Few industries require the use of contracts more than the construction industry. Construction leaders need to be aware of the fundamentals of contracts to be better prepared to bring projects to profitable conclusions. Understanding these fundamentals allows a leader to assess a project and make better decisions, as well as understand available options.
TERMINATION OF A CONTRACT AND REMEDIES
A contract is terminated when the parties have completed full and satisfactory performance of their obligations under the contract. A contract also is terminated when:
- there is a breach of contract caused by a party defaulting from its obligations;
- there is a mutual agreement to terminate the contract;
- unforeseen circumstances render it impossible for a party to perform the duties; or
- the contract is terminated due to an operation of law.
If a contract is terminated through a failure to perform by one party, then the other party likely will receive damages.
Contractual damages are primarily designed to provide the non-breaching party with the benefit that was lost or to “make the party whole.” Depending on the type of damages that are awarded, the non-breaching party likely will receive money damages, restitution, rescission, reformation or specific performance. Money damages mostly are designed to compensate the non-breaching party for the damages equal to the value that the party would have received if the contract had been fully performed or damages for the cost to complete the project after the breach. The difference is primarily on the stage of the project when the breach occurred; the earlier the breach, the more likely that the damages will be designed to provide the loss value.
Restitution is a remedy that restores the non-breaching party to a position prior to the formation of the contract and can include money or property. Rescission allows a non-breaching party to terminate contractual duties if that party entered into the contract by mistake, fraud, undue influence or duress. Reformation allows a court to change the substance of a contract to correct any inequities that were suffered due to mistake, fraud, undue influence or duress. Lastly, specific performance is a remedy that compels a breaching party to complete specific duties and is available usually when monetary damages are inadequate.
ADDITIONAL CONSTRUCTION INDUSTRY APPLICATION
Certain situations arising from contract clauses generate additional angst. For example, the force majeure clause is used in contracts to free all parties of any liability or obligation for extraordinary events that occur beyond the control of any of the parties. This clause is designed to protect the parties from catastrophic circumstances that could not reasonably be expected to occur during a contract’s completion.
As reference in Part I of this article, the force majeure clause would be relevant if flooding occurred that ruined the land on which Knowinlaw Construction was going to build the hospital. The contract between Knowinlaw and Contractors USA may no longer be effective due to this incident, and all parties may be relieved of their duties because the event was not due to fault or negligence. The force majeure clause is often included in the standard terms of a contract, so a general contractor should diligently read the fine print but understand that the courts will most often recognize force majeure if the event is completely unforeseeable. However, courts have placed a high standard in proving the application of the force majeure clause to ensure that it is reserved for situations that are catastrophic.
Another clause that causes frustration is the pay-when-paid/pay-if-paid clause. The most common version of this clause is that the subcontractor is not paid until the general contractor is paid by the owner. This clause is generally within the standard terms of the contract and is largely enforceable in most courts as long as the conditions of the clause are expressed clearly. By expressing the conditions of the clause, general contractors can maintain a pay-when-paid clause that some courts will recognize, although the standard is high to prevent other contractual issues, such as unjust enrichment.
The No Damages for Delay (NDFD) clause often is added to construction contracts. Usually the project owner will add a NDFD clause to bar a contractor’s attempt to recover payment or compensation due to delays, but allow completion of the project. Courts generally will enforce NDFD clauses except in situations in which the delay is caused by fraud, bad faith or interference. For example, if Contractors USA is not able to perform its requirements due to Knowinlaw’s knowledge of a failure in the plans, then Contractors USA may be entitled to damages for the delay and the inefficiencies it caused, because Knowinlaw Construction was aware of the situation.
Indemnification clauses are added to construction contracts to expand the risk that a party will undertake and shift liability to other parties. It usually applies to additional remedies that are available and obligates one party to certain damages for specific occurrences that happen related to the contract. The definition of these occurrences and the damages are identified and defined in the agreement between the parties. For example, the contract between Knowinlaw Construction and Contractors USA includes an indemnification clause against all damages for personal injuries caused by, or in connection with, Contractors USA’s services. If a personal injury occurred onsite related to Contractors USA’s services, Knowinlaw will likely succeed in shifting liability to Contractors USA despite the fact Knowinlaw is the general contractor. This allows Knowinlaw to shift the risk and responsibility.
Contracts are much more than a promise, and certain characteristics are required to ensure that a promise is enforceable through the creation of a legal contract. They promote economic efficiency by ensuring that agreements are completed, insulating parties from additional unexpected costs and providing remedies for any breaches. This is only an introductory perspective on the basic elements of contracts within the construction industry. It is not exhaustive, and legal questions should be directed to an attorney specializing in construction law.