|
Building a solid legal foundation
for your construction project
Once again, cranes punctuate the Alberta urban skylines. Residential suburbs, commercial developments and industrial parks are sprawling outward from urban areas. The construction sector is growing at a rate not seen since the late 1970s, reflecting the province’s robust economy.
Currently, Alberta presents one of the greatest opportunities in the world for development, engineering and building. At the same time, escalating costs for labour and materials - not to mention the shortage of skilled construction labour- may signal that it’s time to take a cautionary historical look at the ups and downs of the construction sector and what this can mean for the province’s land owners, developers, entrepreneurs, contractors, sub-trades and suppliers of building materials.
At the heart of any project is the contract between the various parties. It is through this document that a balance can be struck so that the competing interests of all parties involved are taken into consideration.
After all, the building owner or developer wants their project to be constructed in the agreed-upon time frame and within the allotted budget. On the other hand, contractors need to make a profit on the work they agree to do. Similarly, suppliers of building materials need to be paid for their products.
In an environment of overheated demand and strained supply, the tension between the cost-conscious owner and the profit-conscious contractor or supplier can quickly escalate into legal hostility unless care is taken to anticipate problems areas, and ideally, to avoid the pitfalls by the terms of a comprehensive and well-drafted contract.
Make certain your contract reduces the
unfair transfer of risk
Opportunity abounds in Alberta for development and construction activities. Downtown Calgary, for example, with its high-end vacancy rate of 0.1% in premium office buildings, presents real opportunities for prudent, business-like developers and contractors.
Balance in the negotiation of contracts is critical. If you are a developer, you need to ensure that the contract with your builder reflects your interests. At the same time, it’s important to ensure that the contract is not so onerous, with an unfair transfer of risk, that it puts in peril the contractor’s ability to complete the project on budget and on time. Otherwise, the contractor could be put into financial stress, which, in turn, could put the development project into jeopardy.
Risk factors on a construction project might include:
|
•
|
delay (in speed of construction)
|
•
|
escalation in costs of materials
|
| • |
lack of availability of manpower |
|
•
|
inadequate engineering
|
|
•
|
unforeseen conditions (for example, soil conditions
which are different than predicted)
|
Generally, contractors bear the risk of construction issues, while owners are responsible for design or engineering issues.
However, some contracts try to shift risks, or try to create unfair leverage positions. For example, an unfair situation might emanate from a contract that stipulates progress payments will not be made until the architect approves all work. This can create a real imbalance when disputes arise as to the extent of work done, or whether the work is deficient, because architects are generally hired and paid by the owner.
To avoid unfair shifting of risks, a balanced contract might contain provisions that:
|
•
|
help reduce the risk for both the owner and the contractor through an allocation of different costs. For example, the contract could stipulate that the owner is responsible for certain costs, while the contractor takes responsibility for other costs
|
|
•
|
allow either the owner or the contractor, through a bail-out clause, to decline to proceed further on a project if costs escalate to a certain level over the initial, agreed-upon, budget
|
Due to limited construction knowledge on the part of many new home buyers, and their decreasing bargaining power in a hot housing market, an unfortunate phenomenon has arisen recently in Calgary, and perhaps elsewhere in the province.
Builders who have signed fixed-price contracts to build homes have seen their margins evaporate with dramatic increases in their costs, causing them to demand premiums on the agreed price or to return deposits and walk away from the deal. Either result is potentially catastrophic for the buyer who may have already sold his existing home, or who may have strained the limits of his mortgage capacity.
Broadening these doomsday scenarios as part of the negotiation process is critical to incorporating fair and balanced terms into the contract to avoid, or at least mitigate the effects of spiralling costs.
The allocation of the risks interest in a development or construction project often requires the introduction of a third party such as a surety willing to shoulder a defined portion of the risk in exchange for a fixed fee or premium. The introduction of a performance bond or a labour and material payment bond into a project greatly alleviates the risk to an owner of the consequences of a default in completion.
Essentially, these bonds ensure that if the contactor does default on performance or is unable to pay sub-trades and material suppliers, your project will still continue on. The surety actually promises to step in and complete a job if the contractor who posts the performance bond runs out of money or fails to perform the specified work for some other reason.
The relief of knowing that if the contractor should default on performance, or fail to pay its trades and suppliers, should ideally improve the capacity of the owner to in turn accept some element of risk that it might otherwise seek to shift to the contractor. This balancing act, if responsibly done, might be the difference between a successful job and a litigation-plagued disaster.
In Alberta, the powerhouse economy rests, in part, on adequate financing to fuel the vast number of development and home projects currently underway. The ability to draw on sufficient financing throughout the entire project is all-important for both developers and contractors.
Failing to communicate fully and openly about the security and extent of the sources of financing is to invite the risk of slow payments and squabbles over the extent of work done.
A lack of adequate financing on the part of the contractor or owner could:
| • |
result in a lien registered against the title of the property by third parties such as sub-trades
|
| • |
stop the cash flow of money from financiers, for example, bankers who have until then lent funds as the project proceeded |
| • |
force the total shutdown of the project
|
Construction disputes are rarely straightforward, produce a flood of paperwork between the disputing parties and chew up time for all parties involved. As such, they are best avoided if at all possible.
In some instances, progress on a project can slow down or even grind to a halt while the litigation process is pursued. Yet too often, construction contracts do not contain measures for dealing with any disputes in a method that provides for quick and low-cost resolution.
As a result, it is increasingly important for parties to a construction contract to proactively discuss and agree upon alternate dispute resolution (ADR) mechanisms which can be incorporated into their agreement.
Many such terms impose a positive obligation on the parties to continue with the work and the payment for work done while the resolution process continues. The most common ADR mechanisms are:
| • |
Mediation: negotiation using the services of a third party facilitator
|
| • |
Arbitration: essentially a private trial, often conducted by a retired judge or an experienced construction consultant
|
However, the dispute process can be tailored ahead of time, through a contractual agreement, to best suit the needs of the project and the parties involved.
Although the cost of mediation or arbitration may reach well into the thousands on a commercial project, it may well be worth the money expended. That’s because, in most cases, the amount paid to bring in a third party to resolve the dispute quickly can be much lower than the cost of total work stoppage while the bills continue to mount on a project.
The surge in construction activity in Alberta reflects an economy that is firing on all cylinders, presenting incredible opportunities.
Still, it is essential to protect yourself as much as possible against unforeseen circumstances in either the owner or the contractor’s situation, from disputes or even changing market conditions.
The reality is that each project – whether it’s a home, commercial unit, strip mall, office tower or industrial plant – needs to rest on a solid foundation and bedrock of well-thought out and duly executed legal contracts and agreements.
Borden Ladner Gervais LLP is among Canada’s most respected full-service national law firms. With more than 700 lawyers, intellectual property agents and other professionals in six offices across the country, BLG provides corporate legal services to a wide range of clients nationally and internationally in virtually every area of law. For more information, visit www.blgcanada.com.
This e-newsletter is not intended to be a complete statement of the law or an opinion on the subject. Although we endeavour to ensure its accuracy, no one should act upon it without a thorough examination of the law after the facts of a specific situation are considered. No part of this publication may be reproduced without prior written permission of Borden Ladner Gervais LLP.
|
.jpg)
