By AIA Contract Documents
February 24, 2023
It may be difficult to discuss events of default or a bankruptcy when starting out on a project, but these are essential scenarios to address upfront, so that both parties can be adequately protected. For vigilant construction professionals, preparing for these possibilities begins at contract formation. By including terms that address these risks, the parties may mitigate exposure and uncertainties caused by defaults or a bankruptcy filing on the project. Consider including the following terms and provisions in your construction contract to assist with mitigating risks on your next construction project.
Indemnity. Construction contracts should contain indemnity language that require a contractor to indemnify the owner (or other upstream party) against liens, claims, and losses, arising out of the scope of work. Additionally, indemnity obligations should be flowed down to each subcontract. In the event of a default or a bankruptcy filing, contractual indemnity obligations may create a right for the upstream party to be held harmless for resulting damages. Indemnification clauses may also help protect upstream parties from claims for non-payment, bond claims, and mechanic’s liens asserted by downstream subcontractors or vendors on the project.
Termination for Convenience. Termination for convenience provisions give parties the right to terminate the contract without having to supply a specific reason. A breach of the contract is not a condition precedent for termination. Prudent contracting parties may allow for a termination process, such as a termination for convenience clause, to establish that the contract is no longer in effect at a particular time. This can be helpful in the event of a bankruptcy because the rules governing the action can create uncertainty and delays on a project due to restrictions that may be taken by against a distressed contractor (while the construction contract may still be enforced). Consequently, a way that may reduce the risks of bankruptcy is to terminate, and replace, a distressed party before bankruptcy is declared.
Assignment of Subcontracts. Another means of protection is a contractual provision that assigns subcontracts and vendor agreements to the owner or another upstream party in the event of termination. These provisions allow for an upstream party to assume the rights of the terminated party when termination occurs, as if the upstream party was the original signor of the subcontract or vendor agreement. This way, new subcontracts may not need to be executed to continue work on the project. Practically, when termination occurs, it is unlikely that a new subcontractor can complete the original scope for less money than the remaining unpaid contract balance. By including an assignment of subcontract clause, the original subcontractors and vendors may be able to complete their work for the unpaid balance of each respective agreement without delay.
Right to Supplement the Downstream Work. To help mitigate the impacts of a distressed contractors, consider including terms in the that allow for the owner’s or upstream party’s right to supplement the work. These provisions allow for others to bolster or supplement the downstream party’s work or material supplies. In the event of bankruptcy, terms that allow for the supplementation of the work assist in keeping the project schedule on track, as they may allow for the use of a supplemental contractor to continue the scope of work at the time of a bankruptcy filing.
Defaults, termination, or bankruptcies during a project is rarely in any party’s best interest. However, it is important for your agreement to anticipate reasons and processes in the unfortunate event that these scenarios take place. Clarity in these area may help to make a difficult situation go more smoothly and keep the project moving forward.
AIA Contract Documents 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.