Contracting the Contractors

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.