A poorly drafted contract increases the odds that a problem on a project or a problematic project itself may jeopardize the wellbeing of a contractor’s business. It is imperative that the contract is structured in a way that considers the future implications that a bad project may have on the business and its bottom line. But how can you ensure that the contract is up to this task? With a modern contract review process.
Recent history has shown that new and unanticipated risks can arise overnight. In the current economic climate, project delays caused by supply chain disruptions, material shortages, and subcontractor default can threaten the viability of a contractor and its projects. Unfortunately, too many contractors rely on outdated contract documents and insurance forms that do not reflect changing economic realities or shifts in the insurance and legal landscapes. This “set it and forget it” approach can leave a contractor exposed to evolving risks that should be addressed on an ongoing basis.
This article covers the modern contract review process, which involves collaboration among a contractor, its construction attorney, and insurance broker to:
- Anticipate and manage existing and emerging risks;
- Allocate those risks to the party best suited to mitigate them; and
- Ensure that proper insurance coverage is in place.
The Need for a Modern Contract Review Process
By its nature, construction is a forward-looking endeavor. Contractors rely on sophisticated critical path schedules to plan discrete tasks months into the future. They carefully orchestrate the delivery of materials, equipment, and personnel to accomplish a specific task at a designated time. This careful planning helps contractors anticipate risks, manage costs, and maintain schedules.
The same level of forward-looking planning that is critical to the success of a project should also be applied when reviewing the construction contract terms and insurance policy provisions that form the foundation of a contractor’s risk management program.
Attorney & Insurance Broker Review
Review by and input from an attorney and insurance broker can help ensure that risk allocation is appropriate, and that the business has coverage commensurate with a project’s requirements and needs.
It is important to seek review and counsel from both sources. The broker/insurance professional is trusted to review the insurance policy to see that insurable risks are covered using the most up-to-date coverages and endorsements in the market. Likewise, the attorney confirms that contracts properly identify, manage, and allocate risk to protect the business and help avoid claims and disputes.
Unfortunately, some contractors leave their broker out of the equation during contract development, which leaves the attorney to serve as both a legal and an insurance expert. Other contractors leave their attorney out of the contract review process and look to their insurance broker to review insurance and indemnity provisions. In many cases, neither professional is consulted, and the contractor relies on old contract forms that may not reflect the current project’s specific needs.
Balancing the intent of owners, contractors, subcontractors, and their insurers and sureties is done through well-constructed contract provisions. A construction-specific attorney and insurance broker can properly develop and review contractual terms and create harmony with insurance policies to help achieve the primary risk management objectives of contractual relationships: avoid unnecessary risks, accept only calculated risks, and transfer risk whenever appropriate.
Risk Avoidance
Risk allocation, avoidance, and acceptance in a construction contract can take several forms. Waiver provisions (e.g., waivers for consequential damages and subrogation) help contractors avoid or allocate future risk by eliminating the right of recourse against them for certain categories of damages.
A well-drafted waiver of consequential damages1 provision can help avoid significant potential risk. For example, §15.1.7 of the American Institute of Architects’ (AIA) Document A201TM – 2017 includes the following waiver:
“The Contractor and Owner waive Claims against each other for consequential damages arising out of or relating to this Contract. This mutual waiver includes: (1) damages incurred by the Owner for rental expenses, for losses of use, income, profit, financing, business and reputation, and for loss of management or employee productivity or of the services of such persons; and (2) damages incurred by the Contractor for principal office expenses including the compensation of personnel stationed there, for losses of financing, business and reputation, and for loss of profit, except anticipated profit arising directly from the Work. This mutual waiver is applicable, without limitation, to all consequential damages due to either party’s termination in accordance with Article 14. Nothing contained in this Section 15.1.7 shall be deemed to preclude assessment of liquidated damages, when applicable, in accordance with the requirements of the Contract Documents.”
An appropriate waiver of consequential damages provision may prevent a bad project from turning into a business-ending project. Consider the cautionary tale of Perini Corp. v. Greate Bay Hotel & Casino.2 In that case, Perini agreed to construct a “new glitzy glass façade” on a casino renovation project that was intended to lure people off the boardwalk and into the casino.
Unfortunately, construction was delayed, and the owner alleged it was unable to make full use of the casino and sustained significant financial losses as a result. In the ensuing arbitration, although Perini’s fee for the project was only $600,000, the owner was awarded $14.5 million for lost profits. The award was later upheld on appeal.
Perini Corp. v. Greate Bay Hotel & Casino illustrates the importance of employing a modern contract review process. First, a construction attorney’s review of Perini’s contract today would identify and mitigate the risk of consequential damages through careful drafting and review. Although industry form contracts like AIA and ConsensusDocs include standard waiver language, the scope of the waiver is often subject to disagreement and litigation. As a result, consequential damage waivers are routinely negotiated to specifically define the categories of damages that are excluded.
Second, knowing whether an insurance policy will cover consequential damages is critical information when faced with a contract partner that may not agree to waive such damages. One of the most commonly used coverage forms available, the ISO CG 00 01, provides as follows: “We will pay those sums that the insured becomes legally obligated to pay as damages because of ‘bodily injury’ or ‘property damage’ to which this insurance applies.”3
The phrase “because of” has been interpreted broadly enough to cover certain damages resulting from bodily injury or property damage covered by the policy.4 If property damage (or some other form of insured loss) occurs, which further leads to a project delay with all of its attendant costs (e.g., consequential damages), then those costs may be covered under a general liability policy; however, it is important to note that coverage may not apply if the consequential damages did not result from property damage or bodily injury.
In addition to insurance coverage, consequential damage provisions can be troublesome to a contractor’s surety. Surety support is primarily driven by the contractor’s experience and credit/financials. Potential consequential damages provide a significant unknown for the contractor, and in turn, the surety on a bonded job, given that a surety essentially steps in the contractual shoes of a contractor in the event of a default. A conversation should occur with the contractor’s surety broker and surety around what the surety is willing to support regarding contractual damage provisions, especially consequential damage provisions.
Ultimately, because courts have reached different conclusions about how consequential damage waivers should be construed, the best way to protect against outcomes like Perini Corp. v. Greate Bay Hotel & Casino is to have the construction contract reviewed by counsel familiar with the given state’s laws.
Further underscoring the need for a modern contract review process, consequential damages sustained by an owner or other contracting partner may not be covered by the contractor’s insurance policies. Collaboration with the insurance broker about how best to insure against the risk of losses that cannot otherwise be contractually avoided promotes sound risk management policy.
Waivers of Subrogation
Subrogation is a legal principle that allows an insurer that pays for a loss covered by its policy to seek reimbursement from the party (or parties) responsible for causing the loss.5 An insurer that pays for such a loss is said to “stand in the shoes” of its insured and possesses the same rights as the insured to pursue the responsible party. In other words, if a contractor is at fault for damage to an owner’s building and the owner’s insurer pays the loss, the insurer that stands in the owner’s shoes can pursue a claim against the contractor to recoup its losses. However, the insurer is also subject to whatever contractual limitations have been agreed to by its insured, including potentially the waiver of its own subrogation rights. In this regard, if an owner has agreed to waive subrogation rights against a contractor on a project, so have its insurers.