What to Look for and Avoid When Signing a Home-Building Contract
If you contract directly with a builder, here's what to look for in the fine print.
So, you have decided to build your own home. You’ve chosen your layout and have selected all the home’s finishes and fixtures. The contractor has indicated that there is just one last item to take care of…signing the construction contract.
Before you sign, it is imperative that you review and understand the contract. The contractor won’t tell you this, but you may also wish to (and you have the right to) negotiate certain contract terms. This article offers advice on what to look for (and what to look out for!) in your construction contract.
Why a Construction Contract Is Important
At the most basic level, you want to get the house that was promised, and the contractor wants to get paid for the house being built. The contract serves to reflect this understanding, to make sure there is no disagreement before the actual works begins, and to provide a guide to follow in case a problem arises later.
Most often your contractor will provide you with a contract that’s ready for signing. If not, you may draft one or hire an attorney to draft one (never go forward without a contract!). The contract in its original form may have very few terms with very few details, or it may be so detailed and filled with complicated terms that it is hard to understand. Neither of those situations are acceptable. To fully protect your rights, the contract terms should be complete, specific, and easy to understand.
Commonly Disputed Issues in Construction Contracts
Below is a list of issues that are commonly disputed in residential construction projects. If these items are not covered in your contract, be sure to add them. If they are already included, review them carefully to make sure they sufficiently protect your rights.
Scope of Work. This section describes the work that the contractor agrees to perform. This work typically includes obtaining municipal or other permits, and furnishing the labor, equipment, materials, and other services necessary to complete the house. This section also requires the contractor to conform the work to the house’s plans (drawings) and specifications, which should be attached and made a part of the contract.
Sometimes, even when contract documents are drafted carefully, they contain conflicting terms in the plans, specifications, and/or the written contract. This conflict can lead to confusion and disputes. For example, if the plans depict a master bathroom with one sink, but the specifications call for two sinks, which is correct? Consider specifying that, in case of conflict between the plans and specifications, the specifications will control. And, in all cases of conflict, the contract should be the controlling document.
Although you may assume it is implied, you’d be wise to make sure the contract includes a statement saying that the contractor must complete the work in a good and workmanlike manner in accordance with all applicable laws. That way, if you have an issue with the contractor’s performance, you can point to an explicit contract provision that the contractor breached, and rely on this to pursue legal action.
Timing of the Work. You've probably heard horror stories about building projects going off schedule. How do you protect yourself against this? Make sure the contact contains information about when construction will begin, the schedule of work the contractor must follow, and when construction will end (in other words, when can you move in). Extensions of time may be granted for delays caused by:
- poor weather or other “acts of God”
- labor strikes
- payment delays caused by the owner
- inspection delays caused by the municipality
- changes or additions to scope of work agreed to by both parties, and
- other issues that are beyond the reasonable control of the contractor.
While the contractor may be hesitant to agree to it, consider including a provision for liquidated damages. Basically, this provision states that for every day the contractor works beyond the completion date (subject to the exceptions listed above), the contractor will be charged a certain amount. For example, if the completion date set forth in the contract is May 1, and construction is not complete by that date, the contractor would be required to pay the owner a per diem amount for each additional day of construction.
Such liquidated damage provisions protect the owner from delay, and are an incentive for the contractor to complete work in a timely manner. In most states, to be enforceable, the per diem amount specified must be a fair estimation of actual damages the owner might incur and cannot have been actually known at the time the contract was made. This provision is not meant to be a punishment, but compensation to cover costs that the owner will incur due to the delay. These might include costs to store your furniture or costs to rent an apartment during the period of delay.
Payment. This section should clearly indicate what, when, and how the owner will pay the contractor. Because the contractor will likely be relying on payments from the owner to fund the construction, the payment schedule must provide a steady stream of money so that the house may be built in a timely manner. A typical contract will require an initial payment prior to construction. Then, on a regular basis thereafter, the contractor will submit an application for payment to the owner indicating the amount of work completed during that cycle.
The contractor should also submit to the owner signed “mechanic's lien” releases or waivers, from subcontractors who have provided labor or materials. A subcontractor has a mechanic’s lien, which is an interest in the property, until he or she has been paid by the contractor for the work or materials provided. So, mechanic’s lien releases or waivers provide assurances to the owner that the subcontractor has been paid by the contractor. Though every state has mechanic’s lien laws, the laws vary. Consider consulting a professional concerning your state’s laws.
Often, the final payment on a project is tied to “substantial completion.” The contract might say, for example, that final payment is due 15 days after the house has been substantially completed. This is not problematic so long as “substantial completion” is defined appropriately in the contract.
In some states, the law defines “substantial completion” as the time when the work is complete enough so that the owner can occupy or use the home for its intended purpose. As you will actually be living in the home, you probably do not want the disturbance of much follow-up work. Therefore, consider defining substantial completion in the contract narrowly by listing specific items, or restricting work after substantial completion to minor repairs. Or, if major items remain, the owner should be permitted to withhold payment in an amount to cover such repairs.
Changes to Scope of Work. Sometimes, after construction has begun, the scope of work changes. This could be due to the owner’s decision (let’s add a built-in bookshelf there!), a requirement from the permitting authorities, or the discovery of an unknown property condition affecting construction. The contract should account for the possibility of such changes by requiring written work orders to reflect changes in the scope of work. Never just tell the contractor, “Sure, go ahead with our new plan,” without creating a written work order that both you and the contractor sign. To do otherwise would open the door to additional unanticipated expenses.
Warranty. Although not required in all states, many contracts contain express warranties, describing what types of defects the contractor will take care of later, how long the warranty lasts, your maintenance obligations, and what the contractor is required to do to fix the defects. If your contract contains an express warranty, read it carefully and negotiate the terms if necessary. If your contract does not contain an express warranty, consider adding one to the contract.
If your contract does contain a warranty, it may also limit or waive implied warranties, such as an implied warranty of fitness for a particular purpose or an implied warranty of workmanlike construction (available implied warranties vary by state). While most states recognize the right to limit or waive these warranties, courts have refused enforcement of these waivers unless it is obvious to the court that the owner specifically agreed to the waivers. The contractor is not permitted to include the waivers in the “small print” or buried within the legalese of the contract. If possible, do not agree to a waiver of implied warranties, as it will limit your rights to sue in the event of a later dispute.
Dispute Resolution. No matter how careful you are in drafting the contract or how friendly you are with the contractor, a dispute may arise. It is common for construction contracts to require binding arbitration rather than litigation in a court if there is a dispute.
If the contract requires arbitration, you may not sue the contractor. Instead, you must submit a complaint to an arbitrator – an expert in the construction industry who will listen to both sides of the dispute and issue a binding decision resolving the issue. The arbitrator will conduct a hearing where both sides will have an opportunity to present their position on the issue. The hearing will be conducted similar to a court trial. At the conclusion of the hearing, the arbitrator will issue a final decision.
There are advantages to using arbitration, as it is typically less expensive and less formal than a court trial. Also, you will likely have control over the selection of the arbitrator. However, you waive your right to a trial, and unlike a court trial, neither party may appeal the decision. There is no wrong decision when it comes to selecting arbitration or litigation, so long as you understand your rights and limitations.
Attorneys’ Fees. Consider including a provision in the contract concerning which party pays attorneys’ fees in the case of a dispute. In some states, the successful party cannot recover attorneys’ fees unless this was specifically provided for in the contract.
Contractor Default Provision. Many standard contracts contain information on what constitutes breach of contract and how you can assert your rights. If not, you should include a specific provision that addresses contractor default. It is reasonable to allow the contractor a set amount of time to fix or “cure” a problem. In case the contractor does not then fix the issue you can, in order to make sure the construction gets completed, add a provision allowing you to hire another contractor. You should also have the right to suspend work or terminate your contract with the contractor in case of default.
Quick Tips To Protect Your Rights in a Construction Contract
As described above, seemingly simple contract provisions may be surprisingly complicated. Take the time to understand the entire contract, and take the steps necessary to protect your interests, as follows:
- make sure your contractor has a license
- verify with your contractor that he or she is insured (contractor’s risk, workman’s compensation)
- check your contractor’s references and consult the Better Business Bureau for further information
- review any contract the contractor provides to you – make sure it is clear and complete
- consider hiring a professional to review the plans and specifications
- consider hiring an attorney to review and explain the contract to you, and
- most importantly, do not be afraid to negotiate the contract with the contractor.