The Dotted Line: How to craft contracts to avoid disputes and keep legal fees down

There’s an old saying in construction about there being only two types of contractors: those who have been sued, and those who will be.

While that maxim may be tongue-in-cheek, it received validation recently in a report from business credit scoring agency Creditsafe. The firm found that the construction industry had the third-highest number and cost of legal filings among all U.S. business sectors.

Indeed, construction businesses had 212,582 legal filings entered against them last year, resulting in cumulative losses exceeding $3.36 billion, according to Creditsafe’s State of Credit Risk 2022 report released in February.

For construction attorneys who deal with these disputes, the findings were hardly surprising. They said the numbers merely reflect the fragmented nature of the business.

“On some of these projects, you’ll have 30 or 40 parties involved,” said Elizabeth Coppolecchia, a partner with Miami-based Weiss Serota Helfman Cole + Bierman, who specializes in construction claims. “Anytime you have that many players, when there are disputes, it’s inevitable that you will have a large number of claims.”

That multifaceted structure sets itself apart from business arrangements in other industries, lawyers said, where deals often get done one on one.

“A construction project is not your typically two-party transaction with one contract and one set of rules,” said Philip Mannelly, an attorney in the construction practices group at McDonald Carano in Reno, Nevada. “With so many different interests, there’s just a lot of opportunities for things to go sideways.”

Banking jitters

In the current economic environment, those opportunities have multiplied, attorneys said, as access to capital has tightened and banking jitters have spurred lenders to apply more scrutiny to projects.

“Sometimes, there are provisions that things like change order approvals have to go through the lender itself,” Mannelly said. “So even if the owner and the general contractor agree, if the lender says no, that creates a dispute.”

The cascading provisions that are embedded in many contracts, where the rules that apply to a relationship higher up in the project chain must be adopted by those lower down, can also lead to more disputes when one party doesn’t fulfill its obligations.

“If one person sues at the ownership level, then every trade contractor has to sue their subs and suppliers to protect themselves, so it becomes a mess,” said Andrew Richards, a co-managing partner and co-chair of the construction practice at Kaufman Dolowich Voluck in Woodbury, New York. “It’s the domino effect, and it all runs downhill.” 

Richards points to the gargantuan litigation that’s playing out currently in New York City surrounding 432 Park Avenue, the supertall condominium tower on Billionaire’s Row that has been beset with lawsuits. Owners have sued the developer, claiming more than 1,500 building defects.

“That litigation is a monster,” Richards said. “You’ve got all these wealthy people suing the sponsor who built it, and then the sponsor is suing Lendlease, who was the construction manager. We’ve had to keep a running counsel list just to keep all the parties straight.”

Why does it cost so much?

The same multipliers that lead to a high number of claims also contribute to outsized monetary damages, lawyers said. Larger and more complex projects, paired with increased costs for materials and labor, have upped the dollar amounts that are at stake.

“The price of land has risen, too,” said Richards. “And as construction gets more complicated via the engineering process, buildings are getting bigger. That’s why you have bigger claims. It’s just that simple.”

Another factor has been the spiraling amount of electronic discovery that claims generate as more and more of the construction process is captured digitally.

“One of the biggest reasons, I think, is the advent of technology,” Coppolecchia said. “Even a project that’s not huge could generate multiple terabytes of data in discovery. You’re talking about the cost of collection, and the cost of paying attorneys to find the needle in the haystack.”

How to avoid claims

With both the numbers and dollar amounts of construction claims at dizzying heights, lawyers say the best thing to do is to try to avoid claims in the first place, while writing language into contracts to keep their costs down when they do happen.

As with nearly all aspects of construction, doing so starts with the fine print. While form contracts can be a good starting point, attorneys say provisions for a project’s unique aspects should also be considered, even if those modifications cost more to write up.

“I always tell my clients, spend your money up front,” Coppolecchia said. “You see it all the time where it’s a project that’s worth $60 million, but owners, developers and contractors will just take a form contract, change the names and hope everything will go well. It’s shocking.”

Instead, put in the time and money to make sure the issues of the day, as well as the current project, are reflected in those governing documents. For example, Coppolecchia said that many boilerplate agreements still haven’t taken rising material costs into account.

“A lot of times, nobody considers that’s not really covered in the form docs,” Coppolecchia said. “That’s something you have to add in to protect yourself from industrywide price increases.”

Contractors can also try to limit the types of claims that are permitted under certain scenarios.

“You can use clauses that preclude someone from making a claim based on certain scenarios, such as delay claims,” Richards said. “If you’re a GC, you put in your subcontracts that if the owner has a change or causes a delay, that you’re not liable to your subs unless you recover from the owner. That makes sure the GC doesn’t get caught in the middle.”

Keeping claim costs down

If claims do arise, attorneys say contract language can help keep the price tag down as well. For example, Coppolecchia likes to include provisions for at least two rounds of mediation before a dispute can be taken to court.

“You want to include alternative methods you can use to work through issues with the other party,” Coppolecchia said. “If you can work things out informally, you’ll save quite a bit of money.”

Another strategy is to introduce a clause for liquidated damages — which are paid when a party doesn’t fulfill its side of the agreement — using an amount that’s predetermined before any disputes arise. For example, the owner of a restaurant project may estimate that any delay in opening would cost $1,000 per day, based on lost revenues.

If that gets put in the contract and a delay happens, it helps expedite enforcement, because no expert needs to be brought in at that point to determine what damages should be. But it also puts the contractor on notice for any potential costs.

“It provides a reasonable recovery for the owner if the contractor is legitimately delayed, and it also lets the contractor know what its risk and potential exposure is,” said Mannelly. “That ultimately could lead to a more efficient resolution and negotiation to close out the project.”

While putting specific dollar amounts on items upfront can make negotiations tense, it avoids even more fraught discussions later. “People can be averse to putting a number on it,” said Mannelly. “But on the other hand, you know your risk going in.”

That approach could be a middle ground to waiving damage rights completely, which ironically could result in a higher cost when a dispute arises.

“A lot of times what we see is both parties will agree to a waiver, which is standard in many form contracts,” Coppolecchia said. “But if you’re going through this and you end up in litigation, you really shouldn’t waive those damages. Because a lot of times, that’s where you’ll really end up losing money.”

____________________________________________________________
The Dotted Line series is brought to you by AIA Contract Documents®, a recognized leader in design and construction contracts. To learn more about their 200+ contracts, and to access free resources, visit their website here. AIA Contract Documents has no influence over Construction Dive’s coverage within the articles, and content does not reflect the views or opinions of The American Institute of Architects, AIA Contract Documents or its employees.