What Is a Preconstruction Agreement?
The preconstruction agreement is the contract between Buyer and Seller which sets out the terms for the construction of the home. This agreement is the document that sets out: the price of the home or unit, what is included in that price, a timeline for construction, whether there is a deposit, whether there is a mortgage, and what happens to the agreement if it is not fulfilled.
The preconstruction agreement is a binding contract, meaning that if one party chooses not to have the contract completed, the law has set out the consequences that will apply. If Buyer chooses to pull out of the agreement he or she will be liable to Seller for damages and if Seller chooses to pull out of the agreement he or she could forfeit any deposits paid to them previously by Buyer. This is called a liquidated damages provision and is generally included in all agreements when construction is involved.
Because construction can easily get delayed , the government now requires that a construction contract also be attached to the preconstruction agreement that sets out a more wordy version of what Buyer is allowed to expect from Seller. Big and tall buildings that break ground after April 5, 2018, are now covered under new construction law. Units with either: fewer than 10 residential units, insurance against "builder’s risk" injury or accident, or a cost of construction of less than $1 million are exempt from this new law.
Buyer should read both the construction contract and the preconstruction agreement that apply to his or her home and determine whether the construction of the home will be complete at the time Buyer is promised to take possession of it.
Preconstruction Agreement Basics
These documents serve to limit liability, protect the owner, and provide for greater efficiencies and cost savings in the future. Still, preconstruction agreements have one major downside, at least from the developer and builder’s perspective: They require extra work. Before signing on the dotted line, you need to fully understand all of this. The purpose of this article is to help you do precisely that.
Scope of Work
As the name suggests, the Scope of Work defines exactly what the particulars are between the Developer (or Property Owner) and the Builder. It contains detail for what will be constructed, where it will sit in relation to the existing property, and who is going to design it. The specific parameters contained within the Scope of Work are typically much more exacting than what is found in the contract. No two SOWs are exactly the same, and here are some of the components often found within this section: The purpose of the SOW is to create a clear and exacting vision of the project. To that end, the document should also include any codes and statutes specific to the project area that must be met, such as zoning laws, deed restrictions, environmental concerns, and so on.
Timelines
The Failing to Plan Is Planning to Fail adage has never rung more true than in today’s construction climate. A project that falls behind schedule can wreak havoc on the bottom line. Many construction professionals recommend beginning the planning process as much as three years before ground is broken to account for the potential great and unexpected changes. A construction timeline can provide a structured framework to help you avoid those pitfalls. It is not a promise, but rather a plan. It helps builders anticipate and avoid costs and risks that arise when projects lag behind schedule, and it can also help set expectations for the Developers and end users. A timeline might include the following:
Budget
The Budget is the blueprint for all future budgets. It should contain estimates for all relevant costs from predevelopment through the closeout of the project, including everything like materials, labor, permit fees, utility connections, interest, and more. Transposing these numbers to a timeline of the project duration delivers a visual representation of the anticipated cash flow. This is useful for a variety of reasons: Even with an accurate and well-considered budget, there is no guarantee that unexpected costs will not arise. For this reason, the Budget typically includes a contingency amount to cover the costs of overruns. This provides some peace of mind, as well as a sufficient cushion for the Developer to operate within.
Advantages of a Preconstruction Agreement
By establishing mutual expectations, preconstruction agreements help both owners and contractors be more effective and efficient. Specifically, the agreements can reduce the risk of potential issues arising during project development and construction by setting out each party’s expectations in a clear and legally binding manner. One of the most significant benefits of preconstruction agreements is the clear communication between the owner and the contractor. This ensures that no one is misled either intentionally or unintentionally. It is important to ensure that there is no deceptively negligent language in the agreement that could result in the owner or the contractor being misled. The preconstruction agreement should be drafted with the goal of promoting a clear overlap between the interests of the owner and the contractor. Preconstruction agreements also allow for streamlined project execution and reduce the likelihood of disputes. They set forth the responsibilities of the owner and the contractor, as well as the expectations of third parties with whom the contractor subcontracts. These agreements are usually drafted in most states to prevent either party from directly hiring subcontractors for work on the project. Instead, the contractor has the responsibility of arranging for all additional work to be completed by such subcontractors.
Legal Issues In Preconstruction Agreements
The importance of legal assistance in the preparation and review of preconstruction agreements cannot be over emphasized.
What about Security for Completion and Payment
Although several preconstruction agreements I have seen simply refer to the other agreement between the parties, it is advisable that owners obtain the usual security for completion and payment and include them as part of the preconstruction agreement. Usually these are Letters of Credit, performance bonds, guarantees or holdbacks. No matter how a deal is structured, it is important that the appropriate provisions be dealt with for a number of reasons, not the least of which is bankruptcy of the developer. In one project that I became involved in, a deposit holder was assured by the developer that pre-purchase costs would be reimbursed. The developer did not disclose adequate information to the preconstruction agreement consultant to allow it to evaluate the viability of the development. The developer went bankrupt and the money was essentially lost. Had the amount been secured by a deposit drop-dead certificate (DDC) or another appropriate guarantee, it could well have been returned.
What About Notices and Approvals
All agreements should set out the time periods for providing the owner with submissions such as materials and mock-ups . Some of the agreements I have seen have provisions requiring meeting proceedings and deadlines but the time for submission of the mock-ups is a month before and failing to make that deadline will result in the consultant performance being deemed unsatisfactory. Even if a particular information item is not critical and can go in later, missing a deadline without the required notice to the owner can result in the proper approvals not being given. A very important aspect of making sure approvals are obtained in a timely fashion is to deal with notices. Failing to do so can jeopardize the final payment to a developer.
What About the Bidding Process
Many preconstruction agreements deal with the bidding process and, in some cases, require that the successful bidder accept the design contained in the documents prepared by the owner’s consultant. The agreements I have reviewed also require the successful bidder to deal with a number of remaining issues when the successful tenderer is selected. Ensuring that all payments are made in a timely fashion by the owner to satisfy all preconditions imposed by the major suppliers and/or sub-contractors may well be the difference between success and failure.
Preconstruction Agreements vs. Contracts
Preconstruction agreements are not contracts for construction to be performed. This is a critically important distinction because a typical contract sets out the consideration, or compensation, for the performance of specified work. By contrast, the preconstruction agreement is typically based on a flat fee for the performance of specified services. The services usually include attendance at regular progress meetings, preparation of reports, and interaction with the construction manager and trade contractors. The preconstruction agreement is entered into prior to the actual commencement of work on the project. Once the owner has signed off on the work that the builder is proposing to perform, the contract for construction is created after the pricing is finalized. A well-written preconstruction agreement clarifies this point and will set out separate consideration for the addressed preconstruction services in order to avoid any argument that the preconstruction services are part of the work being performed and part of the contract price.
Negotiating a Preconstruction Agreement
Negotiating the provisions related to bidders’ qualifications is one of the most important negotiating components in a preconstruction agreement and should be used as a time for legal counsel and the developer to collaborate. This is your best opportunity to lay out both parties’ expectations and nail down each party’s responsibilities. Often, a developer who does not have an in-house attorney will rely on their contractor’s counsel. Most general contractors have well-trained in-house counsel that is adept at understanding all of the industry standards and what the developer is really giving away when they agree to certain provisions and change orders. So how do you get a win-win?
Understand the Key Provisions When it comes to establishing a lasting relationship, you can never go wrong by clearly defining expectations in a preconstruction agreement. A few key terms in the agreement to examine are: 1. Indemnification – Understand how indemnification issues will be handled. For example, you need to ascertain whether the project will be treated in the same manner as other projects, or whether arbitration is the preferred method of resolution for disputes. 2. Tender of Contract – Understand the process around accepting a tender of contract. 3. Architect and Engineer – What role will the architect play in the project? Will the GC perform design-build responsibilities? And, what are the ramifications of a designer’s negligence? 4. Insurance – Who carries insurance? What is covered under the insurance policy? Is coverage adequate, and if not, how do you resolve that issue? 5. Termination – Can the contract be terminated without cause? Under what circumstances can it be terminated with or without cause and can termination be carried out by the developer alone? 6. Ownership of Documents – Be clear about the confidential nature of documents under a nondisclosure provision . 7. Compensation – Compensation is always a top priority for contractors, architects, and designers. Make sure to weigh the costs against the prospect of future projects. 8. Workmanship – Standards and development progress reports to track the status of the project can help you identify where there may be an issue and quickly rectify it. 9. Assignability – This provision is especially important to developers. It is almost a given that the contract will be assigned by the developer, but the most commonly asked questions are: can the architect or GC assign their duties or obligations under the agreement when the project is terminated and what type of consent is required of the other party? 10. Claims – Claims and dispute resolution are common components of a bid proposal process. Consider the type of resolution process that will best suit the parties involved: litigation, mediation or arbitration? 11. Change Orders – Understand the processes around obtaining approval for a change in scope or cost, and any potential costs that could be incurred both for you and the other party if a change order is not approved. 12. Employment and Subcontractors – Understand your role in hiring employees or subcontractors and who is responsible for paying them.
Additional Considerations: 1. Timing – Be sure that you’re well-equipped to make timely decisions and communicate those decisions effectively with your project team. Keep your project on schedule by meeting your milestones and the final deadline. 2. Flexibility – Have a system in place for making changes where scope or costs are concerned. Even though you may be tempted to drive a hard bargain on certain selection provisions, if you understand and anticipate these changes make allowances for them; they will occur no matter how meticulous and mindful you are at the outset of the project.
