A set of management skills that always needs continuous improvement for owners and managers (contractors) of new and start-up construction companies is how to read, understand, analyze and negotiate the often confusing commercial terms and conditions found in construction contracts.

A common scenario is this:  Contractor bids on a project.  Contractor is low bidder on the project and it appears he will be awarded the project.  Contractor is given the clients standard contract, which contains the client's favorite set of commercial terms and conditions, to sign as a condition of getting the project award.  Contractor closes his eyes and signs the contract because he is reluctant to try to change the terms to something better for him.  Contractor puts the signed contract in his bottom desk drawer and prays hard that nothing will happen during the course of the project that will cause him to ever have to read the contract again.

Well, it just doesn't work that way.

Here are ten important examples of how it does work:

• Poorly defined scopes of work create claims and disputes.
• The completion schedule is way too short and exposes the contractor to damages for failure to complete on time.
• Terms of payment places contractor in a perpetual negative cash flow situation.
• Client keeps 5% to 10% of contractor's price as retention for up to a year after contractor finishes the project, which may be all the profit in the project.
• Indemnity clauses make contractor financially responsible for bodily injury and property damage claims caused by the negligence of the client.
• Indemnity clauses also make the contractor pay for the legal defense of the client for bodily injury and property damage claims caused by the negligence of the client.
• Contractor is required to name client as additional insured on contractor's general liability insurance policy which gives the client free insurance and full access to the policy coverage and limits.
• The term and/or coverage of the warranty is beyond normal industry standards.
• Dispute resolution clauses require only arbitration and then litigation, probably the two worst ways ever invented to resolve disputes.
• The client's pre-printed final waiver of lien document (necessary for contractor to receive final payment) waives all contractor's rights to recover unpaid extra work and to pursue any claims that arose during the course of the project.

Scope of Work:  Nothing in a construction contract is more important than a clear, well-defined scope of work that, in detail, outlines the work to be performed by the contractor.  The scope of work needs to also define work that is excluded and all work to be done by others, including the owner, that may interface with the contractor's scope of work.  Don't worry about too much detail; that detail will significantly help with the avoidance or resolution of claims and disputes that may arise out of the scope of work.

Schedule:  A simple precaution.  Make sure you have enough time in the schedule to properly perform the scope of work.  Always put some contingency time in the schedule; minor delays, weather, equipment problems, etc. are always going to occur and it's unlikely the client will be sympathetic to giving you more time for these delays.  Contingency time in the schedule is even more important if you are faced with liquidated damages for late completion.

Terms of Payment:  Terms of payment should always generate a positive cash flow.  Negotiate hard for good terms of payment.  Get a downpayment.  Or at least get some form of early payment.  That will get cash coming in early.  Paid when paid and paid if paid terms are unfair, period! Clients who want these types of payment terms all have very good access to plenty of money and can pay you per your preferred terms so you can enjoy positive cash flow.  Remember the three key rules of business: have cash, have cash, have cash.

Retention:  Resist as hard as you can allowing retention to be withheld from your periodic payment invoices; provide a warranty guaranty instead.  The common mantra is:  "the retention will assure your warranty obligations".  If that's what the client wants to achieve, then provide a warranty guaranty which does the same thing.  It's a lot cheaper to provide the guaranty than to allow the general contractor to sit on 5% to 10% of your money for a year or more.  Guaranties are provided by surety companies for a premium.

Indemnities:  Wherever you see the words "indemnify and hold harmless", regardless of the clause heading in the contract, you are looking at an indemnity.  Indemnities come in three flavors: 

• Broad Form:  A broad form indemnity contractually obligates you, the contractor, to be responsible for claims arising out of any amount of the client's negligence, including his sole negligence.  The 100% indemnity.
• Intermediate Form:  An intermediate form indemnity contractually obligates you, the contractor, to be responsible for claims arising out of the client's negligence, excluding only those claims arising out of the client's sole negligence.  The 99.9% indemnity.
• Limited Form:  A limited form indemnity contractually obligates both the contractor and the client to be responsible only to the extent they are negligent for a claim.

Indemnities typically cover claims for bodily injury, death of persons and property damage.  Not only do broad and intermediate form indemnities make you pay for bodily injury, death and property damage claims caused by the client, you will likely be contractually obligated to pay for the clients attorney's fees and defense costs too.  An indemnity in contracts can be a very, very dangerous risk transfer agreement that may be enforceable in a court of law and, if it is enforced, could possibly bankrupt your company for something you didn't do.  Seek help if you don't fully understand how to negotiate away the extreme risk found in indemnity clauses in a contract.

Additional Insured Status:  A typical requirement in the insurance clause in a contract will say:  "Contractor will name Client as an additional insured on his General Liability Insurance policy."  When you name your client as an additional insured to your general liability insurance policy (bodily injury and property damage coverage) he receives full access to the policy monetary limits and coverage provided by the policy -- for free!!  The client also gets to receive and enjoy -- for free! -- the legal defense of a claim because your general liability policy will very likely provide legal defense as part of its coverage.

Why do clients really want to have additional insured status?

Free insurance for one.  But also they want the insurance company to step up and defend them against claims, for free of course, because it's your policy and you pay the premium and deductible.  And don't forget, we're talking about claims arising out of the client's negligence.  It's also much better and easier for the client to get your insurance company to pay for claims and defense costs rather than having to try and enforce the indemnity obligations.

Seek help if you don't fully understand how to negotiate away the extreme risk found in naming your client as an additional insured to your general liability insurance policy.

Warranty:  Warranties are good things!  This is your commitment to stand behind your work and fix or replace something -- without complaining -- that's wrong or irregular about your work.  Standing behind your work with a good warranty is one thing that will give you a very good reputation.  However, warranties don't have to go on forever.  Twelve to 18 months warranty ought to suffice.  Your clients can pay for longer warranties.  Also, your warranty should exclude things like normal wear and tear, corrosion, improper usage, etc.  Make sure your warranty is specific as to what it includes and excludes, when it starts and when it ends.

Dispute Resolution:  Always have a well written dispute resolution clause in all your contracts that outlines the process to try and resolve disputes.  The first avenue of resolution ought to be negotiation (the best!).  If negotiation fails, then go next to mediation (an excellent process by the way!).  If you can't mediate a settlement, then next provide for a senior executive in each organization to try and resolve the dispute.  If these three options fail then all that's left is arbitration and/or litigation and both parties will lose.

Lien Waivers:  Never, never, never, provide an advance waiver of liens.  All 50 states have lien laws that provide contractors with some measure of protection against non-payment by the client.  Also, make sure you study with an eagle's eye the client's final wavier of lien document that will likely be hidden away somewhere in the bowels of the contract documents.  Sometimes these final waivers also waive your rights to collect outstanding extra work and/or pursue bodily injury or property damage claims against your employees or property caused by the negligence of the client.