Contracting the Contractors

Follow this advice to learn what's integral when producing a conclusive contract.

Contracting Contracts

Photo: contractorandinspectorservices.com

Do you need contracts? Yes is the short answer
Contracts are a crucial part of the paper trail that will help assure that you get what you want. This pathway begins with your preliminary drawings and moves on to the designer’s sketches and then to the working drawings. The estimates lead to the contracts and, eventually, the road will be papered with your canceled checks and the Certificate of Occu­pancy. It’s a story with a beginning, middle, and conclusion—and if parts of it are omitted, the ending might not be a happy one.

Contracts are legal documents that specify the responsibilities of the parties. A contract will define the work to be done by each contractor, the sums to be paid by you, and other terms. The documents will probably be drawn on standard forms that you, the contractor, and perhaps your attorney will negotiate and execute.

Contracts should always be in writing
In most states, a contract is not bind­ing if it’s not in writing. It’s only logical: If the understanding isn’t written down to start with, when an argument arises later, how do you know whose recollection is right? Get it on paper.

You may never look at the contract again after you’ve signed it. However, since the contract in a legal sense defines the relationship you have with your con­tractor, you probably will refer to it occasionally as the job progresses and you make payments. When there are disagreements, you will also refer to it since it provides a framework defining expectations, payments, and schedules.

Obviously the word contractor comes from the word contract. Let’s say you’ve met with the contractor, described the job, he’s prepared an estimate, and you’ve agreed upon the other terms of the agreement. The contract that results obligates the contractee (that’s you) to pay the contractor for the agreed-upon work.

Both parties should sign the contract, and both should be bound by the terms and conditions spelled out in the agreement. In general that means the contractor will be obliged to provide specified materials and to perform certain services for you. In turn, you will be required to pay for those goods and that labor.

A contract should, however, specify in as much detail as possible the work to be done. If the estimate was prepared on the basis of the plans and specifications, they should become a part of the contract, too. If the estimate was prepared without a formal set of specifications, now is the time to get specific. The materials to be used should be listed, not only the quantity but also brand names and model numbers and dimensions and weight and quality and color and other details. A schedule for the work should be specified, as well as the prices and the terms of payment.

Most often renovation contracts begin life as estimates. If you are adding a deck off your kitchen, the contractor may arrive at your home one evening, discusswith you the job to be done, inspect the site, and then retire to his calculator and clip­board. He’ll probably use a standard estimate contract form, and may well before your very eyes write down your name, address, a description of the work to be done and the materials to be used, and then sign the sheet and hand it to you for your con­sideration. He may ask you to sign right then and there and also advance a portion of the price. He may promise to begin work in the morning. It can be that simple.

Do you want to sign on the dotted line?
Use your own judgment: It may make sense to hire him, you may want it done right away, you may have done business with this fellow before and know him to be trustworthy. In general, however, I’d sug­gest that you might be better off if you take your time and give the decision proper consideration.

Whether the job is large or small, the price modest or mind-boggling, there are basic questions to ask of the contractor and about the contractor.

Does this contractor do quality work? The only way to know is to check out some of his previous jobs/references.

Is the price fair? Unless you have two or more comparable estimates, you proba­bly can’t make that judgment. Getting at least three is a good practice.

Is this piece of paper fair to you? Particularly if the document is long and packed with tiny print, get your lawyer to have a look. (If the cost of the work being con­tracted for is small, you may not want to spend the time and money in getting your lawyer to review it. It may not make sense if the attorney’s fees will be greater than the contractor’s price. One common rule of thumb is have an attorney review any contract that will cost you more than what you make in a week.)

Do you understand every word? In many states, the law requires that contracts be written in plain language, but whatever the case in your area, take care to under­stand what you are signing. Don’t be fooled by complicated locutions like “hereto­fore” and “notwithstanding” into agreeing to something you don’t mean.

Does the contract incorporate every piece of paper that has gone between the two signers of the contract? That includes the plans and the specifications you gave the contractor and the estimate and any changes he gave you in return. Remember, only written representations will stand the test of most courts.

PAYMENT TERMS
You should never pay more than a fraction of the entire cost of the job before work begins. Advancing 10 or perhaps 15 percent of the estimated cost is reasonable. In general, the principle to follow is that monies should change hands on the basis of progress, not talk or paperwork.

If the contractor demands a disproportionately large payment up front, find another contractor. Good sense also suggests that at least 15 to 20 percent of the total should be withheld until the job is done, and all payments in between should be made only on completion of specific portions of the job, although as major material purchases are made, more money should flow. The payment of bills is your best sin­gle method of controlling quality. You pay when the work is done properly and not before.

KINDS OF CONTRACTS
Contracts vary greatly. Those you agree to with banks for loans will have a lot of language describing the financial ifs, ands, or buts. With bank contracts there isn’t much to negotiate as it’s likely to be a standard contract. With builder’s contracts, every deal is different and there will be many details to discuss. There are also numerous kinds of contractor contracts. Some set a total price in advance so you know exactly what the final price will be; others are more flexible. There’s no one right approach for all jobs, so here are your options.

The Lump-Sum Contract
For a straightforward job without a lot of frills (the use of made-to-order materials, for example, to execute a straightforward design), the lump-sum contract is often best, both for you and the contractor. Your contractor will look at your plans, the specs, and probably the existing building, too. Then he’ll give you a price. If no changes are made after his estimate is submitted, he will be oblig­ated to hold to that price.

The lump-sum contract is simple and establishes before construction begins what the cost will be. However, if you elect to go with this method, make sure you get three or more estimates. When you get a lump-sum estimate, you won’t see a breakdown of materials and labor costs, so it is impossible to tell from the estimate whether the contractoi’s markup for profit and overhead is ten percent or fifty per­cent. If you have several estimates, you have a basis for comparison.

While this may seem an ideal arrangement, many contractors doing renova­tion work won’t agree to a lump-sum contract. There are too many unknowns: What if they discover structural problems? Or have difficulty finding new materials to match the old ones? Insect damage often isn’t identified until the walls are opened up. Contractors don’t want to find their profits entirely eroded by an unpleasant dis­covery they couldn’t have made before starting work.

Cost-plus or time-and-materials contracts. This method of payment means that you and your contractor will agree on a percentage—say, 10 or 20 percent—for his fee. He will then charge his actual costs for time and materials plus the percentage. A job with materials costing, say, $50,000, with an agreed-upon fee of 20 percent for the contractor, would then cost you $60,000.

The most obvious disadvantage of such cost-plus contracts is that the more the contractor spends, the more he makes. There is no incentive for him to keep costs low, as there is when a price is established up front that he knows he has to live with. On the other hand, when it comes to jobs involving retrofitting an older house or where there are necessarily some unknowns (perhaps your final decisions on mate­rials haven’t been made yet), few contractors will give you a lump-sum price. They can’t estimate on what they don’t know.

Make sure you check your contractor’s references doubly carefully if you decide upon a time-and-materials arrangement.

Upset price
One way of establishing an upper limit while retaining the flexibility of a cost-plus arrangement is to get the contractor to agree to do the work on what is known as an “upset price” basis. This means that you both agree to a maximum price before he begins the job. Then he proceeds on a cost-plus basis. Upon completing the job, if the price is less than the upset price in the contract, you pay less; if it is more, it’s his problem, and you pay no more than the upset price.

Hourly rate
Some smaller contractors may ask to work for hourly wages rather than for a fixed fee. They may say that in the end it will probably be cheaper for you.

Well, that’s possible if rather unlikely. It is recommended that you insist upon establishing a price up front. That way you won’t have any surprises down the road. In addition, you avoid having employees and the extra paperwork required.

Draw
Some contractors, especially smaller subs with limited working capital, will ask for a draw arrangement. Though every draw is a little different, the basic idea is to negotiate a fair balance of payment for work done. The two of you might come up with an estimate for the entire cost and a schedule for the work, then divide the total price by the number of weeks required for completion. The contractor would then be paid that fraction of the price at the end of each week. This approach requires care­ful monitoring in case there are delays. It’s only fair as long as the work progresses at the agreed-upon pace.

Such arrangements are fair to both parties, so long as work progresses as scheduled. Make sure, however, in the case of jobs that require inspections by the building department that the bulk of money due on completion of various stages is paid only after the inspections have been made. It should be the contractor’s respon­sibility to handle the inspections. In a typical case, a plumber might ask to be paid 50 or 60 percent of the total price when the “rough-in” is completed. That’s fair enough, as long as the work has passed inspection. You will have to use your instincts and good sense about what portion of a given job is done (if you have an architect or construction manager guiding you, he should make these decisions), but if it’s a quarter complete, don’t pay a third. A quarter is a quarter is a quarter.

An excellent clause to negotiate into a contract is one that states that, should the completion of your job be delayed for an unreasonable time, you may then use the unpaid balance of the contract to hire someone else to finish the job. The clause must specify what is the expected schedule (thereby defining what is “reasonable”), and may also require notification (i.e., that you must advise the contractor he has a few days or a week to get his act together or else). But it does provide you with an option in the event you find yourself wedded to an untrustworthy contractor.

Liquidated damage clauses
For practical purposes, liquidated damage clauses are penalty clauses (in fact, by law in some jurisdictions, these clauses are not enforce­able as they are held to be penalties). Liquidated damage clauses do make their way into construction contracts from time to time but, as a rule, they create as many problems as they solve. If a contractor is going to be late and there is a penalty clause in his contract, you can bet he is going to blame the delays on someone else. And who is to say he’s wrong?

More often than not, penalty clauses succeed only in creating arguments. Putting a specific schedule in the contract is important and probably as valuable as a penalty clause.

Change orders
Change orders are not part of the original contract, but are formal amendments to that agreement. They are issued when something about the job changes: materials are switched, the design amended, or some unanticipated com­plication appears.

Change orders don’t have to be complicated, but if the job changes, then the change orders must be done. They are a key part of the paper trail you are creating in order to control your project.