During and immediately after the most recent recession, construction litigation seemed to hit an apex.  New pre-litigation matters to resolve monetary disputes from recession-era construction projects continue to keep many construction lawyers busy.  As the economy continues to “normalize,” we can look back and draw themes from the work that kept us busy.  Perhaps the most common theme that developed was this:  many of the contracts over which disputes arose often heavily favored the side with the most bargaining power.  

 

Drawing inferences from the provisions ultimately appearing in many of these contracts leads to a conclusion:  developers and owners of large-scale construction projects took advantage of the highly competitive atmosphere as building slowed and those in the construction industry searched for work.  Developers, contractors and subcontractors found more ways to develop contracts that allowed them to maximize the dwindling profit and overhead markups they were forced to accept by whittling away at amounts they would be required to pay their contractors, subcontractors and suppliers.

 

In many cases, the upstream party accomplished this by incorporating numerous provisions into their contracts that made pre-litigation negotiations decidedly more difficult for the downstream contractors, subcontractors and suppliers who found themselves in disputes.  This discussion focuses on the three most prominent provisions we encountered.  

 

First, bilateral attorneys’ fees provisions all but disappeared.  Instead, the attorneys’ fees and indemnification provisions seen in most construction contracts flowed solely to the benefit of the party higher up the chain (usually developers or contractors).  Thus, if there was a dispute over any matter contained in the contract, the party favored by these contracts could recover its attorneys’ fees if it prevailed (and sometimes even if it lost); however, even if the party disfavored by these contracts (whether a contractor, subcontractor or supplier) proved that the other party’s basis for dispute was meritless, the subcontractor was not entitled to recover its fees.  This reality significantly increased the burdened party’s risk and exposure while minimizing its bargaining power during contractual disputes.

 

Second, the termination and termination for convenience provisions frequently found in construction contracts became increasingly one-sided.  In over half of the contracts this author has reviewed since the recession began, the contracts allowed contractors or developers to terminate a contract for any “substandard work” in the contractor’s (or developer’s) sole discretion.  Upon such termination, the developer or contractor could hold payment for all work to which the terminated party was entitled as of the termination, hire a replacement contractor or subcontractor, and recover from the terminated party all actual costs incurred by the developer or contractor plus a 10-20% markup for management/overhead expenses.  These provisions were coupled with a draconian limitation on the terminated party’s damages if it was later determined that the terminated party’s work was not substandard:  the terminated party could only recover its actual, direct costs for the work performed through the date of termination, which was automatically construed as a termination for convenience.  Once again, when the terminated party was limited only to the costs it agreed to accept for its work and was not entitled to recover its anticipated profit and overhead for the work it was wrongfully kept from performing, the bargaining power tilted in favor of the developers or contractors.  The downstream parties burdened by the contracts were not afforded matching termination rights.

 

Third, these recession-era construction contracts often contained arbitration provisions that could be invoked only by the developer or contractor, at the developer or contractor’s sole discretion.  This made pre-litigation expense estimates difficult to deliver and rendered the venue and nature of the battleground uncertain.  As a result, contractors and subcontractors went into pre-litigation dispute resolution partially blind and unable to fully plan and budget for their litigation strategy.

 

Each of these provisions has potential weaknesses that can be exploited by the contractors and subcontractors subject to the provisions.  The unilateral termination provisions that reserve near-absolute discretion for the developer or contractor raise several doctrines that might limit the enforceability and impact of the provision.  The unilateral arbitration provision, if tested, may actually be unenforceable (or, in the jurisdictions that allow it, a court may re-write the provision to require mutual consent).  Finally, the three provisions together may lead a fact-finder to resolve disputes more readily against the party that drafted (and benefits from) these provisions.

 

From the perspective of the parties burdened by these provisions, even though defenses may be available at the end of the day, careful attention should be given to all provisions contained in a contract before it is finalized.  The potential difficulties one might face throughout the project as a result of these provisions are best avoided (or at least mitigated) at this stage.  On the other hand, from the perspective of the parties who would ultimately seek to benefit from these provisions, there are both legal and practical implications from reserving too much discretion.  From the legal standpoint, one-sided provisions may either be unenforceable or may open up arguments from the other side that the party exercising them acted in bad faith.  From a practical standpoint, these contracts may lead to unforeseen long-term reputational consequences. Developers or contractors with a reputation for abusing the negotiating power afforded by heavy-handed provisions may in future projects—and in an improving economy—be unable to find capable contractors, subcontractors or suppliers willing to bid out jobs at reasonable prices. 

 

If you have any questions regarding this issue or any other construction issue, please contact our Construction Practice Group.