The Many Paths (and Perils) of Construction Projects: What you don’t know can hurt you, what you do know can save time and money

Thursday, December 29, 2016 - 13:59

While some companies routinely engage in construction projects, for other companies a construction project can be a once in a decade experience. Some companies have experienced in-house personnel to guide them through a building project while others need to rely upon third-party professionals to evaluate the company’s needs and direct the project. No matter where your company falls within the spectrum of experience, knowing what your options are, what questions to ask along the way, and how to properly address the legal risks will save your company time and money as well as help it to avoid costly claims. 

Project Delivery Methods 

The first step in a significant construction project is to determine the most cost-effective manner of having your project designed and built. From the inception there are two primary options available to an owner. Deciding what option best suits your company’s needs in advance of consulting with third parties ensures that your company’s needs are met while at the same time, the company is not taking on more risk than is required.  

In the traditional design-bid-build model, the owner (you) engages an architect or engineer and works with them to evaluate the company’s needs and to design the building. Once the design is complete, the project can be competitively bid based on a complete set of plans and specifications, and the owner has the option to award the project to the lowest responsible bidder. A private owner can also evaluate the competitive prices and engage the contractor of its choosing at a negotiated price. In this model, the owner has two contracts to administer – one with the design professional and one with the contractor. When using this approach, it is important to ensure that the two contracts are consistent as to responsibilities and dispute resolution forums. This avoids (where a dispute arises) a scenario in which an owner is litigating with the design professional in court and at the same time defending a claim by the contractor in an arbitration tribunal or vice versa. Compounding the complexity is that typical arbitration provisions do not allow for the joinder of additional parties. While courts permit joinder of parties, a party may raise an arbitration clause as an affirmative defense to its joinder, thereby splitting the case in two actions. As a result, the owner may incur double the legal fees and risk inconsistent results. 

One benefit of the traditional method is that since the design professional is in contractual privity with the owner, that professional owes a duty only to the owner and not the contractor. In reviewing completed work, the design professional is required to protect the owner from both defects and overpayment. Understand, however, that this does not make the design professional a guarantor of the contractor’s work under the language of many standard contracts.  

Should a problem arise on a project, there is often finger pointing between the design professional and the contractor. Was the problem caused by a bad design or faulty workmanship? To the extent that the problem arose from an error or omission in the design, the contractor will have a defense against claims of the owner under the traditional method. Likewise, if the contractor incurs additional costs in building the project due to an error or omission in the design documents, the contractor will sue the owner for those damages. Only a limited number of states allow a contractor to sue the design professional directly on a negligent design (misrepresentation) claim. As the owner is the party in the middle of the dispute, it is crucial that the two contracts provide for disputes to be addressed in the same forum with all parties being joined in the same proceeding. In a single, combined proceeding, the owner can defend its position on the basis that it paid both the design professional and the contractor to do their jobs; provide a finished project, and if something is wrong, one or the other (or sometimes both) are responsible. 

The traditional method of contracting has its benefits, but also has pitfalls. As illustrated above, care in drafting the contracts will reduce or alleviate a company’s exposure to these risks. 

Design-Build Considerations  

Over time there has been an appreciable growth in the use of the design-build method. This alternative project delivery method arguably works to expedite the entire process from start to finish and reduce the overall project costs. Under this method the owner engages a design–build contractor, who in turn engages the architect or engineer. For the owner, there is a single contract to administer. The design-build contractor bears legal, and financial responsibility for both the design and construction of the project. 

One of the most cited benefits of design-build is that the design-build contractor can get started with construction as the design is being completed. Since a design-builder is contractually obligated to deliver both the design and finished project, typically the design documents are less detailed than those in the traditional method, thus reducing design costs. Presumably those savings are passed on to the owner. Advocates of design-build will tell an owner that this method is both faster and more economical for the owner. But is it really?  

When considering utilizing the design-build method, an analysis needs to be done to determine whether this approach is legally permissible in the state in which the project is being built. In some states, the architect licensure laws require a direct contractual relationship between the owner and the Architect. Similarly, some states’ engineer licensure laws dictate who may offer to perform or “sell” engineering services. Under the design-build project delivery method, a direct contractual relationship between the owner and the design professional is lacking, which can violate the licensure laws. If the state in which the project is located requires a direct contractual relationship and the design-build method is selected, there is the risk that should problems develop on the project, either party may have difficulty enforcing the parties’ contract. In states where design-build is legally permissible, statutes often dictate that specific disclosures be made in the agreement in order for the contract to be enforceable. Once again, particular care needs to be taken when drafting the contract to ensure compliance with relevant statutes. 

One drawback of the design-build process is that the architect does not owe a duty to the owner due to a lack of contractual privity. Accordingly, any design-build contract should state that the owner is an intended third-party beneficiary of the agreement between the design-build contractor and the architect. As the architect is not an unbiased judge of the quality and quantity of the work, the owner should consider retaining its own “clerk of the works” to monitor and evaluate the quality of the design-builder’s work, assess the reasonableness of the design-build contractor’s application for payments, and opine as to whether substantial completion has been obtained.

Another criticism of the design-build method is that it does not allow the owner to competitively bid the construction work. While the design-build contractor may say it is providing the company with a competitive price and is bidding the subcontracted work, without access to detailed plans, the owner really has no way of ensuring that it is getting the best price. This highlights the need for a company to conduct due diligence on the prospective design-build contractor. 

The lack of detailed plans and specifications also raises issues that may be addressed through good contract language. Under the design-build method, the owner typically pays the design-build contractor for the cost of the design services while the design-builder is still working on establishing the overall price for the project. Should the owner find that the cost is too high or the design-builder isn’t the right “fit”, the owner may have spent significant sums on design and end up empty-handed. One way of preventing this from happening is to add contract language establishing a fixed price for the design and transferring ownership of all design documents to the owner once payment is made for the design documents. While this solves the legal issue and prevents the design-builder from holding the owner hostage, from a practical standpoint the owner may still end up with ownership of only preliminary designs of limited use.  

One key to success with the design-build method of delivery is for company representatives to work closely with the design-builder to prepare a detailed scope for the project and establish a fixed budget for completion. Without a detailed scope, a dispute can arise due to the owner thinking that it was getting a certain component of the project, only to learn that such was not included in the design. Likewise, without a fixed budget, the owner may obtain a wonderful design that it cannot afford to have built. 

Even with a detailed project scope, the lack of detailed specifications and plans being produced by the design-builder’s professional results in more “grey areas” in terms of exactly what the owner is getting for its money  and opens the door to change orders increasing the project’s cost. This further highlights the differences in the two project delivery methods. For an owner who is confident that it can articulate what it wants and evaluate whether the scope is capturing all of its requirements, design-build may be the answer. For the owner that wants peace of mind that it is getting exactly what it wants for the agreed upon price, the complete design under the traditional approach may be the answer. 

So which project method delivery is best for your company? It depends. Are you experienced or not with capital building projects and what is the strength of your internal team? In any event, it is clear that good contracts make good building projects. And by the way, no matter which project delivery method that you chose, don’t forget to check the state’s lien laws to ensure the company is fully protected, and be sure that the insurance and indemnity provisions likewise protect the owner. The bottom line is that good contracts make for good construction projects. 

Diane Tokarsky is chair of the Construction and Procurement Group at McNees Wallace. She represents leaders within the construction industry including owners, design builders and contractors. She can be reached at dtokarsky@mcneeslaw.com.