Identifying The Warning Signs of A Troubled Construction Project

A construction project, be it an entire building or the build-out of an existing structure, is an exciting time for the project owner.  On the other hand, it is also a stressful time filled with uncertainty over costs and timeliness of completion.  Most project owners are not construction “experts”; they only engage in construction on an “as-needed” basis.  By contrast, contractors are the “experts”; their business is construction.  This inherent imbalance in expertise, coupled with the fact that construction is expensive and often needs to be completed on tight, inflexible deadlines, can be a source of great anxiety for a project owner.

While there is no single “magic-bullet” that will eliminate all anxiety, being aware of certain tell-tale warning signs that a project is at risk of incurring cost overruns and delay and having a construction contract that addresses these issues will go a long way to relieving a project owner’s stress.

The common warning signs of a troubled project  include:

• Continued Delay – Some delay is not unusual. .  When the contractor is unable to make up the delay, however, the project will get further and further behind schedule, making timely completion nearly impossible and cost overruns inevitable.
• Poor Quality Schedule Updates –Most contracts for even moderately sized projects will require the contractor to provide a completion schedule.  For more complex projects, the contractor is typically required to provide a manpower/resource loaded fully integrated Critical Path Method (“CPM”) schedule at the beginning of the project and regular updates.  If the project is delayed for reasons the contractor cannot pin on the owner, it is not uncommon for the contractor to try to conceal or minimize the delay by either not providing the required schedule update or providing one that does not properly depict progress and delays.
• Unexplained Changes in Work Sequencing – Modifying the sequence of construction work activities is not in and of itself a warning sign. That said, too much re-sequencing can indicate a poorly planned project. It frequently results in more delay and often causes a “stacking of the trades” because the contractor has too many activities occurring concurrently and in the same space.  
• Workforce Shortages – In addition to causing delays, failure to provide sufficient labor is also a warning sign that the contractor may be having trouble paying its subcontractors or is in a dispute with them.
• Uptick in RFIs –When the contractor has a question about the design, which often involves how two or more elements of the design are to be integrated, the contractor will submit a Request for Information (“RFI”) to the architect/engineer for clarification.  While RFIs are a standard device used in construction, they often presage change order requests from the contractor claiming that the design interpretation by the architect in its response to the RFI involves extra work at an additional cost that will delay the project.  Too many RFIs indicate either an incomplete, improperly thought-out design, a contractor looking to pad an artificially low bid through change orders, or a combination of the two.      
• Changes in Project Management – A strong, experienced project management team is  a precious commodity.  As a result, when it becomes clear a project is hopelessly behind schedule and outrunning all cost projections, contractors will often substitute out the “A” team (for assignment on another potentially profitable project) with the “B” team, whose role is to deal with the cost overruns and schedule delays by making claims for extra money and schedule relief.  Not all changes to a contractor’s project management team portend the ramping up of the claims machine, but they are a warning to an owner to keep a closer eye on its project.  
• Disputes with Subcontractors – It is not unusual for an occasional dispute to pop up between a contractor and its subcontractors.  But when subcontractor disputes become too numerous or linger for too long and threaten work stoppages, the project is in danger of cost overruns and delay.  

Understanding the warning signs, while important, is only half the battle.  The other half is having a project specific contract that addresses both the underlying causes of these issues and includes appropriate mechanisms for dispute resolution so that the construction project is not de-railed.

A common misconception among project owners is that the only “good contract” is one that is so one-sided that it allocates all risk to the contractor.  However, when confronted with one-sided owner-friendly contracts, contractors tend to submit excessive extra work, delay and other claims (e.g. commercial impossibility) in an effort to effectively re-write the contract.  To avoid that situation, the construction contract should create a real partnership between contractor and owner that fosters a shared set of priorities by allocating risk appropriately.  Specific contract provisions that need to be carefully thought through in order to allocate risk appropriately are:

• Payment Terms – From an owner’s perspective it is preferable to tie payment to the contractor’s completion of “objective” milestones.  While not favored by contractors, payment milestones can be a fair allocation of risk as long as they are accurately defined, not subjective, and satisfy the contractor’s cash flow requirements.  Some frontloading of payment to early milestones (such as mobilization to the site) is appropriate to cover the contractor’s cash flow requirements, particularly where procurement of long lead time equipment and materials is necessary.  Owners, however, should avoid tying too much of the contract price to early milestone payments to ensure there is enough payment connected to later contract milestones, such as substantial and final completion, to incentivize timely completion of those work items.  Progress payments, on the other hand, are typically based on the percentage of completion of numerous line items in a Schedule of Values and, unless closely monitored by the owner or its representative, can be little better than a “guesstimate”.  In practice, when using progress payments, it is not unusual for an owner to find itself in a situation where it has paid nearly 100% of the contract price but the project is only 75%, or less, complete.
• Payment Withholding – Contractors are entitled to be timely paid for their work if it conforms to the contract and there are no other uncured events of default.  But, if the work is non-conforming, or the contractor is not able to meet its other contractual obligations, the owner should have the right to withhold payment.  But owners should use this remedy only after careful deliberation, because withholding payment can result in a contractor stopping work.
• Incorporation of Landlord Construction Requirements – When building out leased space as a tenant, it is important to incorporate all of the landlord’s construction-related requirements from the lease into the construction contract Typical landlord construction requirements relate to work access and hour restrictions, noise restrictions and clean-up requirements.  While these items may not seem unreasonable, if the contractor is not aware of them prior to contract execution, they will result in change order claims that can become significant.    
• Completion Requirements – The standard definition for substantial completion used in many form construction contracts is: The stage in the progress of the work when it is sufficiently complete in accordance with the contract so that the owner can occupy or utilize the project for its intended use.  For residential or office construction that definition may be adequate.  For construction of industrial or manufacturing facilities, more specific requirements are needed.  For example, the contract should spell out requirements for mechanical completion (i.e., when all systems necessary to operate the facility are installed and ready for commissioning), for commissioning (i.e., testing of the systems), and for substantial completion (i.e., when the plant as a whole has achieved its guaranteed performance as determined by specified performance testing).   Moreover, because substantial completion is normally when the facility becomes operational and begins to generate revenue for the owner, the conditions for its achievement must be carefully thought out so that any remaining work to be done by the contractor is minimal and will not interfere with the owner’s operation of the plant.
• Bonus and/or Liquidated Damages Provisions Need to be Reasonable –While owners need to ensure their anticipated costs caused by late completion are covered by liquidated damages, they would be well advised to avoid assessing unnecessarily punitive liquidated damages.  
• Warranty –If the contractor is responsible for procuring the equipment under the construction contract (e.g. HVAC system), it is generally reasonable to require the contractor to also include that equipment in its overall warranty (i.e., a fully “wrapped” warranty).  If on the other hand, the owner directly procures the equipment, it is reasonable for the contractor to exclude that equipment from its warranty and force the owner to directly chase the manufacturer for warranty work related to that equipment.   Because it is easier from warranty administration and liability allocation perspectives to have a single entity responsible to the owner for warranty work, it is advisable for an owner to run as much equipment procurement through the construction contract as the contractor is willing to accept.        

Finally, when entering a construction contract, owners should consider the following:

• The construction contract must create a true partnership.  A construction project, especially one beset by problems, will only succeed if both the owner and contractor understand and accommodate each other goals.  For the owner, it is typically getting the project finished as soon possible and for the contractor it is to get paid and move on to the next job.
• The contract terms cannot be so complex and cumbersome that project personnel will ignore them.  While the above contract provisions must be addressed, simpler is better.
• When disputes arise, both the owner and contractor need to take a hard, realistic look at the strengths of their positions.  Bluffing about the strength of your arguments is usually a recipe for prolonged, expensive litigation or arbitration.  

Unfortunately, even with well thought-out contracts disputes do occur and require a strategy for effectively managing them. Because no two disputes are the same, no two strategies for resolving them are the same either. Engaging legal counsel early in the life of a dispute will allow you to tailor a strategy for resolving it, or at a minimum, will put you in the best position to have the dispute resolved favorably.