July 13, 2018
A. Basic Contract Principles
From a legal perspective, contract terms form the basis of the agreement between the various parties in a construction project. At its most basic level, contract terms outline the rights, duties, and obligations of the parties. In essence, the contract terms provide a guideline for the work on the project. For example, the contract terms will set forth how often and how much a contractor will be paid. Contract terms will also establish the deadline for completion of the project and what should happen if problems arise on the project. Therefore, when a legal dispute arises regarding a project, the first document reviewed by the parties and their attorneys is always the contract. Some fundamental rules to keep in mind with regard to contracting:
1. Fundamental Rule #1: Goal = identify and allocate responsibilities and risks
The primary purposes of a construction contract should always be to: a) clearly define and explain the work that will be performed and who will be responsible for that work; and b) identify and allocate the risks so all parties understand their liabilities and can plan (and price) accordingly. Most of the provisions in standard construction contracts are intended to assist in one of these two objectives. With respect to defining and explaining the work, the construction contract should clearly set forth what work will be done, when it will start and what (if any) prerequisites exist for performance, how long it will take, when it will finish, who is responsible for performing the work, how and when it will be reviewed and evaluated, who will perform the work, and how and when the party performing the work will be paid. With respect to identifying and allocating risks and liabilities, the construction contract should state what will happen if the work is not timely commenced or completed, what will happen if the work is defective, what warranties (if any) will be given with the work, what indemnities (if any) will be given by the party performing the work, what rights the performing party has to collect payment and, in the event payment is not received, to lien the project and/or property.
2. Fundamental Rule #2: Perspective matters
Everyone has a bias. Contracts reflect those biases. The same contract for the same services will be entirely different if it is written by an architect, than if it is written by a contractor. The perspective of the contract drafter subtly, and sometimes not so subtly, alters the framework as well as the substantive and procedural provisions in contract. AIA construction documents have been drafted by the American Institute of Architects and therefore, notwithstanding claims of neutrality, they include provisions designed to protect and favor the interests of architects. Appreciate the perspective of the drafter of any contract you review and it will help identify the areas the drafter felt were important enough to address. This can often help parties appreciate what issues are of greatest importance to the other side and work to find ways to craft provisions that protect both parties’ interests.
3. Fundamental Rule #3: Plan for a project to succeed, but contract as if it won’t.
Things go wrong. All the time, every time, on every project. The greatest gift a lawyer can give a client is a clear understanding of what will happen if things go wrong on a project. Parties need to have an arrangement clearly set forth in their contract as to how they will handle the inevitable problems that will arise. At the start of the project is a time when no one knows what problems will arise, who will cause them, or what effect they will have on the project. That is, in some senses, the perfect time for parties to be completely fair and understanding. Many parties and attorneys see this is an opportunity to argue over strict provisions forcing one party to agree to draconian penalties and remedies in the event something happens. Wise counsel instead looks for ways to set mechanisms in place for the parties to quickly identify and isolate problems before they arise or when they are small, and then work together to avoid or fix the problems with the minimal cost and disruption to the project possible. Rather than treating problems as a polarizing event, this approach encourages collaboration and cooperation aimed at problem-solving. Often parties may agree to share minimal losses as a means of encouraging parties to disclose and work together on problems quickly. Even if a construction contract doesn’t do this, it needs to clearly state the risks and who bears the liability in the event of a problem. Even the most draconian liability provisions in a construction contract may be acceptable to a party that can assess and plan ahead with a full appreciation of the risks and rewards of the contract.
B. Contract Formation
1. Types of construction contracts
Construction contracts can be generally categorized by their compensation arrangements and/or their organizational structure.
a. compensation arrangements
i. lump sum or fixed price
The traditional method of compensation under a construction contract is the “lump sum” or “fixed price” arrangement. Under this type of arrangement, the Contractor agrees to complete the project for a fixed fee. Subject to certain compensable changes to the contract, the Contractor is required to complete the project for the fixed fee no matter how much it actually ends up costing the Contractor. The advantage to the Owner from this type of arrangement is that the Owner (theoretically) knows what the project is going to cost and can make financial commitments based on this price. The disadvantage to the Owner is that the Owner may not get top quality work if the Contractor has to cut costs to make the contract profitable, and the Owner may get embroiled in disputes with the Contractor over attempts to increase the contract price. The advantage to the Contractor from the “lump sum” or “fixed price” arrangement is that a savvy Contractor who can predict and control its costs can make a greater profit under this arrangement. This type of arrangement, however, puts most of the risk of unexpected or unpredicted costs on the Contractor and can lead to difficult situations.
ii. unit pricing
Under “unit pricing” the work called for in the construction contract is divided into specific units. For each unit of work performed by the Contractor, the Contractor is paid a set price. Different types of labor or materials will have different prices per unit. Unit pricing reduces the risk to the Contractor because one factor of risk (the quantity of work that will be required to complete the contract) is taken care of under this type of arrangement. One problem with this type of arrangement is locating trained professional people who can accurately compute quantities for unit pricing. If the quantities are underestimated, the use of unit pricing can result in a dispute between the Owner and Contractor as to who takes the risk of the underestimation.
iii. cost plus
Under the “cost plus” compensation arrangement, the Contractor is paid the costs of completing the contract plus a fee. Usually, the fee is either a fixed price or an amount based on a percentage of the cost of completion. The disadvantage to the Owner of this type of arrangement is uncertainty as to what will be the total cost of completing the contract. In addition, under the cost plus arrangement, the Contractor has no incentive to control the costs of the project. For these reasons, the “cost plus” arrangement is usually subject to a maximum price above which the Contractor takes the risk of the cost of completing the contract.
b. Organizational Arrangements
This is the traditional organizational system for a construction project. The Architect first designs the plans and specifications for the project. After approval by the Owner, the plans and specifications are put out to bid. After award to one of the bidding Contractors, the winning Contractor builds the project. The advantages of this system are that it is simple to understand and familiar to the parties involved and the Owner should get a relatively accurate price for the construction of the project (provided that the plans and specifications are clear and the Contractor who provides the winning bid is competent). One of the disadvantages of this system is the long lead time that it takes to get the plans and specifications finalized. Another disadvantage is that the Owner must wait until after the plans and specifications are complete to find out how much the project will cost. This cost could be much more than the Owner envisioned - leading to further delays while the plans and specifications are revised to reduce costs. Another disadvantage of this system is that it leads to confusion over who is responsible for problems that are encountered during the construction process. The Architect, Contractor, and subContractors may often spar over whether such problems are due to “design” versus “construction” defects.
Under this type of organizational system, the Owner contracts with a single entity that both designs and constructs the project. For the Owner, the attractiveness of this system is its simplicity. One entity has the responsibility for design, for submitting a lump sum price for construction, and for carrying out the construction. Thus, if there are any problems in the design or construction of the project, the Owner has only one entity to hold responsible. Another attraction of this system to the Owner is that the process may shorten the time to get the project finished. There are no delays in redesign or in bidding the project out to Contractors. In order to use this type of system, however, the Owner must be able to clearly define the project at an early point in the process. Later revisions to the scope of the project will be hard to accommodate without possible disputes and cost increases. A potential disadvantage of this system to the Owner is that it loses the input and advice of an independent Architect. Under the traditional designbid-build system, the Architect is hired by the Owner and its allegiance is to the Owner and not the Contractor. Under the design-build system, the Architect or designer is part of the Contractor’s team. This switch in allegiance may adversely affect the Owner if the design-build Contractor tries to save costs during construction. To prevent such problems, the Owner may retain the services of an independent Architect or other construction professional to monitor the design-build Contractor. The design build system contains potentially large risks for the design-builder. This is because the designbuild Contractor is taking on both the risks of designing and constructing the project, usually for a lump sum or fixed price. These risks can be magnified if the Owner has not clearly defined the project before it is bid out. Then, the design-builder may have to deal with problems and disputes arising out of Owner instituted changes to the project.
iii. construction management
Construction management became a popular term of art in the 1970’s. Construction management developed due to a weakness in the traditional system of design and construction. The weakness was that Architects were often not very good at estimating the costs of construction, handling disputes as to the scheduling of construction, or controlling the costs of construction. To remedy such weaknesses, Architects, engineers, and Contractors began to hold themselves out to Owners as “construction managers.” These construction managers would offer a variety of services in overseeing some or all of the following: design analysis, bidding, negotiation of contracts, scheduling, cost control, and construction project management. Construction managers are particularly useful to Owners who have little construction experience or who are undertaking a large complex project that will require significant oversight and coordination. The disadvantage of using a construction manager is that it adds another layer of coordination to the team involved in the construction. This may engender confusing lines of authority and responsibility and generate conflicts between the various parties involved in the construction. In this respect, the position of the construction manager has never been fully defined in the construction industry, and there are many variations in contract forms setting out a construction managers’ authority and liability. Both the American Institute of Architects (“AIA”) and the Association of General
Contractors (“AGC”) have several forms of contracts that set out different construction management systems.
iv. multiple primes
Under this organizational system, the Owner, rather than contracting with one general or prime Contractor, contracts directly with a number of Contractors to construct the project. Usually, the Owner contracts with the major subContractors who will be the primary parties involved in constructing the project. Owners usually enter into this arrangement to: (a) cut costs by cutting out the fee to the general Contractor; (b) be able to select the subContractors they want on the job rather than leaving that up to the general Contractor; and (c) eliminate cash flow problems to the subContractors. The multiple prime system, however, creates practical problems that may lead to legal problems. The main problem is the coordination of the work. One of the main jobs of a general Contractor is to coordinate the work at the project. There are usually many Contractors working at a job site. In addition to keeping them out of each other’s way, the various Contractors’ work often has to be coordinated in a logical fashion. If the coordination is lacking, delays occur, defects may occur, and costs will increase. The Contractors will then seek compensation from the Owner. Sometimes an Owner will try to designate one of the multiple Contractors to coordinate the work of the rest. Because this Contractor has no contract with the other Contractors on the project, however, this may only partially solve the practical problems of coordination and may not resolve any of the resulting legal problems.
v. fast track
To expedite the construction process, Owners often engage in phased construction or “fast tracking.” “Fast track” construction allows an Owner to begin construction before the plans and specifications have been finalized. In a fast track project, the Owner may select the Contractor while the project is still in the preliminary design phase. This allows the Contractor to participate in the design process. Such participation can be beneficial from the standpoint of constructability and reducing costs. The Owner may also select the Contractor after the design for a certain phase of the work has been approved but before later phases have been completed or approved. For example, in public projects involving large systems such as water and sewage systems, construction may begin when one phase of the project has an approved design but before later phases are designed or approved.
The major disadvantage of a fast track project is uncertainty. Since the design for the project is not finalized or approved, disputes may arise later as to who is responsible for constructing certain parts of the project and how much they will be paid for such work. These problems particularly arise when the Owner wants a lump sum or fixed price contract with the Contractor. Then the Contractor must be careful to document what is or is not included in the contract. Where allowances are built into the contract, the Contractor must be careful to provide adequate amounts for these allowances or face a dispute later when the Owner tries to hold the Contractor to the specified allowance amounts. Under the AIA form of construction contract, some of these problems may be handled through a construction change directive whereby the Contractor is directed to make a change in the work and the question of compensation for the change is deferred to a later time so as to avoid delays in the project.
2. Components of the construction contract
The construction contract on a project may be composed of some or all of the following which are collectively referred to as the “contract documents:” (a) the bidding documents or requirements; (b) the basic Owner-Contractor agreement; (c) the general conditions of the contract for construction; (d) the supplementary or special conditions; (e) the drawings; (f) the specifications; (g) the addenda; and (h) the modifications.
a. The bidding documents
The bidding documents usually include an invitation to bid, instructions to bidders, and bid forms. The invitation to bid is generally a one or two page announcement directed to general Contractors describing the project and outlining the procedures for bidding and the award of the contract. More specific ground rules which the Contractors should follow in submitting their bids are set forth in the instructions to bidders. The AIA forms of construction contracts do not include bid documents as part of the “contract documents” – ostensibly because the bid documents may significantly vary from or conflict with the eventual contract agreed upon by the parties.
b. The basic owner-contractor agreement
The basic Owner-Contractor agreement is often the only document that is actually signed by the parties. It usually incorporates by reference the other contract documents. The agreement generally covers the following topics: (1) the identity of the parties to the agreement; (2) a description of the work to be performed by the Contractor; (3) the time for the Contractor’s performance of the agreement; (4) the contract price to be paid to the Contractor; and (5) a description of when and how payments are to be made to the Contractor under the agreement.
c. The general conditions
The general conditions of the contract for construction are typically very long and detailed. The general conditions set forth the rights, duties, and responsibilities of the Owner and Contractor. In addition, the general conditions usually set forth certain of the duties and responsibilities of the project’s Architect and construction manager (if applicable). The general conditions used in most construction projects are forms put out by government entities or organizations such as the AIA or AGA. The AIA’s “General Conditions of the Contract for Construction” (Document A201) is one of the most frequently used forms. The most recent AIA Document A201 was put out in 2007.
d. Supplementary conditions
Supplementary and/or special conditions are meant to tailor the general conditions to the particular circumstances of the project in question. They are used to account for specific conditions unique to the project. In addition, they may be used to amend, delete, or modify certain provisions in the general conditions that would otherwise be applicable.
e. The drawings
The drawings or plans show how the project is to be constructed. The drawings are usually put together by an Architect or engineer. The drawings show the type, quantity, size, and location of the various items to be incorporated into the project. The success of any project often depends on how complete and accurate the drawings are. Depending on how complicated and large a project is, the drawings may be divided intothe following disciplines: (1) Architectural; (2) structural; (3) electrical; (4) civil; and (5) mechanical.
f. The specifications
The specifications supplement the drawings of the project. Using words instead of pictures, they describe how the project is to be constructed. The specifications will list the types of products that are to be used, the performance characteristics that are to be met by the products used, the quantities of materials to be used, and the other details concerning the application of such materials or the installation of particular parts of the project. The specifications are also usually organized by divisions and sections pertaining to the various trades or parts of the construction of the project.
Addenda are changes that are made to the project prior to the dates that bids are accepted. Because they may materially change a bidder’s bid, they need to be distributed simultaneously to all prospective bidders well in advance of the bid.
3. The basic owner-contractor agreement
The following are brief descriptions and comments on some of the major elements of a common form of basic Owner-Contractor agreement.
a. identity of the parties
The basic Owner-Contractor agreement should identify the parties by using their full and/or corporate names. Although they are not parties to the agreement, the Architect/engineer and any construction manager should be identified in the agreement. All parties signing the agreement should indicate the legal capacity in which they are signing the agreement, i.e., as individuals, partners, corporate officers, etc.
b. description of the work
The basic Owner-Contractor agreement should also state the scope of work to be performed under the agreement. This is important for at least two reasons. First, the scope of work should be defined clearly so that it can be determined whether later changes ordered by the Owner are within the original scope of work. If they are not within the original scope of work, the Owner may not be able to require the Contractor to perform the ordered changes - at least without additional compensation or contract time.
Second, where the work is divided among a number of Contractors, it is vital that each Contractor’s work is clearly defined so that there is an unmistakable division between the work of the various Contractors. This is necessary to avoid Contractor disputes over who is responsible to perform what portions of the overall project.
c. time for performance
The basic Owner-Contractor agreement usually establishes a time for commencement and a time for completion of the work. This is important inasmuch as delays and failure to complete the work on time are among the most common and difficult disputes to settle between an Owner and Contractor. With respect to the time for commencement, it is often hard to state a particular date since this often depends on when the Owner is able to secure all needed permits and financing. Accordingly, many agreements provide that the work will commence within a certain number of days of the Contractor receiving a notice to proceed from the Owner. This gives the Owner flexibility in determining the start date of the work. The Contractor, however, needs to make sure that enough notice is provided for it to gear up for construction. In addition, the Contractor may want to give the Owner an outside date as to when construction must proceed. This is to avoid the problem of an Owner not giving a notice to proceed for an unduly long period of time during which time the Contractor’s costs may increase so as to make the original construction price unfair. It is also often difficult to state a precise date for completion of the work particularly if the commencement date is not certain. Therefore, many agreements provide for the work to be completed within a certain number of days after commencement of the work. However, it is not uncommon for an Owner to require substantial completion by a precise date. This is usually because the Owner may need to have the project ready for occupancy or some other use by a set date. If the Owner has such a need, the Contractor must be careful in analyzing whether the completion date leaves the Contractor enough time to complete the work. Some contingency time should be built into this analysis since time extensions are often required on a project due to unforseen circumstances. The Owner should also be concerned that the completion time is adequate since it could be faced with a constructive acceleration claim if it fails to grant reasonable time extensions during the performance of the work.
Some agreements contain a “time is of the essence” provision. Such provisions have a significant legal effect and are enforced in the context of claims for liquidated damages and delay damages. See Mayer v. Alexander & Baldwin, Inc., 56 Haw. 195, 532 P.2d 1007 (1975).
d. contract price
The basic Owner-Contractor agreement usually sets out the price that the Owner will pay the Contractor for completion of the work required under the contract. As noted above, the price may be a lump sum, cost-plus, based on unit pricing, or a combination thereof. It is important for the Contractor to specify any work that is not included in the price - such as work that is to be directly paid for by the Owner to another Contractor. It is also important for the Contractor to specify any work that is being provided by the Contractor but on a different basis than the contract price. For example, the lump sum price given by the Contractor may not cover certain items of construction which are to be done under unit pricing or some other basis. On the other hand, if the price is under a cost plus arrangement, the Owner should include in the basic Owner-Contractor agreement any maximum or “not-to-exceed” price that has been agreed upon.
The basic Owner-Contractor agreement usually contains three provisions regarding payments to the Contractor. The first provision sets out when and how progress payments will be made, i.e., partial payments made to the Contractor while construction is proceeding. Under the AIA form of the basic Owner-Contractor agreement, progress payments are made on the basis of monthly applications for payment by the Contractor. Applications for payment are based on what percentage of the work has been completed by the Contractor as determined by a schedule of values for the project.
The second provision sets out what, if any, amount will be withheld from the progress payments as retainage. Retainage is withheld by the Owner to secure completion of the project. If the Contractor does not complete the project, the Owner may use the retainage to perform the uncompleted work. The basic Owner-Contractor agreement may have provisions for payment of part of this retainage to the Contractor as the work nears completion.
The third provision provides for final payment to the Contractor. This generally occurs only upon full performance of the contract - although such payment may be made if there are only minor non-conforming items to be completed. Under the AIA form of agreement, an Architect’s certification is usually required before final payment is made to the Contractor. Details as to what is required for such a certification are included in the AIA’s general conditions of the contract for construction.
f. other provisions
Other common provisions in the basic Owner-Contractor agreement include an enumeration of the contract documents, i.e., a listing of all the drawings, specifications, general conditions, supplementary conditions, and other documents that form the whole of the contract between the parties.
The basic Owner-Contractor agreement may also contain provisions as to when the contract between parties may be terminated or suspended. In the AIA form of agreement, the agreement simply references provisions in the more detailed AIA general conditions of the contract for construction.
The use of standard form contracts is a means of managing risk in that form contracts are (1) well known in the industry; (2) predictable and therefore provide a degree of certainty for the contracting parties; and (3) the subject of court interpretation and therefore offer guidance as to how they should be applied. The most commonly used forms are those put out by the AIA, the AGC, and the Engineers Joint Contract Documents Committee (“EJCDC”). Still used, but less so in Hawaii, are form contracts created by the Savings & Loan League of Hawaii.
Although these standard form agreements facilitate the contract formation process by giving project participants a head-start in establishing the terms and conditions that will govern each party’s performance on the project, the forms themselves need to be carefully reviewed and modified where necessary to balance out equities and essentially make the contract fair. “Fair” is not an absolute term. One party may have better bargaining power and therefore better leverage, and yet the contract can be “fair.” If the contract properly allocates risk to the party that can best absorb or assume that risk, then the contract might be deemed fair even if certain provisions might not. Furthermore, allocation of risk is generally what the market can bear. In a slow building market, where contractors are hungry for work and have less leverage than developers, contractors may have to bear more risk than in boom times in order to get the job. Having to bear more risk under the circumstances does not make the contract “unfair.” Each form contract then, must be assessed and modified if necessary, to satisfy the competing needs, risks, and rewards of the parties.
Some construction industry participants dislike standard form contracts because they believe such contracts may not be detailed enough, or do not go far enough, or are biased in favor of certain participants. However, from a legal perspective, the standard form agreements are preferred and are beneficial in that their familiarity reduces or minimizes legal review and assessment up front, and provides a reasonable degree of reliability because prior court decisions can provide insight and quick resolution to problems that arise. The fact that the far majority of projects use some type of standard form agreement attests to the popularity and utility of such documents.
Every construction contract contains certain implied obligations that the parties must observe. Implied contractual obligations and warranties attempt to ensure that the parties work together toward successfully completing the contract and that one party will not attempt to unfairly take advantage of another party due to a superior position or position of authority. In Hawaii, and in virtually every other jurisdiction as well, “every contract contains an implied covenant of good faith and fair dealing that neither party will do anything that will deprive the other of the benefit of the agreement.”1 Each party to a contract has “a duty of good faith and fair dealing in performing its contractual obligation.”2 Therefore, the covenant of good faith and fair dealing in Hawaii has relatively broad application and should apply to all government and private construction contracts.
In construction projects, in addition to the implied covenant of good faith and fair dealing, there are several other implied warranties that parties should be aware of when prosecuting contractual duties. The following is a brief overview of the some of the key implied warranties that exist in construction contracts.
Duty to schedule and coordinate – Construction contracts impose a duty on the party or parties responsible for scheduling to schedule the work in a normal, reasonable sequence.3 The scheduling should not be done in such a manner that unfairly favors the party responsible for the scheduling or any other party. Scheduling should also not be done in a manner that that interferes with a party’s ability to perform their work. A breach of the duty to schedule and coordinate will expose the party responsible for scheduling to liability to other parties for delays in the project.
Duty not to delay, hinder, or interfere with work – In a construction contract, all parties have an implied obligation not to delay, hinder, or interfere with the other parties’ performance of their contractual obligations. A party’s action or inaction can be considered a delay or interference. Delays or interference can result in increased costs due to idle workers and equipment and from having to perform work under different conditions that originally anticipated. “[A] contractor is entitled to recover damages from an owner for losses due to delay and hindrance of its work if it proves: (1) that its work was delayed or hindered, (2) that it suffered damages because of the delay or hindrance, and (3) that the owner was responsible for the act or omission which caused the delay or hindrance.”4
Duty to cooperate – Construction contracts also contain an implied duty for all parties to cooperate with each other to complete the project. This duty goes hand-in-hand with the duty not to delay, hinder, or interfere with another party’s performance. “Not only must [an owner] refrain from hindering the contractor's performance, it must do whatever is necessary to enable to contractor to perform.”5 In general, to establish a claim for a breach of the duty to cooperate, a party must prove that a party’s “performance was thwarted or frustrated to its detriment by some unreasonable . . . action or inaction.”6 Examples of breaches of the duty to cooperate include situations where the owner responds to a contractor’s request in an evasive or untimely manner,7 where the owner causes the contractor to incur unnecessary expenses,8 and where the owner fails to take an action that is essential for the contractor to perform.9
C. Bid Document Review
One of the most important legal aspects of the contract bidding process is the determination of when a binding and enforceable contract is formed between the owner and the contractor. Under general principles of contract law, in order for an enforceable contract to be formed, a valid offer must be made, the offer must be accepted, and there must be consideration. In the bidding process, an owner’s invitation to bid or request for bids does not constitute an offer. Rather, when a contractor submits a bid to the owner, the bid will be considered the offer.
Bid documents will generally consist of an invitation to bid, instructions to the bidder, the proposed contract, the proposed general conditions, and a description of the project, including any plans, drawings, or specifications. The bid instructions from the owner will typically lay out the procedures and guidelines governing the bidding process and the requirements a contractor will have to meet.10 It is crucial that a contractor read, understand, and follow all of the instructions in the bid documents in order to ensure that its bid meets all of the owner’s bid requirements. A bid that does not meet all of the owner’s requirements will be in danger of being rejected by the owner.
Disputes may sometimes arise as to what extent a contractor can rely on the representations made by the owner in the bid documents. In general, a contractor does have a right to rely on representations made by the owner in bid documents. The right to rely on representations made in the bid documents stems from theory that statements of material fact that are presumed to be in the knowledge of party making them can be relied upon by the party to whom they are made. Therefore a contractor is generally allowed to rely on representations made in bid documents when calculating its bid. Notwithstanding a contractor’s right to rely, a contractor must still use some degree of diligence to protect itself from potential problems in bid documents and any resulting potential damage to its interests. Thus, a contractor has a duty to investigate or seek clarification on any potential problem it discovers in the bid documents. Moreover, the duty to investigate and seek clarification will be triggered and a contractor will be charged with knowledge of a problem in the bid documents if, based on its experience and expertise, the contractor should have discovered the problem. Likewise, if a contractor is placed on notice of a potential problem in bid documents, the contractor’s duty to seek clarification may arise. Common problems with bid documents include ambiguities in the plans or specifications, inconsistencies between the plans and specifications, and mistakes in certain key provisions. If a potential problem is discovered, a contractor can discharge its duty to seek clarification by requesting the owner or its representative clarify any potential problems with the bid documents.
Similar to the contractor’s right to rely on the bid documents, courts have recognized an owner’s implied warranty as to the accuracy and sufficiency of the plans and specifications of the project. Under this implied warranty, the owner warrants that the detailed plans and specifications are adequate for the contemplated work.11 If the plans and specifications are found to not be accurate, the owner is considered to have made a misrepresentation and the owner may be held liable for the consequences of the misrepresentation. These consequences could include liability for delay damages sustained by contractors and the inability to recover for its own delay damages.
In an effort to limit liability for potential problems in bid documents, owners may include disclaimers in the bid documents and in the contract. An example of a disclaimer may be a provision that states that the contractor is responsible for visiting a worksite and discovering potential problems related to the worksite.12 The inclusion of a general disclaimer in a contract does not, however, completely insulate an owner from potential liability for mistakes or misrepresentations in the bid instructions or the contract. Because owners are typically held to warrant the accuracy and adequacy of the plans and specifications provided, general disclaimers in contracts may not absolve an owner of liability for damages that result from faulty or defective plans or specifications.13
1. Submission of a bid and the responsiveness requirement The submission of a bid by a contractor will be considered an offer. Accordingly, should the owner ultimately accept the offer, a binding legal contract will be formed.The bid instructions included with the invitation to bid will often contain the specific format that must be used to submit a bid and details regarding the requirements for the contract.
In order to be properly considered for a project, a bid should be responsive to all requirements specified by the owner. This is because owners are typically looking to award their contract to the lowest responsible bidder, not just the lowest bidder. Hawaii Revised Statutes (“HRS”) § 103D-104 defines a responsive bidder as “a person who has submitted a bid which conforms in all material respects to the invitation for bids.” In other words, a responsive bid will have met all of the requirements specified in the invitation to bid. A responsive bid must be clear and definite as to its terms such that each party’s performance is reasonably certain. A bid’s responsiveness is determined at the time a bid is opened.14 If a contractor’s bid is not responsive to all aspects required by the owner, the bid may be automatically rejected and may not even be considered by the owner.
In Southern Foods Group, L.P. v. State, Dept. of Educ.,15 the Hawaii Supreme Court explained the reasoning underlying the responsiveness requirement in competitive bidding:
The requirement that a bid be responsive is designed to avoid unfairness to other contractors who submitted a sealed bid on the understanding that they must comply with all of the specifications and conditions in the invitation for bids, and who could have made a better proposal if they imposed conditions upon or variances from the contractual terms the government had specified. The rule also avoids placing the contracting officer in the difficult position of having to balance the more favorable offer of the deviating bidder against the disadvantages to the government from the qualifications and conditions the bidder has added. In short, the requirement of responsiveness is designed to avoid a method of awarding government contracts that would be similar to negotiating agreements but which would lack the safeguards present in either that system or in true competitive bidding.
Thus, the responsiveness requirement allows all bidders being considered to stand on equal footing and allows the owner to accurately evaluate and compare each of the bids and the bidders submitting them.16 Notwithstanding the responsiveness requirement, however, state procurement codes, Hawaii’s included, may sometimes provide government agencies with the means to waive certain requirements or mistakes in bids that may be made by bidders.17
For federal projects, a contractor’s bid is statutorily required to be responsive in order to be considered for the project. Title 48 of the Code of Federal Regulations, which governs federal acquisitions, provides:
To be considered for award, a bid must comply in all material respects with the invitation for bids. Such compliance enables bidders to stand on an equal footing and maintain the integrity of the sealed bidding system.18
Therefore, if a bid for a federal project does not comply with all material aspects of the invitation to bid, it will not be considered for the project. In private contracts, the responsiveness requirement for a bid can vary depending on the owner. A private owner basically has unlimited discretion as to whether to accept or reject an unresponsive bid. The basis for this discretion is founded on the principle of freedom of contract. In order to determine what the responsiveness requirement will be for a private contract, a contractor should evaluate the owner’s invitation to bid and any accompanying instructions. Typical form instructions to bidders often contain clauses that provide that an owner will have the right to reject any bids that do not meet the bid requirements in the invitation to bid, while also reserving the right to waive any irregularities in any bids.
2. Irrevocability of bid
A bid submitted as part of competitive bidding process must typically be irrevocable for a certain specified period of time. In other words, once a bid is submitted by a contractor, the bid cannot be withdrawn for a certain period of time. The period of time the bid must remain irrevocable will usually be specified in the invitation to bid. Making an irrevocable bid is known as making a “firm” bid. If the owner accepts the firm offer, the contractor is legally bound to perform the specified work for the specified bid price. If a contractor’s bid is accepted and the contractor, without legal justification, fails to honor the bid, the contractor will be liable for damages to the owner. The amount of damages a contractor will be liable for will depend on what is stated in the invitation to bid. Damages can range from a forfeiture of the bid security posted by the contractor to the difference between the contractor’s dishonored bid and the next highest bid.
Generally, a subcontractor’s bid that is relied on by a general contractor to calculate its bid cannot be withdrawn for a certain period of time. The reason for this is because of the unique situation presented by the fact that the general contractor must rely on the subcontractor’s bid in order to calculate its bid and the lack of remedy a general contractor would have against the subcontractor if it is allowed to withdraw it bid before it can be accepted. When a general contractor uses a subcontractor’s bid in computing its bid, the general contractor binds itself to perform in reliance on the subcontractor’s terms.19 Thus, if a general contractor’s bid is accepted by the owner but a subcontractor is allowed to withdraw its bid, the general contractor may be forced to pay more than intended for the work it bid on. These increased costs would then have to be taken out of the general contractor’s expected profits. As such, a general contractor could be severely prejudiced if a subcontractor is allowed to withdraw its bid.
If a subcontractor refuses to honor a bid that is relied upon by a general contractor, the general contractor is typically allowed to seek damages from the subcontractor. A general contractor’s right to seek damages from a subcontractor in this circumstance is based on the legal principle of promissory estoppel. The theory of promissory estoppel recognizes that “[a] promise which the promisor should reasonably expect to induce action or forbearance on the part of the promisee or a third person and which does induce such action or forbearance is binding if injustice can be avoided only by enforcement of the promise.”20 Thus, the subcontractor submits its bid with the expectation that the general contractor will rely on the subcontractor’s bid to formulate its bid and with the knowledge that if the general contractor’s bid is accepted, the general contractor will be bound to its bid. Therefore, the subcontractor should be held to honor its bid if it is relied upon by the general contractor.
3. Mistakes in bidding and non-enforcement of bids
There are a very few situations where a contractor will be allowed to withdraw a firm bid. However, one such situation is where a general contractor makes a mistake in its bid. Many jurisdictions will allow a bidder to withdraw bids due to a mistake in the bid if the withdrawal is made before acceptance or before another party is prejudiced.21 In order to withdraw its bid, a contractor must usually prove the following elements:
- The mistake is of such nature that enforcement of the bid would be unconscionable;
- The mistake relates to a material element of the contract;
- The contractor acted in good faith and the mistake is not due to any gross negligence on the part of the contractor;
- The bidder promptly notified the other party of the error; and
- The other party has not changed its position in reliance on the mistaken bid or will not be prejudiced by the mistaken bid’s withdrawal.22
The concept of allowing a contractor to withdraw its bid is normally founded upon equitable principles. If a bid is allowed to be withdrawn before the owner accepts the bid, there will usually be no prejudice to the owner by allowing the bid to be withdrawn. The owner has not yet selected a contractor and can simply utilize another bid that has not been withdrawn.
4. Evaluating bids
How an owner evaluates and selects a bid will typically depend on what the owner provides for in the bidding documents. When an owner must simply determine the lowest bidder, it generally does not have much discretion.23 The owner must simply look for the lowest monetary bid. However, a contract put out for bid does not always have to go to the bidder who offers to do the project for the lowest price. For example, in public contracts, the public agency will often times be required to award a contact to the “lowest responsible bidder” or the “lowest and best bidder.” This will generally either be required by statute or regulation.24 In these cases, the authority evaluating the bids must look to a number of factors besides just simply the bid amount. Likewise, a private owner may agree to make a similar award to the “lowest responsible bidder” or the “lowest and best bidder.” The term “lowest responsible bidder” has been interpreted to mean the lowest bidder who best responds in quality, fitness, and capacity to the particular requirements of the proposed work.25 Therefore, where a contract must be awarded to the “lowest responsible bidder,” the contractor must be awarded to bidder with the lowest bid price unless the bidder is not responsible. Similarly, the term “lowest and best bidder” has been interpreted to mean the authority must take into account something more than just the low dollar bid.26
The “responsibility” of a bidder is a determination as to whether the bidder will be able to perform the contract.27 The “responsibility” of a bidder depends on a number of factors. These factors include the bidder’s skill and experience, financial condition, prior performance, ability to actually meet the contract requirements, honesty and integrity, and ability to complete the job in a competent and efficient manner.28 When determining the “lowest responsible bidder” or the “lowest and best bidder” the evaluating authority generally has wide discretion over making the determination.29
Courts will typically respect the wide discretion given to the bid authority. Unless an authority’s decision is arbitrary, capacious, fraudulent or illegal, courts will generally not overturn a determination.30 “The arbitrary or capricious standard is a narrow one; a reviewing court may not substitute its own judgment for that of the agency.”31 Nevertheless, the authority is still bound to use good faith in exercising its discretion. If the lowest bidder desires to challenge an authority’s award of a contract, the burden is typically placed on the bidder challenging the award to either show that it was a responsible bidder or that the authority abused its discretion.
5. Acceptance – creation of contract
A binding and enforceable contract is usually formed when a contractor’s bid is accepted by the owner. Notice must be given to the contractor that its bid has been accepted. Because of the legally binding nature of acceptance of a bid it is important that proper notice of acceptance occur within the requisite time period and the manner prescribed in the bidding instructions.32 The failure of an owner to properly notify the contractor within the specified time could jeopardize the enforceability of the bid.
A basic canon of contract law is that an offer must be accepted on the same terms as it was made. If an offer is accepted on different terms than it was originally made, the acceptance will not be binding and will instead be considered a counteroffer. In the context of competitive bidding, where material changes are made to contract requirements post bid and a contract is awarded according to those revised requirements, the award of the contract could be subject to challenge.33 The award may be challenged because allowing contract requirements to be changed post-bid, such action would open the door to manipulation, favoritism and fraud. An owner who is able to change contract requirements post-bid could purposely change bid requirements to benefit certain contractors and allow those contractor become the successful bidder. Notwithstanding the foregoing, however, courts have sometimes been inclined to allow the owner, in particular, public agencies, to make certain post-bid changes to contract requirements. These types of changes may often take the form of post-bid negotiations an owner engages in with the lowest bidder. For example, in Fischbach and Moore, Inc. v. New York City Transit Authority,34 the court upheld an award of a contract after an unsuccessful bidder challenged the awarded because the Transit Authority engaged in post-bid negotiations with the lowest bidder and received certain concessions from the lowest bidder. The court stated that where there was no evidence of favoritism, fraud or corruption, and bidder was fairly and properly established as lowest responsible bidder, where public interest was advanced through negotiations that resulted in a reduction in cost for the project, and where there was inclusion of a provision for liquidated damages, the award of a contract to a bidder after post-bid negotiations was not inconsistent in any way with policies underlying bidding statutes.
Statutory provisions may also sometimes allow a government agency to negotiate changes to the contract with the lowest responsible bidder. For example, HRS § 103D-302(h) provides in relevant part:
In the event all bids exceed available funds as certified by the appropriate fiscal officer, the head of the purchasing agency responsible for the procurement in question is authorized in situations where time or economic considerations preclude resolicitation of work of a reduced scope to negotiate an adjustment of the bid price, including changes in the bid requirements, with the low responsible and responsive bidder, in order to bring the bid within the amount of available funds. Accordingly, there are certain situations where an owner will be allowed to make postbid changes to contract requirements.
6. Rejecting bids
The fact that a project is put out for bid does not require that a contract be awarded. Owners will often times reserve the right to reject all bids. The owner cannot however, exercise this right in an arbitrary or capricious manner. Nevertheless, as with the owner’s right to accept bids, courts will generally not set aside an owner’s rejection of all bids unless the action was arbitrary, capricious, or illegal.35 In addition, once the owner rejects all bids, some courts may not allow the owner to reconsider those bids.36 In such situation, courts will disallow reconsideration of rejected bids in order to guard against favoritism and improvidence.37 An owner is also permitted to reject fewer than all bids. Owners may sometimes reserve the right to reject “any and all bids.” While such a reservation appears to give the owner broad powers to reject any bid, owners must still exercise such discretion in good faith.38
There are several grounds that an owner can rely on to properly reject a bid. The primary reasons for rejection of a bid include:
a. nonresponsiveness of bid
A bid may be properly rejected where it is deficient or incomplete and fails to meet all of the material requirements of the bid instructions.39 If a bid does not meet or address all of the material requirements of a contract the awarding authority may not be able to effectively evaluate and compare all of the bidders in an equal manner. Therefore, a bid that is nonresponsive will oftentimes be rejected by an owner.
b. the bid is unbalanced
A bid is considered unbalanced “when it is based on prices significantly less than cost for some work and prices which are significantly overstated in relation to cost for other work.”40 Unbalanced bids present a threat of fraud and collusion. If a bidder places higher values and profit on work done earlier in the project and lower values and profit on work done later in the project, the bidder has less incentive to complete the project. A bidder would earn most of its profit at the beginning of a project and would have less financial incentive to complete the project.
Another form of unbalanced bidding occurs where a contractor underbids items that it believes will underrun the quantities listed for the project and overbids items that it believes will overrun the quantities for the project. Essentially, the contractor is gambling that it will have to perform more of the higher priced work which will translate into greater profits. This type of bidding practice is sometime called “nominal bidding” or “pennying.”41
c. inexperienced contractor
Sometimes the lowest bidder for a contract will be an inexperienced contractor. Rejecting a contractor based on inexperience corresponds with a determination of the “responsibility” of a contractor. As discussed previously, a contractor’s “responsibility” is the contractor’s ability to perform the contract and complete the project. Therefore, an inexperienced contractor’s bid may be rejected on the grounds that the contractor is not a responsible bidder.
d. conflict of interest
A bid may also be rejected where it is determined that there is a conflict of interest between the contractor submitting the bid and the owner. A conflict of interest is much more likely to arise in public construction contracts than in private construction contracts. Some examples of a conflict of interest include situations where a decision maker on the government’s side may have a financial interest in the lowest bidder42 and situations where a business relationship exists between the bidder and a member of the government contracting agency.43 Awarding a public contract despite the existence of conflicts of interest erodes public confidence in the competitive bidding process and in the government’s ability to fairly and adequately represent the interests of the public. Accordingly, where a conflict of interest exists, a bid may be properly rejected.
D. Key Contract Provisions
In most contracts, once the parties have signed, the terms and conditions are fixed, and the parties expect that the each will abide by those terms. A construction contract is unique in that it allows one party—the owner—to make a unilateral change to the contract after it has been signed by both parties, so long as there is a “changes” provision in the contract, and the change is not considered a “cardinal” change.44 Changes are documented by way of a change order.
A change order is a document issued after the execution of the contract authorizing a change in the work or an adjustment in the contract sum or the contract time as originally defined by the contract documents. A valid change order may add to, subtract from, or vary the scope of the work originally contemplated without invalidating the contract. Article 7 of the 2007 version of the AIA Document A201 enumerates the requirements for valid changes in the work.
Practically speaking, change orders are an integral part of the construction industry both in residential and commercial projects. Few projects are built without any change orders. Sometimes, changes can have a dramatic impact on the economics of a project from the standpoint of either the owner or the contractor. Accordingly, the change order provision to the standard construction contract is one of the most important provisions. Ideally, all change orders should be in writing and signed by both owner and contractor so that the authority to proceed and the details of the modified work are not disputed. In practice, this often does not happen. The lack of change orders is frequently an invitation to a dispute, and should be the rare exception rather than the rule.
The provisions of the construction contract control the rights and duties of the parties, including the authority to issue change orders. Some contracts require change order approval by both the owner and the architect.45 Other forms provide that the owner alone may issue change orders. In some circumstances, the architect may even be given the authority to issue change orders which bind the contractor and owner, as in the case of “minor changes” under AIA Document A201 § 7.1.2. The contractor should alwaysconfirm that the change order has been properly authorized before proceeding with the requested work. An improperly issued change order is probably invalid.
“Delay claims” arise when the time required for substantial completion of a project extends beyond the time specified in the construction contract, as amended or modified by change orders. The phrase “substantial completion” is defined as the time when the work is sufficiently complete that the owner can occupy or use the improvement as intended46 and the architect has certified that the project is substantially complete.47 Delays affect the time for contract performance and usually produce additional costs for both the owner and the contractor. Timely completion of a construction project depends on proper performance by all the parties involved as well as optimal conditions for performance, such as weather, anticipated working conditions, and availability of materials and labor. Because each construction project entails all of these factors, delays are common in construction, especially in large projects. Depending on the circumstances, delays in the contractor’s performance may warrant an extension in the contract time, an adjustment to the contract price, or both.
Generally, delays are categorized from the standpoint of the contractor. From the contractor’s standpoint, every delay is either excusable or non-excusable. If a delay is excusable, the contractor is granted a time extension to complete the work. Excusable delays are further categorized as either compensable or non-compensable. If it is compensable, the contractor may obtain a time extension and recover damages caused by the delay. If it is non-compensable, the contractor will only receive a time extension and may not recover any damages. Excusable delays are usually either the fault of the owner or the result of acts or occurrences which are beyond the control of the contractor or the owner.
Most contracts also have a provision listing the types of events which will excuse the contractor’s performance of the contract in its entirety or excuse the delay in the contract performance time relating thereto. Typically known as a “force majeure” clause, these provisions are found in most major construction contracts. Force majeure clauses protect the owner and the contractor in the event that a part of the contract cannot be performed due to causes beyond the control of the parties. 48 In other words, the event could not reasonably have been foreseen or avoided by the exercise of due care by either the owner or the contractor. Force majeure provisions generally address acts of God, labor and material problems, and acts of the government.49
The issue of compensability arises only after a delay claim is deemed excusable. The construction contract provides which delays will be compensable and which will be non-compensable. Some contracts provide that virtually all excusable delays are also compensable. Others, however, provide compensation for only certain narrowly-defined excusable delays. For the most part, unless the construction contract contains a “no damage for delay” clause, delays entitle the contractor to delay damages.50
The presence of a “no damages for delay” clause means that the contractor cannot recover any damages resulting from delay. While controversial and strictly construed against the owner by the courts, these clauses are usually held valid and enforceable.51 A broad “no damages for delay” clause in a construction contract means that the contractor cannot recover damages for any delay in work and may only receive an extension of time. The courts uphold these clauses based on the reasoning that the contractor increased, or should have increased the bid to account for a potential delay and the presence of the “no damage for delay” clause in the contract. Therefore, when a evaluating a contract, contractors should be aware of a “no damages for delay” clause and make any necessary adjust