Three Key Contract Terms in a Volatile Market

by J.P. Neyland

September 14, 2022

Since March 2020, the construction industry has seen unprecedented volatility in its material and labor markets. The costs of key materials have risen substantially over pre-pandemic levels, and supply-chain delays have made it considerably more difficult to estimate lead times. In some cases, costs have more than doubled in just two years. And though these costs have been felt throughout the industry, they have proven costliest to those parties who failed to address them ahead of time—by contract.

Owners and contractors alike have grown increasingly concerned about the construction industry’s volatile material and labor markets and are looking to address these issues upfront. Prices for necessary materials and labor continue to fluctuate, disrupting the bidding process and making it harder to negotiate and execute contracts—particularly those with a stipulated sum or a guaranteed maximum price. And on top of inflation, supply chain issues have created substantial uncertainty: it’s hard for anyone to say whether labor and materials will be available months or years down the line, much less how much they will cost.  

Under these conditions, it’s important for both owners and contractors to pay special attention to the contracting phase of any new project. It is not enough to rely on standard-form contracts, most of which do not sufficiently address the price fluctuations and unavoidable delays that plague today’s construction industry. Fortunately, good legal counsel can provide significant protection from market fluctuations and supply-chain issues. The following three drafting techniques are particularly well suited to addressing these risks in the current environment. 

  1. Express Provisions:

The most conspicuous way to address volatility is to expressly state whether the contractor is entitled to an increase in the contract sum or contract time as a result of price escalations or delays in obtaining labor and materials. Of course, given the risks they pose to all parties, these express provisions are often the subject of intense—and sometimes acrimonious—negotiation. Fortunately, there are a number of ways a carefully drafted contract can regulate these issues to all parties’ satisfaction, including: 

  • limits on the total increase in price and time for performance; 
  • limits on the percentage increase in cost of materials;
  • caps on the total amount of increase in the contract sum or contract time;
  • duties to mitigate;
  • notice obligations; and
  • a threshold of change in cost or time that must be met before an adjustment to the contract sum or contract time is permitted. 

The best way to address these issues in the contract will vary according to the structure of the project. But by discussing their concerns openly and collaborating on a solution, parties can typically agree on a method to limit their exposure. 

  1. Exceptions:

Another way to address volatility is to include specific exceptions related to market fluctuations and supply chain issues. As mentioned above, standard industry forms commonly charge the contractor with responsibility for all costs of materials, labor, and equipment. But contractors can avoid excessive exposure by adding language that “carves out” increases in the cost of materials or delays in contract performance caused by market fluctuations and conditions, governmental actions, supply chain issues, or other causes beyond the parties’ control. These “carve-outs” exclude such costs from the contractor’s responsibility and, when triggered, credit the contractor for the additional costs of price hikes and delays.

  1. Allowances:

Finally, parties can use contractual allowances to mitigate fluctuations in the price and availability of supplies. In general, a construction allowance is an estimated amount included in an initial contract sum as a placeholder until the exact pricing of the material or labor is known. If the actual cost of the material or labor exceeds the allowance, the contract requires the parties to execute a change order to increase the contract sum by the amount of the excess cost. 

As with the express provisions discussed above, the potential exposure from an allowance can easily exceed seven figures when there’s a sudden increase in the price of a material, such as lumber. Parties must also consider the potential for triggering liquidated damages provisions due to delays that are largely outside their control. It is therefore essential for both owners and contractors to consult experienced attorneys who can thoroughly review and negotiate their contracts with an eye toward minimizing the risks of the current market. 

The construction-law specialists at Griffith Davison have extensive experience negotiating contracts in all sectors of the industry and can help you navigate this volatile market. To discuss these issues in more detail or to have a legal professional analyze or draft necessary contractual terms, please consult with one of our attorneys at (972) 392-8900. 

Texas Legislature Relieves Contractors of Liability for Design Defects—With a Few Caveats

by Tatianna Brannen

September 7, 2022

Should contractors be on the hook for defective designs that they didn’t create? For more than a century, the Texas Supreme Court answered that question with a “yes,” placing Texas among the small minority of states that expose contractors to liability for defective plans provided to them by the project owner. But the Legislature has now taken matters into its own hands: its latest addition to the Business & Commerce Code relieves builders of liability for defective plans and brings the Lone Star State into line with the national consensus. As with any law, there are exceptions, but the experienced construction attorneys at Griffith Davison are here to help you navigate them. So, what does the new law say, and what does it mean for you?

Under the newly added Chapter 59 of the Texas Business & Commerce Code, contractors are no longer responsible for the consequences of design defects. Tex. Bus. & Com. Code § 59.051(a). The law also ensures that a contractor need not (indeed, may not) “warranty the accuracy, adequacy, sufficiency, or suitability of plans, specifications, or other design documents provided to the contractor by” anyone other than the contractor’s own agent or associate. Id.

Chapter 59 represents a sea change in Texas’s contractor-liability law. Since 1907, the so-called Lonergan Rule has left contractors responsible for defects in design plans and specifications—even where the plans were made by a separate design professional hired by the owner. See Lonergan v. San Antonio Loan & Trust Co., 104 S.W. 1061 (Tex. 1907). Chapter 59’s new regime frees contractors from the risk of legal liability for plans they had no part in creating. Builders can now rely on plans and specifications given to them by project owners without worrying about being sued for flaws in those designs. The new rule does have some important caveats, though. All actors in the construction industry should be aware of these three qualifications:  

  1. Chapter 59 obliges contractors to disclose any design defect they learn about. Specifically, a contractor must, “within a reasonable time,” inform the other party to the contract about “any known defect in the plans, specifications, or other design documents that is discovered by the contractor, or that reasonably should have been discovered by the contractor using ordinary diligence, before or during construction.” Tex. Bus. & Com. Code § 59.051(b). A noncompliant contractor “may be liable for the consequences of defects that result from the failure to disclose.” Id. § 59.051(c). Texas courts have not yet interpreted the contours of this new disclosure duty, but until they do, contractors should scrupulously document and report any concerns raised by a client’s design plans. 
  2. Chapter 59 does not apply to any project that falls within the statutory definition of a “critical infrastructure facility.” Id. § 59.002(b). That definition includes, among other things, oil refineries, power plants, and a range of oil-and-gas-related sites. Id. § 59.001(3). Contractors should carefully review the full list of critical infrastructure facilities before signing on to any large-scale project. 
  3. Logically enough, Chapter 59 does not shield contractors from design-defect liability if they are the reason for the defect. Thus, the Lonergan Rule remains intact to the extent a contractor is responsible for any design documents that turn out to be defective. To this end, Chapter 59 specifically does not cover (1) design‐build contracts insofar as the designs or plans provided by the contractor are defective; (2) engineering, procurement, and construction contracts (again, to the extent the contractor’s designs are at fault); or (3) any portion of a contract where the contractor agrees to provide signed-and-sealed design input that is ultimately incorporated into the project. Id. §§ 59.002(c)–(d). This last carveout can put contractors in a particularly tough position because it determines liability on a piece-by-piece basis. For example, if a swimming pool subcontractor provides signed, sealed shop drawings that are later used during construction, the contractor is exposed to liability for any defect in the pool’s design. Thus, even if the contract with the owner wasn’t labeled as a “design-build” contract, the contractor may still be exposed to liability for the designs of his subcontractors.  

In short, Chapter 59 is a momentous development for the construction industry. The Texas Legislature has turned more than a century of legal precedent on its head to protect contractors from flaws in other people’s designs. The news isn’t all rosy for builders, though: Chapter 59 carries several important caveats that may limit—or in some cases negate—the statute’s benefits. Careful attention to the letter of the law and its judicial interpretations will be indispensable as the industry adjusts to a new legal landscape. 

To discuss how these design-defect laws could impact your business, please consult with one of our attorneys at (972) 392-8900.

Contracts for Services Vs. for the Sale of Goods

by Kylie Barfield

April 15, 2022

Contracts for Services vs. Contracts for the Sale of Goods: What’s the Difference? 
Different laws govern contracts for services and contracts for the sale of goods. While some statutes apply to particular portions of a contract for services, common law principles (i.e., case law, not statute) govern contracts for services. In contrast, Article 2 of the Uniform Commercial Code (“UCC”) governs contracts for the sale of goods. Article 2 defines “goods” to mean all things (including specially manufactured goods) which are movable at the time of identification to the contract for sale. Tex. Bus. & Com. Code § 2.105. For example, the UCC would govern a contract under which a lumber supplier agrees to provide the lumber used by the framer in framing a building. The contract for the labor to frame the structure, on the other hand, would be a contract for services that is mostly governed by case law and not the UCC. 
 
Mixed Goods-Services Contracts: The Predominant Purpose Test
Construction transactions often involve a hybrid of goods and services. So, when a contract requires a party to furnish goods and services, which set of laws apply? Determining which set of laws apply requires an analysis of whether the predominant purpose of the transaction is for services or for the sale of goods.

Courts implement the “predominant purpose test” (also known as the “dominant factor test”) to determine whether common law or the UCC applies to mixed goods-services contracts. Under the “predominant purpose test,” the applicability of either common law or the UCC hinges on whether the predominant purpose of the transaction requires either (1) the performance of services with goods incidentally involved; or (2) the sale of goods with labor incidentally involved. 

When legal disputes arise as to whether the UCC or common law applies to a contract, Texas Courts have implemented the “predominant purpose test” under two styles of analysis. First, some Texas Courts have looked at the actual nature of the dispute to determine which aspect of the transaction the issue most closely pertains. Montgomery Ward & Co. v. Dalton, 665 S.W.2d 507, 511 (Tex. App.—El Paso 1983). In other words, is the dispute more about the good or more about the labor? Under this style of analysis, the language in the pleadings often dictates the applicable law. In other cases, Texas Courts have relied on the language of the contract itself and have not looked to the nature of the dispute to determine whether the UCC applies. Freeman v. Shannon Constr., Inc., 560 S.W.2d 732, 737 (Tex. Civ. App.—Amarillo 1977). Under this alternant analysis, Texas Courts have looked at the transaction as a whole and the wording of the contract to determine if the essence of the contract is furnishing of services or supplying of goods. 
 
Navigating Mixed Goods-Services Contracts 
While the analysis may be far from black-and-white, it is important to know when to utilize contracts for services and contracts for the sale of goods. These two forms of agreements can be, and should be, vastly different. For example, if a services form agreement is used for a sale of goods transaction, the warranty provision may not comply with the UCC and may be deemed void. Unintended results such as this can be the harsh consequence of not utilizing the correct form of agreement. Construction professionals must consider whether the essence of the transaction is for services or the sale of goods when determining which type of contract to implement. Alternatively, to avoid the harsh results of using the wrong form of contract, construction professionals may consider separating the transaction into different agreements, one covering the services and the other covering the sale of goods. Understanding the differences between contracts for the sale of goods and contracts for the labor is critical whether you are the purchaser or seller in the transaction. 

To discuss how these contract laws could impact your business, please consult with one of our transactional lawyers at (972) 392-8900.

Design Defect Bill Passes Texas House, Goes to Governor Abbott

by Patrick Mulry

May 24, 2021

On May 13, the Texas House passed the legislation commonly referred to as the “design defect bill.” The vote in the House was 113-27, again indicating broad bipartisan support for this fundamental change in Texas law.

The design defect bill now goes to Governor Abbott for further action. He has the option to sign it, veto it, or allow it to become law without signature. Given that the bill passed by wide margins in both chambers, Gov. Abbott is expected to sign the bill.

If the design defect bill becomes law, it will go into effect on September 1, 2021. As with other recent changes in construction law-related legislation, application of the law to contracts and subcontracts is not retroactive, but is based upon the date into which the prime contract was entered.

As noted previously, the design defect bill represents a major change in Texas law that should have substantial positive effects for contractors which, under current law, may have exposure to damages caused by a design defect not caused by the contractor and for which the contractor otherwise has no recourse against the responsible design professional.

In advance of the effective date of the law, contractors should consult with counsel for important revisions to their prime contracts, as well as for revisions to subcontract agreements to ensure that all contract forms afford contractors and subcontractors the protections to which they will now be entitled.

Design Defect Bill Passes Texas Senate

by Patrick Mulry

April 12, 2021

The legislation commonly referred to as the “design defect bill” passed the Texas Senate on Thursday, April 8. The vote on Senate Bill 219 was 29-1, indicating that this fundamental change in Texas law has broad bipartisan support. The bill has been forwarded to the House and is expected to be voted on and passed in the next few weeks and then signed into law by Gov. Abbott later this spring.

The heart of the design defect bill is that a contractor cannot be held responsible for the consequences of defects in, and may not warranty the accuracy, adequacy, sufficiency, or suitability of plans, specifications, or other design or bid documents provided to the contractor by the person with whom the contractor entered into a construction contract (or another person on behalf of the contracting person, typically the owner or owner’s representative). Exempted from the protections afforded by the bill are projects designated as critical infrastructure facilities and projects performed under a design-build contract. Also exempted from the bill are design-build portions of work (for example, swimming pools or fire protection systems) that are part of a larger project which is not itself a design-build project.

This bill represents a major change in Texas law that should have substantial positive effects for contractors which, under current law, may have exposure to damages caused by a design defect not caused by the contractor and for which the contractor otherwise has no recourse against the responsible design professional.

Additionally, the design defect bill contains a mandatory prohibition of waiver which prevents the owner from contracting around this protection for the contractor. In return, the bill requires the contractor, which includes all tiers of contractors and subcontractors, to notify the owner if the contractor learns of a defect in the design documents, or of a design defect that the contractor should reasonably have discovered using ordinary diligence before or during construction. Such notice must be given within a reasonable time of learning of the design defect. The language of the bill is thematically similar to the notice concept already embodied in sections 3.2.2 and 3.2.3 of the AIA A201 general conditions, so it does not impose a requirement that should be unfamiliar to most contractors of size.

If passed, the bill will go into effect on September 1, 2021. As we have seen with other construction-related legislation over the past several decades, this bill will not apply retroactively, but instead will apply only to contracts entered into on or after September 1, 2021. Application of the law to subcontracts is based not on the subcontract date, but upon the date into which the prime contract was entered.

Should the design defect bill become law, contractors will want to consult with counsel for important revisions to their prime contracts, as well as for revisions to subcontract agreements to ensure that all contract forms are in compliance with the new law.

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About Griffith Davison

Griffith Davison, P.C. is a boutique law firm, which focuses on the legal needs of the commercial construction and real estate industry. Founded in 1993, the firm provides services in the areas of construction law, commercial real estate, complex commercial litigation and corporate transactions. Griffith Davison understands the construction and real estate industry and works closely with its clients at every phase to help them navigate the legal landscape, manage risk and achieve success.

For more information visit us online at www.GriffithDavison.com or call us at (972) 392-8900.

Timing of Delivery Does Not Always Negate Prompt Payment Act Obligations

by Tatianna Brannen

March 26, 2021

The Fifth District Court of Appeals in Dallas recently affirmed that a contractor violates the Prompt Payment Act by paying themselves with funds intended to pay its subcontractors.

In this case, the contractor subcontracted with a window supplier to provide windows for a hotel project. The window supplier provided the windows and sent the contractor an invoice. The contractor later sent a payment application to the owner requesting payment for several items, including the windows, for work completed in a previous application period.

The owner paid the contractor but withheld payment for the contractor’s overhead and profit. The contractor then decided to pay itself and “select subs” rather than paying all subcontractors. The window supplier did not receive payment.

The contractor argued it was not a violation of the Prompt Pay Act because there was conflicting evidence on whether the windows were delivered to the project before or after the contractor received payment from the owner.  However, because the evidence conclusively established the contractor received payment for the windows pursuant to the pay application, the contractor was obligated to pay the window supplier regardless of when it actually delivered the windows. Unless there is an express contractual provision to the contrary, a contractor is ultimately responsible for its subcontractors’ payment.

Albertelli Constr. v. Ram Indus. Acquisitions, LLC, No. 05-18-01429-CV, 2020 Tex. App. LEXIS 3965 (Tex. App.—Dallas, May 15, 2020, no pet. h.).

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About Griffith Davison

Griffith Davison, P.C. is a boutique law firm, which focuses on the legal needs of the commercial construction and real estate industry. Founded in 1993, the firm provides services in the areas of construction law, commercial real estate, complex commercial litigation and corporate transactions. Griffith Davison understands the construction and real estate industry and works closely with its clients at every phase to help them navigate the legal landscape, manage risk and achieve success.

For more information visit us online at www.GriffithDavison.com or call us at (972) 392-8900.

Pitfalls of Contractor’s Consents

by Michael Lilly

October 23, 2020

You’ve negotiated your Agreement with the Owner and you’ve started to mobilize.  The Owner is still trying to close on its construction financing – but they are “close.”  You receive a call from the Owner’s representative, the representative says “closing is scheduled for tomorrow, the lender just needs you to sign a document before they will fund, it’s no big deal, I’ll send it over to you right now – just sign it and get it to me as soon as possible.”  Finally!  The project is about to start!  You receive the document, a Contractor’s Consent, and you are inclined to just sign it and get to work. Should you?

What Is It Really?

In virtually every construction loan transaction with a commercial lender, the lender will require the borrower (owner) to assign the borrower’s interest in its construction contract with the general contractor, to the lender as additional collateral. This document is generally referred to simply as an Assignment of Construction Contract or Collateral Assignment of Construction Contract.  In connection with the borrower’s delivery of the Assignment of the Construction Contract, the lender will generally require that the borrower’s general contractor consent in writing to such assignment.  Thus, a Contractor’s Consent is first and foremost the general contractor’s written consent to the borrower’s collateral assignment of the construction contract.  However, lenders will ordinarily include multiple additional terms and concepts that the contractor should consider.

THE MAJOR ISSUES

If the Lender elects to assume the Construction Contract, when will it happen?

In the event of a borrower default under the loan documents, nearly every Contractor’s Consent sets forth a procedure allowing for the lender to either (i) terminate the project, or (ii) to assume the construction contract and take-over the project. Often, however, the consent will not require that the lender makes its choice, to either terminate or assume the construction contract, within a specific period of time.  Thus, should the lender declare the borrower in default, what is the general contractor to do?  The short answer is – the general contractor must stop work and wait on the lender to make a decision.  This will, in the very least, result in additional de-mobilization costs and potentially significant re-mobilization costs (should the lender elect to proceed with the contract).

What can the general contractor do?  Negotiate a specific time frame for the lender to make its election to terminate or assume the construction contract.

Lender consent to Change Orders.

Often Contractor’s Consents will include a specific obligation that the borrower and contractor obtain the Lender’s prior consent to any Change Orders.  The result – an already time consuming and often difficult change order process become infinitely more time consuming and difficult, as lenders are typically reluctant to agree to changes in cost and scope for a project.

Tracking and logging COVID-19 expenses

April 10, 2020

Time is crucial in every construction project. Delay costs, liquidated damages, back charges, and additional labor hours for slow and untimely completion can ruin profit margins and lead to serious problems down the road. COVID-19, if it hasn’t already, will inevitably create costs and delays, none of which could have been negotiated or realized when an original construction contract was formed. Examples of these costs and delays include:

  • Government mandated shutdown of jobsites
  • Worker unavailability
  • Costs for extra personal protection equipment
  • Health inspection fees
  • Material expense increases for supply chain disruption and delays in production
  • Increased equipment requirements to keep workers busy but apart from each other
  • Technology costs to provide remote meeting capabilities for management, owners, architects, and contractors
  • Labor expenses after jobsite shutdowns
  • Delays and increased inspection costs

Understanding the rights and responsibilities in a construction contract is vitally important for successfully recovering these costs and delays. For example, many construction contracts contain force majeure clauses that provide time extensions to contractors for “acts of god” or for “other causes beyond the contractor’s control” but often require timely notices and ongoing reporting and due diligence. Further, change orders can provide a means of recovering losses but regularly the contract requires the costs and delays be contemporaneously identified and quantifiable. Regardless of the tool used to mitigate losses, consistent and contemporaneous tracking and detailing is key.

Here are three techniques contractors can use to track their COVID-19 related costs and delays: (1) create a new general ledger account or job; (2) create new costs codes for tracking COVID-19 related costs on a per job basis; and (3) encourage superintendents and those familiar with the jobsite to keep notes regarding additional, new restrictions implemented to slow the pandemic’s spread.

When creating cost codes for COVID-19, it is also important to break the code out to specifically identify the labor and material attached to the code. By removing ambiguities, the contractor preserves its claim, eases its later burden when proving its delays, and takes away an easy and available argument for would-be challengers.

By implementing a system(s) for tracking the inevitable delays now, contractors put themselves in the best position to recover later. If you need help understanding the forms of recovery, the implications in a contract, or have any other questions related to COVID-19’s effect on the construction industry, contact us so we can help you continue business.

 

COVID-19 and the Construction Industry

April 1, 2020

Good news for the construction industry in Texas.

On March 31, 2020, Governor Abbott signed Executive Order GA 14 which clarifies what services are considered essential services during the COVID-19 pandemic. A copy of the Executive Order can be found here:

https://gov.texas.gov/uploads/files/press/EO-GA-14_Statewide_Essential_Service_and_Activity_COVID-19_IMAGE_03-31-2020.pdf

Fortunately, various construction activities are now included in the definition of essential services and companies may continue, as long as they adhere to the requirements for operating an essential service. This Executive Order supersedes any conflicting local orders, which means that we now have a standard definition which governs construction projects throughout the state.

Under the Governor’s Executive Order, Texas will follow the list of “essential services” as defined by the US Department of Homeland Security in its most recent Guidance on Essential Critical Infrastructure Workforce dated March 28, 2020. This updated Guidance adds Commercial Facilities and Residential Facilities to the list of essential services:

Commercial Facilities includes workers who support the supply chain of building materials from production through application/installation, including cabinetry, fixtures, doors, cement, hardware, plumbing, electrical, heating/cooling, refrigeration, appliances, paint/coatings, and employees who provide services that enable repair materials and equipment for essential functions.

Residential Facilities includes workers performing housing construction related activities and workers supporting the construction of housing.

To review the complete March 28, 2020 list of Essential Critical Infrastructure Workforce, follow this link:

https://www.cisa.gov/publication/guidance-essential-critical-infrastructure-workforce#download

Please note that as the country responds to the virus, local and federal regulations continue to change. Contact us if you need guidance on how the latest rules apply to your construction and real estate projects, and how to comply with the rules regarding operating an essential service.