date back to Biblical times, and were commonly used when contracts were generally non-enforceable, so merchants could protect themselves in commercial transactions. Furnishing contractor's bonds began in the late 1800's to provide owners with protection against contractor's defaults, and laborers and material providers with protection against nonpayment. Today, the "Miller Act" (40, United States Cod, section 270) requires contractors to furnish payment and performance bonds as a conditions to the award of any substantial public federal contract. Similarly, all states have "Little Miller Acts" which require the same bond coverage for all public state contracts. Owners, concerned with the threat of mechanic's liens, sought the same kind of bond protection enjoyed by the public sector. Hence, the use of private bonds came into general use. Today, the mechanics lien and the surety bond together furnish the foundation for the credit structure of one of the United States' largest industries, the construction business.

In construction contracts, owners typically will require the contractor to provide the owner with a private payment bond. Private payment bonds protect the owner from mechanic's liens from various subcontractors in the event of their nonpayment by the contractor. The bond's surety either will pay to the extent of the amount specified in the bond (provided the claimant furnishes the requisite notices to the debtor) or will effect performance of the work (i.e. the surety guarantees to the owner faithful performance of the underlying contract between the owner and the contractor).

LIABILITY TO THIRD PARTIES

Owners and General Contractors

An owner's or general contractor's liability in construction projects is dependent on their duty to provide a safe work environment. For construction work that is inherently dangerous, owners and general contractors have been held strictly liable for injuries incurred on-site, unless special precautions are undertaken by the owner or general contractor. Illinois has enacted the Structural Work Act (IL Statutes section 150/1), which was enacted to provide workers in extra-hazardous occupations a relatively safe place to work. In order to establish a cause of action for violation of the Act, the claimant must show that the injury was one designed to be protected from by the Act, those in charge of the work willfully violated the Act, and that violation of the Act proximately caused plaintiff's injury. Significantly, the party (owner or general contractor) in charge of the claimant's work is immune from tort liability under the Structural Work Act, pursuant to Illinois' worker's compensation laws, since the supreme court does not consider worker's compensation benefits to be a collateral source of recovery.

Lenders

Finance creativity in construction projects has resulted in lenders becoming more involved in the construction process, thus expanding the boundaries of lender liability. Developers who wish to obtain a construction loan typically need to present a loan commitment to the construction lender for approval. Upon approval of the loan, the relevant parties agree that when the construction project is completed, the permanent lender (the owner's bank) thereupon will purchase the construction loan from the construction lender (typically a commercial bank that specializes in short-term construction loans).

When lenders participate with developers in joint ventures, courts consistently have found lenders liable to third-party purchasers for construction defects. A joint venture typically exists if four elements are found: (1) a common purpose, (2) joint control or right of control, (3) joint proprietary interest, and (4) mutual sharing of profits and losses. If the existence of each element is proven by the claimant, the lender will be liable to third-party purchasers for construction defects.

Most courts do not hold lenders liable for negligence claims on construction projects. Construction lenders periodically may inspect the site to monitor project progress, and often extract a fee for doing so. If an inspection fee is extracted from the construction loan, this does not give rise to the requisite duty standard required for a negligence action. However, if the lender assumes title of the project or becomes more than a lender by holding itself out to be the developer or owner to purchasers, the lender will then be held liable for completion of the project to the extent of the express representations made to the buyer. Further, the assuming lender may be liable for construction defects and breach of any warranties due to these defects.

Architects and Engineers

In large construction projects (and some smaller jobs), design professionals such as architects or engineers provide blueprints and plans for more sophisticated design projects like condominiums, office buildings, shopping malls, or even homes. Although form agreements in construction contracts have become customary, ignorance of their legal significance can be very problematic for contractors and design professionals alike. If design professionals fail to perform their duties properly, they can be held liable for breach of contract, negligence, failure to disclose a material or latent defect, or other actions if the court finds their conduct subjects the architect or engineer to strict liability.

The construction contract lists the duties of the design professionals, and if these professionals fail to perform their duties, the owner may sue for breach of contract. Damages for breach are limited to an amount that is reasonably foreseeable at the time the contract was made or to an amount that is a natural consequence of the breach.

Design professionals acting in their professional capacity are held to a higher standard of care that is consistent with their higher degree of knowledge and skill. Therefore, a design professional whose performance does not meet the reasonable standard of care of similar professionals with similar skills will be found liable for negligence. This negligence standard applies to the professional's drawings or plans, preparation, inspections, and supervision of relevant personnel. If it is reasonably foreseeable that the negligent conduct will result in injury, the design professional may be liable to third parties for sustained injuries. However, these third parties are only owed a duty of care if they are within a class of persons who the design professional could reasonably foresee might be damaged or injured as a result of the negligence. This class of persons includes project owners, subcontractors, suppliers, contractors, sureties, lenders, and injured construction workers. However, negligence claims or tort actions generally do not allow recovery for solely economic losses. To recover economic losses in a tort action, the design professional must be held liable under a standard called strict liability.

Strict liability is a tort concept in which one is found liable regardless of fault, contributory negligence, or anything else that normally absolves persons of liability. Courts have been very reluctant to impose strict liability on design professionals as it is usually impossible to differentiate between a construction defect and a design defect because they are often closely intertwined.

However, none of these standards of liability are designed to assure conformity with the plans or specifications by the design professional. No construction contract guarantees or implies perfection in either plans or results, and design professionalsabsent strict liabilityare liable only for failure to exercise reasonable skill in preparation and execution of the plans. Similarly, contractors are not responsible for defects in the plans or specifications given to them by design professionals hired as independent contractors.

Independent Contractors

Design professionals may need to hire consultants from various disciplines for construction projects. Consultants such as structural, civil, or mechanical engineers or electrical experts working on construction projects at the behest of the architect or engineer (as opposed to being hired by the owner) are considered independent contractors. According to the federal courts and Restatement (Second) of Agency, $220, in determining whether a consultant is an independent contractor or an employee the court will consider: the extent of control that the design professional may exercise over the details of the work; the terms of the agreement; the method of payment; the degree of skill required for the job; previous dealings between the parties; and previous scopes of employment of the consultant. If the relationship is determined to be employer/employee, then the tort doctrine of respondeat superior applies, making the employer responsible for the torts committed by the employee (if committed within the scope of employment).

A design professional acting as an independent contractor is generally not liable for the acts of the independent contractor, since the duties were delegated to this contractor in a consultant capacity. However, sometimes ordinances or building codes will create non-delegable duties of compliance, such as fire codes regulating a project's design. In these cases, independent contractors may be liable for injuries sustained by those within the class of people intended to be protected by the ordinance.

LIABILITY INSURANCE

Construction agreements commonly provide details on who is responsible for bearing the responsibility for accidents on the site. Florida Statutory law requires comprehensive general liability insurance ($489.115) and workers' compensation insurance ($440 et. seq.). Builder's risk insurance and professional liability insurance are standard in most construction contracts. Most contracts contain indemnity provisions to determine who will bear the risk of loss should an on-site accident occur, and the purchaser of the insurance should be required to furnish a copy of the policy to the other party.

General Liability

Comprehensive General Liability Insurance protects contractors against claims brought against them because of occurrences in privity with the contractor's work, and coverage typically extends only to property damage and bodily injury. Business risks such as claims for defective work or structure defects are covered by other policies; and builder's risk insurance protects against loss to buildings during construction, alteration or repair. (This coverage is usually voided once the work is done or once the project is occupied.) Professional liability insurance is carried by professional designers to protect against losses relating to their work on the project or to cover claims made against them by third parties. Owners are increasingly requiring design professionals to carry liability insurance since owners may have a claim against the design professional for losses relating to the project or for satisfaction of claims to third parties.

Workers' Compensation

Usually a Comprehensive General Liability Insurance policy excludes coverage for workers' compensation claims, unemployment compensation, or disability benefits. This risk insurance is obtained under separate policies, and in every state, workers' compensation coverage is required for all employers. General contractors are often required by the owner to procure workers' compensation for subcontractors as well as employees. However, it is customary for general contractors to fulfill this duty by requiring their subcontractors to procure the coverage themselves, since worker's compensation insurance for employees and subcontractors would be very expensive. If subcontractors do not obtain this coverage, despite their obligation, the general contractor bears responsibility to procure this insurance coverage if the contractor hires the subcontractor. In contrast, the contractor is generally not obligated to provide coverage for vendors or lessors of equipment. Further, if the worker is an independent contractor instead of a subcontractor, general contractors are not obligated to provide workers' compensation coverage. Courts often use a two-pronged test to determine whether the worker is a subcontractor or an independent contractor: 1) Is there a subletting of the contractor's work? and 2) Does the contractor have control over the worker? If an employee files a workers' compensation claim and wins, then that is the sole recovery for the employee. However, it is possible under certain conditions that an independent contractor may file a separate claim against an employee or subcontractor on the site.

REMEDIES

In General

Breach of construction contracts entails many things: the owner's failing to make periodic payments, failure to cooperate by either party, unforeseen conditions that render completion impractical or impossible, project abandonment, or a general failure to fulfill the contractual obligations. If conditions occur that make performance by one party impossible, then a party not at fault may, in good faith, terminate the contract for cause without fear of damages. However, these terminations must not be arbitrary or unreasonable or they will constitute wrongful termination. Wrongful termination is a breach of contract for which the injured party may collect compensatory damages, which typically amount to lost profits and a reasonable calculation of labor and materials involved in the partial completion of the project.

Remedies Clauses

Most construction contracts contain either a Time-Is-Of-The-Essence Clause, a Damages-For-Delay Clause, or a No-Damages-For-Delay Clause. These clauses typically insulate, protect, or prevent one of the parties from having to breach the contract in the event of nonperformances, such as unforeseen circumstances or impractical occurrences. More importantly, they provide remedies, or a limitation of remedies, in the event of a breach. A Time-Is-Of-The-Essence Clause will provide a fixed time for performance, with a remedy if completion exceeds this time allotment. A Damages-For-Delay Clause provides remedies for the contractor in the event of noncooperation from the owner, or contingencies that interfere with a timely performance. No-Damages-For-Delay Clauses protect the owner from breach assessments in the event of certain listed occurrences, such as financing problems or construction access easements. This clause will exclude damages against the owner for delay of performance.

RESOURCES

Introduction to Construction Law, Steven M. Siegfried, ALI/ABA Continuing Legal Education, Philadelphia, PA (1987).

Handbook of Modern Construction Law, Jeremiah D. Lambert and Lawrence White, Prentice-Hall, Inc., Englewood Cliffs, NJ (1982).