Understanding

and Negotiating
Construction
Contracts
Understanding
and Negotiating
Construction
Contracts AandContractor’s
Subcontractor’s
Guide to
Protecting
Company Assets
Second Edition

Kit Werremeyer
This book is printed on acid-­free paper.

Copyright © 2023 by RSMeans. All rights reserved. Published by John Wiley & Sons, Inc.,
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Library of Congress Cataloging-­in-­Publication Data Applied for

Paperback ISBN: 9781394150205 [LCCN 2023011467]

Cover Design: Wiley

Cover Images: Courtesy of Geometrica, Inc;
joffi/Pixabay, Personal Photo By Kit Werremeyer

Set in 12/15pt Warnock pro by Straive, Pondicherry, India

Dedicated to all those contractors and subcontractors who are
interested in learning how to negotiate more favorable commercial
terms and conditions in their construction contracts and thereby better
protect the hard-­earned assets of their companies.
 Contents

Acknowledgments xiii
About the Author xv
Preface xvii
Disclaimer xix
Introduction xxi
The Goals of This Book xxi
What Are the Benefits of This Book? xxi
Contractor & Owner Conventions xxii
Private Contracts or Government Contracts? xxii
Key Contracting Concepts xxii
Two Types of Commercial Terms & Conditions xxiii
The Most Important Commercial Terms & Conditions xxv
The Contracting Process xxv
Excuses for Not Negotiating Better Commercial
Terms & Conditions xxv
The Concept of Risk Transfer xxvi
This Is a Book Developed Just for Contractors xxvii
Three Final Suggestions xxvii
Chapter 1: Contracts: Basic Training 1
What Is a Contract? 1
The Steps to a Contract 1

vii
 Coming to the Party? 2
The Starting Point 3
“Here’s My Proposal” 4
“Consideration,” or Something of Value 5
The “Happy Test” 5
“Can That Person Sign This Contract?” 6
Call in the Enforcer to Close the Breach! 6
A Contract Example 8
Strange Words & Long Paragraphs 10
Contracting Myths 11
Contract Negotiations 12
Chapter 2: Types & Forms of Contracts 15
Fixed Price & Fixed Schedule Contracts 16
Reimbursable Type Contracts 16
Combined Fixed Price & Reimbursable Contracts 18
Cost Plus Fee Contracts 20
Guaranteed Maximum Price Contracts 21
Target Price Contracts 21
Contracts with Performance Incentives 22
Form of Contracts 23
Some Final Contract Housekeeping—­Definitions 30
Conclusion32
Chapter 3: Scope of Work 33
The Scope of Work Matrix 37
Scoping Drawings 39
Conclusion40
Chapter 4: Terms of Payment & Cash Flow 41
Cash Flow 42
Interest Rates 44
Periodic Progress & Milestone Payments 45
Conclusion59
Chapter 5: The Schedule 61
Float62
Time Is of the Essence 64
Extra Time, but No Money 66
Conclusion68
Chapter 6: Assurances of Performance 69
Guaranties & Bonds 70
What Does “Failure to Perform” Mean? 72

viii
 What Is a Bond? 72
Forms of Assurances of Performance 73
Surety Companies 78
Some Language Considerations on Guaranties & Bonds 82
Types of Performance Assurances 82
Conclusion101
Chapter 7: Insurance 103
What Is Insurance? 104
Claims Made vs. Occurrence 105
Types of Insurance 106
Important Issues Associated with Insurance 112
Additional Insured Status 120
Additional Insurance Basics 121
A Typical Insurance Clause in a Construction Contract 134
Safety140
Chapter 8: Indemnity 141
Insurance & Indemnity 142
Indemnity Definitions 142
Transferring the Owner’s Risks to Contractors 143
Fairness Is Not a Consideration 143
Is an Indemnity Required in a Construction Contract? 144
Anti-­Indemnity Legislation 144
Examples of Indemnification Clauses 150
Indemnification, Additional Insured Status, &
Contractual Liability Insurance 157
Owners Love CLAIMS! 161
Negotiating Indemnity Clauses 162
Knock-­for-­Knock Indemnities 165
Conclusion166
Chapter 9: Changes 169
Some Ground Rules 170
Protecting the Project Manager 170
Owners’ Directives 171
Constructive Changes 171
Payment for Changes 172
Sample Change Clauses 172
Major Contract Changes 178
Negotiating Change Clauses 179
Conclusion180

ix
 Chapter 10: Disputes & Their Resolution 183
What’s a Project Manager to Do? A Short Story to Start With 183
Disputes—­The Construction Contract’s Bad Actor 184
An Ounce of Prevention 186
Dispute Resolution Options 186
The Folks who Negotiate, Mediate, Arbitrate, & Litigate 188
Dispute Resolution Clauses 189
Conclusion192
Chapter 11: Damages 193
Breach of Contract/Failure to Perform 194
Contractors’ Financial Exposure 194
Actual Damages—­A Silent Risk? 194
Liquidated Damages 196
Consequential Damages 204
Conclusion206
Chapter 12: Warranties 207
A Workable Definition of Warranty 207
Warranty Issues 208
The Uniform Commercial Code 214
When Is No Warranty Appropriate? 217
Extended Duration Warranties 219
Limiting Provisions in Warranties 221
Pass-­Through Warranties 221
Latent Defects & Warranty 222
A Sample Warranty 224
Conclusion224
Chapter 13: Termination & Suspension 227
Termination for Cause 228
Termination for Convenience 229
Suspension232
Cancellation236
Conclusion236
Chapter 14: Force Majeure 239
Negotiating Clauses 239
Sample Contract Language 240
Conclusion244
Chapter 15: Other Contract Clauses 245
Site Conditions 246
Use of Completed Portions of the Work 251

x
 Patent Indemnity 252
Secrecy & Confidentiality Clauses & Agreements 253
Owner’s Right to Inspect 254
Independent Contractors 257
Assignment258
Acceptance & the Punch List 260
Advance & Partial Waiver of Liens 262
Final Waiver of Liens 265
Audit Rights 268
Severability or Validity Clauses 269
Venue & Applicable Law 269
Florida Civil Code Chapter 47 Venue 270
Texas Business & Commercial Code
Annotated §272.001 271
Venue and Choice of Law State Statutes 271
Contractual Rendition? 271
Changes in the Law 272
Some Interesting Clauses to Close 273
Chapter 16: A Construction Contractor’s
Contract Checklist 275
Chapter 17: International Contracting 283
International Contracts 284
The U.S. Foreign Corrupt Practices Act 285
Letters of Credit 286
Split Contracts: Onshore & Offshore Contracts 288
Political, Religious, & Economic Risks 289
Overseas Private Investment Corporation (OPIC) 290
Legal Systems in Foreign Countries 290
Local Employees, Partners, & Agents 291
Offshore Companies 292
Currency Risks 293
Applicable Law 297
Joint Ventures 299
Joint Operations 299
Import & Export Considerations 300
Understanding INCOTERMS 302
The Export‐­Import Bank of the United States 305
Where to Get Some Help—­Ask the U.S. Government 306
Lastly, Use the Right Paper Size! 307
Conclusion307

xi
 Chapter 18: What’s It Take to Do Business
in Southeast Asia? 309
Patience Is Golden 310
Walk the Talk 310
Time and Money 311
The US Foreign Corrupt Practices Act 312
Center for Strategic and International Studies 313
Trans Pacific Partnership (TPP) 314
Backdoor to China and India 314
SPECIAL SECTION—­The Socialist Republic
of Vietnam (Vietnam) 316
Resources for Business in Southeast Asia 317
Chapter 19: Some Final Thoughts on Negotiating Contracts 319
Why Negotiate? 320
The Concept of Standard Terms & Conditions 320
Risk Transfer Item 1: Get Rid of the Indemnity Clause! 322
Risk Transfer Item 2: Don’t Provide Additional
Insured Status 323
Risk Transfer Clauses, Insurance, & Safety 323
How to Say No without Aggravating the Owner 324
The Worst Contracting Word: “Reasonable” 324
The Best Contracting Word: “Notwith- standing” 325
Win-­Win & Lose-­Lose in Contract
Negotiations—­Fairy Tales? 326
Is There a Price for Bad Commercial Terms & Conditions? 327
Terms of Payment 327
Some Tips on Successful Negotiating 328
Three First (and Final) Suggestions 328
Resources 329
Glossary 333
Index 349

xii
 Acknowledgments

I am grateful to the following people who, by sharing their long-­term

experience in working with construction contracts, added
significantly to this book.
John T. (J.T.) Wodarski and Joseph J. Newman Jr., each of whom has
over 30 years of valuable experience in negotiating commercial terms
and conditions of engineering and construction contracts, provided
many suggestions for improvements in how the issues were covered
in this book. Neither of these two friends (and tough negotiators)
hesitated to challenge me to clarify or expand on some of the
contracting and negotiating guidance I drafted. The results were
significant improvements to the content of the book.
Robert W. Wolfe Esq. has negotiated and reviewed many large and
small domestic and international engineering and construction
contracts from a legal standpoint for more than 25 years. He kept me
straight on the many legal fine points associated with the riskiest
commercial terms and conditions found in contracts. He is the most
practical and effective lawyer I have ever had the opportunity to deal
with in the engineering and construction business.
Bruce Wilkinson Esq. has been working with a wide variety of
contracts for over 35 years. He provided many insightful and useful
comments and suggestions on construction contract commercial
terms and conditions.
Gwen A. Schroder and Ed Jacobs shared their extensive knowledge of
the insurance industry to help guide me through the technical issues
associated with insurance for construction projects.

xiii
 And my wife, Marilyn, a former teacher, reviewed every word in the
book at least twice and made every effort to ensure my spelling and
grammar were generally correct. While she did an excellent job, she
told me she never again wants to read anything about indemnities.
Amen.

xiv
 About the Author

Kit Werremeyer is the owner and president of Southernstar

Consultants LLC, of Valrico, Florida, a company that provides
training in the understanding and negotiating of construction
contracts. The company also offers a broad range of other
professional services to United States and international engineering
and construction companies.
Mr. Werremeyer’s experience includes more than 30 years of sales,
contracting, claims settlement, dispute resolution, and EPC project
development, including work for a broad range of major U.S. and
international companies, such as Bechtel; Kellogg, Brown & Root
(KBR); Fluor; J.A. Jones; Black & Veatch; DuPont; Shell Oil; Caltex;
Exxon/Mobil; BP/Amoco/ARCO; Air Products and Chemicals; Koch
Industries; Florida Power and Light; Chiyoda Corporation (Japan);
Japan Gasoline Corp.; Mitsui (Japan); Mitsubishi Heavy Industries
(Japan); Petronas (Malaysia); Thai Oil Company; Pertamina
(Indonesia); SINOPEC (Peoples Republic of China); Voest-­Alpine
(Austria); Daelim (Korea); and Hyundai (Korea).
Among prior positions, Mr. Werremeyer served as vice president and
area director of sales and marketing in Asia for Chicago Bridge &
Iron Company, an international engineering and construction
company. This position included responsibility for contracting and
the general management of area subsidiaries.
He is a graduate of the University of Illinois at Urbana-­Champaign,
Illinois, with a master’s degree in mechanical engineering.

xv
 Preface

In 1977, I entered a year-­long sales training course presented by my

company, Chicago Bridge & Iron Company (CBI), an international
engineering, procurement, and construction contractor founded in
1889. CBI believed that all of its salespeople must have a strong
foundation in understanding, evaluating, and negotiating the
commercial terms and conditions typically found in engineering and
construction contracts. Specifically, the course was to prepare its
future salespeople to provide clients with “one-­stop shopping.” This
meant being able to work out all the technical and constructability
details of the contract with the client, and then negotiating
appropriate commercial terms and conditions without necessarily
having to go back to CBI’s legal department for advice.
This extra capability—­evaluating and negotiating commercial terms
and conditions for construction contracts—­was designed to give us a
clear edge over our competitors. We could work closely with the
client on all aspects of the project—­both technical and commercial—­
and then close the deal commercially without ever leaving his side or
making an outside telephone call.
The sales training program included a lot of classroom time on such
seemingly routine contractual considerations as terms of payment,
scope of work, schedule, claims and disputes, termination and
suspension, and warranties.
It also introduced us neophyte contractors to such new and
mysterious contractual terms as indemnity, additional insured status,
force majeure, advance waivers of rights, specialty insurance

xvii
 coverage, and assurances of performance. The instructors told us
horror stories about the financial consequences that arose out of
accepting a client’s risky commercial terms and conditions for
engineering and construction contracts.
This training course set the path of my career as, for the next
25 years, I worked in several different sales offices located on the
East Coast and the Midwest of the U.S. and for 13 of those 25 years,
in Southeast Asia. I participated in and/or managed the negotiations
of the commercial terms and conditions for hundreds of engineering
and construction contracts ranging in value from small $50,000
repair projects, to major engineering, procurement, and construction
(EPC) projects worth over $100 million. Clients ranged from small
owners to major international oil, gas, chemical, and petrochemical
clients, and major domestic and international EPC contractors from
the U.S., Europe, and Asia.
There were a huge variety and complexity of commercial terms and
conditions in all these contracts over those 25 years. Every owner or
EPC contractor had their own favorite idea of what constituted
acceptable commercial terms and conditions. Negotiating acceptable
terms and conditions for CBI projects was always a challenge;
nothing ever was the same. On a few occasions, the client’s
commercial terms and conditions were so one-­sided and
unacceptable, and the client was so reluctant to change them, that the
only thing left to do was close the file and walk out the door. It was
time to let some other poor contractor suffer with those lousy
commercial terms and associated risks.
When I retired in 2001 after 32 years with CBI to form my own
company, I looked back at all the diverse practical negotiating
experience I had with engineering and construction contracts in the
U.S. and internationally and felt it was important to write a practical,
user-­friendly, and non-­legalistic book about this subject. It is my hope
that my own experience will help contractors, regardless of the size or
sophistication of their companies, to negotiate better and less risky
commercial terms and conditions for construction contracts—­and
thereby better protect their assets.
I hope that contractors can learn something from this book and use it
as a practical desk reference. If by reading this book, they learn
nothing more than to be able to better identify, understand, and
evaluate risky commercial terms and conditions, and then negotiate
or otherwise seek help to resolve them, I have succeeded.

xviii
 Disclaimer

During the course of writing this book, I was reminded on several

occasions by my good friends and excellent reviewers that I needed to
include a written disclaimer regarding the reader’s use of the
contracting and negotiating guidance provided—­as it is impossible to
anticipate all the circumstances that may arise in a construction
contract. I have tried my best to provide what, in my experience and
opinion, is practical information gained from my over 30 years in the
engineering and construction business. My hope is that this book will
help contractors and subcontractors understand, evaluate, and
favorably negotiate construction and construction-­related contracts
and thereby help protect their assets.
I do not provide any express or implied warranty on the use of any of
the information contained in this book as it may be applied to
understanding, evaluating, and negotiating construction contracts.
Readers should consult, as needed, with professionals on their
particular contracts and circumstances.

– Kit Werremeyer

xix
 Introduction

There is no price for bad terms.

~ Construction contractor from Toledo, Ohio

The Goals This book was written with three important goals in mind:

of This Book 1. Assisting contractors in improving their abilities to identify,

understand, and evaluate certain high-­risk commercial terms
and conditions typically found in all construction contracts.
2. Providing contractors with negotiating suggestions on how to
lower or eliminate the risk associated with commercial terms
and conditions.
3. Providing straightforward information in as uncomplicated and
non-­legalistic a manner as possible.
The book will help contractors in their effort to negotiate favorable
commercial terms and conditions for their construction contracts. By
doing so, this will help lower their commercial risk; assist in
improving their terms of payment; and reduce their exposure to
claims, disputes, and unnecessary or inappropriate risk transfer and
its associated potential financial liability.

What Are Contractors must be able to identify, understand, and evaluate all the
commercial risks that are accepted by agreeing to an owner’s
the Benefits proposed contract. They must then be able to effectively minimize
of This Book? and manage those commercial risks—­mitigating or eliminating them
through negotiations—­and thereby lessen their exposure to any
potential financial liabilities. This will ultimately protect the assets of
their companies. This is the primary benefit of this book.

xxi
 Contractor & This book refers to contractors and owners—­both in the general
sense, and capitalized in actual sample contract clauses. “The
Owner contractor” refers to you, the reader of this book—­whether general
Conventions contractor or subcontractor—­working hard in the construction
business trying to make a living. “The owner” refers to the company
that the contractor is providing construction work for, and with whom
he will sign a construction contract. (Note that throughout this
book, the masculine singular “he” is used, for simplicity only, and
to avoid the more cumbersome “he/she”/“his/her” construction.)
Also for simplicity, the book refers to the construction contract
between the owner and contractor. Often, however, the contractor
will have a contract with another construction company who works
for the owner, perhaps in the role of the owner’s project manager, or
the owner’s main contractor. In this case, the contractor would
typically be considered a subcontractor, and his construction contract
would likely be called a subcontract with the owner’s project manager
or main contractor. It doesn’t matter whether the contract is made
directly with the owner, or whether it’s a subcontract with the owner’s
PM or main contractor—­the information contained in this book
about understanding and negotiating construction contracts applies
equally to all of these contracting relationships.

Private The contracting concepts presented in this book apply to contractors

working with private U.S. owners, and not federal or state government
Contracts or owners. Construction contracts with U.S. federal, state, and local
Government governments may have different commercial contracting challenges.
Sometimes, for instance, government contracts are, by law,
Contracts? nonnegotiable with respect to the types of commercial terms and
conditions a contractor must accept. However, the concepts and
suggestions in this book can be used to help better understand and
manage similar commercial issues in government construction
contracts, and can assist the contractor, particularly in those situations
where negotiation is an acceptable part of the government’s contracting
process. In Chapter 16, “International Contracting,” the additional
concepts presented also apply to contracts between a private
contractor and a private owner. Contracting with foreign governments
and their various departments often presents exceptional contracting
challenges that are beyond the scope of this book.

Key Contracting Throughout this book, two key contracting issues with construction
contracts are discussed:
Concepts • Commercial Risk: The risk associated with the potential for the
contractor to be harmed in some way by accepting the wording

xxii
 in an owner’s construction contract’s commercial terms and
conditions.
• Potential Financial Liability: The possibility of having to pay
money, which would arise from the obligations that a contractor
agrees to accept in the owner’s construction contract’s
commercial terms and conditions, and that might arise also from
the contractor’s common law obligations. Common law is the
body of law that develops out of decisions made by courts—­
called precedence—­rather than law that is created by statute.

Examples of Commercial Risk

Commercial risk creates an exposure to the potential for financial
liability and flows directly from the commercial terms and conditions
contained in the owner’s construction contract. Commercial risk is
probably the risk a contractor finds most difficult to understand and
manage. Some typical examples of a contractor’s exposure to
commercial risk found in a construction contract’s commercial terms
and conditions are:
• Exposure to the financial liability to pay liquidated damages or
other consequences of contractor’s late performance.
• Exposure to the financial liability to pay for damages that are
caused by the owner’s negligence.
• Not being paid for legitimate changes for additional work.
• Not being able to settle legitimate disputes in favor of the
contractor.
• Exposure to an owner cashing in a contractor’s performance or
payment bond without legitimate reasons.
• Exposure to the financial consequences—­not enough cash to pay
bills—­of not being paid by the owner on time for progress
payments.
• Exposure to the financial liability that may arise out of lengthy
warranty periods or requests by an owner to perform warranty
work that is really not warranty work.
• Exposure to the financial liability that may arise out of other
risks encountered on a construction project, such as differing
site conditions and force majeure.

Two Types The commercial terms and conditions typically found in a

construction contract can be split generally into two categories:
of Commercial • Administrative terms
Terms & • Financial liability terms
Conditions
xxiii
 Administrative terms are those commercial terms and conditions
that have a low probability of creating a significant financial
liability for the contractor. Financial liability terms have a high
probability of doing so. The focus of this book is to improve the
contractor’s ability to understand and evaluate these financial
liability terms and conditions and learn ways to lower or eliminate
the commercial risk associated with them through effective
negotiations.
A typical construction contract can be divided between
administrative and financial liability terms as shown in Figure 1.
This book will discuss only those commercial terms and conditions
that tend to create a high probability of financial liability for the
contractor. This doesn’t mean, however, that other terms and
conditions should be ignored or taken lightly. It just means that if the
contractor has to focus his effort primarily on one of these sets of
commercial terms, it should be on the commercial terms that have
the greatest potential for harm.

Figure 1: Types of Contract Terms

xxiv
 The Most The three most important commercial terms and conditions
contained in all construction contracts are:
Important 1. Scope of work
Commercial 2. Pricing and terms of payment
Terms & 3. Schedule
Conditions These commercial terms are the three foundation stones of all
contracts, as shown in Figure 2.

The Contracting Here’s a bold statement: There is no difference between a

construction contract for a new one-­story office building worth
Process $500,000 and a new grassroots oil refinery worth $1 billion. Think
about this for moment. The contractor for each project must have a
written construction contract to perform the work described. Each
contract will have a scope of work section, terms of payment, and a
schedule. Further, each contract will likely have contractual
obligations for insurance, warranty, changes, dispute resolution,
termination and suspension, damages, indemnity, and assurances of
performance.
Certainly, the complexities of the two projects are significantly
different, but the contracting process of understanding and
negotiating commercial risk issues and potential financial liability
issues are the same, and must be properly dealt with by each
contractor in order to protect the assets of their companies.

Excuses for Not What are the typical excuses given by contractors when faced with
the prospect of having to try to negotiate better commercial terms
Negotiating and conditions in the owner’s construction contract? Some of the
Better most common:

Commercial • “It’s too hard to deal with the owner and his lawyers.”
• “The owner will disqualify me if I take exception to his terms
Terms & and conditions.”
Conditions

Figure 2: Three Foundation Stones of a Contract

xxv
 • “I don’t understand the terms and conditions well enough to
negotiate better ones, and I don’t want to hire a contracts expert
or a lawyer.”
• “The competition accepts the owner’s terms and conditions all
the time, so I don’t have much of a chance.”
• “I don’t like to negotiate. Maybe the best thing to do is just sign
the contract, put it in the bottom drawer of the desk, and hope
nothing happens.”
The last excuse basically says this: “sign, do nothing, and pray for the
best.” This strategy works fine as long as nothing goes wrong during
the execution of the contract. However, things often do go wrong
during the course of executing construction contracts!
Let’s say the owner creates lengthy delays to the construction schedule,
refuses to acknowledge his fault, then penalizes the contractor by
imposing liquidated damages for late performance. Once something
like this happens to a contractor just once in his lifetime, he will wish
he had made the effort to negotiate more favorable commercial terms
and conditions prior to signing the contract.
One good reason to negotiate changes to the owner’s commercial
terms and conditions is simply to improve the contract for the benefit
of the contractor, and to lower the contractor’s exposure to potential
financial liability at the same time.
For example, creating a detailed scope of work document that carefully
outlines what the contractor, owner, and all other parties involved in the
contract are obligated to do will always serve to minimize
misunderstandings and disputes over the scope of work. Often the
contractor has the best experience and background to assist the owner
with developing a detailed and comprehensive scope of work document.

The Concept Another contracting concept that will be discussed throughout the
book is the concept of risk transfer. Commercial terms and conditions,
of Risk Transfer such as those associated with insurance and indemnity clauses,
transfer the risk of potential financial liability for certain events from
one organization to another. Insurance transfers the risk of certain
potential financial liabilities from the contractor—­the named
insured—­to the insurance company in return for the payment of a
premium. An indemnity clause in a construction contract can transfer
to the contractor the risk of certain potential financial liabilities that
may arise due to the negligence of the owner—­in return for nothing!
Contractors must understand the consequences of accepting risk
transfer clauses in a construction contract. Negotiating changes to
risk transfer clauses can significantly lower exposure to the possibility
of unnecessary or unwarranted financial loss.

xxvi
 This Is a Book Every attempt has been made to write this book in as non-legalistic a
manner as possible. It was written for those contractors who have no
Developed Just legal training in contract law and are simply in business to engineer,
for Contractors procure, and safely build construction projects.
Anyone who is willing to take the time to understand the basic
concepts of construction contracting can become effective in
understanding, evaluating, and managing commercial risk and
Before the contractor negotiating more favorable commercial terms and conditions. Can a
signs the contract, he lawyer who specializes in construction contracting help a contractor
needs to understand understand and negotiate a construction contract? Certainly he can,
the commercial but that assistance, and cost, is not always necessary.
risks and their
The book features samples of actual contract language—both the good
possible financial and the bad, the fair and the unfair. Each chapter contains these easy-
consequences. The to-understand clauses, in boxes for quick reference, which show
contractor’s assets contractors the kind of language that should be used, as well as jargon
are at stake. and unreasonable terms that should be avoided. Having a good
working knowledge of the major commercial issues involved in
construction contracting will help a contractor understand what he is
getting into, the risks he is taking, and the risks he doesn’t want to take.
This book is not Is the contractor agreeing to a fair contract, or taking on a lot of
designed to be anti- unnecessary responsibilities and commercial risks? Will he get paid
lawyer or anti-owner. on time? These are the types of questions a contractor will be able to
It is designed to be answer and resolve after reading this book—before signing a
pro-contractor. construction contract.
It may appear when reading through this book that owners are cast in
a bad light, and that all too often they demand unacceptable
commercial terms and conditions. This is not true. Some progressive
owners have, or will negotiate, commercial terms and conditions that
are fair and balanced for both parties—the owner and the contractor.
The contractual issues covered in this book are meant to raise the
awareness of contractors to worst-case situations that can arise from
accepting certain commercial terms and conditions in a construction
contract—and how to edit and reword unfair clauses.

Three Final Finally, contractors should remember these three important things:

Suggestions 1. Read and understand everything in the construction contract.

2. Negotiate better commercial terms and conditions with the goal
of reducing commercial risk and the associated exposure to
potential financial liability.
3. Get all agreements in writing from an authorized representative
of the owner!

xxvii
 Chapter
Contracts:
1 Basic Training

What Is a This isn’t a trick question, and it doesn’t have a complicated

answer. For the purposes of this book, the following definition will
Contract? be used:
A contract is a written agreement that clearly defines the
responsibilities and obligations of each included party, is legally
enforceable, and is dated and signed by an authorized representative
of each party.
A contract may also be called an agreement. The term contract will
be used throughout the book.

The Steps to a 1. Receive an inquiry or request for proposal (RFP) from the
owner.
Contract 2. Prepare a proposal for the work and submit it to the owner.
3. Negotiate all the details of the contract with the owner.
4. Sign the contract.

Understanding and Negotiating Construction Contracts: A Contractor’s and Subcontractor’s Guide to

Protecting Company Assets, Second Edition. Kit Werremeyer.
© 2023 John Wiley & Sons, Inc. Published 2023 by John Wiley & Sons, Inc.

1
 It doesn’t appear to be too complicated, does it? However, there are
hundreds of issues—­small and large—­to consider and things to do
during the process of responding to an owner’s RFP. The contractor
must:
• Review and analyze all the written bid documents, including any
attached plans, drawings, and specifications.
• Resolve questions about the scope of work.
• Visit the site.
• Assess the physical and commercial risks.
• Select subcontractors and suppliers.
• Prepare an estimate and proposal.
• Review and comment on the commercial terms and conditions.
• Sort out insurance details.
• Negotiate improvements to the contract.
This chapter covers the basic concepts of contracting and explains
some of the terminology contractors most often encounter.

Coming to So who is a party to a contract? In almost all construction

contracts, there will be at least two parties. One is the contractor
the Party? (who is going to build something), and the other is the owner (who
has a need for what is being built). If the owner hires a project
manager to manage all the contractors on the project, then the
owner’s project manager would also be considered a party to the
contract.
All persons or organizations that have not signed the contract are
called third parties.
Some typical third parties a contractor might see at or near the
project job site are:
1. The owner of the commercial property and buildings adjacent to
the project site.
2. An OHSA safety inspector making a visit to the job site.
3. Another contractor, his subcontractors, and their personnel who
are also working for the owner on the project site.
4. Subcontractors working for the contractor who are not signatory
to the contract with the owner.
5. Local private homeowners or small business owners and tenants
adjacent to the site.
6. Environmental protection groups.
7. The general public, who may wander onto the job site.

2
 The Risk Associated with Third Parties
What’s all the fuss over this business of third parties? The actions of
these people or organizations can create serious commercial risks
and potential financial liability for both the contractor and owner.
Contractors must manage a multitude of job site safety issues in order
to avoid employees’ injuries.
Damage to a third party’s adjacent property or injury to a third-­party
individual, such as a member of the general public, exposes both the
owner and the contractor to lawsuits, legitimate or otherwise, that
could financially ruin either or both of them.
Much of the concept of commercial risk transfer involves
transferring risk from the owner to the contractor. Risk includes
potential financial liability associated with damage to property
belonging to third parties and injury to or death of third-­party
individuals, regardless of any contributing fault or negligence of the
owner. This transfer of risk is accomplished mainly by the use of
indemnity and additional insured clauses. (These topics are covered
in detail in Chapters 7 and 8 of this book.) So although the contract is
between the contractor and the owner, the contractor has to
recognize that individuals or organizations not associated directly
with the contract—­third parties—­may have an impact on the contract
risk.

The Starting The starting point for a construction contract is when an individual
or company decides to construct a new facility to meet its needs.
Point
An Example
Wilson Properties conducts a search of local building contractors
and finds several that are qualified, including National
Construction Company.
Wilson Properties prepares a written inquiry, or as it is commonly
called, a Request for Proposal (RFP), and sends it out to several
contractors for competitive bids. The RFP would typically include:
• A description of the scope of work
• Some idea of a schedule
• The plans and specifications prepared by a design team and
approved by the building department
• Applicable codes and standards
• Commercial terms and conditions the owner expects the
contractor to accept

3
 The RFP might also require the contractor to indicate in writing
whether he will provide a proposal for the work by the time specified
in the inquiry, or whether he will decline to bid.

“Here’s My The written proposal, such as prepared by National Construction

Company, to perform the work is called an offer and is the first half
Proposal” of the contracting concept of offer and acceptance. The offer will
include the contractor’s price and schedule to perform the work and
may contain responses to information requested by the owner’s
inquiry. It may also address specific work scope and commercial
clarifications, as well as any other concerns of the contractor.

An Example
National Construction Company may propose a different
completion schedule than required by Wilson Properties’ RFP
documents, technical substitutions, or other cost- or time-saving
alternatives. National Construction Company may also propose
changes to the commercial terms and conditions that were included
in the Wilson Properties’ RFP documents.
“And I accept, but. . .”
Wilson Properties receives the proposal (offer) to perform the work
from National Construction Company, reviews it for general
compliance with the RFP, and decides that it is a good offer and that
they would like to award the project to National Construction
Company.
However, Wilson Properties has some issues with the schedule, the
price, and the clarifications to the commercial terms and
conditions proposed by National Construction Company. Wilson
Properties has National Construction Company come to their
office to negotiate and tells them, “We would like to accept your
offer, but. . .” The two companies then proceed to negotiate a
Offer and acceptance mutually agreed-on schedule, price, and set of commercial terms
is the technical term and conditions.
used to test whether The acceptance of the offer in this instance is actually a process.
a contract has been Wilson Properties and National Construction Company negotiate
arrived at or not. A back and forth until they reach a mutually-agreeable deal. The
more workable and final offer is defined through the negotiations, and both parties say,
practical definition “Okay, we agree. We have a deal.” This back and forth negotiation is
of the offer and the contract negotiation process.
acceptance process All of the negotiated changes to Wilson Properties’ original RFP are
is successful contract documented in writing. The best way to do this is to make the
negotiations. appropriate changes in the body of the signed contract. An alternate
way is to document all the changes in a separate letter signed by

4
 both parties noting that the changes agreed on supersede and take
precedence over the contract and any similar or conflicting
provisions.
Wilson Properties then advises National Construction Company in
writing that they have been awarded the project, referencing the
original RFP and the letter documenting all the negotiated changes
to the RFP.
This written notification by Wilson Properties signifies their
acceptance of National Construction Company’s offer, as was
revised and agreed on through the two companies’ negotiations.
These are the first two key steps taken in the process of arriving at a
contract: offer and acceptance.

“Consideration,” Each party to the contract must receive something of value in order
for the contract to be legally enforceable. In the previous example, the
or Something of contract calls for Wilson Properties to receive a new office building
Value that will be built in accordance with the RFP—­and the changes to the
RFP mutually agreed to in writing by both parties. The finished
building that Wilson Properties will receive is referred to as
something of value.
National Construction Company receives the agreed-­on contract
price to construct the building for Wilson Properties. The money—­
contract price—­that National Construction Company receives is also
considered something of value. Both parties to the contract receive
something of value, also known as consideration.

The “Happy Both parties must mutually and freely agree to all the conditions
spelled out in the contract. In order for the contract to be legally
Test” enforceable, neither party can use coercion to get the other party to
sign. A contract cannot obligate one party or the other to do
something illegal. An illegal obligation would cause the contract to be
unenforceable.
For example, if one party to a contract brings in a group of armed
thugs and says to the other party, “sign, or else,” then that clearly is
coercion, and the resulting contract would not be legally enforceable.
This is an extreme example, but it makes the point.
If the written conditions in the contract require one of the parties to
have the responsibility of periodically bribing the local customs
official (an illegal act) in order to have him under-­apply import
duties, then the contract would not be enforceable. There can be
nothing in a contract that requires one party or the other to do
something illegal. The best advice is: when in doubt, don’t agree
to do it.

5
 “Can That There are two issues here: the first one involves the competency of
the person signing the contract, and the second one involves whether
Person Sign that person has the authority to sign. Both parties signing the
This Contract?” contract must be competent. If the person signing the contract is
under the influence of drugs or alcohol, or has a serious mental
incapacity, then that person probably does not have the competency
to sign the contract. The contract would likely be legally
unenforceable. A more common concern is whether the person
signing the contract for one of the parties has the authority to do so.

An Example
A young employee of the owner who has just graduated from college is
A contract may be getting ready to sign a high-value EPC contract on behalf of the owner
unenforceable if it is for a major expansion to a complex petrochemical plant. The contractor
signed by someone for the expansion questions the young person’s authority to sign the
who does not have contract. The contractor is accustomed to having much more senior
the proper authority representatives of the owner sign contracts for such major projects.
to commit the party In a situation like this, the contractor might request that the
he represents to the proposed signer of the contract produce a power of attorney
requirements in the document from the company president, or some other senior officer,
contract. granting specific authority to sign the contract. This is a simple
solution to resolving the issue of proper authority.
It’s not too unusual for the owner’s RFP to require the contractor to
have an officer of the company sign the contract. If someone other
than an officer of the contractor’s company plans to sign the contract,
then he must present to the owner an appropriate power of attorney
document giving the signer the authority to sign contracts and
commit the resources of the contractor.

Call in the What does the term legally enforceable mean? A legally enforceable
contract exists when:
Enforcer to 1. A written contract has been negotiated (offered and accepted),
Close the without any coercion, between the owner and the contractor.
Breach! 2. There is nothing illegal contained in the contract.
3. The contract has been signed by representatives of the
owner and the contractor. The contractor and owner (or
representatives) have the authority to commit the resources
of their companies.
If a contract is legally enforceable, the owner can, if necessary, sue the
contractor in court to make him live up to his agreed-on obligations
as defined by the contract. Likewise, the contractor can, if necessary,
sue the owner in court to make him live up to his agreed-on
obligations. The court can act as an enforcer of contract obligations.

6
Into the Breach!
If the owner or the contractor does not abide by his respective
obligations as contained in the contract, then he may be
determined to be in breach of contract. This just means that
someone who is party to the contract is not living up to what he
has contractually agreed to do. Breach of contract is also
commonly called failure to perform. It’s mentioned here only
because the issue rears its head all the time. How many times have
contractors heard it said that, if you don’t do this or that, you are in
breach of the contract?
There is no reason to get excited; the term is overused to exert
leverage on the contractor and is subject to far too many personal
interpretations.

An Example
If an owner agrees in the contract to pay the contractor’s payment
invoices 30 days from the date of each invoice, and does not pay
until the 32nd day, then the owner technically has committed a
breach of contract. The owner may have a variety of reasons—­
legitimate or otherwise—­why he didn’t pay the contractor on time
as required by the contract, but he is still technically in breach of
contract. Unfortunately, the contractor would have to go to court to
have it determined that the owner was actually in breach of
contract. It’s always better to find a way to resolve the issue with the
owner to get him to live up to the terms of payment he agreed
to accept.
The court acts as an enforcer in breach of contract disputes by
compelling the party who has failed to perform to live up to his
contractual obligations, or else pay monetary damages to the other
party.
Sometimes a contractor will hear the owner use the term
material breach of contract. Like many things in a contract, this
term is open to much interpretation. In general, a material breach
of contract is a failure to perform a contractual obligation, and
the failure is extremely serious and damaging to one or both
parties.
In the previous example, the owner paid the contractor on the 32nd
day and so was two days late. That probably would not stand up to
the test or interpretation of what constitutes a material breach of
contract. However, if the owner paid the contractor 60 days late and
did not have a legitimate reason for the delay, it would certainly have
a much better chance of being deemed so.

7
 A Contract The following is an example of a simple “supply and install”
construction contract that illustrates contracting basics.
Example
An Example
National Construction Company responds to Wilson Properties’
RFP for a new office building, negotiates the details (offer and
acceptance), and enters into a construction contract, agreeing to
supply and construct the office building (something of value for
Wilson Properties) in accordance with the drawings and
specifications contained in the RFP.
National Construction Company also agrees to perform the work
within a fixed time period and for a certain fixed price (something
of value for National Construction Company). National
Construction Company is to receive a downpayment from Wilson
Properties prior to starting the work, and will receive the balance
upon satisfactorily completing the building.
No coercion was used by either party regarding the terms of the
contract, and the contract does not include any illegal requirements.
The contract document is signed by Wilson Properties’ President
and by National Construction Company’s Project Manager
(competent parties with authority).
In written form, the contract would look something like this:

Article 1 – Scope of Work and Price

National Construction Company agrees to supply and build a one-story
office building on a site provided by Wilson Properties strictly in accordance
with the attached Plans and Specifications for a fixed, lump-sum price of
$250,000.

Article 2 – Schedule
National Construction Company agrees to complete the one-story office
building within one year from the date of this Contract.

Article 3 – Terms of Payment

Wilson Properties agrees to pay National Construction Company $50,000
as downpayment immediately upon the signing of this Contract, and the
balance of $200,000 immediately upon the completion of the one-story
office building.
Dated: January 1, 2007
Signed:
Wilson Properties National Construction Company
__________________ _________________________
President Project Manager

8
This is an example of a legally enforceable construction contract in its
simplest form. But that’s all that’s actually required. It includes all the
basics:
1. National Construction Company made an offer.
2. Wilson Properties accepted the offer.
3. National Construction Company provides something of value:
the one-story office building.
4. Wilson Properties also provides something of value: the
payment of $250,000.
5. The contract document is signed by a representative of each
company who is competent, and who also has the authority to
commit the resources of the company.
6. No coercion was used and no illegal activities are required.
This sample contract is extremely simple, but it would be perfectly
legal and enforceable. However, almost all construction contracts will
very likely be a lot more complex and will have numerous additional
clauses to cover a variety of commercial terms and conditions, such
as insurance, indemnity, performance and payment bonds, changes,
dispute resolution, safety requirements, and schedule and progress
reporting requirements.
This example could have been expanded to include an additional
clause requiring National Construction Company to provide
Workers’ Compensation insurance and other types and amounts of
insurance, which would read as follows:

Article 4 – Insurance
National Construction Company will provide statutory Workers’ Com-
pensation insurance in accordance with state laws, Comprehensive General
Liability insurance in the amount of $1,000,000, and Automobile insurance
in the amount of $300,000.

These insurance requirements are typical. Most states require

contractors to participate in a Workers’ Compensation insurance
program, and owners typically require contractors to also
provide General Liability and automobile insurance at a
minimum.
All the clauses in a construction contract are collectively called the
commercial terms and conditions. Commercial terms and
conditions define all the responsibilities and obligations of each party
to the construction contract.

9
 Strange Words There are no requirements—legal, cosmic, religious, or otherwise—
for Latin terms to be used in a contract. For example, the Latin term
& Long inter alia, which pops up all the time in construction contracts,
Paragraphs simply means “among other things.” It’s perfectly okay to say “among
other things” if necessary for clarity. Use English! Using only English
terms in a simple and concise manner is a much better way to write a
clear and understandable contract.
Also, there are no requirements, legal or otherwise, for the use of
complicated and abnormally lengthy sentences or paragraphs, or
any other confusing language that could lead to
misunderstanding.
The following is an example of an unnecessarily wordy, complex
contract clause stating that a contractor has to complete the work in
accordance with the contract documents.

Article 25 – Contract Completion by Contractor

In consideration of all the mutual and independent agreements set forth on
the part of the Owner in the Contract as contained herein, Contractor shall,
without exception, construct, complete, and maintain the Work in absolute
full conformity and in all respects with any and all the provisions of the
Contract and Contractor will perform, fulfill, comply with, submit to, and
observe all and singular the provisions, conditions, stipulations, and
requirements and all matters and things expressed or shown in or
reasonably to be inferred from the Contract and which are to be performed,
fulfilled, complied with, submitted to, observed by, or on the part of
Contractor.

Here’s how this clause could be revised to simplify the usual

obligation of the contractor to complete the work in accordance with
the contract documents:

Article 25 – Contract Completion by Contractor

Being clear, concise, Contractor shall complete all the Work in full conformity with Owner’s
Contract documents.
and specific is
the preferred
way to write a Clear and concise English is the best way to write a construction
contract, so that all contract! Being as specific as possible in writing the commercial
those individuals terms and conditions is okay, too. Broadly worded commercial terms
responsible for and conditions are subject to broad interpretation, usually to the
executing the detriment of the contractor. If there is a dispute over what the
contract understand language in a particular commercial clause means, the more specific
what they have to do. and concise the language, the better the chances are of resolving the
dispute.

10
 One thing to remember is that if a contractor ends up in a contract
dispute, and a third party, like a court or an arbitration panel, reads
the commercial terms related to the dispute, there is no assurance
that they will interpret the clause the way the contractor believes it
should be interpreted. Be as specific as possible so that the
interpretation of the wording is clear to everyone.
If a contractor does not understand a paragraph in a proposed
contract because of its length, construction, or use of legal terms,
then he should negotiate a revision to it so that everyone responsible
for actually executing the contract can understand and interpret it,
too.

Contracting One myth to dispel about construction contracts is that of the so-­
called standard construction contract. There is no such thing as a
Myths standard construction contract. There can’t be. There’s no such thing
as a standard construction project.
This “standard construction contract” approach is sometimes used as
a negotiating tool to get one party to the contract to accept
unnecessary and/ or onerous commercial terms and conditions that
are in favor of the other party. Owners will often insist on using their
preferred, standard construction contract as a barrier, or stonewall, to
try to stop the contractor from negotiating more favorable, less
onerous commercial terms and conditions. Their tactic is something
like this, “These standard terms and conditions are well established
and can’t be changed.”
On the other hand, legitimate attempts have been made to try to
standardize construction contracts so that the commercial terms and
conditions they contain have some balance, are easier to understand
and interpret, and are seemingly fair to all parties. This is admirable
in its intent, but can lead to laziness in addressing issues unique to
individual construction projects, and it may actually increase the
commercial risk assumed by one or both of the parties to the
contract. Caution should always be taken whenever a “standard
contract” is suggested.
Examples of standard commercial terms and conditions for
construction contracts are those published by the American Institute
of Architects (AIA) and the Associated General Contractors of
America (AGC). Other options include standard forms from the
Engineers Joint Contract Documents Committee (EJCDC) in the U.S.
and the International Federation of Consulting Engineers (FIDIC) in
Switzerland.
There are certainly opportunities to use these standardized terms on
construction contracts, but contractors must read them carefully and

11
 understand how they apply to the specific project. If some of the
standard terms don’t apply, or tend to create excessive commercial
risk, then the contractor should modify them or delete them. These
standardized terms are not cast in stone, despite the impressiveness
of the contract’s appearance.

A Second Contracting Myth

Another myth to dispel is that only lawyers can write construction
contracts. Once a contractor has an understanding of the risk and
consequences of accepting certain commercial terms and conditions
that can create a potential financial liability for his company, he can
negotiate favorable changes to any offending commercial terms and
conditions and better protect the assets of his company.

Contract One important thing to remember about construction contracts is

this: all the wording of all the commercial terms and conditions in a
Negotiations proposed contract is negotiable. This is especially so if the
contractor’s proposal for the work contains a good price, an
achievable schedule, and is technically solid. As long as what the
contractor is trying to achieve by changing or modifying the language
in a proposed contract is not illegal, then all the commercial terms
and conditions that may create a potential financial liability for the
contractor are fair game for change.
As noted earlier, many owners will have standardized wording for
most all of the commercial clauses in a proposed construction
contract. They would like for this wording to be accepted by all
their contractors. That’s fine, as much of the standardized wording
can probably be classified as administrative terms, or, as it is
sometimes called, boilerplate, and may not impose any additional
or excessive commercial risk and potential financial liability on the
contractor.
However, a conscientious and careful contractor needs to make sure
he carefully reads the contract terms and conditions and understands
all the commercial risk associated with accepting the owner’s
standard contract wording. If the commercial risk is unacceptable,
then negotiations are necessary in order to change the wording to
lower or eliminate the risk.
An unfortunate caution: some owners have been known to insert
unrelated high-­risk terms and conditions within what might be
considered administrative terms, perhaps hoping the contractor will
overlook them. A final waiver of mechanic’s liens, for example, is a
fairly normal requirement for the contractor to provide to the owner

12
 at the conclusion of a construction contract. The owner may even
There is no substitute have a standard form for this. Sometimes that final waiver of liens
for reading and also contains extra language that waives all of the contractor’s rights
understanding to claim legitimate extras that are outstanding. This is unfair, but it
the contract. It is does happen, so be careful.
probably the most After the basics of contracts are understood, the next step is
important part of developing an understanding of the general types and forms of
the contracting contracts that contractors will commonly encounter. This is
process. Of equal discussed in the next chapter.
importance is the
ability to successfully
identify and then
negotiate changes
to any commercial
terms and conditions
that can create
unnecessary
commercial risk and
financial liability.

13
Chapter
Types & Forms
2 of Contracts

Construction contracts do not come in all shapes and sizes. They

conform to a fairly well-­defined set of types and forms. Seven
common types of construction contracts are:
1. Fixed price and fixed schedule
2. Reimbursable (unit rate and cost plus)
3. Combined fixed price and reimbursable
4. Cost plus fee
5. Guaranteed maximum price
6. Design build
7. Design-­bid-­build
Two additional types of contracts that are commonly encountered are
similar to the seven listed above, but with an added twist:
1. Target price contracts
2. Contracts with performance incentives

Understanding and Negotiating Construction Contracts: A Contractor’s and Subcontractor’s Guide to

Protecting Company Assets, Second Edition. Kit Werremeyer.
© 2023 John Wiley & Sons, Inc. Published 2023 by John Wiley & Sons, Inc.

15
 Fixed Price & These are the most common types of construction contracts. The
contractor submits a fixed, lump-sum price for the owner-provided
Fixed Schedule scope of work, as well as a finite completion time schedule. This type
Contracts of contract can be used for small projects, such as a $5,000 addition
to a single-family house, to large contracts, such as a petrochemical
manufacturing facility worth hundreds of millions of dollars. An
example of this would be when a contractor submits a fixed, lump-
sum price of $1,000,000 to an owner, with a firm schedule of 52 weeks
to complete an office building.
In a fixed price contract, the contractor must have the ability to
accurately estimate the costs and time required to perform the work.
The contractor also must have the capabilities to execute the contract
All well-defined for the price and schedule as promised. This type of contract requires
work that can be the owner to provide a comprehensive and accurate definition of the
accurately estimated scope of work.
and planned is a For the owner, this type of contract will likely provide the lowest cost
candidate for a fixed, or best schedule (or both) to get the work done, since he will
lump-sum price and probably have asked several contractors to compete for the work and
schedule contract. provide a formal bid. Having a fixed price and firm schedule allows
the owner to plan better for scheduling and for financing or paying
for the project.
For the contractor, this type of contract requires estimating and
execution skills. It also requires him to make a judgment on how high
to price the work to compete with other contractors. One good thing
about fixed price and schedule contracts is that, if the contractor
performs well against his costs and schedule, it’s likely he will have
savings and thereby increase his estimated profit, and there’s nothing
wrong with that! On the other hand, if the contractor overruns his
estimated costs and/or schedule, it’s unlikely he will get much
sympathy—or money—from the owner.

Reimbursable There are two common and similar types of reimbursable contracts:

Type Contracts • Unit rate

• Cost plus

Unit Rate Contracts

The contractor submits a menu of prices for materials, labor, and
equipment to the owner. These prices include all of the
contractor’s costs and markups, including profit, for the respective
items listed.

16
An Example
The owner wants to install approximately one mile of 24" diameter
underground cast iron pipe in a 6' deep trench. The contractor
provides the following example menu of prices to the owner:
• 24" diameter cast iron pipe: $50/linear foot delivered
• Project foreman: $75/labor hour worked, no overtime
• Laborers: $35/labor hour first 40 hours per week, $55/labor
hour overtime
• Backhoe: $175/hour fueled and operated
• Side-­boom tractor to lay pipe: $175/hour fueled and operated
• 12" rock backfill over pipe: $30/cubic yard delivered
• Miscellaneous expendables: $250/day
At the end of each week during the project, the contractor adds up
the length of pipe installed, the labor hours worked by the foreman
and laborers, the time of use for the backhoe and the side-­boom
tractor, the amount of rock backfill, and miscellaneous expenses.
The contractor then applies the reimbursable rates to each, sums
them up, and sends the owner a bill.

Cost Plus Contracts

In a cost plus construction contract, the contractor submits a menu
of direct costs and associated markups for materials, labor,
subcontracts, and equipment to the owner. The markups (the “plus”)
include all of the contractor’s overhead and profit applied to the
respective items in the menu.

An Example
The owner wants to install approximately one mile of 24" diameter
underground cast iron pipe in a 6' deep trench. The contractor
provides the following menu of costs and markups to the owner:
• All pipe materials delivered to site: direct invoice cost plus 20%
• Project foreman: $45/labor hour worked, plus 50% fringes and
20% overhead and profit
• Laborers: straight time, first 40 hours/week: $23/hour, plus
35% fringes and 20% overhead and profit
• Laborers: overtime, after first 40 hours/week: $34/hour, plus
25% fringes and 15% overhead and profit
• Backhoe: $145/hour, fueled and operated, plus 20% overhead
and profit

17
 • Side-­boom tractor to lay pipe: $145/hour, fueled and operated,
plus 20% overhead and profit
• Rock backfill over pipe delivered to site: direct invoice cost plus
20%
• Subcontracts: cost plus 15% overhead and profit
• Miscellaneous expenses: direct invoice cost plus 20%
At the end of each week during the project, the contractor adds up
the invoice costs of all materials delivered to the site, the labor hours
worked by the foreman and laborers, the time of use for the backhoe
and the side-­boom tractor, the amount of rock backfill, and
miscellaneous expenses. He then applies the noted markups to each,
sums them all up, and sends the owner a bill.
For the owner, these types of reimbursable contracts are useful where
the scope of work and schedule are difficult to define. Maybe there’s
some rock in the ground, or the terrain is difficult, or the weather is
really lousy—­and trying to determine a fair fixed, lump-­sum price
might prove difficult or turn out to be very expensive, as the
contractor will load up his contingency costs.
For the contractor, these types of reimbursable contracts allow him to
take on a job without having to provide a large contingency cost for
unknown conditions and schedule delays. The contractor probably
has to compete with others to get the work, so he’s careful about the
level of his reimbursable pricing and the time he estimates it will take
to complete the work.
On all reimbursable contracts, the contractor should expect that the
owner will want to audit his work records for the labor hours billed,
the time the equipment was used and billed, and for any other
reimbursable work item.

Combined As the name suggests, this contract is a blend of the two types of
contracts. It tends to be used where some of the work is well-­defined,
Fixed Price & and some isn’t.
Reimbursable
An Example
Contracts An owner wants to build a standard-­design, 300-­foot-­tall radio
relay tower on the top of a 10,000-­foot-­high, heavily-­wooded
mountain. There isn’t anything special or unique about the
engineering effort required or the supply of the materials for the
tower. However, getting the materials from the base of the mountain
to the top on an unimproved roadway, and then installing them, is
not conducive to a fixed price, as too many undefinable work and
schedule issues are involved.

18
 The owner ends up with the following example contract pricing
format:
• Engineering: $20,000 lump sum
• Radio tower material supply: $80,000 lump sum
• Transport materials to base of mountain: $5,000 lump sum
• Mobilize crew and equipment at site: $5,000 lump sum
• Project manager: $100/labor hour worked
• Project superintendent: $75/labor hour worked
• Steel erectors: $45/labor hour
• Clearing and installation labor: $30/labor hour
• 10-­ton mobile crane: $125/hour fueled and operated
• 5-­ton special transport: $85/hour fueled and operated
• Excavation: $5/cubic yard excavated and removed
• Portable air compressor and generator: $45/hour fueled and
operated
• Small tools and expendables: $200/day
• Demobilize crew and equipment from site: $3,000 lump sum
The contractor bills the owner for the stated lump sums for the
engineering costs, supply of materials, transport, mobilization, and
demobilization. These scope of work items were well-­defined by the
owner in his inquiry documents, and thus are conducive to fixed,
lump-­sum pricing.
The field installation work proceeds on a “best effort” basis, given
the adverse and difficult-­to-­estimate working conditions. The
contractor bills the owner for the work performed based on the
menu of reimbursable prices provided, just like in the reimbursable
contract example.
For the owner, this type of contract is useful where some aspects of
the scope of work and schedule are easy to define, but some of the
work is difficult to define. Trying to get a fair lump-­sum price for the
entire project might prove difficult, as the contractor will feel the
need to load up his contingency costs for the difficult field working
conditions.
For the contractor, the combined fixed price/reimbursable contract
will allow him to take on a job without having to include a large
contingency cost for unknown field working conditions and any
delays in schedule. He probably will have to compete with others to
get the work, so he’s careful about the level of his fixed, lump-­sum
pricing, the level of the reimbursable pricing, and the time he
estimates it will take to complete the work.

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 Cost Plus Fee A cost plus fee construction contract format is often used for large,
complex projects. Typically, these projects require a significant
Contracts amount of conceptual and design engineering, along with a major
effort to procure a lot of expensive equipment and materials. These
projects also require construction services, including a large and
diverse project management staff and a multi-­disciplined craft labor
force. There might be a completion schedule of several years or more.
In this type of construction contract, the contractor provides, for
example, all permits, studies, design services, detail engineering,
major equipment, materials, and field construction management and
labor, often in a joint effort with the owner. The contractor then bills
the owner for the actual costs, and, in addition, bills the owner a fixed
fee, which would typically include the contractor’s project
management costs, overhead costs, and profit.
All the actual costs associated with engineering, procuring, and
constructing the project are billed directly to the owner for payment,
or reimbursement if the contractor is paying the bills in the first
instance as part of the contract with the owner. In addition, the
owner will pay the contractor the agreed-­on fee on a prorated basis
based on the physical or cost progress of the project.
Many cost plus fee contracts have a provision in them to increase the
fee should the estimated costs or scope of work exceed a certain
amount, or if the estimated schedule extends beyond what was
originally estimated.
For the owner, a key benefit of this type of contract is that it allows
him to build a project on a fast-­track basis. He can negotiate a
contract with a specialized and experienced contractor for the project
and proceed immediately with conceptual and detailed engineering
and procurement of major, long-­lead-­time pieces of equipment. The
owner avoids the lengthy fixed-­price process of selecting a main
contractor, then going through the development of engineering and
the production of bid documents, the bidding and bid review, and
final contractor selection process. The owner might expect to save up
to a year or more on the completion schedule of major projects with
this contracting approach. This type of contract requires full
participation of the owner in the cost control and subcontractor
selection process.
For the contractor, this approach allows him to be reimbursed for all
costs associated with the project and provides him with a fee to cover
project management, overhead, and profit for the project. If the
project expands beyond what was originally expected, then the
contract should allow for an adjustment to the contractor’s fee.

20
 In this type of contract, all reimbursable actual cost records are
auditable by the owner. In addition, the owner might expect to
negotiate the amounts in the fee for the contractor’s project
management, overhead, and profit.

Guaranteed This type of contract would likely be a reimbursable type, or some

combination of reimbursable and fixed price contracts. The
Maximum Price distinguishing feature of this type of contract is that the contractor
Contracts would agree with the owner that the final price to the owner would
not exceed a fixed, certain value. In other words, the contract would
have a guaranteed maximum price.
This is a risky agreement for contractors. If the contractor’s cost of
the project exceeds the guaranteed maximum price, then that’s too
bad for the contractor. The extra money comes out of his pocket. It is
especially risky if the scope of work is poorly defined, and if external
factors like weather or labor conditions create expenses that he
cannot recover through claims or changes to the contract.
For owners, this type of contract is useful where he may, for example,
have to fund the project with outside financing and want to cap his
exposure to project costs.

Target Price A target price contract is one where the contractor and the owner
agree on a certain fixed, lump-­sum price, the target price, and the
Contracts contractor tries to execute the contract at or below it.
One unique feature is that the contractor shares all the costs in the
estimates, including his markups and expected profit, with the owner. The
owner understands the contractor’s estimating process and supports it.
In a target price contract, both parties agree on the level of costs and
contractor markups and profit. This type of contract also requires the
contractor and owner to have a working relationship based on a high
degree of trust.
In the event the contractor completes the project below the estimated
cost, there will be a cost savings, and the contractor and owner will
share that savings in a previously agreed-­on proportion. In the event
the contractor overruns the project costs, then the contractor and
owner will share the expense of the overrun in a similar fashion.

An Example
A contractor and owner agree on a price of $3,500,000 to build a
new, concrete marine cargo unloading jetty for the owner’s ships.
After finishing the project, the contractor manages to save $100,000
on his estimated costs and shares that information with the owner.

21
 The contract between the owner and contractor calls for any savings
against the target price to be split 50-­50. Therefore, the owner ends
up paying $3,450,000 for the project, and the contractor ends up
with an additional $50,000 profit.
In this type of contract, both the owner and contractor have a strong
incentive to work closely together and pool their talents and
resources to find legitimate ways to reduce costs and safely expedite
the overall project schedule.

Design Build Contracts

In this type of construction contract, the Owner signs a single-­source
contract with a Contractor that will cover all the aspects of the design
and construction for the project. The theory is that this will eliminate
multiple contracts and subcontracts for the Owner, find cost and
time savings, reduce paperwork, and streamline the overall bidding
and completion schedule.
Contractor led design-­build contracts can be considered where the
selected contractor has demonstrated engineering, design, and
construction strengths in the type of project being proposed. For
example, a refinery or petrochemical plant.
Architect-­led design-­build contracts can be considered where the
project has some complex and nuance design issues. For example, a
hospital or custom home. The contractor for the construction
might be part of the architect’s organization or perhaps a joint
venture partner.

Design-­Bid-­Build Contracts
The difference between this type of contract and a design-­build
contract is that the Owner issues a separate contract to an architect
for the design of the project and a separate contract for the
construction of the project.
In a design-­bid-­build contract, the construction contractor does not
participate in the project’s design.
An example of this type contracting process might be a single-­or
multistory commercial building.

Contracts with Any of the above-­mentioned types of construction contracts can have
performance-­based incentives included. Some typical performance-­
Performance based incentives are:
Incentives • Safety: such as an incentive bonus for no lost time or recordable
accidents.

22
 • Quality: such as an incentive bonus for achieving 98% or better
flawless x-­rays on all full-­fusion welds in high-­pressure piping.
• Subcontracts: such as an incentive bonus for utilizing a certain
percentage of minority-­owned subcontractors or suppliers.
• Schedule: such as an incentive bonus for finishing ahead of
schedule.
Performance-­based incentives can play a strong role in achieving
certain goals for the owner. For example, if the owner’s company
assigns utmost importance to safety, then the owner should be willing
to “put his money where his mouth is” by making a pool of extra
money available to those contractors on the project who achieve
exemplary safety records.
On the flip side of this issue are those contracts that contain certain
performance disincentives. An example of this may also involve job
site safety, a common performance-­based incentive. In addition to the
pool of extra money that might be available to the contractor for
exemplary safety, the contract may also provide for the contractor to
put, say, 2% (or more) of his contract price at risk for poor safety. If
the contractor doesn’t meet the project’s minimum stated safety goals
for his portion of the work, then the owner has the right to deduct
some or all of the 2% from the contractor’s contract price.
One common disincentive that can be used by the owner is the
imposition of liquidated damages when the contractor fails to meet
or beat the contractual schedule. (Liquidated damages and how to
deal with them are covered thoroughly in Chapter 11.)

Form of Like the types of contracts, the form that a construction contract
takes is fairly standard, too. Organization is typically as follows:
Contracts 1. Preamble
2. General contract and the commercial terms and conditions
3. Special terms and conditions
4. Attachments incorporated by reference
5. Signature block
6. Order of precedence

Preamble
Most contracts begin with what is called a preamble, used to
specifically identify the parties to a contract. This is an excellent
convention to use, as owners may have many different, independent,
and separate business units, both U.S. and foreign subsidiaries, that

23
 have the ability to enter into construction contracts and commit the
use of corporate resources.
Preambles are straightforward in their structure and typically read as
follows:

This Contract is between Wilson Properties (Owner), an organization

registered in the State of Florida and having its registered office at 3160
Ponce DeLeon Way, Orlando, Florida, and National Construction Company
(Contractor), an organization registered in the State of Delaware and having
its registered office at 125 East Orange Street, New York, New York.

Note the convention of capitalizing and putting “contractor” and

“owner” in parentheses after they are identified as a party to the
contract. This is done to define important terms to be used
throughout the contract. It’s also a simplifying procedure. Rather
than using “National Construction Company” to define the
contractor throughout the contract, the capitalized term “Contractor”
is used. Defined terms and additional examples are more thoroughly
discussed later in this chapter.

Recitals
Often following the preamble in a contract is something called
recitals. Recitals typically begin with the word “Whereas,” or
“WHEREAS,” or “WITNESSETH.” A recital typically states facts,
issues, or conditions related to the contract and may read similar to
the following:

WHEREAS: Owner has decided to build a new 10,000 square foot

warehouse on property located in Orlando, Florida.
WHEREAS: Contractor warrants that it is qualified, experienced, and competent
to perform the work.
WHEREAS: Contractor has agreed to do the work subject to the terms and con-
ditions of the Contract.

The recitals section ends with the following, or similar, sentence:

NOW, THEREFORE, IT IS HEREBY MUTUALLY COVENANTED AND

AGREED AS FOLLOWS:

What follows is the body of the construction contract. The recitals

section is an old, and some might say, antiquated practice that doesn’t

24
add much value to the contract. Everything typically stated in the
recitals section would normally be agreed to elsewhere in the body of
the contract and will be just as enforceable. Many modern contracts
no longer use recitals wording.
Having said all this, if an owner presents a draft contract containing a
recitals section, that’s okay. As long as what’s said in the recitals
section is accurate, there is no need to change it or delete it.

General Contract & the Commercial

Terms & Conditions
Following the preamble and recitals (if recitals are used) comes the
main body of the contract. This part of the contract typically contains
a description of the scope of work to be performed by the contractor
and the commercial terms and conditions. Together, these typically
define the rights, duties, responsibilities, and obligations of the owner
and the contractor.
The scope of work section in the commercial terms and conditions
may be sufficiently detailed to fully describe the work, or the work
requirements may be in the form of a separate set of plans and
specifications that are attachments to, and form part of, the
contract documents. Any plans, specifications, codes, or other
requirements that are attached or included by specific written
reference in the contract are considered an enforceable part of
the contract.
The rights, duties, responsibilities, and obligations of the owner
and the contractor are stated in separate and numbered paragraphs
in the body of the contract. These paragraphs are also called
clauses or articles. It doesn’t matter what they are called; these
individual paragraphs require careful reading and analysis, as
each may expose the contractor to some varying degree of
commercial risk.
The degree of commercial risk associated with a paragraph in the
contract may be acceptable, unacceptable, or somewhere in
between. Depending on the level of commercial risk accepted, the
contractor may be exposed to the possibility of accepting a large
amount of potential financial liability. These commercial terms
and conditions are the most likely place in a contract where the
contractor will be exposed to risk and require the most
careful review.
As noted at the beginning of this book, there is no price for bad
terms. Often an owner will state, “If the contractor doesn’t like some

25
 of the general commercial terms and conditions in our contract, then
he should add some money to his price to cover the commercial risk
he believes he is assuming.” There isn’t anything wrong with an owner
making this requirement, as long as the contractor can somehow
accurately measure the value of the commercial risk he is assuming,
and place a price on it. However, how can a contractor measure, for
example, the commercial risk assumed in a broad form indemnity in
the owner’s contract, the consequences of which could bankrupt his
company for something he did not do? There is no price a contractor
can place on that level of commercial risk.

Special Terms & Conditions

Just like the Many large organizations involved in engineering and building
commercial terms projects have a set of standardized general terms and conditions
and conditions in an that they like to use for their construction contracting needs. Based
owner’s proposed on the special needs or issues involved in a particular construction
contract, the special project, they may elect to attach to the contract a set of special
terms and conditions terms and conditions. These will typically supersede any similar or
require the same like terms and the contract’s general terms and conditions. Many
careful review and times, they will have a lead-in paragraph that reads similar to the
following:
analysis.

These Special Terms and Conditions take precedence over any similar or
like terms and conditions found elsewhere in this Contract.

Special terms and conditions can just as easily expose the contractor
to unacceptable commercial risk and exposure to potential financial
liability, as can the owner’s general commercial terms and conditions
discussed above. Just like the comment made for general commercial
terms and conditions, there is no price for bad terms—general,
special, or otherwise.

Attachments Incorporated by Reference

In addition, many contracts will have a variety of attachments,
appendices, or addenda incorporated by reference that spell out
specific contractual requirements for different subjects.
Typical attachments to an owner’s complete construction contract
might include:
• Scope of work description
• Plans and specifications that apply to the work

26
 • List of applicable codes and standards that apply to the work
• Project safety program and requirements
• Overall project schedule
• Special insurance requirements
• Form of performance and payment bonds
• Final acceptance form
• Final waiver form
All attachments incorporated by reference in a construction contract
require the same careful review and analysis. Attachments
incorporated by reference can just as easily expose the contractor to
unacceptable commercial risk and potential financial liability.

Signature Block
This is the last thing to do: sign the contract. Once this is done, then
an enforceable contract is in place. Both parties must perform their
parts of the deal as described in the contract. A typical signature
block might look like this:

IN WITNESS WHEREOF duly authorized officers of the parties hereto

have executed this Contract.
Date: ___________________
National Construction Company Wilson Properties
________________________ __________________________
Name: Name:
Title: Title:

The term in capitals “IN WITNESS WHEREOF” is commonly used,

but is another example of an antique contracting convention. If the
contractor does not like the “IN WITNESS WHEREOF,” then remove
it. A simple alternative:

The parties to this Contract are in agreement and have signed and dated it
below:

Order of Precedence
On most construction projects, the contractor will provide a written
proposal in response to the owner’s inquiry or request for proposal.

27
 In that proposal, the contractor will make an offer to perform the
work specified in the owner’s bidding documents. The contractor’s
proposal will also respond to the bidding requirements, if any, in the
owner’s bid documents. In addition, the contractor may state some of
his own requirements, such as better terms of payment.
He may also take written exception to some of owner’s general terms
and conditions or special conditions because they impose an
unacceptable level of commercial risk on him. The contractor may
also offer alternative technical solutions to the owner’s requirements.
The owner and contractor then meet, work out details, and negotiate
a final price, schedule, and contract. The contractor may find that the
owner accepted his proposal without any changes to his proposed
better terms of payment and all of his exceptions to the owner’s
general terms and conditions and special conditions.
The contract and all attached documents then are given to the
contractor for his acceptance and signature. Then, in the general
terms and conditions, under order of precedence of documents,
there may all of a sudden appear a new paragraph that states:

Article 3 – Order of Precedence

3.1 In the event of any conflict or dispute arising in or out of this Contract,
the order of precedence of documents shall be as follows:
a.) Owner’s Special Terms and Conditions
b.) Owner’s General Terms and Conditions
c.) Owner’s Plans and Specifications
d.) Contractor’s Proposal dated July 7, 2006

If the contractor accepts this order of precedence, signs the contract,

and returns it, he is basically out of luck on getting his preferred
terms of payment and the changes he wanted made to the general
terms and conditions and special conditions. Even though the
contractor proposed some modifications, those modifications stand
little chance of being recognized or enforceable because the
contractor’s proposal is in last place in the order of precedence.
The unfavorable payment terms in the owner’s general terms and
conditions take precedence over the favorable payments terms stated in
the contractor’s proposal. The risky commercial terms that appear in the
special terms and conditions will now take precedence over the similar,
but less risky, commercial terms stated in the contractor’s proposal.
During the execution of the work, the contractor sends in his first
payment invoice specifying his terms as stated in his proposal.

28
The invoice will probably be rejected, as the owner will be able to
enforce the order of precedence clause to use the terms of payments
specified in his general terms and conditions.
When faced with an order of precedence situation described above
with respect to a conflict between the owner’s terms and the
contractor’s proposal, it is recommended that revised wording similar
to the following be negotiated and used:
Often, the negotiations between the owner and the contractor result in
some form of compromised wording that ends up somewhere in
between what the owner wants in his general or special terms and
conditions and what the contractor wants and has stated in his proposal.

Article 3 – Order of Precedence

3.1 In the event of any conflict or dispute arising in or out of this Contract,
the order of precedence of documents shall be as follows:
a.) Owner’s Special Terms and Conditions except those modified by
Contractor’s proposal dated July 7, 2006, which shall take
precedence.
b.) Owner’s General Terms and Conditions except those modified by
Contractor’s proposal dated July 7, 2006, which shall take
precedence.
c.) Owner’s Plans and Specifications except those modified by
Contractor’s proposal dated July 7, 2006, which shall take
precedence.
d.) Contractor’s Proposal dated July 7, 2006.

In this event, a compromise might be agreed to in a separate letter

signed by both the owner and contractor. The revised Article 3.1 a.),
b.), and c.) wording might read similar to the following:

a) The Owner’s Special Terms and Conditions with the modifications to

them as agreed upon in the letter from Contractor dated August 15,
2006.
b) The Owner’s General Terms and Conditions with the modifications to
them as agreed upon in the letter from Contractor dated August 15, 2006.
c) The Owner’s Plans and Specifications with the modifications to them
as agreed upon in the letter from Contractor dated August 15, 2006.
d) Contractor’s Proposal dated July 7, 2006.

At issue here with order of precedence is getting the contractor’s

negotiated modifications to the owner’s terms and conditions recognized
as taking precedence over any of owner’s similar or conflicting provisions.

29
 Acceptable revisions to the owner’s terms and conditions are usually
fought for by the contractor, and it would be a shame for those
revisions to not apply due to an overlooked order of precedence
clause in the contract.

Some Final Construction contracts, regardless of their type or form, can be

wordy and unnecessarily difficult to understand. Defining contract
Contract terminology is a practical way to understand concepts in the
Housekeeping— commercial terms and conditions of a construction contract.
Definitions Providing defined terms, or definitions, in a contract is just good
contract housekeeping.
How is a defined term defined? Often, when a contractor is reading
through the many different clauses in a construction contact, he will
notice that in many of the clauses there are capitalized terms, like
“Contractor,” or “Owner,” or the “Work,” and so on. These are
examples of defined terms.

An Example
At the beginning of this chapter, there is a typical preamble that
begins with a line that states:

This Contract is between National Construction Company (Contractor), an

organization. . .

The defined term here is the capitalized word “Contractor” and is

contained in parentheses. Everywhere else in the contract, without
exception, wherever the capitalized defined term “Contractor” is used it
means “National Construction Company,” as was stated in the preamble.
Also in the sample preamble, the third line states:

. . .and Wilson Properties (Owner), an organization registered. . .

The defined term is the capitalized word “Owner” and it is also

contained in parentheses. Everywhere else in the contract, without
exception, wherever the defined term “Owner” is used, it means
Wilson Properties, as was stated in the preamble.
It is also not unusual to see a defined term fully capitalized, such as
CONTRACTOR or OWNER. Use of partial capitalization or of full
capitalization of defined terms is just a matter of different writing
styles. There is no difference in meaning between a defined term that
is partially capitalized or one that is fully capitalized.

30
Typically, the first time a defined term is used in a contract is where
the shortened form is capitalized. It may appear in parentheses, and
is typically placed immediately following the defined term.
Thereafter, throughout the contract, the capitalized and shortened
form is used. This is practical when, for example, the scope of work is
lengthy and complex and can be defined simply and more easily by
using the capitalized term “Work.”
Some contracts may use an alternative writing style that states in
parentheses: “(hereinafter, Contractor)” immediately following the
term it defines. The use of the term “hereinafter” is another antique
contracting form and means something like, “wherever you see this
term elsewhere in this contract, this is what it means.”
Many contracts have a separate section called “Definitions.” In this
section, terms used frequently throughout the contract are clearly
identified, and their capitalized short form definition is noted. It’s not
unusual for “contractor” and “owner” to be defined again in a definitions
section, just as they may have been earlier defined in the preamble.
Some typical terms that may appear in a definitions section are as
follows.

Article 1.0 – Definitions

1. Contract: all terms and conditions contained in the General
Conditions, the Special Conditions, the Plans and Specifications, the
Attachments to the Contract, and the Contractor’s Proposal.
2. Contractor: the contractor.
3. Owner: the company or individual who requests and is funding the
project.
4. Work: all activities, including design, engineering, supply of materi-
als, manpower, equipment, and field construction necessary to
complete the 10,000-square-foot, single-story building as fully
described and detailed in the Plans and Specifications attached to
this Contract.
5. Job Site: the area of land on which the Work will be constructed as
identified on the map and survey included in the Plans and
Specifications attached to this Contract.
6. Construction Equipment: all equipment supplied and used by
Contractor for the performance of the Work.
7. Acceptance Certificate: a dated and signed document issued to
Contractor by Owner certifying that the Work is completed in accord-
ance with all the provisions of this Contract.
8. Defect Liability Period: the period of time beginning with the date of
the issuance of the Acceptance Certificate for the Work and ending
12 months later.

31
 Clearly defining contract terms is good contracting practice. Definitions
play an important housekeeping role in keeping the language of the
contract readable and somewhat less complex, especially where multiple
references to complicated definitions, like the work, are required. This
helps everyone involved in the actual administration and execution of
the contract—­the real work—­better understand the contract
requirements.
Clarity in construction contracts is essential and helps avoid
misunderstandings. Defined terms help provide this clarity.

Conclusion Just about every contract a contractor will see will conform generally
to the types and forms of contracts described in this chapter.
Regardless of the type of contract, the most important part of any
construction-­related contract is the scope of work section, the subject
of the next chapter.

32
Chapter
Scope of Work
3
It’s a given that in any construction contract requiring the contractor
to build, repair, upgrade, or modify something, an accurate and
concise description of the work should appear. That description of
the work—­which defines what the contractor is obligated to
provide—­is called the scope of work. An accurate, detailed, and
comprehensive scope of work is the most important part of a
construction contract and one of the foundation stones of a good
contract.
It is not uncommon for the owner to believe, perhaps correctly, that
he should be getting more, or something different, than what the
contractor is providing. It’s also not uncommon for the contractor to
believe that he should be providing less, or something different, than
what the owner believes he should receive. Each party will have his
own interpretation of a poorly written scope of work.
All construction projects, even those that appear simple and
straightforward, require comprehensive scope of work documents to
be included as part of the contract. The more complex a construction

Understanding and Negotiating Construction Contracts: A Contractor’s and Subcontractor’s Guide to

Protecting Company Assets, Second Edition. Kit Werremeyer.
© 2023 John Wiley & Sons, Inc. Published 2023 by John Wiley & Sons, Inc.

33
 project is, the more important it is that the scope of work documents
A comprehensive be thorough and detailed.
description of the
On large projects where there are a number of contractors working
work to be performed
side by side at the same time, the scope of work documents should
is an absolute
clearly define the interfaces between them all. This is especially
necessity. It enables important if the work being done by one contractor must hook up or
the contractor to somehow be attached to the work of another. For example, if two
more precisely price, contractors are providing piping on a project, and the piping of both
plan, and schedule must interconnect smoothly at some point, who makes the welded or
the work. It better bolted interconnection between the two pieces of pipe? Maybe it’s
assures the owner not a big deal if only one piping connection is required to connect the
that he will receive piping of both contractors. But what happens if there are several
what he really wants. hundred pipe connections to be made? Who’s responsible now to
And, a well-written make the connections? That interface responsibility should be clearly
scope of work will defined in the scope of work documents.
significantly minimize The owner has the primary responsibility for preparing the scope of
the possibility of work documents. After all, it is his project. He may prepare them
claims, change himself or hire an independent company. In either case, the
orders, and disputes contractor must carefully review these documents and, in his
arising during the proposal for the work, make as many written clarifications as may be
course of the project required to further define the work that is included in his pricing.
over what work is, or More importantly, it is absolutely necessary for the contractor to
is not, required. define what’s not included in the scope of work. Too many claims and
disputes arise out of a difference of opinion between the contractor
and the owner over what is required in the scope of work, and who is
to provide it.

An Example
Let’s consider the single-story office building used in the sample
construction contract in Chapter 1. All the drawings and documents
included in Wilson Properties’ Request for Proposal (RFP) describing
and detailing the building were well-prepared by a local engineering
consulting company hired by Wilson Properties. The contractor,
National Construction Company, put a price and schedule together
to construct the building based on these documents, but made no
clarifications to them in the proposal to the owner.
National Construction Company’s project management, site manager,
work force, and equipment show up at the job site on the contractually
designated date. The site has been cleared and evenly graded. There
is plenty of space for all job site offices and equipment, and all
local gas, water, telephone, and electric power are in place ready for
hook up.

34
As National’s site manager inspects the site, he notices that the
foundations for the building are not there. Uh-­oh! Looks like a
problem. National’s site manager calls his boss, National’s project
manager, on his cell phone. He tells his boss, “I think we have a
small problem here. There aren’t any foundations in the ground,
and they aren’t in my scope of work.”
National’s project manager reviews the Wilson Properties contract
documents, scope of work section, and all referenced attachments.
The scope of work is several pages long and provides a general
description of the building to be constructed. There is no mention
about the building foundation. Included in the RFP are some off-­
the-­shelf standard specifications on excavation, concrete, and rebar,
which would be considered normal for this type of project.
However, there is nothing specific about the building’s foundations
or, more importantly, who is to design, supply, and install them.
There are also no engineering sketches or detail drawings on the
foundation attached in the contract.
National’s project manager re-­reads his company’s proposal for the
work, and the only thing it says is that, “National Construction
Company will provide the work in accordance with the contract
documents.” There is no further clarification.
It’s time to call the owner for a meeting. National Construction
Company’s project manager meets with Wilson Properties’ project
director for this building project. After a review of the contract
documents, Wilson Properties’ project director claims that the
supply and installation of the foundation for the building is part of
National’s scope of work.
National’s project manager says, “I’m not sure how you can come to
that conclusion, as there’s no reference in any of the documents that
the foundations are in our scope of work.”
“You’re right, there’s no specific reference,” says Wilson’s project
director. “But you guys have built buildings for us on several
previous occasions and have always designed and installed the
required foundations. It’s actually one of your company’s strengths.”
“So you’re telling me we have to provide the building’s foundations?”
National’s project manager asks.
“Yes, the foundations are implied in the contract,” says Wilson’s
project director. “You can’t build a building without foundations,
and the concrete and rebar specs are in the contract for a good
reason.”
“But there’s nothing in the scope of work that actually says we have
to provide the foundations,” says National’s project manager.

35
 “Well, that’s true, but there’s a paragraph in the Commercial Terms
and Conditions section that requires National to do all work
reasonably implied from the contract documents,” replies Wilson’s
project director.
“So what you’re telling me is that the building’s foundations are
implied by the contract specifications to be part of National’s
scope?” asks National’s project manager.
“That’s right. You guys have been in the business for a long time and
have done a lot of this type of work. If you overlooked the
foundations, then that’s your problem, but as far as Wilson
Properties is concerned, the building’s foundations are in your scope.”
There is nothing pretty about this picture. Here are all the classic
beginnings of a major contract dispute. The cost to supply and
install the building’s foundations will make the overall contract a
financial loser for National. Wilson Properties doesn’t seem willing
to accept a major change order to the contract. The schedule will
also be greatly impacted.
Is this an oversight on the part of National Construction Company?
Perhaps it is.
As National’s project manager considers what he is going to do next
to resolve this situation, he recalls an earlier conversation with
Wilson’s project director, who said, “You guys really have a good
price this time on this building bid.” He now understands why that
comment was made. He reviews the contract’s commercial terms
and conditions section and all paragraphs concerning the scope of
work once again. He comes across the following paragraph:

Article 8 – Contractor’s Scope of Work

8.1 Contractor shall perform all work strictly in accordance with this
Contract and the Plans and Specifications attached to this Contract, and
shall be solely responsible to perform all work as may be reasonably implied
from the Plans and Specifications that may be necessary to completely and
satisfactorily finish the Work.

He thinks again to himself, “We could have done a better job of

defining what we were going to provide in our proposal. It looks like
Wilson Properties has stuck it to us with some slick terms and
conditions.”
It seems like National Construction Company is out of luck and will
have to put in the foundations. Alternatively, they could make an
issue out of it with Wilson Properties. Either way, it’s a lousy situation
to be in for a contractor, and not a good one for an owner either.

36
 It also appears the relationship between National Construction
Company and Wilson Properties may become adversarial. That’s not
good for either company.
How could a situation like this have been avoided? National
Construction Company should have carefully clarified the scope of
work in their proposal, including that the building’s foundations were
to be designed, supplied, and installed by others. In this case,
National Construction Company should have more carefully
reviewed all the contract documents for inconsistencies and
addressed any they found in their proposal to the owner.
National could also have requested that the contract paragraph noted
above be changed to read similar to the following:

Article 8 – Contractor’s Scope of Work

8.1 Contractor shall perform all work specifically described in the attached
plans and strictly in accordance with the specifications attached to or
referenced in this Contract.

Such a revision might not avoid a dispute over who provides the
building’s foundations, but it would give National Construction
Company a much stronger position in claiming that the foundations
are not part of their scope of work.
The use of words like “reasonably implied” in the scope of work
section of a contract can allow open season on the contractor by the
owner regarding the owner’s requested changes to the scope of work.
On the other hand, it can protect the owner from a host of small and
unnecessary requests for changes from the contractor.
What is “reasonable” to an owner may not be “reasonable” to a
contractor, and vice versa. The best way to avoid situations like this is
to make sure the scope of work description in the contract is very
specific and detailed; this is as much the contractor’s responsibility as
it is the owner’s. If certain items of work are excluded, then all those
exclusions to the scope of work should be specifically detailed in the
contractor’s proposal, and also in the final contract documents.
Plans and specifications and the associated terms and conditions always
have to be carefully reviewed to avoid situations like this. If there is any
doubt as to whether or not something is included in the work, it’s best
to clarify it in writing with the owner prior to signing the contract.

The Scope of This is a useful contracting tool that will benefit both the contractor
and owner. It provides a line-by-line listing of all of the work items
Work Matrix included in the contract. The scope of work matrix can be lengthy

37
 Figure 3.1 Example of Scope of Work Matrix for One-­Story Office
Building
and extremely detailed. Not only does it provide a better overall
description of the work to be performed, but it also requires the
owner and the contractor to more carefully understand what needs to
be provided to complete the project.
A detailed scope of work matrix is always worth the effort and can
play an important role in minimizing claims and disputes over work
scope issues. A scope of work document can also clarify the interfaces
in work scope between different contractors on the same project.
Figure 3.1 is a sample scope of work matrix for a one-­story office
building project, such as what might have been developed by Wilson
Properties for inclusion in their RFP documents.
It really doesn’t matter whether the owner and the contractor use a
scope of work matrix, or some other form or means of description to
accurately define the work. What does matter is that the scope of
work to be performed by the owner, the contractor, and all others

38
 who will be working on the job site is comprehensive and accurately
detailed.
Not only does this process produce a better, more well-­thought-­out
project, it also minimizes the chances of claims and disputes arising
over misunderstandings about what is included in the scope of work
for everyone working on a project.

Scoping Scoping drawings are another excellent tool (similar to the scope of
work matrix) for helping to better define the scope of contractors’
Drawings and owners’ work, responsibilities, and boundaries. These drawings
relate to the project and indicate for the contractor what is “in scope”
for his scope of work and what is “not in scope.” General arrangement
and detail drawings of the project are particularly useful and can be
marked up for this purpose. Figure 3.2 is an example of how scoping
drawings can be used by an owner or a contractor.

Figure 3.2 Example of a Scoping Drawing

39
 Scoping drawings are also useful to outline multiple scopes of work
when there is more than one contractor on the job site, each working
in close proximity to the other.

Conclusion To restate: a well-­defined, carefully detailed, and comprehensive

scope of work document, or scope of work matrix (including scoping
drawings), is probably the most important part of a construction
contract. If contractors could get their clients—­the owners—­to read
just one chapter of this book, this chapter is the one.

40
Chapter
Terms of Payment
4 & Cash Flow

Three Rules of Business: 1. Have cash. 2. Have cash.

3. Have cash.
~ Overheard in a seminar on business

Why does it seem to be so difficult for contractors to negotiate

acceptable payment terms for their work with owners on a
construction contract? Is it just too hard to ask for better terms of
payment? Are contractors afraid their requests for better terms will
be turned down? Does it have something to do with owners’ claims
that they have nonnegotiable “standard terms of payment?”
Good terms of payment are another one of the foundation stones
of a good contract. It is best to again remember that in any
construction contract, there is no such thing as “standard terms” or
“standard terms of payment.” Everything is negotiable, as long as
what’s being negotiated is not illegal. It certainly is not illegal to get
favorable and timely terms of payment for the contractor’s construction
activities.

Understanding and Negotiating Construction Contracts: A Contractor’s and Subcontractor’s Guide to

Protecting Company Assets, Second Edition. Kit Werremeyer.
© 2023 John Wiley & Sons, Inc. Published 2023 by John Wiley & Sons, Inc.

41
 Owners often like to have terms that defer payment to the contractor
for as long as possible. This is a normal situation in the construction
industry. It’s better for the owner to have the contractor’s money in
his pocket for as long as possible.

Cash Flow To many, cash flow is considered an accounting or financial term. But
understanding and managing cash flow is really just good business
practice. Cash flow refers to how much cash an organization—­or a
construction project—­generates, or fails to generate, over a specific
period of time. It can be positive (that’s good!), neutral (which may be
an illusion), or negative (that’s bad!). This chapter focuses on positive
cash flow—­the engine that keeps the contractor in business.
Positive cash flow: Simply put, positive cash flow means that the
periodic payments a contractor receives from the owner for the
performance of the contract’s construction work amount to greater
than what he will pay out during the same period for expenses
associated with the work. The money coming in is greater than the
money going out. That’s good, and that’s what contractors want.
Neutral cash flow: This is simply a concept, and does not exist in
reality. While it may be theoretically calculated, achieving neutral
cash flow is almost impossible, as far too many activities and events
have to happen precisely as planned and predicted. If a contractor
could predict with absolute accuracy and precise timing the outflow
of his hundreds of individual contract expenses, and if he could
predict exactly when he would receive his periodic payments from
the owner, then this would be neutral cash flow. That level of
precision is virtually impossible on a construction project!
Negative cash flow: This is when less money comes into the business
than is going out. If a contractor is spending money paying his
expenses on a construction project, and payments from the owner
are coming in late (or not at all), then the contractor won’t be able to
cover those expenses and must have an alternative source of funds to
pay them. He could pay them from his own cash reserves, or borrow
money until the owner’s payments come in. But if he doesn’t have
ample cash reserves or can’t borrow money, he may be out of
business. All businesses—­and contractors—­must have cash to stay in
business. Negative cash flow can put a contractor out of business
(and then he wouldn’t need this book).
If the contractor does not take in more money than he pays out
during any time period over the duration of the project, then he is
financing part of the construction project during that time period for
the owner. Is the contractor a bank, and in the lending business?

42
 Some contractors have the ability to provide financing to owners for
the owner’s construction projects, either internally, or through their
association with different types of lenders. With contractor-provided
financing comes, of course, the award of the project, and certainly at
a price and on commercial terms and conditions that are favorable
and reflect the provision of the financing.
But even these contractors are not charities. They are making money
by having the resources or ability to provide the owner with some
form of financing. Contractors are in business to make a profit
through their construction activities.
What does cash flow have to do with determining the terms of
payment? Everything. A cash flow calculation for a construction
project determines the contractor’s minimum acceptable terms of
payment required in order to remain cash-positive. When a contractor
accepts terms of payment for a project that are less favorable than what
his cash flow calculations show he requires to remain cash-positive,
then he is probably going to end up in a negative cash flow situation.
This negative cash flow may occur during part of, or all of, the time it
takes the contractor to complete the project. That’s bad.
Typically, a contractor would perform several cash flow calculations
for a project. If the owner has his own preferred terms of payment,
then those terms need to be analyzed to see if the contractor can
remain cash-positive throughout the duration of the project. If the
owner’s preferred terms of payment place the contractor in a negative
cash flow situation, then the contractor may do one of the following:
1. Finance, out of his own pocket, some of the project costs for the
owner.
2. Use his established line of credit to borrow funds to cover
Find out more negative cash flow periods, and include these financing costs in
about cash flow his price.
by searching for 3. Negotiate more favorable terms of payment.
articles online—or This chapter focuses on the third option, negotiating favorable terms
check the business of payment that result in a positive cash flow.
section of your library
for publications on
calculating cash flow. Calculating Cash Flow
Business software There are a variety of computer software programs available to help
programs also offer contractors calculate cash flow for a project. Or, cash flow
a variety of cash flow calculations can be performed on a simple homemade spreadsheet.
calculators. Whatever is the simplest and easiest to perform is best. It really is not
too difficult to calculate cash flow for a construction project.

43
 One of the main issues addressed in this chapter is getting
contractors to think about the linkage between cash flow and terms
of payment. These two issues are joined at the hip. They are not
exclusive events. Understanding how a construction project will
receive and allocate cash will help the contractor determine how he
should negotiate with the owner for terms of payment.
Calculating cash flow for a project is all about timing. When does a
contractor have to pay for direct costs, such as materials, supplies,
subcontractors’ invoices, equipment rental, and job site labor? When
does the contractor ideally want to recover these direct costs plus
overhead and profit? Should he recover overhead and profit over the
duration of the project, skewed up front, all at the end of the project,
or in some other ratio? Once the contractor understands the timing
of his project’s direct cost payouts and decides on the timing of his
overhead cost and profit recovery, then he can determine the terms of
payment that best keep his project cash flow positive.
All cash calculations should be performed on a conservative basis.
For example, in analyzing an owner’s proposed terms of payments,
which state that the contractor’s payments will be made 30 days from
receipt of his invoices for goods and services, it’s better to use 45 to
60 days for receipt of owners’ payments in the cash flow calculations.
Invoices for payment get delayed or rejected by owners for a variety
of reasons, some legitimate, others not. Too many unforeseen things
happen over the life of a construction project to make the prediction
of receipt of owners’ payments perfectly accurate. So, it is important
to stay conservative in the approach to cash flow calculations. It
doesn’t need to be analyzed on a worst case basis, although that’s not
a bad way to understand the consequences of the owner not paying
on time and significantly delaying payments.
A useful tool for contractors to gain some knowledge on the
payment history of companies is the Dun & Bradstreet® (D&B®)
report, which often includes significant detail about recent
payment histories of companies, including owners’! It may be
worth the nominal cost of a basic D&B® report to gain some insight
into the owner’s payment history.

Interest Rates Contractors should also be realistic with respect to the interest rate
they use in analyzing an owner’s proposed terms of payments.
Typically, this might be the contractor’s interest rate on his
established line of credit that he may have to draw on to cover
negative cash flow situations. Interest rates go up and down ­
over time based on a variety of factors, and over the course of a
lengthy construction project, the cost of borrowing money can
vary significantly.
44
 If the contractor has an established line of credit with a local bank,
then that’s a good starting point for determining an interest rate to
use. The interest rate is reviewed from time to time by the bank, and
there is no assurance that it will remain the same over the life of an
extended project. A contractor should not be afraid to add a percent
or two to the going interest rate when he performs his cash flow
calculations, in order to determine the cost of financing he is
providing and include this cost in the price.

Periodic There are all kinds of reimbursable, deferred, and periodic payment
programs used on construction projects. Periodic progress and
Progress & milestone types of payments for construction work are common. For
Milestone payment purposes, periodic progress and milestones are very much
the same. The contractor gets paid for doing some measurable
Payments amount of the construction project.
Periodic progress is a measurement of how much of the project has
been completed over some fixed time period, such as one month. At
the end of this time period, the contractor bills the owner for the
value of the work performed during the previous month.
A milestone is just another specific, predetermined measurement of
the completion of a project that’s probably not tied to a fixed completion
time. For example, the completion of the concrete foundations for a
structure could be a payment milestone. Completion of concrete
foundations may take place sometime during a two-­to three-­month
window in the overall construction schedule. When the contractor is
finished with this element of the project, he gets paid for it.

Progress Payments
With monthly (or similar) progress payments, the contractor has a
better opportunity to keep the cash coming in regularly—­and in some
relationship to how he is spending cash on the project. It’s important
with this type of payment that an agreement is reached in advance
with the owner on how progress is to be measured. The agreement
should be put in writing and made a part of the contract.
One way to better ensure that the contractor will get paid on time with
periodic progress payments is to provide the owner with an estimate of
progress a week or so prior to the end of the time period for which
progress will be claimed. If the contractor turns in a request for a progress
payment, and the owner has questions about the extent of progress
claimed, then it may take more time to get paid than had been planned.
This procedure to provide an early estimate of periodic progress
needs to be required in writing and included as a part of the
commercial terms and conditions in the construction contract.

45
 Early submittal will also ensure that, when received, the contractor’s
invoice for payment of periodic progress is entered into the owner’s
payment system without disagreements.

Milestone Payments
With milestone payments, the contractor may have to wait several
months or longer to be paid for a portion of the work, depending on
how long it takes to achieve a project milestone. Meanwhile, the
contractor is paying for the work being done, and the owner is keeping
the cash in his pocket. Unless the contractor’s price includes costs
associated with not receiving timely payment for his efforts, milestone
payments can be just like free mini-financing schemes for the owner.
Milestones should be described in the contract in as general terms as
possible. The more specific and detailed a milestone is described, the
more difficult it may be to claim payment for the completed work.
For example, payment for all the materials required to construct a
project may be tied to the payment milestone in the contract that
states something like:

Delivery of all contract materials to the job site. All contract materials are
identified and described in detail in the following list: (followed by a lengthy
and detailed list of all project materials).

The difficulty with this milestone is the use of the term “all” and the
requirement for a detailed listing of the project materials. Let’s say
the contractor has a $500,000 payment milestone that is tied to the
delivery of a specific and detailed list of project materials. Once the
contractor can demonstrate to the owner that he has delivered all the
materials on the list to the project site, then he can submit his invoice
for the $500,000 milestone payment. If the contractor is missing
several boxes of custom-manufactured nuts and bolts defined in the
list as worth $500, the owner technically would not have to pay the
contractor for that milestone until he delivered that box of nuts and
bolts. Meanwhile, the contractor is further financing $495,500 worth
of materials collecting dust on the job site, while he tries to locate or
expedite delivery of the missing nuts and bolts.
When dealing with a milestone payment that is linked to some kind
of list, it would be better to describe the milestone in the contract
with wording similar to the following:

Delivery of all major contract materials to the job site. Major contract
materials are defined as follows: (provide a listing of only the major
materials, described as generally as possible).

46
In this example, the contractor and the owner agreed to describe in a
general fashion the major project materials required for the
construction project. Here, the generally defined major contract
materials are actually worth $450,000. The other $50,000 of
miscellaneous nuts and bolts and bits and pieces are not specifically
described. The cost of these materials has been spread across the
major contract materials. They are on order and on their way to the
job site. They will arrive in due course, and the contractor will be paid
in a timely fashion for the project materials.
One way to make generally described milestone payments work
better for the contractor and assist in promoting positive cash flow is
to develop a lot of small milestones. This will take some extra
administrative time and effort, but will be well worth it when the cash
flow for the project is consistently positive.
For example, a typical milestone payment for a large, complex
concrete foundation may read similar to the following:

Milestone 3: $250,000 – Completion and testing of concrete foundation.

In the above example, the contractor would be paid $250,000 by the

owner when the concrete foundation is complete. However, the time
to excavate, supply, install, and test the foundation will take about
four months. During this time period, the contractor foots the bill to
pay all expenses associated with the foundation, plus he delays
recovery of all his overhead and profit markups related to this part of
the project. The contractor may have a negative cash flow for this
portion, due to the time it takes to finish and to get the payment from
the owner.
In order to improve his cash flow—and try to make it positive—the
contractor could break down the large milestone payment into
smaller ones that would allow him to receive payments from the
owner on a more frequent basis. The sample clause could be revised
to read similar to the following:

Milestone 3A: $65,000 – Excavation for concrete foundation

Milestone 3B: $35,000 – Installation for concrete foundation formwork
Milestone 3C: $125,000 – Installation of rebar and concrete for foundation
Milestone 3D: $15,000 – Backfill of concrete
Milestone 3E: $10,000 – Testing of concrete foundation

47
 If the contractor collects one milestone payment each month, for
example, he has significantly improved his cash flow by breaking down
the large milestone into smaller increments, rather than receiving one
sum for all the foundation work at the end of four months.

Time & Manner of Payments

Thirty days from the date of invoice is a typical time period allowed
for owners to pay contractors’ invoices. This allows enough time for
the invoice to go through the owner’s approval, accounting, and
payment process. However, there is nothing wrong with proposing
that payments be made within 15 days from the invoice date. Most
owners do have the ability to make payments quickly, although they
may seem reluctant to do so except in special cases. Contractors
should not be afraid to try to negotiate a shorter period of time for
being paid.
Electronic Funds Transfer (EFT) is common today—­and is
becoming the preferred way to receive payments from owners.
While payment isn’t received instantaneously, it is normally
secured over a one-­to-­three-­day period. EFT can take longer,
however, if payment is made over a weekend, and for international
payments. Today, all banks are set up to disperse and receive funds
through electronic funds transfers.
Payment by check is also still common. The owner telling the
contractor that “the check is in the mail” is common, too. (It’s amazing
how much slower the U.S. and international mail system can become
when an owner uses it to mail a payment check to the contractor!)

Downpayments & Advance Payments

Is a contractor entitled to a downpayment? There is an easy answer to
this—­yes, because a downpayment is just another element of the
terms of payment that can be negotiated. The contractor’s invoice for
the downpayment is typically submitted to the owner when the
contract is signed, or very shortly thereafter.
The best way to come to grips with whether a contractor needs a
downpayment or not is through cash flow analysis. Sales; marketing;
estimating; proposal preparation; preliminary engineering; travel to
inspect the work site; mobilizing people, materials, and equipment;
meetings with the client; and other similar front-­end expenses for a
construction project can be high. Also, the contractor may need to
make some early commitments for specialty or long-­lead-­time
materials and supplies, which may require an early outlay of cash.
A contractor should review several cash flow analyses with different
levels of downpayment to see how this affects his ability to remain

48
cash-­positive throughout the duration of the project. As a general rule,
the larger the downpayment the contractor can negotiate, the better
the chance to have a positive cash flow for the duration of the project.
Often owners will resist agreeing to a downpayment at or near the
time the contract is signed simply because it’s called a downpayment,
a word considered by some to be taboo. So, don’t call it a
downpayment. Owners who resist a downpayment might more easily
agree to an early progress, mobilization, contract initiation fee, or
milestone payment. This may help owners sell the idea within their
own organization, as it probably fits better into the way they are used
to paying for services provided.
If receiving a downpayment isn’t possible, contractors can try to find
a way to establish a large early payment, such as one or two weeks
after contract signing. Such payment can be based on the submission
of the first set of preliminary engineering drawings, delivery of
evidence of insurance certificates, commencement of mobilization at
site, or something similar. There are so many activities that take place
at the front end of a construction project that it is not too difficult to
find one that could be priced and added together to form the basis for
an early payment. Perhaps the contractor receives cash a week or two
later than he might have otherwise through an initial downpayment,
but the early payment will end up having the same beneficial effect—­
successfully achieving a positive cash flow for the project. Don’t
worry about the semantics; get some form of an early payment.
Here’s a question for contractors to ask themselves: How much would
you discount your price for the project if the owner agreed to a 50%
downpayment? Sound unrealistic? Try it out sometime and see how
the owner reacts. Contractors might be pleasantly surprised. If the
contractor is working with an owner who has a lot of cash and wants a
good price for his next construction project, toss this idea out to him.
How much might a 50% downpayment be worth? One way to find out
would be to perform a cash flow analysis on the project assuming a 50%
downpayment and see if that results in a positive cash flow (very likely)
for the project. Apply a current level of interest to the amount of the
positive cash flow calculated, and use that value as a contract discount
for the large downpayment. That amount may be in the 2% to 4% range.
Savvy contractors might consider adding 1% (or 2% or 3%) to the
contract price to negotiate away for good concessions from the owner,
like this level of downpayment. Those contractors with lots of hard-­
earned construction experience will intuitively know that the receipt of
such a large downpayment is good for their project, without having to do
much in the way of calculating cash flow, or dwell too long on whether
to give the owner a 2%, 3%, 4%, or even 5% discount, for example.

49
 Retention
Retention refers to an amount of money that is withheld by the owner
from a contractor’s periodic payments. The typical reason an owner
would want to hold back some amount of money is to provide an
assurance that the contractor will perform the work satisfactorily and
in full accordance with the contract. If the contractor performs all the
work satisfactorily, then the owner will make a final payment in the
full amount of the withheld retention. If the contractor does not
perform as expected, or fails to complete the work, the owner can use
the amount of the retention money withheld to have someone else
complete some or all of the contractor’s unfinished work.

An Example
Let’s say a contractor is executing a contract valued at $1,000,000,
which is to be completed in one year. The owner’s terms of payment
require that 10% retention be withheld from each of the contractor’s
periodic progress payments to ensure full performance of the
contract. During the course of the contract, the owner retains a total
of $100,000 from the contractor’s periodic payments. If the
contractor performed all the work on time and in accordance with
the contract, the owner would make a final payment of retention to
the contractor in the amount of $100,000.
Money withheld from the contractor’s payment invoices as retention
can make it difficult to maintain a positive cash flow for the duration
of the project. Contractors should strongly resist having retention
withheld from their payment invoices. This is particularly true if the
owner requires, in addition to withholding retention, another
performance assurance like a guaranty from a surety company or an
on-­demand bond or standby letter of credit from a bank.
If the contractor must agree to retention, then it is important to
negotiate the retention to be as small as possible. Often a retention
value of 5% to 10% is proposed by the owner in his terms of payment.
Perhaps he claims that retention of some amount is his “standard”
requirement. Again, it’s important to remember that there is no such
thing as a “standard” requirement in contracting for construction
projects. Maybe 2% retention makes sense if a contractor has to agree
to it. The less, the better, and no retention is the best.
When negotiating retention, owners will often claim that they
require some sort of assurance that the contractor will complete
the project on time and in accordance with the plans and
specifications. That’s fine. If the issue of using retention as
performance assurance is a major roadblock to negotiating the

50
contract, then perhaps the owner will agree to the contractor
providing a guaranty or an on-­demand bond or parent company
guaranty in lieu of providing cash retention. This is a perfectly
acceptable way of providing assurance of performance and prevents
the owner from keeping some amount of the contractor’s money
for the duration of the project, or longer.
Sometimes an owner will want to keep the retention agreed to in the
contract until the end of the warranty period. Again, this is done
under the premise of providing an assurance of performance of the
contractor’s obligations during the warranty period. Here’s another
situation where a guaranty from a surety company or an on-­demand
bond from a bank may be a better way to go—­thereby freeing up the
contractor’s cash. (See Chapter 6, “Assurances of Performance,” for
more information on guaranties, bonds, and letters of credit to offer in
lieu of agreeing to retention.)

Terms of Payment Examples

Figures 4.1 through 4.4 are cash flow analyses of four sample terms of
payment that might typically be used in construction contracts. They
are designed to demonstrate the positive effect of having a
downpayment and the elimination of retention.
The project used in the example is a small engineering and
construction project that is completed over a period of 10 months.
The cash flow analysis for each of the terms of payment examples is
straightforward, but could easily be expanded to analyze much longer
and more complex projects. The examples show one typical method
of performing a cash flow analysis.
The last line of all the analyses is titled “Accumulated Interest.” This is
the amount of interest the contractor would theoretically expect to
pay on money borrowed to finance any negative cash flow of the
project. (Negative interest implies a negative cash flow, and a positive
interest implies a positive cash flow.)
The terms of payment on the last example, Figure 4.4, indicate a
positive cash flow and would be the ones the contractor would want
to try to negotiate with the owner.
The four terms of payment and cash flow examples are as follows:
1. Monthly progress, Net 30 days, 10% retention, no downpayment
2. Monthly progress, Net 30 days, 10% retention, 10%
downpayment
3. Monthly progress, Net 30 days, 0% retention, 10% downpayment
4. Monthly progress, Net 30 days, 0% retention, 20% downpayment

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 Owner’s Payment Terms: Monthly Progress, Net 30 days, 10% Retention, 0% Downpayment

Figure 4.1 Terms of Payment Example Number 1

Owner’s Payment Terms: Monthly Progress, Net 30 days, 10% Retention, 10% Downpayment

Figure 4.2 Terms of Payment Example Number 2

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 Owner’s Payment Terms: Monthly Progress, Net 30 days, 0% Retention, 10% Downpayment

Figure 4.3 Terms of Payment Example Number 3

Owner’s Payment Terms: Monthly Progress, Net 30 days, 0% Retention, 20% Downpayment

Figure 4.4 Terms of Payment Example 4

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 These examples show the benefit to the contractor of being paid on a
timely basis, receiving a downpayment, and having no retention
withheld from his payment invoices. Terms of payment that have
these key elements have the best chance of providing a positive cash
flow for the contractor.

Set-offs
Sometimes hidden away in the fine print of a construction contract is
a paragraph allowing the owner to make what are called set-offs
from payments that are legitimately due to the contractor for
performance of the work. If the owner performs some of the
contractor’s work on a project, then he is, of course, entitled to
deduct some amount from what he owes the contractor on one or
more of his periodic payment invoices. That’s fair, as long as the
amount the owner subtracts (sets off ) is fair and agreed to in writing
by both parties.
However, the greater risk to a contractor occurs when he has several
projects under way or recently completed with the same owner. In
this situation, the contractor needs to be careful that in any new
contract he signs with the owner, he does not give the owner the
unilateral right to subtract money from the new project’s invoices for
claims the owner may have outstanding against the contractor on
other projects. This is probably the greatest risk associated with a
set-off, and can place the contractor at a significant level of
commercial risk.
The owner may have what he believes to be legitimate claims or
issues with the contractor on other ongoing or completed projects.
However, the resolution of those claims and issues should remain
independent of the other projects. The owner should not be allowed
the unilateral right to subtract money from the contractor’s invoices
to pay for unresolved claims and issues on other projects. Set-off
provisions in a construction contract that allow the owner to subtract
money from the contractor’s invoices for claims related to other
projects should be deleted.
In the event the owner feels he must have a set-off provision in the
contract, the contractor may consider negotiating wording similar to
the following:

. . .all proposed set-offs from Contractor’s invoices shall be in writing and

mutually agreed on by both Owner and Contractor.

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Wording similar to the above allows the owner to keep the set-­off
provisions in the contract, if that’s important to him. It also provides
protection for the contractor against the owner making unilateral
deductions from the contractor’s invoice for claims and issues that
are unresolved and associated with other projects.
One final note of caution for contractors on set-­offs: The owner’s
provisions for allowing him to take set-­offs may not always be
contained in the proposed terms of payment clause, but may appear
elsewhere in the commercial terms and conditions. It pays to read all
parts of the owner’s proposed construction contract.

“Paid When Paid” & “Paid If Paid”

Although these two types of payment terms can seem acceptable at
first glance, both can create significant commercial risk for the
unsuspecting contractor. These payment terms are more likely to
apply or be seen when there is a subcontractor/main contractor
relationship, rather that a contractor/ owner relationship. So we will
switch gears in this section and talk about subcontractors and main
contractors.
It’s not too difficult to understand what these payment terms mean:
Paid When Paid: This means that when the main contractor receives
payment from the owner for work that includes the subcontractor’s
work, then the main contractor will pay the subcontractor.
Paid If Paid: This means that if the main contractor receives
payment from the owner for his work that includes the
subcontractor’s work, then and only then will the main contractor
pay the subcontractor.
The subcontractors’ commercial risk with both of these types of
payment terms is that they basically relieve the general contractor of
the obligation to pay them on a timely basis for their work.
Claims, disputes, or other issues may arise between the owner and the
main contractor, which may cause the owner to delay paying the
contractor on a timely basis. The main contractor may or may not
suffer from this payment delay, but one thing is for sure—­the
subcontractor will certainly suffer from the delay in payment of his
invoices.
Main contractors like to use these payment terms because they can
avoid having to use their own cash to pay subcontractors. That’s
understandable, but it doesn’t mean that subcontractors have to agree
to these types of payment terms.

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 The bottom line is that the main construction contract for the
project is between the owner and the main contractor, not the
subcontractor and the owner. The subcontractor goes through the
lengthy exercise of estimating, pricing, bidding, and negotiating the
work solely with the main contractor, and the resulting construction
contract and its commercial terms and conditions are negotiated
with the main contractor, not the owner. The commercial terms and
conditions that are negotiated between the owner and the main
contractor are their business, and the subcontractor has little or no
influence or say in the matter.
How can the subcontractor perform a cash flow analysis of his work
without really knowing the time period he can use to receive
payments from the main contractor? The main contractor may agree
to the subcontractor’s 30-­day payment terms, but with a paid when
paid or paid if paid provision also applying.
In this case, what does the subcontractor use as timing in his cash
flow analysis for his receipt of payments? Thirty days, forty-­five, sixty,
or more? Maybe it’s okay for the subcontractor not to rock the boat
and to agree to these types of payment terms and just keep his fingers
crossed that the main contractor will pay him on time, but that’s a
formula for a cash flow problem.
When paid when paid or paid if paid provisions arise, it’s important
for the subcontractor to try to take some measure of control over the
payment terms for his own benefit.
Two good negotiating options are:
1. Delete the contractor’s paid when paid or paid if paid payment
terms in the contract, and substitute the subcontractor’s pre-
ferred terms of payment.
2. Find some compromise payment terms that include the main
contractor’s paid when paid or paid if paid payment terms, but
with some time limitations on receipt of payment that favor the
subcontractor.
The first option is self-­explanatory. If the subcontractor can negotiate
including his preferred payment terms into the commercial terms
and conditions of his construction contract, then that, of course, is
the best way.
However, it may be difficult to get the main contractor to delete
the paid when paid or paid if paid terms. The main contractor
may agree to some time limit to pay the subcontractor. Therefore,
if the main contractor agrees to the subcontractor’s 30-­day
payment period subject to the paid when paid or paid if paid

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provisions, he might also agree to payment terms wording similar
to the following:

Article 44 – Terms of Payment

44.1 Subcontractor’s payment invoices shall be paid within 45 days of
receipt by Main Contractor, provided that Main Contractor has also
been paid by Owner for the work performed under Subcontractor’s
invoices.
44.2 Notwithstanding the above, Main Contractor agrees to pay Subcontractor’s
payment invoices in any event no later than 70 days from date of receipt by Main
Contractor of Subcontractor’s invoice.

Allowing the main contractor 70 days to pay the subcontractor’s

invoices is certainly not the best. But considering that the contractor
might not have to pay the subcontractor’s invoices for a much longer
time under the paid when paid or paid if paid terms of payment, at
least there is a maximum time period in place within which the
contractor must pay the subcontractor’s invoices.
Article 44.2 obligates the main contractor to pay the subcontractor,
regardless of whether or not he has been paid for the subcontractor’s
work by the owner. That’s good. The subcontractor could have tried
to negotiate a shorter time period in Article 44.2, such as 45 days.

Example: Terms of Payment

The following are two sample terms of payment clauses that can be
considered for use in a construction contract that would likely result
in positive cash flow for a contractor.
Example 1: Progress payment terms might read similar to the following:

Article 27 – Terms of Payment (Periodic Progress)

a.) 20% of the Contract Price as downpayment shall be paid upon
signing of the Contract, or Notice of Award, whichever occurs first.
b.) 80% of the Contract Price as progress payments shall be paid
based on approved monthly progress by Contractor for work per-
formed the previous month.
c.) There shall be no Retention withheld by Owner from Contractor’s
downpayment or any of Contractor’s monthly progress payments.
d.) The downpayment is due in full, in cash, within 15 days of the
signing of the Contract, or Notice of Award, whichever occurs first.
e.) All progress payments are due in full, in cash, within thirty (30) days
after receipt by Owner of Contractor’s invoice.
f.) All payments shall be made by electronic funds transfer to (Name of
Contractor’s bank), account number XXXXXX, routing number
YYYYYY with all transfer costs for the account of Owner.

57
 Example 2: Milestone payment terms (percentages are for example
only) might read similar to the following:

Article 27 – Terms of Payment (Milestones)

a.) 20% of the Contract Price upon mobilization by Contractor at the
Project Site, or no later than (insert appropriate date) in the event
mobilization is delayed by Owner.
b.) 15% of Contract Price upon completion of installation of the founda-
tions for the building.
c.) 10% of the Contract Price upon completion of hook-up of all site
utilities.
d.) 25% of the Contract Price upon completion of the building, ready for
interior work.
e.) 20% of the Contract Price upon completion of all building interior
work.
f.) 5% of the Contract Price upon receipt by Contractor of Certificate of
Occupancy.
g.) 5% of the Contract Price upon demobilization by Contractor from
the Project Site.
h.) There shall be no retention withheld by Owner from any of
Contractor’s milestone payments.
i.) All milestone payments are due in full, in cash, within thirty (30) days
after receipt by Owner of Contractor’s invoice.
j.) All payments shall be made by electronic funds transfer to (Name of
Contractor’s bank), account number XXXXXX, routing number
YYYYYY with all transfer costs for the account of Owner.

Prompt Pay Statutes

All 50 states have “Prompt Pay Statutes.” These statutes require that
contractors be paid in a certain amount of time from the submission
of a payment invoice. These statutes are specific to Private, Public,
and Government contracts. However, not all the states have statutes
for prompt payment on private contracts (the main subject of this
book).
For example: Arizona’s Prompt Payment Act covers Private contracts.
Arizona Revised Statutes 32-1129, require, basically, that contractor
invoices must be paid within 21 days from receipt, unless the Owner
provides reason(s) why the invoice was not approved. Approved invoices
not paid within the 21 days accrue interest at the rate of 18% per annum.
A complete, extensive listing of all the 50 states Prompt Payment
Statutes is available online. Check your state’s Prompt Payment

58
 Statute, so you understand its conditions, requirements, and
exceptions.
If your state has a Prompt Payment Statute for Private contracts, put
the reference to that statute on all your invoices to the Owner.

Conclusion As noted throughout this chapter, terms of payment that result in a

positive cash flow are the most desirable for a contractor. Positive
cash flow keeps cash in the contractor’s bank account, and allows the
contractor to stay in business and prosper.
First, remember the three rules of business: Have cash, have cash,
and have cash. It can’t be said much better than that! Cash is the
engine of a business.
Second, remember, everything in a construction contract is negotiable.
Since terms of payment are one of the foundation stones of a good
contract, start negotiations with them!

59
Chapter
The Schedule
5
A well-­defined completion schedule is one of the foundation stones
of a good contract. All construction contracts will include some sort
of stated completion schedule requirements. Meeting the completion
schedule is a key contractual obligation for the contractor. It exposes
him to varying types and amounts of risk—­and potential financial
liabilities if the completion dates are not met. (In some instances,
there may also be the possibility of a bonus if the project is completed
ahead of the agreed-­on completion schedule.)
A completion schedule is defined as the time period stated in the
contract within which the contractor is obligated to complete the
construction project. Completion schedules can be simple, single-­
page bar charts outlining the time durations required to complete all
the major activities in the construction project. They can also be
highly complex—­a bedsheet-­sized listing of hundreds of interrelated
major and minor activities, and their required time durations,
necessary to complete the project. There are also many sophisticated
computer-­based scheduling tools, as well as numerous books and

Understanding and Negotiating Construction Contracts: A Contractor’s and Subcontractor’s Guide to

Protecting Company Assets, Second Edition. Kit Werremeyer.
© 2023 John Wiley & Sons, Inc. Published 2023 by John Wiley & Sons, Inc.

61
 publications on scheduling techniques. These are directed at
improving the scheduling skills of the person responsible for
executing the construction project—­the contractor’s project manager
and his assistants.
It’s important that the project manager be aware of the
consequences of not meeting the completion schedule, making
changes to it, or beating it. Two risk issues regarding completion
schedules that are commonly found in a construction contract’s
terms and conditions are:
1. Float
2. Time is of the Essence

Float Float is an issue that typically comes up in contracts that have fixed,
contractually agreed-­on completion schedules. Float refers to an
amount of additional time, or contingency, in a contractor’s fixed
completion schedule that is over and above what he believes is
actually needed to finish the project, provided everything goes
according to plan.
If the contractor believes he can complete the project in 48 weeks,
and he contracts with the owner for a completion schedule of
52 weeks, then technically there are four weeks of float in the
completion schedule. This additional time gives the contractor, and,
arguably, the owner, a little time cushion in the event unexpected or
unrecoverable delays occur, such as:
• A day or so lost due to unexpected rain
• A few days for a material supplier who doesn’t meet a delivery
date for important materials
• Labor union disputes
Contractors generally have a good feel for how much of a time
cushion needs to be included in a project completion schedule.
During contract negotiations, the float in the completion schedule
also allows the contractor to improve his proposed completion
schedule, if necessary, in order to win out over other bidding
contractors.
An issue that often arises is: who owns the float, or extra time, in a
contract’s completion schedule? If the contractor automatically
assumes he owns it, he may be in for a surprise if he didn’t carefully
read and understand all the commercial terms and conditions in the
construction contract. There may be a paragraph similar to the
following:

62
 Article 10 – Contract Completion Schedule
10.1 Contractor shall complete the project within the time allowed in the
Contract Completion Schedule.
10.2 Any float in Contractor’s Completion Schedule shall be for the exclusive
benefit of Owner and shall be identified in Contractor’s Completion Schedule.
10.3 Any extensions to the Contract Completion Schedule that may be granted
by Owner will be granted only to the extent that such extensions exceed the total
stated float in Contractor’s Completion Schedule.

In the above example, the owner, not the contractor, clearly owns and
controls the float. The contractor has agreed to this transfer of float
ownership by signing the contract, leaving this wording unchanged.

An Example
Let’s use the one-story office building construction contract from
Chapter 1 to see what happens when a contractor, National
Construction Company, wants a one-week extension to the completion
schedule from Wilson Properties for some additional work.
After discussing the situation, Wilson Properties agrees a one-week
extension to the completion schedule would be required in theory to
install several small additional features in the foundation they
asked National Construction to provide. However, they insist that
National Construction keep its original contract completion
schedule. This poses a problem for National, because they feel they
need the extra week—or maybe even two—to complete the new,
additional foundation work they hadn’t planned for.
The contract terms and conditions clearly state that Wilson Properties
owns the four weeks of float time. Although the extra week National
needs would reduce the float to three weeks, this time is owned by
Wilson, so cannot be used by National to absorb any increases in the
completion schedule, as they see it. It appears National is out of luck in
getting that extra week of time they need to do the additional work for
the owner. National agreed to the completion schedule terms and
conditions, like the one noted in the sample Article 10, contract
completion schedule. National would have been better off to have
deleted the completion schedule float ownership paragraph from the
draft contract during negotiations, or simply submitted a schedule that
showed no float in the contract schedule.
Taking a look at the issue of float from a different perspective,
completion schedule float is just like the extra dollars put in a cost
estimate to cover contingencies. This extra money is the contractor’s

63
 to save, to cover true contingencies, or to use as he sees fit. It is part
of the fixed, lump-sum price, and it does not belong to the owner. It’s
hard to imagine a contractor who would agree with contractual
language that gave away his estimated cost contingency to the owner!
Why, then, give away a contractor’s float?
The important thing to remember is that the contractor owns the
float in a completion schedule, not the owner. This is true unless the
contractor contractually gives control of the float to the owner, as
National Construction Company did in the above example.

Time Is of the Completion schedules are very important to owners, as they can be
critical to the owner’s business success. In many instances, the
Essence owner’s revenues are dependent on a facility being completed and
starting to operate by a certain date. That means the owner can start
paying down the loan he took out to build the facility, and hopefully
will begin making a profit.
The owner’s business plan will likely be based on the on-time
completion of the project. The whole issue of the importance of
meeting completion schedule commitments is clearly understood by
everyone working for the owner and the contractor.
Sometimes there will be a paragraph in the commercial terms and
conditions emphasizing the importance of the completion schedule,
similar to the following:

Article 11 – Time Is of the Essence

11.1 Time is of the essence* in this Contract, and Contractor shall immediately
begin work upon receipt of the Notice to Proceed and shall complete the Work
within the time allowed by the Contract Completion Schedule, unless granted
an extension to the Contract Completion Schedule by Owner.

* Note: Sometimes alternative wording is used, such as, “time is an

essential element. . .”

The italicized words “time is of the essence” are another example of

antique contracting language used to contractually emphasize that
the completion of the contract within the agreed-on time frame is
very important. Failure to meet the completion schedule, or getting
behind enough that the completion date or intermediate contract
milestones are unachievable, may immediately place the contractor in
breach of contract and subject him to potential financial liability.
If the contractor does not meet the completion schedule
commitment and ends up in some form of litigation over failure to

64
perform, having the term “time is of the essence” in the contract will
benefit the owner. The emphasis added by this wording makes it
much more difficult for the contractor to avoid being ruled in breach
of contract.
Contractors want to finish on time on lump-sum, fixed-completion
schedule projects, because it costs extra money to keep personnel
and equipment on a job site beyond what was estimated, which eats
into their profits. Owners want their projects completed on time and
as planned, as loan payments, revenues, and their own profits are
planned to begin at the successful completion of the contractor’s
agreed-on completion schedule.
Time is always an important factor in any construction project
contract, regardless of whether or not it is stated to be “of the
essence.” However, the legal significance changes when the words
“time is of the essence” are stated in the contract. These words draw
specific attention to the fact that time-related functions, like the
owner’s completion time schedule or payment of the contractor’s
invoices on time, are very important. If a claim arises over these
issues, one party or the other can’t argue that they didn’t know or
realize that meeting the specified time-related contractual obligations
was an important issue.

Time Is of the Essence – For the Owner

Time can be of the essence for the owner, too, in terms of meeting his
obligations to the contractor. This is particularly applicable to the
timely payment of the contractor’s invoices for work. When a
contractor encounters a “time is of the essence” clause, he might
consider agreeing to it with a revision to the clause similar to the
following:

Article 11 – Time Is of the Essence (revised)

11.1 Time is of the essence in this Contract, and Contractor shall immediately
begin work upon receipt of the Notice to Proceed and shall complete the
Work within the time allowed by the Contract Completion Schedule, unless
granted an extension to the Contract Completion Schedule by Owner.
11.2 Owner agrees that time is of the essence in the prompt payment of all of
Contractor’s periodic payment invoices and agrees to pay such invoices within
the time period stated on each invoice.
11.3 Owner agrees that time is of the essence in the timely return of Contractor’s
submittals, the supply of any Owner-supplied equipment, and all responses to
Contractor’s request for information from Owner.

65
 Getting the owner to agree that time is of the essence for certain
obligations he has to the contractor, such as prompt payment of
contractor’s payment invoices, adds balance to this type of clause.
Both the owner and contractor should agree that in certain matters,
it’s important to do things on time.

Extra Time, but There are a multitude of events that can occur during the course of a
construction project that can cause delays to a contractor’s fixed
No Money completion schedule. Delays may be caused by:
• The contractor’s or owner’s actions or inactions
• Interference or lack of progress by other contractors/subcontractors
• Labor unions striking or slowing down the work
• Weather or other external events
The list of what causes delays in a project construction completion
schedule is probably endless! For a contractor, dealing with delays in
the construction completion schedule is a common event. If the
contractor causes them, then he has to deal with the time and
financial consequences, which is only fair to the owner.
If the owner causes the delay, or if other contractors working for the
owner cause the delay, then the contractor should expect to be
compensated in some fashion, and revise the completion schedule
accordingly.
If external events cause a delay to the contractor’s construction
completion schedule, and neither the contractor, nor the owner, nor
other contractors on the site are at fault, there needs to be a way for
the contractor to resolve the problem with the owner. In this
instance, the resolution process needs to be fair to both the
contractor and the owner.

Example 1
Sometimes a clause appears in the owner’s commercial terms and
conditions similar to the following:

Article 12 – Delays in Completion Schedule

12.1 In the event that delays to Contractor’s Completion Schedule are
caused by Owner or by other contractors, subcontractors, or suppliers
hired by Owner and working on the site, Contractor shall be allowed only
an extension of Contractual Completion Schedule.

That clause sounds fair enough. Or does it? It’s more what the clause
does not state that’s the problem. It is fair enough to allow the
contractor to extend his completion schedule for delays caused by

66
the owner or other contractors, subcontractors, or suppliers working
on the site. However, what about costs the contractor will incur that
may be associated with the delay? For example, if the contractor on a
fixed price project has a major piece of heavy lifting equipment on
the job site that is costing him $5,000 a day to rent, and the owner
has caused a 10-day delay in the use of that equipment, the
contractor could possibly have up to $50,000 of extra costs he hasn’t
estimated.

Example 2
The contractor may want to consider revising the clause to read
similar to the following:

Article 12 – Delays in Completion Schedule

12.1 In the event that delays to Contractor’s Completion Schedule
are caused by Owner or by other contractors, subcontractors, or
suppliers hired by Owner and working on the site, Contractor shall be
allowed an extension to Contractual Completion Schedule and shall
be allowed an increase in Contract Price for documented additional
costs incurred during the delay.

Such a revision is fair to both the owner and the contractor. Most
owners will have additional funds in their project estimates as a
contingency to cover such delays and associated extra costs. However,
some owners may develop heartburn over simply agreeing to increase
the contractor’s price as suggested in the above example.

Example 3
An alternative wording to consider might be similar to the following:

Article 12 – Delays in Completion Schedule

12.1 In the event that delays to Contractor’s Completion Schedule are
caused by Owner or by other contractors, subcontractors, or suppliers
hired by Owner and working on the site, Contractor shall be allowed an
equitable adjustment in Contractual Completion Schedule and an equitable
adjustment in Contract Price for documented additional costs incurred
during the delay.

The only issue with this revision is the use of the words “equitable
adjustment.” The owner and contractor may disagree on what
constitutes an “equitable adjustment” to the schedule and price.
Nevertheless, this wording is a lot better than just agreeing to a
change in the schedule only.

67
 Example 4
Another alternative for this delay clause might read something like this:

Article 12 – Delays in Completion Schedule

12.1 In the event that delays to Contractor’s Completion Schedule are
caused by Owner or by other contractors, subcontractors, or suppliers
hired by Owner and working on the site, such delays shall be treated as a
change under the Changes Clause of this Contract.

In this third revision of the original, the contractor is allowed to

pursue the effects of the delays through the changes clause in the
contract. If the changes clause allows for both time and price
changes, then the contractor has a better chance of being paid for the
consequences of the delay—and having his completion schedule
extended as well. (See Chapter 9 for examples of changes clauses that
treat contractors fairly.)
Other issues related to the contract completion schedule, such as
liquidated damages for failure to finish on time and force majeure
events, are covered separately in Chapters 11 and 14, respectively.

Conclusion The schedule is always a key element of any contractor’s construction

contract and a foundation stone of good contracting. Owners are
notorious for asking contractors to reduce the amount of time in the
schedule—or improve the schedule once the construction project is
underway. When faced with demands to reduce the schedule once
the contract has commenced, contractors need to make doubly sure
that the clauses for delays and changes in the contract are fair and
allow enough time and money for schedule adjustments. When faced
with reducing the schedule at the proposal stage, remember that
schedule adjustments do not have to be free to the owner. It’s
perfectly acceptable to increase the contractor’s price for a schedule
reduction.

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Chapter
Assurances
6 of Performance

This chapter could have been titled, “Surety Bonds, Performance

Bonds, Contract Bonds, True Guaranties, On-­Demand Payment
Instruments, and Other Forms of Contract Assurance.” But that’s
really a mouthful for what is commonly referred to in the
construction business as guaranties and bonds. To make things
even more confusing, the terms “guaranties” and “bonds” are
sometimes used interchangeably to mean the same thing, which is
not correct!
The challenge is how to define and explain the owner’s contractual
requirement that the contractor provide some form of assurance,
typically monetary, of his performance. (This is in addition to the
contractor’s other written assurances provided in the contract.) The
owner’s requirement for an assurance of performance sounds
simple and easy enough to agree to on the surface, but it can be
confusing, with contradictory and misused language—­and can
potentially expose the contractor to a high level of unnecessary
commercial risk.

Understanding and Negotiating Construction Contracts: A Contractor’s and Subcontractor’s Guide to

Protecting Company Assets, Second Edition. Kit Werremeyer.
© 2023 John Wiley & Sons, Inc. Published 2023 by John Wiley & Sons, Inc.

69
 Guaranties & In a construction contract, the requirement for an assurance of the
contractor’s performance is likely to be titled or referred to as a
Bonds performance guaranty or a performance bond. What are they?
What kind of company provides them? Are there different types and
forms? What is the commercial risk a contractor assumes by
providing them to an owner? Is a standby letter of credit a bond or a
guaranty, or neither? What is a surety? Can a bank issue a true
guaranty? What is a parent company guaranty, and is it good enough?
Can the contractor change the owner’s preferred wording on a
guaranty or bond? These are all valid questions that this chapter will
address.
Guaranties and bonds are the two most common terms used—and
misused—to generically describe the type of performance assurance
the owner wants the contractor to provide. Although these terms
tend to be used interchangeably, they are not the same. They can be
significantly different in their scope of coverage, and they can expose
the contractor to significantly different levels of commercial risk.
To illustrate, take a look at the following five examples of how an
owner might word the contractual requirement for a contractor to
provide an assurance of his performance:

Article 23 – Performance Guaranty (Example 1)

23.1 Contractor shall provide a guaranty of his obligations under the
Contract in the form of a Performance Guaranty provided by a surety
company acceptable to Owner.

Article 23 – Performance Guaranty (Example 2)

23.1 Contractor shall provide a Performance Guaranty in the form of an
irrevocable bank guaranty in the amount of 10% of the Contract Price
payable on first demand of Owner to guarantee the performance of
Contractor’s obligations under the Contract.

Article 23 – Performance Guaranty (Example 3)

23.1 Contractor shall provide a guaranty of his performance under the
Contract by providing a Performance Bond in the amount of 10% of the
Contract Price and in the form of an irrevocable guaranty payable on
Owner’s first written demand.

Article 23 – Performance Guaranty (Example 4)

23.1 Contractor shall provide a guaranty of his performance under the
Contract by providing a Performance Bond in the form of a standby letter of
credit for the full value of the Contract Price.

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 Article 23 – Performance Guaranty (Example 5)
23.1 Contractor shall provide a guaranty of his performance under the
Contract by providing a Parent Company Guaranty.

All of the previous examples require exactly the same thing, just in
somewhat different forms, regardless of the use of the words
“guaranty” and “bond.”
They all provide an assurance by a third party—someone not
signatory to the contract between the contractor and the owner—that
the contractor will complete all his obligations as stated in the
construction contract.
Even if the contractor has a successful track record and financial
strength, many owners will always be concerned about the
contractor’s ability to remain solvent, finish the project on time, and
complete all obligations in the construction contract. This concern is
likely an important element of the owner’s standard approach to
managing the risks associated with a construction project.
If the contactor fails to perform, or becomes insolvent, how will the
owner complete the contract? Will enough funds be available to pay
any outstanding balances to material suppliers and subcontractors?
Will the owner be able to restart the project with another contractor
or contractors? What happens if the contractor can’t, or refuses to,
meet the warranty obligations in the contract?
Due to this legitimate concern about the possibility of a contractor’s
A contractor needs failure or inability to perform, owners will typically want a separate
to be knowledgeable company to provide assurance that the contractor, or the company
providing the assurance, will perform all of the obligations in the
about the use
construction contract. Alternatively, in the event of the contractor’s
and application
failure to perform, certain funds will become immediately available to
of performance the owner for use in completing the project.
guaranties and
Performance assurances can come in different forms:
performance bonds
and the commercial • Another company agreeing to complete the contractor’s work in
risk associated with the event the contractor fails to perform or becomes insolvent.
them. He needs to • The parent company of the contractor agreeing to complete the
understand whether contractor’s work in the event the contractor fails to perform or
he is really providing becomes insolvent.
a true guaranty • A payment instrument that the owner can cash in without requiring
or some form of a specific proof of the contractor’s insolvency or failure to perform.
pay-on-demand • A payment instrument the owner can cash in, but that requires
instrument. specific evidence of the contractor’s insolvency or failure to
perform.

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 Detailed explanations of these various forms of assurances of
performance can be found later in this chapter.

What Does A construction contract consists of a number of different obligations

that the contractor has agreed to perform, such as:
“Failure to • Providing certain types and amounts of insurance, typically
Perform” Mean? referred to as a “commercial obligation.”
• Building a structure.
• Having to complete the project within an agreed-­on time frame
(the schedule).
If a contractor does not meet or fulfill the obligations as agreed to in
the construction contract, then he has technically failed to perform.
Failure to perform is also called breach of contract, or simply,
default.
Following are five examples of a contractor’s failure to perform, which
would cause an owner to be seriously concerned:
1. Stopping project work due to insolvency or bankruptcy.
2. Not paying subcontractors and material suppliers who are
working for the contractor on the project.
3. Not providing agreed-­on warranty repairs or replacements.
4. Refusing to enter into a contract with the owner when the
contractor has provided a bid bond (an assurance that the
contractor will enter into the contract with the owner). Perhaps
the contractor discovers his price is way too low, for example, and
the contract would be a financial failure for him, in which case it
may be less expensive to have the owner cash the bid bond.
5. Failing to meet the contract schedule.

What Is This is probably the most common term used and misused in
construction contracts, in terms of obligating the contractor to
a Bond? provide an assurance of performance. The contract may read,
“Contractor will provide a bond,” but what actually is a bond as the
term is used in construction contracts?
In the construction business, a bond is a written risk transfer contract
between three parties—­the owner, the contractor, and a third party.
The third party who provides the bond for a fee is typically a surety
company, an insurance company, a bank, or the parent company of
the contractor. In the event of the contractor’s unwillingness or
inability to perform, the bond contractually transfers the owner’s risk
of the contractor’s failure to perform to the third party. The third
party provides the owner with certain remedies in the event of the
contractor’s failure to perform.

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 .

It is important to remember that a bond is just another contract. It

doesn’t have to conform to an owner’s or a bank’s preferred wording.
As a contract, the requirements contained in any bond are negotiable.
The contractor can put in his two cents worth, too.

Forms of There are three basic forms of commercial instruments that the
contractor can purchase to provide the owner with assurance of
Assurances of performance. They are:
Performance 1. True performance guaranty (true guaranties)
2. On-demand bond (pay-on-demand instruments, usually without
conditions)
3. Standby letters of credit (pay-on-demand instruments, usually
with conditions)
True performance guaranties are very different than on-demand
bonds or standby letters of credit. (On-demand bonds and standby
letters of credit are very similar.) Any of these may be used to provide
owners with a form of assurance that, in the event of the contractor’s
insolvency or failure to perform, the owner’s project will be completed
or, alternatively, he will receive funds to aid in its completion.
In a construction contract, a contractor might see the requirement
for the above forms of assurance described similarly to one of the
following:

1. Contractor shall provide a Performance Bond in the form of a

guaranty from a surety company.
2. Contractor shall provide a Performance Bond in the form of an
on-demand bond from a bank.
3. Contractor shall provide a Performance Bond in the form of a
standby letter of credit from a bank.

True Performance Guaranties

A true performance guaranty is a risk transfer device. In this instance,
the risk of rectifying some form of a contractor’s failure to perform
on a construction project is transferred to a specialized company
called a surety. A surety’s main business role in the construction
industry is to provide performance-related guaranties, which are
referred to as performance guaranties or guaranty bonds. They
may also be referred to as surety bonds or contract bonds.
For the purposes of this book, the following is a working definition of
a performance guaranty for use in construction contracting:

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 A performance guaranty is a written risk transfer contract between
three companies: the contractor, the owner, and a separate company,
called a surety. The surety will provide a guaranty of the performance
of the contractor’s obligations in the construction contract with the
owner. In the event the contractor fails to perform his contractual
obligations, the surety will step in and find a way to fulfill the
contractor’s obligations up to the maximum stated monetary value of
the guaranty.
This is a true guaranty. It involves a third, totally separate company, a
surety, guaranteeing the performance required of the contractor
under the owner’s construction contract. If the contractor fails to
perform or becomes insolvent, the surety will be obligated to take on
the contractor’s unfinished contractual obligations and finish the
project, or instead pay the owner an amount of money not exceeding
the maximum stated value of the guaranty.

Example 1
The owner’s contractual requirement for the contractor to provide a
true guaranty might be similar to the following:

Article 23 – Performance Guaranty

23.1 Contractor shall provide a guaranty of his obligations under the
Contract in the form of a Performance Guaranty provided by a surety
company acceptable to Owner.

Also, this is as good a place as any to interject that a guaranty is not a

warranty. (See Chapter 12. Often, the terms guaranty and warranty
are used interchangeably, which is not correct.)
Here’s the basic difference:
• A guaranty is a contract between three companies: the surety,
owner, and contractor. The surety guarantees the performance
of the contractor’s contractual obligations as stated in the
construction contract for the benefit of the owner.
• A warranty is a contract between two companies: the contractor
and owner. The contractor warrants that the work he performed
for the owner is free of defects, and if any defects are found
within a certain time period, he will repair or replace them.
Figure 6.1 is an example of a true guaranty as might be issued by a
surety company.

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Figure 6.1 Typical Performance Guaranty Bond Wording and Format

On-­Demand Bonds
On-­demand bonds are a popular form of performance assurance
required by owners. Why? The answer is simple. As its name
correctly implies, an on-­demand bond is payable to the owner on his
demand, typically by a bank. The conditions for cashing in an on-­
demand bond are generally few, if any. With most of these types of
bonds, all the owner has to do is take the on-­demand bond to the
bank who issued it, state that the contractor has failed to perform,
and collect the value of the bond. The issuer of the on-­demand bond
(the bank) is generally under no obligation to verify the owner’s
claims that the contractor has failed to perform. This is a pretty good
deal for the owner!

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 An on-demand bond is not a guaranty! The issuer of the on-demand
bond will not step in and complete the contractor’s work in the event
he fails to perform. The only obligation the issuer has is to pay the
owner the face amount of the bond. The only similarity between an
on-demand bond and a true guaranty is that it is a contract between
three companies.

Example 2
The owner’s contractual requirement that the contractor provide an
on-demand bond might be similar to the following:

Article 23 – Performance Guaranty

23.1 Contractor shall provide a Performance Guaranty in the form of an
irrevocable bank guarantee in the amount of 10% of the Contract Price
payable on first demand of Owner to guarantee the performance of
Contractor’s obligations under the Contract.

Example 3
Article 23 – Performance Guaranty
23.1 Contractor shall provide a guaranty of his performance under the
Contract by providing a Performance Bond in the amount of 10% of the
Contract Price and in the form of an irrevocable guaranty payable on
Owner’s first written demand.

The key words for contractors to look for in reviewing these types of
clauses are: “on first demand,” or “on owner’s first written demand,” or
something similar. These code words identify what the owner really
wants: an on-demand bond, even though the commercial language
talks about a guaranty. Figure 6.2 is an example of an on-demand
bond as might be issued by a bank.

Standby Letters of Credit

A standby letter of credit is similar to an on-demand bond and is
typically provided by a bank. The most common use of letters of
credit is in sales transactions between two companies.

An Example
The buyer of certain goods is located in a foreign country, and the
seller of those goods is in the U.S. The buyer arranges for his bank
to establish a letter of credit for payment and lists the documents
required for the seller to submit to the bank for payment.

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Figure 6.2 Typical Performance-­On-­Demand Bond Wording and
Format

The seller produces the goods and takes all of the required
documents to the bank for presentation. If the bank determines
that required documents are in order, the bank pays the seller
under the terms of the letter of credit. The use of letters of credit
for sales transactions significantly reduces the seller’s risk of
nonpayment for his goods.

This type of letter of credit is typically called a commercial letter of

credit, and the bank assumes it will make payment to the seller under
the terms of the letter of credit.

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 In construction, a similar letter of credit may be established by a
A standby letter contractor to meet the owner’s requirements that he provide an
of credit is not a assurance of his performance on a construction project. Like the letter of
guaranty! Like an credit used in sales transactions, there may be requirements for the
on-demand bond, owner to provide certain documents to the bank stating or proving that
a standby letter the contractor has failed to perform. The bank will review these required
of credit is an on- documents, and if they are in order, the bank will pay the owner under
demand payment the terms of the letter of credit. The bank is under no obligation to verify
instrument. On- that the contractor failed to perform. Its only obligation is to make sure
demand bonds and that the documents required by the letter of credit are in order, and if
standby letters of they are, then they pay the owner the value of the letter of credit.
credit are essentially With this standby letter of credit, the bank does not assume it will
the same thing. make payment to the owner under the terms of the letter of credit. It
assumes the contractor will properly complete the contract. In the
event the contractor fails to perform, the bank or issuer will not step
in and complete the contractor’s work. The only obligation the issuer
of the standby letter of credit has is to pay the owner the face amount
of the bond upon presentation of certain required documents.
The only similarity between a standby letter of credit and a true
guaranty is that it is a contract between three companies.

Example 4
The owner’s contractual requirement for the contractor to provide a
standby letter of credit might be similar to the following:

Article 23 – Performance Guaranty

23.1 Contractor shall provide a guaranty of his performance under the
Contract by providing a Performance Bond in the form of a standby letter of
credit for the full value of the Contract price.

Figure 6.3 is an example of a typical standby letter of credit issued by

a bank and as might be used as an assurance of performance.

Surety For the construction industry, a surety company specializes in providing

true performance guaranties. Performance guaranties typically have two
Companies primary obligations for the surety of key interest to the owner:
1. The surety will step in and make arrangements to complete the
contractor’s contractual obligations in the event the contractor
becomes insolvent or fails to perform them.
2. Alternatively, the surety will pay the owner up to a maximum of
the stated face amount of the guaranty, and the owner can use
the money as he sees fit to help finish the project.

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Figure 6.3 Typical Irrevocable Standby Letter of Credit

Surety companies have the financial strength and project

management resources to back up the true performance guaranties
they issue. In the case of the contractor’s insolvency, failure to
perform, or failure to pay subcontractors or material suppliers, the
surety company can step in and take over completion of the work,
assist the contractor in finishing his work, find new contractors to
finish it, or pay the owner up to the face value of the performance
guaranty and let the owner finish the work as he may choose. The
surety company’s maximum financial liability is limited to the stated
face value of the performance guaranty it provides.

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 The Surety Company Qualification Process
Before a surety company will agree to provide a performance
guaranty to the contractor, they will scrutinize the contractor’s
management, project, financial, and other detailed corporate
history. This is the surety company’s prequalification process, which
gives owners an additional assurance of the contractor’s ability to
perform. It’s unlikely a surety would provide a guaranty of
performance for a contractor who didn’t meet its prequalification
criteria.
In addition, the surety company will require that certain contractor’s
assets, both personal and corporate, be pledged to the surety as
collateral in return for issuing performance guaranties on their
behalf. The contractor will have to sign an indemnification agreement
with the surety company providing that, in the event the contractor
defaults on its contractual obligations and the surety company must
step in and pay to have the obligations completed, the contractor will
reimburse the surety company for all costs and expenses required to
finish the contract for the owner.

Bonding Capacity
The surety company will place a maximum dollar limit on the total,
or aggregate, amount of the value of all the performance guaranties
that the contractor can have outstanding at any one time for all the
projects he is working on. This is typically referred to as the
contractor’s bonding capacity.
All performance guarantees provided by a surety will have a stated
start date and expiration date. These dates would normally correspond
with the commencement and completion dates of the construction
project, and may or may not include the warranty period.

An Example
Suppose a contractor’s bonding capacity established with his surety
company is $10,000,000. He may find it difficult or impossible to
contract for a new project if the dollar amount of the performance
guaranty required on that project, when added to the total value of
his other outstanding performance guaranties, exceeds the
$10,000,000 limit set by his surety company.
Let’s say the contractor defaults, and the surety company steps in
and makes arrangements for and pays someone else to have the
contractor’s contractual obligations completed. But the contractor
has a separate indemnity agreement to reimburse the surety for all
costs and expenses associated with completing the defaulted

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 c­ ontract. If the contractor defaults, how can he repay the surety
company for finishing his contract?
If the surety has to take over the contract due to contractor’s default,
it has some, or all, of the contractor’s assets pledged as collateral to
help cover the surety’s costs and expenses associated with completing
the contractor’s work. Plus, the surety will be paid by the owner for
all remaining unpaid amounts under the contract as the work is
completed.
For a fee (the premium for the performance guaranty), the contractor
gets to use the financial strength and assets of the surety company to
stand behind the performance of his work.
Most owners realize that the cost of the performance guaranty will be
included in the contractor’s price for the construction project; they
may feel it’s a small price to pay to be able to sleep better at night and
not worry too much about what happens if the contractor defaults or
fails to perform on the contract. It is also common for the cost of a
required performance guaranty to be shown separately as an extra
amount in the contractor’s pricing. At the option of the owner, he can
elect to pay the extra amount to have the contractor provide the
guaranty.

Surety Terminology
Common terminology associated with true performance guaranties
and surety companies is as follows:
• The surety company who provides the performance guaranty is
called the obligor.
• The contractor who buys the performance guaranty is called the
principal.
• The owner who receives the benefit of the performance guaranty
is called the obligee.
• The maximum dollar value of the performance guaranty that the
surety company may be obligated to pay out is called the penal
sum, or the limit of liability.

How to Locate a Surety

A good source for finding surety companies is the U.S. Government’s
Circular Number 570, “The Treasury List,” which lists all the sureties
qualified to provide performance guaranties on federal projects. These
companies provide performance guaranties to private companies as
well as to the U.S. government. The list can be found on the U.S.
Treasury’s website at www.ustreas.gov

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 Some Language Confusion sometimes arises in the use and misuse of terms for
assurances of performance. What does the owner really want?
Considerations Owners often request a guaranty in the commercial language in the
on Guaranties construction contract, when what they really want is an on-­demand
bond or a standby letter of credit issued by a bank. As noted earlier, a
& Bonds standby letter of credit is just another on-­demand type of payment
instrument.
On-­demand bonds and standby letters of credit do not provide a
guaranty of the contractor’s performance; they provide a monetary
payment to the owner in the event of the contractor’s failure to
perform. Banks and surety companies both use the term “bond” to
generically describe the kind of performance assurance they provide.
The contractor needs to take the time to read past the terms “bond”
and “guaranty” to see what the owner really wants: an on-­demand
type of payment instrument, or a true guaranty.

Types of The five most common types of performance assurances a contractor

will likely encounter on a construction project are:
Performance 1. Willingness to enter into a contract
Assurances 2. Use of money advanced
3. Performance of contractual obligations
4. Payment of subcontractors and suppliers
5. Performance of warranty obligations

Willingness to Enter into a Contract

Bid bond is the generic term used to describe the owner’s
requirement that the contractor provide a performance guaranty or an
on-­demand bond assuring the owner that the contractor will honor
his bid and will enter into a signed contract with the owner. Bid bond
requirements are most often found on federal and state government-­
related contracts. They are rarely required on private construction
contracts. They are also sometimes required on international projects
where the owner is in one country, and the contractor is in another.
Why would an owner require a bid bond? Three typical reasons:
1. To determine the seriousness of the bidder.
2. To cover the owner’s possible cost of re-­bidding the project in
the event the contractor refuses to contract with the owner.
3. As a penalty for inconvenience to the owner if the contractor is
awarded the work and does not accept the project.
Typically, the owner requires that a bid bond be submitted along with
the contractor’s bid, or proposal, to do the work. The value of the

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required bid bond may be a small percentage of the contractor’s bid
price for the project, say, 5%. Alternatively, the owner may require in
the bid documents that the contractor supply a bid bond in a fixed
amount, such as $50,000.

An Example
A contractor submits a bid in the amount of $2,500,000 for the
design, supply, and construction of a small water treatment plant
for a private local factory. The bid documents require that the
contractor provide a bid bond in the amount of 5% of the total
amount bid in order to provide the owner with an assurance that
the contractor will enter into a contract with him. The contractor’s
bid must remain open for acceptance by the owner for a period of
60 days. In this instance, the contractor decides to supply a bid
bond, in the form of an on-­demand bond issued by a bank, in the
amount of $125,000, which is 5% of the amount he bid.
When the contractor secures the bid bond at his local bank, the
bank charges him a fee of 3% of the $125,000 face value of the bid
bond. The bank is now at risk for the $125,000. The bid bond states
that it will be in effect for a period of 60 days, as required by the
owner’s bid documents. The contractor’s out-­of-­pocket cost for the
bid bond is 3% of $125,000, or $3,750, which of course he adds to his
price to the owner.
Let’s say that the contractor’s proposal to the owner for the work is
not accepted. The owner will now return the bid bond to the
contractor along with a notification that he was unsuccessful. The bid
bond will become null and void, and the contractor will return the
original of the bond to his bank. Unfortunately, the bank doesn’t
refund his $3,750. That’s just the cost of doing business.
Alternatively, the owner can’t seem to make up his mind what to do,
and does not award the contract within the 60-­day time period. After
60 days, the bid bond lapses and becomes null and void; so does the
contractor’s bid validity.
In a different situation, the contractor receives notification from the
owner 45 days after submitting his bid that the owner accepts his bid
and wants to enter into a contract with him. By this time, the
contractor has run into some financial difficulties, and tells the owner
he just can’t enter into the contract for the price and terms he
submitted. The contractor is now in default, and he and his bank are
at risk that the owner will cash in the bid bond.
The owner has several choices here: he can negotiate another deal
with the contractor and not cash in the bond, or he can award the

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 contract to another, perhaps higher-­priced bidder and cash in the bid
bond supplied by the defaulting contractor.
If the owner decides to cash in the contractor’s bid bond, he must
notify the contractor’s bank that the contractor has refused to enter
into a contract with him. In this instance, since the bid bond is
actually an on-­demand bond, all the bank requires is the owner’s
statement that the contractor has failed to enter into a contract with
him, and the bank will pay the owner the face amount of the bid
bond, or $125,000. The bank is under no other obligation to
investigate why the contractor failed to enter into a contract with the
owner.
A bid bond is supposed to provide the owner with an assurance that
the contractor will honor his bid and contract with the owner. That’s
the theory, and it works in most cases, but sometimes that’s not what
really happens.
As in the previous example, the contractor (for whatever reasons,
financial or otherwise) decides he won’t sign a contract with the
owner. The contractor has failed to perform, and the owner has the
right to cash in the on-­demand bid bond he supplied with his bid.
The owner gets the face value (the penal sum) of the contractor’s
on-­demand bid bond. If the money received from cashing in the
on-­demand bid bond is equal to or greater than the difference
between the contractor’s low bid and the next acceptable bid, then
the owner is probably okay, dollar-­wise.
However, what if the next acceptable bid is $500,000 higher than the
contractor’s bid? Well, maybe the contractor knew his estimate and
pricing were too low. Maybe he felt that suffering through the call on
the bond was cheaper than trying to perform on a contract that
would surely end up being a huge financial loser, significantly in
excess of the $125,000 that he will ultimately have to reimburse the
bank that provided the on-­demand bid bond to him.
If the owner receives the $125,000 from the contractor’s bank, maybe
that’s enough to help him go through the exercise of rebidding the
work, or working out a deal with one of the acceptable bidders for the
project.
Contractors also need to be aware of the commercial risk associated
with providing guaranties or on-­demand bid bonds for private
projects. The owner’s proposed commercial terms and conditions for
the project may be undesirable or difficult for the contractor to
accept without modification. In this case, the contractor would have
to add specific wording in the guaranty or on-­demand bid bond
stating that he is willing to enter into a contract with the owner,

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subject to the owner agreeing to the commercial terms and conditions
modifications outlined in contractor’s proposal.
If the contractor didn’t do this, the owner could require the
contractor to enter into a contract with him under the owner’s
undesirable terms and conditions.
If the contractor refused, the owner could have legitimate grounds to
enforce a guaranty or cash in an on-­demand bid bond. Also, if an
owner has a preferred or standard format for a guaranty or an on-­
demand bid bond, the contractor needs to carefully read it and make
sure that by agreeing to use the owner’s preferred format he doesn’t
jeopardize his ability to further negotiate acceptable commercial
terms and conditions in the construction contract.

Use of Money Advanced

The generic term for the assurance provided to the owner that any
money advanced to the contractor will be properly used against the
contractor’s costs is an advance payment bond. It is sometimes
called a downpayment bond.
Like other assurances of performance, an advance payment bond may
be in the form of a guaranty or an on-­demand bond. It is usually
issued in the full amount of the advance payment that the contractor
receives from the owner. Probably the most common form for this
type of performance assurance is an on-­demand bond, rather than a
true guaranty.
The advance payment-­on-­demand bond is designed to protect the
owner from the contractor failing to perform on the contract prior
to spending the advance payment on proper contract activities. In
the event the contractor fails to perform, the owner has the ability
to recover some or all of the advance payment made to the
contractor.
An advance payment-­on-­demand bond is provided only when it is a
contractual condition of the construction contract. It is normally
provided to the owner after he awards the contract, but before he
pays the contractor the agreed-­on advance payment, or
downpayment. Typically, the contractor gives the owner the advance
payment-­on-­demand bond along with his invoice for the agreed-­on
downpayment. It’s unlikely an owner will pay the downpayment to
the contractor before he receives the required advance payment-­on-­
demand bond.
Although the owner might want the advance payment-­on-­demand
bond to be in effect for the full duration of the contract, there is no

85
 good reason for that to be the case. Typically, the advance payment
made to the contractor is used to pay for contract costs that are
incurred very early in the project, such as front-­end costs incurred in
the first three months of the contract. If that’s the case, then there is
no reason why the advance payment-­on-­demand bond should not
expire after three months, or shortly thereafter.

An Example
A contractor signs a contract with an owner to build a large health
and fitness complex for $8,000,000. The duration of the contract is
two years. The contractor negotiates a 15% downpayment (and
receives a gold star from the company president for this
accomplishment).
The commercial terms in the contract require an advance payment-­
on-­demand bond in the full amount of the downpayment, or 15% of
the contract price. They also require that any advance payment-­on-­
demand bond be in effect for the duration of the contract, which, in
this case, is two years.
The 15% advance payment-­on-­demand bond is worth $1,200,000,
which reduces the contractor’s bonding capacity with his bank by
the same amount. That may be okay if the contractor has a high
bonding capacity, but in the last six months of the project, when
there is only $1,000,000 worth of work remaining, it sure doesn’t
seem to make sense to have that $1,000,000 worth of remaining work
covered by a $1,200,000 advance payment-­on-­demand bond, plus the
value of any other types of performance assurance the owner may
have required.
Also, if the contractor finished and invoiced more than the full
value of the advance payment bond in the first six months of the
contract, by keeping the advance payment bond in force, the
owner is technically getting some extra, and unnecessary, bond
coverage. In this case though, the contractor could have tried to
negotiate a shorter time period for the advance payment-­on-­
demand bond to be in effect. This would free up valuable bonding
capacity, or credit limit capacity, with his bank. The contractor
could have also considered negotiating a step-­down value for the
on-­demand bond.

Time Limits & Step-­Down Values for Advance

Payment-­on-­Demand Bonds
There are no laws that require an advance payment-­on-­demand bond
to be in effect, or in full value, for the duration of the contract.

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The contractor normally is going to put in place work with a value
that equals or exceeds the value of the advance pay-on-demand bond
in much less time than the full duration of the project.
In the health and fitness center example, the contractor could
have negotiated advance payment bond wording similar to the
following:

Article 24 – Advance Payment Bond

24.1 Prior to the downpayment being made, Contractor shall provide to
Owner an Advance Payment Bond payable on Owner’s first written demand
from a bank acceptable to Owner in the amount of 15% of the Contract
Price, guaranteeing Contractor’s performance of the Work in this Contract.
24.2 The Advance Payment Bond shall be in effect for a period of six months
from the date of signing of the Contract. During the period in which the Advance
Payment Bond is in effect, it shall reduce in value according to the following:
At the end of the first month – 12.5% of the Contract Price
At the end of the second month – 10% of the Contract Price
At the end of the third month – 7.5% of the Contract Price
At the end of the fourth month – 5% of the Contract Price
At the end of the fifth month – 2.5% of the Contract Price
At the end of the sixth month – Advance Payment Bond expires and is no longer
in effect

In this example, the on-demand advance payment bond is supplied in

the amount of 15% of the contract price upon award of the contract
and with the invoice for the downpayment. The bond is in effect for
only six months, and the value of the bond decreases 2.5% per month.
This step-down provision better reflects the value of the work put in
place by the contractor.
There is nothing that requires the contractor to agree to keep an
on-demand bond at its full original value for any period of time. If a
contractor can negotiate a declining value of the on-demand bond to
better represent the value of the work outstanding on the contract,
then that’s fine. The contractor keeps his bonding capacity, or credit
limit, at a higher level, and the owner gets a valuable form of
assurance for the contractor’s performance.
The following is another way to word the contract clause that
describes reducing the value of the advance pay-on-demand bond,
over a longer period of time, for the contract’s duration.

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 Article 24 – Advance Payment Bond
24.1 Prior to the downpayment being made, Contractor shall provide to
Owner an Advance Payment Bond payable on Owner’s first written demand
from a bank acceptable to Owner in the amount of 15% of the Contract
Price, guaranteeing Contractor’s performance of the Work in this Contract.
24.2 The value of the Advance Payment Bond shall be reduced by 15% of the
value of each progress invoice submitted by Contractor to Owner for the Work.

In this example, the advance payment bond’s value steps down by an

amount equal to 15% of the value of the periodic progress invoices
submitted to the owner for the work performed by the contractor.
The difference in this example is that this advance payment-on-
demand bond remains in effect for the full duration of the contract,
but with a steadily declining value. With this method, the advance
payment bond has no value at the end of the contract period.
Figure 6.4 is an example of an advance payment-on-demand bond
with step-down values.

Subcontractor & Material Supplier Payment

Guaranties & Bonds
During the course of a construction contract, the contractor typically
will utilize the services of various subcontractors and material
suppliers who will have subcontracts with the contractor and will
look to the contractor for payment for the services or materials they
supply.
The obligation to provide a payment guaranty or a payment-on-
demand bond is another common type of performance assurance
that owners require from contractors.
In the event the contractor does not pay subcontractors or material
suppliers for their services or materials, they may be able to file a lien
against the owner’s property in an attempt to get their due payment.
A legitimate lien filed in a timely manner by a subcontractor or
material supplier against the owner’s property serves mainly to
motivate the owner to pressure the contractor to pay his bills. It gets
the owner’s attention that there is a problem in the making. Perhaps
the owner will withhold enough money from the contractor’s
progress payments to pay the subcontractors or material suppliers.
Owners don’t like to have liens filed against their property, because it
interferes with their ability to sell the property or use it to secure a loan.
They expect the contractor to pay his subcontractors and material
suppliers on time.

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Figure 6.4 Advance Payment-­on-­Demand Bond with Step-­Down
Values

When the owner feels he requires additional assurance that the

contractor’s subcontractors and suppliers will be paid, he will require
the contractor to furnish a payment guaranty or payment-­on-­demand
bond. The subcontractors and suppliers can make claim for their
unpaid amounts under the bond, which should keep them from filing
liens against the owner’s property. The subcontractors and suppliers
can be added as beneficiaries of the guaranty or the on-­demand bond,
but they may not know that such a guaranty or payment instrument
exists.
For convenience and simplicity, this book uses the contractual
relationship between the owner and the contractor as the standard
example. But, as mentioned previously, the contracting issues

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 discussed in this book apply equally to any contractual relationship
between a subcontractor and a main contractor, or a subcontractor
and the owner’s main contractor.
Let’s take a look at how a payment guaranty or payment-­on-­demand
bond benefits the owner and any of the main contractor’s
subcontractors and suppliers.

An Example
An owner contracts with a main contractor to build a $25,000,000
food processing facility. The owner realizes that the main contractor
will have to have a variety of specialty subcontractors and material
suppliers involved in the project. The contract that the main
contractor signs with the owner obligates the main contractor to
provide the owner with 10% of the contract value payment guaranty
through a surety company. The payment guaranty is to be in place
for the duration of the contract, including the warranty period.
During the course of the contract, the main contractor encounters
financial difficulties and stops paying his subcontractors and
suppliers. The subcontractors and suppliers cease work, but all have
outstanding invoices for work performed or materials supplied. This
is an unfortunate and unpleasant situation, but it happens.
The subcontractors and suppliers begin filing liens against the
owner’s property to protect their interests in the work performed or
materials supplied that they have not been paid for. By this point,
the owner has notified the main contractor’s surety company that
the main contractor has failed to perform by not paying his
subcontractors and suppliers.
After the surety company receives the notice from the owner and
investigates the claim, it steps in and works with the main contractor
to find a way to pay the subcontractors and suppliers. In the event
the main contractor can’t make the payments, the surety company is
obligated to pay the subcontractors and material ­suppliers directly,
up to an aggregate amount of the value of the guaranty, which in
the example used is 10% of $25,000,000, the contract value, or
$2,500,000.
In this example, the payment guaranty provided by the main
contractor acts, to some extent, to insulate the owner from having
liens filed against him by unpaid subcontractors and suppliers. The
value of the payment bond in this example was 10% of $25,000,000, or
$2,500,000. The $2,500,000 is the maximum amount of money
available to the owner and the amount that the surety would have to
pay out to subcontractors and suppliers if required. However, if the

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subcontractors and suppliers had $3,000,000 in unpaid invoices
submitted to the main contractor, then the owner would be faced
with the probability of having to pay the additional $500,000 out of
his pocket, or else be faced with the subcontractors and suppliers
filing liens against his property for that amount.
Alternatively, if the subcontractors and suppliers had $2,000,000
outstanding in unpaid invoices, the owner would likely escape having
any liens filed against his property. He would look to the main
contractor’s surety company that provided the payment guaranty to
fully settle all the unpaid amounts, since they were less than the
payment guaranty’s maximum value of $2,500,000.
For subcontractors and material suppliers, the moral of the story on
payment guaranties and payment-­on-­demand bonds is twofold:
1. First, subcontractors and material suppliers are likely to be in a
strong position to be beneficiaries of a payment guaranty
provided by a surety, although they may not be beneficiaries of a
payment-­on-­demand bond, or a payment standby letter of
credit.
2. Second, subcontractors and material suppliers to a main
contractor on a project should find out if the owner requires a
payment guaranty or payment-­on-­demand bond from the main
contractor. If so, they should get a copy of it and read it.
Subcontractors and material suppliers need to make sure they
understand the conditions in the payment guaranty or payment-­
on-­demand bond under which they will be paid if the main
contractor does not pay them. Just because a payment guaranty
or payment-­on-­demand bond is in place doesn’t necessarily
mean it will be easy or straightforward to claim and receive
payments due.

Performance Guaranties & Performance

Bonds
A performance guaranty, or performance-­on-­demand bond or
standby letter of credit, typically covers all of the contractor’s
obligations in a contract, including payment of subcontractors and
material suppliers and warranty obligations.
A performance guaranty or performance-­on-­demand bond is
normally in effect for the full duration of the contract and may
include the warranty period as well. It will expire at some fixed future
completion date, or it may expire earlier upon the receipt of a
document stating that the work is complete and accepted by
the owner.

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 The maximum value of the performance guaranty or performance-
on-demand bond can be any amount required by the owner or
negotiated between the contractor and the owner. However,
typical amounts are between 5% and 20% of the value of the
contract.
All performance guaranties issued by surety companies and all
performance-on-demand bonds issued by banks will have a fixed
starting date and a fixed expiration date.
Typically, the starting date would be the date the contract is signed,
and the expiration date will be 30 days after the anticipated, or
contractual, contract completion date. In the event the completion
schedule extends beyond the bond’s expiration date, the owner may
require the contractor to extend the expiration date to at least meet
the new contract completion date.
The example below is typical wording for a requirement to provide a
performance guaranty:

Article 32 – Performance Guaranty

32.1 Within seven (7) days of the date of the Notice to Proceed, Contractor
shall provide to Owner a Performance Guaranty in the amount of 10% of
the Contract Price guaranteeing the faithful performance of the Work under
this Contract.
32.2 The Performance Guaranty shall be issued by a surety company accept-
able to Owner, and shall be on terms and conditions that are acceptable to Owner.
32.3 The Performance Guaranty shall remain in effect throughout the sched-
uled execution of the Work, and any extensions to the schedule, and shall expire
upon the completion of the Warranty Period.

Noted below is a typical example of a requirement to provide a

performance-on-demand bond:

Article 32 – Performance Bond

32.1 Within seven (7) days of the date of the Notice to Proceed, Contractor
shall provide to Owner a Performance Bond payable on Owner’s first written
demand in the amount of 10% of the Contract Price guaranteeing the
faithful performance of the Work under this Contract.
32.2 The Performance Bond shall be issued by a bank acceptable to Owner,
and shall be on terms and conditions that are acceptable to Owner.
32.3 The Performance Bond shall remain in effect throughout the scheduled
execution of the Work and any extensions to the schedule, and shall expire upon
the completion of the Warranty Period.

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In these sample clauses, the contractor is required to provide a
performance guaranty or a performance-­on-­demand bond as an
assurance of his performance of all the obligations in the construction
contract. The performance guaranty or on-­demand bond is to be in
effect from the time the contractor receives a notice to proceed with
the work from the owner up to the expiration of the warranty period.
The value of this bond is 10% of the initial contract price.
In the example of the fitness center contract (mentioned earlier in
this chapter), the performance bond provided under Article 32
requirement would be in effect for a period of three years (two years
completion plus one year of warranty), plus any extensions agreed on
between the contractor and the owner.
For a period of three years, the owner has available a performance
guaranty or performance-­on-­demand bond in the amount of
$2,500,000. The contractor’s capacity to secure new guaranties or
on-­demand bonds for new projects is likely reduced, as he will
typically have some limit imposed on him on the total aggregate value
of guaranties or bonds he can have outstanding at any one time.
At issue here is how the contractor can meet the owner’s performance
guaranty or performance-­on-­demand bond requirements in a way that
provides the owner with what he wants, yet does not unnecessarily tie
up the contractor’s guaranty or on-­demand bonding capacity.
There are three possible ways to achieve this:
1. Supply a separate guaranty or on-­demand bond of lesser value to
cover the performance obligations of the warranty period.
2. Step down the value of the performance guaranty or
performance-­on-­demand bond to better represent the value of
the outstanding work.
3. Use both of the above methods.

Warranty Guaranties & On-­Demand Bonds

Since a contractor’s performance obligations will usually continue
through a contractually agreed-­on warranty period, the owner will
likely require that the performance guaranty or performance-­on-­
demand bond extend through this warranty period as well.
Although a performance guaranty or performance-­on-­demand bond can
be in effect during the warranty period, it is not unusual for a contractor
to provide a separate warranty guaranty or warranty-­on-­demand bond
covering the contractor’s obligations during the warranty period.
Also, the maximum value of the warranty guaranty or warranty-­on-­
demand bond can be less than that of the performance guaranty or

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 performance-on-demand bond; there is no legal or other requirement
for its value to be the same. The value just needs to be negotiated
with the owner. Lower value is, in fact, better for the contractor.
If the value of the performance guaranty or performance-on-demand
bond is 10% or more of the contractor’s price, then a warranty
guaranty or warranty-on-demand bond with a value of 5% or less of
the contractor’s price could be negotiated. The amount of the
warranty guaranty or on-demand bond may not necessarily represent
the cost of repairs, but serves more like an incentive for the contractor
to perform any required warranty work in a timely manner.
The contractor’s completion schedule for the actual performance of
the work can expand and compress for many reasons. It’s just easier
to provide a new warranty guaranty or warranty-on-demand bond
covering the warranty period once the actual contract completion
date of the work is known or achieved. In this way, the starting and
expiration date of the warranty guaranty or warranty on-demand
bond will coincide with the actual contractual warranty period.
When there is a provision for separate performance and warranty
guaranties or on-demand bonds, it is not unusual for an owner to
require that the warranty guaranty or warranty-on-demand bond
covering the contractor’s obligations during the warranty period be
submitted along with the contractor’s final invoice for the work.
Receipt by the owner of the warranty guaranty or warranty on-
demand bond is often used to trigger release of the contractor’s final
payment or withheld retention, or both.
The following is an example of a contract requirement for a warranty
period assurance of performance:

Article 33 – Warranty Bond

33.1 Within fourteen (14) days of receipt of the Certificate of Mechanical
Completion, Contractor shall provide to Owner a Warranty Bond in the
amount of 5% of the final Contract Price guaranteeing the faithful
performance of Contractor’s warranty obligations under this Contract.
33.2 The Warranty Bond shall be in effect for a period of one year from the date
of Mechanical Completion.**
33.3 The Warranty Bond shall be payable on Owner’s first written demand and
issued by a bank acceptable to Owner, and shall be on terms and conditions that
are acceptable to Owner.

**Note to contractors: make sure the warranty bond is issued with a

definite date of mechanical completion, so that it is clear that there is
a fixed time period.

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 In the above example, once the contractor receives the certificate of
One important mechanical completion, he is then required to immediately provide a
thing to note is warranty period on-demand bond. This will provide an assurance to
that the warranty the owner that the contractor will meet any contractual obligations
period on-demand that may arise during the warranty period. The value of this warranty
bond need not be period on-demand bond is 5% of the final contract price.
the same value as Typically, the contractor’s final payment or release of any retention
the performance withheld (or both) would require him to have already issued his
guaranty or warranty period guaranty or warranty period on-demand bond to the
performance-on- owner. The terms of payment section of a construction contract often
demand bond includes this requirement.
required by the As a final note, always consider providing a warranty guaranty or
owner. Its value can bond in lieu of having the owner hold any retention money until the
be less, subject end of the warranty period. It’s much better to have the cash in the
to the contractor’s contractor’s bank account.
negotiations with the
owner. Step-Down Values for Performance Guaranties
& Performance-on-Demand Bonds
It’s unlikely that a contractor would be allowed to provide any sort of
performance guaranty or performance-on-demand bond that expires
prior to the completion of the work required under the contract. It’s also
unlikely a contractor would be allowed to provide a warranty guaranty or
warranty period on-demand bond that expires prior to the end of the
contractually required warranty period. It is likely, though, that a
contractor can negotiate terms that would allow for the value of any
required guaranties or on-demand bonds to decline over time, as follows:
In the health and fitness center example used earlier, the contractor
could have negotiated a performance guaranty requirement that read
similar to the following:

Article 32 – Performance Guaranty

32.1 Contractor shall provide a Performance Guaranty from a surety
company or an insurance company acceptable to Owner in the amount of
10% of the Contract Price, guaranteeing Contractor’s performance of the
Work under this Contract.
32.2 The Performance Guaranty shall be in effect for the duration of the
Contract until such time as Contractor achieves Mechanical Completion and
obtains the Certificate of Occupancy for the facility.
32.3 During the period of time in which the Performance Bond is in effect, its
value shall decrease according to the following table:
At the end of the 6th month – 8% of the Contract Price
At the end of the 12th month – 6% of the Contract Price
At the end of the 18th month – 4% of the Contract Price

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 In this example, the value of the performance guaranty starts out at
10% of the value of the contract and declines in accordance with the
table to a value of 4% of the contract price at the end of the 18th
month. The value of the performance bond remains at 4% of the
initial contract price until the contractor’s work is finished.
Why should a contractor concern himself with negotiating lower or
declining values for performance guaranties or performance-­on-­
demand bonds? In the health and fitness center example, the value of
the contract is $8,000,000. The contractor is required to provide a
performance guaranty in the amount of 10% of contract value, or
$800,000, which is to remain in place for the duration of the contract
which (on this project) is two years.
This means that the contractor’s aggregate bonding capacity will be
reduced by $800,000 for the next two years. If the contractor had
negotiated a declining value performance guaranty as in the previous
example Article 32, the value of the performance guaranty at the end
of the first year would be 6% of the contract price, or $480,000. This
frees up $320,000 of bonding capacity ($800,000–$480,000) for the
next 12 months.
Looking at this situation from another vantage point, freeing up
$320,000 in bonding capacity allows the contractor the opportunity
to provide a 10% performance bond on a new contract worth
$3,200,000. It would be unfortunate for a contractor to be looking at
an attractive project and not have enough available bonding capacity
to bid and execute the work.
Contractors should always consider negotiating lower bond limits on
their projects. If the owner wants a 15% performance guaranty,
maybe he will agree to a value of 10%, maybe he’ll agree to a value of
5%, or maybe he’ll agree to a declining value guaranty. Better yet, if
the contractor has an excellent track record, maybe the owner will
delete the requirement for a performance guaranty or performance-­
on-­demand bond. It sure doesn’t hurt to ask.
The same arguments apply for any required warranty period
guaranties or warranty period on-­demand bonds. Keep these separate
from the required performance guaranties or performance-­on-­
demand bonds. Don’t forget that there is no requirement that the
warranty period guaranty or warranty period on-­demand bond must
be the same value as the performance guaranty or performance-­on-­
demand bond. It should be less.
Sometimes an owner will want to keep the retention withheld from
the contractor’s invoices for the duration of the warranty period to
ensure the contractor’s performance of his warranty obligations.

96
This simply is not fair to the contractor—­and it is not helpful to the
contractor’s cash flow.
In this instance, the substitution of a warranty period guaranty or
warranty period on-­demand bond in lieu of withholding retention
may be an acceptable alternative to negotiate with the owner. This
provides the owner with a form of assurance of similar value that the
contractor will meet contractual obligations that may arise during
the warranty period.

Parent Company Guaranties

Sometimes, the subsidiary of a company will be allowed to substitute
a parent company guaranty for a performance guaranty or
performance-­on-­demand bond. One argument for this is that the
financial, physical, and technical assets of the parent company are
often greater than those of the surety company that would supply the
required performance guaranty.
In this situation, the parent company provides a guaranty of the
performance of the subsidiary. In the event the subsidiary company
fails to perform, the parent company guarantees that it will step in
and complete the work and all other contractual obligations of the
subsidiary.
The parent company guaranty acts just like a performance guaranty
provided by a surety company, only without a dollar limit. In some
ways, this is better for the owner, especially if the parent company is a
successful and financially strong organization.

An Example
Canadian Construction Company Limited, of Toronto, Canada, a
wholly-­owned subsidiary of American Construction Company Inc.,
of San Francisco, California, receives a contract to design and build
a $20,000,000 bulk storage facility for wheat at a site located in
Saskatchewan, Canada.
The owner of the new bulk storage facility has in his proposed
construction contract a standard requirement for a 10% performance
on-­demand bond. Canadian Construction Company negotiates
with the owner for its parent company, American Construction
Company Inc., to provide a parent company guaranty in lieu of the
10% performance-­on-­demand bond. The owner agrees that this is
an acceptable alternative, as he is familiar with the success and
financial strength of the parent company.
Figure 6.5 is an example of how a Parent Company Guaranty might
be worded.

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 Figure 6.5 Sample Parent Company Guaranty

Guaranty & On-­Demand Bond Wording

In private contracts, an important thing to remember is that
performance-­related guaranties and on-­demand bonds are
contractual agreements between three parties, and their wording is
negotiable. The wording of any performance guaranty or
performance-­on-­demand bond can be negotiated to meet the needs
or concerns of any one of the parties involved in the contract.
The owner may have a standard format for performance-­related
guaranties and performance-­related on-­demand bonds, which will
likely be favorable to his position and allow him a large degree of
freedom to exercise the provisions of the guaranty or on-­demand
bond with as little hassle as possible.
For a contractor with strong capabilities and financial resources, this
is probably not a big risk, especially if the owner also has a good track
record with contractors and has the financial resources to pay the
contractor for building the project. However, like the different risks
associated with any construction project, all owners will have
different risk profiles for the contractor.
If the contractor believes more protection is needed from an
unwarranted call on any of the guaranties or on-­demand bonds he
has to provide on a construction project, he can modify the wording
in these guaranties and on-­demand bonds through negotiations with

98
the owner. The contractor is under no obligation to accept the
standard wording an owner may prefer. If the owner provides a
standard, preferred format for the guaranties and on-demand bonds
with his inquiry documents, the contractor should advise of any
changes he requires in his proposal for the work. If the contractor
does not revise the wording to something more acceptable, then he is
stuck with the owner’s standard guaranty or on-demand bond
wording and requirements after the contract is signed. This could be
costly or risky for the contractor.
Often, however, there will be guaranty and on-demand bond
requirements in the contract terms and conditions, but without any
standard forms attached with the inquiry. In this case, the contractor
can provide his preferred wording after the award of the contract and
at the time he submits the guaranties or on-demand bonds to meet the
owner’s contractual requirements. In the event the contractor is
concerned about a performance-related on-demand bond being cashed
without good reason, he can consider adding to the conditions of the
on-demand bond, wording similar to one of the following examples.

Owner shall notify Contractor in writing 15 days prior to making a demand

or claim under this Bond, advising Contractor in detail of the reasons he is
in default and providing Contractor the 15 days to rectify the default.
OR
All demands or claims under this Bond shall be detailed in writing and shall be
verified by an independent, third-party engineering consultant, mutually accept-
able to both Owner and Contractor.

The second option introduces an independent third party into the

process of determining whether or not the contractor is in default,
and the owner has a legitimate call against the on-demand bond. The
main point to remember is that the wording of any guaranty or
on-demand bond is negotiable, just like the other terms and
conditions in a construction contract.

Why Negotiate Bonding Limits?

The main reason is to keep the contractor’s unused bonding limit as
high as possible—to give him the opportunity to consider bidding
and executing additional projects.

An Example
Let’s say the contractor has an aggregate bonding limit with his
surety company of $50,000,000. This means he can have an
aggregate maximum of $50,000,000 face value of guaranties

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 outstanding at any one time. If the value of all his outstanding
guaranties averages 10% of contract value, this means he is
executing $500,000,000 of work. He can’t take on any new projects if
the amount of the new work’s guaranty or on-­demand bond
requirements, when added to his current outstanding aggregate
bond amount, exceeds the $50,000,000.
The contractor is having a good year and wants to bid on a new
project worth $60,000,000, which will take three years to complete.
He currently has $45,000,000 worth of bonds outstanding. The new
project’s two bonding requirements are as follows:
1. An advance payment bond or guaranty that will be in place for
the duration of the work in the amount of any downpayment
made to the contractor. (In this case, the contractor will require
a 15% downpayment in his bid for the work.)
2. A performance and payment bond or guaranty in the amount
of 10% of the contract price for the duration of the work,
including the warranty period.
The contractor puts pencil to paper and figures this new contract
will require an advance payment guaranty of $9,000,000 (15% of
$60,000,000), and a performance and payment guaranty of
$6,000,000 (10% of $60,000,000), for a total of $15,000,000 in new
guaranties with his surety. This $15,000,000 in new guaranties will
be in place for three years.
His surety company is reluctant to issue the required new guaranties
because the contractor’s aggregate outstanding bond amount would
then be $60,000,000, which is $10,000,000 higher than his agreement
with the bonding company.
What to do? Negotiate with the owner on the bond requirements.
Consequently, the contractor proposes the following bond program
in his proposal to the owner:
1. An advance payment guaranty in the amount of 10% of the
contract price.
The advance payment guaranty will decline to zero value in
12 equal monthly increments beginning from the date of
contract.
2. A performance bond in the amount of 5% of the contract price
that will be in place for the duration of the contract.
Under this proposal, the contractor initially puts in place two
guaranties for this new project that have a combined value of
$9,000,000: $6,000,000 for the advance payment guaranty and
$3,000,000 for the performance guaranty. After one year, the value of

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 the advance payment guaranty goes to zero, and therefore, the total
value of the guaranties on the project reduces to $3,000,000, which is
now just the value of the performance bond. This alternative method
allows the contractor to bid the work and stay within the maximum
bonding limits he has with his surety.
But, wait a minute. Wasn’t the owner’s original requirement for the
advance payment guaranty for the full value of the contractor’s 15%
downpayment? Yes, it was. Sometimes outside-the-box thinking is in
order. There’s nothing cast in stone that says an advance payment
guaranty or on-demand bond has to equal the downpayment value.
After all, this is an agreement between the owner and the contractor,
and everything is negotiable.
It doesn’t hurt to try to negotiate with the owner for a better deal. A
contractor should never feel constrained by self-imposed or owner-
imposed limits or conditions. Everything is negotiable.

Conclusion Contractors with excellent long-term track records of completing

projects on time and in accordance with all the contractual
conditions should consider resisting requests to provide any sort of
performance-related guaranties, on-demand bonds, or standby letters
Contractors should
of credit, to private companies. The contractor’s excellent track
be very careful with record and financial strength should be enough of an assurance for
the use of standby the owner of the private company. It certainly doesn’t hurt to try to
letters of credit and negotiate this with the owner.
on-demand bonds.
Guaranties, on-demand bonds, and standby letters of credit are all
Make sure the terms
contractual agreements. When absolutely required, the face values
are acceptable and commercial terms can be negotiated with the owner and the
company providing them to make them fairer to one or more of the
parties involved. There is no such thing as a standard format for these
items.
Subcontractors should find out if the main contractor must provide a
payment guaranty, on-demand bond, or standby letter of credit to the
owner. Ask for a copy of it and review it. Subcontractors may be
noted as beneficiaries and will need to understand its conditions if it
has to be used to get paid.

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 Chapter
Insurance
7
Understanding insurance is another part of the process of managing
the risk on a construction project, and will assist contractors in
becoming more successful negotiators when it comes to commercial
Contractors should terms and conditions. This chapter will cover common insurance
consider their issues that will likely be encountered as part of any construction
ability to procure project and contract.
appropriate If a contractor is unable procure insurance, or if insurance becomes
insurance for unaffordable, this will severely affect his ability to compete and secure
their construction construction work. The fact is that the construction job site is among
activities as a the riskiest of work places. Protection (through insurance) for claims
valuable company arising from these risks is absolutely essential.
asset. For a contractor, the major physical risks on a construction job site
are loss of/damage to property, and injury or death of personnel.
These risks are the most likely to expose the contractor to a
significant financial liability. Insurance can provide contractors

Understanding and Negotiating Construction Contracts: A Contractor’s and Subcontractor’s Guide to

Protecting Company Assets, Second Edition. Kit Werremeyer.
© 2023 John Wiley & Sons, Inc. Published 2023 by John Wiley & Sons, Inc.

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 a certain level of protection from these and other types of risks, such
as errors and omissions, and the cost of legal defense for claims
covered under the insurance policy.
Owners almost always require contractors to provide written
evidence of insurance coverage in the types and amounts required in
the construction contract—­before the contractor is allowed to
mobilize at the site and start construction activities. For the
contractor’s own risk management process, it is equally important
not to start construction activities without adequate insurance to
cover the risks he expects to encounter on the job site.
Since every construction project has its own unique set of risks (both
physical and commercial), trying to select appropriate insurance can
be difficult and confusing. There are a multitude of possible risks that
may arise out of any construction contract. Just because an owner
requires certain types and amounts of insurance for a construction
project doesn’t mean the contractor is appropriately covered. Also,
the insurance industry has its own standardized language,
commercial terms and conditions, exclusions, and financial limits
that further complicate things. To make matters worse, there are
numerous—­sometimes conflicting—­court interpretations of the
standard language used in insurance contracts to include or exclude
coverage.
A competent insurance broker can be a real asset to a construction
company in helping to analyze all the risks on a construction project
(physical and commercial) and providing appropriate insurance to
cover them. It is still necessary, however, to have a solid
understanding of insurance types, conditions, and limits.
There are also significant risks to be aware of when providing
certain types of insurance for an owner, such as being required to
add the owner as an additional insured to the contractor’s
Commercial General Liability policy. Naming the owner as an
additional insured gives him full access to the contractor’s policy,
which may even cover accidents caused by the owner that are
completely unrelated to the construction project. The consequences
of adding the owner as an additional insured are more fully covered
later on in this chapter.

What Is Insurance provides a fixed amount of financial protection for the

contractor from the financial liability that arises out of certain
Insurance? defined events—­risks—­that may occur on a construction project.
The insurance industry calls these risks perils, and defines them as
unexpected and unintentional events. In other words, the contractor

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 did not plan for these events (accidents) to happen, nor did they
occur intentionally. The risks covered by insurance can be physical or
commercial:
• Damage to property or injury to persons are examples of
physical risk.
• Payment of the owner’s legal defense costs incurred in a lawsuit
arising out of property damage is an example of a commercial
risk. Payment of liquidated damages by the contractor for failure
to meet the owner’s schedule is also an example.
Insurance is considered a contract between an insurance company
and the contractor. It does all of the following:
1. Defines the various physical and commercial risks covered and
excluded.
2. Has a deductible amount that must first be paid by the
­contractor on any claim.
3. Has a stated maximum financial limit to be paid by the
­insurance company.
4. Has a fixed time period for which the policy is in effect.
5. Has other commercial terms and conditions related to
­notification, payment, and legal defense of claims made by the
contractor or others.
Insurance is provided for a fee, or premium. Insurance companies
expect to pay claims that arise from the occurrence of physical and
commercial risk events specified and covered in the insurance contract.

Claims Made vs. Insurance policies purchased by contractors will pay claims on the
following two situations.
Occurrence
Claims-­Made Basis
The claim must be made during the insurance policy period. For
example, if the insurance purchased by the contractor is for one year
and is a claims-­made basis policy, any claims presented to the
insurance company for payment must be made during the one-­year
period that the insurance policy is in effect. If the contractor presents
a claim after the policy has expired, the insurance company has no
obligation to pay the claim.

Occurrence Basis
The claim can be made after the policy has expired, as long as the
accident resulting in the claim occurred during the period of time
the insurance policy was in effect. For example, if the insurance

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 purchased by the contractor is in force for one year, a claim can be
Delays between the presented for payment after the expiration of the one-year period.
time an accident However, the accident that resulted in the claim must have
takes place occurred during the period of time the insurance was
(occurrence) and in force.
the submission of A contractor’s preference should always be to have insurance on an
a claim (lawsuit) occurrence basis. Why? Let’s say an accident injuring a person occurs
for that accident on the contractor’s job site one month before his General Liability
are common. insurance policy expires. Six months later, and five months after the
They can often be contractor’s general liability policy expired, the injured person files a
lengthy depending claim (lawsuit) for medical and other expenses. Since the contractor’s
on the nature and General Liability policy was an occurrence basis policy, and the
complexity of events accident—the occurrence—happened during the time the policy was
that caused the in effect, the policy would almost certainly cover some, or all, of the
accident. injured person’s claim.

Types of There are many types of insurance coverage available to construction

companies that can cover a wide variety of risks. The types of
Insurance insurance commonly required by most owners are defined in the
following pages.

Commercial General Liability Insurance

Commonly called CGL, this type of insurance provides coverage for
claims for injury to persons, including death and property damage. It
typically covers property damage or personal injury that occurs while
any of the following are taking place:
1. During ongoing operations on the construction job site
2. As a result of the products the contractor has supplied
3. As a result of completed operations after the contractor has left
the job site
Also, CGL can cover the contractor’s liability that may arise from his
assumption of the owner’s risk by way of the construction contract.
(See “Contractual Liability Insurance.”) In order for a claim to be
paid, the person making the claim must have suffered damages
generally as a result of some degree of negligence for which the
contractor would be legally liable.

An Example
Suppose a contractor digs a hole in the ground on his job site,
neglects to properly and safely barricade it, and an individual who
works for another contractor falls in the hole and breaks a leg. The
individual can file a claim for medical and other expenses,

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 i­ ncluding legal expenses, against the contractor claiming negligence
for not properly barricading the hole.
CGL is typically provided on an occurrence basis. It is also sometimes
referred to as Comprehensive General Liability Insurance, a term that
was in use prior to 1986, or Third-­Party General Liability Insurance.

Contractual Liability Insurance

This insurance provides the contractor with coverage for financial
liability connected with claims that may arise from the contractor’s
assumptions of the owner’s liability typically as stated in an indemnity
obligation in the construction contract.
Contractual Liability Insurance (CLI) coverage is normally included
as part of most standard format Commercial General Liability
insurance policies. It is almost always specified by the owner in the
contract’s commercial terms and conditions to be provided as an
addition to the contractor’s Comprehensive General Liability policy.
CLI does not provide coverage for business-­related assumptions of
liability, or for liability associated with breach-­of-­contract situations.
For example, CLI would not cover any claims for the payment of
liquidated damages, consequential damages, unpaid extra work, and
the like. It covers the contractor’s assumption of financial liability for
claims against the owner associated with personal injury, death, or
property damage only, and for the legal defense of those claims.
The indemnification provisions contained in the owner’s
construction contract may obligate the contractor to assume the
owner’s potential financial liability for claims related to personal
injury, death, or property damage caused by the negligence of the
owner, and to also pay for the owner’s legal costs associated with such
claims. These are the specific assumptions of owner’s liability that
Contractual Liability insurance covers.
Having the contractor provide CLI gives the owner an extra measure
of assurance that, in the event the contractor can’t or is unwilling to
meet the financial obligations of the construction contract’s
indemnification provisions, the contractor’s insurance company will
meet them. The insurance company backs up the contractor with this
type of insurance coverage; this is important coverage for the
contractor, too.
Requiring the contractor to provide CLI is also an important risk
transfer consideration for the benefit of the owner. Simply defined,
CLI covers the contractor’s contractual assumptions of liability as
specified in a contract’s indemnity clause. The coverage is generally

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 restricted to those claims and associated defense costs for personal
injury, death, and damage to or loss of property, which may be
attributable to the owner’s negligence. CLI is designed to protect
the contractor first, unless he adds the owner as an additional
insured. (See Chapter 8 for further discussion of indemnity and its
linkage with Contractual Liability insurance and additional
insured status.)
Since CLI is an integral part of almost all CGL policies, it is provided
on an occurrence basis.

Automobile Insurance
This is coverage for injury to persons and damage to property caused
by the contractor’s owned or leased automobiles. It is typically
provided on an occurrence basis.

Workers’ Compensation Insurance

Often called Coverage A, it is typically required to meet the
requirements of worker protection laws that have been enacted in
most states and many countries. It is designed specifically to protect
workers employed by the contractor. It provides a statutory level of
financial compensation to the contractor’s workers for injuries or
death or, in some instances, certain illnesses arising out of the worker’s
employment with the contractor. It also limits the contractor’s liability,
to some degree, to his employees. Premiums for Workers’
Compensation are regulated by the states, as are the benefits paid to
claimants. It is typically provided on an occurrence basis.

Employer’s Liability Insurance

Often called Coverage B, this type of insurance provides protection
for the contractor in the event an injured employee makes a claim
arising out of employment with the contractor that is outside of the
specific defined coverage provided by the state-­required Workers’
Compensation insurance, Coverage A.
It’s been said that Employer’s Liability insurance coverage “fills in the
cracks” in Workers’ Compensation insurance coverage. It is typically
provided on an occurrence basis.

Builder’s Risk Insurance

This covers loss or damage to the work in progress during the course
of construction. Contractors may be required to provide this
insurance for the value of the work they are performing for the owner.
Owners may provide it, and pay its premium, to cover the total value

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of their project. As such, the protection it affords may be available to
all the contractors working on the owner’s project.
When Builder’s Risk insurance is provided by the owner, it’s important
for contractors to make sure that the value of the policy is kept up to
date with the value of the construction work. They must also make
sure the insurance is in place at the commencement of construction
activities and continues until the owner takes occupancy of the
project. Failure to keep up with this may leave the contractor
financially responsible for property damage without insurance.
Builder’s Risk is also typically provided on an occurrence basis.

Professional Liability/Errors &

Omissions Insurance
This insurance covers claims or losses caused by the contractor’s
professional errors or omissions. Probably the most typical use and
application of this type of insurance is to provide coverage for the
contractor’s design and engineering activities associated with a
construction project. It is typically provided on a claims-­made basis.

Transport Insurance
This type provides coverage for loss or damages to materials and
equipment while they are being transported from one place to
another. Typically provided on an occurrence basis.

Completed Operations Insurance

This covers claims for personal injury and property damage that
occur after the contractor has completed his work on the project,
demobilized, and left the job site.
Claims made under Completed Operations are usually related in
some fashion to faulty workmanship or materials and can be very
costly. If the insurance company can prove that the contractor knew
about the faulty workmanship or purposely used less than adequate
materials, it will likely not pay the claims, which may then have to be
paid out of the contractor’s pocket.
Typically required by owners as an addition to the contractor’s
Comprehensive General Liability insurance, Completed Operations
insurance is provided on an occurrence basis.

Travel Accident Insurance

This provides coverage for the contractor’s employees while they are
traveling on company business and is typically provided on an
occurrence basis.

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 Owner-­Provided Wrap-­up Insurance
Usually put together and purchased by owners of large construction
projects, it provides coverage for them and for the many different
engineers, main contractors, subcontractors, inspectors, suppliers,
and others working on the job site. All these other parties are named
as being insured under the policy.
This type of insurance typically covers claims associated with loss of
or damage to property, or injury or death to persons that occur on the
construction job site. It also sometimes covers Workers’
Compensation insurance requirements. Wrap-­up insurance can
lower the owner’s overall insurance cost for a large project, since it
takes the place of similar, overlapping, insurance coverage bought by
each engineer, main contractor, subcontractor, and others working on
the site. This method can reduce the insurance expense on large,
multi-­disciplined projects.
It’s important to understand what Owner-­Provided Wrap-­up
insurance covers and what it doesn’t. Contractors should ask to see
the details of its coverage, deductibles, and exclusions. While
wrap-­up insurance can be a good deal for the contractor, he may still
wish to provide additional insurance to cover his work if it doesn’t
cover all risks.
Wrap-­up insurance is also called an Owner-­Controlled Insurance
Program (OCIP). It typically covers just one project. A Rolling
OCIP (ROCIP) covers a series of the owner’s projects, rather than
just one. It is typically provided on an occurrence basis.

Contractor-­Provided Wrap-­up Insurance

Some contractors are now providing and managing their own
Contractor-­Controlled Insurance Programs (CCIP), which cover
all their subcontractors working on a project. This solves the problem
of some subcontractors having trouble getting or maintaining liability
and property insurance. It also allows the contractor to control the
safety program for the whole project. It is typically provided on an
occurrence basis.

Owner’s & Contractor’s Protective

Liability (OCP)
Purchased and provided by the contractor for the exclusive benefit
of the owner, this insurance names the owner as the insured and
beneficiary of the policy. The contractor can either pay the
premium for this policy or charge the owner for it, which may be
negotiated.

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An OCP covers the owner for claims against him for personal injury
and property damage incurred by third parties, as well as any
associated legal defense costs that arise out of the contractor’s
operations on the construction job site. It typically also covers claims
for the owner’s vicarious liability. Third parties in this instance would
include everyone (and all property) except the owner’s employees and
property.
OCPs are often provided by the contractor for the benefit of the
owner in lieu of adding the owner as an additional insured to the
contractor’s Comprehensive General Liability or other insurance
policies. Claims against an OCP would likely be charged to the
owner’s loss history, since the owner is the named insured, and likely
not against the contractor’s loss history. The contractor simply
purchases this type of policy for the owner’s benefit. OCPs are
typically provided on an occurrence basis.

Umbrella or Excess Liability Insurance

This type provides additional liability coverage for the
Comprehensive General Liability and automobile policies in the event
the occurrence or aggregate limits are exceeded on these policies.
Payment of claims under this type of coverage would not be made
until the limits of the basic, or underlying, CGL or auto policies were
exhausted. This type of insurance is typically provided on an
occurrence basis.

Business Interruption Insurance

This covers the contractor when there are construction delays due to
the covered risks (spelled out in the terms of the insurance policy). It
is designed to retain key employees on salary when work cannot be
performed. It can also cover the extra expense of obtaining rental
equipment if the contractor’s equipment has been damaged. This
type of insurance is typically provided on an occurrence basis.

Terrorism Insurance
Contractors will likely find that any type of coverage for acts of
terrorism is specifically excluded from their insurance policies. This
coverage can possibly be added, but will likely be very expensive.

Specialty Insurance
Many different and unusual risks can be covered to some extent by
specialty insurance policies—­for a price, of course. For example, it is
possible to purchase insurance to cover the contractor’s potential
exposure to liquidated damages, extended warranty time periods,

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 force majeure consequences, and political risk, to name a few. For
unusual risk situations, or for special insurance coverage required by
the owner, it is best to consult a professional insurance broker. Bear
in mind that such types of specialty insurance will likely be expensive
to procure.

Captive Insurance
A captive insurance program is an insurance program wholly owned
and controlled by its insured parties. The purpose of a captive
insurance program is to insure the various risks of its owners.
The owners of captive insurance programs put their own financial
resources at risk with respect to claims made against their captive
insurance program. Owners may also receive broader insurance
benefits that may be available on the commercial insurance market.

Subcontractor Default Insurance

Subcontractor default insurance (SDI) can be used by general
contractors to lessen the risk of a default by one of its subcontractors
on a project. It can be used as an alternative to a surety bond (see
Chapter 6, Assurances of Performance).
Sometimes a surety reacts slowly to a default claim. Since SDI is
insurance, the insurance program can react in a timelier manner to
resolve the default.
The deductible for an SDI policy can be very high.

Important The issues discussed in this section will come up time and time again
in a contractor’s negotiations on insurance for a construction
Issues contract. Some of these points can significantly increase the amount
Associated with of risk the contractor agrees to accept on a construction project, so
it’s important to understand them.
Insurance
Named Insured
Typically this is the company—­the contractor—­that purchases the
insurance policy, pays the policy premium, and assumes payment of
the policy deductible. The contractor would be the named insured on
the Comprehensive General Liability, automobile, and Workers’
Compensation policies, the three most common insurance policies
required by owners on a construction contract.
If the contractor purchases a separate Owner’s and Contractor’s
Protective Liability policy (OCP) for the benefit of the owner, then
the owner becomes the named insured on this type of insurance
policy.

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 Experience Ratings & Loss History
These are measures used by the insurance industry to assist in
determining the premium to charge a contractor for an insurance
policy. If the contractor is a safe worker and has had few or no accidents
injuring people or damaging property that have resulted in claims, then
his experience rating and loss history would tend to be low, which
would be reflected in lower premiums for his required insurance.
If the contractor is a not a safe worker, and has had some accidents
that injured people or damaged property (and resulted in claims),
then his experience rating and loss history would tend to be high.
This would be reflected in higher premiums for his required
insurance or, in the worst case, an inability to procure the required
insurance.

Additional Insured
A person or a company, other than the named insured to an
insurance policy, who can get some or all of the protection provided
by the policy is called an additional insured. Owners will often try to
require the contractor to add them as an additional insured on the
contractor’s Commercial General Liability insurance policy for their
construction project. Granting additional insured status to the owner
should not be taken lightly. The contractor assumes significant risk in
naming others to his insurance policies. (This issue is discussed in
more detail later on in this chapter.)

Deductible Amount
Granting additional This refers to the portion of any claim paid for by the named insured
insured status is to an insurance policy. For example, in a $1,000,000 Commercial
General Liability insurance policy with a $10,000 deductible, the
sometimes referred
named insured (the contractor) would pay the first $10,000 of a claim
to as free insurance
(the deductible), and the insurance company would pay the balance
for the owner. of the claim, up to the policy limit amount of $1,000,000.

Self-Insured Retention (SIR)

In practice, this is basically the same as the insurance policy’s
deductible amount. Some large, long-established contracting
companies may elect to set aside a reserve or establish some other
type of account to pay for insurance claims and deductibles. For
example, a large contractor may decide to self-insure the first
$250,000 of claims against his Commercial General Liability policy.
The contractor’s insurance company would provide insurance to
cover claims in excess of the $250,000. By electing to “self-insure”

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 the first $250,000, the contractor is attempting to lower his insurance
premiums. As an SIR, the contractor may elect to perform some of an
insurance company’s typical functions, like paying claims under a
certain amount.

Combined Single Limit

This is the maximum amount an insurance policy will pay for
combined injury to persons and property damage. For example, the
combined single limit on a contractor’s Comprehensive General
Liability insurance policy for injury to persons and property damage
might be $1,000,000. In the event of a $700,000 personal injury claim
and a $500,000 property damage claim, the insurance company would
pay only $1,000,000, which is the combined single limit of the policy.
This would leave a shortfall of $200,000, which would most likely
have to be paid by the contractor. Having umbrella or excess liability
coverage would benefit the contractor in this instance, as it could
provide coverage for the $200,000 shortfall.

Occurrence Limit
This is the maximum amount an insurance policy will pay for all
injury to persons, property damage, and medical expenses that arise
as the result of a single occurrence. Legal defense costs are usually
provided in addition to the stated occurrence limits, but contractors
should always check with their insurers on this.

Aggregate Limit
This refers to the maximum amount an insurance policy will pay for
all personal injury claims and property damage claims that may arise
as the result of multiple occurrences. Legal defense costs are usually
covered in addition to the stated aggregate limits, but contractors
should always check with their insurers on this. Contractors should
make sure the aggregate limit in their general insurance policies
applies separately to each project.

Waiver of Subrogation
Subrogation, a term that crops up all the time when determining
insurance requirements in a construction contract, can be confusing.
It refers to a waiver of the insurance company’s right to sue the owner
for recovery of money it pays the contractor for an accident caused by
the owner’s negligence. Essentially, in the insurance business,
subrogation is the legal right and procedure that allows company A
(the insurance company) to try and recover costs it paid to company
B (the contractor) for an accident caused by party C (the owner).

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 An Example
Suppose that an accident occurs on the contractor’s construction job
site and causes damage to the contractor’s property. It results in an
insurance claim being filed by the contractor under his Commercial
General Liability insurance in the amount of $100,000.
The accident was caused by the owner’s negligence. The insurance
company pays the contractor for the full value of the claim and
exercises its right to sue (subrogate against) the owner, the negligent
party causing the accident, to try to recover the $100,000 it paid to
the contractor.
Contractors are almost always required by the owner’s commercial
It’s best not to take terms in the construction contract to waive their insurer’s rights of
waiver of subrogation subrogation, especially with respect to Commercial General Liability
too lightly. Just like insurance. In the above example, if the contractor had waived his
any other contractual insurer’s subrogation rights under the Commercial General Liability
term or condition in a policy, then the insurer would not be able to sue the owner for
construction contract, recovery of the $100,000, even though the owner was negligent and
it is possible to put caused the accident. Insurers routinely allow the contractor to waive
limits on waiver subrogation, as long as the waiver is provided prior to a claim
of subrogation being made.
requirements. Contractors should be careful with agreeing to waive rights of
subrogation, especially if they have a large deductible or self-insured
retention on an insurance policy. In the event of a claim, the
contractor would be waiving his own legal right to recover
(subrogate) his deductible amount, which comes out of his pocket,
not from the insurance company or the negligent party. And if the
insurance company also can’t recover the funds it paid out from the
negligent party, then the contractor’s loss history will likely increase.
This means the potential of higher premiums in the future.

An Example
Suppose the contractor has to provide a $1,000,000 Comprehensive
General Liability policy for the owner’s construction project, and the
proposed contract terms and conditions require the contractor to
waive his insurer’s rights of subrogation. The contractor could
consider negotiating limiting language in the insurance section
similar to the following:

To the extent of the first $100,000 payable under Contractor’s Comprehensive

General Liability insurance policy, the insurance company providing this
insurance shall waive its rights of subrogation against Owner. This waiver
of subrogation shall not apply to the sole negligence of Owner.

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 What does this limiting language do for the contractor? If there were
an accident on the contractor’s construction job site caused by the
owner, and it resulted in a claim of $250,000 that was eventually paid
by the insurance company, then the insurance company could sue the
owner for recovery of any amount paid in excess of the first $100,000.
If the accident was judged to be caused by the sole negligence of the
owner, the full $250,000 could be recovered by the insurance
company in a lawsuit against the owner.
One of the significant benefits to the contractor here is that his loss
history would be less affected by the insurance company being able to
recover at least some of the amount of the claim it paid out. This is a
favorable condition for keeping the contractor’s future insurance
premiums down.
Another benefit is that if the accident were caused solely by the
owner’s negligence, then the contractor could recover his deductible
amount or self-­insured retention, and the insurance company would
recover the amount it paid out for the claim.
The contractor can accept, reject, or modify the owner’s requirement
in the construction contract for the contractor to waive his insurer’s
rights of subrogation. It’s just another commercial term among many
in the construction contract that is open to negotiation.

Care, Custody, & Control

Let’s say the owner procures an expensive piece of mechanical
equipment on his own and delivers it to the contractor’s storage yard
at the construction job site. The contractor is required to install this
piece of equipment as part of his construction contract with the
owner. After receipt of the equipment, the contractor now has what’s
called care, custody, and control of that piece of equipment. The
contractor needs to make sure that his insurance for the construction
project will cover a claim in the event of loss or damage to this
equipment while it is in his care, custody, and control.
Denial of coverage for damage to property of others that is in the
care, custody, and control of the named insured (the contractor) is a
frequent exclusion in insurance policies. The exclusion can be
removed in consultation with the insurer, probably for an increased
premium.
Care, custody, and control of another’s property is an area in which
the contractor’s CGL insurance policy will likely have a sub-­limit.
For example, a $1,000,000 CGL policy may have a sub-­limit of
$25,000 for property in the care, custody, and control of the
contractor. It is important to be aware of sub-­limits, as they can

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sneak up. The sub-­limit value of care, custody, and control can vary
greatly from project to project, and should be checked to be sure
that it is adequate.

Cross-­Liability
Often an insurance policy will insure two or more companies.
A cross-­liability clause requires the insurance company to protect
each insured company separately in the same manner as if a separate
insurance policy were in place for each company.
For example, when one of the insured companies causes a loss for the
other, the insurance company pays the claim to the company
incurring the loss. A cross-­liability clause requires the insurer to
protect each insured company separately.
However, even though there may be more than one insured company
under the insurance policy, the monetary limits for all claims will not be
increased. Cross-­liability is also referred to as severability of interest.

Primary & Non-­Contributory

These are two requirements that often appear in the insurance terms
and conditions in a construction contract.
1. Primary defines the first level of insurance and means that the
insurance provided by the insured (likely the contractor) will pay its
stated financial limits first (primary) with respect to any claim paid.
2. Non-­contributory means that the primary insurance will not
require the contribution (non-­contributory) of any other
­insurance that might be available (likely the owner’s) before it
pays its limits.

An Example
Let’s say the owner and contractor have similar insurance that
provides coverage for a claim arising out of the contractor’s work. In
the event of a claim, the contractor’s insurance will pay out first if
this primary and non-­contributory language is a part of the
insurance requirements in the construction contract between the
owner and the contractor.

Riders & Endorsements

These are special provisions to an insurance policy, which are noted
and separately attached to the policy. All insurance policies have a lot
of standard boilerplate language defining the basic terms and
conditions of the insurance contract, including coverage inclusions
and exclusions. Where special situations or circumstances need to be

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 defined or explained, or further additions and exclusions to the policy
coverage are required, then these are made a part of the policy by
adding a rider or an endorsement. This is exactly the same as adding
a special appendix or attachment to a construction contract
modifying certain terms and conditions or better defining work scope
or other contractual issues.
Insurance companies have standard wording for a variety of
endorsements modifying the basic coverage of their insurance
policies. Some are commonly referred to as ISO endorsements, short
for Insurance Services Office, Inc. (One of the services this company
provides is standardized language for insurance policies and
endorsements.)
Endorsements that are unique and contain special wording as agreed
on between the insurance company and the named insured are called
manuscript endorsements. Like any other contract, an insurance
policy (contract) can have modifications made to it to meet the
specific needs of the named insured.

Stacking
This is best illustrated by an example.
Let’s say a contractor agrees to provide a $1,000,000 Commercial
General Liability insurance policy for a construction project, and
also agrees to name the owner as an additional insured to the
policy. The contractor also agrees to indemnify the owner against
losses he may incur during the construction of the project for a
maximum of $1,000,000.
During the construction of the project, an accident occurs on the
contractor’s job site and the owner incurs a $2,000,000 loss. The
insurance company pays the owner $1,000,000, the limit of the
Comprehensive General Liability policy. Next, the owner claims an
additional $1,000,000 from the contractor under the terms of the
indemnity agreement in the construction contract.
By adding the maximum amount available under the indemnity to the
maximum amount from the insurance policy, the owner stacks the
available coverage of both to try to cover his total loss. Protection
against this type of stacking can be negotiated in the contract with
wording similar to the following:

The limit of the indemnity provided by Contractor shall be reduced by any

payments made under the Commercial General Liability insurance policy
provided by Contractor with Owner named as additional insured.

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 With wording like this, the owner gets $1,000,000 of coverage, either
through the insurance policy or by way of the indemnity agreement,
but doesn’t get the benefit of the sum of both.

Notification Provisions
All insurance policies require some form of formal notification
procedure in the event of a claim. Typically, there will be a time
period within which the insurance company must be notified that the
Stacking should be contractor has a claim to file with them. If the contractor fails to
avoided by careful notify the insurance company within the stated time period, then he
contracting. may be unable to file the claim and receive benefits of the policy.
Insurance policies, especially property policies, will usually require
that a proof of loss be filed within a certain period after a loss. The
proof of loss is the insured’s list of all damaged equipment or
property. Contractors should make this list as complete and
comprehensive as possible. It is much easier to adjust it down upon
the discovery that damage is not as significant as the contractor
thought.

Evidence of Insurance Certificate

This refers to an insurance company document to be given to the
owner stating the types and amounts of insurance provided by the
contractor. This document provides the owner with evidence that the
contractor has the insurance required by the construction contract. It
is not a copy of the contractor’s insurance policies.
As a general rule of thumb, contractors should resist providing copies
of their insurance policies to owners. Why? Let’s say the contractor
has a $5,000,000 Commercial General Liability policy in place that
will cover all his construction activities in the United States. The fact
that the contractor has this amount of insurance in place should be
considered a confidential matter. If an owner requires only $1,000,000
of Commercial General Liability insurance for a project, then the
contractor’s insurance company will provide the owner with an
evidence of insurance certificate showing this amount. As long as the
certificate proves that the contractor has the $1,000,000 of
Commercial General Liability as required by the owner’s construction
contract, then that’s all that needs to be shown on the certificate of
insurance.
In the event that there is a claim and lawsuit against the contractor’s
Commercial General Liability policy, it’s best that the maximum
limits of the policy are not generally known or advertised to others.
It’s best if only the contractor knows how deep his pockets are.

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 Additional Granting the owner additional insured status is an extremely
important insurance issue and cannot be taken lightly by the
Insured Status contractor. Contractors need to completely and fully understand the
commercial risk and potential financial consequences associated with
adding the owner as an additional insured to their insurance policies.
Contractors should realize that receiving additional insured status on
the contractor’s insurance policies is one of the most important risk
transfer mechanisms desired by owners.

Why Is Additional Insured Status Wanted

by Owners?
Owners would like to transfer as much project risk as possible to the
contractor, regardless of whether the owner is negligent or otherwise
at fault with respect to claims arising out of that risk. The main risks
that the owner would like to transfer are associated with his own
liability to third parties for negligent or wrongful acts resulting in:
1. Claims involving personal injury or death
2. Claims involving damage to property
3. Legal defense costs associated with defending the above claims
Owners most typically try to transfer these risks to contractors in two
ways:
1. Through indemnity agreements contained in the construction
contract for the project, and/or,
2. By requiring the contractor to name the owner as an additional
insured on the contractor’s CGL insurance policy, and further
requiring that the CGL policy provide for contractual liability
coverage.
Because (in most instances) the contractor will resist voluntarily
complying with the owner’s indemnity claims, the owner will likely
find it difficult or impossible to collect under the contractor’s
indemnity obligations without going to court. Also, the contractor
may not have the resources to cover the financial consequences of a
claim he may be responsible for under an indemnity agreement. The
contractor could also go bankrupt and be unable to perform the
obligations under the indemnity agreement.
Therefore, the preferred risk transfer mechanism for the owner is to
be named as an additional insured on the contractor’s CGL policy,
which includes contractual liability coverage. This way, the owner can
get his defense costs paid by the contractor’s insurer, who will also
pay claims up to the contractually required policy limits. The
contractor’s insurer may, in addition, have to pay claims that arise

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 from the contractor’s obligations as stated in the construction
contract’s indemnity agreement. The contractor’s personal
willingness or financial ability to defend against a claim (or pay for a
claim from his own resources) is not an issue now; the contractor’s
insurance company will foot the bill.

Additional Following are commonly asked questions regarding insurance

terminology.
Insurance • Who is the named insured? This refers to the owner of the
Basics insurance policy and the organization or individual who pays the
premium and deductible for the insurance—­in this case, the
contractor.
• Who is an additional insured? This is another organization(s)
or individual(s) who can claim some rights and benefits of the
named insured’s (the contractor’s) insurance policy, but does not
pay the premium and deductible. Typically, the additional
insured is the owner, but may also be other individuals and
organizations that are closely associated or affiliated with
the owner
• Who is an additional named insured? This may be an affiliated
company of the contractor who may share in paying the
premium and deductible for the insurance policy with the
contractor. It is not the same as an additional insured.
• What is an endorsement? An addition to the standard insurance
policy terms and conditions. The written terms and conditions
of the endorsement may modify, limit, add, or take away certain
insurance coverage provided in the standard insurance policy’s
terms and conditions. Endorsements help tailor the insurance
coverage to meet the specific needs and requirements of the
person or firm that owns the insurance policy, the named
insured. An endorsement is also called a rider. Additional
insured status for an owner may be automatic under some
policies, or it may be conferred in other policies by an
endorsement to the contractor’s CGL and other insurance
policies.
• What type of insurance is most commonly sought by the
additional insured? Coverage under the contractor’s
Commercial General Liability insurance policy as an additional
insured. The contractor’s CGL insurance can provide the owner
with coverage for claims for its legal liability for injury or death
to persons, including death of persons, and property damage. It
also covers the owner’s legal defense of such claims. An owner
can be named as an additional insured to other contractor’s

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 insurance policies, such as automobile insurance, and even the
contractor’s umbrella or excess policies.
• How is additional insured status obtained by the owner? The
owner’s construction contract will have a clause, usually under
the insurance requirements section, which might read simply as
follows:

Contractor shall name Owner as an additional insured on Contractor’s

Commercial General Liability policy.

Such wording makes it a contractual obligation for the

contractor to name the owner as an additional insured on his
CGL policy Failure to add the owner as an additional insured, or
to add the owner as an additional insured on terms and
conditions other than as may be specified in the owner’s
contract, can place the contractor in breach of contract.
• What has to happen in order for the owner to benefit from
being an additional insured? First, an accident must occur on
the construction job site that results in personal injury or
property damage. Next, a claim or lawsuit needs to be made
against the additional insured (the owner) for damages resulting
from the personal injury or property damage. Next, the
additional insured (owner) files with the contractor’s insurance
company to defend them against the claim and pay any resulting
award of damages.

Nine Key Issues Associated with Additional

Insured (AI) Status
There are a number of technical and commercial issues associated
with granting additional insured status to the owner. It’s important
that contractors take the time to understand these issues to assist
them in negotiating to eliminate or otherwise limit the serious
commercial risk associated with granting additional insured status.
1. Generally, an AI (the owner) is provided insurance coverage only
for what is called the vicarious liability of the AI (the owner)
for claims that are attributable to the acts or omissions of the
named insured (the contractor). This is the typical position of
the insurance companies who provide additional insured
coverage.
Vicarious liability is imposed by law on the owner simply
because of the relationship between the owner and the
contractor. In the construction business, this relationship is

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typically established by the construction contract, as the
contractor is working for the owner, building something.
Even though the owner was not involved in any way in causing the
accident that occurred on the job site, and which caused the injury
and subsequent claim, the owner still has a liability for the claim
because the law imputes (imposes) that liability on him based on
the owner/contractor relationship. This relationship is like an
employer/employee relationship as far as the law is concerned. An
employer (the owner) is generally responsible for the negligent
actions of its employees (the contractor) that take place in the
course of their employment (building the construction project).
Legal issues related to the supervision of the contractor by the
AI (the owner), the degree of the owner’s control over the
contractor’s work, and the owner’s maintaining a safe workplace
underlie this employer/ employee relationship and vicarious
liability legal concept.

An Example
A contractor’s employee is injured by a falling piece of metal on
the contractor’s job site. The employee’s only recourse against the
contractor is a claim limited by the prevailing state Workers’
Compensation laws. Not satisfied, the injured employee now files
a claim against the owner based on the owner’s vicarious liability,
claiming perhaps that the owner failed to properly supervise the
contractor. This type of claim by an employee of the contractor
against the owner is called a third-­party over action. The
employee, a third party (someone not signatory to the contract),
goes above the contractor he is working for and sues the owner.
If the owner was named as an AI on the contractor’s CGL, the
owner would look to the contractor’s insurance company to first
defend against the claim, pay for the cost of the legal defense,
and then pay out any damages (up to the insurance policy limits
required by the construction contract) if a settlement is reached
or damages are awarded by a court.
The bottom line here is that the contractor’s insurance company will
have to pay for the cost of the owner’s legal defense, and reimburse
the owner for any damages he is required to pay (up to the insurance
policy limits required in the construction contract). This will
certainly affect the contractor’s insurance experience rating. As a
result of this claim, the contractor’s future premiums for similar
CGL insurance will likely increase. The insurance company could
even elect not to renew—­or even cancel—­the contractor’s CGL
policy because of what it now considers a poor experience rating.

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 2. Generally, the AI (the owner) is not provided insurance coverage for
claims for accidents associated with the contractor’s work that are
the result of the AI’s (the owner’s) sole negligence. This is the typical
position of the insurance companies who provide AI coverage.
AI coverage is likely available to the owner for claims for
accidents associated with the contractor’s work that are the
result of some contributory form of negligence of both the AI
(the owner) and the contractor. Insurance coverage available to
the owner in this situation will cover the owner’s proportionate
liability to the degree of negligence attributable to the owner as
determined by a court or through some negotiated settlement.
The language in the endorsement providing AI status may
include or exclude claims that are attributable to all or some of
the AI’s (the owner’s) own negligence. The wording of the
endorsement providing AI status to the owner is important.
(See issue number 9.)
3. The contractor’s insurer has an obligation to defend the AI (the
owner) in the event of a claim against the owner and to pay for
the costs of the legal defense. This is an extremely important risk
transfer strategy of owners, and perhaps the main reason owners
want to be covered as an additional insured on a contractor’s
CGL policy.
In the first instance, legal defense costs associated with a claim
must be paid, and who better to pay them (at least from the
owner’s standpoint) than the contractor’s insurance company.
Legal defense costs can be significant for a complex and lengthy
construction-­related claim that is somehow attributable to the
contractor’s work. It is possible a claim against an owner could
be denied by the court, but the owner’s legal defense costs will
have to be paid, regardless.
It’s better from the owner’s perspective to be an additional
insured and have the contractor’s insurance company pay these
costs rather than having them paid by the owner’s insurance
company or out of the owner’s own financial resources.
The contract of insurance between the named insured/
additional insured (contractor and owner) and the insurer
(contractor’s insurance company) requires the insurer to defend
a named insured (the contractor) or an additional insured (the
owner) in the event of a claim that may be covered by the
insurance policy.
4. When does the insurance coverage provided to an AI (the
owner) cease? Does insurance coverage extend to completed

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 operations for claims that may be attributable to the contractor’s
work after it is completed and the contractor has left the job
site? Or is AI coverage only for claims that are attributable to the
contractor’s work during the course of construction (prior to
completion) and while the contractor is working on the job site?
The general position of the insurance companies is that
completed operations coverage is not provided to the AI unless
specifically added in the AI endorsement. Again, wording of the
AI endorsement is critical. (See issue number 9.)
5. If the contractor is considered an independent contractor
(which may be so stated in writing in the contract), then
insurance coverage for claims for the vicarious liability of the
owner may not be available to the AI (the owner). However, it is
likely that defense coverage would be available from the insurer
to help the owner prevail on the defense of that claim.
What’s going on here? The owner hires an independent
contractor to produce specified results. In theory, the owner
simply stands back and does not exercise any degree of direct
control over the manner in which the contractor performs all
aspects of the work and ultimately achieves the desired
result—­the owner’s finished construction project. The
contractor performs the work in accordance with terms of the
construction contract and without any direct control over the
work by the owner, so perhaps there is no employer/employee
relationship in effect.
If there is no employer/employee relationship (and theoretically
there is none with an independent contractor), then the owner
can’t have any vicarious liability, or insurance coverage for
claims for vicarious liability. That seems to be the theory,
anyway. Contractors should definitely check with insurance
professionals on this matter.
This AI issue is definitely complex. The underlying theory seems
to follow logic similar to the following:
• As an AI on the contractor’s CGL policy, the owner expects
insurance coverage for third-­party over actions that base
their claim on some form or degree of owner’s vicarious
liability arising from the employer/employee (owner/
contractor) relationship.
• The construction contract with the owner clearly states in
the commercial terms and conditions that the contractor is
an “independent contractor.”
• As an “independent contractor,” the owner does not in
theory exercise, for example, any degree of control or

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 general supervision over the contractor; the owner simply
hires the contractor to produce a certain result.
• Since there is no control or general supervision of the
contractor (implied from the term “independent
contractor”) by the owner, there can’t be any vicarious
liability of the owner.
• Since, as the logic goes, there can’t be any vicarious liability
on the part of the owner in this situation, the contractor’s
insurance company may contend that it provides no
coverage of the claim for the owner as AI.
6. Is the insurance provided to the owner by the additional
insured endorsement primary or excess to the owner’s
­insurance? If the insurance coverage provided to the owner by
an AI endorsement on the contractor’s CGL policy is
­considered primary, then the contractor’s insurance policy
would pay for claims up to the required policy limits in the first
instance. The owner’s insurance would pay for the balance of a
claim (up to its policy limits) only after the contractor’s
­insurance limits were exhausted.
If the insurance coverage an AI endorsement provides is
­considered excess, then the contractor’s insurance policy would
pay the balance of the claim (up to its required policy limits)
only after the owner’s own insurance limits are exhausted.
Example of primary: The construction contract requires an
owner to be an AI on a contractor’s $1,000,000 CGL policy. The
contractor’s insurance is required by the construction contract
to be primary. A claim against the owner in the amount of
$1,500,000 is made. It is found to be covered by the AI coverage
under the contractor’s CGL policy. Since the contractor’s
­insurance is considered primary, his insurance will pay the first
$1,000,000 (the required policy limits), and the owner’s
­insurance company will pay the excess, which is the balance of
the claim, or $500,000, subject to the owner’s deductible.
Example of excess: The construction contract requires the
owner to be an AI on a contractor’s $1,000,000 CGL policy. The
contractor’s CGL insurance is required by the construction
contract to be excess as a result of the contractor’s good
­negotiating skills. A claim against the owner in the amount of
$1,500,000 is made and settled. The owner is entitled to the AI
coverage under the contractor’s CGL policy. Since the
­contractor’s insurance is considered excess, the owner’s
­insurance pays the first $1,000,000 (the owner’s policy limits),

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 subject to the owner’s deductible, and the contractor’s insurance
company pays the excess, which is the balance of the claim, or
$500,000.
Who pays the owner’s legal defense costs in this excess example?
It may be the owner regardless of the primary or excess issue, or
perhaps the owner’s and contractor’s insurance companies
would share the defense costs in some negotiated arrangement.
Negotiating AI coverage as excess is a way for the contractor to
reduce the possible effect a claim can have on his insurance
experience rating, premiums, and future ability to secure
insurance.
7. How many parties may be afforded additional insured status on a
contractor’s CGL policy? There will always be at least one party
required in the contract to be named as an additional insured,
typically the owner. Naming the owner as AI is the common
requirement found in the insurance section of the owner’s
construction contract. However, the owner’s construction
contract may require that, in addition to the owner, the owner’s
project manager, engineer, parent company, or employees,
agents, and representatives, for example, all be included
separately as additional insureds on the contractor’s CGL policy.
It’s risky enough to add the owner as an additional insured on
the contractor’s CGL policy, but to add an unknown group of
extra people over which the contractor has little or no control is
just inviting them to help themselves to the insurance coverage
bought and paid for by the contractor.
Remember that everything in a contract is negotiable.
Contractors don’t have to add the owner as an AI (or anyone
else, for that matter), regardless of what the owner might want.
It’s all a matter of negotiations with the owner as to whether AI
status is granted, and if it is, who is included as an AI.
8. The contractor’s CGL policy deductible is always at risk. In
order to keep insurance premium costs down, a contractor may
elect to have a larger than normal deductible, or self-­insure, as
it’s often called, to cover the first part of a claim.
If a claim is made against the owner, and the owner is an
additional insured on the contractor’s CGL policy, the
deductible portion of that claim may have to be paid out of the
contractor’s pocket, with the contractor’s insurance company
paying the balance of the claim up to the required policy limits.
For contractors with large policy deductibles, this is a serious
risk, with potentially serious financial consequences.

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 9. The specific wording of the additional insured endorsement in
the contractor’s CGL policy that provides legal defense and
breadth of insurance coverage of claims is important. However,
the critical issue is not so much the wording of the actual AI
endorsement, but rather the wording in the owner’s
­construction contract that requires the owner to be named as an
­additional insured. The wording of the AI endorsement can’t
change, amend, or supersede the AI requirements specified in
the contract. The contractor is obligated to provide AI coverage
exactly as specified in the contract’s commercial terms and
conditions. Failure to provide AI coverage as specified in the
contract may place the contractor in breach of contract.

Insurance Services Organizational AI Forms

Standardized wording for different types of common insurance
policies, like the Commercial General Liability policy, and for their
optional endorsements, like the additional insured endorsement, are
provided to many insurers in the U.S. by the Insurance Services
Organization Inc. (ISO). For example: ISO provides a form called CG
20 10 11 85, which is the November, 1985 (11 85) edition of the
additional insured endorsement (CG 20 10) for Commercial General
Liability insurance policies. The title of this common ISO AI
endorsement form is “Additional Insured – Owners, Lessees, or
Contractors – Scheduled Person or Organization.” This endorsement
may be used when a contractor elects to schedule a specific owner as
an AI and also specifically schedules the associated construction
project.
Interpretation of the wording on these standard ISO AI forms has
been the subject of many court rulings in the U.S. Not surprisingly,
different courts in different jurisdictions have made creative rulings
on what the wording in the AI endorsement includes or excludes in
the way of coverage for the AI. Some of these rulings appear to
benefit the contractor, while others appear to benefit the owner. Not
many seem to benefit the insurance industry.
Although there are over 30 additional insured endorsements available
to the construction industry in a standardized format from ISO, the
following five are most likely to be encountered by a construction
company.
1. ISO CG 20 10 11 85: Wording in this AI endorsement
includes the broadly interpreted words, “arising out of (named
insured’s—­the contractor’s) work.” It also has been interpreted
to include very broad defense and claims coverage for the
owner, which will likely include completed operations

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 c­ overage and may even include claims attributable to the sole
negligence of the AI (the owner). Contractors should note that
because of the broad coverage provided to an AI under this
endorsement, it is not readily available anymore from
insurance companies. The caution for contractors is that if
this particular ISO endorsement is specified in an owner’s
construction contract, and the contractor is not able to get his
insurance company to supply it, he therefore may find himself
in breach of contract.
2. ISO CG 20 10 10 93: Wording in this AI endorsement includes
the broadly interpreted, “arising out of (named insured’s—­the
contractor’s) ongoing operations.” This revised wording is an
attempt to exclude completed operations coverage for the AI.
3. ISO CG 20 10 03 97: Revised wording in this AI endorsement
also includes the broadly interpreted “arising out of (named
insured’s—­the contractor’s) ongoing operations,” and the
­additional revised wording is an attempt to exclude completed
operations coverage for the AI.
4. ISO CG 20 10 10 01: Coverage is provided for claims that arise
during the “ongoing operations of the named insured (the
contractor).” Includes a list of exclusions to better define that
completed operations coverage is not provided, and is more
specific. The intent is to cover only those claims that arise
during the period of the on-­site construction.
5. ISO CG 20 10 07 04: Coverage is provided to the AI (the owner)
for claims that arise from the “acts or omissions of (named
insured—­the contractor) in the performance of (named
insured’s—­the contractor’s) ongoing operations.” No coverage is
provided for the sole negligence of the AI (the owner), or
completed operations. The intent is to cover only those claims
that arise during the period of the on-­site construction.
6. ISO CG 20 10 04 13. Similar to the 07 04 edition in 5 above, but
with the following limiting conditions:
“1. The insurance afforded to each additional insured only
applies to the extent permitted by law.”
“2. If coverage provided to the additional insured is required by
contract of agreement, the insurance afforded to such additional
insured will not be broader than that which you are required by
the contract or agreement to provide such additional insured.”
“3. If coverage provided to the additional insured is required by
contract or agreement, the most we will pay on behalf of the
additional insured is the amount of insurance: 1. Required by the

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 contract or agreement, or 2. Available under the applicable
Limits of Insurance shown in the Declarations, whichever is less.”
7. ISO 20 10 12 19. The same as 04 13 edition in 6 above, except
that C.2. was revised to read: “Available under the applicable
limits of insurance.”

Additional Insured Endorsements

for Completed Operations
Additional insured status for Completed Operations was included by
a new form ISO 20 37 10 01, followed by the 07/04, 04/13, and 12/19
editions.
The language and coverage in these three editions of ISO 20 37 for
completed operations are the same as the language and coverage in
the corresponding ISO CG 20 10 10/01, 07/04, 04/13, and 12/19
editions.

Manuscript AI Endorsements
The contractor or owner can also elect to use what is called a
manuscript endorsement to add the owner as an AI to the
contractor’s CGL policy. A manuscript endorsement is written by
either the owner or the contractor for the specific construction
project and adopted by the insurer. It is not made in a standardized
format, such as that used in the standard ISO AI endorsements
examples noted above.
A manuscript AI endorsement may contain any additional insured
requirements or limitations that meet the insurance needs of either
or both parties. It could also be written to include the provisions of a
standard ISO AI endorsement as a base, plus any other provisions,
limitations, or additions the owner and/or the contractor choose to
agree upon.
Contractors should note that a manuscript AI endorsement can be
developed by either the owner or the contractor. A contractor may
elect to add an owner as AI to his CGL policy, but only under the
negotiated terms of a manuscript AI endorsement developed by the
contractor, or developed through negotiations with the owner.
When using a manuscript AI endorsement, it is best to have the
specific terms of the AI endorsement contained, or referenced, in the
insurance section of the construction contract, or otherwise included
as an attachment to the construction contract. This ensures that what
is provided by the contractor’s insurance company in the way of AI
coverage is what was actually negotiated and/or agreed to by the
owner and the contractor.

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Wording AI Endorsements Carefully
Let’s take a look at the following two examples of how an owner
might require the contractor to add him as an additional insured to
the contractor’s CGL policy.

Additional Insured (AI) Example 1

Article 45 – Insurance
45.1 Contractor shall add Owner as an Additional Insured to Contractor’s
Commercial General Liability insurance policy.

Additional Insured (AI) Example 2

Article 45 – Insurance
45.1 Contractor shall add Owner as an Additional Insured to Contractor’s
Commercial General Liability insurance policy per ISO Form CG 20 10 11 85.

There is a big difference in the commercial risk to a contractor in the

requirements of these two seemingly similar insurance requirements
for AI status. In the first example, the contractor could arguably
comply with the obligation under the construction contract by using
any standard ISO AI endorsement. He could even elect to provide a
highly limited manuscript endorsement that mandates that his
deductible be paid by the owner, completed operations coverage be
excluded, and AI insurance coverage be considered excess over the
owner’s primary insurance.
In the second example, the contractor has no choice but to provide
AI insurance coverage in accordance with the terms of ISO AI
endorsement CG 20 10 11 85. This broad-based AI coverage calls for
completed operations coverage and likely covers those claims that
arise out of the owner’s sole negligence. If the contractor provides AI
insurance coverage in some form other than as required by this
contract clause, he risks being in breach of contract.

Some Final Comments on Additional

Insured Status
Being named as an additional insured on the contractor’s
Comprehensive General Liability policy is a good deal for the owner.
It’s important for the contractor to fully understand the consequences
of agreeing to it, as the results could be disastrous. It’s also important
to remember that just because the owner requests being named as an

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 additional insured, it doesn’t mean the contractor has to agree. The
owner always has other insurance options available to him to
purchase.
When the owner is named as an additional insured to contractor’s
CGL policy, the contractor is giving him the benefit of the protection
afforded by that policy at no cost to the owner. Free insurance! Now,
that’s a good deal for the owner!
When the owner is named as an additional insured on contractor’s
CGL policy, he may be able to make a claim under that policy for an
accident on the job site completely unrelated to the contractor’s own
work. That’s also a great, free deal for the owner! Furthermore, the
contractor risks losing control of the claims process, as the insurance
company is obligated by the terms of the policy to deal directly with
the owner as an additional insured, not the contractor. Whenever the
contractor loses control of the claims process, it will cost him.
If the contractor also agrees to waive his insurance company’s rights
of subrogation, then the insurance company will be unable to use the
legal process (subrogation) to try to recover the claim money from
the owner (the additional insured) even if the accident were actually
caused by the owner’s negligence. The owner doesn’t have to use his
own insurance policy to cover a claim in this case, and the contractor
may even have to pay the deductible.
When the owner is named as an additional insured to the contractor’s
CGL policy, the insurance company must pay the owner for a claim.
Since the claim was made under the contractor’s insurance policy, his
loss history is affected, and his future insurance premiums will likely
increase. The insurance company could even refuse to provide
insurance on future work.
In summary, adding the owner as an additional insured to the
contractor’s CGL policy significantly increases the risk a contractor
takes on a construction project. The contractor doesn’t receive any
payment for taking this additional risk. The risks are increased
insurance premiums or cancellation of the contractor’s insurance policy.

Anti Additional Insured State Statutes

The following 8 states outlaw additional insured status in
construction contracts

Texas Kansas Montana

New Mexico Oklahoma Oregon
Utah Colorado

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State statutes that outlaw additional insured status.
1. Texas Insurance Code §151.001
2. Colorado Revised Statutes §12-­21-­111.5(6)(b)
3. Kansas Statutes Annotated 16-­121(c)
4. Montana Code Annotated §28-­2-­2111
5. New Mexico Statute §56-­7-­1
6. Oklahoma Statute §15—­221(b)
7. Oregon Revised Statutes §30.140
8. Utah Code Annotated §13-­8-­1
The text of these statutes is available through an online search. Also,
there is a lot of commentary available online regarding issues with the
requirement to provide additional insured status in construction
contracts.

How to Deal with an Owner’s Demand for Additional

Insured Status
There are four ways a contractor can deal with an owner’s request to
be added as an additional insured:
1. Encourage the owner to buy his own separate, project-­specific
CGL policy to meet his insurance requirements.
2. Purchase a project-­specific Owner’s and Contractor’s Prot­
ective Liability (OCP) policy for the owner and charge him
for it.
3. Negotiate wording in the construction contract significantly
limiting the owner’s use of the policy and its benefit to him as an
additional insured.
4. Negotiate the use of, for example, an ISO AI standard
endorsement that is less broadly worded and more restrictive for
coverage provided.
Also, if the owner is ultimately added as an additional insured, he
should agree to pay for the policy’s deductible in the event he files a
claim. (Otherwise, the contractor would have to pay the policy
deductible.) This is fair because in most situations where the owner
provides wrap-­up or builder’s risk policy with the contractor named
as an additional insured, he will require the contractor to pay the
policy deductible for claims paid.
In the event the contractor must agree to provide additional insured
status to the owner on his CGL policy, then he should try to negotiate
wording that limits the coverage to accidents that are related to his
work only. This won’t completely eliminate the risk associated with

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 a claim made by the owner, but may minimize it. An example of
Like all other typical wording that might be agreed to in the construction contract
provisions in a is as follows.
contract, commercial
terms and conditions
associated with Contractor will name Owner as additional insured on Contractor’s
Comprehensive General Liability insurance policy for the liability of Owner
granting the owner only with respect to Owner’s general supervision of Contractor’s ongoing
additional insured work, and only while Contractor is physically present and working at the job
status are negotiable. site. The policy shall have a deductible of $20,000 per occurrence and limit
of $1,000,000 per occurrence and in the aggregate. Owner agrees to be
With respect to responsible for and pay the deductible portion of any claim made by Owner.
granting insured Owner also agrees that this coverage, including the payment of any defense
status to the owner, costs, will satisfy and offset any indemnification obligation of Contractor
contained in the contract.
contractors need
to ask themselves
if they are in the
construction Agreeing to the above sample wording or something similar won’t
business, or if they completely eliminate the risk associated with having an owner file a
claim under the contractor’s CGL insurance policy. However, it can
are in the insurance
help limit the exposure to events that are strictly related to the
business.
contractor’s work and occur or arise only during the time the
contractor is working on the job site. The owner can’t use this policy
coverage to make claims for events unrelated to the contractor’s work
or that take place away from the site, before the contractor arrives, or
after he leaves the site. This is an important consideration on large,
multi-disciplined projects that have construction activities occurring
over a prolonged period of time and with multiple engineers,
suppliers, inspectors, contractors, and subcontractors working
for the owner.

A Typical It’s helpful to take a look at a typical clause in a construction contract

and break it down to better understand its requirements, and
Insurance therefore, be able to take some action to limit unnecessary or
Clause in a excessive risk.

Construction Each of the subarticles in the following example are accompanied by

explanatory notes (i.e., See Note 1) that follow the example. These
Contract notes provide analysis of the individual subarticles, and some offer
suggestions for negotiating changes to the wording to lower the
contractor’s commercial risk.

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A Negotiating Tactic for the Elimination
of Additional Insured Status
Here’s something to consider when negotiating additional insured
status: make it conditional.
Take a look at the below example language that might be negotiated
to be included in the final contract’s commercial terms and
conditions:

It is agreed and understood that the Contractor’s obligation to provide

additional insured status is contingent on the Contractor being paid on time
and in accordance with the Contract’s payment terms. In the event the
Contractor is not paid on time, or not in accordance with the Contract’s
payment terms, the obligation to provide additional insured status is
immediately deemed null and void.

Just remember, everything about a construction is negotiable, as long

as it is not illegal. It is certainly not illegal to have a conditional
obligation in the final construction contract.
A Contractor could also consider using similar language to make a
broad or intermediate form indemnity in the Contract a conditional
obligation.

Why Do Owners Want Additional

Insured Status?
The following issues are from an Owner’s perspective on why they
would like to be named as an additional insured on the Contractors
General Liability insurance policy.
1. Having someone else’s insurance pay a claim and provide
defense (i.e. the Contractors’), the Owner’s own insurance
experience rating that affects the Owner’s insurance premium is
not affected.
2. The Owner likely can avoid paying from his own self-insured
retentions (a self-insured retention is like a large insurance
policy deductible).
3. The Owner receives insurance coverage that, perhaps, it may
not have or be able to obtain.
Bottom line: Additional insured status is a very, very good deal for the
Owner and a lousy deal for the Contractor who agrees to provide this
coverage.

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 Article 20 – Insurance Requirements
20.1 Contractor shall purchase and maintain at his own expense the
following minimum insurance covering the Work to be performed by
Contractor under this Contract. (See Note 1.)
20.1.1 Workers’ Compensation and Employer’s Liability Insurance. Contractor
shall provide Workers’ Compensation insurance, including occupational disease, as
required by the applicable laws, and Employer’s Liability insurance with a limit of not
less than $1,000,000 per occurrence. Contractor shall provide a waiver of subrogation
in favor of Owner for the Employer’s Liability insurance. The insurance provided shall
provide coverage for liabilities under the U.S. Longshoremen and Harbor Workers’
Compensation Act and the Jones Act, if applicable. (See Note 2.)
20.1.2 Automobile Insurance. Contractor shall provide automobile insurance
for all owned, non-owned, hired, or leased vehicles. Such insurance shall have a
combined single limit of not less than $1,000,000 per occurrence for bodily injury
and property damage. (See Note 3.)
20.1.3 Comprehensive General Liability Insurance. Contractor shall provide
Comprehensive General Liability insurance for bodily injury and property
damage with a combined single limit of not less than $2,000,000 per occurrence.
Such insurance shall also provide coverage for:
a.) Premises and Operations
b.) Underground Explosion and Collapse (XCU)
c.) Products and Completed Operations
d.) Broad Form Blanket Contractual
(See Note 4.)
20.2 Builder’s Risk Insurance. Owner will provide Builder’s Risk insurance
for damage to Owner’s property. Contractor will be named as an insured and will
be responsible for the policy deductible of $10,000. (See Note 5.)
20.3 Owner shall be named as an additional insured on Contractor’s
Comprehensive General Liability insurance. Such insurance shall include the
cost of defense, shall be primary and non-contributory to any other insurance
available to Contractor, shall provide a waiver of subrogation in favor of Owner,
and shall contain a cross-liability or severability of interests clause. (See Note 6.)
20.4 Within 15 days after notice of award of this contract, but prior to any work
being performed, Contractor shall provide for Owner’s approval and acceptance,
certificates of insurance evidencing that the insurance required by this contract
has been obtained and is in full force and effect. (See Note 7.)
20.5 Owner reserves the right to request from Contractor original or certified
copies of insurance policies and endorsements for all insurance required to be
provided by Contractor under this contract. (See Note 8.)
20.6 All insurance required by this contract shall remain in full force and effect with
full policy limits applicable to the work to be performed under this contract and shall
provide for not less than thirty (30) days written notice to Contractor prior to the
effective date of any cancellation or material change of the insurance. (See Note 9.)
20.7 Any self-insured retention or deductible applicable to any policy shall be
satisfied at the sole expense of Contractor. (See Note 10.)

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At first glance, this typical insurance clause requirement looks pretty
straightforward and doesn’t seem to have unrealistic financial limits.
Looks can be deceiving. The following notes contain an analysis of
these insurance requirement clauses as they might apply to a
construction project. Suggestions are provided on how to reduce the
risk the contractor might otherwise have accepted without any
changes, limitations, or deletions.
Note 1: The only consideration here is the reference to minimum
insurance. Contractors can’t buy minimum insurance. Insurance
policies come in fixed amounts of coverage with fixed maximum
limits. It’s best to delete the word “minimum.” Owners would love to
be able to have stated minimum insurance coverage in the
construction contract, with no maximum applicable, particularly
insofar as they are an additional insured.
Note 2: This is a standard requirement to provide Workers’
Compensation insurance and Employer’s Liability insurance with a
typical financial limit. Note that the owner wants the contractor to
waive his insurer’s subrogation rights. The contractor can do this as
long as he understands that in the event the owner is responsible for
a claim under employer’s liability, then his insurer will subsequently
not be able to recover any money from the owner that is paid out for
claims that arose from the owner’s negligence. The Jones Act
provides coverage for sailors employed on American vessels. If the
contractor’s project is on or near the water, then he should check to
determine if the U.S. Longshoremen and Harbor Workers’
Compensation Act and/or the Jones Act apply. (The U.S.
Longshoremen and Harbor Workers’ Compensation Act provides for
the payment of compensation and medical benefits for the disability
or death of an employee engaged in maritime employment.)
Coverage for U.S. Longshoremen and Harbor Workers’
Compensation and the Jones Act must be added by endorsement to
the contractor’s Workers’ Compensation Insurance. If this type of
coverage is required, contractors need to advise their insurers so the
coverage is actually provided.
Note 3: This is a standard requirement for automobile insurance.
Contractors would probably want to revise this paragraph to read:
“$1,000,000 per occurrence and in the aggregate.” Contractors can’t
buy insurance without some aggregate limit to the amount of claims
that the insurer will pay out.
Note 4: A standard requirement for Comprehensive General Liability
insurance. Contractors would want to revise this paragraph to read:
“$2,000,000 per occurrence and in the aggregate” for the same reason

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 as noted above under automobile insurance. Additional coverage
required in the CGL policy:
• Premises and Operations: for claims arising out of premises
owned, rented, leased, or used by the contractor and for his
operations at the construction site.
• Underground Explosion and Collapse (XCU): for claims
arising from explosion, collapse, or damage to underground
property, such as foundations and piping.
• Products and Completed Operations: coverage for claims after
a manufactured product has been sold and after the contractor
has completed his work. Typically covers claims that arise from
defective work.
• Broad Form Blanket Contractual: provides against claims for
the liability of others assumed by the contractor under the
contract with the owner. Note that the term “broad form” refers
to coverage for claims made that involve the owner’s negligence,
likely including those claims that arise out of his sole negligence.
Contractual coverage typically includes the contractor’s
assumption of the liability of others under any indemnification
and/or hold harmless provisions of the contract. The term
“blanket” just means that the contractor has the right to name
someone as an additional insured to his CGL policy without
specifically notifying the insurance company, as long as that
requirement for AI is specifically contained in the commercial
terms and conditions of the construction contract. (See
Chapter 8 for more on indemnification and broad form
indemnities.)
Note 5: The owner is providing a Builder’s Risk insurance policy for
coverage against property damage to the facility that he has hired the
contractor and others to construct for him. The owner will name all
contractors and others working on his project as additional insureds.
Contractors are responsible for the first $10,000—­the policy
deductible—­of any claim they make under this insurance policy. The
owner should be willing to provide evidence of insurance, outlining
the insurance coverage and exclusions. If details of the Builder’s Risk
policy, including any exclusions, are not clearly noted in the contract
provided by the owner, the contractor should ask for a copy of the
actual builder’s risk policy for review.
Note 6: There is a lot of risk to assume if this paragraph is accepted,
with or without significant modification. The owner wants to be
named as an additional insured to the contractor’s CGL insurance
policy, thereby getting free insurance from the contractor.

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This additional insured status also creates the possibility of claims being
made by the owner for accidents occurring on the job site that may be
totally unrelated to the contractor’s work. The owner also wants his
additional insured status under the CGL insurance to include payment
of any legal defense costs incurred by him in defense of a claim. Legal
costs can of course be significant. The waiver of subrogation requested
by the owner will prohibit the contractor’s insurer from using the legal
process of subrogation to recover any money from the owner for claims
it pays where the owner is actually the negligent party.
To recap the consequences of agreeing to this paragraph: The owner
would receive $2,000,000 worth of free insurance. His legal costs
would be paid for if he has to defend against a claim. He may be able
to make claims for accidents unrelated to the contractor’s work. He
also has control over the claims process with the insurance company
on claims he submits. Waiving the insurer’s rights of subrogation
means the insurance company would not receive any money back
from the owner for claims paid even though he was negligent. And,
finally, any claims made by the owner will likely be charged against
the contractor’s loss history, and his insurance premiums will
probably increase. In the worst case, the insurer may not be willing to
provide the contractor insurance for future projects.
What to do with a requirement like this? Consider deleting the entire
clause as part of the overall commercial negotiations for the contract
and suggest that the owner buy an Owner’s and Contractor’s
Protective policy (OCP) instead. Alternatively, limit the claims
allowed to be made by the owner to only those directly related to the
contractor’s work, and only to the time the contractor is physically
present on the site. It’s also a good idea to:
• Limit the defense costs to a relatively low dollar value, such as
$25,000 or less.*
• Limit the value of the subrogation waiver to the first $50,000 of
claims paid.*
• Contractually agree to a joint claims process in the event the
owner files a claim under the policy.
• Exclude any claims by the owner that are the result of his
negligence.
(* Note: Contractors should use dollar amounts that they are
comfortable with and that make sense with respect to the value of the
work they are performing.)
Note 7: This is a normal request to provide some form of written
evidence to the owner that the contractor has put in place the types
and amounts of insurance required in the contract.

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 Note 8: The evidence of insurance the contractor is required to
provide to the owner is a normal request. However, the contractor
should not agree to provide original or certified copies of his
insurance policies to the owner. The reason is that if there is a very
large claim made, the total value of the contractor’s insurance policy
will be public knowledge and he may be at risk. Let’s say the
contractor has a CGL policy with a limit of $10,000,000 that provides
coverage for one year for all his construction operations, wherever
they may take place. He would not want to disclose this upper limit if
all that the owner requires is $2,000,000 of CGL.
The insurer will provide the owner with acceptable evidence of
insurance acknowledging that the required $2,000,000 of CGL is in
place for the project. Providing evidence of insurance certificates is a
normal and standard practice; providing original insurance policies is
not. The owner has no right, legal or otherwise, to compel
contractors to provide original copies of their insurance policies,
unless they agree contractually to provide such.
Note 9: This is a standard notification requirement in the event that
the contractor’s insurance policies are cancelled or changed.
Contractors should make sure their insurance policies have similar
notification times included.
Note 10: This paragraph states that the contractor is responsible for the
deductible portion of any insurance coverage. While this may be stating
the obvious, it is inserted here so there is no confusion over who is
responsible for the deductible for insurance provided by the contractor.

Safety After all is said and done, there is still no better risk management tool
than a first-class job site safety program. As stated earlier, the
construction job site is probably one of the riskiest places to perform
work. Contractors don’t want to be responsible for someone getting
injured or property being damaged while they’re working.
More and more construction contracts are requiring formal safety
The best insurance programs and dedicated safety personnel to be a part of the
policy a contractor contractor’s construction activities. Many progressive owners develop
can have is a good construction projects that include incentive programs to financially
safety program reward safe contractors.
for employees While the specifics of implementing safety programs are beyond the
and construction scope of this book, these measures are well worth noting here, because
activities. contractors with exemplary safety records and effective safety
programs will always be able to get the best insurance rates to cover
their construction activities. They will also get more work, as unsafe
contractors should be excluded from the workplace. So, safety pays!

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Chapter
Indemnity
8
An indemnity clause is probably one of the most high-­risk
commercial terms and conditions in a construction contract and has
the potential to bankrupt a construction company. Simply stated, an
indemnity clause is essentially a risk transfer device, often seemingly
designed to be unfair to contractors. Sound harsh? Perhaps it is. On
most construction projects, however, an owner’s risk management
goal is often to find a way to protect himself from all risks and claims
against him that may arise before, during, or after the construction
project (regardless of whether or not he is negligent with respect to
causing the claims). In a construction contract, an indemnity clause is
a contractual risk and a potential financial liability transfer device.
What does risk transfer by way of the construction contract mean to
the contractor? It means that the contractor agrees, in writing, to
accept the financial responsibility that may arise from certain types of
claims against the owner, even when the owner’s negligence was the
cause of those claims.

Understanding and Negotiating Construction Contracts: A Contractor’s and Subcontractor’s Guide to

Protecting Company Assets, Second Edition. Kit Werremeyer.
© 2023 John Wiley & Sons, Inc. Published 2023 by John Wiley & Sons, Inc.

141
 Insurance & There is often confusion over the difference between insurance and
indemnity. While the two terms are similar in the sense that both
Indemnity serve to contractually transfer certain risks to other parties, they are
different in the following ways
• Insurance protects the owner, through an insurance company,
against certain defined risks and associated potential financial
liability. The insurance company pays the claims from its own
financial resources.
• An indemnity clause protects the owner against certain defined
risks and their associated potential financial liability. The
contractor, who generally takes on the risk, may have to pay any
claims from his own financial resources.

Indemnity The following is one definition of indemnity:

Definitions • A contractual obligation by which the contractor agrees to

protect the owner from certain risks and the associated financial
liabilities that may be incurred by the owner.
Here is an alternative:
• An indemnity clause transfers the potential financial liability of
certain owner’s risks to the contractor.
Finally, here is another, more straightforward definition of indemnity
between an owner and a contractor:
• An indemnity is a contractual obligation by which the contractor
agrees to be responsible for certain risks and the associated
financial liabilities that arise out of claims attributable to some
or all of the owner’s negligence.
This last definition is a good one to remember, because it is
specifically designed to emphasize the risk the contractor will
accept, by way of the contract, when agreeing to an indemnity
clause.
All three definitions are essentially correct. There certainly are
more complex and precise legal and commercial definitions
available, but these are designed to get right to the heart of the
matter as simply as possible as they apply most often to
construction contracts.
There are a few basic terms and concepts that are important for
contractors to understand when reviewing indemnity clauses.
They are:
• Tort liability: The financial liability that arises from a negligent
act that causes harm to persons or property. Courts usually

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 resolve tort liability claims by awarding monetary damages.
Broad form and intermediate form indemnity clauses seek to
transfer the owner’s tort liability arising out of his negligent acts
to the contractor.
• Broad form indemnity: The contractor assumes the potential
financial liability for claims arising out of any amount of the
owner’s negligence, including the owner’s sole negligence.
• Intermediate form indemnity: The contractor assumes the
potential financial liability for claims arising out of any amount
of the owner’s negligence, except those claims attributable to the
owner’s sole negligence.
• Limited form indemnity: The contractor assumes the
potential financial liability for claims arising only out of his
own negligence. The contractor does not assume the financial
liability for claims arising out of any amount of the owner’s
negligence.
• To indemnify: The contractor agrees to accept financial
responsibility for a loss suffered by the owner.
• To hold harmless or to save harmless: The contractor agrees to
reimburse the owner for a loss.

Transferring the The most common risks for which the owner would want the
contractor to assume potential financial liability are:
Owner’s Risks • Personal injury: When a person is injured on the owner’s
to Contractors construction project, and the owner is, to some degree, negligent
in causing the injury.
• Death of a person: When a person is killed on the owner’s
construction project, and the owner is, to some degree, negligent
in causing the death.
• Property damage: When property is damaged or destroyed on
the owner’s construction project, and the owner is, to some
degree, negligent in causing the damage or destruction.
• Owner’s defense costs: The legal defense costs that an owner
would incur in defending himself against a claim for personal
injury, death, or property damage on the project site.

Fairness Is Not It makes no sense to be subtle about what indemnities are designed to
do; in construction contracts, they are designed to get the contractor
a Consideration to pay for the financial liabilities that arise out of claims attributable
to the owner’s negligence. An analogy is that an indemnity is an
owner’s “get out of jail free card” for those readers who are familiar
with the board game of Monopoly™.

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 How can the contractor be responsible, for example, for an injury to a
The indemnity clause person on the job site, or for some property damage on the site that
in the construction the owner may have caused? Easy. The contractor agrees to accept
contract is designed this responsibility by agreeing to the wording in the indemnity clause
to shift some or all in the construction contract.
of an owner’s risks Although it may sound harsh, there is no such thing as a fair
and their associated indemnity clause in a construction contract. Indemnities are not
potential financial designed to be fair; they are designed to contractually transfer the
liability to the responsibility for potential financial liabilities from the owner to the
contractor. contractor. The fairest indemnity is when there is no indemnity in a
construction contract.

Is an Indemnity There is no requirement—statutory, moral, or otherwise—that a

construction contract must have an indemnity clause. Contractors
Required in a should not get their hopes up too much, however, on convincing an
Construction owner to delete the indemnity provisions in his construction
contract. A progressive owner may consider deleting the indemnity
Contract? clause in the construction contract, but for many owners, indemnity
provisions occupy an exalted position in their risk management
program for construction contracts.
By eliminating the indemnity clause, both the owner and the
contractor end up being responsible for the financial consequences
for claims attributable to their own negligence. No risk transfer to the
contractor from the owner takes place.
Although it tends to be difficult to convince owners to delete their
favorite indemnity clause, it doesn’t hurt to propose doing so. Owners
often will agree to modify the language of the indemnity clause to be
less onerous, but they probably will insist on keeping some form of
the clause in the contract. Often, through good negotiation, the
language in an indemnity clause can be modified so that the final
wording provides little, if any, transfer of the owner’s risk to the
contractor. This would meet the owner’s goal of keeping some form
of an indemnity clause in the construction contract, even though it
may only state what the contractor is legally responsible for.

Anti-Indemnity Unlike any other commercial terms and conditions that may be found
in a construction contract, indemnity clauses have historically been
Legislation so unfair in some cases that they have caught the attention of the
lawmakers in many states.
Several states have enacted some form of legislation declaring that an
indemnification agreement in a construction contract obligating one
party to a contract (contractor) to assume the potential financial
responsibility arising out of claims attributable, to some degree, to

144
 the negligence of the other party (owner) is against public policy and
Remember, is, therefore, void and unenforceable.
everything is
Anti-indemnity legislation varies state to state. Some states have
negotiable in a
anti-indemnity laws that exclude the contractor’s assumptions of
construction contract,
liability only for the sole negligence of the owner. Other laws exclude
as long as it’s not the contractor’s assumptions of liability for the partial and sole
illegal. And it is negligence of the owner. Some allow for contractors to provide
certainly not illegal insurance coverage of their assumptions of owner’s liability, yet others
to negotiate more only address public works, professional services, or oil- and gas-
favorable contract related projects.
language to reduce As of the publication of this book, the 37 states in tables have enacted
the amount of risk a some form of anti-indemnity legislation applicable to the
contractor accepts construction industry for private and/or public work:
in a construction
project. Anti-Indemnity State Statutes
The following 26 states outlaw both Broad and Intermediate form
indemnities in Private Contracts.

California Colorado Connecticut

Delaware Florida Illinois
Iowa Kansas Kentucky
Minnesota Mississippi Missouri
Montana Nebraska New Hampshire
New Mexico New York North Carolina
Ohio Oklahoma Oregon
Rhode Island Texas Utah
Washington Wisconsin

The following 17 states outlaw only Broad Form indemnities in

Private Contracts.

Alaska Arizona Arkansas

Georgia Hawaii Idaho
Indiana Maryland Massachusetts
Michigan New Jersey Nevada
South Carolina South Dakota Tennessee
Virginia West Virginia

The following 6 states allow Broad and Intermediate Form

indemnities.

Alabama Maine North Dakota

Pennsylvania Vermont Wyoming

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 The text of the anti-indemnity statutes can be found through an
Since the degree of online search. Also, there is a lot of information regarding
protection afforded indemnities in construction contracts, and information on the
contractors by anti-indemnity statutes noted above.
the anti-indemnity
The American Subcontractors’ Association Inc. provides excellent
legislation in and timely information on the various states’ anti-indemnity
each state varies, legislation (http://www.asaonline.com). No question about it—
contractors should anti-indemnity legislation is good for contractors, but don’t clap yet.
always take the time, There are several ways that owners can circumvent the law. Agreeing
or seek professional to any form of indemnity in an anti-indemnity state, with the belief
assistance, to that it is unenforceable, doesn’t guarantee the contractor that his
understand the anti- insurance carrier won’t end up paying the bill for some amount of the
indemnity laws in owner’s negligence.
effect in the state
in which they are Sample State Statutes
working or the laws The following are examples of anti-indemnification legislation for
of the state as may three states, South Carolina, Montana, and Alabama, along with
apply to the contract. some accompanying notes.

South Carolina State Statute

South Carolina State Statute 32-2-10: Hold Harmless Clauses in
Certain Construction Contracts Void as Against Public Policy
Notwithstanding any other provision of law, a promise or agreement in
connection with the design, planning, construction, alteration, repair, or
maintenance of a building, structure, highway, road, appurtenance, or
appliance, including moving, demolition, and excavating, purporting to
indemnify the promisee (typically, the Owner), its independent contractors,
agents, employees, or indemnitees against liability for damages arising out
of bodily injury or property damage proximately caused by or resulting from
the sole negligence of the promisee (typically, the Owner), its independent
contractors, agents, employees, or indemnitees is against public policy and
unenforceable.
Nothing contained in this section shall affect a promise or agreement whereby
the promisor (typically, the Contractor) shall indemnify or hold harmless the
promisee (typically, the Owner) or the promisee’s (typically, the Owner’s) inde-
pendent contractors, agents, employees, or indemnitees against liability for
damages resulting from the negligence, in whole or in part, of the promisor (typi-
cally, the Contractor), its agents or employees.
The provisions of this section shall not affect any insurance contract or Workers’
Compensation agreements; nor shall it apply to any electric utility, electric coop-
erative, common carriers by rail and their corporate affiliates or the South Carolina
Public Service Authority.

146
 1. The italicized words in parentheses have been added by the
author for clarification to identify who is a typical promisee or
promisor, e.g., (typically, the Owner).
2. The statute bars indemnities for sole negligence (typically, a broad
form of indemnity where the owner requires the contractor to
indemnify him for claims arising out of the owner’s sole negligence).
3. The statute allows insurance, such as having the owner named
as an additional insured on the contractor’s General Liability
policy, to cover indemnity obligations.
4. The statute does not apply to certain South Carolina public or
quasi-public organizations. For example, a contract with the
South Carolina Department of Transportation (a public
organization) would likely be exempt from the provisions of this
anti-indemnity statute.

Montana State Statute

Montana State Statute 28-2-2111: Construction Contract
Indemnification Provisions
(1) Except as provided in subsections (2) and (3), a construction contract
provision that requires one party to the contract to indemnify, hold harmless,
insure, or defend the other party to the contract or the other party’s officers,
employees, or agents for liability, damages, losses, or costs that are caused
by the negligence, recklessness, or intentional misconduct of the other
party or the other party’s officers, employees, or agents is void as against
the public policy of this state.
(2) A construction contract may contain a provision:
(a) requiring one party to the contract to indemnify, hold
harmless, or insure the other party to the contract or the other
party’s officers, employees, or agents for liability, damages,
losses, or costs, including but not limited to reasonable
attorney fees, only to the extent that the liability, damages,
losses, or costs are caused by the negligence, recklessness,
or intentional misconduct of a third party or of the indemnifying
party or the indemnifying party’s officers, employees, or
agents; or
(b) requiring a party to the contract to purchase a project-
specific insurance policy, including but not limited to an owner’s
and contractor’s protective insurance, a project management
protective liability insurance, or a builder’s risk insurance.
(3) This section does not apply to indemnity of a surety by a principal on a
construction contract bond or to an insurer’s obligation to its insureds.
(4) As used in this section, “construction contract” means an agreement
for architectural services, alterations, construction, demolition, design
services, development, engineering services, excavation, maintenance,
repair, or other improvement to real property, including any agreement to
supply labor, materials, or equipment for an improvement to real property.

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 Notes on Montana’s legislation:
1. The statute bars indemnities for sole and/or partial negligence
(typically, a broad form or intermediate form indemnity where
the owner requires the contractor to indemnify him for claims
arising out of the owner’s partial and/or sole negligence).
2. The statute allows indemnities that apply only to the extent of
the parties’ negligence (limited form indemnity).
3. The statute allows project-specific insurance, e.g., an OCP, to be
purchased to cover liabilities that might typically be transferred
in an indemnity.
4. The statute appears to apply to both public and private projects.

Colorado State Statute

Colorado Revised Statute Title 13, 13-50.5-102, Section 8(a)
(8)(a) Any public contract or agreement for architectural, engineering, or
surveying services; design; construction; alteration; repair; or maintenance
of any building, structure, highway, bridge, viaduct, water, sewer, or gas
distribution system, or other works dealing with construction, or any moving,
demolition, or excavation connected with such construction that contains a
covenant, promise, agreement, or combination thereof to defend, indemnify,
or hold harmless any public entity is enforceable only to the extent and for
an amount represented by the degree or percentage of negligence or fault
attributable to the indemnity obligor or the indemnity obligor’s agents,
representatives, subcontractors, or suppliers. Any such covenant, promise,
agreement, or combination thereof requiring an indemnity obligor to defend,
indemnify, or hold harmless any public entity from that public entity’s own
negligence is void as against public policy and wholly unenforceable.

Notes on Colorado’s legislation:

1. The statue outlaws broad and intermediate form indemnities.
2. The statute allows indemnities that apply only to the extent of
the party’s negligence (limited form indemnity).
3. Contractors should also take the time to read the lengthy and
comprehensive Colorado Revised Title 13, Section 13-21-111.5.
a. This Sections allows limited form indemnities.
b. This Section reaffirms that broad and intermediate form
indemnities are void and unenforceable.
c. This Section voids, with conditions, providing additional
insured status.

Alabama State Statute

As of the publication date of this book, Alabama does not have an
anti-indemnity statute.

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Without an anti-indemnity statute in place, a contractor may not
have any legal protection against a broad or intermediate form
indemnity in a construction contract. In other words, a contractor
who agrees to a broad or intermediate form indemnity in a
construction contract where Alabama state law applies—even though
he may not even be working in Alabama—could potentially be held
liable to pay for claims for personal injury and property damage, and
legal defense of those claims, that arise out of the owner’s sole or
partial negligence.

Texas State Statute

Sec. 151.102. AGREEMENT VOID AND UNENFORCEABLE. Except as provided

by Section 151.103, a provision in a construction contract, or in an agreement
collateral to or affecting a construction contract, is void and unenforceable as
against public policy to the extent that it requires an indemnitor to indemnify, hold
harmless, or defend a party, including a third party, against a claim caused by
the negligence or fault, the breach or violation of a statute, ordinance,
governmental regulation, standard, or rule, or the breach of contract of the
indemnitee, its agent or employee, or any third party under the control or
supervision of the indemnitee, other than the indemnitor or its agent, employee,
or subcontractor of any tier.
Sec. 151.103. EXCEPTION FOR EMPLOYEE CLAIM. Section 151.102 does not
apply to a provision in a construction contract that requires a person to indemnify,
hold harmless, or defend another party to the construction contract or a third
party against a claim for the bodily injury or death of an employee of the
indemnitor, its agent, or its subcontractor of any tier.
Sec. 151.104. UNENFORCEABLE ADDITIONAL INSURANCE PROVISION.
(a) Except as provided by Subsection (b), a provision in a construction contract
that requires the purchase of additional insured coverage, or any coverage
endorsement, or provision within an insurance policy providing additional insured
coverage, is void and unenforceable to the extent that it requires or provides
coverage the scope of which is prohibited under this subchapter for an agree-
ment to indemnify, hold harmless, or defend.
(b) This section does not apply to a provision in an insurance policy, or an
endorsement to an insurance policy, issued under a consolidated insurance pro-
gram to the extent that the provision or endorsement lists, adds, or deletes
named insureds to the policy.

Notes on the Texas legislation;

1. The statute outlaws broad and intermediate form indemnities.
2. The statute outlaws additional insured status.
3. The above Sections were taken from Texas Statute 151.
Contractors should take the time to read the entire Section as
there are other provisions and exclusions.

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 Examples of Indemnity Example Number 1: 53 Words
Indemnification to Bankrupt a Contractor
Clauses Noted below is an example of an indemnity clause that might be
found in a typical construction contract:

Article 20 – Indemnity
20.1 Contractor shall defend, indemnify, and save Owner harmless from
all claims for injuries to, or death of, any and all persons, and for loss of or
damage to property arising under or by reason of this Contract, except
claims resulting from the sole negligence of Owner, his employees, his
subcontractors, agents, or representatives.

• “Contractor shall defend. . .” means that contractor will take

responsibility to defend the owner in a legal action, and pay for
the cost of defense, for all claims of personal injury, death, or
property damage (made by anyone).
• “Contractor shall. . .indemnify. . .” means that the contractor
agrees to be financially responsible for any court judgments
against the owner that are associated with claims for personal
injury, death, or property damage.
• “Contractor shall. . .save owner harmless. . .” means that the
contractor agrees to pay or reimburse the owner for any financial
judgments against him a court may award for claims associated
with personal injury, death, or property damage.
• “. . . from all claims for injuries to, or death of, any and all
persons, and for loss of or damage to property. . .” broadly and
without exception describes the type of claims (risks) the
contractor agrees to defend the owner against, assume
responsibility for, and pay for any resulting court awarded
monetary damages.
• “. . . arising under or by reason of this Contract. . .” means that
all claims for personal injury, death, or property damage that the
owner can somehow, rightly or wrongly, attribute to the
contractor’s work, regardless of fault, are covered under this
indemnity clause. The use of the phrases “arising under. . .this
contract” and “or by reason of this contract” are left to broad
interpretation that the owner, and ultimately the court, may choose
to apply in the event a claim and legal action is made against the
owner by some third party associated with the contract.
In the event a claim is made against the owner for an accident
that took place on his work site, or even away from the site or
before construction begins, then he will look to the contractor

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 to protect him under the broadly interpreted “arising under or
by reason of this Contract” wording in the indemnity clause.
Note that these words say nothing at all about whether the
contractor had any responsibility for the claims, only that the
contractor just accepts the responsibility to pay for them.
Typically, when the owner notifies the contractor about a claim,
the contractor would deny that the claim met the test of “arising
under or by reason of this Contract” and refuse to defend the
owner, or pay for the owner’s defense costs and/or the amount
of any financial judgment against the owner. A lawsuit would
most likely be initiated by the owner and left to the court to
decide if the claim actually met the test of “arising under or by
reason of this Contract” Leaving the courts to interpret this
language can be a risky roll of the dice for the contractor—­and
expensive!
If 100 people were asked what the words “arising under or by
reason of this Contract” mean, 100 different answers would
probably be given. Contractors take on a lot of risk by allowing a
judge in a court of law to interpret these words. It’s not difficult
to imagine what might happen if the judge has not had any
construction-­related experience.
Rather than taking the risk of allowing a court to interpret a
broadly worded indemnity clause, it’s more responsible
contracting to negotiate less risky wording in an indemnity
clause, or get rid of the indemnity clause in its entirety.
• “. . . except claims resulting from the sole negligence of
Owner, his employees, or his subcontractors, agents, or
representatives.” This wording means that the owner, his
employees, subcontractors, agents, or representatives agree to be
responsible only for those claims resulting from their sole
negligence. The only reason this “sole negligence” wording is
included in the indemnity clause is because of the anti-­
indemnity legislation enacted by various states.
Many of the anti-­indemnity states prohibit the owner from
making someone else, like the contractor, responsible for the
potential financial liability associated with claims attributable
to the owner’s sole negligence. Sole negligence means the
owner is 100% responsible for the circumstances that caused
the claim resulting in the lawsuit. Contractors should bear in
mind that on a job site with multiple contractors,
subcontractors, material suppliers, inspectors, owner’s
representatives, and the like, it may be extremely difficult to
prove “sole negligence.”

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 What happens if the court determines the owner to be 95%
negligent, and the contractor is found to be 5% negligent in a
claim? In this sample clause, the contractor may still have to pay
the entire claim because the owner was not determined to be
solely (100%) negligent. In this event the court may decide to
enforce the indemnity clause and make the contractor pay the
full amount of the claim, since the owner was not solely
negligent, as well as require him to reimburse the legal defense
costs of the owner.
The contractor should not overlook the diverse group of people
he is agreeing to indemnify. In the earlier sample clause, the
people defined as the “owner and his employees” is
straightforward and easy enough to understand. However, the
people defined as “subcontractors, agents, and representatives”
is unclear. Are the subcontractors of the owner even on the job
site? Who is an agent or representative of the owner? Where are
all these people located? Are they all following proper safety
procedures, such as refraining from smoking and wearing safety
goggles, shoes, and hard hats?
The contractor, and maybe even the owner, may have little or
no control over the behavior of this diverse group of people, yet
the contractor is agreeing to be financially responsible—­by way
of the indemnity clause—­for claims that may be the result of
their negligent behavior. This situation could result in a
significant claim and possibly a large financial loss for the
contractor.
In addition, there is nothing contained in this indemnity clause that
limits the potential financial liability of the contractor. Theoretically,
the contractor would be liable to pay for unlimited legal defense costs
of the owner, and unlimited financial awards a court would make for
a claim covered under this indemnity agreement. A large award made
by a court under this indemnity clause could bankrupt a contractor. It
could also exhaust a contractor’s insurance coverage if he has
contractual liability insurance to cover this type of potential
financial liability.
Should this example indemnity scare a contractor? Yes, it should.
There is an enormous amount of owner’s risk transferred to the
contractor when he accepts the 53 words of this indemnity
example.

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Clear and Unequivocal
Take a look at Article 20 – Indemnity, presented below is a different
manner.

Article 20 – Indemnity
20.1 Contractor shall defend, indemnify, and save Owner harmless
from all claims for injuries to, or death of, any and all persons, and for
loss of or damage to property arising under or by reason of this
Contract, except claims resulting from the sole negligence of Owner,
his employees, his subcontractors, agents or representatives.

Or, you might see the same Article 20 – Indemnity, presented below
in another different manner.

Article 20 – Indemnity
20.1 CONTRACTOR SHALL DEFEND, INDEMNIFY, AND SAVE OWNER
HARMLESS FROM ALL CLAIMS FOR INJURIES TO, OR DEATH OF,
ANY AND ALL PERSONS, AND FOR LOSS OF OR DAMAGE TO
PROOPERTY ARISING UNDER OR BY REASON OF THIS CONTRACT,
EXCEPT CLAIMS RESULTING FROM THE SOLE NEGLIGENCE OF
OWNER, HIS EMPLOYEES, HIS SUBCONTRACTORS, AGENTS OR
REPRESENTATIVES.

Some States may allow such indemnities as shown above because

they are “clear and unequivocal.” The “clear and unequivocal”
consideration comes because the indemnities as written are in either
bold print or bold capitalized print. This sets the indemnity clause
apart from all the other clauses in the contract that are not written in
bold or bold and capitalized print.
The compelling argument seems to be: “Mr. Contractor, how could
you possibly not miss or misunderstand this clause?”

Indemnity Example Number 2: More Words

to Bankrupt a Contractor
Following is an example of a lengthier indemnity clause that was
designed to cover anyone remotely associated with the owner—and
just about every conceivable situation that could happen on a
construction job site.

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 Article 20 – Indemnity
To the fullest extent permitted by law, Contractor shall indemnify and hold
harmless Owner, Lender, Construction Adviser, and all their respective
parents, subsidiaries, affiliated companies, agents, representatives, and
employees (each individually and all collectively referred to hereinafter as
“Indemnitee”), from and against (i) all claims, suits, actions, and proceedings
(Claims), whatsoever which may be brought or instituted on account of,
grow out of, occur from, be incident to, or result directly or indirectly from
any and all injuries to persons (including death) or damage to property
(whether property of the parties hereto or of others) in connection with or
growing out of the Work or the performance or nonperformance by
Contractor of its obligations under this Contract, and (ii) all losses, costs,
damages and expenses related to the Claims, including, but not limited to,
attorney’s fees and other costs of defending the Claims. Contractor’s
indemnity given herein shall apply with full force and effect whether or not
any such injury, death, or damage results from or is claimed to have resulted
from, in whole or in part, the negligence of any Indemnitee. Contractor shall
conduct with due diligence and in good faith the defense of all Claims
against any Indemnitee, even if such Claims be groundless, false, or
fraudulent and shall bear the cost of all judgments and settlements in
connection therewith; provided, however, without relieving Contractor of its
obligations under the Contract, and Indemnitee, at its election, may defend
or participate in the defense of any Claim against such Indemnitee.
Maintenance by Contractor of insurance covering the liability of Owner
hereunder shall not affect Contractor’s obligations hereunder, and the limits
of such insurance shall not constitute a limitation of Contractor’s liability
under this indemnity.

There are a lot of words contained in this clause, but the end result is
the same as in the first example—the contractor assumes an
unlimited amount of potential financial liability for the owner’s
defense costs and claims for personal injury and property damage
that may be caused by any amount of negligence of the owner and the
other diverse groups and individuals identified.
The amount of risk transferred to the contractor is similar to the first
example, just more wordy. Let’s break it down and see what the
contractor is actually agreeing to accept.
• The words “to the fullest extent permitted by law, Contractor
shall indemnify and hold harmless Owner, Lender, Construction
Adviser and all their respective parents, subsidiaries, affiliated
companies, agents, representatives, and employees (each
individually and all collectively referred to hereinafter as
‘Indemnitee’)” obligate the contractor to take responsibility for
(indemnify) and pay for (hold harmless) claims made against the
large group of companies and individuals listed. This is legalese.
It is hard to imagine an owner agreeing to wording that read, for
example, “only to 50% of that permitted by law.”

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 The phrase “To the fullest extent of the law” is used in an effort
to keep the clause from being totally voided by a court. These
words are inserted so that, if the indemnity clause is ruled
unenforceable or void by a court, then the owner can try to
argue, “What is the fullest extent of the law that can be applied
for an indemnity in this situation? We’ll take that, thank you.”
These words are sometimes referred to as a “survival clause,” in
the sense that it’s better to get something out of the indemnity
rather than nothing.
Note that the diverse group of companies and individuals is
made capitalized and therefore a defined term: indemnitee. This
helps simplify the wording when the group is referenced later on
in the indemnity clause. This is good contracting form, but it is
still a large, undefined, and uncontrollable group of people to be
responsible for, especially if a claim arises from their negligent
actions or behavior.
• The next words: “from and against (i) all claims, suits, actions,
and proceedings (Claims), whatsoever which may be brought or
instituted on account of, grow out of, occur from, be incident to,
or result directly or indirectly,” define the different events that
make up the capitalized and therefore defined term “Claims,”
and go on further to define in detail how any claim is related to
the contract and to the contractor’s work.
• Reworded, the relationship of the claims covered by this
indemnity to the contractor’s work might read: “brought or
instituted on account of Contractor’s work, grows out of
Contractor’s work, occurs from Contractor’s work, as may be
incident to Contractor’s work, or results directly or indirectly
from Contractor’s work.” Basically these words mean that if the
owner can attribute a claim made against him to the contractor’s
work for any reason whatsoever, it’s likely he will attempt to get
the contractor to pay for the claim under the provisions of this
indemnity clause.
• Continuing on, the next words: “from any and all injuries to
persons (including death) or damage to property (whether
property of the parties hereto or of others) in connection with or
growing out of the Work or the performance or nonperformance
by Contractor of its obligations under this contract, and (ii) all
losses, costs, damages and expenses related to the Claims,
including, but not limited to, attorney’s fees and other costs of
defending the Claims.” This defines what types of claims are to
be covered by this indemnity clause. Note there is no financial
limitation available to the contractor in this clause with respect

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 to his assumption of these losses, costs, damages, expenses, and
defense costs.
• Next: “Contractor’s indemnity given herein shall apply with full
force and effect whether or not any such injury, death, or damage
results from or is claimed to have resulted from, in whole or in
part, the negligence of any Indemnitee.” This clause obligates the
contractor to take full and complete responsibility for the
potential financial liability for claims that may be the result of the
indemnitee’s negligence, possibly including the indemnitee’s sole
negligence, as sole negligence is not specifically excluded.

An Example
Let’s say a claim is made against the owner by one of the contractor’s
employees, who is injured at the job site, and this results in a
$1,000,000 court award. The owner was deemed 100% responsible
(solely negligent) for the injury resulting in the claim. The owner now
takes the contractor to court to try to recover all his defense costs
and the full amount of the $1,000,000 court award. He argues that
this protection is provided to the owner by the contractor per the
terms of the construction contract’s indemnity clause.
In an anti-­indemnity state, it’s likely the court would declare the
indemnity as void and unenforceable, as it provides for the
contractor being responsible for the sole negligence of the
indemnitee. Indemnities that transfer the potential financial
liability for claims attributable to the sole negligence of the owner
are generally held to be unenforceable in anti-­indemnity states.
In this case, the contractor would likely have a good chance of
being relieved of any payment obligations under the indemnity
clause. However, if this situation occurred in a state (or country)
that did not have any anti-­indemnification statutes, then the court
could choose to enforce the provisions of the indemnity clause, and
the contractor (or his insurer, or both) would get stuck with having
to pay the owner the $1,000,000 plus the owner’s defense costs.
That’s a lousy deal for the contractor. Given the size of personal
injury awards made today, the $1,000,000 may be small! It could
be much, much more.
• Finally, the clause states, “Maintenance by Contractor of
insurance covering the liability of Owner hereunder shall not
affect Contractor’s obligations hereunder, and the limits of such
insurance shall not constitute a limitation of Contractor’s
liability under this indemnity.” The last part of this indemnity
just says that the amount of the contractor’s contractual liability
insurance available to cover this type of contractual obligation

156
 can’t be construed to be a limit on how much the contractor
would have to pay out for a claim.
A little better explanation is that if a judgment under the
indemnity required the contractor to pay a claim of $1,000,000,
and his contractual liability insurance paid only $500,000, then
the contractor would be stuck paying $500,000 out of his own
pocket. The contractor could not claim that his financial liability
was limited to the $500,000 available through his contractual
liability insurance coverage.
This second indemnity example was written to make the contractor
financially responsible for just about anything that would happen on
or off the job site—­before the work started, during the course of the
work, and after the work was completed. A claim would not
necessarily have to have any relation to the contractor’s work, and
regardless of the degree of negligence attributable to anyone in the
long list of companies and individuals defined as the indemnitees, the
contractor would still have to pay.
The responsibilities described in this second indemnity example, and
in similar broadly worded indemnities, have actually been accepted
by contractors. Maybe those contractors who accept such indemnity
language just close their eyes, cross their fingers, and pray nothing
bad happens on the job.
Some contractors will say that they have Contractual Liability
insurance to cover the potential financial liability exposure contained
in an indemnity clause. They may believe that they don’t need to
worry about how onerous the terms of an indemnity clause are. It’s
true that contractual liability insurance can provide some measure of
protection against the financial liability that may arise from an
indemnity. However, contractors should not forget that once an
insurance company pays out a large claim, the relationship between
the contractor and the insurance company will likely change. In the
future, the insurance company might charge significantly higher
premiums for similar coverage, or they might decide to cancel the
contractor’s policy or not provide coverage on future projects.

Indemnification, Many standard formats of Commercial General Liability insurance

policies include a separate provision to provide the contractor
Additional insurance coverage for what is called contractual liability. Contractual
Insured Status, Liability insurance is typically provided as a component of the

& Contractual Commercial General Liability (CGL) policy. It is designed to provide

insurance coverage for the named insured (the contractor) for the
Liability potential financial liability that can arise from the contractor’s
Insurance assumption of the owner’s liability for claims associated with personal

157
 injury, damage to or loss of property, and legal defense of such claims.
Contractual Liability These assumptions of the owner’s liability are typically found in the
insurance covers owner’s indemnity clause in the construction contract.
the contractor for
Some insurers may require contractual liability coverage to be added
the financial liability
to the contractor’s CGL policy by way of a specific endorsement.
under a construction From an insurance industry standpoint, Contractual Liability
contract’s indemnity insurance covers the personal injury, property damage, and legal
agreement. It applies defense costs risks assumed by a contractor under what the insurance
to personal injury and industry calls an “insured contract.”
property damage
claims attributable What Is an Insured Contract?
to the negligence of As it applies to a typical construction contract, an insured contract is
the owner, and the defined by the insurance industry as that part of an agreement
owner’s associated (a construction contract) in which the contractor assumes the tort
legal defense costs. liability of the owner for claims involving injury to persons, death of
persons, and property damage. The tort liability of the owner usually
arises from an accident attributable in whole or in part to the owner’s
negligent acts or behavior.
These assumptions of liability for claims for personal injury and
property damage arising from the negligence of the owner, and the
additional liability for payment of the owner’s defense costs for such
claims, are typically found in the construction contract’s indemnity
clause. Of particular note is that there is often nothing contained in
the insurance industry’s definition of an insured contract that defines
what degree of owner negligence is covered by the insurance. The
owner could be anywhere from barely (1%) negligent all the way to
solely (100%) negligent for the accident that caused the claim. This
insurance can, unless specifically limited, cover the risks associated
with the assumptions of liability contained in a broad form indemnity
(defined earlier).

Additional Insured Status & Contractual

Liability Insurance
When a contractor adds an owner as an additional insured to his
CGL policy, the owner receives the free benefit of having full access
to the coverage provided by the included contractual liability
insurance. This is on top of the free insurance coverage he receives as
an additional insured for claims involving his vicarious liability,
maybe his own negligence, and perhaps even for claims arising out of
completed operations.
It might appear that all of this insurance coverage required by the
owner in his standard construction contract (additional insured

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status plus contractual indemnity) is overlapping or redundant. This
apparent “doubling up” of coverage by having additional insured
status/contractual liability plus the addition of an indemnity
agreement is a good deal for the owner, as his risk transfer
department or consultant is keenly aware.
Why not just require one or the other risk transfer mechanism to
cover the risks the owner wants to transfer to the contractor or to the
contractor’s insurance company? Why are two similar risk transfer
provisions commonly required? The consequences of this “doubling
up” of coverage are best described by the following example:
• The insurance clause of the owner’s construction contract
requires the contractor to: “add owner as an Additional Insured
to Contractor’s Commercial General Liability insurance policy,
which policy shall also include Contractual Liability insurance
covering Contractor’s contractual obligations under the
Indemnity clause contained in the Construction Contract.”
• The indemnity clause of the owner’s construction contract
requires the contractor to: “defend, indemnify, and save Owner
harmless from all claims, including any claims which may
involve Owner’s negligence, for injuries to persons, or death of
persons, and for loss of or damage to property arising under this
Contract.”

An Example
Let’s say that an accident injuring a person occurs on the
­contractor’s job site. The cause of the accident turns out to be the
result of the sole (100%) negligence of the owner. The injured person
sues the owner for damages and is awarded $500,000. The owner’s
defense costs for the claim amount to $100,000. In total, the owner
is out $600,000.
The owner then sues the contractor, demanding that the contractor
indemnify and hold him harmless for the amount of award plus all
his accrued defense costs (in simpler words: accept responsibility for
the claim and reimburse him $600,000) in accordance with the terms
of the indemnity agreement contained in the construction contract.
The indemnity clause transferred the complete financial liability,
including all of the owner’s defense costs, to the contractor, even
though the owner was solely negligent. The state in which the court
case takes place is an anti-­indemnity state that prohibits
­agreements in construction contracts that require the indemnitor
(the contractor) to indemnify, hold harmless, and defend the
­indemnitee (the owner) for claims involving the indemnitee’s (the
owner’s) sole negligence.

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 The court determines that the indemnity clause contained in the
construction contract between the owner and the contractor violates
the state’s anti-indemnity statute. Therefore, it rules the owner’s
indemnity clause void and unenforceable. As a result, the owner’s
risk transfer coverage for claims arising out of his negligence that he
believed he had under the indemnity clause is eliminated.
Not to be deterred, the owner’s risk management group now demands
that the insurance company that provided the contractor’s CGL policy
(to which the owner was named as an additional insured) reimburse
the cost of the claim and the defense costs associated with the claim.
If the court ruled that the indemnity clause was void and unenforceable,
how can it be, then, that the contractor’s insurance company must now
reimburse the owner for the amount awarded under this claim, as well
as the owner’s defense costs, since the accident that caused the claim was
attributable to the sole negligence of the owner? The “doubling up” effect
mentioned earlier of having an indemnity from the contractor, plus
having the additional insured status on the contractor’s CGL policy now
pays wonderful dividends for the owner.
The state anti-indemnity statute, which was enforced by the court in
this example and voided the indemnity clause, unfortunately for the
contractor, contains the following exception:

This section does not affect the validity of any insurance contract, Workers’
Compensation, or any other agreement issued by an insurer.1

What this exclusion in the anti-indemnity statute means is that it’s

okay for the contractor to insure the assumption of liability risks
contained in the owner’s indemnity clause. This is what the owner
received when he became an additional insured on the contractor’s
CGL policy, which also included contractual liability coverage. The
owner received the full benefit of this insurance coverage for the
contractor’s assumptions of liability under an indemnity clause.
The contractor’s insurance company would likely now have to
reimburse the owner for the amount it had to pay under the claim,
plus the owner’s defense costs. The owner gets reimbursed the full
$600,000 by the contractor’s insurance company, less the policy
deductible, which the contractor has to contribute.
The reasoning behind the typical insurance exception shown in the
sample anti-indemnity statute is simple: this is what insurance
1
Excerpted from the State of Maryland Code Ann. § 5-401 (1999). Certain Construction Industry Indemnity
Agreements Prohibited. This state anti-indemnity statute prohibits indemnities in construction contracts allowing for
the indemnitor (the contractor) to provide coverage of claims arising out of the sole negligence of the indemnitee (the
owner), but allows for insurance to provide coverage and defense of such claims. The Maryland Code is similar in scope
and exception to anti-indemnity legislation in other states.

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 companies do for a living. Insurance companies provide coverage for
certain risks in return for a premium. They also expect to pay claims
as part of their business. In this instance, the risks covered were the
assumption of liability risks by the contractor that were contained in
the owner’s indemnity clause.
Just to make matters worse, the payout by the insurance company,
$600,000, now goes against contractor’s insurance industry
experience rating, since it is his policy. The owner’s experience rating
for insurance may be unaffected. The contractor may now be faced
with an increased premium for his CGL coverage on future projects,
or his insurance company may decide not to renew—­or may even
cancel—­his policy.
All of this happens to the contractor for an accident caused by the
sole negligence of the owner, and, arguably, the poor contract
negotiating on the part of the contractor.

Owners Love Contractors should note that when owners are establishing
construction contracts, they are always thinking about CLAIMS—
CLAIMS! not claims for extra work or disputes, but:
Contractual
Liability insurance, plus
Additional
Insured status equals
Money
Saved for the Owner
Just because a contractor is performing a construction contract in a
state that has some form of anti-­indemnity legislation in place,
doesn’t mean he can accept, without risk, an owner’s broadly worded
indemnity clause.
A court’s decision on the enforceability or unenforceability of a
particular indemnity clause with respect to a state’s anti-­indemnity
statute is unpredictable at best. There may not be as much “anti-­
indemnity” protection available to the contractor as he might believe.
In any event, responsible contracting, or contract negotiating, is a
much better course of action for the contractor.
It can be difficult for an owner to force a contractor to defend him or
reimburse him for a claim under the provisions of an indemnity
clause in the construction contract, short of taking the contractor to
court. Smart owners also have a method that provides them with
extra protection in the event an indemnity clause is ruled
unenforceable or the contractor is unwilling or financially unable to

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 meet the obligations in the indemnity clause. The owner’s “extra
protection” is achieved through two contractual requirements:
1. Require the contractor to add the owner as an additional insured
to the contractor’s Commercial General Liability policy for the
project, and;
2. Specifically require that the contractor’s CGL policy include
contractual liability coverage for the indemnity contained in the
construction contract.
Being named as an additional insured to the contractor’s CGL policy,
which has contractual liability included, is the owner’s fallback
position in the event the indemnity is ruled to be unenforceable by a
court. The contractor escapes defense and payment obligations under
the indemnity, but his insurance company will have to pay for the
defense costs of the owner and the claim.
It is also the owner’s fallback position if the contractor is unwilling or
unable to meet the obligations of the indemnity clause. The owner
now has insurance available to him to cover his defense costs and
some or all of the contractor’s indemnity obligations.
In the final analysis, the owner may be able to have coverage for claims
attributable to his own negligence, including the defense costs against
such claims, under the indemnity and insurance clauses either directly
from the contractor or from the insurance company, or perhaps both.

Negotiating In most construction contracts, it is unlikely that the owner’s

proposed indemnity clause will be favorable to the contractor. As
Indemnity noted throughout this chapter, indemnity clauses are not designed to
Clauses be fair. It is likely that the owner’s proposed indemnity clause will
expose the contractor to a significant level of transferred risk and
associated potential financial liability.
The contractor’s goal in negotiating an indemnity clause should be to
limit, to the greatest degree possible, his exposure to transferred risk
and associated financial liability for accidents that were caused by the
negligence of others. This means negotiating with the owner the
following:
1. Indemnify only the owner and his employees, not a long list of
other undefined and unknown individuals and associated
companies.
2. Eliminate being responsible for claims attributable to any degree
of negligence by the owner.
3. Be responsible only for those claims attributable to the
­contractor’s negligence.
4. Have the indemnity be applicable only to claims for personal
injury, death, and existing property damage.
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 5. Limit the events that are covered under the indemnity only to
those that take place while the contractor is performing his work
and is physically present at the owner’s job site.
6. Place a fixed, maximum limit on the financial liability of the
contractor.
Let’s reword the first sample clause in this chapter to include the
issues just listed. (Note: changes are shown in bold)

Article 20 – Indemnity
20.1 Contractor shall defend, indemnify, and save Owner harmless only
to the extent a claim is caused by the negligence of Contractor and
only for injuries to, or death of, any and all persons, and for loss of or
damage to existing property occurring only during the on-site
performance of Contractor’s work under this contract and only while
Contractor is physically present on the job site.
Article 21 – Limitation of Liability (new clause)
Contractor’s total liability under this Contract, including any defense
costs on behalf of Owner, shall not exceed US$1,000,000 in the
aggregate.

Note that the indemnity clause was revised to cover the owner and
employees and no one else. Adding the new words “to the extent a
claim is caused by the negligence of Contractor and only” means
that the contractor agrees to be responsible for the portion of a
claim attributable only to the degree (amount) of his negligence. It
also means the contractor does not agree to accept responsibility
for any portion of the owner’s negligence that caused the
same claim.
This typical “to the extent” wording covers the indemnity negotiating
Being absolutely issues numbers 2 and 3. For example, if a court determines that the
specific with the owner is 75% negligent, and the contractor is 25% negligent in a
claim, then the contractor would pay 25% of the amount awarded
wording of an
under the claim.
indemnity clause
is critical and Adding the new word “only” just gives more strength and clarity to
helps minimize the fact that the indemnity provided only covers claims for injury to
opportunities for persons, death of persons, or property damage. Nothing else is
judges to creatively covered, not even the owner’s defense costs. This covers indemnity
negotiating issue number 4.
interpret the
indemnity wording in Adding the new words, “occurring only during the on-site
a way that is adverse performance of Contractor’s work under this Contract and only while
to the contractor. Contractor is physically present on the job site,” specifically defines
when and where the indemnity applies. The contractor’s
indemnification of the owner is applicable for claims that occur only
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 when the contractor is doing his construction work at the owner’s
job site.
It’s very important to be specific about what the indemnity applies to,
how it applies and where it applies. It’s better to have highly specific
wording in place in the event the contractor has to go to court to
defend against a claim brought by the owner to enforce the indemnity
in the construction contract. Broad-based and open-ended wording
can be interpreted loosely by the courts.
Creative interpretation by the courts of an indemnity could be to the
significant financial detriment of the contractor. So, it’s better to try
to negotiate wording that is simple and easy to understand, and most
importantly, specific. Tighten it up; vaguely worded indemnities left
open to interpretation are very dangerous, and expensive!
When the contractor
The original wording in the indemnity example stated that it covered
is not physically
all claims “arising under or by reason of this Contract.” This wording
present on the site, is too broad and subject to creative interpretation. Keep in mind that
he has no control the greatest risk for personal injury, death, or property damage is
over any of the present when the contractor and others are physically working on the
activities taking job site. The words “arising under” and “by reason of ” could be
place there and construed to mean that the indemnity would apply prior to the
should not have contractor arriving at the site, while the contractor is on the site, or
any exposure to an after the contractor leaves the site. That is a lot of risk to accept, and
indemnity. When the probably for no increase in the contractor’s price for the project.
contractor is present The construction contract typically will span all the time periods
and working, it is noted above. There are contractual issues to take care of prior to
more likely he will be arriving at the job site, things to build while working there, and
able to exercise more contractual issues to attend to after leaving the site and prior to the
effective control over conclusion of the contract. It makes no sense to take the chance of
his work activities getting stuck with the financial liability for an accident that happened
and safety practices while the contractor was not even on the site, and is attributable to
to prevent personal the negligence of the owner!
injury and property One of the issues often used in negotiating indemnities is the concept
damage. The of control. Owners like to argue that since the contractor is in
contractor should control of the site, he should be fully responsible for whatever
be responsible only happens on the site and should accept the indemnity as written. This
to the extent of his sounds logical enough at first glance. It is a good negotiating tactic by
negligence under an the owner, but it is unrealistic.
indemnity, unless it is When the contractor is physically present on the site, he has much
determined that he better control (better, not total) over his day-to-day working and
left the job site in an safety activities, or lack of activities, that could cause personal injury,
unsafe condition. death, or property damage. He may not have any control whatsoever
over the activities of the owner, his employees, agents,

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 representatives, affiliated companies, and the like who might be
included as beneficiaries of the contractor’s indemnity.
It’s possible that a person could be injured on the contractor’s job
site after the contractor leaves, and it could be construed in court
that the indemnity would apply, if not specifically limited as noted.
Likewise, when a contractor concludes his work and leaves the site,
he should have no exposure under an indemnity. Limiting the time
in which an indemnity applies to when the contractor is physically
present on the job site covers indemnity negotiating issue
number 5.
An added clause (new clause Article 21 – Limitation of Liability)
limits the amount of money the contractor agrees to pay to the owner
in the event a court makes an award under the provisions of the
indemnity statement. This financial limit is only with respect to the
contractor’s liability to the owner and does not stop the court from
making a larger award in the event of a claim.

An Example
A person is injured on the contractor’s job site and later sues the
owner for $2,000,000. The court rules in favor of the injured
person. The owner is required to pay the full amount of the claim
and then sues the contractor under the provisions of the
­indemnity clause in the construction contract to try to recover the
$2,000,000.
The court agrees that the indemnity and limitation of liability
clauses are enforceable and awards the owner $1,000,000, the limit
of liability specifically stated in the construction contract. The
contractor must pay the owner $1,000,000.
The idea here is that the contractor was required to pay $1,000,000,
not $2,000,000, because he successfully negotiated an enforceable
limitation of liability clause in the construction contract. If the
contractor hadn’t negotiated this, he could have been required by the
court to pay the full $2,000,000 to the owner. This limitation of
liability covers indemnity negotiating issue number 6.

Knock-­for-­Knock Another approach that appears to be generally fair to both the

contractor and the owner is to use what is commonly referred to as a
Indemnities knock-­for-­knock indemnity. This type of indemnity establishes that
the contractor and the owner agree to be responsible for claims
associated with personal injury and property damage for their own
employees and their own property, regardless of how it was caused
and the other party’s negligence. A knock-­for-­knock indemnity might
read similar to the following:

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 Article 20 – Indemnity
20.1 Owner agrees to indemnify and hold harmless Contractor from any
claims, regardless of how caused and regardless of Contractor’s negligence,
that arise out of personal injury to or death of Owner’s employees and loss
of or damage to Owner’s property during the on-site performance of the Work.
20.2 Contractor agrees to indemnify and hold harmless Owner from any
claims, regardless of how caused and regardless of Owner’s negligence, that
arise out of personal injury to or death of Contractor’s employees and loss of or
damage to Contractor’s property during the on-site performance of the Work.

This indemnity is silent on responsibility for claims from third parties

(other than the owner’s or contractor’s employees or property), so
assignment of blame and assessment of damages for such claims
would likely be left to the courts to decide.
An indemnity clause like this one might possibly be construed by a
court to involve indemnification against the negligence of one party
or the other. As such, it might then run afoul of a particular state’s
anti-indemnity legislation, and contractors should check with
contracting professionals on the use of knock-for-knock indemnities.

Conclusion Indemnity clauses are designed to transfer as much risk and exposure
to potential financial liability as possible to the contractor from the
owner, even if the owner is almost completely responsible for the
event resulting in a claim.
Indemnity clauses can create significant financial risk for the
contractor. Contractors need to understand the level of risk they accept
when agreeing to an indemnity clause, as well as how to try to negotiate
away the unacceptable risk contained in these types of clauses.
Contractors must also make sure their insurance companies’
endorsement of additional insured status for the owner and the
contractual liability insurance endorsement on the CGL policies are
both in line with all the limitations set out in the final negotiated
indemnity provisions of the construction contract with the owner.
Many construction contracts will simply require the contractor to add
the owner as an additional insured to the contractor’s CGL policy and
also require that contractual liability coverage be included. There may
not be any specific contractual provisions in the contract for how the
endorsements must read in the contractor’s CGL policy that provides
for additional insured status and contractual liability coverage.
Contractors should make sure that the endorsement adding
contractual liability conveys what they want to agree to in limited
indemnity clauses. That endorsement will likely be scrutinized by the
court in the event of a claim or lawsuit. The endorsement should be

166
specific as to limitations of coverage so that the chances are better
that the endorsement’s wording won’t be too broadly, or creatively,
interpreted by the courts against the contractor.
Broad interpretation by a court of law of contractual wording
(construction contracts or insurance contracts) is a significant risk for
the contractor. This can be managed by understanding how to
negotiate limited indemnity clauses—­and by making sure insurance
policy endorsement language for additional insured status and
contractual liability coverage tracks with the indemnity limitations
agreed to by the contractor.
Last, always remember that a construction contract does not need an
indemnity clause; the contractor and the owner should each be
responsible for the consequences of their own actions.

Some Last Thoughts on Indemnity and

Additional Insured Status

Alessandro Grandini/Adobe Stock.

Dinosaurs once roamed the Earth; now they are extinct. Contracting
dinosaurs exist today and they are the unfair risk transfer clauses of
indemnity and additional insured status roaming the landscape of
construction contracts. Some day they will be extinct, too, just like
the T-­Rex.
Good bye indemnosaurs! Extinction is on the way and it can’t be too
soon. It’s on the horizon and it’s quickly approaching.
Good bye additional insuredosaurs! Extinction is on the way and it,
also, can’t be too soon.
The majority of the states in the United States have some sort of
anti-­indemnity legislation in place, or common law decisions, voiding

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 indemnities in construction contracts branding them as
unenforceable and against public policy. A growing number of states
have outlawed or restricted additional insured status.
Negotiate hard to eliminate unfair risk transfer indemnity clauses and
the equally unfair requirement to provide additional insured status.

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Chapter
Changes
9
Disagreements related to changes in the contract scope of work or to
the schedule are probably the number one cause of emotionally
charged exchanges between an owner and a contractor during the
course of a construction contract. Of all the clauses found in a
construction contract, the change clause seems to be the one that has
the greatest variation in the way it is written. Every contract writer
has his or her own way of defining how changes will be handled.
Owners and contractors, too, often have their own take on changes.
Owners may believe that every time they ask contractors to do
something that isn’t definitively spelled out in the contract
documents that contractors will request more time and money. Most
contractors have heard owners say, “there’s no way this contractor
thinks he’s going to make his profit at my expense due to changes.”
On the other hand, contractors may believe that owners look to have
new work, overlooked work, or new schedule considerations added
to the contract for free—­and to be done within the original contract
schedule. Most owners have heard contractors say, “there’s no way

Understanding and Negotiating Construction Contracts: A Contractor’s and Subcontractor’s Guide to

Protecting Company Assets, Second Edition. Kit Werremeyer.
© 2023 John Wiley & Sons, Inc. Published 2023 by John Wiley & Sons, Inc.

169
 this owner thinks he’s going to get a bunch of work for free at my
expense.”
In short, most contractors and owners have been in the situation of
dealing with changes and their effects on the contract’s schedule.
Both will agree it’s not fun. It does seem, though, that there must be a
better way to deal with work scope and schedule changes so that both
are treated fairly. Keeping tempers below the boiling point when
negotiating changes is always beneficial for both sides, as well as for
the project as a whole. Neither side should feel the need to come out
with guns blazing regarding this issue.

Some Ground A few ground rules for contractors and owners are in order here
when dealing with changes:
Rules 1. The contractor should expect to be paid by the owner for
­legitimate scope of work changes.
2. The contractor should expect the owner to allow schedule
adjustments for legitimate scope of work changes.
3. The owner should expect to be treated fairly by the contractor
with respect to how much he is charged for legitimate scope of
work changes.
4. The owner should expect to be treated fairly by the contractor
with respect to schedule adjustments required by the contractor
for legitimate scope of work changes.
5. All changes and associated cost and schedule consequences
should be agreed to in writing. No exceptions!
Rule #5 stops short of saying that all changes must be in writing
“prior to performing the change.” This is because sometimes that is
not possible or practical in order to keep the project moving
forward, or for safety reasons. However, it is best to have all
changes agreed to in writing prior to actually doing the work
contemplated in the change order whenever possible. If the change
isn’t agreed to in writing prior to doing the work, then there needs
to be a written procedure in the construction contract requiring
the parties to process the verbalized change as soon as possible
afterwards.

Protecting One thing that’s important for contractors to remember is that when
they are in the negotiating phase of the contract, getting a fair and
the Project well-­written change clause into the contract is vital. This is because
Manager the contractor’s project manager will have to abide by its provisions
during the course of the project. If the change clause is poorly written
or heavily in favor of the owner, the contractor’s project manager may
find it difficult, or impossible, to recover the value of changes and

170
 associated increases in the project’s schedule. Therefore, when
contractors are negotiating the change clause in a contract, they need
to remember that, in addition to protecting their company’s financial
and scheduling interests, they need to protect the project manager’s
ability for changes and schedule time.
If the construction contract has a liquidated damages clause in it for
failure to meet the schedule, it’s even more important that the project
manager have a fair and workable changes clause. This is so he can
get appropriate extensions to the contract schedule for changes and
not end up being unfairly exposed to a liquidated damages clause
associated with failure to meet a schedule. (For a more detailed
discussion of liquidated damages, see Chapter 11.)

Owners’ Most owners will agree to issue some sort of simple written field
directive to perform small amounts of new or emergency work,
Directives which will end up being an authorized change to the contractor’s
scope of work and/or schedule. This is easy enough to enforce.
Contractors should have something in writing directing them to
perform the change before proceeding with it.
Oral directives from the owner to perform work that can be
considered a change should be avoided. Many owner’s contracts
expressly forbid the contractor from proceeding with a non-­written
change except when personnel or property are at risk. When the job
is over, or even during the course of the job, trying to get paid for
additional work that was never written down is difficult at best.
Despite what the owner may say about processing such verbal
directives, the bottom line is that it’s poor contracting by both
parties. All verbal requests for changes—­big or small—­from the
owner should be immediately followed up with some form of written
confirmation as to the price and schedule consequences.

Constructive A constructive change refers to any of the following:

1. A change allowed for over-­inspection by the owner’s inspectors,
Changes and the associated slow-­down or extra expense to the
contractor.
2. A change eventually allowed for the owner’s failure to grant a
legitimate schedule extension.
3. A change associated with the owner’s failure to coordinate other
contractors on the job site, and the associated schedule and cost
consequences.
By nature, constructive changes may be difficult to prove, unless very
good record-­keeping is maintained by the contractor and his project
manager.

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 Payment How should a contractor be paid for the increased cost of changes to
the schedule and/or scope of work? If the increased costs aren’t too
for Changes significant with respect to the original contract price, the contractor
should be paid the full value of the change, without any retention
withheld, and without having to increase the value of any bonds or
security instruments in place for the project.

An Example
Let’s say a contractor is working on a $1,000,000 fixed-price con-
struction project. The terms of payment provide for deducting 5%
retention from all progress payments. The contractor also has
provided the owner with a performance bond in the amount of 5%
of the contract price, or $50,000.
During the course of the project, the owner authorizes in writing a
$10,000 change for some additional work.
Once the work in the owner’s change order is completed, the owner
should be billed for the entire $10,000 without its value being
reduced by the 5% retention provided for in the contract’s terms of
payment. The contractor should also not be required to increase the
value of the performance bond, or surety guaranty, he provided to
the owner. This is fair. The additional work was not contemplated
during the original negotiations for the project, nor was increasing
the value of the performance bond.
It’s okay to have a different set of payment terms for changes or to avoid
going through the cost and administrative exercise of increasing the
value of any form of on-demand performance bond, surety guaranty, or
standby letter of credit used as an assurance of performance.

Sample Change There is a variety of ways to write a change clause; following are a few
examples.
Clauses
Example 1

Article 22 – Changes
22.1 Owner has the right to make changes in the Work, including alterations,
reductions, or additions. Upon receipt by Contractor of Owner’s written
notification of a change, Contractor shall: (1) provide a written estimate for
the increase or decrease in cost due to the change, and; (2) notify Owner in
writing of any estimated change in the existing completion date.
22.2 If Owner instructs in writing, Contractor shall suspend work on that portion of
the Work affected by a change, pending Owner’s decision to proceed with the change.
22.3 If Owner elects to make the change, Owner shall issue a change order for
the change, and Contractor shall not commence work on any change until the
written change order has been issued.

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All things considered, this change clause is fairly simple and
straightforward. It basically says that no changes will be made unless
they are in writing (good!), and that the owner will issue a written
change order to the contractor prior to the start of any work under the
change (even better!). The clause provides a simple procedure to
follow for changes.
The only thing this sample clause doesn’t do is provide a mechanism
for the contractor to initiate a change if he thinks one is necessary.
However, the contractor could circle back through the owner, advise
him of the change, and, if the contractor is persuasive, have the owner
initiate the change. When the relationship between the owner and
the contractor is good, this will usually work.

Example 2
The following is an example of an unfair change clause, fully in favor
of the owner, and one that would need some major editorial surgery
to make it more fair to the contractor.

Article 22 – Changes
22.1 Owner shall have the right, without notice to or the consent of the
surety or sureties on Contractor’s bond or bonds to order changes in the
Work, or to order the omission of any of the Work, or to order extra work or
material within the general scope of the Work.
22.2 Contractor shall proceed with the Work in accordance with all orders
given by Owner. Should any such order materially increase or decrease the cost
of the Work, an equitable adjustment of the contract price shall be made.
22.3 The party desiring such an adjustment shall submit to the other party,
within fifteen (15) days after receipt of the relevant order, a written claim setting
forth the amount of the desired adjustment and the other party hereto shall
either approve or disapprove the proposed adjustment in writing within ten (10)
days after receipt of the claim therefore.
22.4 If any adjustment so proposed is not approved within the time above
specified, and if the matter is not settled by mutual agreement after written notice
or disapproval has been given or after expiration of the time allowed for approval,
then the amount of increase or decrease in the Contract Price, if any, shall be
determined in the Dispute clause in this Contract.

Getting treated fairly for cost and schedule changes under the
provisions of this change clause might prove tough for the contractor,
maybe even impossible. The first paragraph, 22.1, gives the owner the
right to unilaterally order the contractor to perform extra work
associated with a change made by the owner.
Paragraph 22.2 says, “Should any such order materially increase or
decrease. . .” Who is the judge of whether or not an owner-directed
change is “material”? “Material” is another one of those words used in

173
 contracts that is open to too much interpretation. In this particular
Contractors will clause, the owner would be the judge of what is “material.” It’s
likely have different possible the owner could decide that a $10,000 change in a $1,000,000
experiences with contract was not “material,” and the contractor was not entitled to a
resolving changes change in that amount. Too bad for the contractor. Looks like a
with different owners. dispute is brewing. Good luck with getting his money due for the
Some owners will be change or any necessary schedule adjustment.
fair to contractors in Paragraph 22.2 goes on further to say, “an equitable adjustment shall
determining what is be made. . .” if the owner judges the change to be “material.” What
“material” and what does an “equitable adjustment” mean? Who decides what’s
is “equitable.” Others “equitable”? “Equitable” is another one of those words used in
will not. contracts that is open to broad interpretation.
In this case, the owner would also be the judge of what should be an
“equitable adjustment.” If the contractor submits a bill for $10,000 for the
ordered change and the owner deems an “equitable adjustment” is only
$2,000, what’s the contractor to do? Again, this is a recipe for dispute.
Paragraph 22.3 goes on further to provide for some timing of
submitting costs and approvals or rejections of the submitted costs—
not much meat here other than an administrative effort.
The last paragraph, 22.4, basically indicates that if no agreement on
the value of the change is reached, then the issue will be settled in
accordance with the contract’s disputes clause. But the contractor
must proceed with the work in the meantime. Again, too bad for the
contractor, especially if the disputes clause is as unfair to the
contractor as the changes clause is! Note, too, that nothing is said in
this changes clause about providing the contractor an extension to the
Any time the owner schedule that may by occasioned by a change in the scope of work.
is allowed by the What’s “reasonable, equitable, and material” to the owner may not be
contract to interpret to the contractor. These types of words, sometimes appropriately
ambiguous words called “weasel words” are best left out of a contract. Discovering this
like “reasonable,” type of wording in an owner’s contract should immediately raise a red
“equitable,” and flag. It’s not difficult to negotiate and put in writing a fair and
“material” in a unambiguous change procedure, replacing ambiguous wording with
contract clause, words that have a more precise meaning. It’s always better to butt
the owner has an heads over the negotiating table prior to signing a contract than to do
unfair advantage so later over the change order table.
in deciding their Example 3
meaning.
The following example addresses a typical situation where a
subcontractor has a separate contract with a prime contractor. The
prime contractor has his own separate contract (the prime contract)
with the owner. (The prime contractor is in-between the
subcontractor and the owner.)

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 Article 22 – Changes
22.1 This Subcontract is subject to the right of Owner to make changes in
the Drawings and/or Specifications that are associated with the Prime
Contract.
22.2 In such event, Prime Contractor shall make required changes in the
Drawings and Specifications, require additional products, materials or services,
or suspend or omit all or portions of the requirements covered by this Subcontract.
22.3 If such changes cause an increase or decrease in the Subcontract Price or
in the time for the Subcontract’s completion, then the price and completion time
of this Subcontract shall be modified in writing; provided, however, that any such
adjustment is also made in Prime Contractor’s contract with Owner to incorporate
the adjustment in the price or in the completion time for the Prime Contract.
22.4 In the event that the adjustment submitted by Subcontractor is not
approved or accepted by Owner, Subcontractor may at own expense dispute
the decision of Owner in accordance with the disputes procedures set forth in
the Prime Contract, provided, however, that nothing shall excuse Subcontractor
from proceeding with the supplying of the products, materials, or services as
changed by Owner.
22.5 All changes involving increases or decreases in the Subcontract price or
changes in the completion time shall be considered accepted by Subcontractor
unless they are rejected in writing by Subcontractor within the time allowed in the
Prime Contract to dispute any changes.

Paragraph 22.3 provides for the subcontractor’s cost and schedule

changes and requires them to be approved in writing. While this is a
good idea, the clause goes on to imply that these subcontractor
changes must be approved by the owner, and that the same changes
be made to the prime contract as well. There is nothing wrong with
this requirement in theory, but what happens if the owner does not
approve the changes?
Paragraph 22.4 says that if the owner does not approve the changes,
the subcontractor still has to perform the changes and may, at his
own expense, dispute the owner’s decision. That’s not good for the
subcontractor. This paragraph goes on to require the subcontractor
to perform the changes regardless of whether or not he is paid for
them.
This change clause won’t be too difficult to live with if the
subcontractor negotiated the complete removal of paragraph 22.4
and the last half of paragraph 22.3.

Example 4
The following changes clause is poorly-written and an example of
confusing wording that needs editing.

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 Article 22 – Changes
22.1 Owner may order extra work or changes to the Work by altering,
adding to, or deducting from the Work. Any extra work or changes ordered
by Owner shall be executed by Subcontractor in accordance with all the
terms and conditions of this Contract.
22.2 Any claim by Contractor for an adjustment in the Contract Price or the
Contract Completion Schedule under this Article must be submitted to Owner in
writing within seven (7) calendar days from the date any extra work or a change
is ordered.
22.3 In the event Owner and Contractor fail to agree upon the extent or amount
of an adjustment to the Contract Price or Contract Completion Schedule,
Contractor shall nevertheless proceed with the completion of the extra work or
change.
22.4 If Contractor does not notify Owner of any increase in Contractor’s cost or
time within the seven (7) calendar days, it shall be presumed by Owner that
there is no increase in the Contract Price or the Contract Completion Schedule
and Contractor shall forfeit its rights to any increases.
22.5 Owner shall have the authority to order minor changes in the Work that do
not involve extra costs, but otherwise, no extra work or changes shall be done
without a written order from Owner, except in an emergency endangering life or
property.
22.6 For all extra work or changes, the amount of the Contract Price shall be
adjusted as may be agreed upon between the parties.

The above example is problematic for the following reasons:

• Paragraph 22.1 gives only the owner the authority to order extra
work or changes.
• Paragraph 22.2 gives the contractor only seven days to provide a
cost and schedule change proposal. Note that it says “calendar
days,” which means both days worked and those not worked, like
Saturdays, Sundays, and holidays.
• Paragraph 22.3 states that if the owner doesn’t like the
contractor’s price and schedule proposal for extra work or a
change, the owner can reject the proposal, yet the contractor has
to perform the work anyway.
• Paragraph 22.4 says that if the contractor doesn’t provide the
owner, within seven calendar days, a proposal for the cost and
schedule changes for extra work or a change, then the contractor
must to do the work at no cost to the owner and without any
schedule adjustment.
• Paragraph 22.5 gives the owner the authority to order the
contractor to do “minor work” for free. The owner’s definition of
“minor work” may not be same as the contractor’s definition.

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 • Paragraph 22.6 says the contract price will be adjusted. While
this might be okay, what about changes to the contract
completion schedule? The contractor’s project manager may
have a difficult time trying to get price and schedule changes
agreed upon with the owner if this clause ends up being in the
contract as written.
Let’s take example Article 4 and make some revisions to it that would
make it more fair for a contractor.

Article 22 – Changes (New wording is in bold) (Continued)

22.1 Owner may order extra work or changes to the Work by altering,
adding to, or deducting from the Work. Any extra work or changes ordered
by Owner shall be executed by Subcontractor in accordance with all the
terms and conditions of this Contract.
22.2 Any claim by Contractor for an adjustment in the Contract Price or the
Contract Completion Schedule under this Article must be submitted to Owner in
writing within fourteen (14) calendar days from the date any extra work or a
change is ordered.
22.3 Owner and Contractor shall agree in writing upon the extent or amount
of an adjustment to the Contract Price or Contract Completion Schedule prior to
the work being performed by Contractor.
22.4 If Contractor does not notify Owner of any increase in Contractor’s cost or
time within the fourteen (14) calendar days it shall be presumed by Owner that
there is no increase in the Contract Price or the Contract Completion Schedule
and Contractor shall forfeit its rights to any increases.
22.5 No extra work or changes shall be done without a written order from
Owner, except in an emergency endangering life or property.
22.6 For all extra work or changes, the amount of the Contract Price and
Contract Completion Schedule shall be adjusted as agreed upon between the
parties in accordance with the provisions of Article 22.3.

One final exceptional example of an unfair change clause:

Example 5

Article 22 – Changes
22.1 Owner will not agree to any cost or schedule changes in the Work
during the course of the Contract.
22.2 If Contractor believes there may be changes in the Work occurring during
the course of the Contract, he should provide for them in his firm lump-sum price
and fixed schedule for the Work.

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 This is just a joke, right? There couldn’t possibly be such an unfair
change order clause in a contract. A contractor should never
underestimate what he might find written in a construction contract.
This is especially so when it comes to change order clauses, of which
there are many, many creative varieties in favor of the owner.
(A clause very much like this one was found hidden in an actual
construction contract). Read the contract!

Major Contract Sometimes on large and complex projects, a major change to the
scope of work will be considered by the owner. In this event, the
Changes contractor may have to utilize the services of engineers and/or other
specialists to put together a proposal for the changes being
considered. It may also take a significant amount of the contractor’s
time and effort to study, evaluate, estimate, and properly price the
proposed change.
Large changes (15% or more of contract price) may also require
increasing the value of any assurance of performance the contractor
has provided and may significantly increase indirect costs
associated with project management and home office costs
(overhead).
The development of large, complex change proposals can turn out to
be an expensive and time-­consuming effort by the contractor. Who
pays for this?
It’s one thing if putting together a change proposal for the owner
costs several hundred dollars; this may just be the cost of doing
business. It’s another matter entirely if the cost to put together a
proposal for changes amounts to thousands or tens of thousands of
dollars. The owner should pay for this effort in the event he does not
accept the changes being considered. If the owner accepts the
changes, then presumably the contractor has included his costs to
develop the change proposal in his price for the changes he submits
to the owner.
To guard against the situation where a major change is not accepted
by the owner, and the contractor wants to be paid for the cost of his
development efforts, language similar to the following can be
included in the change clause in the contract.

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 Article 23 – Major Changes
23.1 Owner agrees that in the event Contractor’s cost to prepare a
proposed major change to the Scope of Work requested by Owner exceeds
$1,500 (or some other value as may be appropriate), Owner will reimburse
Contractor for such costs if the proposed change is not accepted by Owner.
23.2 For such major changes, Contractor shall submit to Owner an estimate of
his costs to prepare a proposal for the major change.
23.3 Owner will approve or disapprove in writing the cost submitted by
Contractor to prepare the proposal for the major change.
23.4 If the cost submitted by Contractor is approved, then Contractor will
develop the proposal for the major change and submit it to Owner.
23.5 If the proposal for the major change is not accepted by Owner, the cost to
prepare the proposal will be reimbursed to Contractor.

Negotiating Prior to negotiating modifications to a change clause in a contract,

contractors may want to discuss with the owner the five ground rules
Change Clauses noted at the beginning of this chapter. Starting the negotiation
process for a particular clause with a simple philosophy of fairness to
both parties often leads to a successful negotiation for the contractor.
If these five ground rules can be agreed on by both the owner and the
contractor, then a fair change clause can probably be negotiated.

A Model Change Clause

Here’s an example of a change clause that contractors can consider
using as a basic model for negotiating purposes:

Article 22 – Changes
22.1 Owner and Contractor will agree in writing to all changes in the Work
and prior to the changes being performed. An adjustment in the Contract
Price and in the Contract Completion Date shall be made to reflect the
changes. Contractor shall submit to Owner a written proposal describing
the change in the Scope of Work, its value, and any applicable schedule
impact. Owner shall approve or disapprove in writing Contractor’s proposal
within seven (7) days of receipt by Owner.
22.2 If no agreement can be negotiated between Owner and Contractor as to
the value of the change and impact on the Contract Completion Date, if any, then
Owner may request Contractor to perform the change on a cost reimbursable
basis and all time required to complete the changes will be added to the Contract
Completion Date.
22.3 All agreed-upon pricing changes to the Scope of Work shall be paid at full
value at the completion of the changes, or other agreed-upon payment terms,
without the withholding of any retention and without the modification of any pay-
ment or performance related bonds, including surety guaranties, provided by
Contractor for the Scope of Work.

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 What does a contractor get out of a change clause like this one?
• All changes to the contractor’s price and schedule are agreed on
in writing before the work required under the change order is
performed.
• If no agreement is reached on cost and schedule, work is done
on a reimbursable basis. (Many owners have contractors provide
an extensive list of unit rates and markups to use for extra work,
included as part of the contract.)
• All changes are paid in full without retention.
• There are no changes to any on-­demand bonds or surety
guaranties. (This keeps the contractor’s administrative costs and
time to a minimum.)

The Contract Change Matrix

A good way to make contract changes is to agree before the contract
begins with a predetermined way to price contract changes. This
process would be included as part of the final contract documents.
An example follows:
The following shall be used to determine the price of contract
changes. Rates include contractor’s overhead and profit.

Category Rate

Project manager $150/hr

Project superintendent $100/hr
Field engineer $75/hr
Engineering $100/hr
Craft labor Craft rate:
i.e. Boilermaker Welder: $75/hr
Equipment Rental rate:
i.e. 15 Ton Mobile Crane Fueled and operated:
$150/hr
Materials Cost plus 20%
Subcontracts Cost plus 20%

Conclusion When reviewing, analyzing, and negotiating change clauses, watch

out for the following issues:
1. Imprecise words in the change clause that are open to the
owner’s sole interpretation, such as “reasonable,” “material,” and
“equitable.” These words increase the contractor’s risk of not
being paid for legitimate changes and not being allowed
legitimate extensions to his schedule.

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 2. Cost-­only type of change clauses that don’t allow the
contractor the ability to change his completion schedule.
Extensions to schedule are important, especially if the contract
provides for liquidated damages for late completion.
3. Unilateral change clauses that allow the owner to direct the
contractor to make a change with the sorting out of cost and
schedule changes to take place at some later date. This is sometimes
described by contractors as a “20 cents on the dollar clause.”
4. Verbal change clauses that don’t require all changes documented
in writing. All changes must be in writing. No excuses allowed!
5. Any change clause that is written in an unnecessarily
complicated and overly obtuse legalistic manner. The use of
plain and understandable English is a benefit to everyone,
especially the contractor’s project manager, who has to work
with the requirements of a contract.
Cost and schedule changes are inevitable on construction contracts.
One of the best ways to minimize them is for both the owner (mainly)
and the contractor to take all the time necessary to develop and agree
on a detailed and comprehensive scope of work, such as described in
Chapter 3 of this book.

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 Chapter
Disputes &
10 Their Resolution

What’s a Project At the end of a long day of trying to resolve one problem after
another on the job site, a project manager storms into the job site
Manager to Do? office, tosses his hard hat in a corner, and announces loudly to his
A Short Story assistant, “These guys we are building this project for are really
amazing. We’re getting frustrated out there on the site with the
to Start With behavior of the owner’s inspectors, and it’s starting to cause
­problems. I finally got fed up today with the three inspectors who
were assigned to look over our piping work. I tried to be as d
­ iplomatic
as possible when I told them what the problem was all about.”
The project manager continued, “Not one of the owner’s inspectors
assigned to our piping work has more than three months of
­construction experience. They stop us and slow us down because
they just don’t know what they are doing.
We have lost hundreds of productive hours and wasted equipment
rental and project management time while these inspectors stop the
work to try to determine if the piping is installed according to the

Understanding and Negotiating Construction Contracts: A Contractor’s and Subcontractor’s Guide to

Protecting Company Assets, Second Edition. Kit Werremeyer.
© 2023 John Wiley & Sons, Inc. Published 2023 by John Wiley & Sons, Inc.

183
 specs and the code. I don’t think these guys have ever seen a pipe job
before! All we are doing out there is running a training program for
these three guys, at our cost, of course.
“After we take the time to guide them through the job specs and the
piping codes, they finally allow us to go back to work. Yesterday, they
stopped us for almost half a day and finally said everything looked
okay and we could go back to work. Those welders and fitters and
equipment operators on our payroll, and my project staff, sure don’t
stop getting paid during this downtime.
“I calculated the other day that we have lost about $50,000 in
downtime and related delays due to the inexperience of these three
inspectors. We haven’t got nearly that much extra money in the
estimate. The owner should have some sort of obligation to put
experienced inspectors on the job, and so I’m going to put in a claim
for what I think we’ve lost in this exercise to train his piping
­inspectors. Where’s a copy of the contract, so I can take a look at
how to resolve this dispute?”
It appears as if a serious dispute is brewing on this project. The
contractor feels that the owner has a contractual obligation to
provide experienced inspectors. The contractor didn’t include money
in his estimate for running a training program for inspectors! On the
other hand, the owner needs to have the flexibility to assign his own
people to the job to represent and oversee his interests, and he feels
the contractor has a contractual obligation to work together with the
people he assigns to the project.

Disputes—­The It’s unlikely disputes will ever go away in construction contracting.

Every contractor has had them. Disputes will continue to occur in
Construction future contracts because they are written by human beings, and no
Contract’s Bad one is perfect. A contractor doesn’t need to write his yearly business
plan around resolving disputes, but it does make good sense to be
Actor knowledgeable about how to contract for, manage, and resolve
them.
It’s just about impossible to write a contract that perfectly describes
the scope of work and all the responsibilities of the contractor and
the owner. The larger and more complex the contract, the higher the
probability a dispute will occur. Disputes arising out of disagreements
over the scope of work and commercial terms, and
misunderstandings between the contractor and the owner, are going
to take place during the course of all contracts.
Many times these disputes are small, and the contractor just deals
with them as a normal, if disagreeable, part of being in the
construction business.

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An Example
Let’s suppose a contractor on a new office building project reads the
contract’s plans and specifications to include 100 new doorways in
office areas. During the course of the work, the owner points out to
the contractor that 105 doors are actually required. The contractor
disagrees, which causes the potential for a dispute. The cost of each
new doorway is $500, so the contractor is looking at an extra cost of
$2,500. His total project value is $600,000. He has had a good
relationship with the owner prior to this disagreement. The
­contractor makes a business decision to install the extra doors,
absorb the extra cost himself, and schedule the time, to avoid a
dispute with the owner. Hopefully, the owner will remember this
small favor on the next project the contractor bids to him.
Sometimes it’s best for an owner, too, to resolve a potential dispute to
the contractor’s satisfaction. On the other hand, sometimes a dispute
creates a major cost or scheduling problem, with both the contractor
and owner claiming it’s the other party’s problem. Consequently, the
contractor often must take some sort of action to try to resolve it,
hopefully in his favor.
A major dispute can be very disruptive to a contractor’s organization.
It can involve a lot of valuable time and resources that would
otherwise be put to good use selling and building profitable projects.
A major dispute can erode a good working relationship with an
owner that may have been carefully cultivated over a long period of
time—­and can make it difficult or impossible to get future business
from him.
No contractor plans to have disputes in a contract—­nor, for that
matter, does the owner. Both try, to the best of their abilities, to put
together a good contract with a definitive scope of work and clear
commercial terms spelling out each other’s duties and
responsibilities.
Unfortunately, despite the best efforts of both the owner and the
contractor, misunderstandings and disagreements can develop that are
difficult to resolve, and then both parties find themselves mired in a
dispute. It’s been said that once the contract has been signed by the
owner and the contractor, it gets put in a bottom desk drawer and
doesn’t again see the light of day until there is a dispute. Then everyone
involved decides it’s time to pull it out, dust it off, and read it.
Most construction contracts have a clause outlining a process to be
used to resolve a dispute. Some, however, will not have a full dispute
resolution clause in them; the contract may be silent on how to
resolve disputes, and that’s a problem for the contractor.

185
 An Ounce The following steps outline the best way to minimize the possibility
of disputes developing during the course of a construction contract.
of Prevention 1. Define the Scope of Work: Include a well-­defined and detailed
scope of work in the contract documents. The extra time spent
developing a detailed scope of work will always benefit both the
owner and contractor by reducing the possibility of disputes
arising. The scope of work document should outline all the
known responsibilities of both parties, and all others directly
involved in the construction project. This is particularly
­important where there are interfaces that will take place with
other contractors or parties, like the owner’s third-­party
­inspectors, project manager, or architect.
2. Include a Disputes Clause: Make sure that the construction
contract has a dispute resolution clause included that clearly
outlines a process for resolving disputes and is satisfactory to the
contractor. Including a disputes clause is key to good, basic
construction contracting and is also part of the risk management
process associated with any construction contracting effort.
3. Document Everything in Writing: Written documentation of
all activities associated with a dispute is absolutely critical to
resolution in favor of the contractor. This process is often
­difficult to make happen when project management and staff are
busy with building the project. Filling out extra paperwork on
something that may or may not be disputed all too often isn’t a
high priority, but should be. The better documented the
­contractor’s case, the better the chances of a successful
­resolution of the dispute. The contractor’s project manager and
staff also must be alert to situations that may cause disputes.
4. Practice Early Identification: Bring a potential dispute to the
attention of the owner as early as possible. Keep it on the table
as long as necessary, and document it in the minutes of job site
meetings. Owners don’t like disputes any more than contractors,
so early identification of a potential dispute makes satisfactory
resolution more likely. The worst thing to do is to wait until the
end of the project to try to settle disputes; if you do, good luck.

Dispute There are four basic ways of resolving disputes that develop during
the course of a construction contract:
Resolution 1. Negotiation: This is by far the best way to resolve disputes and
Options helps maintain a good working relationship between the owner
and contractor. The negotiation process also requires
­understanding and compromise on the part of both the

186
 c­ ontractor and the owner, and the final resolution usually leaves
both parties feeling equally good or bad about the outcome, but
ready to get on with completing the project.
2. Mediation: This is the simplest and most straightforward form
of what is commonly called Alternative Dispute Resolution, or
ADR for short. A neutral professional mediator is hired by
mutual agreement of the contractor and the owner. The
­mediator is trained in resolving disputes and should be selected
from candidates who have strong construction backgrounds.
The goal is to get both groups to the bargaining table and talking
to each other, and to ultimately help them compromise on a
solution to the dispute. The mediator does not impose a
­solution, but helps each side find one they both can live with.
The contractor and the owner split the cost of the mediator—­a
low-­cost way to settle disputes. The details of the settlement
remain private.
The mediation process is simple and effective, and works well
where both sides are interested in finding a peaceful solution.
Professional mediators are available from a wide variety of firms
and organizations that offer ADR services.
3. Arbitration: This is another form of ADR, although it is more
formal and complex than mediation. The contractor and owner
agree on a single arbitrator who will listen to the details of the
dispute from both sides and then make a decision. Alternatively,
the contractor and owner can each separately nominate one
arbitrator, and then the two nominated arbitrators will appoint a
third to fill out a three-­person arbitration panel. The arbitrator
selected by the contractor should have construction experience,
but nothing compels the owner to select an arbitrator with a
construction background. This three-­person panel will listen to
the details of the dispute from both sides and give a decision.
Arbitration may or may not be binding, depending on the
­decision made by the contractor and owner during the contract
negotiation process. Binding arbitration simply means that both
parties agree ahead of time to abide by the arbitrator’s decisions.
However, binding arbitration can sometimes be subject to
appeal, so it’s important to understand the circumstances of any
binding arbitration process. Nonbinding arbitration is just that:
neither contractor nor owner has to accept the decision of the
arbitrators.
The contractor and owner share the costs of arbitration, but not
necessarily in equal parts. Lengthy arbitration proceedings can

187
 be expensive and time-­consuming. The proceedings and any
decisions made by the arbitrators are private. Note that there is
a downside to using a three-­person arbitration panel. The
arbitrator selected by the owner and the third arbitrator selected
by the other two arbitrators do not necessarily have to have
construction backgrounds, so two of the arbitrators on the panel
may have little or no experience in the construction industry.
However, professional arbitration boards and organizations are
widely established, have common rules and procedures, and are
readily available to help contractors and owners resolve
disputes.
4. Litigation: This is a costly and lengthy adversarial process, and
requires both parties to take the dispute to court for a decision.
The contractor and owner will engage lawyers, go through a
lengthy discovery process of document review and testimony
from individuals involved in the dispute, and then both sides will
go to court to present their cases. If the contractor or the owner
does not like the decision made by the court, they may be able to
appeal the court’s verdict to a higher court. Litigation is costly
and time-­and resource-­consuming for the contractor and the
owner. Decisions made by the courts can be unpredictable and
become public information.

The Folks who When trying to resolve a dispute related to a construction project,
who would likely be better at resolving the matter? Would someone
Negotiate, experienced in the construction business be better? Or would
Mediate, someone who may be good at just interpreting the words in a
contract be better? In negotiations, the experience and background
Arbitrate, & of the people involved with the settlement process is very
Litigate important. The negotiators for the owner and the contractor are
more likely to have construction backgrounds, which aids in finding
a solution.
In mediation, however, the owner and contractor normally select a
mediator jointly (as described earlier) who should ideally have a
strong construction background. He can help both sides work
through the dispute without getting unnecessarily bogged down in
the legal/commercial aspects of the written contract. The mediator
should be looking for a fair compromise between the parties, rather
than strictly interpreting the words in the contract in favor of one
party or the other. Mediators with strong construction backgrounds
are widely available.

188
 In arbitration, it is not uncommon to find that the individuals who
are available to act as arbitrators are lawyers or retired judges. While
they may be good at interpreting—based on their own perceptions—
what they believe the wording in a contract means and how it may or
may not apply to a dispute, they may not have any experience in the
construction business.
Despite the assurances that may be made by a contractor’s legal
representatives, the decisions made by courts are unpredictable at
best. The chances of a favorable outcome for the contractor are about
the same as throwing a winning roll of the dice at the craps tables—
and maybe less. As previously noted, the litigation process is
expensive, extremely time-consuming, and the outcome is highly
unpredictable. The legal representatives for the contractor or owner
may not have any practical construction experience. The judge, who
The negotiating table will listen to the facts and the evidence in the case and render a
is by far the best decision, may not have any practical construction experience either.
place to resolve a Many times, one party will file a lawsuit just to try to drive the other
dispute. party to the negotiating table.
An aside here worth mentioning is that in some other countries, such
as in Asia, going to court to resolve a dispute is an absolute last resort
and is considered to be a personal failure on the part of all the
individuals involved in trying to resolve the dispute.

Dispute All construction contracts should have a fair dispute resolution

clause that allows for ADR (mediation or arbitration) as part of
Resolution the commercial terms and conditions. Such a clause doesn’t need
Clauses to be lengthy or complex, but should clearly outline the process
the contractor and owner agree to use to settle any disputes that
may develop during the course of the contract. Having a fair
dispute resolution clause as part of the commercial terms and
conditions allows the contractor to apply pressure on the owner to
settle any dispute, since there is an agreed-on procedure to use.
Focusing on resolving disputes as soon as they develop is
extremely important to achieving a resolution that is favorable to
the contractor.

189
 Example 1
Following is an example of a one-sided dispute resolution clause.

Article 31 – Disputes
31.1 During the course of this Contract, any dispute between the parties
arising out of the performance of this Contract which is not disposed of by
agreement shall be decided by Owner, which shall reduce its decision to
writing and then mail or otherwise furnish a copy thereof to Contractor.
31.2 The decision of Owner shall be final and conclusive unless, within 30 days
from the date of receipt of such copy, Contractor mails or otherwise furnishes to
Owner a written appeal. The decision of Owner on such appeals shall be final
and conclusive.
31.3 In connection with any appeal of Owner’s decision under this paragraph,
Contractor shall be afforded an opportunity to be heard and to offer evidence in
support of its appeal.
31.4 Pending final decision of dispute hereunder, Contractor shall proceed diligently
with the performance of the Contract and in accordance with Owner’s decision.

The owner holds almost all of the cards in this example. The words
“which is not disposed of by agreement” appear to give the contractor a
chance to negotiate a resolution of the dispute with the owner. If those
negotiations fail, then, by contract agreement, the owner becomes sole
judge, jury, and executioner in the resolution of disputes with the
contractor. Even the appeals process noted in the clause gives the owner
all the decision-making powers, with none allocated to the contractor.

Example 2
The example below, may not be the best dispute resolution clause,
but is more fair. It is a good example of one that is short, simple, and
to the point, specifying the process of consultation and negotiation as
a first step toward dispute resolution.

Article 31 – Disputes
31.1 Owner and Contractor shall attempt to settle amicably by consultation
and negotiation any dispute arising out of the performance or interpretation
of this Contract.
31.2 If the dispute cannot be settled in an amicable manner, then the dispute
shall be settled by binding arbitration in accordance with the Construction
Industry Arbitration Rules of the American Arbitration Association before a single
arbitrator selected in accordance with such rules.
31.3 The arbitration shall take place in Toledo, Ohio and shall be conducted in
the English language.

Including a clause similar to the above in a construction contract will at

least give the contractor a good chance of resolving disputes in his favor.

190
Note, however, that the conditions of this clause require binding
arbitration. If the decision of the arbitrator is against the contractor, he
has to accept that decision. If the decision is in favor of the contractor,
the owner must accept it.

Example 3
The following third example, while not too different from the previous
one in that it provides first for settling disputes in an amicable manner,
requires that a panel of three arbitrators be used if necessary.

Article 31 – Disputes
31.1 Any dispute or differences arising out of or in connection with the
Contract or the implementation of any of the provisions of the Contract that
cannot be settled amicably through negotiation shall be submitted to
arbitration under the auspices of the New York Regional Center for Arbitration
and the reference shall be to a panel of three (3) arbitrators, one to be
appointed by each party and the third, who shall be Chairman, to be jointly
appointed by both sides. In the event the two appointed arbitrators fail to
appoint the third arbitrator, the said Center shall be the appointing authority.
31.2 The arbitration shall be conducted in New York, New York, in accordance
with the rules of arbitration of the New York Regional Center for Arbitration. The
language of the arbitration shall be the English language. The arbitration pro-
ceedings, including the making of the award to the arbitrators, shall be final and
binding upon the parties.

Example 4
The fourth and final example, below, calls for Alternative Dispute
Resolution to be used if initial negotiation doesn’t work. This leaves the
door open to use mediation or arbitration to settle the dispute, as may be
appropriate. If all efforts to resolve the dispute fail, then both parties still
have the option “to pursue a legal remedy,” which simply means that both
parties can resort to using litigation in an attempt to resolve the dispute.

Article 31 – Disputes
31.1 Any claim arising out of or attributable to the interpretation or
performance of this Contract that cannot be resolved through negotiation
shall be considered a dispute within the meaning of this clause.
31.2 The parties agree to consider resolution of the dispute through some form
of an Alternative Dispute Resolution (ADR) process that is mutually acceptable
to the parties.
31.3 Should the parties agree to pursue an ADR process, each party will be respon-
sible for its own expenses incurred to resolve the dispute during the ADR process.
31.4 If the parties do not agree to an ADR process or are unable to resolve the dis-
pute through ADR, either party shall than have the right to pursue a legal remedy.

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 Conclusion Disputes are always going to be a part of being a contractor in the
construction business. Having a designated method of resolving them
spelled out in the contract is key to good contracting. Keeping
written details of events and activities related to actual or possible
disputes is essential, and cannot be overemphasized.

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Chapter
Damages
11
There are three main types of damages to which a contractor will likely
be exposed during the course of a construction contract. These are:
1. Actual damages
2. Liquidated damages
3. Consequential damages
A fourth type of damages, punitive, may come into play, though is
generally not applied to situations involving breach of contract/failure
to perform. As the name implies, punitive damages may be imposed
as punishment by a court of law for fraud or illegal activity, or for
grossly negligent, intentional, reckless, malicious, or willful types of
behavior. Punitive damages can be awarded in addition to actual or
other types of damages. This chapter will focus mainly on the other
three types of damages listed above.

Understanding and Negotiating Construction Contracts: A Contractor’s and Subcontractor’s Guide to

Protecting Company Assets, Second Edition. Kit Werremeyer.
© 2023 John Wiley & Sons, Inc. Published 2023 by John Wiley & Sons, Inc.

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 Breach The terms breach of contract and failure to perform are used
interchangeably. They simply mean that a party to the contract did
of Contract/ not do what he was supposed to do, as specifically required and
Failure agreed on in the written contract. For the balance of this chapter,
failure to perform will be used to describe this situation.
to Perform
A typical failure to perform on the part of the contractor, for which
he may be exposed to monetary damages, is not meeting the schedule
to complete the work without a legitimate reason. A legitimate reason
why the contractor may not be able to meet the schedule might be,
for example, an unusual three-­week-­long period of rain at the job site
that severely slows down the construction effort.
A typical failure to perform on the part of the owner, for which he
may be exposed to monetary damages, would be not paying the
contractor on time without a legitimate reason. A legitimate reason
for this might be, for example, that the contractor did not include,
with his request for payment, all the necessary inspection reports that
were required as a condition of payment.

Contractors’ To many contractors, the chance of financially exposing their

companies as a result of damages awarded to an owner for their
Financial failure to perform seems remote. This is something that only happens
Exposure to other contractors, they think. After all, the contractor plans to
complete all work safely, in accordance with the plans and
specifications, the contract schedule, and all the other various
commercial terms and conditions of the contract. If everything goes
according to plan, the contractor will safely complete the work, finish
on time, make a profit, and satisfy the owner. However, things don’t
always proceed according to the plan.
As a part of the risk management process for contracts, contractors
need to consider and minimize the potential for any financial
exposure that might arise out of damages assessed against them for
failure to perform certain aspects of the contract.
Owners and their contracting teams are already considering the
possibility that contractors will fail to perform some portion of the
contract and will attempt to protect themselves from the financial
consequences by including special protective clauses in the contract.
These clauses provide for the payment of monetary damages in the event
of the contractors’ failure to perform certain aspects of the contract.

Actual Actual damages can be assessed against the owner or the contractor if
either or both fail to perform their respective responsibilities and
Damages—­A obligations as outlined in the construction contract. Actual damages are
Silent Risk? considered economic (monetary) damages that can be clearly proven

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 and determined, typically awarded by a court of law as the result of a
lawsuit brought by one of the parties to the construction contract.
Neither party can just step up in front of the judge and tell him that they
believe the other party caused him $10,000 in damages; the judge will
want some legitimate facts and figures to prove the claim is valid.
The imposition of actual damages on a contractor could bankrupt
him, making it critical to understand this risk. It’s unlikely that an
owner will include a separate paragraph in a construction contract
that specifically addresses actual damages, which is why they can be
considered a “silent risk.” There is no need to include an actual
damages clause in a construction contract. The owner—and the
contractor, too—always has the right to file a lawsuit to try to recover
actual damages they believe they can prove.
A lawsuit for actual damages can be initiated by either party. The
owner can file a lawsuit against the contractor for actual damages he
feels were the result of the contractor’s failure to perform one or
Both the owner and more of his contractual requirements. Likewise, the contractor can
the contractor are file a lawsuit for actual damages he feels were the result of the owner’s
expected to perform failure to perform one or more of his contractual requirements.
in accordance with The court would examine the contract, take a look at the facts and
all the terms and figures, sort out the details, and, if appropriate, make a determination
conditions of the of the amount of monetary damages, if any, to be awarded. Awarding
construction contract. monetary damages to the aggrieved party will supposedly make him
If one party fails to “whole.” The award on monetary damages is based on the court’s
perform as agreed, assessment of how much the failure to perform by one party costs the
then the other party other.
may suffer some An Example
legitimate amount of
Let’s say a contractor installs an incorrect piece of equipment on a
economic damage construction project, and it costs the owner an additional $25,000
as a result of that for plant downtime to replace it with the correct equipment. If he
failure. The monetary can prove these costs in court, then the court may award monetary
damages awarded to damages in the amount of $25,000. This award reimburses the
one party are meant owner for his extra costs and makes him “whole.” It restores him—
to compensate financially/economically—to the point where he would have been if
the other party for the contractor had installed the correct piece of equipment.
some or all of the Can the owner or contractor negotiate a clause into a construction
actual value of the contract that relieves one or both of them from exposure to actual
economic damages damages? They might try, but the short answer is no. It’s very unlikely
he suffered due to that an owner or contractor would agree to some form of commercial
the other party’s language that would take away their right to pursue compensation for
failure to perform. actual damages caused by the other party’s failure to perform. It is
possible, though, to include a clause to exclude consequential

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 damages (which could be construed as a type of actual damages), put
in a limitation of liability clause, or limit the contractor’s exposure to
damages through a liquidated damages clause. (More information
about these special types of damages and limitations are provided
later in this chapter.)
In general, contractors understand that if they do not perform in
accordance with the terms and conditions of a construction contract,
then they have failed to perform. As a result, the owner may suffer
some amount of economic damage. If the owner can prove in court
that he has actually suffered economic damages on account of the
contractor’s failure to perform, the court may order the contractor to
pay some amount of monetary compensation for such actual
damages. Likewise, actual damages may be awarded to a contractor
by a court if the owner fails to perform. There are two sides to the
coin here.
The moral of the story is: there are no excuses. The owner and the
contractor are both at risk for actual damages, and both need to
perform the construction contract in accordance with the mutually
agreed-­on terms and conditions.

Liquidated Liquidated damages—­LDs as they are commonly called—­are the

owner’s estimate of how much he is financially “damaged” in the
Damages event the contractor fails to perform. The idea behind LDs is that the
owner feels it is not possible to accurately determine the precise
amount of the actual damages he will incur by the contractor’s failure
to perform. Therefore, the amount of the LDs stipulated in the
contract’s commercial terms and conditions is an agreed-­on estimate
of the value of the economic damages incurred by the owner by the
contractor’s failure to perform.
When a liquidated damages clause appears in a construction
contract, it has usually been drafted by the owner. In most
construction contracts, this clause will provide for some specific
amount of monetary damages to apply against the contractor for his
failure to meet the contractual schedule.
For example, if a contractor agrees to a 12-­month completion
schedule for the work and finishes in 13 months, the liquidated
damages clause would typically call for the contractor to pay a certain
amount of money to the owner for every day, week, or month that the
completion date exceeds the completion date indicated in the
contract.
Liquidated damages are also common in contracts where a certain
process or performance is guaranteed. For example, if a contractor
builds a chemical plant using his own proprietary chemical

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manufacturing process, and the final output of the plant is less than
what was stipulated in the contract, the liquidated damages clause
might call for some financial payment to the owner for every
percentage or unit of output less than agreed on in the contract.

An Example
Suppose a contractor builds a chemical manufacturing plant, and
that plant’s required output (as agreed on in the contract) is 10,000
tons of a specific chemical every month. Once the plant is up and
running, it only produces 9,500 tons of the chemical every month. In
this instance, there was a liquidated damages clause in the contract
obligating the contractor to pay the owner $20,000 ($4,000 per ton
per month reduced output) per month in liquidated damages until
the plant was fixed to produce the required output. The $20,000 is
the owner’s estimate of how much he would be damaged by the
reduced output. Perhaps the owner had to purchase the chemical
from a competitor to meet his customer’s needs.
Sometimes owners can be very creative in the application of
liquidated damages clauses. For example, the owner may have an LD
clause in the contract relating to the contractor’s project manager. If
the contractor pulls his project manager off the project prior to the
end of the job, the LD clause may come into play against the
contractor. Presumably, in this situation, the owner had some part in
the selection process of an experienced project manager, likes his
skills and capabilities, and wants to discourage the contractor from
pulling him off the project prior to the completion of the work.
The example and sample LD clauses that follow outline what may
occur when the contractor fails to meet the schedule—­probably the
most common situation where the owner would want to apply
liquidated damages.

An Example
Let’s say an owner wants to build a marine jetty, complete with
cargo loading and unloading facilities to handle ocean-­going ships.
The owner hires a contractor to design and build the jetty and
associated loading facilities on a turnkey, engineering, procurement,
and construction basis. They agree on a final price of $10,000,000
and an 18-­month overall completion schedule. The contract
requires that at the end of the 18 months from the date of signing
the contract, the jetty and facilities will be complete and ready to
load or unload cargo from ships.
Because it takes a significant amount of lead time to schedule ships
and organize exported and imported cargo, the owner proceeds

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 immediately after awarding the contract to schedule the arrival of
the first ship to coincide with the completion of the jetty and
unloading facilities, relying on the contractor to finish on time. As it
turns out, the contractor does not finish the marine jetty and
associated loading and unloading facilities within the contractual
completion time and is 20 days late.
Since the jetty and unloading facilities were not completed on time,
the ship scheduled by the owner now has to sit at anchorage in a
nearby harbor waiting to unload. The owner is subject to demurrage
(waiting time on the ship) of $7,000 per day by the shipping company.
There are also other financial considerations the owner has to face,
such as being penalized by his own customers for not being able to
deliver the product that is on the ship waiting to unload at the
unfinished jetty. The owner may also have to pay for unloading the
ship at an alternate and more expensive location.
The owner, to protect himself against any such consequences of the
contractor not finishing on time, had included a liquidated damages
clause in the contract. It stipulated that the contractor will pay the
owner $10,000 per day for each day it takes to complete the jetty
beyond the contractual completion date of 18 months.
In determining the amount of liquidated damages, the owner
estimated that the demurrage cost on the ship would escalate to
about $7,000 per day by the time the jetty and unloading facilities
were completed. He also estimated another $1,000 per day to cover
the extra costs and penalties he would likely incur by not being able
to deliver the product that was on the ship to his customers on time.
He further estimated another $2,000 per day in the event he had to
use alternative unloading facilities if the new jetty and unloading
facilities were not completed on time. The $10,000 per day in
liquidated damages represents a fair estimate of what the owner
would have to pay if the jetty and unloading facilities were not
completed on time. The liquidated damages clause in the contract
for the marine jetty read as follows:

Article 40 – Liquidated Damages

40.1 In the event Contractor fails to complete the Work within the schedule
and completion dates established in the Contract, Contractor agrees to pay
Owner liquidated damages in the amount of $10,000 per calendar day of
delay in final completion calculated from the Contract Completion Date up
to and including the actual date of completion.

Since the contractor was twenty days late in finishing the jetty and
associated loading and unloading facilities, he failed to perform the

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 contract in accordance with one of the key contract requirements—­
the requirement to finish the job in 18 months. Because the
­contractor failed to perform and had no legitimate reason for the
delay, the owner is exposed to additional costs.
Consequently, the owner has the right to enforce the terms of the
liquidated damages clause in the contract and charge the contractor
20 days multiplied by $10,000 per day, for a total of $200,000 in
liquidated damages. If the contractor refuses to pay, the owner would
most likely be able to have a court of law enforce the liquidated
­damages clause. If the contract allowed the owner to withhold r­ etention
from the contractor’s monthly progress invoices, he may subtract the full
amount of the liquidated damages from the amounts retained.
The above example was straightforward. It was designed to show how
an owner can estimate a value for liquidated damages and specify it
in a contract, as well as how it can be legitimately applied against the
contractor for his failure to perform without valid reasons for the
failure.
The practice of using liquidated damages to reimburse an owner for
the financial loss he may incur by a contractor’s failure to perform on
a construction contract is fair and acceptable, in theory, as long as it’s
not abused. Unfortunately, the application and use of liquidated
damages in a construction contract is not always as fair and
straightforward as in the above example.
The imposition of liquidated damages on the contractor by an owner,
or by a major engineering, procurement, and construction (EPC)
contractor, on lower tier contractors and subcontractors without due
regard to fairness can be a serious risk and potential financial liability
for a contractor or subcontractor.
From a risk management perspective, it’s important for the
contractor to protect himself by negotiating limits and conditions to
any liquidated damages clause in a construction contract. The
following are eight important issues for contractors to consider when
analyzing and negotiating a liquidated damages clause in a contract:
1. Does the amount of liquidated damages proposed by the owner
make sense with respect to the price, schedule, and risk for the
work?
2. Will the owner agree to put a financial cap (maximum) or other
limiting provisions on the amount of liquidated damages?
3. Does the contract have good changes and delays clauses that
require the owner and contractor to agree in writing on the
price and schedule? This is especially important if there are LDs
related to schedule compliance.

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 4. Has the owner insisted on an unrealistic completion schedule?
5. Will the possibility of liquidated damages being imposed on the
contractor create an adversarial relationship among the
­contractor, his project manager, and the owner during the
course of the contract?
6. Are liquidated damages really necessary for the contract, or are
they included to apply pressure on the contractor to perform?
7. Does it appear that liquidated damages are really a penalty?
8. If the contractor agrees to accept liquidated damages for failure
to complete the work on time, will the owner then agree to pay
the contractor a bonus for early completion?

Amount of Liquidated Damages

The amount of liquidated damages that might be imposed on a
contractor for failure to perform should bear some relationship to the
value of the contract and the risk associated with the completion
schedule and the nature of the work.
For example, if the contractor’s price to perform a construction
project with a tight schedule is $1,000,000, and the owner insists on
$25,000 per day in liquidated damages for failure to meet the
schedule, it wouldn’t take many days of schedule overrun to put the
contractor out of business. Maybe, in reality, $500 per day is a more
realistic amount for any liquidated damages.
In this case, if the owner refuses to negotiate a lower amount of LDs that
makes sense with respect to the value of the contract, its profit potential
for the contractor, and the level of risk associated with the work, then
this might be a good example of a project to let the competition have.
It’s not worth “betting the company’s future” on a contract like this.

Limiting Provisions
If the contractor has to agree to a liquidated damages clause in the
construction contract, then he should try to negotiate some limiting
conditions so that the potential financial exposure for failure to
perform can be understood and not unlimited.

An Example
Let’s say that a contractor has a $10,000,000 contract to build a new
office building on a design and construct basis. The contractual
completion schedule is 24 months from the date of signing the
contract. The owner wants liquidated damages to apply in the
amount of $5,000 per day for each day the contractor fails to meet
the agreed-­on completion schedule.

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 The contractor is comfortable with the $5,000 per day amount, but
is concerned that there is no limit to the maximum amount he may
have to pay for his failure to meet the schedule.

Example 1: Financial Cap

In the example, the contractor and owner could negotiate the
following clause that limits the total amount of liquidated damages:

Article 41 – Liquidated Damages

41.1 Should Contractor fail to complete the Work within the schedule and
completion dates established in the Contract, Contractor agrees to pay, as
its sole liability to Owner for delays, liquidated damages in the amount of
$5,000 per calendar day of delay in final completion calculated from the
Contract Completion Date up to and including the actual date of completion,
to a maximum amount of 2% of the Contract Price, or $200,000.

In the above example, the contractor’s maximum financial exposure,

or cap, is $200,000. In another example of financial caps, let’s say the
owner in the same example is agreeable to a financial cap but now
wants $10,000 per day in liquidated damages.

Example 2: Financial Cap & Steps

The owner and contractor may agree to the following clause that
limits, in a little different way, the total amount of liquidated
damages:

Article 41 – Liquidated Damages

41.1 Should Contractor fail to complete the Work within the schedule and
completion dates established in the Contract, Contractor agrees to pay, as
his sole liability to Owner for delays, liquidated damages as follows:
a.) $5,000 per day for the first 20 calendar days of delay in final
completion calculated from the Contract Completion Date, and;
b.) $10,000 per day thereafter for delay up to and including the actual
date of completion, and;
c.) Contractor’s maximum liability for liquidated damages shall not
exceed 3% of the Contract Price, or $300,000.

In this example, the contractor gets a little relief from the full $10,000
per day for the first 20 days of delay, but has to pay $10,000 per day
after that for delays, up to a maximum combined amount of
$300,000. This “stepped” approach can be expanded by contractors as
necessary to lower the amount of liquidated damages they are
exposed to for short delays in the completion schedule.

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 Example 3: Financial Cap & Grace Period
Sometimes an owner will accept the fact that it is difficult to exactly
meet a contractual completion date, even though the contractor is
applying his best efforts and doing a good job. In this case, the owner,
even though he wants liquidated damages in the contract, might
agree to a liquidated damages clause containing a “grace period”
similar to the following:

Article 41 – Liquidated Damages

41.1 Should Contractor fail to complete the Work within the schedule and
completion dates established in the Contract, Contractor agrees to pay, as
his sole liability to Owner for delays, liquidated damages in the amount of
$5,000 per calendar day of delay in final completion calculated from a time
period commencing 15 days after the Contract Completion Date up to and
including the actual date of completion, to a maximum amount of 2% of the
Contract Price, or $200,000.

In this example, the contractor is allowed to exceed the contractual

completion date by 15 days before liquidated damages begin to apply.
The 15 days is the “grace period.”
Limiting or eliminating liquidated damages may also be a good
idea when a main contractor working for the owner has
contracted with subcontractors for certain portions of the work.
The main contractor has accepted liquidated damages in his
contract with the owner and may want to include similar
liquidated damage provisions in contracts with all his
subcontractors on the project.
In this situation, a subcontractor may be completely finished with his
part of the project well in advance of the contractual completion date
in the main contract. Depending on the nature of the subcontractor’s
work, his failure to meet his own schedule may or may not have any
impact whatsoever on the achievement of the main contract’s
scheduled completion date.
The conflict is this: suppose the subcontractor fails to finish on time,
and the main contractor imposes liquidated damages on him.
However, the main contractor finishes the overall project on time and
pays no liquidated damages to the owner. Is it fair, then, that the main
contractor be allowed to impose the liquidated damages on the
subcontractor who did not meet his schedule? Maybe, if the main
contractor could prove that he had to spend money to finish on time
as a result of the subcontractor’s delay.

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 Example 4: Financial Cap for Subcontractors
Let’s say the subcontractor has a subcontract in the amount of
$5,000,000 for civil and site work on an industrial project. The
subcontractor’s completion schedule is 12 months from the date of
signing the subcontract with the main contractor. The main
contractor has a contract with the owner to complete the overall
project in 36 months from the date of signing of the contract. The
main contractor wants all subcontractors who are working for him to
agree to a liquidated damages clause in their subcontracts.
In response to the main contactor’s requirement for a liquidated
damages clause, the subcontractor for the civil and site work may want
to try to negotiate a liquidated damages clause similar to the following:

Article 41 – Liquidated Damages

41.1 Should Subcontractor fail to complete the Work within the schedule
and completion dates established in the Subcontract, Subcontractor agrees
to pay, as his sole liability to Main Contractor for delays, liquidated damages
in the amount of $5,000 per calendar day of delay in final completion
calculated from the Subcontract Completion Date up to and including the
actual date of completion, to a maximum amount of 2% of the Contract
Price, or $100,000.
41.2 Notwithstanding the above, Subcontractor shall not be required to pay
liquidated damages to Main Contractor in the event Main Contractor does not
have to pay any liquidated damages to Owner.

This is a simple “no harm, no pay” liquidated damages clause.

A subcontractor who was late in meeting his schedule would not be
exposed to liquidated damages if the main contractor did not have to
pay any liquidated damages to the owner. This clause could be further
expanded to include “steps” such as noted in Example 2. A “grace
period” could be added as well, similar to Example 3.

Change & Delay Clauses with Liquidated

Damages
Delays in the If an owner insists on having a liquidated damages clause in the
schedule on account construction contract, then it’s important to carefully review the
of legitimate changes changes and delays clauses as well, and negotiate changes to them as
and delays must necessary to take into account the exposure to liquidated damages for
be recognized and failure to meet the completion schedule.
incorporated into Legitimate changes and delays need to have their effect on the project
a revised project schedule recognized by the owner as soon as they occur. If schedule
schedule and delays are not recognized and not added to the time for completion,
completion date. then the contractor may be unfairly exposed to paying liquidated

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 damages in the event he does not meet the original completion
schedule.
As a matter of good contracting, all changes and delays need to be
accepted in writing by the owner. This is even more important where
the contractor may be exposed to paying liquidated damages for
failure to meet the completion schedule.

The Adversarial Effect of Liquidated Damages

The contractor’s project manager is responsible for completing the
project work on time, among about a thousand other things he is
responsible for achieving. If a contract is not completed on time and
the owner decides to invoke the provisions of the liquidated damages
clause, not only does this affect the contractor financially, but it also
may impact the reputation of the contractor’s project manager. A
good project manager will make sure that every change or delay
occasioned by the owner is addressed, and that the effects are
properly added to extend the project’s completion date.
What this means is that all delays, regardless of how small, will attract
the attention of the project manager, and he will insist that the owner
extend the project completion date accordingly so that the project is
not unfairly exposed to liquidated damages. On a project without
LDs, many of the small delays may be just absorbed into the existing
schedule by the project manager.
Constantly presenting the owner with lots of small delays can create
an unnecessary adversarial relationship between the owner and the
contractor and his project manager. Bringing up the possibility of this
adversarial relationship developing at the contract negotiating stage is
a good tactic to negotiate less onerous LD clauses, or eliminate them
completely.

Consequential Consequential damages are those that may occur indirectly as the
result of a failure to perform or as a consequence of some damage to
Damages property or injury to people.

An Example
A contractor is building a new manufacturing facility. During the
course of the construction, the contractor’s 100-­ton crane
­accidentally hits the edge of some newly installed structural
­columns. The columns fall over and destroy a main pump that is
part of an operating system of the owner’s adjacent facility. The
destroyed pump causes the adjacent facility to completely shut down.
The owner claims actual damages for all his costs associated with
the replacement of the pump, and also claims for the loss of profit he

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 suffered by the plant having to shut down for three weeks while the
new pump was procured, installed, and tested. The additional
claim for reimbursement of the owner’s loss of profit is a type of
consequential damage. The loss of profit the owner incurred from the
existing facility being shut down was a consequence of the contractor’s
accident that occurred on the new facility being built by the contractor.
The contractor’s project value in the above example was $5,000,000.
The cost to replace and install the new pump in the owner’s
adjacent facility was $150,000. The contractor can probably deal
with that type of cost exposure on this size of a contract, and
probably has insurance to cover this cost.
However, the owner claims that the loss of profit from the three-week
shutdown of his operating facility was $500,000, and has backup
information to substantiate it. The contractor doesn’t have insurance
to cover this type of loss, so in the event the owner was successful in a
lawsuit, the $500,000 would come out of the contractor’s pocket.
Could the contractor have done anything to avoid this type of
financial exposure? The answer is yes. During the contract
negotiations with the owner, the contractor could have negotiated a
waiver, or exclusion, of consequential damages into the terms and
conditions of the contract.
The following is a typical exclusion of consequential damages clause
that could be considered for inclusion in the terms and conditions of
a construction contract:

Clause 50 – Exclusion of Consequential Damages

50.1 Regardless of how caused, Contractor shall not be liable to Owner
for any special, indirect, incidental, or consequential damages, including
loss of profits or revenues, or damage to adjacent facilities.

The inclusion of a simple exclusionary clause like the above has the
potential to save the contractor from financial liability that could
arise out of consequential damages, which could put his company
into bankruptcy and out of business.
Often, the owner may object to the exclusion of consequential
damages applying to the contractor only, but may agree to revised
wording similar to the following:

Article 50 – Exclusion of Consequential Damages

50.1 Regardless of how caused, neither Contractor nor Owner shall be
liable to the other for any special, indirect, incidental, or consequential
damages, including loss of profits or revenues or damage to adjacent facilities.

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 The above clause is a mutual agreement between the contractor and
It is not sufficient the owner that neither will be liable to the other for consequential
to be silent in the damages.
contract terms
The following are two key reasons why it is important to have a
and conditions
separate clause for consequential damages:
on the issue of
1. If the exclusionary language were included elsewhere in the
consequential
contract, such as in the indemnity clause, and the entire
damages; a separate
indemnity clause is later ruled unenforceable as the result of a
clause is required lawsuit, the contractor could potentially lose the protection of
specifically excluding the exclusion of consequential damages.
consequential (and
2. As a separate clause, it’s more clear to a judge and/or jury in a
similar) damages. lawsuit that the owner and the contractor were both aware at the
Exposure to onset of the contract of the exclusionary language. This gives
consequential the contractor a significantly better chance of avoiding any type
damages is a of consequential damages the owner may try to receive in a
significant risk to a lawsuit.
contractor and must Is it fair for a contractor to seek a waiver of consequential damages?
not be taken lightly! Certainly it is. Contracts are two-way streets; they are not just for the
exclusive and sole benefit of the owner.

Conclusion Liquidated damages will likely be the most common type of damages
a contractor, and his project manager, will be exposed to in a
construction contract. Contractors who accept these clauses should
make sure the value of the LDs is fair with respect to the total value of
the contract and limiting provisions should always be negotiated.
Better yet, LD clauses should just be eliminated. Despite an owner’s
persuasive arguments to the contrary, many LD clauses are included
in contracts to act as pressure on the contractor to meet the schedule
or as a penalty.
Consequential damages could theoretically be financially unlimited.
They must always be specifically excluded in a separate clause in a
contract. The imposition of consequential damages on a contractor
could place him in bankruptcy.

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Chapter
Warranties
12
A warranty is a contractor’s pledge that he will stand behind the
work he performs—­and fix it if it doesn’t work. But, is it really that
simple? No, it’s not, in fact. Like all commercial terms and conditions
contractors must deal with in a construction contract, warranties can
range from simple to complex, and may expose them to the potential
for unnecessary or unacceptable financial liability.

A Workable A definition is in order for this term as it applies in a construction

contract:
Definition A warranty is an agreement provided by a contractor giving an
of Warranty owner assurance that the work performed will be done in accordance
with the contract and its plans and specifications, and will be free of
defects.
The warranty definition may go on to say:
The contractor will fix or replace any defective work discovered within
a fixed time period that starts at the completion date of the project.

Understanding and Negotiating Construction Contracts: A Contractor’s and Subcontractor’s Guide to

Protecting Company Assets, Second Edition. Kit Werremeyer.
© 2023 John Wiley & Sons, Inc. Published 2023 by John Wiley & Sons, Inc.

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 Like other contract clauses, warranties are optional in the contract.
There is no rule that requires a contractor to provide an owner with a
written warranty; it’s just another negotiable clause. Sometimes, in
fact, there are good reasons not to provide a warranty, and other
times the contractor provides a warranty without even knowing it!
Both of these warranty situations will be explained later on in this
chapter.

Warranty Issues There are two basic issues with warranties that need to be carefully
addressed:
1. If defects in the work are found, what is the process for the
contractor to fix them?
2. Does the work function as intended? If not, what is the process
for the contractor to fix the problem?

Warranty & Guaranty—­What’s

the Difference?
A guaranty is not the same as a warranty, though the terms are
frequently—­and incorrectly—­used interchangeably. A warranty is an
agreement between two parties, typically the contractor and the
owner. The contractor agrees to provide the owner with a warranty
for his work, which promises that the work will be built in accordance
with the contract and be free of defects. A guaranty is an agreement
between three parties, typically the contractor, owner, and a third
party, called a guarantor. A guaranty is typically provided by a
specialized company called a surety, which provides a guaranty to the
owner for the performance of the contractor in a construction
project. If the contractor fails to perform as outlined in the contract,
the surety company will step in and find a way to finish the remaining
contractual obligations or perhaps pay the owner. (Guaranties are
more fully discussed in Chapter 6.)

What Do Warranties Provide an Owner?

Owners expect the contractor to properly build the project, and if a
defect is found within the warranty’s allowable time period, then the
owner expects the contractor to fix it. Building projects on time and
in accordance with the plans and specifications, and without defects,
is what establishes the good reputation of a contractor. If some
portion of the work is found to be defective, the contractor’s
reputation is enhanced by promptly fixing it without any hassles to
the owner. No one likes to make mistakes in building a project, but
they happen; it’s part of being in the construction business, as is
properly fixing any defects.

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Examples of Warranty Clauses
Warranty clauses can range from simple to complex. The following
are several examples and explanations of what they cover (or don’t).
The first is straightforward and provides for the major assurances an
owner will likely want from a contractor in a warranty agreement:
1. All work performed by the contractor will be free of defects.
2. The warranty period will be 12 months from the date of comple-
tion (in this case the issuance of the certificate of Mechanical
Completion, a document that states the work is finished).
3. The contractor agrees to repair or replace all defective work at
his expense.

Example 1

Article 28 – Warranty
28.1 Contractor warrants that all Work performed by him shall comply
with the terms of this Contract and all of its Plans and Specifications, and
that all Work performed by Contractor will be free of defects in design,
materials, and workmanship.
28.2 The warranty period shall be 12 months and shall commence upon the
date of Owner’s issuance of the Mechanical Completion certificate to Contractor
for his Work.
28.3 Any defect found in the Work within the warranty period shall be promptly
replaced or repaired by Contractor at no cost to Owner.

Example 2
The following example is the same warranty with an added twist that
will increase the contractor’s risk:

Article 28 – Warranty
28.1 Contractor warrants that the Work performed by him shall be suitable
for the purposes intended, shall comply with this Contract and its Plans
and Specifications, and will be free of defects in design, materials, and
workmanship.
28.2 The warranty period shall be 12 months and shall commence upon
Owner’s issuance of the Mechanical Completion certificate.
28.3 Any defect found in the Work within the warranty period shall be promptly
replaced or repaired by Contractor at no cost to Owner.

What’s so different about this warranty clause and the first one?
Though very few words have been added, there is more risk in the

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 second line of paragraph 28.1, “Work. . .shall be suitable for the
purposes intended.” In this second example, the contractor is
responsible for the design of the project, in addition to supplying
materials and constructing it. Of course it’s likely that the contractor
has knowledge of the original purpose for which the project is being
built. However, the owner could decide to use the facility later on for
something other than what the contractor—or the owner, for that
matter—envisioned in the original design. This may expose the
contractor to unnecessary potential financial liability if the facility
fails or doesn’t work properly when the owner uses it for other
purposes.
Does this sound far-fetched? Maybe, but in a lawsuit, a judge and jury
with little or no engineering design or construction experience could
decide that the owner’s new use of the facility falls within the
“suitable for the purposes intended” clause. The contractor would
lose the case and need to get out his checkbook.
In this instance, the contractor, who did not design the plant, would
have been better off deleting the words, “shall be suitable for the
purposes intended,” or negotiating a change in the first paragraph of
the owner’s proposed warranty clause. A revised version could read
similar to the following:

Article 28 – Warranty 28
28.1 Contractor warrants that the Work performed by him shall comply
with this Contract and its Plans and Specifications, be suitable only for the
purpose(s) expressly specified in the design criteria of the Contract, and
be free of defects in design, materials, and workmanship.

It’s always best The revised wording strictly limits the purposes intended as only to
to be specific in those specifically described in the contract’s plans and specifications.
contract wording. This removes the risk of allowing someone else, not associated with
When the language the contract, to speculate and determine what the “purposes
in a contract is too intended” may mean.
broad and open to Contractors should be careful in agreeing to warranty clauses that
wide interpretation have broad, undefined “purposes intended” wording. It’s much better
by someone else to eliminate the “purposes intended” language or, alternatively,
(owner, arbitrator, carefully specify what the “purposes intended” are. After all, it is the
judge, or jury), the owner’s project, and he should know what the intended purposes are
contractor may and be willing to note them in the contract.
end up assuming Also note that in this example no specific time limit applies to the
significant potential undefined “purposes intended” obligation. The implication of this is
financial liability. that the contractor could find himself in a lawsuit years after the
project is successfully finished.

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As a final note on the topic, let’s say the contractor in this case had no
design responsibility. His scope of work was only material supply and
construction. The contractor was to follow the plans and
specifications developed by the owner or the owner’s engineer. To
agree to the general “purposes intended” language in a warranty
clause for which only material supply and construction work was
contracted could expose the contractor unfairly to future financial
liability for events over which he has absolutely no control or input.

Example 3
The following is another example of a typical warranty clause with an
extended time period and several exclusions:

Article 28 – Warranty
28.1 Contractor warrants that the Work performed by him shall comply
with this Contract and the Plans and Specifications, and that the Work will
be free of defects in design, materials, and workmanship.
28.2 The Warranty Period shall be twenty-four (24) months from the date of
Mechanical Completion of the Work or twelve (12) months from the date of Start
of Operations, whichever occurs first.
28.3 If any defect is found in the Work during the Warranty Period, Contractor
shall promptly repair, replace, or otherwise make good the defect and any dam-
age to the Work caused by the defect at his own cost.
28.4 Contractor shall not be responsible for any defect or damage to the Work
resulting from:
a.) Improper operation or maintenance of the Work by Owner
b.) Operation of the Work that is outside the specifications in the
Contract
28.5 If Contractor repairs or replaces any part of the Work under this warranty
clause, such repair or replacement part shall be subject to the same warranty
time period as for the original Work, beginning with the completion date of the
repairs or replacements.

This is the type of warranty a contractor might see when there are a
number of different contractors working on a large, multi-disciplined
project that requires several years or more to complete.
Paragraph 28.2 anticipates that the contractor may finish his work
and receive his mechanical acceptance certificate prior to the
completion of the project and start of operations. The owner’s goal is
to have a normal 12-month warranty period be in effect for the
contractor’s work while his facility is in operation.
He wants the contractor’s warranty period to begin more or less at
the start up of the facility. That’s the goal. So the owner requires

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 a 24-­month maximum warranty period from the contractor. This
gives the owner a 12-­month “cushion,” or idle time, to get the entire
facility built and in operation and still have a 12-­month warranty
period in effect for contractor’s work.

An Example
Let’s say the contractor completes his work in 12 months, and the
facility is completed and starts up 6 months later. In this situation,
the contractor’s 12-­month warranty period begins at the start-­up of
the facility per the terms of the warranty clause. The contractor ends
up providing a warranty of his work for a total of 18 months
(6 months idle time, plus 12 months of operating time). There is
some risk here for extended warranty, but maybe not too much.
In a different situation, suppose the contractor completes his work
and the facility is completed and starts up 18 months later. In this
situation, the contractor’s warranty period becomes the maximum of
24 months from the date of the Mechanical Completion (the
18 months of idle time, plus 6 months of operation time). The
contractor’s warranty period will expire 6 months after the facility
starts to operate because the 24-­month maximum time limit is met.
The owner would have liked to have had the contractor’s warranty for
his work in place for 12 months of operation of the facility, but he ends
up only receiving 6 months of warranty while the facility is operating,
due to the 24 months time limit constraint in the warranty clause.
Paragraph 28.3 obligates the contractor to fix any defects in his work
found during the warranty period, and at his cost. This is normal.
However, the owner has thrown in a twist with the words, “and any
damage to the Work caused by the defect.” Although this sounds fair,
this type of wording is open to wide interpretation, and, hence, the
contractor’s commercial risk can significantly increase. Who’s to
judge that any damage occurred and was actually caused by the
defect? The owner? The contractor? Some third-­party inspector? As
it reads, it looks like the owner gets to make a unilateral decision on
whether or not the defect caused additional damage, which isn’t fair
to the contractor.
In this case, the contractor would be better off eliminating such
wording at the contract negotiation stage, or perhaps revising it to
something similar to the following: “and any damage to the Work
caused by the defect as may be determined by a mutually acceptable
third-­party inspection agency.” This achieves what the owner wants
in the way of protection for damage to the work caused by defects,
but also gives the contractor some measure of protection against
unwarranted claims for damage by the owner.

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Paragraph 28.4 protects the contractor from any actions by the owner
that may cause defects or damage to the work. The owner must take
responsibility for the operation and maintenance of the facility. If
defects or damage to the contractor’s work occur as the result of
owner’s improper operation or maintenance, the owner can’t come
back to the contractor for repairs under the warranty clause. The
paragraph also frees the contractor from the potential financial
liability of repairing defects or damage caused by the owner’s
improper operation of contractor’s work in the facility.
Exclusions like the two shown in paragraph 28.4 should be part of all
warranty clauses. Many things can happen to the contractor’s work
after he leaves the site. Defects and damage caused by natural events
or the owner’s lack of maintenance or improper operation are outside
of the contractor’s control, and he should not be responsible under
any warranty clause for the consequences of those actions.
Finally, paragraph 28.5 states that if the contractor repairs or replaces
a defect during the warranty period, he will warranty those repairs or
replacements for another 12 months. The 24-­month maximum time
limit contained in the warranty clause doesn’t apply in this case.

An Example
Let’s presume that everything goes according to plan. The contractor
finishes his work, and the plant starts up 12 months thereafter. The
contractor’s warranty on his work is in effect for the 12 full months
during the operation of the plant. The 24-­month maximum time
period and expiration of the 12-­month warranty period on the work
after it starts up occur at the same time.
Ten months into the operation of the facility, the owner discovers a
defect in the contractor’s work. A main pump begins to malfunction
and eventually fails. It doesn’t stop the plant, because the pump has
a backup that immediately begins working after the main pump
fails. The owner notifies the contractor that the pump failed. The
contractor quickly procures a new pump and promptly and safely
installs it for him.
The provisions of paragraph 28.5 require that any repairs or
replacements performed by the contractor be warranted for
12 months. Even though the contractor’s warranty on all the rest of
his work expires in 2 more months, the warranty on the new
replacement pump he installed will run for an additional
12 months from the date of installation and start-­up of the pump.
This requirement to provide an extension of warranty on repairs and
replacements is sometimes called an “evergreen” clause, and should
be avoided if possible.

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 The Uniform What place does a discussion on the Uniform Commercial Code
(UCC) have in a chapter on construction contract warranties? The
Commercial UCC is about 800 pages of rules and regulations regarding the sale of
Code goods. (Goods are considered moveable items for sale.) It is the
commercial law in place in all states in the U.S., except Louisiana, as
of the date of publication of this book. (Even Louisiana, however, uses
most of the UCC regulations.)
The UCC does not apply to contracts for construction in general,
since what is built is generally considered not moveable. However,
because it is virtually impossible to predict how a court of law may
rule with respect to what’s considered “moveable”—­and whether or
not the UCC applies—­it’s better for contractors to adopt a few simple
precautionary modifications or additions to their contracts’ warranty
provisions. This precaution is best exemplified by what the UCC
considers implied warranties.

Implied Warranty
An implied warranty is a warranty imposed by a state law, like
the UCC. It doesn’t necessarily have to be in writing to be in effect;
the absence of a written warranty doesn’t necessarily mean that the
owner is completely without some form of warranty protection.
The two most common types of implied warranties that may be
encountered by a contractor are:
1. Implied warranty of merchantability: Goods must function
how they are typically intended (ordinary purpose). This may be
applicable to some or all of a construction project, in the sense
that what is constructed should function as intended. For exam-
ple, if a contractor builds an office building per an owner’s plans
and specifications, the ordinary purpose of this project is a
building that provides office space for tenants. In simpler terms,
the usual and normal purpose for which this building will be
used is as an office building.
2. Implied warranty of fitness for a particular purpose: Goods
should perform how the contractor advises the owner they
should. This, too, could possibly apply to some or all of a
­construction project. For example, if a contractor builds an office
building for an owner and also advises the owner that the b ­ uilding
can be used as a discothèque and nightclub, this is a non-­ordinary
or particular purpose. In simpler terms, is the building fit to be
used for some other purpose than as an office building?
So, what’s the big deal? Why is this important? The implied
warranties that come out of the UCC are designed to protect
consumers against defective goods, like tennis racquets, automobiles,

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or specialized computer equipment. In theory, this is good for
consumers buying merchandise from local retail outlets, but how
might this implied warranty theory get applied to construction
contracts?
As earlier noted, the UCC is designed to apply to moveable goods
and, in theory, not to construction projects, which, presumably,
construct immoveable goods. But who determines what a “moveable
good” is? For example, let’s say a contractor constructs a building that
could theoretically, at some later date, be lifted onto beams and
moved 2,000 yards to a new location. Is that building considered a
“moveable good,” or is still part of a construction project? In another
situation, what if a contractor builds a high-­strength steel pressure
vessel for an oil refinery that weighs 1,000 tons, is 400 feet tall, and is
permanently anchored through a base ring with 100–2-­1/2″ diameter
anchor bolts that are all deeply embedded in a concrete foundation.
Theoretically, the nuts on the anchor bolts could be loosened and
removed, and the 1,000-­ton pressure vessel could be moved to a new
location. Is this large, heavy pressure vessel really a “moveable good”
or is it, in reality, part of a construction project and not technically
“moveable.” Were the structures in either of these two examples
intended by their owners to be “moveable goods?”
The problem a contractor may have to deal with in situations similar
to those noted in the above example is who determines whether or
not the structures provided in the construction project are
moveable—­and whether the implied warranty laws of the UCC apply.
In the event a claim or dispute arises over a warranty, it may go
before a panel of arbitrators or a judge in a court case, neither of
which may have any experience in the construction business.
The outcome of the arbitration or court case is impossible to predict.
There is no way to stop creative interpretation of the UCC laws on
implied warranties—­or any laws for that matter—­by these groups. If
the contractor does not have a written warranty in place that
specifically disclaims any implied warranties, then an arbitrator or a
court of law may make a decision on what implied warranties the
contractor should be responsible for.
How can a contractor avoid exposure to the potential financial
liability that may arise out of an improper application of an implied
warranty? This is easy. First, the contractor must put the details of
his warranty in writing in all construction contracts and, secondly,
he must conspicuously exclude any sort of implied warranties in the
written warranty he provides. The best defense against potential
exposure to the financial liability that may arise under any sort of
implied warranty is to have a specific, well-­written warranty in the

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 construction contract and that excludes implied warranties of
any sort.
Contractors should always try their best not to be put in a position
that allows others to decide what their warranty should cover. The
good news is that the UCC, which provides for implied warranties,
also provides contractors a way to exclude them, which is clarified in
the following section.

Express Warranties & Conspicuous Exclusion

of Implied Warranties
A written warranty is called an express warranty. It is important for
contractors to provide a specific and well-written warranty for all
work. In addition to documenting how to properly take care of
defects and placing a time limit on the warranty, as shown in earlier
examples in this chapter, it is necessary to conspicuously exclude
implied warranties.
Contractors can easily disclaim any implied warranties and all
warranties for fitness for a particular purpose and of merchantability.
The UCC requires that this disclaimer be done in a conspicuous
manner in the contract. An additional paragraph, similar to the
following, could be added to the warranty shown earlier as Example 3.

28.6 Owner and Contractor agree that the Warranty contained in this
Contract is the only Warranty provided, and there are no other warranties,
express or implied. Owner and Contractor further agree that ALL
WARRANTIES OF FITNESS FOR A PARTICULAR PURPOSE OR OF
MERCHANTIBILITY ARE SPECIFICALLY EXCLUDED.

If the contractor had carefully described in writing the sole

purpose(s) intended for the work provided in the warranty clause,
then the second sentence in the above paragraph is probably
unnecessary. If he hadn’t, however, then he may be exposed to an
implied warranty and it would be best to add the second sentence
of 28.6.
The capitalized words and bold print have been added to make the
exclusion conspicuous. In the event a contractor is faced with a claim
or lawsuit involving an implied warranty on his work, he could point
to the capitalized section and present a strong case questioning how
the owner could possibly have missed this conspicuous exclusionary
language. Actually, the contractor could have capitalized the entire
paragraph—even put all of it in bold print—to make it even more
obvious that the only warranty provided is the written one contained
in the contract.

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 When Is No Earlier in this chapter, it was noted that when contractors provide a
written warranty for work and abide by its provisions, their
Warranty reputations can be enhanced. After all, who would want to deal with a
Appropriate? contractor who was unwilling to warranty his work?
The following is an example of a project where providing a warranty,
however, may expose the contractor to potential significant financial
liability.

An Example
The owner of a 25-­year-­old chemical manufacturing plant needs
some extensive repairs and modifications performed on the plant’s
existing process vessels and surrounding process piping and
structural supports. The owner specifies in the construction contract
the amount and type of repairs and modifications required. The
process vessels produce specialty chemicals. The owner agrees to
shut the plant down and make the area safe for the contractor to do
the required work.
The contractual terms and conditions proposed by the owner
­contain a requirement for a full one-­year warranty for design,
materials, and workmanship.
Why would the contractor not consider providing a warranty for the
repair work for this chemical manufacturing plant?
Consider this situation:
Six months after the contractor completes the repairs and
­modifications, a catastrophic explosion takes place at the chemical
manufacturing plant in one of the process vessels that the contractor
repaired. Not much is left of the plant except rubble and scrap.
Several people are severely injured, and there is significant damage
to adjacent properties of other companies.
The owner faces significant financial liability and will be looking for
someone to blame and help share the costs. After all, it could not
have been the owner’s operating fault that this catastrophic accident
occurred!
In reviewing contracts for recent work at the plant, the owner finds
the contractor’s contract for repairs and modifications to the process
vessel that exploded and sees that he has a valid one-­year warranty
for design, materials, and workmanship still in effect.
The owner now files a lawsuit alleging that the repairs and
­modifications made by the contractor were defective in design,
materials, and workmanship. His lawsuit notes that the work
performed is still under warranty. He claims that the catastrophic
failure of the process vessel was due to defects in the contractor’s

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 work. The lawsuit, of course, seeks significant monetary damages
from contractor.
When the contractor first considered bidding on the repair work, he
should have given more consideration to the fact that the facility was
25 years old, and that providing repairs to it was risky enough,
let alone providing the owner with a broad warranty typically only
used for new projects.
This is an example of a project in which the contractor must consider
not providing any sort of warranty. However, it’s important to not
simply leave out the warranty clause (remember the issues of implied
warranties) altogether.

Example 1 –Warranty Exclusion

Instead, contractors should include a clause specifically disclaiming
any sort of warranty. Wording similar to the following could be used:

Article 28 – Warranty
28.1 Owner takes full and complete responsibility for the adequacy of all
Work specified in this Contract, and Owner further agrees and understands
that Contractor will only use ordinary skill in performing the Work specified
by Owner.
28.2 With respect to all Work performed by Contractor, Owner agrees and
understands that CONTRACTOR MAKES NO WARRANTY OF FITNESS FOR
A PARTICULAR PURPOSE OR OF MERCHANTABILITY OR ANY OTHER
WARRANTY, EXPRESS OR IMPLIED.

In a catastrophic situation as described in the earlier example, it’s

likely the owner will still take the contractor and anyone else he can
find to court claiming negligence, poor workmanship, etc. The
contractor in this instance would at least have a strong defense
because the exclusion of warranty was very conspicuously noted in
the contract with the owner.
Note that the example used was extreme and should not be construed
to mean that all repairs and modifications to existing facilities should
exclude a warranty. The decision about whether or not to provide a
warranty—or to provide one with limited coverage—is a risk
management issue that should be determined based on the nature of
the work. What is meant to be emphasized here is that if a contractor
is unwilling to provide a warranty for his work, whatever the
circumstances might be, he needs to do so in writing and in a
conspicuous manner.

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 Extended While there probably is no absolute correct duration of a warranty for a
construction project, one year is a typical time period. It gives the owner
Duration plenty of time to make sure the contractor did the work correctly.
Warranties In warranty Example 3, discussed earlier in this chapter, paragraph
28.2 stated:

28.2 The warranty period shall be twenty-four (24) months from the date
of Mechanical Completion of the Work or twelve (12) months from the date
of Start of Operations, whichever occurs first.

This would be considered an extended duration warranty if the

contractor’s normal warranty for his work was only one year. Assume
that the contractor finishes his work on time (receives the Mechanical
Completion certificate), and his completed work sits idle for one year
while the rest of the owner’s project is being completed by other
contractors. The facility starts up (Start of Operations), and his work
remains under warranty for another year. His warranty is then in
effect for a full 24 months.
Again, this is an issue of risk assessment for the contractor. What
additional risk does he accept by providing what could end up
becoming a two-year warranty, even though for one of the years his
completed work sits idle? The risk of a defect being discovered is
certainly more likely once the contractor’s work is in operation,
beginning after the Start of Operations. Perhaps the contractor needs
to provide some sort of physical protection to his completed work for
the potential one-year idle period. Or perhaps he must put some
limiting provisions in the warranty clause to provide for any additional
risk he believes he will incur by agreeing to a longer warranty period.
At any rate, there’s a strong likelihood that agreeing to provide an
extended warranty may create additional costs for the contractor.
Let’s say that the contractor is in the business of designing and
building high-rise office buildings. The owner’s contract has the
following warranty clause in the contract’s terms and conditions:

Article 28 – Warranty
28.1 Contractor warrants that the Work performed by him shall comply
with this Contract and its Plans and Specifications, and that the Work will
be free of defects in design, materials, and workmanship.
28.2 The warranty period shall be 60 months and shall commence upon the
date of issuance of the Certificate of Occupancy.
28.3 Any defect found in the Work within the warranty period shall be promptly
replaced or repaired by Contractor at no cost to Owner.

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 On first review, this appears to be a standard warranty, except that
it runs for five years—­60 months—­from the date of the Certificate
of Occupancy (usually issued by state or local government building
authorities stating all required permits are complete and the
building has been properly inspected and is ready for
occupancy).
The contractor’s normal warranty duration period is one year. He
may choose to allow up to a three-­year warranty duration period
from time to time on some of his residential building work, but five
years for a commercial building is too long. Why would an owner
request an unusually long warranty duration period? It may be that
the competitive environment in the building construction business is
such that he can get away with requiring this length of warranty.
Maybe the owner feels he can use the extended warranty period to
get some free maintenance out of the contractor. It should be clear
that extended duration periods for warranties can significantly
increase the risk a contractor takes on a project.
Listed below are some options the contractor should consider when
faced with accepting or negotiating an extended duration warranty:
• Add money to the price to fund a reserve for taking care of
legitimate warranty work that may occur during the extended
duration period of the warranty.
• Talk to an insurance broker about buying insurance to cover
costs that may be incurred for warranty work that occurs after a
three-­year period.
• Add limiting provisions to the warranty to escape from warranty
claims by the owner that are in actuality maintenance work the
owner would normally perform.
• Pass on the longer warranty provisions to any subcontractors or
material and equipment suppliers.
• Negotiate with the owner for a warranty duration period that is
shorter than what was requested; it doesn’t hurt to ask the owner
for less than what he wants.
• Require the owner to pay for any requested site visits to address
warranty issues and to validate that the contractor’s work is still
in as-­new condition and no warranty work is required.
Warranties with extended duration periods over and above what the
contractor normally offers, or what is standard in the industry for
different classes of work, can represent a significant risk to the
contractor. It will always pay dividends to the contractor to make sure
his warranty obligations expire in a time period that makes sense for
the type of work performed.

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 Limiting An owner is free to put in a warranty claim to the contractor at any
time during the warranty duration period. However, the owner
Provisions shouldn’t be able to make a warranty claim against the contractor’s
in Warranties work for certain conditions, such as corrosion that occurs naturally
on parts and equipment. Therefore, it’s important that the contractor
place certain appropriate limiting provisions in his warranty to avoid
inappropriate claims.
The following are examples of some common limiting provisions:
• Corrosion, however caused, of materials and equipment.
• Abrasion by wind and sand, or similar material, of equipment
and materials.
• Chemical attack of materials and equipment.
• Electrolytic attack of materials and equipment.
• Damage caused by third parties.
• Improper use and operation of the work by the owner.
• Improper or lack of maintenance of the work by the owner.
• Equipment and materials provided by the owner and installed by
the contractor. (The contractor should be responsible only for
workmanship related to the installation.)
• An exclusion for the owner’s normal and expected maintenance
work on materials and equipment.
• Exclusion for normal wear and tear.
(See sample warranty Article 33 later in this chapter on how a
contractor could consider including these limiting provisions.)

Pass-­Through Many projects call for equipment made by specialty manufacturers.

This specialized equipment will normally have a manufacturer’s
Warranties standard written warranty, for a specific duration period, and may
contain limiting provisions on the equipment’s use. This is normal.
Owners certainly understand that specially manufactured equipment
supplied and installed by the contractor as part of his work to
complete the project may have warranties that are different from the
warranty in the construction contract. However, the owner will still
expect that the contractor take care of any warranty claims related to
any equipment supplied by a specialty manufacturer in accordance
with the warranty terms in the construction contract.
The major risk to the contractor is if the standard warranty supplied
by the manufacturer of the specialized equipment is significantly
different than the terms of the warranty in the contractor’s
construction contract with the owner. A good example of this is
where the manufacturer of the specialized equipment only offers

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 a warranty for one year, yet the contractor agrees to a longer duration
with the owner. In this event, the contractor could be exposed to the
financial liability associated with a warranty claim on the specialized
equipment after its manufacturer’s warranty expires.
One option is to insert a clause in the warranty to the owner that
“passes through” the warranty of specialized equipment
manufacturers. When the contractor purchases specialized
manufactured equipment for a project, the manufacturer of that
equipment will have his own written warranty for the equipment.
The contractor receives that warranty and provides it to the owner as
part of the package of final contract documents. In this fashion, the
contractor “passes through” the manufacturer’s warranty for the
specialized equipment to the owner. The owner may accept pass-­
through warranties, but is well within his rights to reject them and
insist that the contractor honor the warranty contained in the
contract. In this situation, the contractor needs to assess the
associated risks.
In the event the owner specifies a particular type or manufacturer of
specialized equipment, then the contractor is on much stronger
negotiating grounds to insist that the owner accept the
manufacturer’s warranty on a pass-­through basis.
However, a note of caution on pass-­through warranties is in order.
Often a manufacturer’s warranty excludes all field installation or
repair costs. The manufacturer will replace the defective equipment,
but the contractor will have to re-­install the replacement equipment.
This could be expensive for contractor!

Latent Defects A latent defect is one that is hidden and may not be discovered for a
number of years after the owner’s construction project is complete. If
& Warranty the contractor’s warranty period for the project was one year, and the
hidden, or latent, defect was found three years later, then there,
arguably, would be no warranty coverage available for the owner to
fix or replace the defect.
However, the owner may be able to file a product liability claim
against the contractor in an attempt to remedy this latent defect.
Contractors should check with their insurance agents to see if they
can obtain general, ongoing, product liability insurance to cover the
liability that may arise under claims for latent defects in their
construction projects.

Good and Workmanlike Manner?

Take a look at Warranty Example 1. Subparagraph 28.1 reads as
follows:

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 28.1 Contractor warrants that all Work performed by him shall comply
with the terms of this Contract and all of its Plans and Specifications, and
that all Work performed by Contractor will be free of defects in design,
materials, and workmanship.

Often times, the last word in the last line of the paragraph—
workmanship—is replaced as follows:
. . .in design, materials and shall be performed in a good and
workmanlike manner.
What does “good and workmanlike manner” mean? This is, of course,
one of those terms that is open to interpretation. The Owner may
have one definition and the Contractor may have a different
interpretation.
Such term typically means that the Contractor is warranting that the
craft labor employed on the project are skilled, well trained, and
experienced in the trades they perform.
There is probably not a lot of undue risk in this “good and
workmanlike manner” language; it is common in many construction
contracts and readily accepted by Contractors. However, it is good to
know what it means.

When Does a Warranty Start?

Take a look at Warranty Example 1. Subparagraph 28.2 reads as
follows:

28.2 The warranty period shall be 12 months and shall commence upon
the date of Owner’s issuance of the Mechanical Completion Certificate to
Contractor for his work.

Typically, a Contractor would notify the Owner, in writing, that the

Contractor’s work on the project has been fully completed and
requests the Owner issue the Mechanical Completion Certificate.
How long should the Contractor wait for the Mechanical Completion
Certificate to be issued? Three days? One week? One month?
Remember, the warranty period begins upon the date of the
Mechanical Completion Certificate.
If the Owner delays issuing the Mechanical Completion Certificate
for say, 30 days, the Owner gets an extra month on the warranty:
13 months instead of the contractually agreed upon term of
12 months. Maybe longer if the Owner further delays issuing the
Mechanical Completion Certificate.

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 In order to prevent this delay from occurring, the following wording,
or similar, can be added to the Subparagraph 28.2 above. (Addition in
bold)

28.2 The warranty period shall be 12 months and shall commence upon
the date of Owner’s issuance of the Mechanical Completion Certificate to
Contractor for his work. In the event the issuance of the Mechanical
Completion Certificate is delayed by Owner, the Mechanical
Completion Certificate of the project shall be deemed issued 14 days
after the date the Contractor provided the request to the Owner.

In this way the term of the warranty is started without further delays
by the Owner. Contractor bargained for a 12-month warranty,
nothing more.

A Sample Contractors want to assure the owner that their workmanship is

sound and that they will fix any defects in the work found during the
Warranty period of the warranty. Although this assurance may seem simple and
straightforward, the concepts of warranty and the issues surrounding
it can be complex.
Warranty duration, implied warranties lurking out there under state
law, warranties of fitness for an intended purpose and
merchantability, limiting provisions, pass-through warranties, and
defects or maintenance issues all must be understood and considered
as part of the commercial risk assessment process the contractor goes
through for any warranty provided for a project.
Article 33 is a sample warranty addressing the main issues discussed
in this chapter and that a contractor may consider using as a starting
point or warranty guide.

Conclusion Warranties are expected by owners for work performed by a

contractor, and contractors who promptly fix or repair defects in
accordance with the terms of their warranty enhance their
reputations as a good contractors.
However, implied warranties, warranties that have significantly
extended time periods, or those that require the contractor to do the
owner’s normal maintenance work create a high level of commercial
risk and potential financial liability for any contractor.
Warranties, like any other commercial term in a construction
contract, are negotiable. Contractors should always take the time to
negotiate with the owner an acceptable warranty prior to signing the
contract.

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Article 33 – Warranty
33.1 Contractor warrants that the Work performed by him shall comply
with this Contract and its Plans and Specifications, and that the Work will
be free of defects in design, materials, and workmanship.
33.2 The warranty period shall be 12 months and shall commence upon the
date of Owner’s written acceptance of Contractor’s Work.
33.3 Any defect found in the Work within the warranty period shall be promptly
replaced or repaired by Contractor at no cost to Owner.
33.4 This warranty shall not apply to the following:
a.) Corrosion, however caused, of materials and equipment
b.) Abrasion by wind and sand, or similar material, of materials and
equipment
c.) Chemical attack of materials and equipment
d.) Electrolytic attack of materials and equipment
e.) Damage caused by third parties
f.) Improper use and operation of the Work by Owner
g.) Improper maintenance of the Work by Owner
h.) Owner’s normal and expected maintenance work on materials and
equipment
33.5 Contractor will only be responsible for the workmanship required to install
any equipment procured by Owner for installation by Contractor.
33.6 All manufacturers’ warranties on equipment specified by Owner by brand
or manufacturer shall be passed though to Owner and be in lieu of this warranty.
Contractor will only be responsible for the workmanship required to install such
equipment.
33.7 Owner and Contractor agree that the Warranty contained in this Contract
is the only Warranty provided and there are no other warranties, express or
implied. Owner and Contractor further agree that ALL WARRANTIES OF
FITNESS FOR A PARTICULAR PURPOSE OR OF MERCHANTIBILITY ARE
SPECIFICALLY EXCLUDED.

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Chapter
Termination &
13 Suspension

Good plans of both owners and contractors sometimes go awry.

Unforeseen events or financial difficulties may crop up for both
owners and contractors. In some cases, owners may be faced with
terminating or suspending a project due to the contractor’s inability
or difficulty completing the job, or the contractor encounters serious
financial difficulties on the project and can’t complete it. Sometimes
owners run into financial difficulties, too, and have to terminate or
suspend their project. In other cases, owners may terminate the
contract for their own convenience without an apparent legitimate
reason.
This chapter will cover the three following contractual
considerations:
1. Termination for cause
2. Termination for convenience
3. Suspension

Understanding and Negotiating Construction Contracts: A Contractor’s and Subcontractor’s Guide to

Protecting Company Assets, Second Edition. Kit Werremeyer.
© 2023 John Wiley & Sons, Inc. Published 2023 by John Wiley & Sons, Inc.

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 Termination Termination for cause, also referred to as termination for default, or
simply, cancellation, may occur when:
for Cause • The contractor becomes bankrupt or otherwise gets into serious
financial difficulties.
• The contractor is unable to perform the work in accordance with
the terms of the contract.
• The contractor does not execute the work in a timely fashion.
A termination for cause clause in a construction contract provides
an enforceable exit mechanism for the owner when the contractor
fails, financially or otherwise. These clauses tend to be broadly
worded, giving the owner wide latitude in terminating the
construction contract and providing him with a variety of actions
against the contractor. Contractors need to read these clauses
carefully and understand the risk associated with a contract
termination.
Following is an example of a typical termination for cause clause:

Article 18 – Termination for Cause

18.1 Should Contractor fi le for bankruptcy or be adjudged bankrupt, or
should he make a general assignment for the benefit of his creditors, or if a
receiver should be appointed for Contractor, or if he should fail to supply
enough skilled workers or equipment or materials, or fail to make sufficient
progress, or if he should abandon the Work or unreasonably delay its
progress or completion, or persistently disregard the law, ordinances, or the
instructions of Owner, or otherwise be guilty of a substantial violation of
any provisions of the Contract documents, then Owner may terminate this
Contract by giving Contractor written notice.
18.2 After giving written notice of termination under this article to Contractor,
Owner may take possession of the premises and the Work, all materials for the
Work, all tools and equipment and all temporary construction that was used in
connection with the Work, and Owner may finish the Work by whatever method
he may choose at the expense of Contractor.
18.3 After giving written notice of termination under this article, Contractor
shall not be entitled to receive any further payment until Work is
completed.
18.4 If Owner’s costs of completing Work, including any court and legal fees,
exceed any amount due to Contractor, then Contractor shall pay the difference to
Owner.
18.5 If Contractor fails to pay Owner the amount due as noted in paragraph 18.4
above within 15 days after written notice to do so, then Owner shall have the right
to sell the whole or any part of Contractor’s materials, tools, plant, equipment,
and temporary structures.

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 Such a termination for cause clause in a construction contract
The ability to provides the owner with a broad menu of justifiable reasons to
terminate for cause terminate the contract with the contractor. Most, if not all, owners
provides protection will be very reluctant to negotiate any substantial changes to a
for the owner from termination for cause article that will diminish any of their rights to
the consequences of legitimately terminate the contract.
having a contractor A termination for cause article is one of those clauses in a
go bankrupt or construction contract that the contractor is likely going to have to live
severely failing to with. For contractors with good financial standing and the ability to
perform the work. perform the work and meet the schedule, a termination for cause
article should represent little risk.

Termination Terminating a contract for the owner’s convenience, simply put, is

unfair to contractors, yet such clauses often appear in construction
for Convenience contracts. These broadly worded clauses allow the owner to
terminate the contract with no more justification than waking up on
the wrong side of the bed one morning and deciding he just doesn’t
want to do the project, and therefore will terminate the contract for
his convenience. These clauses should more properly be named
“termination for owner’s convenience only,” as they certainly aren’t
for the convenience of the contractor.
Most termination for convenience clauses allow the contractor to
recover all costs for the work he has done up to the time of
termination. Recovery of some of the contractor’s overhead
markup and profit may also be provided for. Proving the costs
associated with the physical work actually performed is not too
difficult, but the contractor’s administrative, overhead, lost work
opportunities, loss of use of experienced personnel, business
interruption, and other similar, hard- to- prove, intangible types of
costs will be difficult or impossible to recover from the owner.
Unless he negotiates some changes in his favor to an owner’s
termination for convenience clause, there is little chance for a
contractor to fully recover all of his costs and his legitimate
markups for overhead and profit when an owner exercises his
rights under such a clause.

Example 1
Following is an example of a typical termination for convenience
clause.

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 Article 19 – Termination for Convenience
19.1 Upon written notice to Contractor, Owner may, without cause,
terminate all or any part of this Contract. Upon receipt of the notice,
Contractor shall immediately stop work and stop the placing of orders for
materials, equipment, and supplies in connection with the performance of
the terminated Work.
19.2 Contractor shall make all reasonable efforts to secure cancellation of
existing orders and subcontracts upon terms and conditions that are satisfactory
to Owner.
19.3 After termination, Contractor shall perform only such work as may be nec-
essary to preserve and protect Work already in progress and shall continue to
complete any Work not terminated. Contractor shall protect all materials and
equipment on the site, or in transit to the site, that are associated with the termi-
nated Work.
19.4 Should Owner elect to terminate this Contract for convenience under
this article, the settlement of all claims of Contractor shall be made as
follows:
19.4.1 Owner shall reimburse Contractor for all reasonable costs incurred after
the date of termination for protecting Owner’s property.
19.4.2 Owner shall reimburse Contractor for the proportion of his Contract
Price for Work actually completed and accepted by Owner. In no event shall
Contractor’s total reimbursement exceed the Contract Price.

This termination for convenience clause allows the owner to

terminate the construction contract for any reason, without penalty
or any amount of prior notice, and provides for paying the contractor
only for the work he has completed that has been officially accepted
by the owner.
On a complex construction project, it may be difficult to accurately
determine the total value of the contractor’s job site and home office
effort at the time of the termination. The owner will likely insist on a
lot of documentation to justify costs and will try his best to minimize
what he has to pay the contractor.
How does a contractor place a cost on having one of his best field
superintendents out of work due to the termination for convenience,
especially when the superintendent could have been valuable on
another, perhaps more profitable, project? What happens if the
project completion is measured at 30% and the contractor’s
expenditure to date is actually 40%? Will getting 30% of the price as
allowed in the termination for convenience cover the contractor’s
costs, markups, and profit on all the work actually completed?
Probably not.

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An improvement, at least from the contractor’s standpoint, would
have been to negotiate some changes to subclause 19.4 in the sample
termination for convenience clause similar to the following:

19.4.1 Owner shall reimburse Contractor for all his direct and indirect
costs, plus 30% markup for overhead and profit, that occur after the date of
termination, and including all those direct and indirect costs that are
incurred for protecting Owner’s property.
19.4.2 Owner shall reimburse Contractor for the proportion of his Contract
Price that represents the actual amount of the Work Contractor has completed
under the Contract, plus all outstanding approved and unapproved extras and
additions. In no event shall Contractor’s total reimbursement exceed the Contract
Price, plus the value of all approved and unapproved extras and additions.
19.4.3 Owner shall reimburse Contractor for all his direct and indirect demobi-
lization costs and expenses, plus 30% markup for overhead and profit.
19.4.4 In addition to the above noted reimbursements, Owner shall pay
Contractor termination fees within 30 days of termination in accordance with the
following table:

Days from Award Termination Fee Percent of

of Contract Contract Price
0 thru 60 days 10%
61 thru 120 days 15%
121 thru 180 days 20%
181 days or later 25%

19.4.5 It is agreed and understood that Contractor will not provide any Warranty
at all, express or implied, on any of Contractor’s completed and uncompleted work.

Let’s take a look at what the suggested modifications to subclause

19.4 of this termination for convenience clause mean to the
contractor.
Paragraph 19.4.1 – The word “reasonable” was removed. What’s
reasonable to the owner may not be—and is not likely to be—
reasonable to the contractor. A percentage markup was added to the
contractor’s direct costs for overhead and profit; contractors should
not be in the charity business.
Paragraph 19.4.2 – The value of all extras and additions was added.
Otherwise, contractor may not have a chance to recover them.
Paragraph 19.4.3 – This is a new paragraph. The contractor should
be reimbursed for demobilization costs plus a percentage markup for
overhead and profit.

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 Paragraph 19.4.4 – This new paragraph adds a termination fee for
the owner having the luxury to terminate the contract solely for his
convenience. This clause can help sort out the risky owner from the
serious and committed owner. An owner’s unwillingness to add this
consideration should raise a red flag. This termination fee schedule
could also be worded as a liquidated damages clause in favor of the
contractor.
Paragraph 19.4.5 – This new paragraph aims to make it
understood by the owner that he will not have any sort of warranty
on the completed or uncompleted work performed by the
contractor.
The noted changes are just examples of what a contractor might edit
in a termination for convenience clause if he is uncomfortable with
the owner or the project. Such changes lower the contractor’s overall
commercial risk. It’s vital that the contractor assess his own particular
risks and make necessary changes, if any, to the language in the
contract. After the contract is signed, it’s too late to change the
language to something more acceptable.
For substantial and financially strong owners with good track
records of completed projects, the contractor may be at little risk
accepting a broadly worded termination for convenience clause.
Such a clause may be part of the owner’s standard boilerplate in his
company’s construction contract documents. In a situation like
this, a progressive owner may even agree to remove the
termination for convenience clause in its entirety if requested by
the contractor.
In those situations where the contractor has no experience with an
owner, the owner is new to the business, or if there are other valid
concerns, it will be worth the contractor’s effort to renegotiate the
termination for convenience language to something more
acceptable—­protecting him both financially and contractually.

Suspension Construction contracts will likely have some type of suspension of

work clause, which allows the owner to suspend work on the
project for some period of time and then resume, or even cancel,
the project. These clauses rarely, if ever, provide any specific
reasons for suspension other than of the owner’s discretion or
convenience.
Suspension clauses that don’t have a maximum time limit for the
suspension, or that don’t address how to reimburse the contractor for
his associated costs, are fraught with danger for the contractor.

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Contractors are more likely to be faced with a project suspension
than a termination for cause or convenience. Therefore, extra
attention must be paid to make sure that the language of a suspension
clause allows for the contractor to be treated fairly and to be paid for
related costs he incurs.

Example 1
Here’s one example of a typical suspension clause:

Article 20 – Suspension
20.1 Owner may, by written notice to Contractor, suspend the performance
of the Work to be performed under this Contract. Upon receipt of the notice,
Contractor shall:
a.) Immediately discontinue work;
b.) Place no further orders or subcontracts for materials, services, and
equipment;
c.) Make every effort to obtain suspension upon terms satisfactory to
Owner of all orders and subcontracts;
d.) Protect and maintain the suspended Work; and,
e.) Take all other steps necessary to minimize costs associated with
the suspension.
20.2 Upon receipt of a notice to resume the suspended Work, Contractor shall
immediately resume performance of the Work under this Contract, and submit to
Owner for reimbursement any reasonable costs incurred by Contractor due to
the suspension.

At first glance, this suspension clause doesn’t look too bad, and the
owner even agrees to cover the contractor’s costs incurred during the
suspension. If the suspension is for 30 days or less, maybe the
contractor can live with this.
But what happens if the suspension is for one year? Or two years? In
an extended suspension, the contractor doesn’t have the right per
subparagraph 20.2 to get even his “reasonable” costs back until the
project starts up again. What happens if the project never starts up
again? Hopefully there is a fair contract cancellation mechanism in
the owner’s construction contract’s terms and conditions that will
allow the contractor to be fairly reimbursed for his efforts during the
suspension and subsequent cancellation. To better protect his
interests, the contractor can consider negotiating changes in this
Suspension clause similar to the following:

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 Article 20 – Suspension (continued)
20.2 Upon receipt of a notice to resume the suspended work, Contractor
shall immediately resume performance of the Work under this Contract.
Every 30 days during the suspension period Contractor shall submit to
Owner for reimbursement all costs incurred by Contractor due to the
suspension, plus 30% to cover Contractor’s overhead and profit.
20.3 In the event the suspension exceeds 180 days, Contractor may terminate
the Contract by notifying Owner in writing. In this event, Owner shall, in addition
to the reimbursements in article 20.2, reimburse Contractor for all costs incurred
to completely demobilize from the job site plus 30% to cover Contractor’s over-
head and profit, and also release any retention withheld from any of Contractor’s
payments.
20.4 In the event Contractor exercises his right to cancel under article 20.3, it
is understood and agreed by Owner that there are no warranties provided,
express or implied, on the work performed by Contractor under this Contract.
20.5 In the event Contractor exercises his right to cancel under article 20.3, it
is understood and agreed by Owner that any performance guaranties or bonds
provided to Owner by Contractor are null and void as of the date of the notice of
termination by Contractor.

So what do these changes do for the contractor? Paragraph 20.2 is

revised to allow the contractor to bill the owner for his costs incurred
during the suspension period, plus a percentage markup for overhead
and profit. These additional costs on account of the suspension are
no different than the normal costs of actually performing the work,
and should be paid for on some timely and periodic basis similar to
the contractor’s normal terms of payment. As noted above, 30% uplift
on costs for O&P is fair.
Paragraph 20.3 is a new paragraph that allows the contractor to
terminate the contract if the suspension extends beyond 180 days and
bill the owner for his demobilization costs, plus a percentage markup
for overhead and profit.
Paragraph 20.4, also a new paragraph, nullifies any warranty on work
performed if the contract is terminated. It’s risky to be exposed to
warranty claims from the owner on an uncompleted and unaccepted
project.
Paragraph 20.5 nullifies any guaranties or on-demand bonds the
contractor was required to provide to the owner as a condition of the
contract.
The proposed changes illustrate some of the considerations a
contractor might be faced with during a suspension. A lengthy
suspension, or one that ends in a cancellation of the contract, can
subject the contractor to a complex mix of cost and commercial

234
considerations. It’s always best to address these ramifications early in
the negotiation of the contract’s commercial terms and conditions.
Some owners recognize that it makes sense to include a time limit in
a suspension clause, after which the contract is cancelled in some
orderly fashion. This is a realistic approach. If an extended
suspension is necessary, for whatever reasons, and the owner then
decides to continue, the owner should terminate the contract and be
willing to renegotiate fairly with the contractor to restructure, re-
price, and reschedule the contract in the new time frame.

Example 2
Here’s a second example of a typical owner’s Suspension clause
containing a time limit, which could also benefit from some editing to
make more fair.

Article 20 – Suspension
20.1 Owner may at any time suspend performance of all or part of the
Work by giving written notice to Contractor.
20.2 The suspension may continue for a period of not longer than six (6)
calendar months after the date of suspension. If at the end of the six-month
period, Owner has not resumed the Work, the portion of the Work that was
suspended shall be deemed to be terminated.
20.3 Owner shall compensate Contractor in accordance with the provisions of
the Changes clause for the following costs incurred during the suspension
period:
a.) Safeguarding the Work and the materials and equipment in transit
or at the job site;
b.) Keeping personnel, subcontractors, and rented equipment on the
job site necessary to maintain the Work; and
c.) Other reasonable and unavoidable costs of Contractor that result
directly from the suspension.

Although the contract terminates after a six-month suspension,

nothing is stopping the owner from renegotiating the contract with
the contractor if the owner decides to continue with the project. This
time limit also gives the contractor some leverage with the owner to
renegotiate the contract if the owner wants to continue. This is fair,
because over a six-month period, the contractor’s pricing
considerations may change dramatically due to labor and material
supply restrictions, cost increases, weather considerations, and the
like. This final example of a suspension clause would be improved by
adding additional language similar to that suggested in the first
example that:

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 1. Allows the contractor to bill on a periodic basis for his
suspension-­related costs and add some amount of markup for
his overhead and profit.
2. Allows the contractor to recover all his demobilization costs
from the job site, plus some amount of markup for his overhead
and profit.
3. Makes a positive and clear statement that no warranties, express
or implied, apply to any of the terminated work.
4. Adds an agreement that the contractor’s performance guaranties
and on-­demand bonds are null and void as of the date of
termination.

Cancellation Cancellation of a contract is just another term for what comes from a
termination for cause or convenience, or perhaps at the end of an
extended project suspension. Sometimes there will be a clause in a
construction contract that is titled “Cancellation.” It will likely be a
termination for cause or termination for convenience clause; the
author of the contract may feel that cancellation doesn’t sound as bad
as termination.

Conclusion Deciding on whether to take issue with termination and suspension

clauses is a part of the contractor’s commercial risk management
process. With an owner who is financially strong and has a good track
record of developing and completing projects, perhaps the contractor
can live with the original language in these clauses, since termination
or suspension with the particular owner is not likely.
On the other hand, if the contractor is uncertain of the owner’s
finances and project track record, he may want to negotiate changes
to the termination and suspension clauses to protect his commercial
interests.
Keep in mind these points:
• Renegotiating termination for cause clauses is tricky and
often unsuccessful. In fact, if a contractor attempts to change
the wording, the owner may get suspicious of his capabilities or
financial strength. There is often no getting around a
termination for cause clause in a construction contract, as it
provides the owner a legal avenue to terminate a contract. It also
provides some protection against the potential for contractor
bankruptcy and from the contractor’s failure to perform.
• A termination for convenience clause that has no financial
protection for the contractor is simply unfair. Termination for
convenience clauses should be carefully reviewed by the

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 contractor and changes negotiated to protect his ability to
recover costs and markups, and to limit his exposure to other
commercial risks, such as warranties on unfinished work and
inappropriate calls on guaranties and bonds.
• Termination for convenience should not come for free. If the
owner wants the privilege of having this type of clause in the
construction contract, he should be willing to pay for it.
Contractors should strongly consider including a termination fee
schedule in these clauses.
• Suspension of the work on a contract is not an uncommon
event in the construction business. Legitimate work
suspensions that are limited in time are inconvenient events for
both owner and contractor. However, limited duration
suspensions can probably be managed by the contractor without
unnecessarily exposing him to significant extra costs or
disruption to the schedule.
• Lengthy suspensions can disrupt a contractor’s organization and
impact his productivity. He may have to demobilize from the
site, but still leave a small team there to protect the work and
manage shutdown of other subcontractors and suppliers. The
owner may continue to hold any retention withheld from the
contractor’s progress payments, and this could affect the
contractor’s cash flow and profitability.
• There is also the risk that the contractor’s team may not be
available when the project is restarted. Costs for bringing back
subcontractors will increase. Labor and material costs may
escalate substantially during the lengthy suspension. The owner
will want to minimize, to the greatest extent possible, the costs
associated with the suspension. But contractors need to consider
all of their costs related to a lengthy suspension.
• Contractors should be entitled to an overhead recovery
and a profit on the costs they incur during a suspension.
All suspension-­related costs incurred by a contractor are no
different than project-­related costs and should have a
percentage uplift added to them for overhead and profit
recovery.
• Contractors should carefully review how they will be paid for all
costs incurred during a suspension. Payment of costs incurred
during a suspension should be made on some regular, periodic
basis, and not at the end of the suspension. The owner may be
out of money, out of business, or both, at the end of a lengthy
suspension.

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 • The duration of the suspension should be limited to an
established maximum amount of time. After this time elapses,
the contractor may elect to terminate or renegotiate the contract.
If the contractor terminates, he needs commercial language in
the Suspension clause that eliminates or otherwise limits his
warranty obligations for completed and uncompleted work.
• Contractors need commercial language that makes any
guaranties or on-­demand bonds furnished to the owner null
and void in the event that the owner terminates or suspends
the contract.

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Chapter
Force Majeure
14
Literally translated, force majeure means “major force,” and refers to
an event that cannot be anticipated. In construction, these events can
have an effect on a contractor’s exposure to liquidated damages,
delays, and change clauses. A force majeure clause in a construction
contract attempts to define those events that may be considered “acts
of God,” such as natural disasters, unanticipated government
mandates, civil disturbances, and so forth, that would give the
contractor or owner legitimate reasons to delay the project, cease
work, or cancel the contract without penalty.

Negotiating Force majeure clauses are often overlooked or taken too lightly in
contract negotiations. Depending on the type of construction work
Clauses performed and its location, leaving out this clause, or agreeing to a
poorly worded one, can be a big mistake for a contractor.
Depending on where, geographically, in the world a contractor is
working and on the type of project he is building, a variety of
different events could take place that would be considered force

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239
 majeure. Following are three examples of construction situations that
would have different force majeure event considerations.
1. A building contractor constructing a small commercial building
in the middle of an open field in the central United States
during the summer may feel the only force majeure risks that he
needs to address in his contract with the owner are tornados
and lightning strikes, and he may not feel that those risks are
very high.
2. A marine contractor laying an undersea pipeline in an area of
the ocean prone to hurricanes, typhoons, or cyclones may have
an entirely different appreciation of the risk involved, and will
want to make sure the force majeure clause in his contract with
the owner addresses these events and what he may do (cease
work, pull up anchor, and get to a safe harbor) in the event one
of these dangerous storms comes his way.
3. An international contractor who is building a new power plant
in an unstable foreign country with a war going on just across
that country’s border may want to make sure he has a compre-
hensive force majeure clause in his contract with the owner that
covers, among other events, war, rebellion, expropriation, con-
fiscation, and civil disturbances.
When negotiating or reviewing force majeure clauses, contractors
need to consider two important issues:
1. What natural or man-­made events are considered force
majeure? The contractor should make this determination based
on discussions with the owner and include them in the final
force majeure clause in the contract. If there’s a chance force
majeure events may occur, owners typically have just as much
interest in accurately defining what they are and how they’ll be
handled.
2. What courses of action are available to the contractor and the
owner if a force majeure event occurs during the construction of
a project?

Sample Example 1
Contract The following is an example of a simple force majeure clause that is
open to wide interpretation. The downside of ambiguous wording is
Language that the owner and contractor may not see eye-­to-­eye on what is
considered a force majeure event because none are named or
specified. The owner could, theoretically, use such a clause to
suspend or delay payments to the contractor for work already
performed.

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 Article 36 – Force Majeure
36.1 Owner and Contractor shall not be liable to each other for any failure
to perform any term or condition of the Contract if such performance has
been delayed, interfered with, or otherwise prevented by any event that is
beyond the control of the party concerned and was not reasonably
foreseeable and was attributable to such event.

If the contractor is convinced that the particular project he is bidding

on has little risk of a force majeure event occurring, then a clause like
the one above is probably acceptable and does not expose him to any
objectionable commercial risk. However, if he’s bidding on a project
where there is a likelihood of extreme weather, for example, then it’s
best to itemize weather-related force majeure events in the clause.
Example 1 has another drawback—it doesn’t describe what options
are available to the contractor and owner in the event a force majeure
event creates a lengthy delay or extra costs for the contractor.
Suggestions for added contract language to cover these contingencies
are noted in the next example.

Example 2

Article 36 – Force Majeure

36.1 Force Majeure means the occurrence of an event that is unforeseen,
insurmountable, and outside the control of and without fault or negligence
of Owner or Contractor, and that causes Owner or Contractor to be unable
to comply totally or partially with their respective obligations under the
Contract.
36.2 Force Majeure events include Acts of God, such as an epidemic, tidal
wave, lightning, earthquake, or named hurricane; hostilities, acts of war, riots,
civil or military disturbances; national, regional, and professional strikes; and
acts of any government or government authority. Force Majeure does not include
the bankruptcy or insolvency of Owner or Contractor.

The above is a fairly typical force majeure clause. Depending on the

location of the construction project, the contractor may decide to add
additional events to the list to be safe, or may find it satisfactory as it
is. (Refer to the list of descriptions taken from actual contracts of
force majeure events at the end of this chapter.)
What the clause in Example 2 does not do is specify what the owner
and contractor agree to do in the event that the contract is delayed or
cancelled due to a force majeure event. This is important, especially
for the contractor, as he could otherwise be trapped into
unnecessarily keeping the project in a standby or suspended mode, all

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 the while generating costs that he might not be able to recover
because there is no specific provision in the contract for
reimbursement.
Faced with the force majeure clause shown in Example 2, the
contractor might consider adding several new paragraphs that would
read similar to the following:

36.3 In the event that Force Majeure causes the Work to be stopped for a
period of time up to 120 days, and prior to restarting the Work, Owner shall
make adjustments to Contractor’s price and schedule to reflect any changes
as a result of such Force Majeure.
36.4 If Owner and Contractor cannot agree on the changes, then Contractor
may terminate the Contract. Owner will pay Contractor for the Work completed
effective as of the date of the Force Majeure event that stopped the Work.
36.5 Owner shall reimburse all of Contractor’s costs and expenses required to
maintain and protect the Work after the occurrence of the Force Majeure event
up to time of the restarting or terminating of the Contract.
36.6 In the event that the Work is stopped for a period of time longer than
120 days, then either Owner or Contractor may terminate the Contract, and
Owner will pay Contractor for the Work performed effective as of the date of the
Force Majeure, and for Contractor’s costs and expenses to maintain and protect
the work after the occurrence of the Force Majeure event up to the time of the
termination of the Contract.

Contractors need to make sure that a force majeure clause provides a

way to terminate the contract if the delay is prolonged. This is usually
a designated maximum time limit after the occurrence of the event.
For those Also, the contractor should be entitled to recover all costs necessary
construction to maintain or protect the work—or repair or reconstruct work that
contracts that was damaged or destroyed by the force majeure event. Contractors
contain a liquidated may decide they can forego overhead and profit on costs incurred on
damages clause for account of a force majeure event, but at least they should get their
costs and expenses reimbursed by the owner.
failure to meet the
contract schedule, Many force majeure clauses do not provide compensation for the
it is important that contractor for his costs incurred to maintain or protect the project
any force majeure after an event. The reasoning seems to be that both the owner and
clause provides contractor are somehow affected equally by the event, and both
should bear their own burden, since no one could have accurately
for immediate
predicted the catastrophe.
cancellation or
renegotiation of the While this may be a compelling argument used by an owner, the
liquidated damages contractor has only one shot at making a profit on the project. If the
clause. owner has to pay the contractor something extra to cover the
contractor’s costs and expenses that arise out of a force majeure

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event, that’s fair, because at least the owner will have a chance to
recover those additional costs from the ongoing operations of his
completed project. It may take the owner a little longer to recover
those extra costs from the profits of his operation, but at least he has
the chance to do so. Contractors do not have that luxury.
The following is a list of events excerpted from actual force majeure
clauses found in construction contracts to illustrate the variety of
different examples of actual contract language.

1 . Acts of God or the public enemy

2. Expropriation or confiscation
3. War
4. Rebellion
5. Civil disturbances
6. Riots
7. Floods or unusually severe weather that could not have been
anticipated
8. Fires
9. Explosions
10. Earthquakes
11. Tidal waves
12. Lightning
13. Named hurricane or typhoon
14. Epidemic
15. Hostilities or acts of war, whether declared or not
16. Orders, restraints, or prohibitions by any governmental authority
17. Civil commotions
18. Strikes, lockouts, or other concerted acts of workers
19. Sabotage
20. Denial of the use of railway, port, airport shipping services, or other
means of public transportation
21. Adverse weather
22. Warlike operations
23. Invasion
24. Act of foreign enemy and civil war
25. Revolution
26. Mutiny

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 27. Usurpation of civil or military government authority
28. Conspiracy
29. Terrorist acts
30. Confiscation, nationalization, mobilization, commandeering, or
requisition by or under the order of any government authority or
ruler
31. Embargo
32. Import restriction
33. Port congestion
34. Shipwreck
35. Shortage or restriction of power supply
36. Epidemics, quarantine, and the plague
37. Landslide
38. Volcanic activity
39. Tidal waves or tsunamis
40. Typhoon or cyclone
41. Hurricane
42. Nuclear events
43. Pressure waves
44. Named hurricane as designated by the U.S. National Weather
Service in Coral Gables, Florida.
45. Unreasonable delay in unloading ships and clearing customs
46. Unusually severe weather
47. Failure of the Owner to provide funds

Conclusion The occurrence of a force majeure event that will interrupt or

terminate a construction project is impossible to plan for or predict.
There should be language in the construction contract terms and
conditions that lists such possible events—to the extent they can be
named—and what should happen if one occurs. There should also be
a mechanism for restart or termination of the contract and some fair
provisions for the contractor to recover costs associated with, or
arising out of, the event.

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Chapter
Other Contract
15 Clauses

Construction contracts can be lengthy, as owners often have all types

of commercial and other issues that they want to address
contractually with the contractor. Construction contracts rarely, if
ever, reduce in length, even during the negotiating phase. Rather, they
seem to grow longer as owners find new and creative commercial
issues that they want to contractually address. This chapter will
review some of the most commonly used additional clauses that may
appear in construction contracts—­those that may present elevated
risk for the contractor, including:
• Site conditions
• Use of completed portions of the work
• Patent indemnity
• Secrecy and confidentiality agreements
• Owner’s right to inspect
• Independent contractors
• Assignment (transfer of rights and obligations)

Understanding and Negotiating Construction Contracts: A Contractor’s and Subcontractor’s Guide to

Protecting Company Assets, Second Edition. Kit Werremeyer.
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245
 • Acceptance procedures and the punch list
• Advance waiver of liens
• Final waivers
• Audit rights
• Severability
• Venue and applicable law
• Changes in law
At the end of the chapter, we’ll examine a few additional obscure ones.

Site Conditions A site conditions clause usually requires the contractor to inspect and
understand the grade level and above-­ground job site conditions
prior to the start of any construction activities. It can, however, have
the potential to be an expensive risk transfer clause for the contractor
in a fixed price contract.
Often, there will be a clause in the contract regarding which party—­
the owner or the contractor—­will accept responsibility for the
physical job site conditions, including subsurface conditions. Owners
expect the contractor to have visited and inspected the job site and to
make provisions in the estimate for any improvements necessary to
prepare the site for construction. These may include:
• Building temporary access roads to the site and/or temporary
marine jetties
• Providing temporary storage, staging, offloading, and work areas
• Clearing brush and leveling high areas
• Filling in low-­lying areas on the site to keep them free of
standing water
As long as the contractor has access to the site prior to bidding, he
can examine, measure, and estimate what needs to be done at grade
level or above ground to the site to properly prepare it for
construction. Sometimes a site conditions clause in the contract will
specifically require the contractor to do this type of preliminary work
as a part of the project.
What can be extremely risky for the contractor, however, is a site
conditions clause that transfers to the contractor the potential
financial risk that may arise from unpredictable behavior or unknown
composition of the site’s subsurface soil conditions. Listed below are
examples of subsurface conditions that, when left undiscovered, can
create problems for contractors:
• Rock
• High water levels

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 • Buried toxic waste materials
• Soft organic or clay-­like materials unsuitable for foundations
• Cavities such as limestone caves, old tunnels, etc.
An attempt to better define subsurface conditions is typically made
by performing a soils investigation. A soils investigation is typically
performed by a specialized geotechnical company, who will likely
have a separate contract with the owner to take soil borings at the
site, analyze them, and produce a written geotechnical report, often
called a soils report. This report may include recommendations for
the design of the project’s foundations or other below grade
construction activities.
Some typical observations and recommendations contained in a
geotechnical report would be:
• A description of the site’s subsurface soils composition,
developed from a series of individual soil borings taken at the
site (e.g., sand, rock, gravel, organic materials, clay, etc.).
• An indication of how deep the water table, if any, resides below
site grade level.
• Recommendations on the ability of the soil to carry different
types of loads imposed by the project’s structures.
• Recommendations for the use of an allowable soil bearing
pressure to be used in conjunction with the design of concrete
spread footing or similar types of foundations for the project’s
structures.
• Recommendations on the amount of potential subsidence
(settlement) of the soils that may occur over time due to the
loads imposed by the project’s structures.
• Recommendations for the type and size of piles to be used with
the design of pile type foundations, and a depth below grade
level to which they should be driven to carry their design load.
Contractors should recognize that the prediction of subsurface soil
behavior is not an exact science. Also, assuming the underlying soil
composition is uniform across a large project site can be risky if only
a few soil borings are taken and analyzed. All geotechnical reports
will typically contain a disclaimer by the geotechnical company who
prepared the report stating that the recommendations, predictions,
and design considerations are best estimates that should be used with
some degree of discretion by the owner. In the event the geotechnical
report is found to be in error, the report will include a limitation of
the geotechnical company’s financial liability to the owner to some
maximum monetary amount. This value will be representative of the

247
 value of their contract to perform the soils investigation, prepare the
subsequent report, and, if required, provide recommendations for
foundation design and expected subsidence of the soil.
If the geotechnical company that performed the soils investigation
states that the findings and conclusions contained in their
geotechnical report are a “best estimate,” or they won’t guaranty the
absolute accuracy of their findings, then the contractor needs to take
note of this and more carefully consider the risks involved.
Here are some examples of the risks that may arise from unknown or
undiscovered site conditions:
1. A soils report recommends that steel pipe pilings designed to each
carry 100 tons are to be used for the project’s foundations. These
pilings are to be driven to a depth of 50 feet below grade level. The
soils report predicts that at the 50-­foot depth, the piles will
encounter enough resistance to further driving to support their
design load of 100 tons. The contractor is required to drive 200
piles, and bases his firm price estimate on the soils report’s
recommendations for length. During the piling operations, it
turns out that the contractor has to drive 100 of the piles to a
depth of 65 feet to develop enough resistance to further driving to
support the design loads. Who pays for the extra 1,500 feet of
piles the contractor has to supply and install?
2. A soils report for a very large site contains a dozen random soils
borings to investigate the subsurface conditions. Analysis of the
individual borings reveals mainly sand and compacted gravel
extending to a depth of 20 feet below grade. The project requires a
significant amount of site excavation. The contractor establishes
his firm price estimate based on using motorized earth-­moving
equipment to excavate. During excavation of the site, the
contractor encounters a large amount of rock that requires
blasting to remove. The random borings missed the rock. Who
pays for the significant extra costs and safety considerations
necessary to blast out the rock?
3. A soils report recommends that an allowable soil bearing pressure
of 2,500 psf should be used for the design of all concrete
foundations for the project structures. Using this 2,500 psf
loading, the soils report predicts that a ¼" subsidence (settlement)
of the soil is to be expected over time. The contractor designs all
the project’s concrete foundations based on the soils report design
criteria and predicted soils subsidence. After the project is
complete and during the warranty period the owner notices
several of the project structures have settled about 2".

248
 This settlement is causing cracks in the structure and
foundations, and creating problems with piping attached to the
structures. Who pays to correct these problems?
In the above examples, the contractor based his firm-price estimates
on the recommendations, observations, and predictions contained in
the geotechnical report prepared by another company and supplied
to him by the owner. He did nothing to protect himself from the risk
of additional costs in the event that the findings of the report turned
out to be incorrect. Is this situation just too bad for the contractor? Is
it time for him to get out his checkbook to pay for necessary repairs,
changes, or modifications? Yes, possibly, though this situation could
have been avoided through the contractor negotiating changes to the
contractual language covering site conditions.
The following are two examples of clauses that expose the contractor
to additional costs and loss of time in the schedule because of
differing site conditions.

Example 1

Article 45 – Site Conditions

45.1 Contractor agrees that he has carefully examined the Work site and
is familiar with all conditions affecting the Work and has prepared his pricing
accordingly. No additional compensation or time extension shall be allowed
in the event these site conditions differ from those expected by Contractor.

Example 2

Article 45 – Site Conditions

45.1 Owner has provided to Contractor, as part of the bid documents, a
site and soils report prepared by Owner’s geotechnical consultant containing
the data on the hydrological and subsurface conditions at the Work site and
recommendations for the design of required foundations. Contractor shall
be responsible for interpreting all the data and recommendations in the
report and shall include in his pricing any contingencies he feels are
necessary.

The second example is particularly risky in that it exposes the

contractor to extra costs that may arise out of using the geotechnical
report’s recommendations for the design of the project foundations.
The contractor may, as the first example implies and the second
requires, add a contingency to his pricing to accommodate any extra
costs he feels may arise from unknown subsurface conditions or from

249
 the consequences of foundation design recommendations that turn
Contractors need to out to be incorrect. How should the contractor calculate and add a
always remember contingency when he may not have any idea of unusual subsurface
that it’s the owner’s conditions or whether the foundation design recommendations are
soil, not the correct? These types of clauses transfer the potential financial risk
contractor’s, and the associated with unknown subsurface conditions and incorrect
owner is ultimately foundation design recommendations to the contractor.
responsible for Often the owner has years of experience with his property, whereas
its makeup and the contractor may have little, if any, experience with the job site
behavior. beyond a visual inspection and whatever random testing is provided
in a geotechnical report. Who should bear the risk of subsurface
surprises? Certainly this risk should not be borne by the contractor.

Example 3
In situations where the contractor has valid concerns about the site
subsurface conditions and/or the foundation design recommendations
provided by third parties, he could consider negotiating additional
wording similar to the following for the above examples:

Article 45 – Site Conditions

45.2 Contractor has based the fixed price strictly upon the soils boring
data and foundation design recommendations contained in the geotechnical
report provided with the bid documents. In the event that the subsurface
The owner conditions differ from the subsurface conditions described in the soils
must retain full boring (e.g., rock instead of loose excavation, buried barrels of toxic waste,
underground caverns), or there is subsidence of the soils beyond that
responsibility for recommended by the geotechnical reports foundation design criteria, then
the project site’s all additional costs and time to accommodate differing site subsurface
composition, conditions, or to repair, replace, or rectify foundations and attached
structures due to subsidence of the soils greater than that recommended in
condition, behavior the soils report shall be for the account of Owner.
under load,
and, especially,
the subsurface If piling is also required for the project foundation, wording similar to
conditions. the following could be added:

45.3 Contractor has based the fixed price for the piling required on the
recommendations and lengths stated in the geotechnical report provided
with the bid documents. In the event that final piling lengths differ from
those stated in the geotechnical report, then the following deductions or
additions to the Contract price will apply:
a.) $50.00 per foot deduction for piles driven to less than the depth
stated in the geotechnical report, and;
b.) $100.00 per foot addition for piles driven to more than the depth
stated in the geotechnical report.

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 Geotechnical companies will attempt to limit their financial liability
in their contract with the owner so they are not exposed to any
extra costs an owner or contractor may incur on account of the
reports recommendations, observations, and predictions being
incorrect. However, geotechnical companies get paid by the owner
for all the work they perform at the job site. Why shouldn’t the
contractor get paid for all the work he ultimately has to perform
there? The ultimate responsibility for using the recommendations,
observations, and predictions of the geotechnical company rests
with the owner.
Since the value of the geotechnical company’s contract for soils
investigation and recommendations will likely be very small
compared to the potential costs associated with repairing
foundations, extra costs for pilings, or excavation of undisclosed rock,
the owner would like to pass on the potential financial responsibility
for these and similar site related risks to the contractor by a risk
transfer site conditions clause.
Another tactic the contractor can use is to strongly encourage the
owner to provide a more comprehensive site soils boring
investigation. For example, taking 30 soil borings on a large site where
extensive excavation is required, rather than 10, is inexpensive
insurance for the owner. Having as much data as possible about the
site’s subsurface conditions will always give the contractor better
information on which to base his firm price estimate and lessen his
concern about adding excessive site related contingency to his
pricing.

Use of Often a construction contract will contain a clause giving the owner
the right to use portions of a project prior to its overall completion.
Completed Although the contractor would likely want to accommodate the
Portions of the owner in his request, there are risks associated with agreeing to allow
this to occur. These include:
Work • Warranty issues associated with early use.
• Safety issues associated with the owner’s employees using a
portion of the work while construction is ongoing.
• Owner access and egress through the construction site.
• Extra costs to secure the part of the work being used by the
owner from the rest of the construction site.
• Delays to the overall project schedule that may ensue through
the owner’s use of completed portions of the work.

251
 The following is a typical clause allowing the owner to use a portion
While a contractor of the work.
should try his best to
accommodate the
Article 47 – Use of Completed Work
owner’s request to use
47.1 Owner shall have the right to use any portion of the Work before full
completed portions completion of the Work. Such partial use shall not in any way be construed
of the work, it should as Owner’s acceptance of the Work.
not be at the added
expense or increased
risk of the contractor. If the contractor has concern about the risks and costs of allowing the
owner to use portions of the work prior to overall project completion,
he could add wording to this example clause similar to the following
to protect himself:

47.2 In the event that Owner takes over and uses any portion of the Work
before full completion of all the Work, Owner agrees to reimburse Contractor
for all expenses, plus a markup for overhead and profit, that Contractor may
incur in association with any early takeover.
47.3 Owner agrees to accept the portion of the Work taken over early as com-
plete, and further agrees that Contractor’s warranty on the portion of the Work
taken over early by Owner shall commence upon the date of the early takeover.
47.4 Owner and Contractor shall mutually agree upon a safety plan regarding
Owner’s early takeover and use of a portion of the Work prior to the full comple-
tion of the Work.

These three additional subclauses address the consequences and risks

associated with early takeover, specifying how additional costs,
warranty, and safety will be handled. Contractors should also check
with their insurance companies to see if there are any additional
insurance coverage concerns to be considered. This is important so
that the contractor doesn’t lose any protection afforded by his
project-related insurance policies.

Patent A patent indemnity clause in a construction contract is designed to

protect the owner from the potential financial liability that may
Indemnity arise out of the contractor’s infringement of a patent that exists on
processes or equipment incorporated into the owner’s project.

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 A typical patent indemnity clause follows.

Article 48 – Patent Indemnity

48.1 Contractor shall pay all license fees and royalties that may be
required to perform the Work, and shall indemnify, hold harmless, and
defend Owner from all lawsuits or claims arising out of the infringement of
any patent rights that may be related to the Work.
48.2 If any part of the Work is determined to be an infringement of any patent,
Contractor shall, at his own expense, and with Owner’s approval:
48.2.1 Secure for Owner’s benefit the right to use the Work that has been
determined to be an infringement of a patent; or
48.2.2 Replace any part of the Work with equal non-patent infringing work; or
48.2.3 Modify any part of the Work to make it equal and non-patent infringing.

Since the patent indemnity as written is unlimited in potential

financial exposure to the contractor, it’s a good idea to place some
maximum financial limit by negotiating additional wording similar to
the following:

48.3 Contractor’s liability in the aggregate under the provisions of this

Article 48 shall not exceed (insert an appropriate monetary value) less a
depreciation allowance for the part of the work that was determined to be
an infringement of a patent.

Secrecy & Owners who build projects using their own proprietary technical
information, processes, and/or highly specialized equipment will
Confidentiality likely require the contractor to agree to a secrecy or confidentiality
Clauses & clause in the contract, or to a completely separate secrecy agreement.
These obligate the contractor to safeguard the information received
Agreements from the owner, maintain its confidentiality, and not release any of it
to the public or to other third parties without the written consent of
the owner.
Often, the owner will require a contractor to sign a separate secrecy
or confidentiality agreement prior to, and as a condition of, receiving
the bid documents. A typical confidentiality clause in a construction
contract follows.

253
 Article 49 – Confidentiality
49.1 All information provided to Contractor by Owner in connection with
the Work shall remain the property of Owner, shall remain confidential, and
shall not be copied or used in any way except in connection with the
performance of the Work by Contractor and his employees.
49.2 Contractor shall not disclose any information provided by Owner in con-
nection with the Work to the public or any third parties without the written consent
of Owner.
49.3 In the event Owner authorizes disclosure of information to a subcontrac-
tor, material supplier, or equipment supplier of Contractor, then such subcontrac-
tor, material supplier, or equipment supplier shall also be bound by the
confidentiality requirements of this Article 49.
49.4 Information that is determined to be in the public domain, or information
that is developed independently by Contractor, shall not be subject to the confi-
dentiality requirements of this Article 49.
49.5 Information required to be disclosed by law (i.e., by a court order) shall not
be subject to the confidentiality requirements of this Article 49.

One risk the contractor takes in accepting the above, Article 49, is
that there is no expiration of the confidentiality requirements. It can
be argued that the provisions of this clause could be enforced long
after the contractor completes the project. An unintentional release
of information years after the completion of the project could
potentially expose the contractor to a claim for breach of contract
and to unnecessary potential financial liability because of that breach.
If the contractor is uncomfortable with the risk of having the
potential exposure to a never-ending secrecy agreement, he can
negotiate time-limiting wording similar to the following:

49.6 The provisions of this Article 49 shall expire five years (or some other
time period) from the date of completion of the Work (or some other fixed
date in the future).

Sometimes an owner will require the contractor to sign a separate

secrecy agreement prior to receiving the set of bidding documents for
the project. Figure 15.1 is an example of a separate secrecy agreement
that addresses the bidding and construction phases in the event the
contractor is successful in winning the work. (Note the fixed
expiration date.)

Owner’s Right In most construction projects, the owner will hire inspectors to
inspect the contractor’s work to make sure that it conforms to
to Inspect applicable codes, standards, and requirements of the construction

254
Figure 15.1 Sample Secrecy Agreement

contract. This inspection process is typical on a project. The owner

has the right to nominate inspectors to act on his behalf; these
inspectors may be employees of the owner or hired third-party
inspectors. The following is a typical example of an inspection clause.

Article 50 – Inspection by Owner

50.1 Owner’s inspectors shall have unlimited access at all times to all
portions of the Work in progress. Contractor shall not cover any portion of
the Work until Owner has completed his inspection of such Work.
50.2 Owner’s inspection of Contractor’s Work shall not relieve Contractor of his
contractual obligations to perform the Work in accordance with the Contract.

255
 On first inspection, Article 50 may seem somewhat harsh or
one-sided, but actually the wording in this clause is common to
construction contracts and is generally considered to be fair. Owners
have the right to inspect the work done by their hired contractors.
Competent and qualified inspectors on a construction project can be
a big help to the contractor. They can help resolve questions about
the work they are inspecting in a timely manner or help find defects
or improperly installed work. It’s always better to have one of the
owner’s inspectors find a problem and help solve it during the
construction of the project than the owner finding the problem after
the project is complete, when the contractor would have to return to
the site to fix it.
The risk to the contractor is that the inspectors hired by the owner
may not be competent and/or qualified or arrive at the job site in
timely fashion to perform their inspections. The owner, of course, has
the right to nominate his own inspectors, and if the contractor takes
issue with the owner’s selection, this can create a problem. The best
way for the contractor to resolve any concerns regarding the owner’s
inspectors is to address them early. Owners are, for the most part,
interested in having qualified and competent people working for
them. The contractor has a right to expect qualified and competent
inspectors to be assigned to his work. Life is easier for everyone when
this is the case!
Therefore, if the contractor is concerned with the owner’s choice of
inspectors, he might negotiate wording in the contract similar to the
following:

50.3 Owner agrees to provide qualified and competent inspectors to

inspect in a timely manner the Work performed by the Contractor. Owner
will provide to Contractor prior to the commencement of construction
activities the names and qualifications of all his inspectors assigned to
the Work.

If a contractor can get the owner to agree to provide “qualified and

competent” inspectors, and is allowed access early on to the list of the
inspectors and what their experience and qualifications are, then he
may be able to raise any issues he may have privately with the owner.
Sometimes this is the best way to effect a change in the
contractor’s favor.
Note that the additional paragraph doesn’t convey any rights of
selection or rejection of inspectors to the contractor. (Owners would
likely object to allowing contractors to do this.)

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Independent Some construction contracts may include a clause specifying that the
contractor is an independent contractor. There are two issues
Contractors involved with independent contractor status:
1. The Internal Revenue Service (IRS) makes a distinction for
taxing purposes between an “independent contractor” and
several different types of employees. Employees are those
individuals who work for an owner (or contractor) and who are
generally under their direct control and direction. By law, the
owner and contractor have to withhold or pay certain types of
taxes on behalf of or from their employees, such as Social
Security, federal and state tax withholdings, and state and local
unemployment and Workers’ Compensation taxes. Employees
may also be entitled to certain benefits in connection with
their employment status with the owner or contractor, such as
vacation pay, retirement plan contributions, health benefits,
and educational benefits, to name a few.
2. There is a legal definition of the term “independent contractor.”
The following definition from Barron’s Law Dictionary is helpful:
One who makes an agreement with another to do a piece of
work, retaining in himself control of the means, method and
manner of producing the result to be accomplished, neither
party having the right to terminate the contract at will.
When an owner contracts with a contractor who is by the terms of
the construction contract an independent contractor, he hires him to
produce a specific result and, in theory, does not exercise any direct
control over the contractor or provide any direction of the work
being performed by the contractor. The owner doesn’t have to pay the
above noted taxes and benefits that he normally would for someone
classified as an employee. The IRS notes and recognizes this
distinction and has a series of tests it makes to determine if someone
is an employee or an independent contractor. (See IRS publication
1779 “Independent Contractor or Employee” for more information.)
Here’s an example of an independent contractor clause that may be
found in a construction contract:

Article 51 – Independent Contractor

51.1 Contractor shall be deemed to be an Independent Contractor, and
not an employee, servant, or agent of Owner, and all personnel furnished
by Contractor shall be deemed to be employees and personnel of Contractor
and not of Owner.

If a contractor is specified by the construction contract to be an

independent contractor, the owner may be able to avoid certain types

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 of claims associated with injuries to persons or property caused by
the independent contractor. While the owner may be responsible for
injuries or property damage caused by his own employees, who are
under his control and direction, an independent contractor and his
employees are not considered employees of the owner.
A final note on the issue is that neither the independent contractor
nor the owner has the authority to terminate the contract at will,
according to part of the Barron’s Law Dictionary legal definition (on
the previous page). If this part of the definition really applies, then it
would seem to void any unfair termination for convenience clauses
that may be included in a construction contract. This would be a
good deal for independent contractors. If being specified as an
independent contractor would tend to make a termination for
convenience (owner’s convenience, that is) unenforceable, that
would be a good deal for a contactor. This is just a thought to keep in
mind when negotiating commercial terms and conditions with
an owner.

Assignment An assignment is a written agreement that transfers all or some of

one party’s rights and/or obligations in a contract to a third party.
The distinction between the assignment of rights and the
assignment of obligations is an important one to understand. For
example, when an owner secures outside financing for a
construction project, the financial organization would typically
require him to assign his rights in the construction contract to it as
a condition of the agreement. In the event the owner becomes
bankrupt, the financial organization now would have all the owner’s
rights in the construction contract transferred to it by the terms of
the assignment clause in the financing agreement, and likely
through a similar or parallel assignment clause in the construction
contract.
However, it is likely that the owner didn’t assign to the financial
organization any of his obligations in the construction contract. This
is a key issue for contractors to be aware of with assignments made by
the owner. The assignment will likely transfer only the owner’s rights,
but none of his obligations. For example, one of the key obligations in
the construction contract is for the owner to pay the contractor for
the work performed. In the example above, the financing organization
acquires all the rights (including the right to enforce the liquidated
damages provisions in the contract against the contractor) by the
assignment agreement, but none of the obligations (such as payment
to the contractor for work performed). It is important for a
contractor to fully understand the possible consequences of the

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 owner assigning some or all of his rights and perhaps none of his
obligations of the construction contract to some third party.
Most construction contracts will include a clause that prohibits a
contractor from assigning any of his own rights and obligations in the
construction contract to a third party. The following is an example of a
simple assignment clause that requires the contractor to obtain written
permission from the owner to assign the contract to someone else.

Example 1
Article 51 – Assignment
51.1 Contractor shall not assign the Contract without the prior written
consent of Owner.

Example 2
The following is another example of an assignment clause that
If the contractor prohibits the contractor from assigning the contract, but allows the
has the right to owner to assign the construction contract, with the sole obligation of
approve the owner’s notifying the contractor that he has done so.
assignment of the
contract, then he Article 51 – Assignment
should review it and 51.1 Contractor shall not be entitled to assign in whole or in part any of its
understand how it rights and obligations under the Contract without the prior written consent
of Owner.
might affect his work.
If the contractor 51.2 Owner may assign any or all of its rights and/or obligations under the
Contract subject only to prior notification in writing to Contractor.
has valid concerns
or issues arising
from the owner’s Example 3
assignment, he at The following example is more fair to both parties.
least has some
leverage to revise the Article 51 – Assignment
contract. 51.1 Owner shall not assign any of his rights or obligations in the Contract
without the prior written consent of Contractor.
51.2 Contractor shall not assign any of his rights or obligations in the Contract
without the prior written consent of Owner.
51.3 Owner and Contractor have the right to review any proposed assignment
agreement.

Clauses that provide for the mutual agreement to the assignment of

rights and obligations are the best way to go. Each party may have
legitimate reasons for an assignment. As noted earlier, some owners

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 may be required to assign their construction contracts for a project to
their lenders in order to meet financing requirements. This is
acceptable, but the contractor should understand how that
assignment affects him and his work.

Acceptance & All construction contracts should contain a clause that describes the
acceptance process that applies to the contractor’s work—­and how
the Punch List and when the owner will provide written acceptance of that work.
This process concludes by providing documents and defining some
dates that are important to the contractor:
• The start date of the contractual warranty period.
• The document used to trigger final payment and/or the release
of retained monies.
• The ending date of any outstanding payment and performance
guaranties, on-­demand bonds, or standby letters of credit.
• The start date for any required warranty period on-­demand
bond or guaranty, general performance-­on-­demand bond or
guaranty, or standby letter of credit.
• The document provided by the owner signifying the work is
complete, tested, and ready for use.
• The ending date of the work, as it may be used for the
determination and imposition of any liquidated damages that
may apply due to contractor’s late performance.
• The ending date of the work, as it may be used for the
determination and award of any bonus available due to
contractor’s early completion.
The documents provided by the owner that signify his acceptance of
the contractor’s work are called by a variety of names, including:
• Certificate of mechanical completion or acceptance
• Certificate of final acceptance
• Certificate of occupancy
• Certificate of taking over
• Certificate of operational acceptance
• Certificate of practical completion
If not specifically defined in the contract by any of the above terms,
the acceptance clause may simply state that acceptance of the
contractor’s work will be provided in writing by the owner.
Another issue that arises in the acceptance process is the issue of a
punch list. This is a list of final minor items of work that need to be
completed by the contractor, but do not interfere with the completion

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notice given by the owner. Typically, the contractor will receive the
completion notice, along with the punch list and a specified time in
which to complete the outstanding items. The minor tasks included on
the punch list do not affect the takeover and use of the work by the
owner and should not be used by the owner to delay or stop the
acceptance process of the project. Typical punch list items might include:
• Touch-up painting or minor repairs
• Minor site restoration, repair, or cleanup
• Minor repairs or adjustments that don’t hinder the operation,
performance, or use of the completed work
The contractor is normally given some amount of time (such as
30 days) to complete punch list items. Meanwhile, the acceptance
process should continue to completion without delay.

Example 1
Following is an example of a typical acceptance clause that gives the
owner 30 days to review the contractor’s work and issue a certificate of
completion. The only problem with a clause like this one is that it gives
the owner the right to keeping looping through the 30 days’ acceptance
period if he does not like the way in which the contractor resolved
uncompleted work issues. Acceptance by the owner with the use of this
clause could go on for a period of time well in excess of 30 days.

Article 54 – Acceptance
54.1 Contractor shall provide Owner with written notice that the Work is
complete. Owner shall have 30 days after receipt of notice to determine if
the Work is complete.
54.2 If the Work is complete, Owner shall notify Contractor in writing that the
Work has been completed to his satisfaction and shall issue a Certificate of
Acceptance to Contractor.
54.3 If the Work is not complete, Owner shall notify Contractor in writing of the
uncompleted or defective portions and Contractor shall correct them at
Contractor’s expense.
54.4 The procedure in this Article 54 shall be repeated until the Work is com-
pleted and Contractor receives the Certificate of Acceptance from Owner.
54.5 Contractor’s Warranty Period shall commence upon the date of the
Certificate of Acceptance.

Example 2
The second example is a bit more favorable to the contractor. The
contractor agrees to take care of all deficiencies (the punch list)
within 30 days from the time he finishes the work. Even if the owner

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 does not start the facility within 90 days of the contractor’s notice of
practical completion, the contractor automatically gets the final
completion notice. This clause puts a time limit on the acceptance
process.

Article 54 – Acceptance
54.1 Owner shall provide Contractor with a Certificate of Practical
Completion upon completion of the Work, which will list all deficiencies
discovered in the Work.
54.2 Contractor shall rectify all deficiencies listed in the Certificate of Practical
Completion within 30 days after issue.
54.3 If Owner does not begin operating the Work within 90 days from the date
of the Certificate of Practical Completion for reasons other than those arising out
of defects or delays in the Work, then Owner shall issue Contractor a Certificate
of Final Completion.
54.4 Contractor’s Warranty Period shall commence upon the date of the
Certificate of Final Completion.

One issue associated with the acceptance process is delay (intentional

A well-thought-out or unintentional) by the owner in granting formal acceptance. For
acceptance process example, it’s not too difficult to understand what might drive an
that defines how the owner’s delay in accepting the work if the contractor is eligible to
owner will accept receive a $10,000 per day bonus for early completion! If the
the project, clarifies a contractor feels that a delay of acceptance might be a risk, he can
punch list that will not negotiate additional wording that places a time limit on the owner in
delay acceptance, the acceptance clause similar to the following:
and places a time
limit on the owner’s 54.5 Contractor shall notify Owner in writing that the Work has been
acceptance is completed and is ready for Owner’s acceptance. Within three weeks after
the date of the notification, Owner shall advise Contractor in writing of any
valuable for both deficiencies in the Work. In the event Owner does not advise Contractor of
the owner and the any deficiencies in the Work within the noted three-week period, then the
contractor. Work shall be deemed to be accepted by Owner.

A clear acceptance process will make it easier for the contractor to

close out the project, establish the beginning of his warranty period,
receive final payments, lessen exposure to liquidated damages, and
cancel project-related on-demand bonds and surety obligations.

Advance & As a matter of good contracting, contractors should not waive any of
their rights, legal or otherwise, in advance as a condition of the
Partial Waiver construction contract. Many contracts have unfair clauses in them
of Liens that obligate the contractor to waive certain rights he has for the

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duration of the contract and perhaps even afterwards. This prevents a
contractor from exercising those certain rights that are normally
available to him under the laws of the state he is working in. Think of
it this way: why would a contractor waive in advance—at the time he
signs the contract—his right to be paid on time?
One of the most typical applications of the owner requesting an
advance waiver of rights is in regard to the contractor’s right to file a
mechanic’s lien against the owner’s property. If the owner does not
pay the contractor for the work he has performed or the materials he
supplied, the contractor may file a mechanic’s lien against the owner’s
property. There are mechanic’s lien laws favorable to contractors in
place in all states, which contractors can use to force owners to pay
them for work they have performed or materials they have supplied
(and the owner has not paid for). A mechanic’s lien on the owner’s
property places a legal encumbrance on the property and may
prevent the owner from securing financing for his project—or
prevent him from selling the property without first discharging the
lien. The right to file such a lien is valuable to keep in the contract in
the event the owner refuses to or cannot pay the contractor for the
work he has performed.

Example 1
The following is an example of an unfair clause (subclause 56.2 in
particular) in which the owner wants the contractor to waive in
advance his mechanic’s lien rights:

Article 56 – Liens
56.1 Contractor shall promptly pay for all subcontractor services, labor,
equipment, or materials provided by Contractor in connection with the
performance of the Work.
56.2 Contractor hereby waives all rights to fi le any mechanic’s lien and/or all
other similar liens for the payment of services, labor, equipment, or materials
furnished by Contractor in connection with the performance of the Work against
Owner’s premises or property.
56.3 Owner shall not make final payment to Contractor until the Contractor has
delivered to Owner a final release of liens in a form acceptable to Owner.

With respect to mechanic’s liens and waivers of rights, there are two
issues at work:
1. The owner expects the contractor to fully and timely pay all
subcontractors and material suppliers who do work for the
contractor on the owner’s project.

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 2. The contractor expects the owner to fully and timely pay him for
The contractor the work he has performed.
expects to be paid
The owner has a legitimate right to expect the contractor to pay
by the owner for
subcontractors and material suppliers. Since the owner is paying
his efforts and in
only the contractor, he wants some protection in the event the
accordance with contractor does not pay his subcontractors and material
the terms of the suppliers. If the contractor does not pay them, they have the right
contract. If the owner to file a lien against the owner’s property. An owner doesn’t want
refuses to pay him or to be in the position of paying the contractor for work and then
becomes bankrupt, having to pay a subcontractor for the same work because the
the contractor wants contractor didn’t pay the subcontractor or material supplier in
some way to get the first place.
the money that’s All 50 states in the U.S. have mechanic’s lien laws. Each has specific
owed him. Filing filing and notification requirements, and the contractor will
a mechanic’s lien ultimately have to file a lawsuit to foreclose against the owner’s
against the owner’s property to force a sale of the property and be paid from the
project is one proceeds. The filing of a lien can also put pressure on the owner to
method. It is also a resolve the payment issue.
good reason not to It’s not simple, nor is it easy, and it’s not a guaranteed payment
waive in advance— process, but filing a mechanic’s or similar lien against an owner is
at the time of signing something that the contractor does not want to waive his right to use.
the contract—any Lien laws can be complex, and the failure to provide timely notices
right to file a lien. may invalidate any lien rights the contractor negotiated into the
contract. Each state has slightly different requirements, so it’s
important to understand them before signing a contract.
If the owner has borrowed money to build his project, lenders tend to
be unhappy about having outstanding liens against the project they
have lent their money to build. A mechanic’s lien in this instance
provides the contractor with some leverage to get paid. Owners
requesting an advance waiver of a contractor’s lien rights are often
willing to allow the contractor to provide partial waivers of liens as
the work progresses.

An Example
A contractor has a $1,000,000 contract to build a building. With the
first progress invoice for $100,000, the contractor provides the owner
with an executed waiver of liens for the value of the work performed
and paid for under the invoice. With each subsequent invoice, the
contractor provides similar waivers of liens for the value of the work
performed under those invoices. At the conclusion of the project, the
owner has received waivers of liens amounting to the full value of his
project; this procedure meets the needs of most owners.

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 When faced with an advance waiver of liens clause in a construction
contract like the one noted above in Article 56, revised wording
similar to the following could be negotiated:

Article 56 – Liens
56.1 Keep as is.
56.2 Delete this subparagraph.
56.3 Reword: With each payment invoice, Contractor shall, as a condition of
being paid, submit a waiver of any and all liens for the payment of services, labor,
materials, and equipment supplied in connection with all the work performed
under the invoice, and such waiver shall become effective only upon receipt of
full payment of Contractor’s payment invoice.

In this manner, the owner receives the protection from liens that he
wants, and the contractor also preserves his right to file a lien against
the owner’s property in the event he does not receive timely payment
from the owner.

Final Waiver Requiring a contractor to provide a final waiver of liens as a condition

of receiving his final payment or release of retention money is fairly
of Liens typical. A final waiver of liens is like a partial waiver of liens, but
covers the entire value of the project.
Although this chapter has already addressed advance and partial
waivers of liens, it can’t be emphasized enough that the contractor
must make sure that any final waiver document contained in the
owner’s construction contract is actually a final waiver of liens, and
not something more. Any time an owner provides his own waiver
forms in a construction contract, they need to be carefully reviewed.
This caution is important because these final waivers that the owner
would want the contractor to sign often have to be executed and filed
as a condition of receiving any final payments. The right time to make
any revisions to owner-generated final waiver documents is at the
negotiation phase of the contract.
Figures 15.2 and 15.3 are examples of two final waiver documents.
Figure 15.2 is an example of an unfair owner-generated form that
must be executed by the contractor as a condition of receiving final
payment for the work performed. Typically, this form would have to
be signed by the contractor and submitted along with his final
payment invoice. No signed final waiver means no final payment.
Blackmail? Perhaps. Not only does this owner-supplied form provide
a final release of liens (which is okay and normal), but as stated in
item #2, it: “Fully releases and discharges Owner against all liens,

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 Figure 15.2 Final Waiver Example

claims, demands, and causes of action of every kind and nature

arising directly or indirectly out of the performance of the Work.”
In addition, item #5 states that with respect to any liens, claims, or
demands, “Contractor will indemnify and hold harmless Owner from
and against any such payments, all costs of defense and all other costs
incurred in connection therewith.” In signing such a form, the
contractor takes a significant risk by waiving his rights to any claims
or demands he may have against the owner. Such claims or demands
may be separate issues and not have anything to do with a lien. Also,
the contractor agrees to indemnify the owner, for an unlimited

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Figure 15.3 Final Waiver Example

amount of money, against any payments he may have for claims or

demands and, in addition, the contractor agrees to pay for the defense
of the owner in such cases. What has happened here is that the owner
has made the provision of providing an unlimited indemnity a
condition of receiving final payment. Such a form should be tossed in
the garbage can at the beginning of the contract negotiations!
As an example of the havoc a final waiver like that shown in
Figure 15.2 can create, let’s say the owner damages a piece of the
contractor’s construction equipment during the course of the
construction. The contractor files a claim with the owner for the cost
of repairing the equipment. The owner stonewalls resolution and the
claim is outstanding at the end of the job. The contractor signs the
final waiver and gets his final payment—­but that’s it.
In signing the final waiver form, it’s likely that the contractor would
be prevented from resolving his claim on the damaged equipment,
since he waived his right to do so. He could also get stuck paying any
legal bills the owner may incur to defend against the contractor’s
claim for the damaged equipment. Always read and understand any
owner-­supplied documents like final waivers.

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 Figure 15.3 is another example of an owner-generated form to be
used with the contractor’s invoice for final payment. This is an
example of a fair final waiver of liens form to be supplied by the
contractor with his final payment invoice. No other waivers of rights
or claims or the provisions of indemnities—like those shown in
Figure 15.2—are required of the contractor as a condition of receiving
his final payment.

Audit Rights Sometimes an owner will want the contractor to allow him to audit
the contractor’s accounts related to the owner’s construction project.
On a cost reimbursable contract where the owner is paying the
contractor based on direct costs incurred, and agreed-on markups on
those costs, then allowing the owner to audit the project’s accounts is
appropriate.
However, on a fixed price contract, and especially where the
contractor has bid in competition with others, the owner really has
no business being allowed to audit the contractor’s accounts related
to the project. If such audit rights are so important to the owner, then
he should strongly consider doing his project on a cost-reimbursable
basis where he can have access to the details of the costs incurred by
the contractor. On a fixed price contract, audit rights would only
likely be granted for those changes to the scope of work which would
be performed on some type of cost-reimbursable basis.
The following is a typical audit rights clause in a construction
contract:

Article 57 – Audit Rights

57.1 Contractor shall keep all accounts and records in conjunction with
the performance of the Work for a period of three years from completion of
the Work.
57.2 Owner shall have the right to examine and copy such accounts and records
with advance notice to Contractor.

For a cost-reimbursable type of construction contract, this clause is

probably acceptable to use. However, if it appears in a fixed-price
contract, the contractor may want to consider negotiating additional
wording similar to the following:

57.3 This Article 57 is not applicable to any fixed price construction

contracts. It is only applicable to cost reimbursable types of construction
contracts and to any extras and additions to fixed price contracts that are
paid for on a cost reimbursable basis.

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 Severability or Almost all construction contracts will contain a severability or validity
clause, which can be a benefit to a contractor who understands the
Validity Clauses nuances of negotiating construction contracts. Basically, such a clause
says that if one or more of the clauses in a construction contract ends
up being ruled unenforceable or invalid (most likely as a result of some
kind of court ruling), then the remaining clauses will continue to be in
full force and effect. This has the effect of severing the unenforceable
or invalid clause from the construction contract.
The risk here is that the contractor who is not careful might lose his
hard-negotiated limitation of liability and exclusion of consequential
damages. Take the instance of a contractor who negotiates a
limitation of his liability and includes this limiting language within
the contract’s indemnity clause. Since the limitation of liability is not
a separate clause, it is possible the contractor could lose it if a court
ruled that the indemnity clause was unenforceable or invalid, and
struck (severed) the entire clause from the contract.
The same holds true if the contractor had successfully negotiated an
exclusion of consequential damages and included it within the
indemnity clause. If the indemnity clause is, for some reason, ruled
unenforceable, the contractor will likely lose his protection from any
consequential damages that may arise against him. This is a serious
risk! It is worth noting that incorporating an exclusion of
consequential damages clause within an indemnity clause could be
ruled to apply to the indemnity only, and not across the board, as
desired by the contractor. This is why it’s important to have a separate
limitation of liability clause and a separate exclusion of consequential
damages clause, along with a separate indemnity clause. If this is
done, then if the indemnity gets severed from the contract, the
contractor doesn’t lose the protection of the limitation of liability
and/or the exclusion of consequential damages clauses.
The following is an example of a typical severability clause.

Article 58 – Severability
58.1 If one or more of the provisions of the Contract should become
invalid or unenforceable, the validity of the Contract and of all the other
provisions of the Contract shall not be affected.

If such a clause is not in a construction contract, the contractor may

want to negotiate with the owner for its inclusion.

Venue & Most construction contracts contain a clause that reads similar to the
following example:
Applicable Law
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 Article 59 – Applicable Law
This Contract shall be construed in accordance with and shall be governed
by the laws of the State of Florida.

This type of clause is commonly used to set out the agreement

Changes in the
between the owner and contractor that, in the event of a lawsuit, both
law that have a agree to the legal jurisdiction (venue) and the laws of a named state
cost effect on the (applicable law). Each state may have slightly different laws that apply
owner’s project are to construction contracts. The contract law considerations in one
the responsibility of state may tend to favor the owner and not the contractor on certain
the owner, not the matters, such as with regard to indemnity agreements.
contractor. A good example of this is when the contractor is involved with a
construction contract in Florida where there is anti-indemnification
legislation in place that provides some measure of protection for the
contractor, and agrees to an applicable law clause in the contract that
says the laws of the state of Alabama apply. The contractor is at risk
in this situation; Alabama, as of the time of writing of this book, has
no anti-indemnity state statute in place.
Also, if the contractor in this example is working in Florida, he may
have to go to Alabama to pursue a legal solution to a claim or
dispute. Applicable law is, arguably, not one of the riskiest contract
clauses a contractor has to worry about, but with respect to
those states that don’t have anti-indemnity legislation in place, it
could be.

Florida Civil Code Chapter 47 Venue

47.025 Actions against contractors.—Any venue provision in a contract

for improvement to real property which requires legal action involving a
resident contractor, subcontractor, sub-subcontractor, or materialman, as
defined in 1part I of chapter 713, to be brought outside this state is void as
a matter of public policy. To the extent that the venue provision in the contract
is void under this section, any legal action arising out of that contract shall
be brought only in this state in the county where the defendant resides,
where the cause of action accrued, or where the property in litigation is
located, unless, after the dispute arises, the parties stipulate to
another venue.

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Texas Business & Commercial Code
Annotated §272.001
If a contract [that is principally for the construction or repair of an improvement
to real property located in this state] contains a provision making the contract
or any conflict arising under the contract subject to another state’s law, litigation
in the courts of another state, or arbitration in another state, that provision
is voidable by the party obligated by the contract to perform the construction
or repair.

Venue and Choice of Law State Statutes

The following 26 states have enacted legislation, so called home court
rules, for construction projects requiring claims and disputes arising
from construction projects in that state to be ruled by the laws of
that state.
Arizona California Connecticut
Florida Illinois Indiana
Kansas Louisiana Minnesota
Montana Nevada Nebraska
New Mexico New York North Carolina
Ohio Oklahoma Oregon
Pennsylvania Rhode Island South Carolina
Tennessee Texas Utah
Virginia Wisconsin
These statutes can be amended and new state statutes added so an
online search for “venue and choice of law” can update the above
chart.

Contractual Rendition?
Here’s one example of a popular current day definition of rendition:
“the practice of sending a foreign criminal or terrorist suspect covertly
to be interrogated in a country with less rigorous regulations for the
humane treatment of prisoners.”
Let’s say you have a construction contract that contains a broad-form
or intermediate form indemnity and the venue and state law clause in

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 the construction contract require that all claims and disputes arising
out of the contract shall be adjudicated in the State of Alabama and
under the laws of the State of Alabama.
Absent a venue and state law “home court rule” statute in the state in
which the construction project is performed, the contractor would
then have to get on his horse and go to Alabama to defend or
otherwise resolve the claim under the laws, or lack thereof, of
Alabama.
Alabama currently does not have an anti-indemnity statute on the
books.
This is called “contractual rendition.” Being forced to go to another
state to be tortured by the lack of anti-indemnity legislation in that
state.
Always check the venue and state law legislation in place for the state
in which you are performing a construction contract.

Changes in the Law

If the laws of a state change during the course of a construction
contract, the contractor’s costs may be adversely affected. For
example, a change in state environmental laws may require the
contractor to immediately adopt certain environmental protection
measures that he had not included in his original estimate.
Contractors can gain protection from costs associated with such law
changes by adding a new paragraph (or separate clause) to the
applicable law clause with wording similar to the following in 59.2:

Article 59 – Applicable Law

59.1 This Contract shall be construed in accordance with and shall be
governed by the laws of the State of Florida.
59.2 Any new laws, codes, or regulations or modifications of existing laws,
codes, or regulations which take effect after the signing date of this Contract shall
be a basis for adjustment of the Contract Price and Schedule.

The owner may argue that this is just a risk that the contractor has to
accept. No, it isn’t. The contractor has just one shot at making a profit
on a construction project. The owner at least has the ongoing profit-
making capability of his newly completed project to recover the
additional costs of changes in the law.

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 Some And finally, a couple of interesting clauses extracted from actual
construction contracts worth commenting on:
Interesting
Clauses to Close Article 60 – Consultation and Advice
60.1 In addition to its other obligations in the Contract, Contractor shall,
when requested, and without additional compensation, consult with and
advise Owner on any question or technical matter which may arise in
connection with the Work.

If a contractor ever wondered what it would cost to train the entire

group of young new engineers and junior project managers on an
owner’s staff, he can agree to this clause.
And one of the better ones:

Article 70 – Don’t Bother George!

70.1 Contractor shall not bother, feed, poke, prod, or in any way disturb or
aggravate George during the course of the site construction.

It turns out that George is a fondly thought-of 8-½ foot alligator who
makes his comfortable home in and around a golf course pond adjacent
to the site where a new structure is to be erected. Finally, someone with
a sense of humor contributes to a construction contract!

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Chapter
A Construction
16 Contractor’s
Contract Checklist
It has been said that a checklist creates laziness on the part of the
user. Fill out the checklist and if the results look okay for whatever the
checklist analyses, proceed and don’t do any further analysis.
Performing a thorough analysis of the commercial risks associated
with a construction contract for a project requires some skill and the
ability to understand and evaluate the proposed commercial terms
and conditions in order to best protect the assets of the company.
Each construction project will always have a different mix of
commercial risks associated with the project contract’s commercial
terms and conditions.
There is no such thing as a standard construction project. There is
also no such thing as standard commercial terms and conditions for a
construction project. As such, it is difficult to develop an all-­
encompassing and comprehensive checklist that would be
appropriate for each and every construction project and set of
commercial terms and conditions.

Understanding and Negotiating Construction Contracts: A Contractor’s and Subcontractor’s Guide to

Protecting Company Assets, Second Edition. Kit Werremeyer.
© 2023 John Wiley & Sons, Inc. Published 2023 by John Wiley & Sons, Inc.

275
 Having a thorough knowledge of the typical risks associated with
commercial terms and conditions and having the ability to
independently understand and analyze these risks for each contract
are the best ways to lower your commercial risk.
Having said all that, a checklist is simply one tool to use in the
contract analysis process. If it is used with some circumspection,
it will at least highlight some of the most common or typical
commercial risks associated with a construction contract. As
long as a checklist is used in conjunction with independent
evaluation and analysis of the commercial terms by the
reviewer, then the risk review process can be performed more
efficiently.
One final point: use your own knowledge and skill—­or the knowledge
and skills of others—­to thoroughly understand and evaluate the risks
associated with each of the construction contract’s commercial terms
and conditions. After you sign the contract, it is too late to change
those risky commercial oversights!
Here is a checklist of 11 important and commonly encountered
contracting issues all earlier discussed in this book, along with 54
clarifying notes, to consider using as part of a comprehensive
contract evaluation and analysis process:

Contract Clause Issue to Review OK? Not OK?

See Note
Scope of Work Thoroughly written? 1
Battery limits defined? 2
Interfaces defined? 3
Exceptions defined? 4
Work by others defined? 5
Terms of Positive cash flow? 6
Payment Down payment/early payment? 7
Retention? 8
Paid when paid/paid if paid? 9
More than 30 days terms? 10
Electronic transfer of funds? 11
Set offs? 12
Schedule Adequate time for scope of work? 13
Realistic if liquidated damages? 14
Contingency (float) in schedule? 15
Who owns the “float”? 16
Letter of Intent “Commitment” only? 17
Defined scope and payment? 18

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Contract Clause Issue to Review OK? Not OK?
See Note
Insurance Realistic amounts? 19
(General Liability) Additional insured status? 20
Contractual liability? 21
OCP allowed? 22
Completed operations? 23
Care, custody, and control? 24
Indemnity Broad form? 25
Intermediate form? 26
Limited form? 27
Knock for knock? 28
Who’s covered? 29
Financial limits? 30
Location limits? 31
Time limits? 32
Anti-­indemnity legislation? 33
Venue/Applicable law? 34
Changes Time only? 35
Time and money? 36
Process to get change defined? 37
Payment for changes? 38
Contract rates for changes? 39
Disputes Negotiate first required? 40
Executive solutions required 41
Mediation required? 42
Arbitration required? 43
Litigation? 44
Assurances of On-­demand bond? 45
Performance Surety bond? 46
Standby letter of credit? 47
Parent company guarantee 48
Damages Direct/Actual? 49
Liquidated? 50
Consequential? 51
Warranty Start time defined? 52
Duration defined? 53
Exclusions defined? 54

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 Notes
1. M
 ake sure the scope of work is comprehensive and very thoroughly
written. Most claims and disputes arise out of poorly written scopes of
work.
2. The battery limits define the outside limit of perimeter of your work.
This is where your work ends and someone else’s begins.
3. At your battery limits—­the interface between your work and someone
else’s—­define what your scope is at that interface. For example: who
hooks up the piping from your work to another contractor’s work.
4. Clearly define what work is not included in your scope. For example:
construction permits and local environmental permits.
5. Make sure you specifically define work that you expect to be performed
by others. For example: owner is providing scaffolding services for all
contractors on the jobsite.
6. Analyze the proposed terms of payment. Make sure the proposed terms
yield a positive cash flow. If they don’t, negotiate terms that do.
7. Always try to negotiate a down payment or an early payment. An early
payment may be made on something such as submission of bills
of materials or unpriced POs for contract materials. Invoice for the
breakout value of materials. Be creative.
8. Always try to eliminate retention. In lieu of retention, negotiate providing
a warranty bond along with invoice for final payment. Clients like
to claim that retention assures the warranty obligations, as does a
warranty bond.
9. If you agree to be paid when paid or paid if paid terms, make sure you
establish some maximum time that your invoice can be outstanding.
Better yet, negotiate more favorable terms. Your client has the money to
pay you on time and in accordance with your preferred terms.
10. You do not have to agree to payment terms beyond 30 days. Try to
negotiate 15-­day terms by electronic transfer of funds.
11. Learn how to establish electronic transfer of funds for payment of your
invoices.
12. A set-­off contractually allows your client to subtract money from your
invoices for money, he claims you owe them for a different project. Do
not ever agree to set-­offs.
13. Make sure there is adequate time in your schedule to properly and
safely perform the work.
14. If there are liquidated damages in the contract, it is even more
important that there is adequate time in your schedule to perform the
work.
15. Make sure there is at least some contingency time in your schedule as
unforeseen delays are common.
16. Do not ever agree to give your client ownership of your contingency
time in the schedule. Contingency time is commonly called “float.” It is
yours; keep it.
17. A letter of intent that only expresses a “commitment” to award you
the project, subject to some final unresolved issues or terms and
conditions is nice, but it is not a contract.
18. A vastly improved letter of intent expresses the commitment to award
and also defines scope of work to perform, like engineering and
procurement of materials, plus the commitment to pay for this scope
prior to a final contract being signed.

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Notes
19. Is the amount of General Liability insurance, or its follow on Completed
Operations insurance, appropriate for the work? A requirement
for $10,000,000 of GL and CO insurance for a $250,000 job is not
appropriate. GL insurance is in effect during the course of your project
and ends when you leave the jobsite. See note 23 below for Completed
Operations insurance.
20. If you agree to name your client as an additional insured of your GL
policy, he has full access to the coverage and limits of the policy at no
cost to him, including the insurer’s obligation to provide and pay for
legal defense of a claim. A claim by your client as additional insured
could ruin your ability to secure GL insurance or significantly increase
your premiums. Try hard not to agree to add your client as an additional
insured. Your client can buy his own insurance to meet his own needs.
Insurance is an asset; protect it!
21. Contractual liability is likely a component part of your GL insurance
policy. It covers the obligations you agree to in an indemnity clause
in the construction contract. Make sure your agent or broker carefully
explains contractual liability coverage to you and the issues that arise
when you also agree to name your client as an additional insured on
your GL policy.
22. An Owners and Contractors Protective liability insurance policy—­an
OCP—­covers an Owner against the vicarious liability arising out of
so-­called third party over claims, most typically in relation to workers
compensation cases. This is a completely acceptable substitute for
naming your client as an additional insured on your GL policy. You
purchase the OCP for client and you can include the charge in your
contract price.
23. Completed Operations insurance is a separate GL policy that begins
once you have completed your work and left the jobsite. Make sure you
know how long the client wants the CO insurance in place, one to three
years is normal. Also, try not to add your client as an additional insured
to this CO insurance. Same comment as note 20 above. Remember,
insurance is an asset; protect it!
24. If you accept equipment procured by your client for your installation,
make sure your GL policy provides for this as “Care, Custody and
Control.” This is typically a component part of your GL policy, but
check, just in case.
25. A broad form indemnity makes you responsible for the financial liability
arising out of claims for bodily injury, including death, and property
damage caused by any degree of negligence of your client, including his
sole negligence. You also would have to pay your client’s legal defense
costs. This is a contractual landmine. Don’t agree to it! If you have to
agree, make sure you negotiate a financial limitation of liability as a
separate clause in your contract. See note 30 below.
26. An intermediate form indemnity is the same as a broad form indemnity,
except it excludes claims for bodily injury, including death, and property
damage arising out of the client’s sole negligence. A client could be
99% negligent for a claim and you would be responsible for the resulting
financial liability. You also would have to pay your client’s legal defense
costs. Don’t agree to it! If you have to agree, make sure you negotiate a
financial limitation of liability as a separate clause in your contract. See
note 30 below.

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 Notes
27. A limited form indemnity makes you and you client responsible for the
financial liability arising out of claims for bodily injury, including death,
and property damage but only to the extent of your negligence and
your client’s. This is the type of indemnity you always try to negotiate
into all your construction contracts.
28. A so-­called Knock-­for-­Knock indemnity obligates you and your client
to be responsible for the financial liability arising out of bodily injury,
including death, and property damage of their own employees and
property, regardless of the degree of negligence one or the other party
may have regarding the claim. Just beware that a Knock-­for-­Knock
indemnity may run afoul of state anti-­indemnity laws. See note 33
below.
29. Try not to cover more than your client and his employees in the
indemnities you negotiate. “Agents, representatives, subsidiaries” and
other third parties are dangerous, unsafe, additions.
30. If you have to agree to a broad-­or intermediate form indemnity, try
to negotiate a financial limitation of your liability as a separate clause
in the contract, preferable one that would fall within the limits of your
insurance program.
31. Any indemnity you agree to in a contract should be limited to
covering claims occurring only during the on-­site performance of
your work, nowhere else, and at no other time before or after you are
on the site.
32. Any indemnity should be limited to covering claims occurring only
during the time you are physically present on the jobsite.
33. A number of progressive states have statutes—­laws—­in place that
make broad-­and intermediate form indemnities “against public
policy and therefore void and unenforceable.” Some of these
statutes also disallow providing of additional insured status to
cover indemnity obligations. Legislation that only outlaws broad
form indemnities is completely worthless since intermediate form
indemnities may still be enforced. Some states have no such laws.
Some states have common law decisions in place to void broad-­
and intermediate form indemnities. Knowledge of these statutes and
common law considerations are very powerful negotiating tools for
a contractor. Your contracts pro or attorney can keep you abreast of
these laws.
34. A hidden land mine in contracts is a venue and choice of law clause.
Clever clients like to insert a clause that obligates the parties to resolve
claims or litigate in states, other than the state in which the project is
located, that have no effective anti-­indemnity legislation in place. Make
sure you understand the consequences of working in one state, but
subject to the laws of another state. Also, some states have statutes
in place that require parties to claim to resolve the claim in the state in
which the project is located. This is another powerful negotiating tool
which your contracts pro or attorney can advise.
35. Changes clauses that only allow time only should never be agreed to.
Are you a charity?
36. All changes clauses should be negotiated to include for both time and
money.
37. Make sure the changes clause has a well-­defined and fair process to
have change reviewed.

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Notes
38. P ayment for changes should be 100%. They were not part of the
original contract where other payment terms were agreed to.
39. Strongly consider adding an addendum to all construction contracts
that includes for unit rates for engineering, labor, materials,
subcontracts, equipment rental, etc. to use when changes arise.
40. A dispute clause should require the parties to first try to negotiate a
resolution.
41. A dispute clause should require the parties to nominate an executive
of each party to meet and try to resolve the dispute in the event
negotiations fail.
42. A dispute clause should require the parties to use mediation in the
event negotiation or executive resolution fail.
43. Arbitration is a very poor dispute resolution process. It is really not
much different from litigation and can drag on forever and cost a lot
more than litigation. A clause that requires the parties to always go to
arbitration is meant only to intimidate the contractor from pursing a
claim. If you have to use arbitration, make sure the arbitrator(s) have
some long-­term practical construction experience and are not just
retired judges or lawyers who just read words.
44. Do not ever agree to a dispute clause that requires the parties
to resolve by going to court without at least trying to resolve by
negotiating, executive resolution, or mediation.
45. An on-­demand bond—­likely issued by a bank—­is not an assurance of
performance nor is it a guaranty. As the name implies, a client can go
to the bank and cash the bond simply by stating the contractor failed
to perform. On-­demand bonds are dangerous and are used in many
occasions by clients to pressure the contractor not to pursue legitimate
claims.
46. A surety bond is an assurance of performance and a guaranty. Always
use if a “bond” is required.
47. A stand by letter of credit is nothing more than the on-­demand
described in note 45.
48. A parent company guaranty is as the name implies as assurance of
performance by the contractor’s parent company.
49. You are responsible for actual damages caused by your construction
activities. However, the actual damages must be proven, typically in a
court case.
50. Liquidated damages in a contract create an adversarial relationship
between the contractor and the Owner or his General Contractor, or both.
LDs should bear some reasonable estimate to how much the Owner or his
GC are actually damaged by the contractor’s late or other performance-­
related issues. LD clauses should always have a financial cap.
51. Always negotiate a separate clause in the contract excluding
consequential damages. It is not sufficient to be silent on consequential
damages in a contract.
52. Make sure the warranty period begins with some well-­defined
completion occurrence, excluding punch list items.
53. Make sure the warranty period is well defined. For example: 18 months
from contractor’s scope of work completion, or 12 months from project
start up, whichever occurs first.
54. Make sure your warranty clearly provides for exclusions like corrosion,
improper maintenance, etc.

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Chapter
International
17 Contracting

So far, this book has focused on how construction companies can

better negotiate construction contracts for work performed for
private companies in the United States. However, many U.S.
construction companies work in foreign countries—­or would be
interested in doing so. Some U.S. construction companies may have
one or more divisions or subsidiaries located in other countries to
pursue new work and execute projects. Others may be interested in
expanding their business by seeking new construction opportunities
in overseas locations.
Although the contracting process for a project in the U.S. can at times
be complex, at least the parties involved speak the same language, use
the same monetary system, have a mature legal system to work with,
and live within a stable economic and political environment. And, for
the most part, a contractor building a project in California can talk to
the owner in New York during the business day and not worry much
about time zone differences of up to 14 hours.

Understanding and Negotiating Construction Contracts: A Contractor’s and Subcontractor’s Guide to

Protecting Company Assets, Second Edition. Kit Werremeyer.
© 2023 John Wiley & Sons, Inc. Published 2023 by John Wiley & Sons, Inc.

283
 Often contractors working in foreign locations are overheard saying,
“That’s how we work and contract in the U.S., so it ought to be the way it’s
done in this country.” While there are many similarities between
construction contracts in the U.S. and those of other countries, there are
many important differences to consider, too. Contracting and commercial
risk issues can change dramatically when working abroad. U.S.
contractors considering doing construction work in another country must
understand the various risks involved, and the different and unusual
situations that may arise. This will improve the chances of success.
This chapter will present an overview of some of the most common
risks and considerations a contractor will be exposed to. In
international contracting, it pays to do your homework—­a lot of
homework. When in doubt, ask for help!
This chapter will cover the following topics:
• International contracts
• The U.S. Foreign Corrupt Practices Act (FCPA)
• Letters of credit
• Split contracts
• Political, religious, and economic risks
• Overseas Political Investment Corporation (OPIC)
• Legal systems
• Local employees, partners, and agents
• Offshore companies
• Currency risks, devaluation, and payment in foreign currency
• Applicable law
• Joint ventures and joint operations
• Import and export considerations
• Understanding INCOTERMS
• The Export‐­Import Bank of the United States (Ex‐­Im Bank)
• Assistance from the U.S. government

International An international construction contract, in its basic form, is not much

different from what a contractor would expect to see for similar work
Contracts in the United States. Since English is the world’s business language,
it’s likely that an owner who requires worldwide sourcing for his
construction project will write the inquiry documents and contract in
English. Often, owners hire U.S. companies with international
experience to project manage the work. These companies will likely
use a contracting format they are comfortable with, typically the same
used on their U.S.‐­based construction contracts.

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 In fact, many of the commercial clauses in an international
construction contract will be similar to, if not exactly the same as,
those in a U.S. contract. Contractors can expect to see clauses
covering scope of work, terms of payment, insurance, indemnity,
termination and suspension, dispute resolution, force majeure, and
others that may read just like their commercial counterparts in a U.S.
construction project contract.
The risk of accepting clauses as written in an international contract
for construction work in a foreign country, however, may be greater.
For example, the terms of payment a contractor may be willing to
accept from an owner in the U.S. in a construction contract may not
be acceptable, or even workable, in a complex international contract
with an owner who is new and unknown to the contractor.

The U.S. Foreign The U.S. Foreign Corrupt Practices Act (FCPA) is a U.S. law that
addresses a problem most are not comfortable discussing: bribery of
Corrupt foreign government officials by U.S. business people (or any business
Practices Act people or business subject to U.S. laws) in an effort to gain assistance
in securing new, or keeping existing, business. It is important to be
aware of the reality of bribery in foreign countries, and the penalties
to pay if one is convicted of bribing, even indirectly, a foreign
government official.
Enacted in 1977 (with several amendments since), the FCPA
prohibits payments to foreign government officials for the purpose of
inducing them to assist a company in obtaining new business or
keeping existing business. There are also record‐­keeping provisions
of the FCPA that need to be followed, requiring that all accounting
entries be clearly defined. (Vaguely‐­defined entries may be used to
conceal bribes.) These requirements are enforced by the U.S.
Securities and Exchange Commission and the U.S. Department of
Justice.
Many U.S. companies operating in a foreign location have local
agents or representatives to assist them in their business activities in
the country—­a normal and useful international business practice.
However, if it can be proven that the local agent or representative
used the money paid to him by the U.S. company to bribe a
government official, then the U.S. company may be subject to
prosecution under the provisions of the FCPA. This is an example of
the indirect consequence of bribing a foreign official.
Agreements with local agents or representatives in a foreign country
need to be in writing. The U.S. company hiring the local agent or
representative also must perform a due diligence review of the agent’s
or representative’s business activities to determine if he is reputable

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 and qualified. A thorough analysis of what constitutes appropriate
due diligence for a foreign agent or representative is well beyond the
scope of this chapter and would certainly vary greatly country to
country. “Due diligence” just means taking a careful, closer, in‐­depth,
look at the business and background of a candidate agent or
representative. The results of the due diligence process should be
documented and made part of the U.S. company’s internal business
records. The written agreement with a local agent or representative
should also contain a clause prohibiting bribery of foreign officials
and include a specific reference to the provisions of the U.S. FCPA.
(See the section later on in this chapter entitled “Local Employees,
Partners, & Agents” for additional information on due diligence and
agreements.)
While bribing a foreign government official is illegal under the
provisions of the FCPA—­and often under the laws of the official’s own
country—­certain facilitating payments made to expedite performance
of what the FCPA calls “routine governmental actions” may be allowed.
Facilitating payments might include the costs to obtain licenses,
process government papers like visas, provide police protection, load
or unload cargo, and schedule inspections. (A slang term for facilitating
payments is simply “grease,” or “grease money.”) Contractors must
make sure they understand what constitutes a facilitating payment
under the provisions of the FCPA. Consult legal counsel experienced in
FCPA matters or the U.S. Department of Justice if in doubt.
U.S. companies interested in doing construction business in foreign
countries can obtain more detailed information on the FCPA from
the Office of the Chief Counsel for International Commerce, located
at the U.S. Department of Commerce in Washington, D.C., as well as
from the Department of Justice in Washington, D.C.
As a final note, in some countries, it may be the long‐­standing
business custom to provide gifts to local businessmen and perhaps
even local government officials. A U.S. company doing business in
foreign countries should consider having some sort of written policy
on gift‐­giving that does not run afoul of the U.S. FCPA. The best bet
is to check with legal counsel experienced in FCPA matters.

Letters of Credit An essential part of doing international business involves

understanding how to use a documentary letter of credit to receive
payment for work performed. This is typically referred to as a letter
of credit, or just “L/C” for short. L/Cs used for international payment
transactions should be irrevocable. Once the L/C is in place, it should
not be revoked by the organization who put the L/C in place, typically
the owner.

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An Example
A contractor has a contract to build a new, small power plant in
Thailand. The contractor is responsible for engineering, material
supply, ocean transport of materials from the United States to
Thailand, and the onshore construction and start‐­up of the power
plant. The combined value of the engineering, material supply, and
ocean transport to Thailand is US$8,000,000. The value of the
onshore construction and start‐­up in Thailand is US$3,000,000.
The terms of payment in the contract require the full price of the
engineering, material supply, and ocean transport to Thailand to be
paid in full under an irrevocable L/C provided by the owner. The
contract also requires the L/C to be provided by a bank acceptable
to the contractor—­and on terms acceptable to the contractor.
The contractor advises the owner that Chase Manhattan Bank’s
Bangkok branch is acceptable to him for use in providing the L/C.
The owner arranges for Chase to provide the L/C either by directly
depositing the US$8,000,000 in the bank, establishing a line of credit
for that amount, or providing for the transfer of the amount from
the owner’s regular bank, the Bank of Thailand.
The commercial terms of the L/C provided to the contractor by
Chase Manhattan Bank require the following:
1. Payment of the full US$8,000,000 will be made by Chase
Manhattan Bank in cash to the contractor upon presentation of
shipping documents evidencing that all the materials required
by the contract have been placed aboard the ship going to
Thailand. Partial shipments and payments are allowed.
2. Payment of the US$8,000,000 will be made by any of the Chase
Manhattan Bank’s offices in the United States.
3. Insurance documents are to be provided showing that the
materials being shipped are properly valued and insured.
4. Loading of the materials aboard the ship going to Thailand
must take place on or before a certain date. Otherwise, the L/C
can’t be cashed without revising the terms.
Once the contractor finishes the engineering, procures all the
materials, packs them for ocean shipment, and loads them on the ship
bound for Thailand, he assembles all the documents pertaining to the
shipment and the evidence of insurance coverage and goes to the bank.
At one of the local U.S. offices of Chase Manhattan Bank, the
contractor presents his documents as required under the terms of the
L/C. The bank reviews the documents and, if they are in order, pays
the contractor the US$8,000,000 or a partial payment for a partial
shipment. The bank’s only obligation is to review the documents

287
 required by the L/C and presented to them. Banks pay on
­presentation of proper documents, hence the term documentary
letter of credit.
Using L/Cs to pay for the supply of goods and services provided from
outside the country in which the project is being built is common on
international construction contracts. This is one of the most common
uses of an L/C. L/Cs are also a good practice with owners whose
ability to pay may be in doubt, or who have no past payment record
with the contractor. They can also be structured to pay for onshore
construction activities in the foreign country, if necessary.
While L/Cs can be complex in their documentary requirements and
other conditions, they allow a contractor to be paid by a reputable
third party—­a bank—­in a simple and timely manner upon
presentation of the proper documents. Contractors interested in
working in a foreign location should talk with their banker about the
benefits of using L/Cs for some or all of their contract payments from
the owner.
One last comment on L/Cs: it’s hard to find much better payment
terms than payment in cash in U.S. dollars under an irrevocable letter
of credit.

Split Contracts: In the previous example for the project in Thailand, the U.S.
contractor had in place two separate contracts from the owner—­one
Onshore & worth $8,000,000 for engineering, materials, and ocean transport of
Offshore those materials to Thailand, and another for $3,000,000 to perform
construction and start‐­up. The separate contract to supply the
Contracts engineering, project materials, and ocean transport of materials is
referred to as an offshore contract. The contract to construct and
start up the project in Thailand is called an onshore contract.
Considered together, they are called split contracts.
The following are some benefits of split contracts:
• The offshore contract can be denominated in the contractor’s
preferred currency.
• The offshore contract can be paid by a letter of credit, thereby
virtually eliminating the risk of nonpayment for the value of the
goods and services provided from outside the foreign country
where the actual construction takes place.
• Certain U.S. corporate administrative and overhead costs and
markups associated with the value of the onshore construction
work can be legitimately shifted to an offshore contract,
thereby eliminating the risk of non‐­recovery of these costs and
markups.

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 • The value of the offshore contract may be, and probably will be,
exempt from taxes, fees, stamp duties on contract value, and the
like, which can be imposed by the foreign country on the value
of the onshore contract.
• There may be certain U.S. tax advantages available to the
contractor to have the offshore contract awarded to a subsidiary
of his company that is incorporated outside the United States in
a country other than where the actual construction will occur.
• The onshore contract can be denominated in the contractor’s or
owner’s preferred currency, or it can be denominated in the
currency of the foreign country in which the construction
occurs. A competitive advantage may be gained by denominating
the onshore contract in the currency of the foreign country.
It’s also advisable for the contractor to have the owner contract with
two different entities. For the offshore portion of the contract, the
owner could contract with the contractor’s U.S. organization or one
of the contractor’s U.S. subsidiaries, or a foreign subsidiary of the
contractor, if there is one. For the onshore portion of the contract, the
owner would contract with a different subsidiary of the contractor,
possibly a new company, partnership, or joint venture the contractor
had established in the foreign country.
Setting up to work with split contracts requires some expertise. It’s
worth the time and effort to seek the advice of an experienced
company that can provide accounting, tax, and legal guidance in this
form of contracting and the establishment and use of offshore
subsidiaries.

Political, Is it safe to work in a foreign country? Is it possible to do well there?

The correct answer to both is maybe, and quite possibly yes, if you do
Religious, & your homework. Foreign countries with stable political, religious,
Economic Risks legal, and economic institutions tend to better attract new and
continuous capital investment and foreign lending, which can
translate into construction opportunities for a U.S. contractor. This
doesn’t mean that the risk of performing construction work in a
foreign country is small, or similar to the risk of working in the U.S. It
does mean, however, that a contractor needs to be prepared,
understand the various risks, and account for them when pricing any
construction work and in developing business plans for work in a
foreign country.
Prior to working in a foreign country, it’s best to do some homework
on what it takes to do business in that country and what kind of
physical and commercial risks the contractor might expect to

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 encounter. Most foreign countries have U.S. embassies with
commercial and economic officers on staff who can provide
information about doing business in that particular country. Many
foreign countries also have a branch of the American Chamber of
Commerce, or “AmCham” for short. The U.S. Commercial Service,
part of the U.S. Department of Commerce, has offices all over the
world, staffed with commercial officers whose job it is to assist U.S.
companies interested in doing business abroad. (See the section later
in this chapter on “Getting Some Help from the U.S. Government.”)

Overseas Contractors with serious concerns regarding the political and

economic risks associated with working in a foreign country can
Private explore the option of procuring political insurance, either on their
Investment own or through the U.S. government’s Overseas Private Investment
Corporation (OPIC). Headquartered in Washington, D.C., OPIC can
Corporation provide insurance coverage, project finance, and investment funds to
(OPIC) U.S. companies expanding into approved foreign countries. As of the
writing of this book, OPIC works with 140 approved countries.
For a fee, OPIC offers U.S. contractors performing construction work
in foreign countries and U.S. companies exporting U.S. goods
insurance to protect against:
1. The wrongful calling of bid, performance, or advance payment
guaranties, custom bonds, and other guaranties.
2. Loss of physical assets and bank accounts due to confiscation or
political violence and inconvertibility of proceeds from the sale
of equipment used at a site.
3. Losses due to certain breaches of contract by foreign buyers
related to the contract’s dispute resolution procedures.
Detailed information is available at the OPIC website (http://www.
opic.gov). For broader insurance coverage than that offered by OPIC,
contact a business insurance broker.

Legal Systems If there is a need to legally enforce some aspect of the contract with
the owner in a foreign country, the contractor may have to utilize that
in Foreign country’s legal system. It is always a good idea to have a thorough
Countries understanding of the workings of the local legal system. What looks
good on paper may not be so good in reality.
It’s also important to understand all the legal requirements of
working in a foreign country and establishing a company there. Many
foreign countries have well‐­developed legal systems that can assist a
foreign contractor in resolving construction contracting issues and in
properly establishing a local operating company or joint venture. It’s
always best to develop a relationship with an experienced local law

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 firm prior to establishing a local company or joint venture and prior
to negotiating and signing contracts in a foreign country.

Local Doing construction work in a foreign country requires local assistance

and knowledge. Trying to do business without local help will likely
Employees, result in failure. It may be, too, that having a local partner is a legal
Partners, & requirement in order for a U.S. company to do business in a particular
country. Even though English may be widely used in other countries,
Agents having employees who speak the local language can help resolve or
head off a lot of unnecessary problems. Being able to effectively
communicate with local government officials, customs officers,
immigration officials for visas, the police, tax officials, bankers,
accountants, subcontractors, suppliers and vendors, and the like is
important to the success of a contractor’s efforts in a foreign country.
Having a local partner or agent is another matter, however. Typically,
a U.S. contractor would have some sort of written agreement with a
local business partner or a local agent. Partners and agents can
provide valuable assistance to a U.S. contractor working in the
country, but once the association is made, it may be very difficult and
time‐consuming to terminate the relationship.
Generally, a local partner would likely have an ownership interest,
along with the U.S. contractor, in the local company established. The
local partner would provide assistance to the U.S. contractor in
securing work in the country and would receive a share of the profits
of the local company. A local agent would, for a fee, simply represent
the U.S. contractor’s interests in the country, provide assistance with
a specific project, or provide assistance with local business or
Partners and agents
technical matters.
in foreign countries
can provide When selecting partners or agents, here are three tips to keep in
valuable assistance mind:
in securing work 1. The U.S. contractor should take as much time as he feels neces-
and assisting with sary on deciding who should be his local partner(s) or agent(s).
resolving day‐to‐day Often, there are time constraints placed on a contractor by his
problems. However, own company in the U.S. when he travels to a foreign county. In
their selection the long run, a second or third trip to the foreign country may
should be carefully result in a much better selection of a local partner or agent.
thought‐out, as the 2. The U.S. contractor should perform a due diligence review of
U.S. contractor is the local partner or agent and on his business interests.
likely establishing 3. Any agreement with a new local partner or agent should be in
a long‐term writing and carefully define responsibilities and the system for
relationship. payment of services rendered, as well as address the
requirements of the U.S. Foreign Corrupt Practices Act.

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 Once a partner or agent is selected, the written partnership or agency
agreement should have a section on the applicability of the U.S.
FCPA. This can provide some measure of protection from any
indirect exposure to bribery of foreign government officials.

Offshore For a U.S. contractor, an offshore company is simply a company he

establishes in a country outside the United States. It does not
Companies necessarily have to be located—­and probably shouldn’t be located—­in
the country in which the contractor wants to do foreign construction
work. It also doesn’t have to have a name that sounds anything like
the contractor’s parent company. For example, a U.S. contractor who
is planning a construction project in Thailand may establish a
separate company in Thailand to do that construction work; this is
his onshore company. The U.S. contractor may also establish a
separate company in the British Virgin Islands, for example, to supply
materials and other services in support of the project in Thailand;
this is his offshore company.
There may be U.S. and foreign tax advantages available to the
contractor’s U.S. parent company and to its foreign subsidiaries in the
use of an offshore company. Certain foreign countries provide
favorable tax treatment of profits, so prior to establishing an offshore
company, the U.S. contractor needs to understand the tax laws of the
countries in which he wants to establish an offshore company.
An offshore company is particularly useful when a U.S. contractor is
doing construction work in a foreign country, and the contract
requires the supply of materials and/or services from outside the
foreign country. Material supply and other services can be contracted
through the U.S. contractor’s offshore company. (This is the concept
of split contracts that was covered earlier in this chapter.)

An Example
American Civil Engineering and Construction Company (ACECC),
a U.S. company, secures a construction contract from Indian Power
Company in India. The contract in India is awarded to ACECC’s
Indian subsidiary company, India Civil Engineering and
Construction Company (ICECC).
The contract requires the supply of certain specialty materials from
outside of India. ACECC has an offshore company, Material Supply
Company, Inc., organized in Tortola, British Virgin Islands. ICECC’s
proposal for work states that the materials supplied from outside of
India will be supplied by a separate contract to a nominated
material supplier, Material Supply Company, Inc. If the owner,
India Power Company, has a concern about the use of this “unknown”

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 company, ICECC is willing to provide a parent company guaranty
covering the performance of Material Supply Company, Inc.
Material Supply Company, Inc. is to be paid in U.S. dollars by an
irrevocable letter of credit from a bank acceptable to ACECC.
Material Supply Company, Inc. may choose to procure the required
materials as it sees fit, including buying the materials from ACECC,
its parent company.
Figure 17.1 shows how this contract might be constructed.

Figure 17.1 Typical Onshore/Offshore Contract Structure

A benefit of having an offshore company like Material Supply

Company, Inc. in this example is that the offshore company’s separate
contract can have payments made to it in U.S. dollars through an
irrevocable letter of credit. Receiving payment in a strong,
international, and readily convertible currency, like U.S. dollars, can
be important where there may exist significant currency
convertibility or devaluation risks involved in taking payment in local
currency.

Currency Risks A major risk for U.S. contractors working in foreign countries is
agreeing to accept full or partial payment for the contract in the local
currency. After receipt of the local currency payment, the contractor

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 may then find out that there are restrictions to converting the local
currency to U.S. dollars or transferring the funds out of the country.
This can make it difficult or impossible to convert the local currency
to U.S. dollars and repatriate any foreign earned profits, or pay direct
costs accrued outside the country and collect any overhead costs
associated with the contractor’s U.S. operations.
Understanding the strengths or weaknesses of foreign currency and the
currency exchange controls in effect is important. Knowledge of the
currency controls in existence in a foreign country can help U.S.
contractors decide on alternate contracting methods, negotiating to
receive payments from the foreign owner in U.S. dollars, or deciding not
to bid on a contract where only local currency will be used for payment.
Some foreign currencies may not be readily converted into U.S.
dollars, or there may be severe restrictions on how much can be
legally converted at any one time. What can happen is that the U.S.
contractor can end up being stuck with a lot of foreign currency and
no ability to convert it to U.S. dollars—­and limited ability to use all of
it to pay for the costs associated with his foreign operations.
One bright spot is that it is not uncommon for foreign construction
contracts to be denominated in U.S. dollars, or partially in
combination with U.S. dollars and the local currency. Often, a major
construction project in a foreign country will be financed by another
country (or group of countries), and U.S. dollars or other readily
convertible international currencies will be used for payment.
Another major risk is the devaluation (loss of value) of a local
currency with respect to the U.S. dollar, referred to as exchange risk.
Sometimes, for a variety of political and economic reasons, the value
of a local currency with respect to other foreign currencies declines.
Devaluation means that it takes more of the local currency to
purchase U.S. dollars than it did at an earlier point in time. For a U.S.
contractor, this means he will receive fewer U.S. dollars for the local
currency, which can be costly when working in a foreign country.

An Example
A U.S. contractor was awarded a construction contract valued at
the local currency, baht, 250,000,000 in Thailand in early 1998. At
that time, the baht, was B25 to US$1. This conversion rate had been
steady for 20 years or more. Therefore, it did not appear to be too
risky in taking a construction contract in Thailand denominated in
Thai baht. The value of the contract could be collected, and any
baht amount not used in Thailand could be converted to U.S.
dollars—­and the U.S. dollars sent to countries outside of Thailand
without any undue restrictions.

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 At the then‐­steady conversion rate of B25 to US$1, the value of the
construction contract for the contractor was US$10,000,000. The
contractor had a lot of additional costs, both outside of and within
Thailand. The contractor didn’t concern himself with the risk of the
Thai baht losing value against the U.S. dollar.
Then, in early 1998, the Asian financial crisis hit. The Thai baht,
like many other Asian currencies, lost a significant amount of its
value against the U.S. dollar. It devalued quickly from B25 to US$1
to between B40 and B50 to the dollar. Therefore, the U.S. contractor
saw the dollar value of his onshore construction project in Thailand
devalue by almost 50%, as his project was now worth about
US$5,000,000. Needless to say, the contractor’s ability to pay his
U.S. dollar denominated costs by converting Thai baht progress
payments into U.S. dollars was destroyed.
This extreme example would be a disaster for a U.S. contractor who
had an enforceable, fixed price, baht‐­denominated construction
contract in Thailand with no contractual provisions to protect from
such a significant devaluation of the local currency. Perhaps he
could claim such an extreme devaluation was a force majeure event.
Good luck.
A more typical example of foreign currency exchange risk would be a
devaluation of the foreign currency in the 5% to 10% range. This
could be enough to wipe out any profit on a job. However, there is a
way for U.S. contractors to protect themselves from this type of
currency devaluation. For a fee, contractors can purchase from a
bank a forward exchange contract, or a foreign currency option,
described below.
1. Forward exchange contract: The buyer (U.S. contractor) has
the obligation to sell a certain amount of foreign currency at or
within a certain time to the bank who sold him the forward
exchange contract at a fixed exchange rate.
2. Foreign currency option: The buyer (U.S. contractor) has the
right, but not the obligation, to sell a certain amount of foreign
currency at or within a certain fixed time period to the bank who
sold him the foreign currency option at a fixed exchange rate.
Both serve as “insurance policies” against the risk of incurring
financial loss when converting a foreign currency into U.S. dollars.

An Example
A U.S. contractor working in a foreign country takes a contract
denominated in Japanese yen. The construction project is financed
through a branch of the Japanese Government called JBIC, the

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 Japan Bank of International Cooperation, and all construction
contracts on the project are denominated in yen.
The U.S. contractor is awarded a construction contract in the
foreign country valued at ¥750,000,000, or the equivalent of
approximately US$6,500,000 at the prevailing exchange rate of
¥115 to US$1. The U.S. contractor expects to receive the equivalent
of $6,500,000 after converting his yen payments to U.S. dollars. He
needs to collect this amount to make a profit on the construction
contract.
The U.S. contractor intends to convert all his yen progress payments
into U.S. dollars, assuming the rate is ¥115 to US$1. However, he
wants to protect himself against a possible devaluation of the yen
against the dollar, so he contacts his banker and arranges to buy a
series of forward exchange contracts (or foreign currency options) for
Japanese yen. The timing of these forward exchange contracts
coincides with his expected receipt of progress payments over the life
of the project, and assures him he will be able to sell the Japanese
yen to the bank for the fixed conversion rate of ¥115 to US$1.
These forward exchange contracts provide a guaranty to the
contractor that he can exchange the yen he receives as progress
payments into dollars at the rate he expects. In other words, for a
fee, the bank takes the risk of a future devaluation of a certain
amount of Japanese yen currency. If, during the open periods of the
forward currency exchange rate contracts, the yen devalues to ¥130
to US$1, the contractor is protected from the exchange loss, as he
has a contract with his bank to sell them the Japanese yen for ¥115
to US$1. If the contractor receives a progress payment of
¥150,000,000, and the yen had devalued to ¥130 to US$1, he is
protected. If he had to convert the same yen payment at the
prevailing rate at time of receipt at ¥130 to US$1, he would have
received only $1,150,000, or an exchange loss of $150,000.
Where forward exchange contracts are available for selected
currencies, they are an effective means of lowering the risk of foreign
currency exchange losses. Contractors should talk to their banks and
consider purchasing such options at the estimating stage of the
contract so that the costs can be included in the price.
Another sometimes successful way of protecting against the risk of
exchange loss on a foreign construction project is to negotiate with
the owner a fixed or variable exchange rate to apply to each local
currency progress invoice. The local currency invoice would be
converted into U.S. dollars at the agreed‐­on rate and paid to the
contractor.

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Applicable Law Construction contracts for work in a foreign country will almost
always contain a clause specifying which country’s law will apply to
the contract. This sounds odd. Why wouldn’t the contract laws of the
country in which the project is being built automatically apply? Just
because a construction contract takes place in Brazil doesn’t
necessarily mean that the laws applicable to contracts in Brazil will
apply to the contract in the event of a lawsuit, dispute, arbitration
proceeding, or some other form of alternative dispute resolution.
It is not uncommon for an owner in a foreign country to contract with a
large international company to perform a major construction project
and act as the project manager. This international company will have
the skills, as well as the financial and staffing resources, to engineer,
build, and project manage the work. The international company will
likely subcontract much of the work rather than self‐perform it, and will
award subcontracts for various portions to a combination of local and
foreign companies. In this fashion, the owner of a major construction
project in a foreign country is able to have access to worldwide sourcing
of capabilities and specialized materials and equipment.
The international company serving as project manager for the work
will likely have a preference for the laws of one country. A major
U.S.‐based international engineering and construction company
that is acting as project manager for an owner in Brazil may have a
clause in its standard construction contract form that states U.S.
laws will apply.
The following is a simple example of an applicable law clause as it
may appear in an international contract.

Article 41 – Applicable Law

41.1 This Contract shall be governed and interpreted under the laws of
the United States of America.

In the above example, even though the contract is being executed in

Brazil, U.S. law would apply to the administration of the construction
contract. The clause could have just as well stated: “. . .under the laws
of Brazil.” Below is an example of a better way to define which law
applies.

Article 41 – Applicable Law

41.1 This Contract shall be governed and interpreted under the laws of
Brazil that are in effect at the time of signing this Contract. Any new laws,
codes, or regulations different from those noted in this Contract shall be the
basis for an adjustment in the Contract Price and Contract Schedule.

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 This clause is much better, as it allows the U.S. contractor to be
compensated for the effects of changes in local laws, regulations, and
codes—an important issue when working in a foreign country (as
well as in the United States, for that matter).
Following is another example of an applicable law clause that
addresses how the parties to the contract will use the laws of England
to interpret the contract, and how they will resort to arbitration to
resolve disputes. Clauses similar to this one are typically considered
fair to contractors and owners.

Article 41 – Applicable Law

41.1 This Contract shall be governed and interpreted in accordance with
the laws of England.
41.2 Any dispute arising out of or in connection with the Contractor or the provi-
sions of the Contract which cannot be amicably settled shall be submitted to
arbitration under the auspices of the International Chamber of Commerce.
41.3 Any arbitration shall be conducted in London, England. The language of
the arbitration shall be English.

Under the provisions of this clause, the laws of England related to

contracts would apply. If the parties to the contract decided to go to
arbitration to settle the dispute, they would both have to go to
London for the proceedings. Why go through all of this extra
commercial language on applicable law if the foreign country in
which the project is being built has a legal system and also has the
ability to conduct formal arbitration proceedings?
There are two prevailing reasons for including this type of applicable
law language:
1. To make it more difficult for a contractor or subcontractor to
initiate legal or arbitral proceedings against the owner or the
For U.S. contractors,
owner’s project manager.
there’s nothing
2. To protect the interests of the contractor or the subcontractor
wrong with trying to
and the owner’s project manager from legal and arbitral systems
negotiate a change
in the country in which the work is being performed that may be
in the applicable law prone to or subject to corruption, political influence, lack of
clause in a foreign experience, or all three.
construction contract
Contractors should always take the time to understand the
to make the laws of
consequences of agreeing to be subject to the local legal system, or
the United States
the legal system of a country other than that in which the project is
apply. being built.

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Joint Ventures A joint venture is an organization established by two or more
companies joining together to provide resources, share management
responsibilities, and share any resulting profit or losses. For a U.S.
construction company doing business in a foreign country, a joint
venture is a way to formally team up with another
company—­U.S.‐­based or foreign—­to build a project. Each company
in the joint venture will have a certain scope of work to perform, and
each will bring their own expertise, as well as financial and
management resources, to the project.
The joint venture company established in a foreign country will likely
be subject to all the business and taxation laws of that country. It will
also likely be treated as a separate business entity for taxation purposes.
Typically, a formal joint venture agreement would be drawn up
detailing the scope of work each party will perform and what
management and other responsibilities each will undertake through
the course of the project. This agreement will also outline how any
profit and losses of the completed project will be shared. It should
also mandate that both parties abide by the provisions of the U.S.
Foreign Corrupt Practices Act.
Project and contractual responsibilities with respect to the owner will
likely be shared in some form of a joint and several basis by both of the
companies who make up the joint venture. Joint and several means
that all parties (joint) in a joint venture are responsible for the project;
in the event one of the parties fails to perform, the other party or
parties (several) in the joint venture would still be fully responsible for
the project. An owner may insist that the parties in the joint venture
each accept some degree of joint and several responsibilities, in the
event one or more is in breach of the contract or becomes bankrupt,
insolvent, or otherwise fails to perform. Also, there may be tax laws
specifically for joint ventures in foreign countries, so it’s necessary to
check with an experienced accounting firm and law firm in the
country in which the joint venture will operate.
A joint venture is a good way to combine the skills and expertise of
several companies to secure work in a foreign country. Having a
capable and experienced local joint venture partner with a strong
financial base from the country in which the work is to be performed
can be a real asset in securing work in a foreign country.

Joint A joint operation is similar to a joint venture in the sense that two or
more companies join forces to work together to build a specific
Operations project in a foreign country. However, each party to the joint
operation is responsible for independently estimating and performing
its own scope of work, and will receive any profit or accept any loss

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 that may result from its own operations. Unlike a joint venture, profit
and losses resulting from the project are not pooled together and
then split between the parties. The basic idea of a joint operation is
not to form a separate taxable entity in the foreign county. Each party
to the joint operation would be responsible for the tax considerations
that may arise from the profit or loss on his own scope of work on the
project. A joint operation can be established by what is called a
Memorandum of Understanding, or MOU, which outlines the
responsibilities of each of the parties, including scope of work and
joint or joint and several responsibilities with respect to the project
and contractual obligations with the owner.
A joint operation may be formed with companies of significantly
unequal resources and skills. There may be good reasons (such as
political), for a U.S. construction company to consider having some
formal working arrangement with a local company for a specific
project. Just because a local company doesn’t have significant
financial or people resources or doesn’t have much experience in
managing projects, this shouldn’t automatically exclude the local
company from developing a working relationship with a U.S.
contractor. The company may, for instance, have excellent personal
contacts within the local business or political community that can
greatly assist the U.S. contractor in his work. There may also be
benefits to advertising that the U.S. contractor has a working
relationship, through the joint operation for the project, with a local
company. For example, a politically well‐­connected local company
would likely be able to facilitate the U.S. contractor gaining
opportunities for additional profitable projects in the foreign country.
With a joint operation, the U.S. construction company may find that
the owner will insist that the U.S. company take full responsibility for
completing the project, and will not agree to a joint and several
responsibility relationship with the local company.

Import & A U.S. contractor may find that he has a complex mix of local
regulations—­and associated costs—­to deal with when bringing
Export materials, supplies, personnel, and construction equipment into a
Considerations foreign country, and when removing construction equipment out of
the country at the conclusion of the project. If the contractor needs
to import materials for the project, there may be duties applied to
their stated value, and the materials may be held up at the docks after
they have been off‐­loaded until all import duties are paid in full.
In some cases, imported materials may be duty‐­free, particularly if
the construction project is being built for the local government or
one of its agencies. Sometimes, private foreign construction projects

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may have duty‐­free status for imported materials, especially those
that are not available in the foreign country. In these cases, properly
filled out paperwork must be supplied to the country’s customs
officials in order for the materials to be released from customs at port
of import.
Specialized construction equipment is often required on a
construction site. If the site is remote, or the equipment is not
available in the foreign country, it’s not uncommon for the contractor
to be required by the local government to bring the specialized
equipment in under an on‐­demand performance bond. The U.S.
contractor would have to buy the bond from a local bank in order to
import the equipment into the country. The contractor would likely
also have to agree not to sell the equipment in the country, and
further agree to export the equipment out of the country at the end of
the project. If the contractor fails to meet these restrictions and
conditions, then the bond that was supplied by him would be cashed
in by the government. If the contractor does not sell the equipment in
the country and exports the equipment out of the country at the end
of the project, then the bond is void. The bond is the local
government’s assurance of performance that the contractor will not
sell the equipment in the country and that he will export it at the
conclusion of the project.
It’s important to note that some materials and supplies that a U.S.
contractor might prefer to import may be subject to high import
duties, since similar materials and supplies may be available in the
country—­a practice designed to protect local industries. There may
even be a prohibition on the import of certain materials and supplies
if they are readily available locally in the foreign country.
On foreign projects that have been granted duty‐­free status, all
imported materials will have to be described on what is sometimes
referred to as a Master List. This is a listing of duty‐­free materials for
the project and is provided by the owner for use by the foreign
country’s customs officers at the port or ports of import. The
imported materials described on the shipping manifest must match
the materials described on the Master List. Accuracy is critical.
However, too much detail can lead to delays as custom officers try to
match each and every item on the Master List with each item on the
shipping manifest. It’s best to keep descriptions simple and as broadly
worded as possible.
When dealing with imported materials, supplies, and equipment, it’s
absolutely essential to employ a local shipping agent or freight
forwarder who can assist a U.S. contractor in meeting all the local

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 import rules and regulations. Having critical material and equipment
tied up at the docks due to incorrectly prepared paperwork, or
because import fees and duties aren’t paid on time, can cause
significant delays in a foreign construction project. Local shipping
agents or freight forwards are also likely to have good personal
relationships with the local customs officials, which can help speed
up the process of getting imported materials, supplies, and
equipment through the customs process and onward to the
construction job site.
U.S. contractors should be sure to include a clause in the contract
that clearly defines the tax status of the project and who is
responsible—owner or contractor—for directly paying any duties and
fees on imported materials and supplies for the project. A typical
clause for payment of duties and fees on imported materials might
look like the following:

Article 51 – Duties and Fees on Imported Materials

51.1 Contractor shall be fully responsible for the timely payment of all
applicable duties and fees in effect at the time of signing of this Contract on
all materials supplied from outside of the Country and imported into the
Country.
51.2 Owner shall reimburse Contractor at cost for the value of any increases in
duties and fees on imported materials that arise after the date of the signing of
this Contract.

This clause states that the contractor has included in his price for the
project all duties and fees assessed on the value of any materials
imported into the country. The clause also provides for the owner to
pay any increases in duties and fees on imported materials that
become effective after the date of the signing of the contract. On any
foreign project that enjoys tax‐ or duty‐free status, it’s also
important to state that status in the construction contract and to
also have the clause provide for the owner paying any duties and fees
on imported materials in the event the project loses its tax‐ or
duty‐free status.

Understanding INCOTERMS, an abbreviation for “International Commercial

Terms,” are a set of international rules first established in 1936 for the
INCOTERMS interpretation of commonly used shipping terms. Full descriptions of
all INCOTERMS are published by the International Chamber of
Commerce. Of particular importance to a U.S. contractor working in
a foreign country is the use of those INCOTERMS that are related to
the shipment of goods from one international location to another

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international location. INCOTERMS describe the duties and
responsibilities of buyers and sellers for the shipment of goods. As
such, each different INCOTERM that describes a required shipping
process will have a different set of duties, responsibilities, risks, and
costs for both the owner and contractor.
There are 13 INCOTERMS commonly used for shipping goods. They
are: EXW (Ex‐­Works)
1. FAS (Free Alongside Ship)
2. FOB (Free on Board)
3. FCA (Free Carrier)
4. CFR (Cost and Freight)
5. CIF (Cost Insurance and Freight)
6. CPT (Carriage Paid To)
7. CIP (Carriage and Insurance Paid To)
8. DES (Delivered Ex‐­Ship)
9. DEQ (Delivered Ex‐­Quay)
10. DAF (Delivered at Frontier)
11. DDU (Delivered Duty Unpaid)
12. DDP (Delivered Duty Paid)
Each of the above 13 terms would typically have a named location
attached to it to designate where the goods are going, for example:
FOB, port of export, Baltimore, Maryland. In this example, “port of
export, Baltimore, Maryland” is the named location of destination of
the goods.
The contractor’s shipping responsibilities, cost, and commercial risk
can increase significantly as the shipping of project materials
becomes more complex going from EXW (Ex‐­Works, named
location), which will likely be the least expensive and least risky, to
DDP (Delivered Duty Paid, named location), which will likely be the
most expensive and most risky. The best way to explain the use of
these terms is through examples. Let’s say a U.S. contractor procures
from a supplier in the United States, the materials for a major
construction project near Cairo, Egypt.
1. EXW (Ex‐­Works): In this example, the contractor states in his
proposal to the Egyptian owner that all materials for the project
will be procured and shipped “EXW (Ex‐­Works), Contractor’s
Warehouse, Baltimore, Maryland.” What this shipping term
means is that the contractor is responsible for the costs to
supply project materials, including any delivery costs, only to the
back door of his warehouse in Baltimore, Maryland.

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 The Egyptian owner, or another party retained by the owner,
would be responsible for all the costs and logistics of getting the
materials from the Ex‐Works location—the contractor’s ware-
house in Baltimore, Maryland—to the project job site location in
Egypt. This shipping option is the least expensive and least
difficult and risky one for the contactor.
2. CIF (Cost, Insurance, & Freight): In this example, the contrac-
tor states in his proposal to the Egyptian owner that all materials
for the project will be procured and shipped “CIF, Port of
Import, Alexandria, Egypt.” What this shipping term means is
that the contractor is responsible for the costs to supply project
materials and deliver the materials to the port of import at
Alexandria, Egypt. In this instance, the contractor pays for all
costs to pack the goods for ocean shipment, take them to the
port of export (Baltimore, MD), arrange for ocean shipment to
the port of import, Alexandria, Egypt, get the materials loaded
on the ship, and insure the goods during the ocean shipment to
Egypt. Once the ship arrives at Alexandria, the contractor’s
shipping responsibilities are fulfilled. The client receives the
goods and is responsible for all further efforts and costs to get
the materials to the job site near Cairo. This is a normal shipping
responsibility of an international contractor and does not typi-
cally carry any unusual risk. As a typical method of international
shipping, costs are well known.
3. DDP (Delivered Duty Paid): In this example, the contractor
states in his proposal to the Egyptian owner that all materials for
the project will be procured and shipped “DDP, Job Site, Cairo,
Egypt.” What this shipping term means is that the contractor is
Understanding responsible for the cost to supply project materials and deliver
INCOTERMS used them to the owner’s job site located outside of Cairo, Egypt.
in the shipment of These costs will include all U.S. inland freight, ocean shipment,
project materials insurance, and foreign country inland shipping costs to the
to a foreign job project job site, plus all imposed duties and fees on imported
site is an essential materials. The U.S. contractor is responsible for all the costs and
part of international logistics of getting the materials from wherever he gets them in
contracting. A good the United States to the project job site location near Cairo,
freight forwarding Egypt. This shipping responsibility is the most costly and risky,
agent is an asset and the contractor would have to fully understand how to
to a U.S. contractor properly undertake and estimate this delivery effort.
when international INCOTERMS are copyrighted by the International Chamber of
shipment of goods is Commerce. Detailed descriptions of INCOTERMS can be purchased
required. through their online bookstore at http://www.iccwbo.org

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 The Export‐­ The Export‐­Import Bank of the United States (Ex‐­Im bank) is an
agency of the U.S. government that provides lending and insurance
Import Bank of services to U.S. exporters of goods and services. The Ex‐­Im Bank
the United provides guaranties for commercial loans to U.S. exporters of U.S.
manufactured goods and also provides direct loans to international
States buyers of U.S. goods and services.
Foreign owners of construction projects can seek some or most of
their project financing requirements through the Ex‐­Im Bank. As a
condition of receiving the Ex‐­Im Bank‐­supported project financing,
the owner of the foreign project must agree to use the financing
provided to procure from U.S. companies some portion of the goods
and services needed for the project. The portion of the project
financing that must be allocated to U.S. companies is expressed as a
percentage of the amount of financing provided. Typically, when
project financing is provided to a foreign owner by the Ex‐­Im Bank, a
minimum of 50% of the amount must be used to procure U.S. goods
and services; in some instances, this percentage amount can be
higher.
Having the financing of a foreign construction project provided only
by the Ex‐­Im Bank can create a competitive edge for a U.S.
construction company. However, the U.S. contractor competing on a
foreign construction project needs to understand that Ex‐­Im Bank
financing competes with similar institutions from other countries.
The U.S. is not the only country providing government support
services to its own providers and exporters of goods and services. For
example, similar government financing support is provided by
countries in Europe and by Japan.
Consequently, a U.S. contractor competing for a foreign project needs
to try to determine how the project will be financed. Just because the
owner is considering applying for Ex‐­Im Bank financing support
doesn’t mean he will receive it, or that it will be competitive against
other foreign lending institutions. It would be indeed unfortunate if a
U.S. contractor based his pricing and plan to secure a foreign
construction project on the basis that Ex‐­Im Bank financing support
would be provided, and then the Ex‐­Im Bank financing offer was not
competitive with other financing packages.
The Ex‐­Im Bank also provides insurance for U.S. exporters of U.S.
goods. This insurance can cover situations such as buyer nonpayment
and political risk, like war. For more information on the Export‐­
Import Bank and the services it provides, see their website at http://
www.exim.gov

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 Where to Get Nothing will ever beat doing a lot of homework before embarking on
bidding on a foreign construction project. Assuming the effort to
Some Help— build the project will be just like doing work in the United States is a
Ask the U.S. formula for failure. The best advice is to get some help!

Government The following are some excellent initial sources of information on

doing business in a foreign country:
1. The U.S. Embassy and/or U.S. Consulates located in the foreign
country
2. The U.S. Commercial Service Office located in the foreign country
3. The American Chamber of Commerce office located in the
foreign country
Falling under the jurisdiction of the U.S. Department of State, the
U.S. Embassy and/or U.S. Consulate in a foreign country is typically
staffed with economic officers, who can provide contractors with
information on visas and work permits, as well as the business,
political, and legal climate in the country. It can also assist with
dealing with the local government offices and contacting other U.S.
businesses working there. For U.S. Embassy information on a
particular country, visit http://usembassy.state.gov
The U.S. Commercial Service Office, which falls under the
The American
jurisdiction of the U.S. Department of Commerce, promotes U.S.
Chamber of goods and services in foreign countries and assists U.S. businesses
Commerce in a who want to work or invest there. It may have offices in the local U.S.
foreign country can Embassy compound, or may have its own separate office elsewhere in
provide excellent the country. For contact information on U.S. Commercial Services,
references to legal, visit http://www.buyusa.gov
accounting, and In many countries where there is a significant U.S. business presence,
other professional it’s likely that an American Chamber of Commerce Abroad
services that may be organization, commonly called an “AmCham” will be active. It is an
required by a U.S. organization made up of U.S. businesses and their representatives
contractor. working and living in the country. The American Chamber of
Commerce Abroad is an independent organization affiliated with the
U.S. Chamber of Commerce in Washington, D.C., that works closely
with the U.S. Embassy and the U.S. Commercial Service regarding
U.S. business interests in the country, but it is not part of any U.S.
Government agency. The American Chamber of Commerce in a
foreign country is an excellent place to meet other U.S. businessmen
to get a first‐hand overview of doing business in that country. There
are currently 104 AmChams in 91 countries.
To find contact information for an American Chamber of Commerce
office in an international location, go to http://www.uschamber.org/
international/directory. This site also provides useful contact

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 information for all the U.S. Embassy and Consulate locations in
foreign countries.

Lastly, Use If a U.S. contractor is going to do business in a foreign country, he

must learn to use A4 sized paper for communications and sales and
the Right Paper marketing efforts. The A4 designation refers to the metric size of the
Size! paper, which is 210 mm wide and 297 mm long. Converted to English
dimensions, A4 paper is 8.27″ wide and 11.69″ long. Most foreign
countries use A4 sized paper, which is a little longer and a little
narrower than the 8‐­1/2″ by 11″ paper typically used in the
United States. Using A4 size paper for international proposals,
international marketing and promotional materials, and general
international communications adds a nice touch to a contractor’s
approach to his foreign clients. It’s also a small, but important,
acknowledgement by the contractor that he understands that doing
work in a foreign country is not like doing work in the U.S. A4 size
paper is available at many office supply companies in the U.S.

Conclusion Performing construction projects and doing business in foreign

countries is different than in the United States. To believe that it is
the same is a certain formula for failure. However, for the contractor
who is prepared to take the time necessary to carefully do his
homework on how to conduct business in a foreign country, there
will be plenty of opportunities for good projects—­and making a good
profit on them.

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Chapter
What’s It Take to
18 Do Business in
Southeast Asia?
The first step in being successful in Southeast Asia is NOT
assuming that business is done just like it is in the US!
You are a US businessman and you want to take a look at doing
business in Southeast Asia.
To many Americans, hearing the term “Southeast Asia” brings back
old memories of the US military involvement in Vietnam in the 1960s
and 1970s.
Times have changed. So has Southeast Asia. Today, Southeast Asia, a
diverse mix of countries, peoples, cultures, religions, and politics,
offers many good opportunities for US businesses interested in
working or investing there. US companies working in Southeast Asia
range from newcomers to the region to companies that have been
working in Southeast Asia for over 100 years.
The countries of Southeast Asia are Myanmar (formerly Burma),
Thailand, Laos, Cambodia, Vietnam, Malaysia, Singapore, Brunei,
Indonesia, and the Philippines. These ten countries are the members

Understanding and Negotiating Construction Contracts: A Contractor’s and Subcontractor’s Guide to

Protecting Company Assets, Second Edition. Kit Werremeyer.
© 2023 John Wiley & Sons, Inc. Published 2023 by John Wiley & Sons, Inc.

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 of an organization called ASEAN. ASEAN, established in 1967, is the
acronym for the Association of South East Asian Nations. ASEAN
promotes the mutual interests and solidarity of the ten member
countries.
Thailand, Malaysia, Singapore, Brunei, and the Philippines offer
reasonably stable political, legal, banking and business environments
(especially Singapore). Indonesia is trying to implement positive
changes in their legal, banking, and business environments. Laos,
Cambodia, Vietnam and Myanmar are somewhat less developed and
have much less certain legal, banking, political, and business
environments.
The ASEAN countries are rich in natural resources and people
resources with a regional population of 667,000,000 or about 9% of
the world’s population, and a combined GDP of USD $3 trillion.
All of the ASEAN countries are interested in foreign investment and
can provide varying degrees of tax and financial incentives to foreign
companies willing to invest in their country’s economic
improvement.
A work force of college and university educated people, skilled labor,
and unskilled labor, with diverse language abilities, is readily available
at very competitive rates.
What does it take for a US company to do business in Southeast Asia?
Here are some things to think about:

Patience Is The most important element of doing business in Southeast Asia is

patience. You will need plenty of it. Things just don’t happen as
Golden quickly or efficiently as you might like. If you are used to closing
deals in one or two meetings back home, you may have to have
two, three, four, five, or more meetings to achieve the same result
in Southeast Asia. Everything takes more time to do in
Southeast Asia.
With nearly all business communication taking place instantly or very
quickly via email, be aware that it is an Asian tendency not to respond
to emails if they do not have a response to your questions or enquiry.
Therefore, you can expect it may take two to five days or more to
receive a response. In order to ensure that your efforts do progress,
always give whomever you are communicating with a target date for
their reply to move the process along.

Walk the Talk English is widely spoken and used in all the countries, especially in
the business communities and you will be able to conduct most of
your business in English.

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 However, it will always be a plus for you to be able to speak a little of
the local language as in greetings, thank you, and good bye.
Take the time to learn how to say a few phrases in the local language:
“Good morning,” “How are you?,” “Nice to meet you,” and “My name
is . . . .” Even if you do not say these greetings very well, your foreign
counterparts will be pleased that you at least made an attempt. It
breaks the ice when meeting people for the first time. However, be
prepared for misunderstandings to occur as English will be the
second language of the people you are dealing with and their skill
levels in the use of English will vary.
Be patient, speak slowly (or slower), clearly, quietly, and avoid the
use of complicated sentences and slang. The written
communication of your Asian counterpart may not be perfect, so
therefore it is wise to be neither judgmental nor correct their
written capabilities. It would be more productive to respond in
simple written English.

Time and Be prepared to spend time and money developing and establishing
your business. Just because you arrive in one of the countries with the
Money world’s best widget in your pocket doesn’t guarantee you instant
success. It will require time and money to develop your local business
support services, arrange for and receive necessary local government
permits, promote your products, and meet your local business
contacts and prospective clients. The same holds true if all you are
looking to do is to develop a local supplier for export of goods or
services back to your country.

Get Some Help

Actually, get some local help. Forget about trying to be superman and
doing it all on your own, or you’ll take an early and frustrated exit
from the country without results. Having a local associate, agent, or
employee is a good idea. You will need someone to provide assistance
to you as you work your way through the local business, political,
legal, and cultural system.
It really helps, too, to have a local associate who speaks the language
and can help get you from point A to point B in a hot, jam-­packed
city, or find a remote site way out in the countryside.
If you intend to establish a company in one of the ASEAN countries,
you should contact a local accounting and legal firm to advise you on
rules and regulations your new company would have to follow.
A number of US accounting and legal firms have subsidiaries in the
ASEAN countries.

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 Having a local business partner can make sense, but may not be
absolutely necessary. Do not rush into signing up the first company
or individual that claims he or she can open up all the local back
doors to businesses and politicians.
Remember, do your due diligence and investigate a potential
partner through the resident country’s trade association or embassy
in your home country. They may or may not be able to assist you
but often can give you further direction. Once you agree to take on
a partner, you have that individual for better or worse, for a long
time. Your new partner may be “politically in” today, and “politically
out” tomorrow. Careful is the watchword here. Take your time, as
you can always bring in a more permanent partner or investor at a
later date.

The US Foreign All US businesses and their foreign subsidiaries are subject to the US
Foreign Corrupt Practices Act (FCPA). The FCPA makes it a crime to
Corrupt bribe local government officials in order to obtain new business or
Practices Act keep existing business.
This act applies as well to any bribery of local government officials by
the local employees or partners of a US subsidiary.
If you intend to have a local partner or company, then perform a
thorough written due diligence report on that individual(s) or
company and keep a copy of it. Any written agreement between your
US company and your partner’s local company or individual(s) must
contain a clause incorporating by reference the provisions of the
FCPA as may from time to time be amended.
The FCPA allows for what are called “facilitating payments.” The US
Justice Department can provide clarifying information on facilitating
payments.
Details of the FCPA can be found at http://www.justice.gov/
criminal-­fraud/foreigh-­corrupt-­practices-­act

Culture Shock
The countries of Southeast Asia have many cultures, customs, no-­
no’s, and religious practices. Just because you finally figure out how
you can comfortably work with the folks in Singapore does not
automatically mean you can apply the same formula to the folks in
Indonesia or Thailand!
You will find there are many similarities in working with the people
and respecting the cultures in each of the Southeast Asian countries.
You will find there are many differences, too, and this is where having

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 a good local associate is very valuable. He can keep you out of
cultural trouble.
Here are some examples of social behavior to observe: In Thailand,
do not say anything bad about or make fun of the King or Queen, or
you could end up in trouble with the law. In Malaysia, if a man and
his wife are introduced to you as Datuk and Datin, that’s not their
first names; those are conferred titles.
In Indonesia, the largest Muslim country in the world (274,000,000
population), it would be in very poor taste to offer pork to your local
guests. In Burma, do not pat the little kids on the head. They are
Buddhists, and they believe the head to be the highest and most
revered part of the body. In Singapore, Lee Hsien Loong is the Prime
Minister; his last name (surname) is Lee, not Loon. Hsien and Loon
are his Chinese given names. Chinese people place their last name
first when introducing themselves. You would address him as
Mr. Lee, not Mr. Loong.
In doing business in Southeast Asia, it is important to understand the
social and religious customs and practices of the people in the
different countries. It is not too hard to learn about these customs
and practices and follow them in your everyday dealings with the
local people.
Knowing and applying these social and religious customs and
practices will certainly help you be successful in your business
activities as it will be observed as a sign of respect. Many western
business people come to Southeast Asia without any cultural
awareness. This is viewed negatively by the local people. Generally,
people from this region are familiar with the United States due to
the regular coverage of US news, politics, economics in their
national newspapers, and TV news. Popular American TV and
reality shows, books, and magazines are also widely available.
Advent of the internet and search engines with specific domain and
translations capabilities allows for easy research of US news and
vice versa.

Center for If you would like to do business with Southeast Asia whether you
want to break into the market to sell a product or service via
Strategic and distributors, establish operations, search for a joint venture or
International outsource to third-­party contract manufacturing, an organization
that you should be aware of is The Center for Strategic &
Studies International Studies, which is a think tank based in
Washington D.C., website: http://csis.org/programs/southeast-­
asia-­program

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 Specifically, the CSIS Southeast Asian Program is the premier forum
for sustained high-­level policy dialogue focusing on Southeast Asia
and the US business interest in the region.
Subscribe to its newsletter as it is an excellent source of information
to understand US government initiatives are for the region, which
directly relates to present and future opportunities for US businesses.

Trans Pacific Have you heard of the Trans Pacific Partnership (TTP) also known as
the Trans Pacific Strategic Economic Partnership Agreement? It is a
Partnership multilateral free-­trade agreement that aims to further liberalize the
(TPP) economies of the Asia-­Pacific region.
The original agreement between the countries of Brunei, Chile,
New Zealand, and Singapore was signed on June 3, 2005, and entered
into force on May 28, 2006. Five additional countries—­Australia,
Malaysia, Peru, Japan, United States, were later added. The US
withdraw from the agreement during the term of President
Donald Trump.
The objective of the original agreement was to eliminate ninety
percent of all tariffs between member countries by January 1, 2006,
and reduce all trade tariffs to zero by the year 2015. It is a
comprehensive agreement covering all the main pillars of a free trade
agreement, including trade in goods, rules of origin, trade remedies,
sanitary and phytosanitary measures, technical barriers to trade,
trade in services, intellectual property, government procurement, and
competition policy.
TPP advised that the value of 2011 US trade with its SEA members is
as follows:
Vietnam: US$20 Billion
Malaysia: US$37 Billion
Singapore: US$46 Billion
The US has had a bilateral Free Trade Agreement (FTA) with
Singapore since 2004, which secured a US presence in Southeast Asia
and provided a standard of free trade that encourages a high level of
liberalization.
Bilateral economic and trade cooperation between the United States
and this dynamic region is reaching new levels.

Backdoor to US companies remain focused on doing business with China and

India. However, more experienced business persons are realizing the
China and value that the long-­term relationships the countries in ASEAN have
India with China and India. Nowadays many of the ASEAN countries have

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extensive trade links to China and India. US companies that choose
to do business via Southeast Asia are benefitting from such
established linkages and trade agreements between the ASEAN
countries and China and India.

Have You Done Your Homework?

There are many resources available to the US business person
interested in learning more about doing business in Southeast Asia.
Economic Officers resident at the US Embassy in each of the
countries can help provide country-­specific business information.
For a listing of US embassies in Southeast Asian countries, see
http:/ www.usembassy.gov/ The US Commercial Service, a division
of the US Department of Commerce, also provides resident
Commercial Counselors to help provide country-­specific business
information. The main role of the US Commercial Service is to
promote the sales of US goods and services to foreign countries. For a
listing of US Commercial Service offices in Southeast Asian
countries, see http:/ trade.gov/US-­commercial-­service
The US Commercial Service may charge a fee for certain of the
services it provides. These Commercial Counselors and Economic
Officers are excellent sources of information on the ins and outs of
doing business in the country.
All the ASEAN countries have an active American Chamber of
Commerce organization. This is an organization consisting of US and
local business persons who are living and working in the specific
country. Each chamber offers varying services; some are also able to
organize meetings for companies interested in doing business in the
country. These meetings are excellent opportunities to learn about
doing business in the country from American and foreign companies
actually working there; however, there are associated charges for such
services. For a listing of US Chambers of Commerce abroad, see
http://www.uschamber.com/international-­affairs

Modern Business Environment in ASEAN

The modern-­day business environment in ASEAN is challenging. It is
also dynamic, high growth, and very opportunistic at this time as it is
poised for growth.
It is a region that should be approached realistically and
systematically. Prior to any action advice should be sought from a
reliable source preferably upon recommendation. Attempt to fully
understand what you will be facing, such as significant time

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 differences that can make communication challenging, more public
holidays than in the United States and prepare to visit the region a
few times if you do not have any representation. Don’t try to change
the system or the business culture because as a foreigner you must fit
in with their culture to be successful, not the other way around.

SPECIAL The Vietnamese economy is at the heart of the fast-­growing

Southeast Asia region and is one of Asia’s great success stories.
SECTION—­The Vietnam’s economy has grown rapidly since the country opened its
Socialist economy in the 1980s. This country with a population of about
97 million has posted economic growth of about 7%.
Republic
Vietnam has also prospered by choosing to open itself more broadly
of Vietnam to the outside world, joining the World Trade Organization (WTO)
(Vietnam) in 2007 and normalizing trade relations with the United States. These
steps have helped to ensure that the economy is consistently ranked
as one of the region’s most attractive destinations for foreign
investors.
Vietnam has also expanded its exports of manufactured goods,
especially products such as textiles and footwear. The liberalization of
services created opportunities for rapid expansion across a range of
sectors including retail and transportation. The nation also boosted
its tourism infrastructure and experienced a surge of interest in
residential and commercial real estate. Vietnam’s exports of
commodities such as rice and coffee have also grown briskly.
Industrial production is growing about 9% annually.
As Vietnam continues economic development by liberalizing its
economy and strengthening its growth policies and infrastructure, it
is becoming a more attractive option to US companies seeking
alternative trade and investment to China. In February 1994, the
United States lifted its trade embargo against Vietnam and restored
full diplomatic relations in July 1995. In December 2001, the two
countries signed a bilateral trade agreement. The United States and
Vietnam still have differences on issues such as human rights, but
even so they have started talking about negotiating a “strategic
partnership.”
The US–Vietnam Road Map proved to be an invaluable mechanism
as the two sides addressed subsequent trade issues that surfaced due
to the fact that Vietnam is a communist country governed by socialist
laws. It provided the United States with an opportunity to spell out
exactly what it was looking for and gave the Vietnamese clarity and
confidence about what they would get in exchange for specific steps
they took. As Washington and Hanoi normalized relations, more
overseas Vietnamese returned to Vietnam bringing investment and

316
 technical skills, which helped Vietnam develop as it liberalized its
economy and opened up to foreign investors.
The population of Vietnam is large enough to make it second most
populous country in the Southeast Asia (behind Indonesia), seventh
in the Asia-­Pacific region, and the 12th most populous in the world
list. One should also notice that the ratio of literate persons is high in
Vietnam and the majority of the population is young.
However, doing business in Vietnam, like most foreign countries, can
still be challenging and any business person should perform adequate
due diligence on local businesses it intends to do business with,
whether it is for import or export.
Having local representation on the ground may allow business
transactions to progress in a short time period than via telephone and
email. Remember in Asia people still like to meet and greet the
people they are going to do business with, shake their hands, or share
a meal, not to say that business cannot be facilitated via the internet
and multimedia communication. It may take longer than you
expected. As mentioned previously, patience is king when doing
business in Southeast Asia.
If you are interested in purchasing goods manufactured in Vietnam
or are attempting to expand your business into this country, contact
the US Chamber of Commerce in Hanoi or Ho Chi Minh City
(formerly Saigon), as well as a Vietnamese chamber of commerce or
business organization in the United States. These organizations are a
good starting point and can advise or give you direction on initial
steps to take. Attending business briefings and country presentations
on doing business with Vietnam that are held in the United States is
another way to begin networking with people, organizations, and
companies that specialize in business with Vietnam.

Resources for There are also many internet websites with information on the
countries in Southeast Asia. Check out the following websites:
Business in • The CIA World Factbook provides general information on all
Southeast Asia the countries in the world. You can also find contact information
for US embassies in the countries. Go to this website and click
on “The World Factbook” under Library and Reference.
See: http://cia.gov/the-­world-­factbook
• The US-­ASEAN Business Council, Inc. provides excellent
business-­related information on the Southeast Asian countries
and on US businesses working there. This site is devoted to
promoting US business interests in the ASEAN countries.
See: http://us-­asean.org

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 • The website maintained by ASEAN and is an excellent source of
business, political, social, and economic information on all the
ASEAN countries. See: http://asean.org
• The US Small Business Administration provides a number of
services for US importers and exporters. See: http://sba.gov/
content/expoprt-­assistance
• SCORE can provide free business counseling service for US
business persons interested in international trade. SCORE has
365 offices in the United States. To find an office near you,
see: http://www.score.org
Doing business in Southeast Asia will be challenging and often
frustrating for a business person who is unprepared. However, for the
business person who has patience and does his homework well, the
opportunities and rewards are there.

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Chapter
Some Final
19 Thoughts on
Negotiating
Contracts
It’s time to lighten things up a bit after the previous chapters’ serious
discussion of contract terms and conditions, commercial risk, and
negotiating. The fact is, the process of negotiating better terms and
conditions in a construction contract can be a frustrating and
mentally tiring effort, but it absolutely needs to be understood by
anyone in the construction contracting business. This chapter
contains some important final points about contracting and
negotiating based on the author’s experience. They may be helpful in
negotiating efforts to achieve more favorable terms and conditions
and to reduce the commercial risk you accept in the contract. At the
very least, they will give you something to think—­and perhaps
laugh—­about. After all, it’s important to maintain a sense of humor
about some of the events that occur during negotiations on a
construction contract.

Understanding and Negotiating Construction Contracts: A Contractor’s and Subcontractor’s Guide to

Protecting Company Assets, Second Edition. Kit Werremeyer.
© 2023 John Wiley & Sons, Inc. Published 2023 by John Wiley & Sons, Inc.

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Why Negotiate? Obviously, every single term or condition in an owner’s proposed
construction contract will not have to be negotiated. A careful review
of all the different physical and commercial risks involved in any one
construction project and its proposed contract will point the way to
those that need attention. Negotiating better terms and conditions
protects the assets of your company, plain and simple.

The Concept “You want to negotiate these terms and conditions?” says the owner’s
contracts manager. “Son, just listen up here for a moment. You need
of Standard to understand that these are our standard terms and conditions.”
Terms & How about getting a nickel for every time a contractor has heard this?
Conditions He could comfortably retire from the contracting business and not
have to negotiate terms and conditions anymore!
A Basic Contracting Rule: There is no such thing as “standard
terms and conditions.” Each and every construction project is
different—­physically and in terms of commercial risk. If there were
such a thing as a “standard construction project,” then one could
perhaps successfully argue that there was the need for such a thing as
“standard terms and conditions.”
If an owner tells you that you cannot change the proposed commercial
terms and conditions contained in the bidding documents, he is
putting up his company’s first obstacle. Those so-­called standard
terms and conditions are typically carefully designed to protect the
commercial interests of the owner—­not the contractor.

An Example
During the course of commercial negotiations with a contractor for
a large construction project, the owner’s commercial manager said
to the contractor, “I don’t understand why you object to so many of
our terms. It took us two years of working with our lawyers to come
up with this set of terms and conditions. We really worked hard
within our company to develop what we believe are fair terms.”
“Did you ever take the time to get some feedback from one of your
better contractors on what they thought of your terms during the
two years that it took you to develop them?” replied the contractor.
“Well, no,” said the owner’s commercial manager. “Our lawyers told
us all contractors would accept them.”
It’s not too hard to understand why negotiations for terms and
conditions on this construction project were likely to become long
and difficult.
The above is not an unusual example. Many owners develop standard
terms and conditions for their construction projects without any

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 input whatsoever from the people who they will have to rely on to
successfully complete the project—the contractors. The way to
circumvent this obstacle of an owner’s standard terms and conditions
is with proper planning, determination, and effort. First of all, expect
to be told that the owner’s standard terms and conditions are chiseled
in stone and nothing short of an act of God will change them. This, of
course, is nonsense. If your offer for the project is competitive in
price and schedule, or your company has something unique to offer,
you have a very good chance of getting consideration from the owner
on modifying contract conditions to better meet your company’s
commercial needs and interests.
The process of negotiating better commercial terms and conditions
begins with addressing the issue of revised terms and conditions in
your proposal to the owner. Sending along your company’s own
preferred set of terms and conditions is one way of starting the
negotiation process. However, it may result in an “it’s too difficult to
deal with these guys” attitude from the owner. The owner is not likely
going to, carte blanche, accept 100% of any contractor’s preferred
terms and conditions. Sending along your own set of terms and
conditions also rejects the owner’s standard terms and conditions,
which usually creates a larger barrier to achieving agreement on a set
of mutually acceptable terms and conditions.
A more professional way to begin the negotiating process is to
If your proposal carefully review the owner’s proposed terms and conditions and
for the work is decide on what additions, deletions, and modifications you would
competitive, you are like—then include these specific clarifications in a separate section of
likely to get a chance your written proposal for the work. By doing it this way, you’re
to negotiate changes indicating to the owner that you can live with some or most of his pet
to an owner’s terms and conditions, but there are a few that need revision. Don’t be
standard terms and deterred when an owner suggests that it is just too hard to change his
conditions. standard terms and conditions, as there is no space on the document
to write in the changes the contractor wants. This is just another
obstacle put in front of the contractor. A separate letter (which can be
used as an addendum to the contract) containing the revised terms,
signed by the owner and the contractor, and incorporated into the
final contract by specific reference, is a perfectly acceptable way of
revising the owner’s standard terms and conditions.
Some owners state in their bid documents:

No exceptions to Owner’s standard terms and conditions will be accepted.

Contractor risks being disqualified from the bidding if exceptions are taken.

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 The easiest solution to this obstacle is not to take any exceptions and
state so. Simply include a separate section in your proposal entitled
“Clarifications” that provides for revising the owner’s standard terms
and conditions to be more favorable to your company. A clarification
is technically not an exception, and if your proposal for the work is
competitive, you will get a chance to negotiate.
For example, you could clarify in your proposal that the above clause
should be modified to read:

No exceptions to Owner’s standard terms and conditions will be accepted,

unless done so in writing.

Remember, it first takes a competitive offer just to get in the door in

order to have the opportunity to negotiate better terms and
conditions than those proposed by the owner.

Risk Transfer Don’t forget that as a contractor, you always have the option to tell
the owner that you don’t see the need to have an indemnity in the
Item 1: Get Rid terms and conditions, and you want to completely delete the owner’s
of the Indemnity proposed indemnity clause. Remember that it is likely that the only
reason an indemnity clause is in the contract is to transfer the owner’s
Clause! liability for claims associated with personal injury, property damage,
and defense costs associated with those claims that arise out of his
negligence. Explain that you believe both the owner and the
contractor should be responsible for the consequences of their own
actions and behavior, and so there is no need to have any commercial
language in the contract that inappropriately shifts any of one party’s
risk to the other party.
The owner’s commercial representatives or lawyers who are involved
in the contract negotiations may give you an incredulous look. After
all, eliminating the indemnity clause, which is often considered the
Holy Grail of the owner’s terms and conditions, seems just too much
to ask for. The discomfort that comes from this request is always
amazing. After all, an indemnity clause in the owner’s terms and
conditions is designed to shift the potential financial liability for the
owner’s negligent acts to you, the contractor. The owner would like
very much to have that risk shift made. Better you pay than he for the
consequences of his negligence.
But, having said all of this, sometimes an owner’s progressive
commercial representative or lawyer will say, “OK, let’s see if we can
make that work,” and you negotiate a way to eliminate the indemnity.
If an owner can be comfortable with accepting the consequences of
his own acts, then there is no need for an indemnity. Purchasing his

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 own insurance policy and working closely with the contractor on an
effective job site safety program is the best way for an owner to
protect himself from the risks he wants to transfer in an indemnity
clause.

Risk Transfer Remember that granting additional insured status to the owner on
your Commercial General Liability (CGL) policy gives the owner full
Item 2: Don’t access to the benefits of that policy—­and he doesn’t have to pay
Provide anything to get it! You are responsible for paying the policy
deductible for an accident caused by the owner, and the policy may
Additional likely cover the owner even if the accident is the result of his sole
Insured Status (100%) negligence. In addition, recall that if the owner makes a claim
against your CGL as an additional insured, your experience rating
will likely change for the worse, and your future premiums for
insurance may increase or, in the worst case, your insurance company
won’t renew your policy.
The acceptable alternative to granting additional insured status is to
provide the owner with an Owners’ and Contractors’ Protective
(OCP) policy or a separate, project-­specific General Liability policy
on which he is the named insured. The owner pays for the premium
for these types of insurance policies, pays the deductible on any
claims, and, if there is a claim, his experience rating will likely suffer,
rather than yours.

Risk Transfer Risk transfer to contractors (and subcontractors) for the negligence of
the owner, his project manager, his general contractor, or any others
Clauses, is simply out of date and needs to be eliminated. The two most
Insurance, & important risk transfer clauses a contractor will have to negotiate
with the owner are indemnity and additional insured status, as
Safety described above.
Risk transfer to contractors is a paradigm in the world of
construction contracting. Owners should not be allowed to hide
behind the terms and conditions of their construction contracts
when it comes to accepting responsibility for their actions and
behaviors. Insurance companies are established to accept risk
transfer and the potential financial liabilities. This is their business,
and they are paid premiums to accept risk and pay claims that may
arise out of that risk. Owners need to embrace, and pay for, the
benefit of hiring safe contractors who have demonstrated a
commitment to excellence and safety on the job site. The elimination
of injury to persons or damage to property through safe work
practices and programs needs to be a primary concern of both the
owner and the contractor.

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 How to Say No Sometimes during the course of contract negotiations, the owner may
be asking for too much in the way of risky commercial terms and
without conditions, and your only alternative is to say no. Following is a
Aggravating suggested resolution:

the Owner An Example

During negotiations for a large construction contract with the
commercial representatives of a major Japanese engineering, pro-
curement, and construction (EPC) company, the contractor asked to
change some of the proposed commercial terms and conditions of
the contract. After much discussion in Japanese, the commercial
representatives of the Japanese EPC company switched back to
English and said that they could accept most of what was requested.
However, on one of the requested changes, they simply said, “Please
withdraw your request for this change.”
Later, it occurred to the contractor that he basically had been told
“no” on that one issue; asking him to “please withdraw your
request” was just a nice way of saying, “no, we can’t accept what
you want to do.”
The next time the owner asks you to warranty your work for, say, five
years (instead of the one year you normally offer), you can carefully
explain why your company is unable to do that, and then politely ask
the owner to “please withdraw the request.” If that doesn’t work, you
can simply revert to more direct negotiating terms and say, “no.”

The Worst Observant readers have probably noticed that up to this point in the
book, the word “reasonable” has generally not been used, except in a
Contracting few sample contract clauses. In many instances, such as in the cost of
Word: changes to an owner, what is completely reasonable to the owner may
be completely unreasonable to the contractor. The word “reasonable”
“Reasonable” calls for a subjective assessment—­precisely the reason it appears so
often in an owner’s construction contract. The owner gets to define it
as may suit his own interests.
Some examples of the use of “reasonable” from contracts:
• “In the reasonable opinion of Owner. . .”
• “Owner will approve all reasonable changes to the contract price
and schedule.”
• “All requests by Owner for the addition of reasonably small
amounts of extra work will be performed at no charge by
Contractor.”
• “All work that may be reasonably inferred from the Plans and
Specifications will be performed by Contractor.”

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 • “Contractor shall follow all reasonable directions provided by
Owner.”
Again, what is reasonable to the owner may not be reasonable to the
contractor—and end up costing the contractor a lot of money.
Unfortunately, it will be tough to eliminate all references to
“reasonable” in an owner’s construction contract. Contractors should
select the most important clauses and negotiate substituting the word
“reasonable” with more specific wording that is less susceptible to
broad, one-sided, interpretation of how to resolve the issue.

The Best The word “notwithstanding” is a great word to know how to use in
negotiating construction contracts. It simply means “despite anything
Contracting to the contrary,” or, as is often the case in the construction industry,
Word: “it doesn’t matter what was said, here is what we really mean.”

“Notwith- For example, let’s say a contractor is faced with the following
indemnity clause in the owner’s standard terms and conditions
standing” proposed for use in a construction contract:

Article 20 – Indemnity
20.1 Contractor shall indemnify and hold Owner harmless from all
financial liability, including all legal costs, that may arise out of any and all
claims or demands that occur on the job site prior to Contractor’s arrival at
the job site, during Contractor’s work at the job site, and forever after
Contractor leaves the job site, regardless of how caused, and including
those claims and demands arising from any amount of negligent behavior
or acts of Owner.

Most will agree that this looks like a fairly normal indemnification
clause where, as a reward for getting the work, the contractor gets to
be financially responsible for everything that may happen on the site,
including anything caused by the owner’s negligent acts or behavior.
During contract negotiations, the owner is not interested in changing
his pre-printed and standard indemnity terms and conditions.
However, he agrees, by way of an addendum to the contract, to add a
second paragraph to Article 20, that was proposed by the contractor
and that reads as follows:

20.2 Notwithstanding anything to the contrary in the above Article 20,

subparagraph 20.1, Contractor agrees to indemnify Owner only to the
extent of Contractor’s negligence for claims and demands for injury to
persons, including death, and damage to property occurring only during the
on-site construction of Contractor’s Work and only while Contractor is
physically present on the job site.

325
 The phrase “notwithstanding anything to the contrary” in the above
paragraph basically means that whatever has been stated in the
preceding clause (owner’s unfair indemnity requirement in
subparagraph 20.1) is made null and void, and that the indemnity the
owner and contractor really agree to is as stated in this new
paragraph 20.2.
The new indemnity in paragraph 20.2 makes the contractor
responsible for claims and demands that are attributable only to the
extent of his own negligence and that occur only while he is physically
present and working on the site. The new paragraph eliminates the
requirement to pay for the owner’s legal defense costs, as well.
If you are having trouble revising or rewriting any unacceptable or
unnecessary paragraphs in the owner’s proposed contract, then
consider using a new paragraph beginning with, “notwithstanding
anything to the contrary in the above paragraph(s),” and then
followed by what you actually want to agree to, including deleting any
offending clauses.
Any “notwithstanding” clauses that need to be agreed on can also be
put in a separate letter (or addendum), signed by both the owner and
the contractor and incorporated into the final contract. (This way the
owner won’t have to mess up or rewrite his standard terms and
conditions pages in the contract.)

Win-­Win & These two concepts are fairy tales. They simply don’t exist except in
the minds of people who have ever had to negotiate a construction
Lose-­Lose contract or its commercial terms and conditions, or resolve a claim or
in Contract dispute.

Negotiations—­ Win-­win implies that both parties to the negotiations win something
and go away happy or satisfied, while lose-­lose implies that both
Fairy Tales? parties lose something and go away unhappy or dissatisfied. The
better question to ask is whether the negotiations, claim, or dispute
can be considered resolved, or if it is unresolved.
A good negotiator tries his best to resolve matters. The final
resolution arrived at between the contractor and owner may have
varying degrees of the so-­called win-­win or lose-­lose concepts
involved, but the contract negotiation, claim, or dispute is resolved,
and both parties can get on with completing the project. The matter
is now in the rearview mirror.
An unresolved matter is just that. The owner and contractor have
failed to resolve whatever it is they are negotiating—­a contract, a
claim, or a dispute. After entering into negotiations for a contract, if
both parties can’t agree on commercial terms, then no contract is

326
 arrived at, and both parties go their own way—hardly a win-win
situation. Some might call it a lose-lose situation, but in fact, this is
not necessarily so for the contractor. If the indemnity clause and
additional insured requirements wanted by the owner were too risky
for the contractor to accept, and the owner was unwilling to negotiate
better terms, then the contractor has won (or at least avoided losing)
by not entering into the contract.
How can the loss of what appears to be a good construction contract
be good for the contractor? Sometimes a contract is just not worth
accepting. If the proposed commercial terms and conditions are totally
unacceptable and present too much commercial risk for the contractor,
then he stops the negotiations and goes on to other work. It may turn
out to be one of the better decisions the contractor has made.

Is There a Price Someday, you may see—or you may have already seen—the following
commercial terms in an owner’s proposed construction contract:
for Bad
Commercial Contractor’s base bid price is to be in accordance with the terms and

Terms & conditions in the bidding documents. Any exceptions or deviations must be
accompanied by an appropriate adjustment in Contractor’s price.
Conditions?
Some owners try to require (although it’s more likely just to be a
negotiating obstacle on their part) that a contractor put a cost in
his price to cover certain terms and conditions that the contractor
doesn’t like. Some commercial terms can’t be priced by a
contractor. For example, how would you price an owner’s
preferred indemnity, or liquidated damages clause, which, if
enforced, could ultimately put your construction company into
bankruptcy? Some commercial terms are so unfair that they can’t
be priced. It’s always better to try to negotiate more favorable
commercial terms that are less risky to the contractor. As the
contractor from Toledo quoted in the introduction to this book
said, “There is no price for bad terms.”

Terms There are three simple rules to improve terms of payment and cash
flow:
of Payment 1. Always negotiate a downpayment or some form of advance
payment.
2. Insist on being paid on time.
3. Don’t agree to retention money being withheld.
Remember the three rules of business: 1. have cash, 2. have cash,
3. have cash. Getting and keeping cash for your construction efforts is
a good way to stay in business.

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 Some Tips • Be prepared: know your subject matter and the facts and
details.
on Successful • Think ahead: what commercial terms and conditions are most
Negotiating important to the owner, and what strategies and tactics will you
have to employ to get him to change them?
• Be knowledgeable: understand the issues involved with
construction contract terms and conditions; have options and
alternatives to present.
• Listen carefully and attentively to what the owner says during
negotiations. Try to understand, even if you don’t agree.
• Be patient: the negotiations may take more than an hour, a day,
or a week.
• Negotiations are just that; as things proceed, you may find that
you have to take back something you agreed to earlier,
depending on how things go.
• Find a back door: having a good working relationship with one
of the owner’s senior or influential people not associated with
the contract, claim, or dispute negotiations can be valuable.
• Try not to negotiate too much over the telephone; it is unlikely
each party will fully understand what the other said. All
negotiations need to be put in writing. Document all phone
conversations in writing and then fax or email confirmation.
• Stay positive during the negotiations. Look for solutions, not
roadblocks.
• Explain your concerns and positions; if they are well thought
out and well-­founded, reasonable owners will listen.
• Try to avoid “nickel and diming” of your claim by the owner;
look for a global settlement, not a series of small settlements.
• Develop thick skin.

Three First If you remember anything from this book, remember these three
points:
(and Final) 1. Read and understand everything in the construction contract.
Suggestions 2. Protect the assets of your company by negotiating better com-
mercial terms and conditions with the goal of reducing commer-
cial risk and the associated exposure to potential financial
liability.
3. Put all your agreements in writing! No excuses granted!
And, don’t forget to work safely!

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 Resources

Resources American Concrete Institute (ACI)

http://www.concrete.org
for Contractors American Council of Engineering Companies (ACEC)
Doing Business http://www.acec.org

in the U.S. American Institute of Architects (AIA)

http://www.aia.org
American Society of Civil Engineers (ASCE)
http://www.asce.org
American Society of Heating, Refrigerating, and Air-­Conditioning
Engineers (ASHRAE)
http://www.ashrae.org
American Subcontractors Association Inc. (ASA)
http://www.asaonline.com
Associated Builders and Contractors (ABC)
http://www.abc.org
Associated General Contractors of America (AGC)
http://www.agc.org
Construction Specifications Institute (CSI)
http://www.csinet.org

Understanding and Negotiating Construction Contracts: A Contractor’s and Subcontractor’s Guide to

Protecting Company Assets, Second Edition. Kit Werremeyer.
© 2023 John Wiley & Sons, Inc. Published 2023 by John Wiley & Sons, Inc.

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 Design-­Build Institute of America (DBIA)
http://www.dbia.org
Engineers Joint Contract Documents Committee (EJCDC)
http://www.ejcdc.org
Insurance Services Office Inc. (ISO)
http://www.iso.com
Mason Contractors Association of America
http://www.masoncontractors.org
Mechanical Contractors Association of America
http://www.mcaa.org
National Electrical Contractors Association (NECA)
http://www.necanet.org
National Society of Professional Engineers (NSPE)
http://www.nspe.com
National Utility Contractors Association (NUCA)
http://www.nuca.com
Sheet Metal & Air Conditioning Contractors’ National Association
(SMACNA)
http://www.smacna.org
U.S. Department of the Treasury
http://www.ustreas.gov
U.S. Treasury, for Surety Bonds
http://www.fms.treas.gov/c570/
Export-­Import Bank of the United States (Ex-­Im Bank)
http://www.exim.gov
International Chamber of Commerce
http://www.iccwbo.org
INCOTERMS
http://www.iccbooksusa.com
International Federation of Consulting Engineers (FIDIC)
http://www.fidic.org
Office of Chief Counsel of International Commerce
http://www.ogc.doc.gov/intl_comm_home.html
Overseas Private Investment Corporation
http://www.opic.gov/
U.S. Chambers of Commerce Abroad (AmChams)
http://www.uschamber.org/international/directory/default

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U.S. Commercial Service (division of the U.S. Department of Commerce’s
International Trade Administration)
http://trade.gov/cs/
U.S. Department of Commerce
http://www.commerce.gov/index.html
U.S. Department of Justice
http://www.usdoj.gov
U.S. Embassies and Consulates in Foreign Countries
http://www.usembassy.state.gov

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 Glossary

Terms are defined in this glossary as they apply to a typical construction or

construction-­related contract between an owner and a contractor.
acceptance The process by which an owner documents approval of the
satisfactory completion of a project.
acceptance certificate A dated and signed document issued to a
contractor by an owner certifying that all the work of a construction project
is complete and in accordance with all provisions of the contract.
actual damages Damages that can be assessed against an owner or
contractor if either or both fail to perform their respective responsibilities
and obligations as contained in the construction contract. Actual damages
are considered economic (monetary) damages that can be clearly
determined and proven, typically awarded by a court as the result of a
lawsuit brought by one of the parties to the construction contract.
additional insured A person or a company (typically the owner) other
than the named insured (typically the contractor) who is added to an
insurance policy and who may be able to receive some or all of the coverage
provided by the policy.
advance payment A partial payment to a contractor made shortly after
the contract is signed. Similar to a downpayment.

Understanding and Negotiating Construction Contracts: A Contractor’s and Subcontractor’s Guide to

Protecting Company Assets, Second Edition. Kit Werremeyer.
© 2023 John Wiley & Sons, Inc. Published 2023 by John Wiley & Sons, Inc.

333
 advance payment bond The generic term for the assurance of
performance provided by a contractor to an owner that any money
advanced to the contractor will be properly used to pay for project costs.
Sometimes called a downpayment bond.
advance waiver of liens A waiver of all of the contractor’s rights to file
mechanic’s or materialsmen’s liens against the owner for nonpayment for work
performed. Such advance waiver may be a condition of the owner’s contract.
aggregate limit The maximum amount an insurance policy will pay for
the sum of all personal injury and property damage claims that may arise
during the term of the policy as the result of multiple occurrences. Legal
defense costs may be excluded from this limit.
Alternative Dispute Resolution (ADR) A confidential method of settling a
dispute without going to court, typically negotiation, mediation, or arbitration.
applicable law A typical clause in a construction contract that defines the
laws of a particular state or country that will apply to the legal resolution of
any issues that arise out of the contract.
arbitration The process by which parties (e.g., the owner and the
contractor) agree to submit their disputes to the determination of a third,
impartial party (referred to as the arbitrator, or as an arbitration panel),
rather than pursue their claims in court. Parties may agree in advance to
binding or nonbinding arbitration of disputes, typically stated in a clause in
the contract. Binding arbitration: both parties agree ahead of time to abide
by the arbitrator’s decisions. Nonbinding arbitration: neither contractor
nor owner has to accept the decisions of the arbitrator.
articles Also referred to as clauses, these separate and numbered
paragraphs within a construction contract state the rights, duties,
responsibilities, and obligations of the parties (e.g., the owner and the
contractor) to the contract.
assignment A written agreement that transfers all or some of the owner’s
or contractor’s rights and/or obligations in a contract to a third party.
automobile insurance Coverage for claims for injury to persons and
damage to property, and defense of those claims, caused by the contractor’s
owned or leased automobiles. Typically provided on an occurrence basis.
bid bond An assurance of performance provided by the contractor that
he will enter into a contract with the owner within a specified period of
time. May be in the form of an on-­demand bond or a guaranty provided by
a surety company.
boilerplate Standard, formulaic text often used in documents such as
contract agreements.
bond The generic term for an assurance of performance for some or all of
the contractor’s obligations in a construction contract. It may be in the form
of an on-­demand bond, a guaranty provided by a surety company, a standby
letter of credit, or a parent company guaranty.

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bonding capacity The maximum dollar limit a surety company will place
on the total, or aggregate, amount of the value of all the performance
guaranties that a contractor can have outstanding at any one time for all
projects he is working on. Also refers to the maximum dollar limit a bank
will place on the total, or aggregate, amount of the value of all the on-­
demand bonds or standby letters of credit that a contractor can have
outstanding at any one time.
breach of contract The failure of an owner or a contractor, without a
legitimate reason, to perform some contractually agreed-­on obligation in
accordance with the terms of the contract.
builder’s risk insurance A specialized form of property insurance that
provides coverage for loss or damage to the work that occurs during the
time it is under construction. Can be purchased by either the owner or the
contractor.
business interruption insurance An insurance policy that protects a
contractor from the financial consequences of certain risks when there are,
for example, lengthy delays in a construction project he is working on. It
may provide payment for key employees on salary when work cannot be
performed and may also cover the extra expense of obtaining rental
equipment if the contractor’s equipment has been damaged.
care, custody, and control A term used when a contractor receives a
piece of equipment purchased by the owner for later installation in the
construction project by the contractor. Once the contractor takes
possession of the owner’s purchased equipment, it is considered to be in the
contractor’s “care, custody, and control.”
cash flow The amount of cash a company or construction project
generates, or fails to generate, over a specific period of time.
clauses See articles.
combined fixed price and reimbursable contract A contract that
combines the elements of a fixed price contract and a cost reimbursable
contract. It is used for contracts where some portions of the work are
well-­defined, and other portions are not. See fixed price contract and cost
reimbursable contract.
combined single limit The maximum amount an insurance policy will
pay for combined injury to persons and property damage.
Commercial General Liability insurance Commonly called CGL, this
type of insurance provides coverage for claims involving personal injury,
including death, and property damage. Legal defense of such claims is also
generally covered.
commercial letter of credit A payment instrument, typically issued by a
bank, that will pay out a certain amount of money within a fixed time
period upon presentation of all the documents specified in the body of the
letter of credit. Used mainly for the payment of sales of goods, such as the

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 supply of specialty materials from a foreign location for a construction
project. Banks expect to pay out the proceeds of the commercial letter of
credit. See standby letter of credit.
commercial risk A type of risk that arises out of the commercial terms
and conditions contained in a construction contract. Typical examples are:
indemnity, granting additional insured status, and liquidated damages for
not meeting the contract schedule.
commercial terms and conditions The clauses in a construction
contract that contain all the rights, duties, responsibilities, and obligations
of each party (e.g., the owner and the contractor) to a construction contract.
completed operations insurance Provides coverage for claims for
injuries to persons, including death, or damage to property that may arise
after all operations under the contract have been completed by the
contractor, or otherwise abandoned by the contractor, or after the work has
been put to its intended use by the owner. Legal defense of such claims is
also generally covered. Completed operations insurance does not generally
apply to damage caused by third parties to the completed work itself or to
legitimate warranty claims.
completion schedule The time period stated in the contract within
which the contractor is obligated to complete the construction project.
consequential damages Damages that occur indirectly from, or as a
consequence of, an accident or the contractor’s or owner’s failure to
perform. For example, if a job site explosion causes damage to a private
house a mile away, the damage would likely be considered consequential.
Such damages are usually rectified by a monetary award.
constructive change A change allowed to the contractor for the
consequences of an owner failing to perform certain obligations in a
contract, where such failure causes extra cost and schedule for the
contractor. Examples include over-­inspection by the owner, the owner’s
failure to grant legitimate schedule extensions, or the owner’s failure to
coordinate other contractors and subcontractors on the job site.
contract A written agreement that clearly defines the rights, duties,
responsibilities, and obligations of each included party, is legally
enforceable, dated, and signed by an authorized representative of each party
(e.g., the owner and the contractor).
contractor-­provided wrap-­up insurance An insurance policy purchased
by contractors to cover all the subcontractors working on a project (often
solving the problem of some subcontractors having trouble getting or
maintaining liability and property insurance).
contractual liability insurance Insurance that provides the contractor
with coverage for financial liability that arises out of certain commercial
terms and conditions in a construction contract. It typically covers the
contractor only for the financial liability for claims for personal injury, death
of persons, and property damage, including legal defense of those claims,

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that he may be exposed to through the risk transfer obligations found in an
owner’s construction contract indemnity agreement.
contributory negligence When the negligent actions of the owner and
contractor both contribute in part to causing an accident or creating some
failure to perform.
cost-­only type of change clauses Change clauses in a contract that allow
the contractor to recover only the costs involved in a change to the scope of
work but don’t allow the contractor the ability to change his completion
schedule.
cost plus fee contract A contract that provides for payment of all direct,
documented engineering, material supply, and construction costs
associated with the completion of the work, plus a fee for services to cover
the contractor’s overhead and profit.
cost reimbursable contract A contract that provides for payment of all
direct, documented engineering, material supply, and construction costs
associated with the completion of the work, plus fixed markups applied to
those direct costs for the contractor’s overhead and profit.
cross-­liability clause A contractual obligation that requires an insurance
company to protect each insured company separately in the same manner
as if a separate insurance policy were in place for each company. Also called
a severability of interest clause.
default See breach of contract or failure to perform.
defect liability period A contracting term for the warranty period. It
refers to the period of time that begins when the work performed by the
contractor is final and accepted by the owner and ends at some fixed later
date. During this period of time, the contractor is obligated to fix or repair
any defects found in the work he performed.
defined terms Terms defined at the beginning of a contract document
and used frequently throughout the contract, such as scope of work, owner,
or contractor, that are either partially or fully capitalized.
devaluation Loss of comparative value of one country’s currency with
respect to the value of another country’s currency.
disputes resolution clause A clause included in a contract that clearly
outlines a process for resolving disputes between the owner and the
contractor.
downpayment A partial payment of the construction project’s contract
price made by an owner to a contractor immediately at the beginning of the
contract.
downpayment bond See advance payment bond.
drawings Graphic illustrations depicting the dimensions, design, details,
and location of a project. Generally including plans, elevations, details,
diagrams, schedules, and sections.

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 employer’s liability insurance Provides coverage for employers against
claims made by employees that arise out of injuries or certain diseases
sustained in the course of their employment that are outside of the coverage
provided by the employer’s Workers’ Compensation insurance. Often called
Coverage B.
endorsement A supplement or addition to an insurance policy that
clarifies, modifies, includes, or excludes coverage for certain types of risks.
exchange risk The risk of the change in value of one country’s currency
with respect to the value of another country’s currency.
express warranty A written warranty.
facilitating payments Payments that may be allowed under the
provisions of the U.S. Foreign Corrupt Practices Act (FCPA) to be made to
foreign government officials to, for example, expedite routine governmental
actions, such as processing visas, providing police protection, or loading or
unloading cargo.
failure to perform When an owner or contractor, or both, does not
perform each and all of his respective obligations in the construction
contract.
final waiver of liens A document prepared and executed by the
contractor at the conclusion of the project stating that all subcontractors
and material suppliers have been paid in full and that no mechanic’s or
materialsmen’s liens will be filed against the owner. Typically required to be
filed with the owner as a condition of receiving the contractor’s final
payment or release of retention for the work he performed.
fixed price contract A type of contract in which the contractor agrees to
construct a project for an established price, agreed-­on in advance.
float An amount of additional time, or contingency, in a contractor’s fixed
completion schedule that is over and above what he believes is actually
needed to finish the project.
force majeure An unexpected or unanticipated event that, if it occurs,
can provide the owner or contractor, or both, a legitimate reason to delay
the project, cease work, or cancel the contract without penalty. A force
majeure clause in a construction contract attempts to define those events.
Such events may be, for example, natural disasters deemed “acts of God,”
unanticipated government mandates, civil disturbances, and so forth.
Foreign Corrupt Practices Act (FCPA) A U.S. law that prohibits
payments to foreign government officials for the purpose of inducing them
to assist a company in obtaining new business or keeping existing business.
foreign currency option The buyer (contractor) has the right, but not the
obligation, to sell a certain amount of foreign currency at a fixed exchange
rate at or within a certain fixed time period to the bank that sold him the
foreign currency option.

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forward exchange contract The buyer (contractor) has the obligation to
sell a certain amount of foreign currency at a fixed exchange rate at, or
within, a certain time to the bank that sold him the forward exchange
contract.

general terms and conditions Contract commercial terms and

conditions covering general needs or issues involved in a particular
construction project.

guaranteed maximum price contract A contract for construction,

wherein the contractor’s price is most likely stated as a combination of
accountable cost plus a fee, with a promise provided by the contractor that
the final contract price will be limited to a specific maximum amount.

guaranty A contract between three parties: a surety (or contractor’s

parent company), owner, and contractor. The surety (or contractor’s parent
company) guarantees the performance of the contractor’s contractual
obligations as stated in the construction contract for the benefit of the
owner.
implied warranty A nonwritten warranty, such as an implied warranty of
merchantability or implied warranty of fitness for a particular purpose, that
is imposed by law and legally enforceable.

imputed liability See vicarious liability.

INCOTERMS A set of international rules first established in 1936 for the

interpretation of commonly used shipping terms. Full descriptions of all
INCOTERMS are published by the International Chamber of Commerce.

indemnification An obligation assumed by contract or imposed by law

on one party to protect another against the financial liability arising from
stated risks.

indemnity, broad form A type of indemnity where the contractor

agrees to be responsible for the financial liability that arises from claims
for personal injury, death of persons, and property damage, including
legal defense of those claims, that are the result of any amount of the
owner’s negligence, including his sole negligence.

indemnity, intermediate form A type of indemnity where the contractor

agrees to be responsible for the financial liability that arises from claims for
personal injury, death of persons, and property damage, including legal
defense of those claims, that are the result of any amount of the owner’s
negligence, but excluding only those claims that arise out of the owner’s sole
negligence.

indemnity, knock-­for-­knock A type of indemnity that establishes that a

contractor and an owner agree to be responsible for claims associated with
personal injury and property damage for their own employees and property,
regardless of how caused and regardless of the other party’s negligence.

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 indemnity, limited form A type of indemnity where the contractor
agrees to be responsible for the financial liability that arises from claims for
personal injury, death of persons, and property damage, including legal
defense of those claims, that are the result only to the extent of the
contractor’s negligence.
indemnity, patent A type of indemnity where the contractor agrees to be
solely responsible for resolving claims arising out of utilizing equipment or
processes on an owner’s project that infringe on existing patents.
indemnity clause A contractual obligation by which the contractor
agrees to be responsible for certain risks and the associated financial
liabilities that arise out of claims attributable to some or all of the owner’s
negligence.
independent contractor A contractor who, under written contract,
provides services to an owner but is not considered an employee of the
owner for tax or other legal reasons. The independent contractor controls
the means, method, and manner of producing the result to be accomplished.
inquiry See request for proposal (RFP).
insured contract That part of a construction contract (typically the
indemnity clause) in which the contractor assumes the tort liability of the
owner for claims involving injury to persons, death of persons, and property
damage. See tort liability.
ISO endorsements Standardized language for endorsements to insurance
policies written by the Insurance Services Office Inc.
job site The entire area, or part of the area, within the defined boundaries
of a project.
joint and several All parties (joint) in a joint venture are responsible for
the project. In the event one of the parties fails to perform, the other party
or parties (several) in the joint venture would still be fully responsible for
the project.
joint operation Two or more companies working together to build a
specific project, where each company is responsible for independently
estimating and performing its own scope of work, and each company will
receive its proportionate share of any profit or loss that may result from its
own operations.
joint venture An organization established by two or more companies
joining together to provide resources, share management responsibilities,
and share any resulting profit or losses.
latent defect A defect that would not be revealed under reasonably
careful observation.
legally enforceable contract A contract that holds up under the law
because it has been negotiated without any coercion, has something of

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value for both parties, has nothing illegal in it, and has been signed by
representatives of the owner and the contractor who have the authority to
commit the resources of their companies.
liability The obligation to pay money.
liquidated damages (LDs) A monetary amount specified in a
construction contract to cover estimated damages incurred by the owner as
a result of the contractor’s failure to perform. Typically applies when the
contractor fails to complete the work within the time frame set forth in the
contract, or a production process provided by the contractor fails to
conform to the contract’s design specifications.
litigation The time-­consuming, expensive, and adversarial process by
which contractor and owner hire lawyers and submit their disputes to the
jurisdiction and procedures of federal or state courts for an indeterminate
resolution that then becomes public knowledge.
master list A list of a construction project’s duty-­free materials provided
by an owner for use by the foreign country’s customs officers at the port or
ports of import.
material breach of contract A failure to perform a contractual obligation,
where the failure is extremely serious and damaging to one or both parties.
materialsmen’s lien If an owner or contractor does not pay a material
supplier for materials supplied, the material supplier can place a lien against
the owner’s property that may hinder or prevent the owner from securing
financing for his project or selling the property without first discharging the
lien.
mechanic’s lien If an owner does not pay a contractor or subcontractor
for work performed, the contractor or subcontractor can place a lien against
the owner’s property that may hinder or prevent the owner from securing
financing for his project or selling the property without first discharging the
lien.
mediation The simplest, least expensive, and most straightforward form
of ADR, where a neutral professional mediator, who likely has significant
construction experience, is hired by mutual agreement of the contractor
and the owner to resolve a contract dispute. Mediation is a confidential
dispute resolution process.
memorandum of understanding (MOU) Used to establish a joint
operation by outlining the duties and responsibilities of each of the parties,
including scope of work and joint or joint and several responsibilities with
respect to the project and contractual obligations with the owner.
milestone A specific, predetermined measurement of the completion of a
project typically used for progress payment purposes.
named insured The owner of the insurance policy, most often the
contractor. The named insured pays the policy premium and any deductible
on a claim.

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 negative cash flow On a construction project, when the periodic
payments a contractor receives from an owner for the performance of the
contract’s construction work amount to less than what he will pay out
during the same period for expenses associated with the work. (The amount
of money coming in is less than the amount going out.)
neutral cash flow On a construction project, when the periodic payments
a contractor receives from an owner for the performance of the contract’s
construction work equal what he will pay out during the same period for
expenses associated with the work. (The amount of money coming in
equals the amount going out.) This is virtually impossible to achieve.
occurrence limit The maximum amount an insurance policy will pay for
all injury to persons, property damage, and medical expenses that arise as
the result of a single occurrence.
offer A written proposal or bid form prepared by the contractor to
perform the work required by the owner.
offer and acceptance The term used to test whether a contract has been
arrived at or not—­basically successful contract negotiations between the
owner and the contractor.
offshore contract A contract between a company in one country and a
company in another country. Typically used in conjunction with an onshore
contract.
on-­demand bond A monetary form of contractor performance
assurance, typically provided by a bank, where the bond is payable to the
owner simply on his demand, and usually without the owner having to
provide the bank any evidence or details of the contractor’s failure to
perform.
onshore contract A contract between two companies in the same
country. Typically used in conjunction with an offshore contract.
order of precedence A clause in a construction contract that specifies the
order in which contract documents and contractor’s proposal or other
submissions will apply in the event a dispute or claim arises over similar or
conflicting terms.
owner-­provided wrap-­up insurance Also called an Owner-­Controlled
Insurance Program (OCIP), it provides coverage for owners of large
construction projects and for the many different engineers, main
contractors, subcontractors, inspectors, suppliers, and others working on
the job site.
owner’s and contractor’s protective liability (OCP) An insurance policy
purchased and provided by a contractor for the exclusive benefit of an owner
that covers the owner for claims against him for personal injury and property
damage incurred by third parties, as well as any associated legal defense costs,
that arise out of the contractor’s operations on the construction job site. The
owner is the named insured on an OCP.

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paid if paid If the main contractor receives payment from the owner for
his work that includes the subcontractor’s work, then and only then will the
main contractor pay the subcontractor.
paid when paid When the contractor receives payment from the owner
for work that includes the subcontractor’s work, then the main contractor
will pay the subcontractor.
penal sum The technical term used to designate the maximum amount of
money a surety bond will pay the owner in the event the contractor fails to
perform and the surety has to take over his contractual obligations.
performance bond A generic term for an assurance of performance
provided to the owner by the contractor. It may take the form of an on-­
demand bond, a performance guaranty from a surety, a standby letter of
credit, or a parent company guaranty. The performance bond is used to
provide the owner some measure of assurance that the contractor will
complete the construction project in accordance with the provisions of the
contract.
performance guaranty, parent company A written risk transfer contract
between three parties: a contractor, an owner, and the parent company of
the contractor. The parent company guarantees the performance of the
contractor’s obligations in the construction contract with the owner. In the
event the contractor fails to perform, the parent company will step in and
finish the contractor’s work.
performance guaranty, surety A written risk transfer contract between
three parties: a contractor, an owner, and a separate company, called a
surety. The surety guarantees the performance of the contractor’s
obligations in the construction contract with the owner. In the event the
contractor fails to perform, the surety company will step in and finish the
contractor’s work, or pay the owner some money up to the amount of the
guaranty’s penal sum.
performance incentive A feature of a contract whereby the contractor
can earn extra money for certain types of exemplary performance, such as a
safety bonus for having no lost-­time accidents on a construction project
during the full course of construction.
periodic progress payment A measurement of how much of a
construction project has been completed over some fixed time period, such
as one month. At the end of the specified time period, the contractor bills
the owner for the value of the work performed.
personal injury When a person is injured, regardless of how caused.
Includes death of persons and sometimes certain diseases.
physical risk The risk of personal injury or property damage that is ever
present due to the working conditions on construction job sites that can
create safety hazards. Working at heights, unprotected excavations,
overhead power lines, movement of heavy equipment, demolition activities,

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 asbestos remediation, and blasting are examples of physical risk
activities that may create safety issues and may injure persons or damage
property.
plans The two-­dimensional overview of the design, location, and
dimensions of a project.
positive cash flow When the periodic payments a contractor receives
from the owner for the performance of the contract’s construction work
amount to greater than what he will pay out during the same period for
expenses associated with the work. (The amount of money coming in is
greater than the amount going out.)
preamble The opening paragraph(s) of a contract used to specifically
identify the parties to a contract.
premium The fee charged for an insurance policy.
principal As used in relation to construction contracts, when a contractor
secures a performance guaranty from a surety company, the contractor is
considered the “principal” on the guaranty.
professional liability insurance Also called errors and omissions
insurance, provides coverage for the insured professional’s liability for
claims, and legal defense of those claims, for damages sustained by others
that arise as a result of negligent acts, errors, or omissions in the
performance of their professional services.
property damage When property is damaged or destroyed.
proposal A complete signed bid to perform construction work (or a
designated portion) for a stipulated price. The proposal is submitted to the
owner by the contractor in accordance with the inquiry or request for
proposal.
punch list A final list of minor work items remaining to be performed by
the contractor to fully complete the project, prepared by an owner or his
representative and confirmed by the contractor. Typically a punch list does
not stop the owner from issuing the contractor some form of final
completion notice.
punitive damages Damages that may be imposed as punishment by a
court for fraud or misfeasance, or for grossly negligent, intentional, reckless,
malicious, or willful types of behavior.
request for proposal (RFP) A set of documents, plans, and specifications
prepared by the owner or his engineer or project manager that is given to
contractors and that forms the basis of the contractor’s bid—­proposal—­for
the project. Often called an inquiry.
retention A percentage of the value of each payment invoice from a
contractor that is withheld by the owner until the end of the project. The
retention is typically held until all terms of the contract have been fulfilled.
rider See endorsement.

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scope of work An accurate, detailed, and concise description of the work
to be performed by the contractor, the owner, and third parties in a
construction contract.
scope of work matrix A document that contains a line-­by-­line
description of all of the work items included in a construction contract, and
specifies who is responsible for performing each of them—­the contractor,
the owner, or others.
scoping drawings Contract drawings that are marked up to indicate for a
contractor what is “in scope” for his scope of work and what is not.
secrecy agreement An agreement signed by the contractor that obligates
him to keep certain information about the owner’s project or process
confidential. Typically applies to most of the contractor’s material suppliers
and subcontractors working on the project.
self-­insure An insured’s decision to take on a larger deductible than
would otherwise be included in an insurance policy. This approach is used
by contractors to lower the premiums they pay for insurance.
self-­insured retention (SIR) Basically the same as to self-­insure (above),
but the insured in this case may take on the functions normally provided by
an insurance company such as directly paying claims.
set-­offs Money that the owner can deduct from a contractor’s payments
for parts of the contractor’s work that the owner performs, or money related
to claims or disputes on other projects a contractor performed for the owner.
Amounts for set-­offs should always be agreed to in writing by both parties.
severability clause Also called a validity clause, this states that if one or
more of the clauses in a construction contract is ruled to be unenforceable
or invalid, the remaining clauses will continue to be in full force and effect.
site conditions clause A contract clause that typically requires the
contractor to, at a minimum, inspect and understand the grade level and
above-­ground job site conditions prior to the start of any construction
activities. The clause may also obligate the contractor to take full
responsibility for the site’s subsurface conditions.
soils investigation An investigation of the job site surface and subsurface
conditions typically prepared by a specialized engineering company. It
describes and reports on the conditions in detail and may provide
recommendations for the design of foundations and the possible maximum
subsidence of the soil when the site foundations are under load.
special terms and conditions Contract commercial terms and conditions
covering any special needs or issues involved in a particular construction
project. These will typically supersede any similar or like terms found in the
contract’s general terms and conditions.
specifications Documents that define the qualitative requirements for
products, materials, and workmanship on which the contract for
construction is based.

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 split contracts A term typically used in international contracts to note
the existence of both an offshore contract and an onshore contract for the
same construction project.
stacking The practice of adding together—­stacking—­the maximum
amount of money available from an insurance policy to the maximum
amount of money available under an indemnity agreement to use in paying
a claim.
standby letter of credit A payment instrument that can be used by
owners as an assurance of the contractor’s performance, typically issued by a
bank, that will pay out a certain amount of money within a fixed time period
upon presentation of documents specified in the body of the letter. In the
event the contractor fails to perform, the owner can cash the standby letter
of credit, subject to the presentation of any documents required. See
commercial letter of credit.
subrogation The legal process by which one party (e.g., an insurance
company) can recover money it paid out for a claim submitted by its
policyholder (e.g., the contractor) from the negligent party who was
responsible for causing the claim (e.g., the owner).
surety company A company that specializes in providing guaranties of
performance for contractors. In the event the contractor fails to perform on
a contract, the surety company will step in and finish the project for the
owner, or pay the owner up to the maximum stated monetary value of the
guaranty.
suspension of work clause A contractual right that allows an owner to
suspend work on a construction project for some period of time and then
resume, or even cancel, the project.
target price contracts A contract where a contractor and owner agree on
a certain fixed, lump-­sum price, the target price, and then the contractor
tries to execute the contract at or below that price. The contractor typically
shares all his estimated project costs, markups, and expected profit with
the owner.
termination for cause clause A contractual right that provides an
enforceable exit mechanism for the owner when the contractor fails to
perform, financially or otherwise.
termination for convenience clause A contractual right that allows the
owner to terminate the contract at his convenience with little or no
justification.
third parties All persons or organizations that are not signatory to the
construction contract between the owner and the contractor.
time is of the essence A term used in contracts to imply that it is very
important to finish an obligation, typically the contractor’s completion
schedule, as agreed on in the contract.

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tort A civil wrong. Typically on a construction site a tort (civil wrong) is
an incident or act arising out of the negligence of the owner and/or
contractor that damages property or injures a person or persons.
tort liability The financial liability that arises from a negligent act that
causes harm to persons or property. Such financial liability is usually
determined in court.
transport insurance Insurance coverage for loss or damages to materials
and equipment while they are being transported from one place to another.
travel accident insurance Insurance coverage for the contractor’s
employees while they are traveling on company business.
umbrella or excess liability insurance Insurance that provides additional
liability coverage for the Comprehensive General Liability and automobile
policies in the event the occurrence or aggregate limits are exceeded on
these policies.
unilateral change clauses Change clauses in a contract that allow the
owner to direct the contractor to perform a change with the sorting out of
cost and schedule changes to take place at some later date.
unit rate contract A construction contract in which the contractor’s
payment is based on a mix of varying unit rates for all the different elements
of the work performed.
vicarious liability The liability that arises where one person (an employer
or an owner) is deemed responsible for the actions of another (an employee
or a contractor). Also known as imputed liability.
waiver of subrogation A waiver by one party (the contractor) of another
party’s (the contractor’s insurance company who paid a claim on his behalf )
right to recover the amount of the claim from the party whose negligence
caused the claim (the owner). See subrogation.
warranty A contract between two companies—­the contractor and owner.
The contractor warrants that the work he performed for the owner is free of
defects, and if any defects are found within a certain time period, he will
repair or replace them.
Workers’ Compensation insurance Insurance covering the liability of an
employer to employees for claims, compensation, and other benefits
required by statutory Workers’ Compensation laws with respect to injury,
sickness, disease, or death arising from their employment. Often called
Coverage A in a contract.

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 Index

A articles, definition of, 25

acceptance, 246, 260–262 assignment, 245, 258–260
certificate of, 31 Associated General Contractors of
acts of God, See force majeure America (AGC), 11
actual damages, 193–196 assurances of performance, 69–101
additional insured, 113, advance payment bond, 85–87
120–134, 323 bonds, 70–73
administrative terms, xxiv downpayment bond, 85
advance payment bond, 85–87 guaranties, 70–72
advance waiver of liens, 246, on‐demand bond, 73, 75–76, 84,
262–265 85, 87, 89, 93–99, 101
aggregate limit, insurance, 114 parent company guaranties,
Alternative Dispute Resolution 97–98
(ADR), 186–188, 191 performance bonds, 91–93
American Arbitration performance guaranties, 91–93
Association, 190 standby letter of credit, 73,
American Chamber of Commerce 76–78, 101, 260
(AmCham), 290, 306–307 step‐down values, 95–97
American Institute of Architects subcontractor payment
(AIA), 11 guaranties and bonds, 88–91
anti‐indemnity legislation, 144–149 supplier payment guaranties and
applicable law, 246, 269–272 bonds, 88–91
in international contracting, true performance guaranty,
284–285, 297 73–75
arbitration, 187–188, 190, 191, 215 warranty guaranties, 93–95

Understanding and Negotiating Construction Contracts: A Contractor’s and Subcontractor’s Guide to

Protecting Company Assets, Second Edition. Kit Werremeyer.
© 2023 John Wiley & Sons, Inc. Published 2023 by John Wiley & Sons, Inc.

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attachments, to contract, 26–27 combined fixed price and myths, 11–12
audit reimbursable contracts, negotiations, 12–13,
of contractor’s work records, 18 18–19 320–328
rights to, 246, 268 combined single‐limit, parties involved, 2–3, 5
automobile insurance, 108 insurance, 114 private, xxii
Commercial General Liability proposal for, 4–5
B insurance, 104, 106–107, signatory parties, 5
bankruptcy, 72 115, 120–123, 126–128, starting point, 3–4
bid bond, 82–85 130–132, 134, 138–140, 323 steps in, 1–2
bid documents, 2, 20 commercial letter of credit, 77 types and forms of, 15–32
bid review, 20 commercial obligation, 72 contracting, process, xxv
binding arbitration, 188 commercial terms and Contractor‐Provided Wrap‐up
boilerplate language, in contracts, conditions, xxi, 9, 25–26 insurance, 110
12, 117 administrative, xxiv contractor selection, 20
bonding capacity, 80, 86, 96 financial liability, xxiv Contractual Liability insurance,
bonding limits, 99–101 negotiating, xxv, xxvi 107–108, 157–162
bonds, 70–73, 173 common law, xxiii contributory form, 124
breach of contract, 7, 72, 194 Completed Operations insurance, cost plus fee contracts, 15,
broad form blanket contractual 109, 130 20–21
coverage, 138 endorsements, 130 cost reimbursable contract, 269
Builder’s Risk insurance, completed portions of work, use cross‐liability, 117
108–109 of, 245, 251 currency, 293–296
Business Interruption completion schedule, See
insurance, 111 schedule D
conditions, of contract, xxi damages, 193–206
C confidentiality agreements, 245, actual, 193–196
cancellation, 228, 236 See also 253–254 consequential, 193, 204–206
termination consequential damages, 193, 195, liquidated, xxiii, 23, 171, 193,
captive insurance, 112 204–206 197–204, 206, 242
care, custody, and control, consideration/something of value, punitive, 193
insurance, 116–117 5, 9 subcontractors and, 203
cash flow, 42–43, 97 construction equipment, 31 deductible, insurance, 113
calculating, 43–44 contingency, 18, 62, 250 default, 72
negative, 42, 51 contract bonds, 73 defect liability period, 31
neutral, 42 contract completion, 10 definitions, contracting, 30–32
positive, 42, 51 contract language, sample, xxvii delays, xxvi, 66–68, 203–204
certificate of mechanic contracts design‐bid‐build contracts, 22
completion, 209, 213, 219, breach of, 7, 72, 194 design‐build contracts, 22
260 conditions of, xxi design engineering, 20
certificate of occupancy, 58, 220 consideration, 5 devaluation, 295
changes clause, 169–181, definition, 1 directives, owners’, 171
199, 204 design‐bid‐build, 22 disputes, 38, 174, 186, 189–191
claims, 38, 120–131 design‐build, 22 resolutions to, 183–192
claims made vs. occurrence, example of, 8–9 downpayment, 327
insurance, 105–106 government, xxii downpayment bond, 85
clauses, definition of, 25 international, xxii, 284–285 Dun & Bradstreet®, 44
codes and standards, 3, 27 language in, 10–11 duty‐free status, 300, 301

350
E G Commercial General Liability,
Employer’s Liability insurance, grace periods, damage clauses 107, 115, 120–123, 125, 127,
108 and, 202 128, 130–132, 134, 138–140,
Engineering, Procurement, and guaranteed maximum price 162, 323
Construction (EPC) contract, 15 Completed Operations, 109,
­contractor, 199 guaranties, 69–75, 208 130
Engineers Joint Contract Contractor‐Provided
Documents Committee I Wrap‐up, 110
(EJCDC), 11 implied warranty, 214–216 Contractual Liability, 107–108
environmental protection conspicuous exclusion of, 216 Coverage B, 108–109
groups, 2 imports, 300–302 cross‐liability, 117
equipment and material indemnity, xxvi, 141–167, deductible, 105, 113, 115
procurement, 20 322–323, 325–327 definition of, 105
evidence of insurance and additional insured status, Employer’s Liability, 108
certificate, 140 157–162 evidence of insurance
excess, coverage on additional and claims, 161–162 certificate, 119
insured insurance policy, and contractual liability experience rating, 113
126–127 insurance, 157–162 General Liability, 9
exchange risk, currency, 294 definitions, 142–143 manuscript endorsements,
experience rating, insurance, 113 examples of, 150–157 118, 130
Export‐Import Bank of the and fairness, 143 named insured, 112
United States (Ex‐Im Bank), and insurance, 142 notification provisions, 119
284, 305 knock‐for‐knock, 165–166 occurrence limit, 114
exports, 300–302 legislation for, 144–149 Owner‐Provided Wrap‐up, 110
express warranties, 216 negotiating, 162–166 Owner’s and Contractor’s
extended duration warranties, patent, 245, 252–253 Protective Liability, 110–111
219–220 transferring the owner’s risks perils, 104
to contractors, 143 premium, 105, 115
F independent contractors, 125, primary and non‐contributory,
failure to perform, 7, 72, 194, 245, 257–258 117
195 insolvency, 72 Professional Liability/Errors
fast‐track projects, 20 inspection, owner’s right, 245, and Omissions, 109
final waiver form, 27 254–256 reviewing details of, 2
final waiver of liens, 13, 246, insurance, xxvi, 9, 103–140, 323 riders and endorsements, 117
265–268 additional insured, 113, sample clause, 134–140
financial liabilities, xxi, xxiii, xxiv 120–134, 157–161 self‐insured retention (SIR),
fitness for a particular purpose, aggregate limit, 114 113–114
implied warranty of, automobile, 9, 108, 136 special requirements for, 27
214, 218 broker, 104 specialty insurance, 111–112
fixed price contract, 16, 268 Builder’s Risk, 108–109, 136 stacking, 118–119
fixed schedule contract, 16 Business Interruption, 111 subcontractor default
float, 62–63 captive insurance, 112 insurance (SDI), 112
force majeure, xxiii, 239–244 care, custody, and control, terrorism insurance, 111
Foreign Corrupt PracticesAct 116–117 transport insurance, 109
(FCPA), 284–286, 291, claims made vs. occurrence, types of, 106–112
292, 312 105 umbrella/excess liability, 111
foreign currency option, 295 combined single‐limit, 114 vicarious liability, 122

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insurance (cont’d ) limit of liability, 81 offer, 4, 9
waiver of subrogation, 114–116 line of credit, 44 offshore companies, 292–293
Workers’ Compensation, 9, liquidated damages, xxiii, 23, 171, offshore contracts, 288–289
108, 136, 257 193, 196–204, 206, 242 on‐demand bond, 73, 75, 84, 86
Insurance Services Organization, litigation, as a dispute resolution onshore contracts, 288–289
Inc. (ISO), 128–130 option, 188 order of precedence, 23, 27–30
endorsements, 118, 130 OSHA safety inspector, 2
interest M overhead, 17, 20
accumulated, 51 manuscript endorsements, 118 Overseas Private Investment
negative, 51 markups, 16, 17, 21 Corporation (OPIC), 284,
positive, 51 master list, 301 290
rates, 44–45 material breach of contract, 7 Owner’s and Contractor’s
Internal Revenue Service materials Protective Liability
(IRS), 257 delivery of, 46 insurance, 110–111
International Commercial Terms lead‐time for, 48 Owner‐Provided Wrap‐up
(INCOTERMS), 284, mechanic’s lien, 12, 263–264 insurance, 110
302–304 mechanical completion
international contracting, xxii, certificate, 209, 212, 219, 260 P
283–307 mediation, as dispute resolution, partial waiver of liens, 262–265
International Federation of 187 pass‐through warranties,
Consulting Engineers Memorandum of Understanding 221–222
(FIDIC), 11 (MOU), 300 patent indemnity, 245, 252–253
merchantability, implied warranty payment, xxv
J of, 214, 218 advance, 48–49
joint operations, 284, 300 milestone payments, 45–59 cash flow, 42–44
joint ventures, 284, 299 mobilization, 48, 49 downpayment, 48–49, 327
myths, of contracting, 11 electronic funds transfer
K (EFT), 48
knock‐for‐knock indemnity, N example of, 58–59
165–166 named insured, 112 for changes, 172
negligence, 114 interest rates, 44–45
L negotiating, final thoughts on, milestone payments, 45–59
labor unions, 66 319–328 “paid if paid,” 55–57
latent defect, 222 negotiation, as dispute resolution, “paid when paid,” 55–57
law, applicable, 246, 269–272 186–187 periodic progress payments,
changes in, 246, 272 nonbinding arbitration, 187 45–59
common, xxiii Notice to Proceed, 92 retention, 50–51, 57, 180, 327
international, 284, 297 notification provisions, set‐offs, 54
legal systems, foreign, 284, insurance, 119 terms of, 8, 41–59, 327
290–291 payment bond, xxiii, 28
legally enforceable contract, 6 O penal sum, 81, 84
letters of credit, 73, 76–78, 101, obligations, assignment of, performance, assurances of,
260, 284, 286–288 258–259 69–101
liabilities, financial, xxiii, xxiv obligee, 81 advance payment bond, 85, 86
lien, 88 obligor, 81 bonds, 70–73
mechanic’s, 12, 262–264 occurrence limit, insurance, 114 downpayment bond, 85
waiver of, 12, 246, 262–268 offer and acceptance, 3, 4 guaranties, 70–72

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 on‐demand bond, 73, 75–76, R specialty insurance, 111–112
84, 85, 87, 89, 93–99, 101, recitals, 24–25 specifications, 2, 3, 26
180, 260 reimbursable type contracts, split contracts, 284, 288–289
parent company guaranties, 16–18 stacking, insurance, 118–119
97–99 cost plus, 16–18 standby letter of credit, 73,
performance bonds, 27, unit rate, 16–17 76–78, 101, 260
91–93, 172 request for proposal (RFP), 1, 3, 5, subcontractor default insurance
performance guaranties, 91–93 8, 38 (SDI), 112
standby letter of credit, 73, retention, 50–51, 58, 180, 327 subcontractor payment
76–79, 101, 260 riders and endorsements, guaranties and bonds,
step‐down values, 95–97 insurance, 117–118 88–91
subcontractor payment rights, assignment of, 258–259 subcontractors, 23, 174, 175
guaranties and bonds, 88–91 risk damages and, 202–203
supplier payment guaranties commercial, xxii–xxiii, xxiv, 2, selecting, 2
and bonds, 88–91 25, 104 supplier payment guaranties and
true performance guaranty, of conditions to contract, xxi bonds, 88–90
73–75 and insurance, 105 suppliers, selecting, 2
warranty guaranties, 93–95 management, 194 surety, 73, 80–81, 172, 173,
performance bonds, 27, perils, 104 180, 208
91–93, 172 physical, 105 suspension, of a contract,
performance guaranties, 70, 73, third parties and, 2 227–238
260 transfer clause, xxvi, 3
performance incentive contracts, T
16, 22–23 S target price contract, 15, 21–22
performance, late, xxiii safety, 2, 27, 251, 323 termination
periodic progress payments, contractor incentive for, 22–23 for cause, 228–229, 236
45–59 schedule, xxv, xxvi, 3, 9, 19, 20, of contract, 227–238
plans, 2, 3, 26 26, 61–68 for convenience, 229–232,
preamble, 23–25 changes in, 179, 180 236–237
premises and operations, 138 contractor incentive for, 22–23 terms and conditions,
premium, insurance, 105 float, 62–64 of contract, xxi
pricing, of work, xxv, 8 time is of the essence, 64–66 standard, 320–322
primary, coverage on additional scope of work, xxv, 2, 3, 8, 19, 21, terms of payment, 41–59, 327
insured insurance policy, 25, 26, 33–40, 185 terrorism insurance, 111
126–127 changes to, 169, 170, 178–179 third‐party over action, 123
principal, 81 matrix, 37–39 time is of the essence, 64–66
products and completed scoping drawings, 39–40 transport insurance, 109
operations coverage, 138 secrecy agreements, 245, 253–254 true performance guaranty,
Professional Liability/Errors and self‐insure, 127 73–75
Omissions insurance, 109 self‐insured retention (SIR), 113
profit, 16, 17, 21 severability, 246, 269 U
progress payments, xxiii signature block, 23, 27 umbrella/excess liability, 111
project management staff, 20 site conditions, xxiii, 245–251 underground explosion and
project manager, 2 site visit, 2 collapse (XCU)
proposal, 1, 28 soils investigation, 246–248 coverage, 138
punch list, 246, 260–262 special terms and conditions, 23, Uniform Commercial Code
punitive damages, 193 26–28 (UCC), 214–216

353
V waiver of subrogation, 114–116 obligations, 82
validity clauses, 269 warranties, 74, 207–225, pass‐through, 221–222
vicarious liability, 122 251, 260 period, 92
clauses, 208–213 work, xxiii
W express, 216 weather, effects of, 21, 66
waiver of liens, 246 extended duration, 219–220 Workers’ Compensation, 9, 108,
advance, 262–265 guaranties, 93–95 136, 257
final, 265–268 implied, 214–216

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