Construction Contracts – 5 Key Issues

I recently had the privilege of presenting to Bob Andersen’s Mentoring Group on the topic of Construction Contracts.

I think the key message is that, certainly in Victoria, the most commonly used standard form Major Domestic Building Contracts are prepared by the builder’s associations.  As such, I think there are some key issues that both home builders and developers should review prior to signing a building contract.

The necessary conclusion is that home buyers and developers shouldn’t be scared to seek some amendments to the standard form contract.  Below I have set out 5 key issues that should be considered prior to signing.

Specifications

It is important to include detailed specifications and the get them right before you sign the contract.  You should annex to the contract detailed lists of what is to be included in each room – from floor coverings to light fitting and everything in between.  A key area to be particularly careful is the kitchen and any appliances other inclusions.
Detailed specifications mean:

  •  there is less room for misunderstanding and therefore disputes once construction has begun;
  • you are less likely to request variations and therefore incur additional costs and completion delays; and
  • the builder can give you a more accurate contract price before building commences noting that changes after constructions starts are likely to be more expensive.

Prime Cost / Provision Cost Items

A prime cost item is one where the builder includes an estimate of the cost in the Contract, but you are expected to pay the excess if the actual cost exceeds the estimate.

This has been a contentious issue in the past.  Some builders achieved a lower overall quote by understating prime cost estimates.  This means that once construction starts the owner is likely be required to bear unexpected costs when the actual costs exceed the estimates.

The best solution is to push for prime cost items to be removed from the contract.  That is, if your specifications are detailed enough the number and value of prime cost items should be able to be reduced.

Where that isn’t possible, you should ensure that the estimates are realistic and then select prime cost items with the estimates in mind to reduce unexpected cost increases during the build.

Completion Date

The completion date is generally fixed by calculating the number of working days required and then adding allowances for weekends and other non-working days and an allowance for days lost to weather events.

If the number of adverse weather days exceeds the budgeted number, this will cause the completion date to be delayed.  Variations, delays in getting permits or other details to the builder and suspensions for slow payment and other breaches will also result in extensions to the completion date.

Liquidated damages

Liquidated damages is the legal expression for the compensation that the builder should pay you to compensate you for completing the works late.
A weekly figure of $250.00 is the figure often nominated in standard form contracts.

However, if you are paying an interest rate of 5% on a million dollar mortgage then the cost to you of delays is likely to be around $1,000.00 in interest per week and that doesn’t include property outgoings and any other expenses you might incur.

It is interesting to note that these standard contracts often provide that you will pay high rates of interest (20% pa isn’t uncommon) if you are late making progress payments.
I therefore suggest that you consider carefully what the appropriate figure is.  The goal is not to profit from any delays on the part of the builder, but rather to ensure that you aren’t out of pocket for delays that are outside your control.

Costs on Termination

The standard contracts typically provide that if you terminate the contract, as a result of a default by the builder, then you are entitled to get another builder to complete the work.  You are then entitled to deduct the “reasonable cost” of completing the work from the contract price agreed with the original builder.

I recommend to clients that you amend the contract to provide that “reasonable cost” extends to include interest costs associated with the inevitable delay and any legal or other costs you incur as a result of the builder’s default.

Finally… One final thought is that if you can negotiate the progress payments so that the builder collects more than the standard 10% on completion then your interests will be better aligned.  This means that earlier progress payments will need to be reduced – which the builder won’t like.

However, completion is the only stage that is useful to you as the owner – but 10% in return for finalising all the loose ends may not be as attractive as larger stage payments on another project?

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