New York Law Journal

Spring Quarterly Special Monday, April 12, 2004

TRENDS IN REAL ESTATE AND TITLE INSURANCE

Counsel Can and Should Do More to Prevent Construction Disputes

By: Kevin J. ConnollyDuval & Stachenfeld LLP

eal estate lawyers are trained to fight over every sentence, if not every word and punctuation mark, in the contract. That’s because real estate deals are concerned with terms that go on for a very long time. A fee can last forever. A mortgage can run for a generation. Leases can be for

long-term or short-term, but even a short-term lease will run five years or so. That’s a long time to live with a bad deal.

RConstruction is different. The best outcome for a construction contract is that it is put into a

drawer after being signed, and never gets taken out again. Even if it is taken out, it must be remembered that it’s just a tool for getting the project built. On Budget and On Time, which usually means getting in and out in a year or two at most.

It’s about the Project, not the Contract

That insight has some immediate implications for the contract award process, and beyond. Most simply, it is often forgotten that the contract is useless as a tool for getting the project built if it has not been signed. Getting the contract signed usually requires compromises. Setting the tone during contract award—creating an atmosphere of partnering and respect—is patently valuable in getting the project built.

Recognizing the primacy of the project, and the secondary nature of the contract, carries another important implication: the lawyer is not in charge of the project. Lawyers often lose sight of this during the contract award process, which is, after all, a legal procedure. Even then, however, the Architect or Engineer or the Owner’s representative or manager is, or should be, primary.

If you look at the AIA “Standard” form construction contracts, one thing that stands out is the definition of “Contract Documents.” This typically includes the agreement, general conditions and supplementary conditions—documents that the lawyer prepares. The “Contract Documents” also includes drawings and specifications—documents that the Architect or Engineer prepares.

Lawyers are used to working in collaboration with other professionals. We often incorporate the work of other lawyers—often specialists in arcane areas such as taxation, franchising, intellectual property, securities—into the final product. The conveyancers might not have a deep understanding of the arcane parts of their deals, but they know what is in the documents. But a lawyer would never (I hope!) incorporate those materials sight unseen.

Construction Lawyers, for the most part, do something that is nearly as dangerous: they incorporate the drawings and specifications into the contract without ever looking at them. Should they?

Consider the kinds of things that are typically found in the Specifications:

Control over the site and access to it—what parts of the site does the Contractor get to use to lay down materials, stage equipment and install temporary facilities from field offices through sanitation and waste disposal?

Payment procedures—how does the contractor get paid, and for what, and when does the Owner get to Charge Back for problems?

Contract Modification Procedures—having spent time and money getting the contract in place, how do we assure that it does not slip away while still recognizing that in construction, the only constant is change?

Warranties—did not we lawyers spend a good bit of time in law school studying these beasts?

To put it simply, the lawyer should know the entire contract. That means reading the specifications—especially Division I of the specifications, known as the “General Requirements” of the Project.

Use the Lawyer Wisely.

So the Owner has hired a lawyer and paid him or her handsomely for guidance through the process of forming a construction contract. Should the client send the lawyer away, to await a summons in the future, when disagreements morph into full-dress disputes that threaten to shut down the job?

Most people do just that. One of the results of that practice is that most construction lawyers are litigators, rather than “transactional” lawyers. To put a fine point on it: most construction law practices derive more than 85% of their revenue from mediation, arbitration, and litigation.

It can be different. There are lawyers whose revenues are predominately transaction-driven rather than flowing from dispute resolution.

Here is an example of what can go wrong if the lawyer is out of the loop until war breaks out. There was a contract for the conversion of a very large landmarked building into high-end condominiums. The construction manager’s counsel won a number of crucial points during a protracted contract award process, crafting a contract whose provisions were downright splendid, at least from the constructor’s point of view. To put it simply, the four corners of the contract gave the contractor carte blanche to spend the Owner’s money as needed, with the contractor’s profit being stated as a straight percentage of the costs. The more it cost, the greater the profit.

However, in practice, the job was run with fairly stringent cost controls, resulting in the contractor submitting bills that read as though the approved budget stated an upper limit of project cost. When push came to shove over the final accounting and closeout, the contractor lost and the elaborate architecture of the contract came to nothing, thanks to the way the project had been run and the legal principle of practical construction. Practical construction is valuable, but it should be guided by counsel

every step of the way. Just as important is the rule that the documents should speak to the transaction. There is less room for practical construction to overrule the terms of the contract if the contract actually reflects the way the job is going to be built.

There are lots of other opportunities for contract parties to misunderstand the terms of the contract, or to be completely ignorant of the terms that their lawyers haggled over for so long and at such high cost. This is not that different from the role of the Architect or Engineer. Having hired the design professional to create the design, one does not normally sit back and tell the Architect “Thanks and I’ll call you when I have a problem.” No, on the contrary, the Architect is in the loop every step of the way to make sure that the project is built in keeping with the design. The lawyer does not need to be in the loop in the same way, but the lawyer can be a useful participant in keeping the job on track.

Recently, a project that was not being run this way had a problem with weather-related delays. The contractor was claiming it was entitled to an extension of the completion date and increased payments for general conditions as a result of the days on which it could not do work because of inclement weather. The Owner was on the verge of signing the change order when counsel pointed out that the contract contained a different provision on weather: weather delays were supposed to have been anticipated by the contractor when it placed its bid, and getting an extension was dependent on showing that the weather was “extraordinary.” That clause is in the standard AIA documentation, but like any contract clause, it can be waived by conduct of the parties that is consistent with a different understanding.

When Should I Engage the Lawyer?

Now!

An owner of real estate to be developed can benefit from involving construction counsel at the earliest stages of the development cycle.

The lawyer can assist in the qualification and selection of the architect or engineer, negotiate and document the terms of the designer’s engagement, and assist in identifying the pre-design activities that may be appropriate, including…

Zoning.

Geotechnical Studies.

Feasibility Studies.

Existing Facilities Surveys, particularly studies to identify hazardous materials.

Owner’s Programming, embodying the program in the documentation or specifying the constraints under which the program will be developed with the help of the design professional.

The lawyer can assist in identifying the professions that will need to be part of the team, and whether to hire the specialists directly or have them serve as consultants to the Lead Architect. These can include:

One or more Architects (including architects who specialize in curtain walls, roofs, and other specialties; “Production” Architects are an emerging specialty as well)

Structural Engineer

Mechanical Engineer

Electrical Engineer

Plumbing Engineer

Civil Engineer

Landscape Architect

If the design team is hired through separate contracts and care is not taken to coordinate the work done by the different members of the team, there can be some interesting results. There is no shortage of war stories about the use by the mechanical, electrical and plumbing engineers of the exact same riser to carry ventilation ducts, electrical conduits, and water pipes, even though the size of the riser is adequate for only one set of utilities. That is only the most obvious opportunity for disappointment when the designers are not working for the Architect.

The lawyer should assist the Owner in selecting a method of Project Delivery. The lawyer should make sure the Owner understands the advantages and drawbacks of each method:

Conventional Design-Bid-Build: Lump Sum, Cost-Plus, Guaranteed Maximum Price (“GMP”).

Advisory Construction Management

Construction Manager “at Risk”: With or Without GMP

Design-Build

The lawyer should assist the Owner in the development of a Risk Management Profile. This includes recognizing the risks that are best handled by insurance and those that require something else, either in addition to or in lieu of insurance. The lawyer should work closely with the Owner’s insurance advisers to ensure that, in combination with the insurance to be required from the construction contractors, the risk of loss to the Project is adequately hedged. Finding out after a loss that the Builder’s Risk policy does not cover uninstalled materials and equipment (or has a sublimit so small as to be essentially worthless) is simply too late.

The lawyer should participate in the development of the bidding or negotiating package. Before bids are solicited, the lawyer should vet the entire package as well as the bids that result. If there is a Pre-Bid Conference, the lawyer should attend it or at least review the minutes of the conference and approve any Bulletins or Addenda that result. The lawyer should approve the Request for Proposals and the proposals that are submitted.

The lawyer should prepare or approve all of the contract documents (other than the drawings, as discussed below). As indicated above, it is a good idea to include all of the terms and conditions in the bidding package, lest the contract formation process derail when counsel—after bids have been opened—weighs in with comments on the general conditions: doing so is generally a counteroffer that vitiates the bid.

While the lawyer should not be reviewing drawings for their content, he should make certain that the drawings are properly listed, dated and scheduled; “drawings” sometimes include “Project Notes” or comparable written material, and those should be reviewed to make sure they are consistent with the other contract documents. The General Requirements section of the specifications should be reviewed by counsel to ensure coordination with the General and Supplementary Conditions.

If there is a pre-bid conference, it is a good idea for counsel to attend, or at least to receive the minutes of the conference. If the bidders’ comments are adopted, the result will be an addendum to the bidding package, and the addendum is going to be a contract document when the contract is actually awarded. One does not need to stretch one’s imagination very far to see the potential for grief in the process if the terms of the addendum are not coordinated with the other contract documents.

The lawyer should actually see certain of the submittals made by the contractors, including insurance certificates, bonds, and proposed warranty forms. Showing the warranty to the lawyer at the time of closeout is usually too late to make a difference. One of the little wrinkles that lawyers should attend to is the dual warranty program that some manufacturers employ. Typical is the way extended warranties for roofs are handled. Failures in roofs are usually traceable to a mistake during installation: either the underlying substrate was not prepared properly, or something goes wrong in the way the roof membrane is attached to that substrate. It is not at all unusual for the manufacturer’s warranty to exclude

the first two years after installation; during that time, the warranty is the installer’s obligation. If the general contractor does not commit to supply acceptable warranties from both the manufacturer and the installer, there will be a gap, one which could have been prevented had counsel been involved and alert.

The lawyer should usually see at least the first application for payment in order to ensure that the documentation called-for by the contract is present and correct. This includes lien waivers, receipts for materials, and cost-accounting documentation for a cost-plus contract. It may also be a time to see how relations with subcontractors have been set up. Are there multiple tiers of sub-subcontractors? Are some of the subcontractors billing on a cost-plus basis? Does the Owner understand how much trouble those structures can produce?

Another opportunity for counsel to render services is the closeout process. The Work may be complete, or nearly so, but there is often a welter of paperwork that needs to be submitted and vetted. This typically includes final warranty certificates, operating and maintenance manuals, final lien waivers, governmental approval certificates, and “as-built” drawings. In sophisticated projects, it is not unusual for the contract documents to require more or less extensive testing to ensure that the finished Work meets operational acceptance criteria established in the contract documents. Again, while counsel may not be qualified to say that a testing certificate does or does not establish conformity of the Work to the requirements of the Contract Documents, counsel certainly can assist the Owner in reviewing the closeout submittals to see that they are all present and accounted for.

In short, even the best-written contract in the world is not enough to bring the project in successfully. The contract is not the end of the process, it is the beginning. Likewise, contract award (or sooner) should be the start of counsel’s involvement in the process, not the end. Remember, it’s not about the contract, it’s about the PROJECT.