Contract review is crucial for construction companies to mitigate risks, ensure compliance, and achieve project success. Creating an internal contract review process, paying particular attention to the below sections, will ensure that you are not agreeing to onerous contract terms, while making your surety underwriter confident in your risk management process. Here are comprehensive guidelines for reviewing contracts:
1. Project Scope and Description
- Detailed Description: Ensure the contract explicitly describes the project scope, including specifications, deliverables, and timelines.
- Scope Changes: Define procedures for handling scope changes, including approval processes and impact on costs and schedules.
- Surety Impact: In a claim situation, the surety will review this section to ensure you are actually responsible for the work in dispute, and the owner followed protocol for any changes.
2. Responsibilities and Roles
- Parties Involved: Clearly identify all parties involved (owner, contractor, subcontractors, suppliers).
- Duties and Obligations: Outline the responsibilities and duties of each party to avoid ambiguity and potential disputes.
- Surety Impact: Duties and obligations should be as detailed as possible to alleviate any unknowns during the claims process.
3. Payment Terms
- Payment Schedule: Specify the payment schedule, including milestones, retainage, and final payment terms.
- Invoicing Procedures: Detail the invoicing process, required documentation, and payment timelines.
- Surety Impact: The surety prefers payment terms that are 30-60 days, however with certain industries this is not feasible such as Healthcare. In the case where payment terms are stretched out 60-90 days, the surety will want to see that you can cashflow the project well without using your bank line extensively. The surety will want to see cash balances strong enough to withstand these longer payment terms.
4. Performance and Quality Standards
- Quality Requirements: Define quality standards and performance criteria for materials, workmanship, and services.
- Inspection and Testing: Include provisions for inspections, testing procedures, and remedies for non-compliance.
- Surety Impact: At times, making sure you have inspections and testing approval in writing can impact whether you will be held responsible for unforeseen issues later in the project.
5. Time and Schedule
- Project Timeline: Ensure the contract includes a comprehensive project schedule with key milestones and completion dates.
- Delays and Extensions: Address how delays will be managed, including allowable extensions and penalties for delays.
- Surety Impact: The surety will want to see that you are comfortable with the schedule, you have added days for weather into your schedule, and that any penalties are clearly stated and capped at a certain value if applicable. In today’s market, the surety will also want to make sure that the schedule allows you to receive your materials in time for substantial completion.
6. Change Orders
- Change Management: Establish a formal process for submitting, reviewing, and approving change orders.
- Impact on Costs and Schedule: Specify how change orders will affect project costs and timelines.
- Surety Impact: One of the most important, and at times the most difficult, task is to get change orders in writing. Planning a process and setting clear expectations at the beginning of a project and agreeing to this process in the contract can save your firm money and time when conflicts arise.
7. Risk Management
- Insurance Requirements: Ensure the contract outlines the required insurance coverages, including general liability, workers’ compensation, and professional liability.
- Bond Requirements: Ensure that the contract outlines the bond percentage, requirements for the warranty period, and includes any specific bond forms required
- Safety Requirements: Include safety protocols and requirements to be followed on-site.
- Surety/Insurance Impact: If you are found to be responsible for a loss and do not comply with the insurance or bonding requirements, you will still be required to pay the loss, but you will have no risk transfer tool in place to alleviate the effects of the loss on your company.
8. Warranties and Guarantees
- Warranty Period: Define the warranty period for materials and workmanship.
- Correction of Defects: Include procedures for identifying and correcting defects during the warranty period.
- Surety Impact: The surety will want to confirm that the warranty period is not a long-term commitment. Sureties typically like to see warranties no longer than 2 years.
9. Dispute Resolution
- Resolution Mechanisms: Specify mechanisms for resolving disputes, such as mediation, arbitration, or litigation.
- Governing Law: Determine the governing law and jurisdiction for resolving disputes.
- Surety Impact: Mediation is always the best form of dispute resolution in the eyes of the surety. When looking at jurisdiction, they want to ensure that the state in which the project is located is listed in this section.
10. Termination Clauses
- Termination for Cause: Detail conditions under which the contract can be terminated for cause.
- Termination for Convenience: Include provisions for termination for convenience, outlining any compensation or penalties.
- Surety Impact: The surety will review this section to confirm there is nothing out of the ordinary. Typically, these terms are fairly standard, but if not, the surety may provide language to assist in limiting your exposure.
11. Force Majeure
- Definition and Scope: Define force majeure events and how they will be handled.
- Impact on Obligations: Clarify the impact of force majeure events on contractual obligations and project timelines.
- Surety Impact: The surety doesn’t usually put much emphasis on force majeure. The underwriter will confirm this clause is present and has all the standard language included.
12. Compliance and Legal Requirements
- Regulatory Compliance: Ensure compliance with relevant laws, regulations, and building codes.
- Permits and Licenses: Specify responsibility for obtaining necessary permits and licenses.
- Surety Impact: There is attention paid to this section when a client is entering a new geographic area or a market where permits are more difficult to obtain. In these instances, the surety prefers the owner take on this responsibility. It is important to note that if you are in one of the above situations, you may want to negotiate language into the contract allowing for extra time if permits cannot be obtained.
13. Subcontracting and Assignment
- Subcontractor Approval: Include provisions for the approval of subcontractors and assignment of contract duties.
- Liability and Responsibility: Clarify the contractor’s liability for subcontractors’ performance.
- Surety Impact: This clause is more geared towards general contractors and construction management firms. At times, the surety will require their GC/CM clients to obtain subcontractor bonds from critical path subs or subs with larger contract values in order to alleviate any effects that a sub default would have on their client.
15. Final Acceptance and Closeout
- Completion Criteria: Define criteria for substantial and final completion of the project.
- Closeout Procedures: Include procedures for project closeout, including punch list completion and final inspections.
- Surety Impact: The surety does not put much emphasis on this clause, but all contractors should ensure that they are aware of any penalties for not hitting milestones or substantial completion. Following all closeout procedures and completing punch list items is vital to final payment and closing out projects.
16. Signatures and Execution
- Authorized Signatories: Ensure the contract is signed by authorized representatives of all parties.
- Execution Date: Confirm the date of execution and the commencement of contractual obligations.
- Surety Impact: Many times, the surety does not receive the final, executed version of the contract. It is important for all contractors to verify that the owner signed the contract and file the original for the length of time of the statute of repose in your state. While it may seem like a redundant thing to not, many contractors have missed this in my experience.
Additional Considerations Addressed in More Detail in Part 2
- Indemnity Clauses: Review indemnity clauses to understand the extent of liability and protection.
- Liquidated Damages: Assess provisions for liquidated damages in case of delays or non-performance.
By following these guidelines, construction companies can effectively manage contractual risks and promote successful project outcomes. Your surety agent should be your first line of defense when it comes to contract review. While, as agents, we cannot offer legal advice, we can speak to clauses and terminology that are seen as onerous in the surety industry. To take it a step further, most sureties have in-house claims staff with legal backgrounds that can offer assistance with contract review. To learn more about what we, at McConkey, offer our surety clients, click below.