THE CONSTRUCTION CONTRACT
Study the contract that follows. In the thirteenth century, there was a philosopher named William of Occam who said, “What happens if we have two competing theories and they both have the same intellectual strength? They both make sense. Which theory is the better?” The answer was the simpler of the two, and thus the postulate, “Occam’s razor,” which is often cited in game and risk theory and economics. This contract is a classic example of Occam’s razor. You could use this contract to do ninety percent of the contracting for your home.
1. The Players
In drawing up construction contracts it is important to know who the players are and to keep their distinctions clearly in mind. Under the law a general contractor is anyone who contracts directly with the owner. For example; you hire a builder, John Jones, to build your home. He’s usually known as a general contractor. But let us assume you also hire Tom Smith, an electrician, to do the electrical work. He’s also a general contractor because he contracted directly with the owner. If you’re the owner and are also managing the building of your own home then you are both the owner and general contractor. In this case the electrician is also a general contractor because he contracted directly with the owner of the house. But if John Jones had hired him instead of you then Smith, the electrician, would be a subcontractor.
In the practical sense a general contractor is somebody who manages the building of your home and hires the other trades. But from a legal standpoint a general contractor is anyone who contracts directly with the owner. From a legal standpoint it is important to make a distinction between the general contractor and the subcontractor. In building your own home most of the people with whom you will be contracting will be general contractors, regardless of their job description.
In addition to the Owner and General Contractor, the other players are:
The Subcontractors or Mechanics: The subcontractor is a worker or mechanic who contracts with the general contractor. A mechanic is an old English term, somebody who performs a trade—a plumber, an electrician, an insulation mechanic, a trim carpenter, or framing carpenter. All trade people are mechanics. A mechanic’s lien is the right of somebody who has performed the work on your house to claim an interest in that house for nonpayment for services that he has performed.
Materialmen: The materialmen supply the material. It could be lumber or it could be drywall. A mechanic can be not only a mechanic but also a materialman. So there can be a mechanic’s lien or a materialman’s lien; the effect is the same.
2. The Essence of the Contract
In the contract you need to list the parties to the contract and to specify exactly what is to be done. And you need to specify the cost and payment schedule. The more specific you are in every category, the better. If a contractor is going to install the heating, ventilation, and air conditioning, he should identify the quantity of material and the brand name or that what he will furnish will be comparable to a brand name. If he says, “Carrier or comparable” for the air conditioner, for example, that’s a legal term. But it has to be something that is comparable to a Carrier. If you want only a Carrier, scratch out the words “or comparable” and make sure you both initial the change.
When the contractor signs the contract it is then an offer to furnish and install. He will specify a time frame (generally ten days or thirty days) within which it can be accepted. If you don’t accept it within that time frame, the offer expires. If you do sign it within that time frame, it is an executory contract.
All material is to be guaranteed as specified; all work is to be completed in a “workmanlike” manner. That is a legal term, meaning it has to conform to the industry standards in your particular area. Any alteration or deviation from these specifications involving extra cost will be executed only upon written order. You can alter it orally if it is less than 500, but we recommend that all changes, no matter how small, be in writing.
The contract also makes reference to workmen’s compensation insurance. Workmen’s compensation insurance is probably not sufficient coverage. You contractor should have general liability insurance as well. Ask him for a certificate from his insurance carrier for both types of coverage. The greater the amount of work he is to perform the more important the insurance is.
This contract does not specify that the work must “conform to code” (the local regulations). You can insist on that but you will usually have to write it into the contract. And be sure to include provision for attorney’s fees in the event that you have to sue.
Some people like to specify that in the event of a dispute it will be turned over to arbitration. We do not recommend this. Studies have shown that in arbitration there is an effort to compromise on the problem rather than to solve it on the merits. And no matter how the arbitration agreement is drafted, in all probability the party who loses arbitration is going to sue anyway. So arbitration just delays the inevitable.
Look for the elements included in our contract in whatever form your contractor uses. If he doesn’t have a form, we recommend this one; it can be bought at any stationery store. Don’t make your agreement on an envelope while standing on your property, because you could omit something important.
3. The Payment Schedule
The payment schedule needs to be well thought out. We can illustrate this point with a story. A home improvement contractor comes to your neighborhood and agrees to build five family rooms for five different homeowners. He gets out of his car, looks at your house, and starts walking around, still looking, he already knows that it’s going to cost him 10,000 to do the job, and he’ll probably mark it up a hundred percent, charging you 20,000. But he’s taking plenty of time in order to make his estimate look studied and solid. He quotes the same price to all five homeowners, but they all decide on different payment schedules.
The first, Mr. Stingy, says, “Tell you what I’m going to do. I’m going to give you 2,000 now and 18,000 upon completion.” Down the street is Mr. Quickdeal. He says, “I’ll give you 10,000 now and 10,000 when you complete the job.” The next guy is Mr. Reasonable. He says, “I’m going to pay you 5,000 now, 5,000 when it is 25% done, 5,000 when it’s 50% done, and 5,000 upon completion.” The next guy is Mr. Smart. He says, “I’m going to give you 1,000 now and then I’m going to give you 5,000, 5,000, 5,000 and 4,000. That adds up to 20,000.” The last guy is Mr. Justright. He agrees to put down 2,000, make three payments of 5,334 as the work progresses, and pay 2,000 when the work is completed.
The contractor signs up all five homebuilders. Which house does he start on first? You can be sure he does not start on Mr. Quickdeal’s house. Quickdeal would be the last one he starts because he already has 10,000 without doing any work. And he’s not going to start with Mr. Stingy’s home first because he’ll receive only 2,000 up front and must then complete the job before he receives another cent.
The point to remember is that you have to position yourself somewhere between too stingy and too generous with your contractor. Both the Mr. Reasonable and Mr. Smart deals are all right but we prefer the arrangement made by the last one, Mr. Justright. It does three things: (1) it brings and keeps people on the job, because as they work they receive instantaneous reward, (2) it never gives the contractor more than ten percent of the contract price at a time—any more would be providing capital for the contractor (which should be unnecessary), and any less would make him think you are stingy, and (3) at the end, it does not hold back a large sum and give him the feeling he will never be paid. Holding back at least ten percent assures that he will finish the job. This is the 10/80/10 rule, which is the best payment schedule—never more or less than ten percent to begin with; never much more or less than ten percent at the end; and the middle eighty percent should entail as many payments as practicable. This will keep the contractor’s morale high. It is very important to establish a good rapport with your contractors. Frequent payments for work performed will do more to get your home built quickly than any other incentive or contract provision we know. Overpaying or underpaying will increase the likelihood that your contractor will avoid your job site. He’s going to go somewhere where he gets paid when he does some work. A fair payment program is the most effective way we know to keep the contractor(s) on the job.
4. Licensed, Bonded, and Insured
You will find that almost all contractors are licensed, bonded and insured. But you should check to make certain that they are properly certified. The contractor should have two licenses—a trade license and a business license which authorize him to perform his trade in your county. A trade license is granted him by the authority that regulates his trade, and it is very important. A business license is a permit to operate a business in that county. From your standpoint a business license is not as important as the license for his trade. You should make certain that the plumbers’ association in your area certifies that he knows how to plumb.
You also need to know for how much and for what he is bonded. A bond for 1,000 isn’t going to help you much if he can’t perform. The word “bonded” on the side of a truck does not really mean much. However, if you pay him for his work and materials on a reasonable draw schedule, the you don’t have to worry about whether a contractor is bonded. If he isn’toverpaid and doesn’t finish the work your loss will be the administrative effort to find another contractor rather than a financial loss for paying for work not done.
5. Quantum Meruit
The legal term quantum meruit means that a person is entitled to be paid a reasonable amount for the work that he has done even if he doesn’t complete the entire contract. It makes no difference whether you fire him or he quits. If a plumber contracts to plumb your house for 5,000 then quits (or gets fired for cause) after he’s done half of the work, do you owe him money? The answer is yes. You owe him for that portion of the contract he has completed. But, if he has done half the work does he get 2,500? Probably not. You only owe him the difference between what it will cost you to have the job completed and 5,000. When someone quits halfway through a job the new person will probably charge more than half the total amount of money to complete the job.
6. Mitigation of Damages
When a person breaches a contract the aggrieved party has an obligation to mitigate (minimize) the damages that result from that breach. In the above example of the plumber who quit after completing half of the work you must make reasonable efforts to find someone to complete the job for the best price possible. (Remember, the first plumber gets the difference in the contract price and the completion price.) You cannot take advantage of the first plumber by agreeing to pay 4,000 to complete the job if the second plumber would have done it for less. Also, if the first plumber has left his material or tools out in the weather you must make a reasonable effort to keep them from being damaged. Even if you’re upset with him you are legally responsible for mitigating (minimizing) his damages.