Reviewing and understanding the terms of your construction contract before signing on the dotted line (ideally with counsel involved) is an obvious best practice – whether you are owner, general contractor, design-professional or down-tier subcontractor or supplier. Typically, during this review process, parties pay closest attention to terms relating to price, scope, schedule, insurance, indemnification, and damages. And rightfully so, as these are just some of the most fundamental and important clauses of any construction contract.
But during this review and understanding process, parties often overlook and fail to fully review and understand several notably important contract provisions (other than the examples above) which can have just as significant an impact on the project and even unintended consequences once construction starts. This article discusses three (3) of these often-overlooked provisions which should also be carefully reviewed to ensure the project runs smoothly and to avoid unintended consequences or even disputes (and litigation) during construction:
- Incorporation by reference clause;
- Order of precedence or higher standard clause; and
- Choice of law clause.
Incorporation by Reference Clause
An incorporation by reference clause is very common in construction contracts and is often used to “flow-down” obligations from one party to another and/or to make secondary or additional documents part of the underlying contract rather than including the full text or full version of the referenced document.
An example of an incorporation by reference clause with critical flow down-language of the owner and contractor agreement down to subcontractor is below:
The Prime Contract is incorporated by reference herein and specifically made part of this Agreement. Subcontractor is bound to Contractor by all terms and conditions of the Prime Contract and assumes towards Contractor and Owner all the obligations and responsibilities that Contractor, by that instrument, assumes towards Owner.
Important for this type of flow-down clause, the clause may be interpreted and enforced differently depending on the controlling law of the contract. For example, New York courts will likely not flow down to a subcontractor the prime contractor’s obligations to the owner on important issues like “pay when paid” or indemnification provisions, because New York court have “incorporation clauses in a construction subcontract, which incorporate by reference clauses in the prime contract into the subcontract, bind a subcontractor only to the prime contract provisions relating to the scope, quality, character and manner of the work to be performed by the subcontractor.”[1] Therefore, all parties should seek advice of counsel whether the flow-down clause in your contract is enforceable in the controlling jurisdiction and whether the clause is capturing the flow-down intent of the parties.
Another type of incorporation by reference clause incorporates construction documents by reference into the Contract. For example, the incorporation by reference clause is often used to make drawings, specifications, schedule, bid proposals, and general conditions part of the contract documents. However, there is greater risk for ambiguity and conflicting terms and specifications when this is done. This is especially important on more complex jobs where a contractor, for example, is relying on the drawings and specifications prepared a third-party design professional. The contractor should carefully review the incorporated documents (request copies if you do not have them) and make sure that drawings/specifications are not placing greater responsibility on the contractor than its prepared to or capable of handling. Similarly, owners and general contractors will likely want to avoid allowing down-tier contractors or suppliers to incorporate their bid or proposal documents to the extent those documents were to modify the scope of work.
In summary, for a party to fully understand what its obligations are under the contract, it’s not enough to review the four corners of the signed agreement – a party should make it its general practice to review all documents incorporated by reference.
Order of Precedence or Higher Standard Clause.
An order of precedence or higher standard clause can be used to resolve potential ambiguities or inconsistencies in the contract, including any confusion which may exist with the documents incorporated by referenced (as discussed above). Typically, this type of clause will list the documents in order of precedence in the event of any ambiguity or inconsistency in the contract documents. Conflicts often exist between the contract’s scope of work and the contractor’s bid proposal or in general conditions documents incorporated by reference. Therefore, it’s critical to understand the conflicts to understand which document controls in the event of conflict. However, if you fail to confirm if there are conflicts, it will be difficult to anticipate what the governing standard may be.
An alternative provision to an order of precedence clause is a “higher standard” clause. Instead of relying on a higher “ranked” section of the contract in order of precedence clauses, a higher standard clause requires the contractor, subcontractor, or supplier to meet the highest standard specified in the contract, wherever that provision may appear in the contract documents. However, there may be a question of which is the higher standard, therefore, the higher standard clause can still lead to some questions in construction.
Whether you use an incorporation by reference or higher standard clause, the best approach when reviewing and negotiating your contract is to resolve ambiguities and inconsistencies prior to execution. This may require engaging technical, legal, procurement, and commercial teams to complete a detailed review of the contract.
Choice of Law
Choice of law provisions establish which state’s laws apply to the contract. The choice of law provision is important because depending on which state’s laws apply could have a significant impact on contract terms like indemnification, limitation of liability, and notice or waiver provisions. For example, a contract could have broad indemnity obligations where an indemnifying party has to indemnify the indemnitee, even for the indemnitee’s own negligence or fault, but if the contract is governed by Texas law, the Texas Anti-Indemnity Act may apply and the indemnification language may be void as a matter of law.
Typically, the choice of law will be the state’s laws where the project is located. But sometimes, an owner or prime contractor may prefer another state’s laws (different from the project location) because the other state’s laws are more favorable. And while the choice of law selected by the parties is typically enforceable, some states like Florida, Texas, and Louisiana may prohibit parties from agreeing to the application of another state’s law for construction projects in their states. For example in Texas, Texas has an anti-choice-of-law statute for construction contracts providing that the provision is voidable by the party performing the work. This anti-choice-of-law provision allows the contractor or subcontractor the right to decide whether the choice-of-law provision will apply or not.
Therefore, all parties should be familiar with the state’s laws governing the contract, including consulting with construction attorneys in that state to ensure they have a complete understanding of the parties’ respective rights and obligations under the contract.
Recommendation
Don’t wait until after contract execution to review and understand the significance and impact these three (3) clauses can have on your construction project. Paying close attention to these clauses can go a long way in achieving a successful construction project, including mitigating risks and potential disputes in the long run.
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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.
[1] S. Leo Harmonay, Inc. v. Binks Mfg. Co., 597 F. Supp. 1014 (S.D.N.Y. 1984, aff’d, 762 F.2d 990 (2d Cir. 1985).