Real Estate Construction Contracts: Owner Obligations

Owners who approach construction contracts with a hands-off attitude may be in for surprises when it comes to express and implied obligations contained in the contract. Some of …

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Owners who approach construction contracts with a hands-off attitude may be in for surprises when it comes to express and implied obligations contained in the contract. Some of these obligations will include agreements to provide timely access to the worksite and not hinder the construction process. The contract will also contain specific determinations about payment the owner must know, or possibly face penalties. It is also a good idea for the owner to understand the difference between providing more direction for the work to be complete and asking for changes that will entitle the contractor to more money and time to do the job. For more on this continue reading the following article from JDSupra.

Driving a construction contract to signature can sometimes feel like reaching the finishing line of a  very  long,  uphill  race.  The  tender  process  for  the  contract  may  have  included  a  prequalification  stage  or  a  multi-tiered  tender  review,  protracted  dialogue  with  one  or  more tenderers to reach a preferred bidders stage, and then a lengthy negotiation to finalise the contract-drafting.

Owners might be forgiven for preferring to take a hands-off  approach to their construction contract,  simply  stepping  away  until  such  time  as  they  need  to  take  over  the  project  for operational purposes.

Unfortunately this approach can land an owner in hot water. He may risk, by his own actions or inactions,  decreasing (or  even  eradicating)  any  rights  of  claim  he  may  have  under  his construction contract or, worse, trigger claims from his contractor. It really is crucial for owners to read their contract, understand their obligations, and comply with them in every respect.

It is not possible here to discuss the full range of obligations that an owner would need to comply with under his construction contract – in any event many such obligations will be particular to the drafting of the contract itself. However, we know that an owner will face a typical range of major obligations.

I Just Follow the Contract, right?

Owners may be interested to know that the obligations they have under a contract are not just those expressly contained in the contract itself. Contractual terms may be broadly split into express  contractual  obligations  and  obligations  which  are  imposed  upon  the  parties  by implication at law. Owners need to be fully aware of these unsaid or unwritten obligations.

Let us Cooperate and not Hinder

The ‘prevention principle’ is an implied term under English law, to the effect that neither party may do anything to hinder the other from performing the contract. Or from another perspective, no party is able to take advantage of his own wrongdoing. Beware the overbearing owner who is hit with a whole host of claims on completion of the works for having hampered the contractor’s progress through his own excessive involvement.

Owners may also face the argument that they have a positive obligation to do anything that may be necessary to enable the contractor to perform his own duties. This is effectively an obligation to cooperate, albeit a limited one in English law: "to the extent that it is necessary to make the contract workable"1, so that such an obligation might be a ‘best endeavours’ or even ‘reasonable endeavours’ obligation rather than an absolute obligation. Civil jurisdictions tend to impose a stronger cooperation obligation than this by operation of their civil code principles of good faith and fair dealing.

The spirit of these two implied terms runs through the core of every construction contract and needs to be borne in mind at all times by owners in everything they do.

Access all Areas?

One of the most fundamental obligations at law of any owner is the requirement to give access and/or undisturbed possession of the site for the purposes of performing the works in the manner  (which includes the sequence) of the contractor’s choice. An owner must give his contractor timely access in accordance with the terms of the contract. Failing express provision, English common law implies a term that the site will be handed over to the contractor within a reasonable period of signing the contract.

It is relatively common in construction contracts to include provisions for the awarding of time and money to a contractor who has been denied timely access, or alternatively denied access strictly on the terms set out in the contract. Even if no such express provision exists, the contractor would typically have an entitlement to damages at law for contractual breach. A timely reminder at this point: every owner needs to ensure that, at the outset when the contract is being drafted, he is contracting to perform only those matters that are actually within his power to perform. Beware a commitment to provide access and possession of a site which is not yet in the control of an owner.

Show me the Money

The obligation to make payment is clearly one of the most important owner obligations. To reflect this, there are normally quite serious consequences for failure to make payment set out in a construction contract, including the right for the contractor to suspend for non-payment (such right also being entrenched in law in many jurisdictions; in England via the Housing Grants, Construction and Regeneration Act 1996 which applies to construction contracts), and ultimately to terminate the contract if the non-payment is persisting.

The payment provisions in any particular contract will invariably reflect a finely balanced liquidity profile  – many contractors will expect to be able to operate on at least a cash-neutral basis. Payment provisions may therefore include an obligation to make an advance payment to the contractor, perhaps to secure long-lead items of equipment.

The payment provisions may include either for monthly payments, or for staged payments upon achievement of particular milestones. The owner will be required to make such payments upon a particular due date, failing which he may be obliged to pay interest on any payments being made later than such due dates.

Although entitled to withhold payments for disputed amounts, owners will often be obliged to tell the contractor in advance of the due date what sums will be withheld and why (again, in some jurisdictions this obligation is also entrenched in law).
There may also be provisions relating to the right of the owner to take retention as a form of performance security  – however the owner must stay on top of his obligation to repay the retention monies, usually in two stages upon practical completion and then the end of the defects liability (or maintenance) period.

Every owner needs to make sure in all of this that the terms agreed for payment are terms which his own accounting teams can actually achieve  – promising 30-day payment terms which an owner’s internal processes cannot manage will lead to extra costs and give the contractor some legitimate causes for claim.

I have Changed my Mind

An  owner should expect  (and  want) to have  an  obligation to propose and/or approve any changes/variations to the scope of the works. Normally an owner’s comments or approvals will need to be made within a specific timeframe. An owner failure to comply with a timeframe under the contract may amount to a breach entitling the contractor to damages to the extent that he can prove any losses attributed to such breach.

Whether or not a contractor is required to continue with the works pending agreement of the extra time and/or cost of the change will define the practical urgency with which an owner must comply with any timeframes under the contract. In reality, it will suit many owners to leave assessment of variations to the end of the project, when they can be swept up with any other claims that may be pending from the contractor.

You Need to Tell me What You Want

An owner can expect contract terms relating to the provision of information necessary for the carrying out of the works. Again, failure to comply with this obligation within the timescales set out in the contract (or failing express provision, a reasonable time, according to the prevention principle) may have time and cost consequences. It is in every party’s interest that the contractor be in possession of any relevant data, and particularly any relevant geological/site/engineering data, say, for example, feasibility studies.

Very few construction contracts are able to contain sufficient detail that subsequent ‘instructions’ are not also required. Instructions, to be distinguished from changes/variations, are extra detail which the contractor needs from the owner to be able to perform the existing works. By contrast, changes/variations are extra works which will entitle the contractor to more time and/or money. It is normal for a construction contract to contain an obligation for the contractor to perform the
works in accordance with, amongst other things, written instructions of the owner. A sensible construction contract will contain a procedure for such instructions to be formalised.

Sounds straight-forward, but in reality it can be very difficult to distinguish an instruction from a change to the works, and this often leads to major claims and disputes.

Necessary instructions  can,  for  common  law purposes,  fall  into  the  requirement  for  owner provision of timely information to the contractor (on the basis of the prevention principle), and failure  to  provide  timely  instructions  may  accordingly  entitle  the  contractor  to  damages. Persistent failure, or alternatively failure to provide information that is strictly necessary for the works, may ultimately be considered as a repudiatory breach of the contract at law, entitling the contractor to terminate.

A common cause of action that we see regularly tested is that of time and money claims for failure to approve drawings/samples/other documents in a timely manner. Although from time-to-time there may be claims resting upon the owner’s failure to approve one particular crucial document, claims of this nature will usually aim to demonstrate the creeping effect upon a project programme of failure generally by the owner (or his agent) to push through all document approvals quickly enough.

A well-drafted construction contract will include an approvals process with timescales (e.g., 14 days from receipt) for approval of each and every document by the owner.

The success or failure of a claim of this nature will rest upon the evidence available to the parties. Does the contractor have sufficient evidence to prove that he has incurred cost and delay  as  a  result  of  late  approvals?  Or  can  the  owner  demonstrate  that  he  did  approve documents on time, or that the time and cost incurred by the contractor was not incurred as a result of delayed approvals? The keeping of good records by an owner is an extremely important project management responsibility  (rather than an actual contractual obligation) and one to which every owner needs to pay some attention.

For practical purposes…what does all this mean?

Owners can invest heavily in the drafting and negotiation of construction contracts, but the work does not  stop  there.  Owners must  be  aware  of  their obligations and  be  proactive  in  their management  of  the  contracts.  To  do  otherwise  risks  a  wasted  investment,  or  worse  still, exposure to additional risks and claims from the contractor.

This work falls broadly under the banner of project management: the act of planning, organising, securing,  and  managing  resources  to  achieve  particular  goals.  Even  an  owner  who  has appointed  an  EPC  contractor  to  take  on  responsibility  for  the  entire  project  still  needs  to implement a degree of project management support on his own side to manage his obligations and ensure he doesn’t inadvertently commit any contractual breaches.
 
From a practical perspective, many owners simply do not have adequate resources to be able to handle project management internally, and will choose instead to appoint a separate company to perform that role. One way or another, this role needs to be performed to avoid time slippages, cost increases and/or quality suffering.

About Reed Smith
Reed Smith is a global relationship law firm with more than 1,600 lawyers in 23 offices throughout the United States, Europe, Asia and the Middle East.

The information contained herein is intended to be a general guide only and not to be comprehensive, nor to provide legal advice. You should not rely on the information contained herein as if it were legal or other professional advice.

Reed Smith LLP is a limited liability partnership registered in England and Wales with registered number OC303620 and its registered office at The Broadgate Tower, 20 Primrose Street, London EC2A 2RS. Reed Smith LLP is regulated by the Solicitors Regulation Authority. Any reference to the term ‘partner’ in connection to Reed Smith LLP is a reference to a member of it or an employee of equivalent status.

This Client Alert was compiled up to and including January 2012. The business carried on from offices in the United States and Germany is carried on by Reed Smith LLP of Delaware, USA; from the other offices is carried on by Reed Smith LLP of England; but in Hong Kong, the business is carried on by Reed Smith Richards Butler. A list of all Partners and employed attorneys as well as their court admissions can be inspected at the website http://www.reedsmith.com/.

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