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Five More Contract Provisions That May Be Unenforceable

A surprising lack of uniformity in state laws exist that are applicable to fairly common construction contract provisions. Even within states, courts are less than uniform in their approaches, and many states’ statutes and court decisions did not address critical questions about the enforceability of the provisions. In the previous issue of Risk Management, Leavitt and Rosenberg addressed pay-if-paid/pay-when-paid contingencies, no damage for delay, change orders, no lien clauses and statutes of limitations clauses in contracts. Here are five more clauses that may or may not be enforceable.

1.   Indemnification Clauses

Typically, construction contracts require downstream parties to indemnify upstream parties in the event of a lawsuit. Such clauses are designed to protect the indemnitee from personal injury and property damage claims when something goes wrong on a project. Upstream parties typically seek such clauses by arguing that they should not be responsible when something goes wrong due to events primarily controlled by the downstream party. For example, the subcontractor that built a wall that collapsed should be responsible for the resulting liability from the collapse, not the owner or general contractor. It is not unusual, however, for construction indemnification clauses to require the downstream party to indemnify the upstream parties for any claim resulting from the downstream party’s work–even if the downstream indemnitor had nothing to do with the acts giving rise to liability.

Many, but not all, state legislatures have responded to perceptions that upstream parties have inordinate leverage in these situations by passing what are known as “anti-indemnity” acts. These acts limit or void the effect of certain contractual indemnity clauses. The scope of the various anti-indemnity acts varies greatly. Some acts–known as “sole negligence” acts–void indemnity clauses that do anything more than making a downstream contractor responsible for its own sole negligence. Other anti-indemnity acts–known as partial negligence acts–are narrower and allow the contract to specify that the downstream party is required to indemnify the upstream parties if the indemnitee was a partial cause of the injury at issue. While anti-indemnity acts may not affect an upstream party’s ability to demand indemnity for a third-party’s actions, the parties could be left in some jurisdictions with an indemnity clause that is entirely unenforceable because it is too broad by including a void indemnity provision.

 2.   Additional Insured Clauses

Closely related to indemnification clauses are “additional insured” clauses. These clauses typically require the downstream party to include the upstream party as an “additional insured” on the downstream party’s insurance–particularly on the party’s commercial general liability insurance. Thus, if an injury occurs, the upstream party can seek insurance under the downstream party’s policy. In their broadest form, these clauses are not limited in any way. Thus, if anything goes wrong on a project the owner could seek coverage for any event under the general contractor and all subcontractors’ policies regardless of whether or not the subcontractor, for example, had anything to do with causing the liability.

There are two potential problems with such additional insured clauses. First, increasingly anti-indemnity acts bar such clauses or severely limit their application. Legislatures in some states have determined as a matter of public policy that upstream parties should not be able to force downstream parties to provide insurance.

Second, and not surprisingly, insurers seek to limit and control their exposure. Increasingly, the availability of such additional insured coverage is limited or costly in the marketplace. Some contractors or subcontractors may be unable to add parties to their insurance or may only be able to do so on a limited basis.

 3.   No Interest or Slow Pay Provisions

Contracts often contain clauses specifying when a payment is due–these clauses typically give the owner, general contractor or project architect a fair amount of time to process and pay a payment application. The result may be that the lowest tier subcontractors and subconsultants effectively become the project’s bankers because they often are forced to wait months to be paid and have no contractual recourse to obtain interest, unless they go to the expense and trouble of recording a lien and filing a lien foreclosure lawsuit. Governments particularly are notorious for being slow payers.

Legislatures have recognized prompt payment of amounts legitimately due is important to the industry. As a result, nearly every state in the country has passed some version of a prompt pay act that requires payment within a certain number of days. Overall, such acts in many instances render unenforceable the timing of payment and interest on past due payment clauses included within contracts.

Again the scope of these acts varies. Some only apply to governmental construction contracts while some only apply to private contracts and other states have acts that apply to all types of construction. Some prompt pay acts do nothing more than allow the contractor to collect interest for delayed payment. Others establish if an upstream party fails to deny a properly submitted payment application in writing within a certain number of days, then that application is deemed accepted and cannot be later contested.

The penalties provisions of the prompt pay acts can be cumulative of other recoveries and can provide for significant interest and penalties if ignored. Importantly, determining whether a prompt pay act’s protections can be waived by contract and the language that must included to waive the applicable act varies significantly state by state. In many states, it has not been fully determined.

 4.   Choice of Law and Forum Selection Clauses

Parties with leverage often impose choice of law clauses provide the protection of state laws with which they are most familiar. Similarly they impose forum selection clauses in their home states that create cost and time impediments to claims and afford perceived “home court advantage” when claims are filed.

In some states, statutes have been enacted prohibiting construction contracts from subjecting disputes to the laws of a state other than where the project located. Similarly, mechanics lien acts and other statutes often specify what court is to hear a construction dispute.

 5.   Liquidated Damages Clauses

Many owners faced with extreme risks of lost profits and other losses, particularly with respect to project delays, seek to impose liquidated damages (LDs) on their contractors and designers. The LDs are often calculable and expressed in terms of dollar per day charges. Other owners use an approach that combines LDs with early completion bonuses, but the effect of failure to meet schedule can still lead to severe liquidated damages consequences.

Not every such clause is enforceable, however. Under the applicable case law of many states, LD clauses are only enforceable if they meet a multi-part test that generally requires some version of the following test recognized in the authors’ home state:

  • The parties intended to agree in advance to a settlement of damages that might arise from a breach;
  • The set amount was reasonable at the time of contracting and bearing some relation to damages that might be sustained; and
  • The amount of damages would be uncertain and difficult to prove.

This test is arguably inconsistent and difficult to apply. For example, how are damages capable of being estimated and difficult to prove at the same time? A contract drafter must walk a fine line in crafting an LD clause to make sure it’s actually enforceable.

To craft an effective and enforceable contract for clients doing business in multiple states, a drafter must be aware of state-by-state nuances and trends. But the practical realities of what is required in a contract must be kept in mind, including contract provisions to which no contractor or subcontractor can comply or that result in extreme price increases may not serve either the parties’ interests nor the client’s relationship or business interests.

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