Important Construction Contract Provisions for Major Repairs in Condominiums & HOAs

Important Construction Contract Provisions for Major Repairs in Condominiums & HOAs

The overwhelming majority of condominium and homeowners associations will, at some point in time, need to enter into a large construction contract for a major repair or replacement. Complex construction contracts are more frequent in condominiums, where associations have a much larger number of items that they are responsible for maintaining. However, even smaller homeowners associations may have to contract for a repair or replacement to certain large items, such as private roads/drives or shared stormwater drainage systems for their communities. These contracts can also arise when a community is making large capital improvements, such as adding a swimming pool or recreational clubhouse, and when a community is responding to a natural disaster, such as flooding or fire damage.

Due to the large sums of money typically being expended for these types of projects, and the potential issues associated with defective work, community associations must be extremely vigilant and perform due diligence before signing any contracts. The board of directors should always start with obtaining multiple bids/proposals for large projects. That being said, the cheapest estimate is not always the “best” estimate and the old adage “you get what you pay for” should be considered.

Anyone hiring a contractor for a large or complex project should always try to:

(1) obtain recommendations from others who have used the proposed contractor and can attest to the quality of the contractor’s work;

(2) travel to inspect and evaluate previous projects with a similar scope of work performed by the contractor;

(3) check online reviews for potentially negative feedback; and

(4) search for active or previous lawsuits involving the proposed contractor.

Once a contractor has been selected, a contract will typically be prepared by the contractor on their “standard form.” Some contractors will use nothing more than a simple one-page estimate or proposal that outlines the general scope of work and lists the total payment amount. Other contractors will prepare a customized comprehensive contract, which will include detailed terms and conditions outlining the parties’ respective obligations. Some contractors may also use a “standard form” contract prepared by the American Institute of Architects (referred to as “AIA Contracts”). Any contract being prepared by a contractor will almost always be skewed in the contractor’s favor and may fail to adequately protect the customer’s interest.

Before entering into a large construction contract, community associations should carefully review and consider each of the following items with the assistance of legal counsel:

1. Payment Schedule and Variable Costs – The most important term of any construction contract for most customers is typically the contract price. While this is a critical term, the finer details surrounding the price must also be considered. For example, how much of a “down” payment must the customer make before work commences and at which intervals of construction are additional payments required? What type of inspections must be performed before payment requests are approved? Is the contract for a fixed price, or are there variables that could change the cost after the project commences? Who is responsible for paying permitting fees, inspection fees, and similar costs imposed by municipalities? If the money is being paid in whole or in part by insurance or a bank/lender, these important details need to be carefully addressed before the contract is signed. In addition, community associations may want to consider a “holdback” arrangement, where a percentage of funds are withheld until the construction is completed and has passed all necessary inspections.
2. Scope of Work and Construction Schedule – The scope of work must also be carefully evaluated before signing a construction contract. In certain instances, community associations may want to consult with an engineer or architect regarding the scope (particularly when any structural work is being performed) to confirm that the proposed work meets code and will not cause other unexpected issues. Deadlines for commencement of construction, completion of certain stages of work, and completion of the project should also be considered. Most contractors will not put a deadline for completion in the contract unless the customer specifically requests and negotiates for that term. If there are deadlines for completion of work, a penalty clause should also be considered if the contractor is delayed in completing the project for reasons within the contractor’s control. Failure to properly address these items could potentially expose your community association to significant liability if a project is substantially delayed and there is no way to hold the contractor responsible for the delay.
3. Change Orders – It is common for changes to be made to the scope of work after a construction project has commenced. Most construction contracts require that change orders must be in writing and signed by both parties to be legally effective. However, parties commonly agree to change orders in a less formal manner, such as via oral conversations, text messages, or emails. To avoid potential disputes down the line concerning the scope of work or the agreed upon price, parties should always endeavor to document change orders in writing. Community associations should also be cautious about paying invoices that exceed the amount set forth in the written contract when change orders were not documented.
4. Insurance – While all community associations should be maintaining their own insurance policies, it is also critical to ensure that all contractors performing work on the project are licensed and insured. Community associations may want to require their contractors to maintain appropriate limits of each of the following types of insurance: (i) Commercial General Liability Insurance; (ii) Builder’s Risk Insurance; and (iii) Worker’s Compensation Insurance. Umbrella insurance may also be desirable depending on the limits of coverage of the underlying policies and the scope of work. Community associations may want to be listed as an additional named insured under the contractor’s insurance policies, as this allows the association to file a claim directly under the contractor’s insurance policy. Community associations should also require certificates of insurance to be provided before construction commences and require that the association be notified of any change or cancellation in the policy. Finally, many insurance policies include what is called a “cross-party exclusion” which states that the policy will not cover any claim or lawsuit filed by one named insured against another named insured. Although these exclusions typically end when construction is completed, community associations should insist that any insurance policies obtained by the contractor do not contain a cross-party exclusion, otherwise there may be no coverage if the association sues the contractor for a claim arising during construction (such as when someone is injured because of negligence during the construction).
5. Subcontractors – Contractors often choose to subcontract one or more parts of the job to other contractors. If subcontractors are going to be used, the contract should require all subcontractors to be disclosed to the customer and should require all subcontractors to maintain the same types and levels or insurance as the contractor is required.
6. Inspections – Community associations should have major construction work independently inspected by professionals, such as engineers and architects. For large projects, these inspections should occur during major intervals of construction and after construction is completed. Often times, inspections by local municipalities are not as comprehensive as private inspections by qualified professionals. In Michigan, municipalities and building inspectors may be shielded from liability for negligence if they fail to identify a defect in a building inspection under Michigan’s Governmental Tort Liability Act. See MCL 691.1407. Thus, simply relying on the municipality’s generic building inspections could be insufficient for complex construction.
7. Indemnification – Indemnification is when one party agrees to reimburse another party for claims or damages incurred by the second party because of the first party’s actions or omissions. In construction contracts, a contractor may agree to indemnify a community association if a member of the community sues the association because of an injury caused by the contractor’s negligence during the course of construction. The contractor may also require the association to indemnify the contractor in the event claims are brought against the contractor because of the association’s actions. For example, if a homeowner asserts a claim against the contractor several years after construction is completed because of the association’s failure to maintain or repair the piece of construction, the contract could require the association to indemnify the contractor in this situation. There are limitations on the scope of indemnification clauses under Michigan law, so these provisions must be carefully reviewed by legal counsel.
8. Warranties – Most contractors offer some type of warranty on their work for large projects. For example, it is common for roofing contractors to pass along a manufacturers warranty covering the materials used onto the customer. These material warranties often cover a time period of anywhere from 15-30 years depending on the type of materials selected for the project. In addition to the warranty on materials, contractors often provide a warranty on their own labor and workmanship. These workmanship warranties are typically much shorter in duration, often being 1-5 years. Warranties are a critical item of any construction contract and can be negotiated. In addition to negotiating the warranty term, customers should carefully review the exclusions and requirements for giving notice of claims under the warranty. Many customers mistakenly believe that all defects and issues are covered under warranties, but most warranties include a long list of exclusions. Finally, the financial condition of the warrantor should also be evaluated since the warranty will be worthless if the warrantor is insolvent or files for bankruptcy.
9. Performance Bonds – Another way to protect against defective or incomplete work is to require a performance bond. Performance bonds are a special type of insurance in which a third party (called a surety) provides a certain amount of money to be used toward completing the construction contract if the contractor fails to do so. If a contractor provides a performance bond and fails to complete the project, the customer can file a claim under the bond and request release of the funds necessary to complete (up to the limit of insurance in the bond). Performance bonds are typically not required for private construction contracts in the State of Michigan (although they are more frequently required when a contractor is doing work for a municipal entity), but it may be advisable to consider requiring the contractor to provide such a bond to ensure completion of the contract.
10. Default and Limitations of Liability – Construction contracts should also clearly identify what is considered a default under the contract and outline the steps each party may take in the event of a default by the other party. Often times, this includes a requirement to send the party in default a formal written notice advising them of the default and giving them a period of time to cure or correct the default. If the default is not corrected, the contract should outline the parties’ respective options and liabilities as a result of the default. Default remedies for the customer can include the right to terminate the contract, withhold any future payment from the contractor, and the right to hire a new contractor to complete or correct the work, at the original contractor’s cost and expense. Default remedies for the contractor can include the right to charge penalties, such as late fees and interest, the right to stop work if the customer fails to make timely payment, and the right to record a construction lien against the property to secure repayment. In addition, community associations must be very cautions of agreeing to a “liquidated damages” clause in a construction contract. These types of clauses are becoming more and more common in service contracts, and these clauses often say that the service provider’s liability to the customer is limited to the amount paid under the contract.

As set forth above, construction contracts can be highly complex and should be carefully negotiated and reviewed with the assistance of experienced legal counsel. Without carefully considering the above items in the initial construction contract, associations could potentially find themselves dealing with unexpected issues and liabilities. In addition, a board of directors who fails to exercise proper business judgment, which could potentially include the failure to consult with a qualified architect, engineer, construction manager, and/or attorney prior to entering into a large construction contract, could be exposed to liability if the association incurs liabilities arising out of an unfavorable contract entered into by the association.

 

Brandan A. Hallaq is a Senior Attorney with Hirzel Law, PLC where he litigates cases involving defective construction, contract disputes, shareholder/member disputes, quiet title actions to determine interests in property, enforcement of restrictive covenants, real estate foreclosure actions, and bankruptcy matters representing creditors. Mr. Hallaq is also a licensed Real Estate Broker in the State of Michigan and leads the real estate transactions department at Hirzel Law, PLC where he negotiates and prepares the necessary documents for business and real estate transactions, including purchase agreements, franchise agreements, loan/financing documents, and commercial and residential leases and mortgages. In each year from 2018 through 2022, he has been recognized as a Rising Star in the area of real estate law by Super Lawyers Magazine, a designation that is given to no more than 2.5% of the attorneys in the State of Michigan each year. He was also recognized as a 2020 Up & Coming Lawyer by Michigan Lawyer’s Weekly, an award given to no more than 30 attorneys in the state each year, and he has been recognized in the Best Lawyers in America: “Ones to Watch” list for professional excellence in real estate law in each year from 2021 through 2023. Mr. Hallaq obtained his Juris Doctor degree, cum laude, from Wayne State University Law School where he served as an editor on the Wayne Law Review. Prior to joining Hirzel Law, PLC, Mr. Hallaq worked for a Federal Judge and in a Fortune 500 corporation’s in-house legal department. He can be reached at (248) 478-1800 or at bhallaq@hirzellaw.com.