By: William E. Underwood, Associate, Jones Walker LLP
Project closeout is sometimes one of the last things on a contractor’s mind at the beginning of a project, but project closeout can have a huge impact on a contractor’s overall profitability and success. Effectively managing the closeout process is critical, and it all begins with the negotiation and execution of the project contract. This contract can, and should, provide a complete roadmap for project closeout, as addressing these issues on the front end can set up the parties for successful project completion. It is then equally important to re-review the terms of the contract as project closeout approaches to ensure that everyone, including the owner, adheres to all contractual requirements.
This article examines several pertinent issues related to project closeout that should be addressed during the contracting stage, including defining substantial and final completion, inspection and acceptance, punch lists, and warranties.
Defining Substantial and Final Completion
Having clear definitions for both substantial and final completion in your construction contract is an important and necessary early step in achieving successful project closeout.
Properly defining and determining substantial completion is important for a number of different reasons. Primarily, achieving substantial completion means that the owner has received what it contracted for—a working project—and that the contractor is entitled to payment (minus the cost of remedying any minor defects that might remain). Furthermore, many warranty provisions are triggered by substantial completion. Similarly, the assessment period for liquidated damages (if any) often ends with the achievement of substantial completion.
There is no universal definition for “substantial completion,” as various courts and boards have defined this term in a number of different ways. As a result, it is important to plainly define substantial completion in the contract. Substantial completion is generally achieved when the owner has the use and benefit of the contractor’s work and the project is capable of being used for its intended purpose. For example, the ConsensusDocs 200 Standard Agreement at section 2.4.24 provides that:
“Substantial Completion” of the Work, or of a designated portion, occurs on the date when the Work is sufficiently complete in accordance with the Contract Documents so that the Owner may occupy or utilize the Project, or a designated portion, for the use for which it is intended, without unscheduled disruption.
Although it is difficult to eliminate all ambiguity or potential for dispute from the definition of substantial completion, the ConsensusDocs model language offers a succinct and easy to understand clause that provides necessary guidance to the parties. But substantial completion does not constitute the end of the project.
Final completion is generally defined as when all punch list work is finished and the project is ready for final inspection and acceptance by the owner. Although issues may arise during the final inspection (see below), final completion is generally easier to define than substantial completion because there is less room for individual interpretation of the term: final completion means all the work is complete and ready for a final signoff by the owner. Nonetheless, it is still important to plainly define final completion in the contract. (See section 9.8 of the ConsensusDocs 200 Standard Agreement for model language regarding final acceptance). Perhaps most importantly, determining final acceptance is key because it generally triggers final payment for the contractor, as well as any other contractual requirements that may exist to receive final payment, such as providing contractually required closeout documents, like payment affidavits, copies of warranties, owner’s manuals, etc. to the owner. So although final completion may be easier to define and more universally understood, it is nonetheless important to include final completion provisions in your construction contract.
Inspection and Acceptance
The project contract should clearly define any inspection obligations and procedures, including those related to final completion and acceptance. The timing of inspections is also a key consideration: will they take place throughout project performance? Or will there only be one final inspection after either substantial , final completion, or both? Having a defined inspection procedure can reduce the likelihood for disputes between the owner and contractor regarding the timing and number of permissible inspections.
It is also important to identify who will be responsible for the inspections: Will the contractor inspect its own work (unlikely)? Will a third-party conduct the inspections? If so, who is responsible for obtaining and paying the third-party inspectors? Or, will the owner handle the inspections directly (as is often the case on federal government projects, a government-employed inspector will conduct project inspections)? Simply stated, there are many considerations to take into account when drafting and negotiating contractual provisions regarding inspection, but the most important consideration is to hammer out the details on the front end to the satisfaction of all parties. Doing so can lead to effective project closeout that is free from otherwise avoidable disputes regarding inspections.
Section 3.7 of the ConsensusDocs 200 Standard Agreement is a good example to incorporate into a standard construction contract, as it succinctly outlines inspection obligations, procedures, and other relevant requirements and further identifies the parties’ respective responsibilities.
After inspection, the owner often has the right to reject the work for non-conformance (assuming there is non-conforming work) and require correction of this work. It is important for the contract documents to delineate the procedure for identifying and notifying the contractor of non-confirming work. The contract should require specific notice requirements, including the identification of each defect with sufficient specificity to permit the contractor to identify and correct the non-confirming work quickly and efficiently. All too often, disputes arise between parties regarding vague allegations of non-conforming work discovered during inspections.
Furthermore, inspections generally do not waive a contractor’s obligation to otherwise comply with project’s specifications or requirements. In other words, a successful inspection does not necessarily mean that the contractor is off the hook for defects (hidden or obvious) that an owner may discover later.
Finally, it is worth noting that on federal government contracts the government may revoke its final acceptance if it later discovers latent defects in the contractor’s work. Latent defects are flaws in the work that existed at the time of final completion and acceptance, but were not discovered and could not have been discovered by a reasonable inspection.1 So, although a contractor might achieve final acceptance on a government contract, that does not necessarily mean that the government (i.e. the owner) is barred from forcing the contractor to repair, or otherwise pay for, defective work after final acceptance.
Likewise, a contractor may also remain liable for latent defects discovered on a private project. Liability for latent defects differs from state to state, as well as the period of time during which such claims can be brought.
Punch Lists
Completing punch list work can create significant snags in achieving final acceptance on a project. Sometimes as a project approaches completion, a seemingly endless series of punch lists can emerge with each one creating new hurdles to completion. As a contractor, it is important to use the project contract to establish clear parameters for punch lists, including addressing the following: Who has the authority to create a punch list? When will a final punch list be prepared? How many punch lists will be permitted? What happens if the punch list imposes new or additional requirements for the work beyond the terms of the contract?
Addressing these issues on the front end can prevent significant headaches during closeout. In an ideal world, one master punch list will be created, the identified items will be repaired, and the owner will sign off on final acceptance. Although this is rarely the case, drafting clear contractual provisions regarding expectations and requirements for punch list work prior to project execution will provide a useful road map for achieving an acceptable resolution to these issues during closeout.
Warranties
The failure to properly and clearly establish the terms of any express warranties contained in the construction contract can lead to significant issues during and after the closeout phase of a project.2
First and foremost, it is critical to unambiguously identify in the contract all express warranties, including when each warranty will begin and how long it will last. Section 3.8 of the ConsensusDocs 200 Standard Agreement provides a good starting point for drafting standard express warranty language to include in the contract.
However, determining the start and end date for an express warranty can be an especially tricky issue in situations involving partial occupancy. Partial occupancy entails the owner’s beneficially using portions of the work prior to final completion of the entire project. This raises issues: Do the warranties covering the partially used portion of the work begin with the owner’s use? Or do warranties commence upon substantial or final completion, despite the fact that the owner is already “putting miles” on certain portions of the work? Again, addressing these issues on the front end can help avoid issues and disputes during closeout.
Further, use of portions of the work prior to substantial completion may also present issues with any manufacturer warranties for certain products as well. Generally, the contractor will be responsible for these warranties and it may be necessary to purchase extended warranties if the owner will begin using portions of the work prior to completion. Thus, it is important to address warranties on the front end before they become an issue during closeout. Failure to do so can lead to protracted disputes and a prolonged closeout process.
Conclusion
Contractors should ensure that the project contract clearly addresses the various aspects of the close out process. Taking the time on the front end of the project to address these issues can help avoid serious headaches on the backend. Overall, the contract should serve as a roadmap to successful closeout.
1 Procedures for addressing latent defects discovered after final acceptance can also be a useful addition to private contracts as well. For example, the ConsensusDocs 200 Standard Agreement contains an express carve out regarding owner claims related to latent defects.
2 “Express warranties” are explicitly identified within the contract. Note that many jurisdictions also recognize “implied warranties.” “Implied Warranties” are additional warranties that may apply to certain construction work, regardless of whether they are expressly identified in the contract.
The views expressed in this article are not necessarily those of ConsensusDocs. Readers should not take or refrain from taking any action based on any information without first seeking legal advice.