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Reading Key Contract Clauses & Other Quick Tips for Avoiding Liability

The first component to performing work on a construction project is the negotiating and drafting of the construction contract.  This is because the terms and clauses in the construction contract define each party’s rights and obligations for the subject construction project.  This includes the scope of work each party is to perform; timing for performance; payment schedule; the forum to litigate any breach of contract issues; etc.

How well the construction contract is negotiated and drafted will determine how much time, expense and litigation will be involved when issues arise.  The better negotiated and drafted the contract, the less litigation, time and expense will be involved in resolving these issues.

1. Scope of Work

All construction contracts have a scope of work clause.  This clause defines the work that the contractor is to perform on the subject project.  This clause should be clearly defined and not just cut and pasted from pervious contracts.  Further, the party performing the work should clearly understand all the work that is set-forth in the contract.  This party will be held responsible for the scope of work in the contract, whether or not they understand it at the time of execution. Read more about Scope of Work here.

2. Change Orders

There are almost always changes made to the scope of work section after a construction contact has been executed by the parties.  This is done through a change order. Note: the change order should always be in writing.

In limited contracts the parties will only need a simple procedure for change orders.  This is because there are a limited amount of people to approve the change order i.e. the owner.  Large scale projects on the other hand, should have a very detailed procedure for change orders. This is because many different people and departments within the prime contractor’s company will be involved with approving the change order.  Any confusion in the change of scope of work can lead to litigation.

On large projects, the construction contract should clearly define who has the authority to authorize changes to the scope of work and determine the procedure for how the change is to be made i.e. through office and/or field personnel.  It is important that field personnel and not office personnel be authorized to made the changes in the scope of work. This is because the field personnel are out at the project and can define the change more efficiently then office personnel.

3. Contract Price

The cost for the original scope work contemplated in the construction contract should be clearly defined.  Further, the construction contract should define what the payment terms will be for the changes to the scope of work i.e. does it become time and material or another formula.

4. Payment Schedule

Most owners and/or prime contractors do not have sufficient funds to pay the subcontractors at the commencement of the project.  Instead they make progress payments as the work is completed. There are different formulas. Make sure the formula is agreed upon before execution and clearly outlined in the payment terms.

5. Insurance

All parties must have proper insurance to protect against both common and catastrophic risks, (e.g. workers’ compensation and comprehensive general liability insurance in occurrence based form with riders for owned, non-owned and hired vehicles.)  It is important for each party to consultant with their insurance broker and insure that they have proper coverage for the work contemplated. Improper insurance may mean loss of coverage at the time of litigation.

6. All Documents Should be Referenced

All documents, which the parties are relying on for their performance under the contract, should be clearly referenced, if not attached to the contract.  This includes bids, plans, specifications and schedules. Any ambiguities to the construction documents should be addressed before executing the contract.

7. Claims Resolution

There are various ways to formally resolve issues that arise under the contract.  The three most common ways to formally resolve issues is through mediation, arbitration and litigation. (Each of these forums will be discussed in detail below.)  It is in each of the parties’ interest to determine, while negotiating the contract, which forum they want to resolve these issues. To do this, the parties should include the forum that they are most comfortable litigating in.                                       

If the parties choose to arbitrate, they must decide what organization they want to use to arbitrate.  Each arbitration association has its own rules and procedures. These rules and procedures will have their advantages and disadvantage.                 

Should the parties decide to have their disputes heard in court, the parties must decided which law will be governing should any party be out of state and or the contract is executed out of state.

8. Assignment

Owners and prime contractors will usually include a prohibition on assignment of duties in the construction contract.  Part of the reason for this is that the owner and/or prime contractor is relying on the reputation and skills of the subcontractor who they are contracting with to perform the work.  The owner and/or prime contractor may not know the work product of the party that the subcontractor intends to assign part of its work to under the contract.

Everything in a contract is negotiable.  Should the subcontractor need to subcontract some of the work, the subcontractor should discuss this in advance with the owner and/or the prime contractor.  Most owners and/or prime contractors are willing to carve out a small exception to the prohibition against the assignment if it is negotiated in advance.

9. Attorneys’ Fees

A majority of contracts have an attorneys’ fees provision in them. Attorneys’ fees can act as leverage for settlement negotiation.

10. Governing Law

The contract should always include what law i.e. state, federal, etc. will govern if and when a contract becomes in dispute.  This is especially important if there are parties out of state and/or the contract is executed out of state.      

A judge or arbitrator will decide what law governs should the contract not specify.  This will not only cause more time and litigation expenses, but the parties may not secure the outcome they are expecting.  This is because different laws can have completely different outcomes.

Resources for Construction Contractors

Construction Organizations

San Luis Obispo County Builders Exchange

American Bar Association

Santa Barbara Contractors Association

Remodeler’s & Custom Builders Council of Southern California

Society of American Military Engineers (SAME)

Women in Construction Operations (WiOPS)

Home Builders Association of the Central Coast

Los Angeles County Bar Association

San Luis Obispo County Bar Association

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