Large construction projects come loaded with latent risks that could lead to project failure or excessive cost due to the interdependent relationships of material suppliers, sub-contractors, general contractors, architects, and engineers. Some of these risks may be mitigated through no-cost contract and process controls, while other risk management methods will inevitably add expense to your project. The best strategy to protect your project against failure or runaway costs will likely include a combination of techniques, including some of the methods described below.
1. Clarify Contract Issues with the Architect and Construction Manager. Make sure that your architect fees won’t spiral out of control by limiting the scope of extra-cost services. Because the architect’s fee is usually a percentage of the total project costs, also limit these fees by stipulating that the total project cost will exclude construction manager fees and will be subject to a “declining scale of rates” for increased construction costs. It can be a good idea to require approval before the architect and construction manager can engage third party consultants. Also, make sure that the architect and construction manager agreements don’t contain provisions that overlap or conflict.
2. Determine What Kinds of Surety Bonds Are Appropriate for Your Project. Surety bonds are similar to insurance policies for developers and lenders to ensure that construction will be performed and that all construction costs will be paid. A bid bond assures that a contractor who submits a bid will honor and perform its bid, if accepted. A performance bond is a security that is generally equal to the contract price, where a contractor promises to perform the specified terms of the contract. Sometimes, this is combined with a payment bond or a labor and material payment bond, which requires a contractor to assure that it will pay all bills submitted by laborers, material suppliers, and subcontractors. Somewhat related, a lien bond protects a developer if the contractor fails to make payments to these parties. Maintenance bonds guarantee that contractors will perform maintenance and correctional work during the guarantee period. Like an insurance policy, surety bonds are an added cost to your project, and thus, it is important to weigh the risks and benefits of implementing different kinds of surety bonds.
3. Negotiate Key Provisions of Your Surety Bonds. Ensure that key terms in the surety bond are defined similarly to any applicable laws. For example, the definition of ‘claimant’ in a lien bond should mach the definition of ‘claimant’ under the state’s mechanic’s lien law. Notice requirements can be relaxed to waive notice of time extensions, work changes, and consent to contractor payments. Time limitations for legal enforcement can be extended beyond a state’s statute of limitations. Also, you may benefit from modifying or eliminating bond provisions that give a surety the option of either paying for completion costs or allowing the surety to complete the work; this could remove uncertainty and delay that might occur if a surety has the option and spends a prolonged period of time to elect its option.
4. Consider Owner or Contractor Controlled Insurance Programs. Each of the contractors involved in a construction project needs insurance to protect against the myriad of professional and work-related liabilities encountered on a project. The cost of insurance for each contractor is ultimately passed on to a developer in the total project cost and can add up to a very expensive sum in large projects. Owner or contractor controlled insurance programs may help reduce this cost by establishing a single policy or “wrap up” that will cover all of the contractors involved in a project.
5. Predetermine Dispute Resolution Mechanisms and Terms. Going to court to resolve construction issues can be a time consuming and expensive procedure. Many developers choose to require binding arbitration as a fair and faster alternative to a lawsuit. Additionally, it’s important to consider the types of costs that may be involved in dispute resolution, such as lawyer and expert fees. Unless your contract with architects, construction managers, and contractors includes a provision requiring them to cover legal costs if they are found to be negligent, you will be stuck holding the bill.