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Allocating and Minimizing the Risk of Construction Delays

By Raymond Kwasnick and Erin Morrissey
August 2009
People: Raymond M. Kwasnick

When a construction delay occurs, there is no question that the Owner suffers financially. But the extent to which an Owner can recover its loss of income from the Contractor, and, more importantly, minimize the risk that such delays will occur, depends largely on how the construction contract was drawn up – long before the first piece of heavy equipment rolled onto the site. As the result of the Perini case and the 1997 alterations to the standard American Institute of Architects (AIA) construction contract forms, Owners find that the damages they are able to recover in the event of a construction delay have been dramatically limited.

The Perini Case Leads to Changes in Standard Contract Forms

In 1983, Perini Corp. entered into a contract to manage the partial renovation of the Sands Hotel and Casino in Atlantic City, New Jersey. The guaranteed maximum price was $24 million and Perini’s agreed upon fee was $600,000. The project was delayed by nearly four months, forcing the Owner to keep part of the resort closed during the lucrative summer season. Even though the contract did not contain a “time is of the essence” provision, the Owner was awarded over $14,500,00 in damages for lost profits, including $4,000,000 in delay damages.

The Perini case roused the contracting community to action. At the urging of the Associated General Contractors of America (AGC), the AIA significantly changed the forms of agreements commonly used for construction projects. In 1997, the standard AIA General Conditions (Form A201) were revised to include a mutual waiver of consequential damages.
Consequential damages include those damages that were reasonably foreseeable or contemplated by the parties at the time the contract was entered into as the probable result of a breach.

However, in many instances, lost profits are not consequential damages, but are direct damages which are typically compensable. The AGC and AIA realized this, and therefore broadened the Owner’s waiver in the standard AIA form construction contract to include claims for loss of rent, use, income, profit, financing, business and reputation, and loss of management or employee productivity. For this reason, the form contract considerably undermines the value of the Contractor’s promise to complete the project on a timely basis, and may leave the Owner with no effective remedy if construction drags out past the agreed-upon deadline.

Recommended Strategies

There are a range of strategies which Owners can use, in negotiating construction contracts, to confront these issues. One approach would be to modify or eliminate the waiver of consequential damages so as to allow the Owner to retain the right to recover from the Contractor any damages that the Owner can prove.

As contemplated by the AIA form, a second approach would have the parties agree upon a liquidated damages formula which fixes the Contractor’s exposure. This approach has the virtue of forcing the Owner to examine its possible losses in the event of a delay before the contract is executed. The Owner may even agree to a liquidated damages formula that does not fully recover the possible loss, on the theory that the agreed-upon formula is better than no remedy and no contract.

Another approach is to manage the construction project so that a delay does not occur. A detailed schedule should be attached to the construction agreement, enabling both parties to assess the risk that completion of the project will be delayed. The Owner must be sure to have an effective and trustworthy project manager. In addition, a sufficient Owner’s contingency must be available to the project manager to spend on acceleration costs in the event of any delay.

Suggested Contract Provisions

The Owner should also have a few carefully drafted contract provisions in its tool kit. These provisions should establish the actions that the Contractor must take if it falls behind the project schedule, grant the Owner the right to order the Contractor to take whatever “extraordinary measures” are necessary to speed up the progress of construction, and grant the Owner the right, at its election, to nullify the waiver of consequential damages and liquidated damages provisions if the Owner directs the Contractor to accelerate the project under a recovery plan, tenders to the Contractor the funds to pay for the recovery plan under a reservation of rights (i.e. for a later determination as to whether the Contractor was at fault for the delay and thus responsible for the cost of the recovery plan), and the Contractor refuses to accept Owner’s funds and implement the recovery plan.

Conclusion

The issue of who bears the risk of construction delays is often the most difficult issue to negotiate in a construction contract. The typical approaches to the issue either leave the Contractor fully exposed to the risk of delay or provide the Owner with limited or no recourse. With a good schedule, competent project management, a reasonable Owner’s contingency, and the appropriate contractual provisions, the interests of the Owner and the Contractor can be aligned, thus enabling contract negotiations to be completed without difficulty while giving the Owner the best possible assurance that the work will be completed on time.

For questions regarding the information contained in this G&S Advisory, please contact your usual Goulston & Storrs attorney or: 

Raymond M. Kwasnick
(617) 574-4197
rkwasnick@goulstonstorrs.com

This G&S Advisory was co-written by Erin E. Morrissey, an associate in the firm's Real Estate group.

This advisory should not be construed as legal advice or legal opinion on any specific facts or circumstances. The contents are intended for general informational purposes only, and you are urged to consult your own lawyer concerning your situation and any specific legal questions you may have.

Pursuant to IRS Circular 230, please be advised that, this communication is not intended to be, was not written to be and cannot be used by any taxpayer for the purpose of (i) avoiding penalties under U.S. federal tax law or (ii) promoting, marketing or recommending to another taxpayer any transaction or matter addressed herein.


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