By Kenneth Cobleigh, Esq, Managing Director and Counsel, AIA Contract Documents
Many construction projects are now being suspended or significantly curtailed in order to abide by rules imposed by governmental entities or to adhere to social distancing guidelines associated with the Covid-19 crisis. Nonetheless, some owners and contractors are looking to the future and working to finalize contracts for construction. Even after governmental restrictions are lifted, it is not certain that all forms of labor, equipment or materials will be readily available. How then, can owners and contractors enter into construction contracts with such uncertainty? While there is always some risk in negotiating a contract, even in the best of times, here are some ideas that might help in dealing with some of the uncertainty in the present market.[i]
One way to work around the uncertainty of the labor and supply markets is an agreement to pay the contractor for the work based on the actual cost incurred in providing the labor, or procuring the materials or equipment, plus a fee to cover overhead, profit, and other ancillary costs. This might be done for all work to be provided under the contract, or for discrete elements of labor, materials or equipment identified as having too much uncertainty to reasonably price. The AIA publishes a number of agreements that allow for cost plus payment in all delivery methods.[ii] Often these agreements also envision that total payments to the contractor will be capped at an agreed to Guaranteed Maximum Price (“GMP”). The GMP gives an owner certainty as to the amount it will be obligated to pay for the work covered by the agreement. The GMP normally represents the contractor’s estimate for the actual cost to be incurred for the work, plus a contingency for unanticipated costs, and the contractor’s fee. To encourage the contractor to work hard to manage costs, the parties can use a shared savings clause. Shared savings clauses reward the contractor for controlling costs by establishing that the contractor will be paid a percentage of the difference between the actual cost and fee incurred and the GMP. This percentage of the “shared savings” represents pure profit to the contractor, as opposed to the much lower mark up it would realize if that money was spent on project costs.
In situations where the contractor feels comfortable providing a stipulated sum for most elements of the work, consider using allowances for select items. The AIA contracts based on both a stipulated sum, such as A101-2017, Standard Form of Agreement Between Owner and Contractor, and cost plus with a GMP payment method, such as A102-2017 and A133-2019, include fill points for allowances. Additionally, whether based on a stipulated sum or cost-plus basis (with or without a GMP) the AIA contracts anticipate a potential need for the parties to state assumptions and clarifications upon which the stipulated sum, GMP, or control estimate is based.[iii] These provisions should serve as valuable tools to help manage a certain level of uncertainty in terms of project cost.
Under certain circumstances it might be feasible to price and proceed with the project in phases. This option is sometimes used to “fast track” a project, starting with sitework and structural elements before other aspects of the project design are finished. It would seem that even if the project is not being fast tracked, terms could be worked out to allow for the start of some preliminary elements while awaiting better information and knowledge upon which to price and schedule downstream elements. Similarly, the contractor might be able to devise a staggered (although perhaps less efficient) work schedule to allow for safe separation of trades. It is conceivable that the owner and contractor might develop alternate scheduling options to be evaluated at set intervals or project milestones, with the alternative methods to be employed as conditions allow.
*AIA has provided this article for general informational purposes only. The information provided is not legal opinion or legal advice and does not create an attorney-client relationship of any kind. This article is also not intended to provide guidance as to how project parties should interpret their specific contracts or resolve contract disputes, as those decisions will need to be made in consultation with legal counsel, insurance counsel, and other professionals, and based upon a multitude of factors.
[i] While this paper is written in the context of negotiating contracts for future projects, many of the principles might also be applied to help resolve concerns on ongoing projects, when the parties are considering their options, including whether or not they might need to exercise termination rights rather than face economic uncertainties when work can technically resume. While a contract modification might not be legally required under the terms of the existing contract, from a business perspective, it might make good sense to develop modifications that address potential uncertainties in a manner that encourages the parties to keep the underlying contract in place.
[ii] The AIA publishes cost-plus based agreements in all the major project delivery models. These agreements include A102-2017, A103-2017, A104-2017, A132-2019, A133-2019, A134-2019, A141-2014, and A142-2014.
[iii] For AIA contracts that are cost-plus agreements but do not include a GMP, the contractor is required to provide a control estimate against which actual costs are tracked throughout the project. For examples, see A103-2017 and A134-2019.