What is a new construction contract?
A new construction contract is generally any contract in which a builder or developer agrees to build a structure for an owner, or to renovate or expand on an existing structure. New construction contracts include several components essential to the successful outcome of a project. Frequently broken down into two categories, residential and commercial, new construction contracts contain information essential to both owners and contractors alike.
From the owner’s perspective, new construction contracts clarify the work to be completed, indicate when the work must be done, describe payment schedules, and explain what happens if the job is completed late. New construction contracts also indicate disputes that may arise between the parties and provide a plan for resolution . From the contractor’s perspective, new construction contracts allow for a claim for damages if the owner fails to fulfill his part of the agreement. New construction contracts also provide for liens, should a contractor not be paid for the work performed.
Contractors, individuals, and companies involved in a new construction project should pay careful attention to the terms and conditions of the new construction contract. Each side should have an attorney review the new construction contract in an effort to make certain that the contract contains everything necessary, and should limit any unnecessary provisions that may put either side at a disadvantage. A poorly written new construction contract may result in costly mistakes and even costly litigation.
Important provisions of a new construction contract
A successful construction project is dependent on detailed communication between homeowner and contractor before the construction period starts. This is done through a contract that contains a number of essential clauses that should be reviewed by both parties to ensure each party is aware of exactly what is expected. A contract should clearly express the expectations, obligations, and rights of both homeowner and contractor.
Payment Terms
In general, construction contracts for new homes require payment to the contractor before the home is completed. A homeowner usually pays a modest deposit down, with additional increments to follow as certain milestones in the construction are completed. For example, a housing contract might require a homeowner to pay 10% of the cost of the home once the foundation is completed, 25% of the cost when the framing of the home is done, and the balance upon completion of the home.
It is important for a homeowner to be aware of all payment requirements in a new construction contract and to make certain that the home is actually compliant before making any further payments. A contractor might insist that payment is due upon completion of the framing, however a careful review of the contract might indicate that additional steps must be taken before framing can reasonably be considered complete. For example, the foundation of a home may need to be fully cured before additional construction begins, rather than a simple placement of the concrete into the foundation.
Project Scope
The scope of work clause in a contract is designed to protect a homeowner from a contractor insisting on expanding the scope of the work after the contract has been signed. For example, if you have a contract for a three-bedroom, two-bathroom house, a contractor should not be entitled to additional money on the contract if he decides to build you a four-bedroom, three-bathhouse. Through a scope of work clause, the homeowner can prevent a contractor from collecting money on a contract for additional bedrooms, even if they might increase the overall value of the home.
Timelines
Without timelines, a homeowner has little protection against delays in construction. The contract should set time limits on how long a builder will take to complete the home. Likewise, it should also specify how long they should take to complete specific phases of construction that went into the contract price. Homeowners generally do not expect a general contractor to have the home built overnight; however an unfinished home for several years is often not acceptable. Timelines for construction can be used to prevent this problem.
Warranties
A new home usually comes with several warranties regarding construction and major appliances. For example, a warranty may provide a homeowner with the right to seek a refund should his dishwasher or stove break within the first 5 years of use. A warranty might also provide a homeowner with the right to compensation should a roof leak within 10 years of completion of the home. If a new home does not come with such warranties, buyers should seek them out to create additional protection.
Common issues with construction contracts
A common mistake that new construction buyers make is a feeling of comfort without the contract. When this happens, the buyer sets itself up for conflict down the road. Therefore, even though you may not feel uncomfortable with your contract, take the time to read it and ask difficult questions in advance of signing.
Over the years, disputes break down into five categories for these common pitfalls:
- Conditions to Closing. After every deal, someone says "if I had only known." Include every rescission requirement as a condition to closing. This is particularly true of financing. A new buyer can usually obtain favorable financing on a more experienced purchaser or a larger purchaser.
- Security Deposits. Once security has been paid, if the deal does not come together, say what is to become of the security. If security is forfeitable, it should be. If security is refundable, include a provision for damages. If a concession of price is granted or a discount on the purchase price, if the deal does not come together for any reason, you should receive the discount plus all security back.
- Site Plan. New buyers frequently assume that after signing the deal, they will be able to produce plans for the required approvals and row builder. This is not always the case. Sometimes the approved plans are out and sometimes the community or other neighbors oppose the project. Even an engineering problem can stop the project. Be very clear in the contract what happens if material approvals have not been obtained by the time of closing.
- Assignment. We often see contracts where one of the parties’ ability to assign the contract and or a right to compel a contract transfer is either not discussed or discussed poorly or improperly. An example is making both parties a mutual party to a three-party agreement. This is an invitation to conflicting obligations amongst the parties. Avoid this type of pitfalls.
- Material Approvals. In order to obtain all the necessary approvals, you need to agree to the amount of time required to obtain approvals. This will slow down the purchasing process but at the same time, allow the development team to create the proper entitlement package.
Negotiating a construction contract
Engaging in negotiations with a contractor prior to signing a contract is of critical importance. There are a number of tips that should be reviewed and discussed before a construction contract is signed. It’s important to start the process early and leave enough time to negotiate the final contract. Getting started several weeks before a project is scheduled to begin is important, so that everyone has the time to make sure there is a clear understanding of what the final contract will include. When it comes time to negotiate the terms of a contract, things are likely to go much smoother if everyone is ready to negotiate.
Typically, the very first step to take is to collect several bids or quotes on a project. Since not every contractor may be interested in bidding, getting more than one or two quotes is often necessary. This initial step is also important because it determines what kind of work can be completed within a homeowner’s budget. Next, walk through each of the quotes and calculate the average price. If there are any outliers, you can usually eliminate those right away as they may not represent fair market value on the proposed contract. You may also want to eliminate any bids from contractors whom you have read negative reviews about or whom you have heard bad things.
Once bids are received and reviewed, there is usually a clear understanding of what a homeowner is willing to spend on the proposed project. The next step is to identify any contingencies that could impact the overall cost of the project. For example, if weather conditions are often poor in the area, making it difficult to complete exterior work, that may have to be considered.
Homeowners should also have a clear understanding about which parts of the project they consider to be essential and which parts of the project they are willing to compromise on. For example, if a homeowner is willing to consider used or recycled materials, that could help them to save money on the overall cost of the project. When negotiating, the goal is to get to a place where both parties feel both satisfied and comfortable with the final contract.
The final step in contract negotiation is to review the final contract once it has been presented. Have a lawyer review the contract before signing. This step is especially critical if any specific warranties or guarantees are included. Consider using the contract as a form of checklist, to make sure there is a clear understanding of when and how the work will get completed.
The importance of having an attorney for your construction contract
While many of us don’t consider it, the need for legal counsel takes a different form on a new construction contract. Because residential new construction contracts are generally preprinted forms, there is often little a legal professional will do to draft the initial contract but their involvement in reviewing the contract can at least provide peace of mind if nothing else. Simply reading through the contract with your attorney and having them explain the various provisions can insure that you, as a party to the contract, have a complete understanding of your obligations and rights under the contract.
However, if you, not the builder, have drafted the contract because a contract form did not already exist one or both parties may include provisions that are not entirely fair, or correct , because of their lack of knowledge of the law. A legal professional’s job in this case is to make sure the contract complies with applicable law and that all parties have obligations and rights that are fair and reasonable. A legal professional will also identify potential liabilities throughout the contract and suggest ways to minimize riskâoften this may mean adding additional provisions to the contract. Adding additional provisions or simply crossing out terms in the contract that you do not agree with is not something that you, or any non-attorney, should do. If you do not like or agree with a term in the contract you should have a legal professional make the change. If you cross through something in the contract and the builder’s agent agrees, the contract should be re-executed before it is sent to the builder.
Case studies of commercial construction contract disputes
To get a better understanding of how new construction contract litigation can arise, let’s look at some real-world examples:
The Neighborly Dispute
While most construction contracts do not require the contractor to reimburse the homeowner for the loss of use of the property while the work is performed (in fact, it’s highly likely that your contract limits any liability to the actual repair of damages to any property), some do. For example, your HOA may require you to obtain a license from them for any outside work. In those contracts, there are typically clauses that require you to forfeit the money you made while doing the work AND reimburse some amount for the loss of use on top of that removal of funds.
In one case that made it to court, the HOA claimed and won on the issue of liability but lost about $300,000 in "damages" because their interpretation of loss of use didn’t include any contingencies for normal wear & tear. In this particular case, the HOA essentially spent as much or more than it was owed and ended up with no additional compensation from the contractor.
The Buyer/Seller Disagreement
There are a few ways that new construction contracts can make it to litigation. The most common is when the home buyer assumes the contractor is responsible for certain items because they are "standard" in new home construction. Or the seller assumes that the above mentioned item is basically covered by what’s supposed to be in the buyer contract.
Unfortunately, people make these assumptions all the time. In a case like this, finding out the truth of the matter means going back to the actual contract language to see if it covers these issues, rather than just what was done in other instances. Additionally, the home buyer often does his or her own "upgrades" that are not directly addressed in the contract, which can require a completely new layer of legal discussion.
Your contract may provide options to treat these instances, but assuming the best scenario for you or the other party is not a good idea. So carefully review your contract for inclusion of any language that makes certain items the contractor’s responsibility. Plus, even if you have a provision, if the work has been done, courts may not look favorably on trying to go back and force a contractor to re-do anything. Rather, pay attention to the contract terms and carefully read them before signing!
New construction contract checklist
Below are some questions and topics to keep in mind as a checklist and red flag guide when you go to review a new construction contract (again, not an exhaustive list).
Will you own the land parcel, or are you entering into a ground lease arrangement?
What is the price of the contract?
What is the construction timeline – is there a hard deadline for completion, or is there a window of time agreed upon that is adequate?
Who will be responsible for paying the utilities during construction?
Have you hired qualified architects and engineers to your project , prior to construction begin?
Have you reviewed the proposed floor layout and blueprints?
Does your broker have a history of working with the developer, or has he worked on similar projects in the past?
Are there any disclosures you will likely need to follow up on upon the completion of the build?
Have you set aside a budget for construction overruns?
Do you have the professional expertise on-hand to effectively manage your project?