Navigating Construction Contracts During COVID-19
The COVID-19 pandemic has posed many challenges to construction companies and raised questions regarding the best ways to navigate construction contracts during this time. Should contractors approach contracts the same way they did prior to the pandemic, or is it time to revise their strategy? New challenges may warrant some modified provisions in your construction contracts.
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How COVID-19 Is Impacting Construction Projects
Changing the way you negotiate construction contracts makes sense when you consider all the ways the COVID-19 pandemic has impacted and may continue impacting the construction industry. Forces outside of your company's control can cause anything from a minor inconvenience to a major roadblock, ultimately affecting your project's timeline, cost and feasibility. Some primary ways construction companies have felt the effects of COVID-19 are outlined below:
1. Government Mandates
At the state and local levels, areas across the U.S. and other countries have experienced various types of shutdowns. In many instances, non-essential work outside the home has been ceased to help slow the spread of the coronavirus. Whether construction work is considered essential depends on the jurisdiction and may hinge on the particular project, as well.
Government mandates are inconsistent across geographical areas, and they are also continually evolving. Even if your state or city is allowing construction work to continue right now, it may not in a month from now. Construction companies are currently contending with this uncertainty and may continue grappling with it for some time. Shutdowns are causing construction businesses to place projects on hold, and the ever-present risk of future lockdowns should impact the way organizations structure their contracts moving forward.
2. Labor Shortages
Another major issue for construction companies during this time is labor shortages. This is an ongoing problem for the construction industry independent of COVID-19, but the pandemic has exasperated the issue. One problem is workers contracting the virus. When this happens, other workers on the same crew may have been exposed to the virus. Even if there isn't an outbreak among employees, they may still have to self-quarantine, leaving a company short-staffed for weeks at a time.
Other factors beyond being sick have kept some construction workers at home. This includes everything from issues with public transportation to child care. Another contributor to labor shortages is economic factors leading to layoffs or furloughs. While some businesses have been fortunate enough to keep all their employees on, half of all construction companies predominately in the U.S. with fewer than 1,000 employees have had to lay off some workers, according to an Association of Equipment Manufacturers survey.
3. Supply Chain Disruptions
Supply chain disruptions have been another major challenge across many industries, including construction. At the least, supply chain problems have resulted in material lag times, which can delay a project timeline. In more serious cases, a supply chain disruption may mean a company has to find new suppliers. In the worst cases, it could mean a complete inability to find the materials needed for a job.
The problem has been especially pronounced for companies that were used to sourcing certain equipment or materials from Asia, such as rolled rubber, steel, aluminum, cement, HVAC equipment, electrical equipment and much more. Supply chain disruptions have a ripple effect that can cause problems all the way down the chain, so your construction company has likely felt the effects in some way.
4. Higher Material Costs
Even when you can get the materials needed for a job, those materials will likely cost more. According to the National Association of Home Builders (NAHB), the cost of framing lumber increased by more than 170% from mid-April to mid-September 2020. That increase translated to more than $16,000 in added costs for a new build on a single-family home.
Changes in the supply chain and material demand may continue causing price fluctuations in the coming months. Price increases could eat into contractors' profits if they do not account for this possibility in their construction agreements. Contractors may need to explain to project owners why the overall cost of projects is increased at this time.
5. Diminished Revenue Streams
Many of the issues above have resulted in diminished revenue streams for contractors. Problems like rising material costs and supply chain disruptions have negatively impacted many contractors' profits, even causing some to merely break even on a job. Shutdowns and other circumstances have stopped some owners or general contractors from making progress payments that downstream contractors need to pay their workers and fund their operations.
The bottom line is that this pandemic has exaggerated some preexisting problems for the construction industry and introduced new issues, all of which threaten to disrupt construction projects. Construction contracts must account for these potential COVID-related issues.
How to Account for Pandemic-Related Problems in Construction Contracts
Considering all the challenges we discussed above, and possibly more, it's wise to reevaluate the way you structure construction contracts during this time. Overall, construction during COVID-19 is less predictable and is complicated by more variables, so construction contracts should be more flexible than the agreements you may be used to. This flexibility can benefit both contractors and owners, ensuring the necessary terms are established to allow both parties to make changes if and when these are warranted by coronavirus-related problems.
Let's look at six ways you can modify new construction contracts to account for pandemic-related challenges:
1. Revisit Your Force Majeure Clause
When the pandemic began causing problems, making it impossible to fulfill a contract's terms, many project owners and contractors looked to their contract's force majeure clause. This clause is a traditional inclusion in construction contracts, allowing one or both parties to withdraw from the agreement or allow a contractor to extend the timeline for completing work. The contractor can also increase the contract sum in special circumstances outside of their control.
Some force majeure clauses function as a sort of catch-all, using language broad enough to apply to a range of unforeseen circumstances. According to the American Bar Association, a global pandemic would reasonably fall within this catch-all provision. Other clauses may be more exclusive, outlining exactly what would constitute a force majeure. For contracts negotiated pre-pandemic, parties should revisit the force majeure clause to see whether it speaks to the current circumstances.
For new construction contracts, contractors should consider revising their standard force majeure clause to include explicit language regarding the pandemic. Specific language will help ensure both parties are on the same page regarding this critical clause. It will also increase the likelihood that a court would legitimize a party's decision to pull out of the contract if that choice arose from circumstances clearly identified in the force majeure clause.
In listing possible problems that would constitute a force majeure, be clear on the problem's scope. For example, if you include unforeseeable supply chain disruptions as a possible force majeure, make sure all parties are clear on whether this means the contractor is unable to source material from their established suppliers or whether the material must be wholly unavailable from any suppliers within the country or a specific region.
The key here is to keep some language flexible enough that it can cover unforeseen issues while hedging against ambiguities that could work in the other party's favor by including specific language where needed.
2. Consider Adding a New COVID-19 Clause
While the force majeure clause is a familiar one that can be adapted to fit COVID-19 challenges, contractors should also consider adding a new clause to their contracts that explicitly focuses on the pandemic and the potential problems that might arise from it.
In this instance, you might leave your force majeure clause as a more general catch-all for extenuating circumstances. You could use your COVID-19 clause to address issues that are not necessarily unforeseeable catastrophes but are unpredictable circumstances and are directly or indirectly tied to the pandemic.
The challenge here for contractors is to determine what aspects of the pandemic's effect on their business are already present or are foreseen and what possible new problems could arise after the contract is formed. For example, you may already have workarounds in place to help you deal with supply chain disruptions or increased material costs, but what if new government legislation deems your work non-essential and forces it to stop? Or what if your crew experiences a COVID-19 outbreak, and everyone must stay home to self-quarantine?
Again, try to strike the right balance of specificity and inclusivity that will make the clause useful if a problem outside of your control occurs. Also, be sure you negotiate with the owner to determine whether time extensions due to COVID-related problems outside of the contractor's control should be compensable or not.
3. Define Your COVID-Related Terms
Regardless of what clause you use primarily to discuss COVID-19 terms, make sure those terms are clearly defined in the contract. Defining your terms is always a best practice for legally binding agreements, but it can get overlooked when you're adding new clauses and terms to your document. Rather than assuming all parties and the courts will be on the same page regarding a term's definition, remove as much ambiguity as possible.
For instance, you don't want to run into a situation where you cease work because you've experienced a COVID-19 outbreak among your workers, but the owner disagrees regarding what constitutes an outbreak. The terms you'll need to define depend on what you've included in your contract.
Any terms related to COVID-19 should be clearly established at the outset of the contract. Rather than calling out several specific situations throughout your contract, you may prefer to use more general terms that you can repeat within the document. If you choose this approach, define those general terms and list out specific situations included within those broad terms.
For instance, since government directives can take different forms, such as orders, mandates and laws, you may want to use a term like "COVID-19 proclamations" to refer to any government directives concerning COVID-19 from public bodies with jurisdiction over the project. In your definition, you could include examples of what would constitute a proclamation.
Another broad term you could use is "COVID-19 condition." This term could refer to any circumstance related to the pandemic that is outside of the contractor's control. This phrasing could include COVID-19 proclamations, supply chain disruptions, labor shortages and other circumstances related to COVID-19. Make sure your list includes a catch-all rather than being an exclusive set of examples.
Since some COVID-19 conditions are ongoing and others may arise during a project, it may be wise to use a separate term, such as "unforeseen COVID-19 conditions" or "unknown COVID-19 conditions" for circumstances unknown to the contractor at the time of the contract. The parties may agree that these unforeseen conditions would constitute excusable delays while known conditions at the time of the contract would not.
4. Adopt Flexible Payment Terms
A key part of making a construction contract more flexible during this time is opting for payment schemes and terms that allow for unpredictable changes in costs. The American Institute of Architects (AIA) points out that some contractors may want to use a cost-plus-fee payment scheme. This model ensures contractors are paid according to the actual cost incurred during the project, along with a fee that covers more general expenses like overhead and profits.
Most of the AIA's agreements using a cost-plus-fee scheme also include a Guaranteed Maximum Price (GMP). This way, owners have a ceiling in place so they don't have to worry about their final sum rising indefinitely. The GMP should be high enough to allow room for unexpected costs.
If you're fortunate enough to have completed a project without running into extra costs, you may be able to take advantage of a shared savings clause if you've included this clause in your contract. This allows a contractor to take a specified percentage of the difference between their cost plus their fee and the GMP. This percentage is pure profit.
Some contracts include no-damages-for-delay clauses, which preclude a contractor from recovering costs related to a delay. This means if a project takes longer than expected, expenses like additional labor costs or extended equipment rentals will cut into a contractor's profits. That may be reasonable if the delay is due to project management issues on the contractor's part, but when delays are caused by external problems related to the pandemic, contractors shouldn't have to bear these costs.
Contractors should avoid including no-damages-for-delay clauses in their contracts or should specify this clause does not apply to extenuating circumstances related to COVID-19. You may need to reference another clause to be more specific about what those circumstances may look like. Ensure somewhere in the contract that you clearly spell out the criteria for compensation. For example, you may note that costs are compensable if they are due to coronavirus-related circumstances that were both unknown at the time of the contract and are not the fault of the contractor.
5. Adjust Terms for Suspension or Termination of Work
Construction contracts should always include some terms regarding whether and how either party can suspend work or terminate the contract altogether. During the pandemic, you may need to adjust or add to these terms to make sure you're prepared for the unique risks.
One risk to be aware of is the possibility that a state or local government will issue a mandate that all non-essential work will be halted. If your project is considered non-essential, you could be looking at a sudden and possibly indefinite project suspension. Anticipate this possibility in your contract with clear language that states a contractor must comply with legal mandates and that specifies the contractor's responsibility to protect and preserve the job site during the suspension.
Protecting the site may include securing materials in place, storing tools or other equipment in a locked container, covering or barricading trenches, posting warning signs, installing security cameras or personnel and taking other measures necessary to protect assets and preserve the work that has been done.
Another possibility is that an owner will want to suspend work, even if it is legally allowed, because of concerns related to COVID-19. This is a more likely scenario for jobs that occur within an owner's residence. Include terms in the contract that specify whether this is a valid reason for an owner to suspend or terminate work and what sort of relief the contractor is entitled to in this instance.
In case of a suspension, whether it's due to a government mandate, the owner's preference or another reason allowed for in the contract, specify whether a certain lapse of time opens up the option for either party to terminate the contract.
6. Consider Breaking the Project Into Phases
Another piece of advice from the AIA regarding construction contracts during the COVID-19 pandemic is to consider opting for unconventional scheduling techniques that create more flexibility. One way to do this is to release a project in phases rather than creating a contract that governs the job as a whole from start to finish.
This method may be especially advisable for large undertakings that will take many months to complete. It is next to impossible to predict, at this point in time, what sorts of conditions will affect your project months ahead or a year into the future. That's always the reality to some degree, but there are more variables in play due to the pandemic.
Breaking a project into more manageable sections, each with its own set of deliverables, can help you eliminate some uncertainty. You can tailor each contract, including your timeline and price quote, to supply chain conditions, available labor and other factors as they stand at the time. For example, you could begin with site work and structural elements and create a new contract for the project's later stages.
You can also break a project into phases based on trades rather than on a linear timeline. This may not be feasible for some assignments, but where possible, you could have electrical work as one project milestone, plumbing as another and so forth. As with other terms we've discussed, this approach can help you build more flexibility into a job.
How to Proactively Deal With Pandemic-Related Problems on a Project
Optimizing your construction contract is key, but you must also remain vigilant during a project to ensure you are protected from issues related to COVID-19. These are a few tips to prioritize to make the most of your contract:
- Mitigate COVID-related risks as much as possible: You don't want to run into an avoidable situation that can be attributed to COVID-19. For instance, what if careless safety and hygiene practices lead to a virus outbreak that delays a project and adds on costs? An owner may pin that responsibility on the contractor and deny that this constitutes a compensable circumstance.
- Promptly notify the project owner of claims: When a circumstance arises that a contractor believes entitles them to additional compensation or a time extension, the contractor should promptly advise the project owner of this claim. The owner may want to place a time limit between when a circumstance occurred and when the contractor must assert a claim, so they can deal with these claims as they arise.
- Keep careful records: Contractors should also keep careful records of any costs or other impacts on a project related to COVID-19. Rather than simply documenting that something took extra time, for instance, you would want to document what the specific reasons for that delay were and how they related to the pandemic. This way, contractors can back requests, notices or claims with evidence of their legitimacy.
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