Contract Surety Bonds guarantee the terms of a contract. Unfortunately, there are many unfavorable contract terms that contractors and their bond companies should carefully review before signing on the bottom line. Below are common contract terms that can have major impacts on contractors and their surety bond companies. 

Contingent Payment Clauses

Contingent Payment Clauses are contract language that conditions payment under the contract to act outside of simply performing work or supplying material. Usually this condition is payment by the Project Owner to the General Contractor. In construction contracts, Contingent Payment Clauses usually take the form of either Pay When Paid or Pay if Paid language. It is important to note that contingent payment laws and whether they are enforceable varies by state. Contractor should check the laws for the states in which they are operating. An excellent resource can be found here. 

Pay When Paid

A Pay When Paid clause usually means that a payment from a General Contractor to a Subcontractor or Supplier on a project will be paid for their work or material WHEN the General Contractor is paid for the work or material from the Project Owner. Most states treat Pay When Paid clauses as a timing mechanism, meaning that the Subcontractor or Supplier is owed the money regardless of if the General Contractor is paid. The Subcontractor or Supplier will be paid within a reasonable time. However, what is reasonable is up for debate. 

Pay if Paid

A Pay if Paid clause means that a payment from a General Contractor to a Subcontractor or Supplier on a project will be paid for their work or material IF the General Contractor is paid for the work or material from the Project Owner. This language creates a condition precedent for payment beyond simply fulfilling the contract. That condition is payment by the Project Owner to the General Contractor. 

Pay if Paid clauses push a tremendous amount of risk to Subcontractors and Suppliers. In addition to the normal risk of construction, they are assuming the risk of the Project Owners’ non payment, even though a direct relationship to the Owner may not exist. 

It is important to notice that many jurisdictions do not recognize Pay if Paid language and may rule it unenforceable. Those that do recognize Pay if Paid language often require additional steps to be taken to make it valid such as clear and unambiguous language or acknowledgement by the Subcontractor or Supplier. However, all parties should carefully review these clauses and assess their comfort and risk with such provisions.

Flow Down Clauses

A Flow Down Clause is a contract provision that binds Subcontractors and Material Suppliers to the same terms and conditions as the Prime Contract between the Project Owner and General Contractor. Flow Down Clauses can be dangerous for Subcontractors and Suppliers. These clauses can limit payment, unfairly assess damages and commit the party to requirements without having a relationship with the Project Owner.

Before signing a contract with a Flow Down Clause, a party should always request a copy of the contract between the Owner and General Contractor to review the obligations they are committing to. Some General Contractors may push back on providing this document but it is only fair if this scenario and both the contractor and bond company need a chance to review the obligations before committing to them. 

Delay Damages

Delay Damages are financial consequences for a project not being completed in the time allowed by the contract. Delay Damages can be a major cost and risk for both contractors and their surety bond companies. 

Consequential Damages

Consequential or Special Damages are a remedy for items such as lost profits, loss of income, loss of rent, loss of use, loss of reputation and many other items. These items can be difficult to predict and carry huge penalties. One famous example is Perini Corp. v. Greate Bay Hotel & Casino, Inc. In the case, the court awarded the casino $14,500,000 in consequential damages for lost profits because of delays. 

However, consequential damages are a risk for both parties. Contractors can also claim consequential damages to a General Contractor or Project Owner that include things such as reputational risk, financing costs, and others. As such, a good practice is for both parties to agree to a Mutual Waiver of Consequential Damages. 

Liquidated Damages

Liquidated Damages are a remedy that seeks to compensate a party when actual damages may be difficult to quantify. In construction, it is common for liquidated damages to be a set amount for each day that the project is not completed by the agreed time. Liquidated Damages are agreed upon by both parties when the contract is signed so they are easy to calculate and each party knows the risk. Liquidated Damages are the method preferred by surety bond companies and should be preferred by contractors as well.

Silent Damages

Many contractors assume that if a contract does not list damages, there are none. When a contractor is silent to damages, it opens the contractor to risk. If a delay occurs, an Owner may claim consequential damages. For this reason, a contractor should spell out delay damages in the contract and insist upon Liquidated Damages.

Waiving Payment Rights

Mechanic’s Liens are a powerful tool for contractors and material suppliers to get paid. For years courts have recognized the need for Mechanic’s Liens on private projects. Federal projects are protected by The Miller Act and Little Miller Acts. However, some contracts contain provisions asking contractors to waive their payment rights. 

Contract clauses waiving lien rights are void and unenforceable in many jurisdictions. However a few states either allow them or are silent on them. A good map can be found here. Contractors operating in these jurisdictions should carefully review their contracts for these clauses. Waiving payment rights is a highly risky proposition for all contractors. 

Short Cure Period

A cure period is time given to a contractor to correct a default under a contract. A short cure period is a major risk to contractors. Two and three day cure periods are becoming an industry norm. However, assessing a problem, getting material, labor and equipment onsite can take time and may not be possible in such a short period. This increases the likelihood that a contractor will be terminated under the contract and a claim made against their performance bond. 

Contractors should endeavor to negotiate realistic cure periods. This is in the best interest of all parties to keep the project on time and budget. Although contractors often use cure periods as a way of applying pressure to keep a project moving, the reality is that terminating a contractor and finding a replacement will be far more time consuming and expensive. 

Termination for Convenience

Construction Contracts commonly have a Termination for Cause clause meaning that if a party fails to complete one of their obligations, the contract can be terminated. However, most construction contracts now have a Termination for Convenience. These clauses allow the contract to be terminated even when no default occurs. 

Termination for Convenience can be very problematic for contractors. Construction projects are long term in nature and contractors generally plan their labor, equipment, supervision and profit around existing contracts. An unexpected termination could leave the contractor scrambling for work to fill the void. There are some things contractors can do to help protect themselves.

Keep Good Records

Even when a contract is terminated for convenience, a contractor is owed for work and material done under the contract. Disputes may arise as to what work the contractor is actually owed for though. Keep good records so that you can easily submit billings for work completed. 

Be Overbilled

Slight overbillings on a project are considered a good practice. This is especially true if a contractor is terminated for convenience as it is better to be ahead. Conversely, underbillings present a large risk on a project that is terminated for convenience. Getting change orders approved after a project is terminated may be impossible and the contractor may be stuck with a loss. 

Wind Down Cost Clauses

Make sure the contract has a wind down provision along with the termination for convenience clauses. These clauses ensure that a contractor is compensated for ordered materials, supplies, equipment and mobilization costs. This should be included with all Termination for Convenience clauses.

Termination Settlement

Although not as common as Wind Down Clauses, the parties should try to negotiate a Termination Settlement into the contract. This settlement can give a terminated contractor agreed upon overhead and profit for work not completed. 

Long Term Warranties or Maintenance

Warranties generally refer to making sure a product works to specifications for a period of time. Maintenance is making sure the project is free of defects for a certain period. These two are often used interchangeably, but most construction contracts have a provision guaranteeing warranty or maintenance for some period of time. 

All things break down over time. Contractors should be skeptical about any contracts with long term maintenance requirements. It can be very costly to come back and repair wear and tear over the years. Surety Bond companies generally want to keep warranties under 24 months. 

Longer warranties should be passed back to the product manufacturer. This is common in trades such as solar, commercial roofs and athletic fields. In these instances, the manufacturer provides a long term warranty on the product itself, but labor for the repairs is limited to 2 years or less. 

Efficiency or Performance Guarantees

Related to Warranties are Efficiency or Performance Guarantees. These guarantees promise a level of output or money savings on a project. For example, a contract for solar panels may require that the panels generate a certain amount of power. Another example may be a large mechanical contract requiring pumps to move a certain amount of liquid per day. 

These performance guarantees are not the purpose of contract surety bonds and should be passed back to the manufacturer. Contractors want to limit their exposure to installing the equipment correctly and do not want to be obligated to manufacturer deficiencies. 

Incomplete Designs

Incomplete Designs designs are a major cause of construction disputes and project problems. Incomplete Designs can refer to any set of plans that are missing information. However, contractors should be cautious of bidding on projects of designs that are incomplete such as 60% drawings. These incomplete drawings often lead to increased costs and disputes down the road. 

If a contractor does bid incomplete designs, make sure to document all the assumptions that are going into the bid and provide those with your proposal. Try to clarify any gray areas before submitting the bid. Contractors should also include a large cushion to make up for any ambiguities and contingencies that may need to be addressed later in the project.

Construction is inherently a risky business and many disputes do arise. However, contractors can do a lot to protect themselves by reviewing contracts and risky contract terms up front. Having a construction attorney review a contract may cost money upfront, but it will be much cheaper than paying them to litigate on the backend. 

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Josh Carson, AFSB

Vice President at Axcess Surety

Vice President of Axcess Surety. Surety Bond and financial expert dedicated to helping contractors, businesses and individuals understand and obtain surety bond credit.

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