Addressing Contractor Concerns in Turbulent Times

April 2009

By: Michelle A. Schaap, Andrew S. Kent, and Joseph Zawila

Wolff & Samson PC, Construction Law Alert

With the recent passage of the economic stimulus package aimed at bolstering employment by rebuilding the nation's outdated roads, bridges, highways and rail lines, demand for construction services is expected to increase. However, contractors should consider requiring additional assurances from developers to mitigate the risk of loss in these new projects. This Client Alert identifies three different ways that a contractor can better protect itself when entering into a standard owner/ contractor and contractor/subcontractor agreement. While there can be no guaranty that a contractor will emerge unscathed, these approaches may help the contractor avoid financial ruin if the developer and/or the project were to become insolvent.1

I. One way that a contractor can minimize its financial risk on a construction project is to require that the owner or developer post security for the benefit of the contractor, whether by a letter of credit, an escrow agreement or a payment bond, representing a certain percentage of the overall construction costs. For projects in which financing is involved, the contractor may also seek to secure direct payment of loan advances from the lender to the contractor for approved pay applications. Such assurances are not always available, but in this economy, it is prudent to ask.

II. Whether or not such security is available, a contractor should consider requiring financial representations and covenants from the developer or owner that are more extensive than the vague provision (found in current industry standard forms) that requires owners to provide only "financial assurances." For example, the developer could be asked to represent and covenant to the contractor that:

- The developer is and will be solvent at all times during the business relationship;

- The developer has sufficient funds for its required payments to the contractor, and will continue to have such funds throughout the business relationship;

- The present value of the developer's assets, after any applicable financing, exceeds the value of its debts;

- The developer does not intend to incur debts beyond its ability to pay those debts; and

- The developer agrees to provide financial statements, no less than quarterly, that fairly present that the developer's financial position is in accord with the above representations and covenants.

Additionally, if a developer or owner finances a project, the contractor should consider insisting on certain representations and covenants ensuring the financing agreement is adequate and enforceable. Such provisions may include that:

- The developer shall agree to present, prior to commencement of any construction, and periodically thereafter, acceptable evidence to the contractor that the financing has been consummated and that the developer is not in default under the financing agreement;

- The developer shall not change the terms of its financing agreement in any way that adversely affects its ability to perform its obligations under the construction agreement without the contractor's consent; and

- The lender will copy the contractor on any default notice served upon the developer/borrower.

As suggested above, a contractor may seek regular reports ensuring that it receives timely notice if the developer's finances are troubled. At a minimum, the contractor should be notified in the following circumstances:

- An adverse change with respect to the financial condition or business of the developer or its lender;

- The commencement of any investigation or litigation relating to the developer or its lender which could adversely affect the developer's (or lender's) financial condition or business; and

- The receipt by the developer of any notice from any administrative agency relating to any law or information which would adversely affect its financial condition or business.

III. There are several contractual provisions that a contractor should consider adding to, or excluding from, its form agreements in addition to those listed above. The following is a sampling of such provisions:

- "Best efforts" type standards should be avoided. Such standards can put an unreasonable financial strain on the contractor, and may even void insurance coverage.

- Costs of materials should be borne by the developer.

- The contractor should have the right to suspend performance immediately if the owner/developer fails to provide financial information or other assurances when they are contractually due. The current AlA forms allow for a contractor to suspend performance only under limited circumstances, and then only after a series of notices has been delivered.

The three options highlighted above are available to a contractor and can provide either alone or in conjunction with each other - additional protections in this difficult economic climate. By using this three pronged approach, the contractor can potentially decrease the likelihood of serious economic harm in the unfortunate event that the developer or the project becomes distressed.

For more information on how to modify standard form agreements in order to better protect your construction business, please contact:Michelle A. Schaap, member of Wolff & Samson, PC in West Orange, New Jersey. She may be reached at (973) 530-2026 or via e-mail at: mschaap@wolffsamson.com; Andrew S. Kent, Counsel, (973) 530-2054 or via e-mail at: akent@wolffsamson.com; or Joseph Zawila, Counsel, (973) 530-2042 or via e-mail at: jzawila@wolffsamson.com.

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ENDNOTES

1. To ensure that standard forms of construction documents are the documents that fit a project, such documents should be thoroughly reviewed and understood, and an attorney should be consulted.

This Client Alert should not be construed as legal advice or a legal opinion on any specific facts or circumstances. The contents are intended for general informational purposes only, and you are urged to consult your own lawyer conceming your specific situation or any legal questions you may have.

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