By Mike Koger, Director & Counsel, AIA Contract Documents
You know the moment. You’re reading a contract and come across a provision that stops you in your tracks. ‘This can’t be right, can it? Do they really think I would sign something so one-sided?’ Dealing with unfair provisions is an inevitable part of negotiating construction contracts. However, if you have negotiated contracts long enough, you learn to quickly spot unfair provisions and develop strategies for dealing with them. In this article, you will find my top 5 list of unfair provisions in construction contracts and corresponding negotiation tactics between owners and contractors. I will also provide some tips on how to counter biased provisions to come to a fairer contract.
Before I get into the list, a brief word about what it means to label a contract provision as “unfair”. Webster’s defines unfair as “marked by injustice, partiality, or deception”. Another definition would be any provision that significantly shifts risk away from a party who is in the best position to manage that risk and towards the party who is not. And while both definitions are meaningful guideposts, I will let my own experience serve as a guide and state that this is a list of provisions and tactics that have given me the most heartburn over the years – particularly those that repeatedly come up in construction contracts.
Indemnity provisions are some of the most confusing and frustrating language in a construction contract. Deep within the murky recesses of an indemnity provision can lie nuanced language that drastically shifts risk and liability from one party to another. There are numerous articles and court opinions that dissect indemnity provisions and serve as guides for how to navigate tricky indemnity language. That analysis is beyond the scope of this article, however, I will share an important tip for reviewing indemnity provisions that has served me well over the years – read them carefully and ask yourself, “How is the other side trying to pull one over on me?” If there is any provision that tempts you to pick up the phone and call your attorney for advice, this should be the one.
To be clear, not all indemnity provisions are unfair or overreaching. A good example of a fair indemnity provision comes from Section 3.18 of AIA Document A201-2017, General Conditions of the Contract for Construction.
§ 3.18 Indemnification
§ 3.18.1 To the fullest extent permitted by law, the Contractor shall indemnify and hold harmless the Owner, Architect, Architect’s consultants, and agents and employees of any of them from and against claims, damages, losses, and expenses, including but not limited to attorneys’ fees, arising out of or resulting from performance of the Work, provided that such claim, damage, loss, or expense is attributable to bodily injury, sickness, disease or death, or to injury to or destruction of tangible property (other than the Work itself), but only to the extent caused by the negligent acts or omissions of the Contractor, a Subcontractor, anyone directly or indirectly employed by them, or anyone for whose acts they may be liable, regardless of whether or not such claim, damage, loss, or expense is caused in part by a party indemnified hereunder. Such obligation shall not be construed to negate, abridge, or reduce other rights or obligations of indemnity that would otherwise exist as to a party or person described in this Section 3.18.
Notably, Section 3.18 does not require the contractor to “defend” the owner, an obligation that has been construed by some courts to require the contractor to pay for defense costs before fault has been established1. Section 3.18 is also limited in scope as the contractor only provides indemnity for losses “to the extent caused by the negligent acts or omissions” of the contractor itself or one of its employees or subcontractors. While it might seem counterintuitive to newcomers to the construction industry, it is not at all uncommon to find indemnity provisions where one party is required to provide indemnity where fault is shared (i.e. intermediary indemnity) or where the other party is solely at fault for a loss (i.e. broad form indemnity)2. Such practices may be curtailed by state anti-indemnity statutes, but it is always best to make sure these types of overreaching indemnity provisions don’t find their way into your contracts in the first place.
Liquidated damages are a part of many contracts and, when done right, act as a reasonable estimate of damages to make the non-breaching party whole3. Liquidated damages provisions are routinely upheld and enforced by courts4. Still, liquidated damages provisions can be abused and the inclusion of liquidated damages in a contract should be closely scrutinized by the party who may eventually have to pay them. All too often, owners (and their attorneys) insert liquidated damages not as a reasonable estimate of future damages, but as a weapon to use against a contractor in case of delayed performance or as a holdover provision from a previous contract.5 After all, it is far easier to scare a contractor into compliance with the threat that every day of delay will cost them additional money in the form of liquidated damages. When faced with a potential liquidated damages provision, contractors should always discuss with the owner how they arrived at the amount and what concerns the owner has that led to the inclusion of liquidated damages in the first place. Often, an owner’s concerns can be satisfied without including liquidated damages in a contract.
Liquidated damages that act as a penalty, rather than a reasonable estimate of future damages, may be invalidated by courts.6 Liquidated damages are likely to be deemed a penalty if they are grossly excessive and disproportionate to the damages that might reasonably result from a breach of contract.7 Even with these safeguards in place, contractors should not rely on courts to invalidate overreaching liquidated damages. Once a contract is signed, the owner’s argument for entitlement to liquidated damages is simple – the contractor agreed to it freely. The contractor’s task to invalidate a liquidated damages amount is far more difficult – they have to argue that the liquidated damages provision that they freely agreed to is an unreasonable penalty. The better practice, of course, is to scrutinize and negotiate liquidated damages at the time of contracting and determine a fair amount – or come up with a better way to satisfy the owner’s concerns about delayed performance.
No damages for delay clauses prohibit a contractor from recovering costs due to a delay caused by the owner or by one of the owner’s consultants or separate contractors. Contractors should be on the lookout for these provisions when negotiating contracts because owner-caused delays can mean more than just lost time. They can increase the contractor’s costs through demobilization and remobilization, inability to use laborers on another job, additional supervision, and higher costs for materials and equipment rentals. If a “no damages for delay” clause is included in a contract, the contractor will only be able to seek a time extension for owner-caused delays and will be prohibited from entitlement to these other associated costs. States vary in recognizing no damages for delay clauses as permissible, and judiciaries may carve out exceptions to enforcing them. Courts may even invalidate a no damages for delay clause if the owner intentionally or recklessly caused the delay to the detriment of the contractor. Nevertheless, a fair contract permits the contractor to recover monetary damages when delayed by the owner, and in turn, requires the contractor to pay the owner when the contractor causes a delay.
One common tactic in contract negotiation occurs when one party attempts to pressure the other to agree to something against their interest. This often comes in the form of one party rushing the other to sign an agreement with no ability to negotiate reasonable concerns. Of course, there are plenty of reasons why a contract may need to be signed quickly or when negotiations of a particular variety aren’t feasible. Yet, in most cases, these practices are nothing more than negotiation tactics to apply pressure, tip the power balance, and rush a quick decision. These practices are often combined with contract clauses stating that both parties have had the opportunity to consult with an attorney and that the contract shall not be construed against the party who drafted it. Normally, these clauses are innocent enough; however, in the rushed-contract scenario these clauses are inserted to head-off challenges that the receiving party did not have enough time to properly review the contract or consult with an attorney.
When you see this combination of factors – a rush to sign a contract, no ability to negotiate reasonable concerns, and contract language that is designed to ward off challenges – it should put you on high alert. One simple countermeasure to being rushed to sign a quick agreement is to insist upon (a) more time to review the contract and (b) a good reason for the time crunch. Those acting in good faith will usually extend a 24-hour deadline to 48 or 72 hours without much hesitation. As for not being able to negotiate reasonable concerns, always press the other party to provide a reason that truly makes sense. If none is forthcoming, and the concerns are important enough, this might just be a red flag that you should walk away from the negotiation.
If there is one contract provision that all contractors, subcontractors, and material suppliers should learn and understand thoroughly, it is “pay-if-paid” clauses and their confusingly similar cousin, the “pay-when-paid” clause. The simple math of it is, if you are a downstream contractor or subcontractor, “pay-if-paid” clauses are bad, but “pay-when-paid” clauses are usually fine.
“Pay-when-paid” clauses affect the timing of payment and provide that the downstream party (usually a subcontractor) will receive payment a certain number of days after the upstream party (usually a contractor) has received payment. Pay-when-paid clauses are usually enforceable because they only affect the timing of payment. The AIA’s A201® embodies the concept of pay-when-paid in Section 9.6.2, by stating that the “Contractor shall pay each Subcontractor, no later than seven days after receipt of payment from the Owner, the amount to which the Subcontractor is entitled…”
Pay-if-paid clauses, on the other hand, completely shift the risk of nonpayment downstream. These types of clauses not only affect the timing of payment, but also affect the right to receive payment at all. In this regard, pay-if-paid clauses usually embody the concept that if an upstream party doesn’t get paid, then the downstream party doesn’t get paid either. Legally, “pay-if-paid” are sometimes referred to as a “condition precedent” and are looked upon more skeptically by courts because of their harsh result.
Learn more about how to identify unfair contract terms that can cause an imbalance in responsibilities and roles or be detrimental to the interests of the signing parties, watch on-demand webinar “Don’t Sign That Contract Yet! 5 Warning Signs of an Unfair Construction Contract.” Watch On-Demand >
1.Crawford v. Weather Shield Mfg., Inc., 44 Cal. 4th 541, 553–54, 187 P.3d 424, 431–32 (2008) (“A contractual promise to “defend” another against specified claims clearly connotes an obligation of active responsibility, from the outset, for the promisee’s defense against such claims. The duty promised is to render, or fund, the service of providing a defense on the promisee’s behalf – a duty that necessarily arises as soon as such claims are made against the promisee, and may continue until they have been resolved.”); Reyburn Lawn & Landscape Designers, Inc. v. Plaster Dev. Co., 127 Nev. 331, 344–45, 255 P.3d 268, 277 (2011) (“the duty to defend is broader than the duty to indemnify because it covers not just claims under which the indemnitor is liable, but also claims under which the indemnitor could be found liable.”)
2. Courts generally recognize three types of indemnity – limited form indemnity, intermediate form indemnity, and broad form indemnity See James v. Burlington N. Santa Fe Ry. Co., 636 F. Supp. 2d 961, 968 (D. Ariz. 2007) (“[L]imited form indemnity requires the indemnitor to save and hold harmless the indemnitee only for the indemnitor’s own negligence. The intermediate form indemnity requires the indemnitor to indemnify for all liability excluding that which arises out of the indemnitee’s sole negligence. Finally, the broad form indemnity obligates the indemnitor to save and hold harmless the indemnitee from all liability arising from the project, “regardless of which party’s negligence caused the liability.”)
3. Boone Coleman Constr., Inc. v. Piketon, 2016-Ohio-628, ¶ 11, 145 Ohio St. 3d 450, 453, 50 N.E.3d 502, 508 (“Simply stated, liquidated damages are damages that the parties to a contract agree upon, or stipulate to, as the actual damages that will result from a future breach of the contract.”)
4. Carrothers Const. Co. v. City of S. Hutchinson, 39 Kan. App. 2d 703, 704, 184 P.3d 943, 945 (2008) (“The reasonableness of a liquidated damages clause should be determined as of the time the contract was executed, not with the benefit of hindsight. However, to recover under a liquidated damages clause, the amount of liquidated damages must bear some reasonable relationship to the actual injury or damages caused by the breach.”
5. Hanover Ins. Co. v. Binnacle Dev., LLC, No. 3:19-CV-00111, 2020 WL 5912803, at *3 (S.D. Tex. Oct. 6, 2020) (Holding that liquidated damages that were leftover from a form contract that neither Hanover nor the defendants drafted were unenforceable and that for liquidated damages to be “reasonable forecasts,” Texas courts require at least some thought in their making.)
6. Id at 3.
7. Id at 4.
8. See W.C. James, Inc. v. Phillips Petroleum Co., 485 F.2d 22, 25 (10th Cir.1973) (observing that “[s]uch clauses are commonly used in the construction industry and are generally recognized as valid and enforceable”); Owen Constr. Co. v. Iowa State Dep’t of Transp., 274 N.W.2d 304, 306 (Iowa 1979) (“Such clauses are defended [in cases involving public contracts] on the theory they protect public agencies which contract for large improvements to be paid for through fixed appropriations against vexatious litigation based on claims, real or fancied, that the agency has been responsible for unreasonable delays.”)(citing A. Kaplen & Son, Ltd. v. Hous. Auth., 42 N.J.Super. 230, 233, 126 A.2d 13, 15 (1956)); Maurice T. Brunner, Annotation, Validity and Construction of “No Damage” Clause with Respect to Delay in Building or Construction Contract, 74 A.L.R.3d 187 (1976 & 2007 Cum.Supp.) (collecting numerous state and federal cases upholding “no damages for delay” clauses).
9. Zachry Const. Corp. v. Port of Houston Auth. of Harris Cty., 449 S.W.3d 98, 116 (Tex. 2014) (holding that “pre-injury waivers of future liability for gross negligence are void as against public policy. Generally, a contractual provision exempting a party from tort liability for harm caused intentionally or recklessly is unenforceable on grounds of public policy.)
10. MidAmerica Const. Management Co., Inc. v. Mastec North America, Inc., 436 F.3d 1257 (10th Cir.2006), (“The theory is that a “pay-when-paid” clause creates a timing mechanism only. Such a clause does not create a condition precedent to the obligation to ever make payment, and it does not expressly shift the risk of the owner’s nonpayment to the subcontractor.”)
11. Id at 1261. (“Under a “pay-if-paid” provision in a construction contract, receipt of payment by the contractor from the owner is an express condition precedent to the contractor’s obligation to pay the subcontractor. A “pay-if-paid” provision in a construction subcontract is meant to shift the risk of the owner’s nonpayment under the subcontract from the contractor to the subcontractor.”)