Dangerous Contracts

The cardinal rule of contractual risk allocation is that the party best able to manage any particular risk should be the one to bear it. If a risk more appropriately borne by one party is to be shifted to the other, that increase in risk should be balanced by a negotiated adjustment in price. A well written contract accurately records the allocation of risks between the parties as they have freely negotiated them.

That’s the theory. The reality is different. Consulting engineers who work regularly with construction contracts should know that even the best contracts, including standard form documents in wide use throughout Canada, contain provisions that allocate risk in unusual or unexpected ways. Other clauses that apparently allocate risk away, such as an indemnity, may actually allow the risk to spring back upon a party if, for example, the loss exceeds a certain amount. Still other clauses may severely limit or remove entirely rights taken for granted, such as the right to sue upon a claim.

Clauses like these are dangerous. Going unrecognized and unmanaged, they can prompt nasty surprises. And the key word here is surprise. It is unrealistic to expect you can avoid contracts containing such provisions. But parties going into a contract and their advisors should ensure that each is aware of the risks as they are actually allocated within the text of the document, if only to ensure that they are capable of managing the risks and thereby minimizing disputes.

Consider the following three examples. The first comes from a standard form of general contract used by a municipality: “The Contractor declares and represents that in entering into this Contract, it has either investigated for himself [sic] the character of the Work to be done and all local conditions . . . that might affect its acceptance of the Work, or, that not having so investigated, it is willing to assume and does hereby assume, all risk of conditions now existing or arising in the course of the work which might or could make the Work . . . more expensive in character, or more onerous to fulfil, than was contemplated or known when this Contract was entered into.”

On a quick read, this clause appears to allocate to the contractor all the site risks, such as unforeseen subsurface conditions. But in fact, the clause extends considerably beyond this and appears to cover any “local conditions” at all. These presumably include conditions utterly beyond the assessment and control of the contractor, for example a delay in project commencement caused by an unresolved ratepayer group objection. As drafted, the clause is a recipe for an expensive dispute.

Or consider this provision, contained within the specifications in a general contract for the construction of an art gallery: “The Contractor warrants that the mechanical systems to be supplied and installed shall at all times be capable of maintaining a humidification level within the Work of 47% humidity, within a tolerance of 2% plus or minus.”

This is a “performance specification” and it properly belongs in a design-build contract. Unfortunately, the project in this case was a traditional, design-bid-build arrangement in which the owner retained separate design and construction teams. When the HVAC system failed to maintain humidity within the specified tolerances, the owner, design engineer and contractor all became embroiled in protracted litigation over who was responsible for warranting the system design: the owner and his engineer (who one might expect) or the contractor (who appeared to have unwittingly picked up this liability under the clause). The cumulative costs of the dispute far exceeded the cost of rectifying the problem in the first place.

Finally, consider GC 8.2.2 of the CCDC 2-1994 Stipulated Price Contract: “A party shall be conclusively deemed to have accepted a finding of the Consultant under GC 2.2 – Role of the Consultant, and to have expressly waived and released the other party from any claims in respect of the particular matter dealt with in that finding unless, within 15 Working Days after receipt of that finding, the party sends a notice in writing of dispute to the other party and to the Consultant, which contains the particulars of the matter in dispute and the relevant portions of the Contract Documents . . . “

CCDC 2-1994 is a standard general contract widely employed throughout Canada. How many users of the document are fully aware that they risk losing their right to claim if they fail to take the step required by the above clause? In other words, how many realize that they must send a written notice of dispute in response to a letter from the project consultant that might be construed to be his “finding” upon the subject matter of a claim?

To avoid the dangers that lurk within contractual terms, here are five suggestions:

Read the draft contract! The advice sounds trite, but it’s amazing how often contracts are signed without reading them amid the haste to conclude and get on with the job.

Have the draft contract vetted by others. Those who price the work will see things that the marketing people will miss. The financial people will spot still other issues, as will the design consultants.

As you read the draft, think “What if?” and then “Who’s responsible?” Play devil’s advocate. Ask the tough questions — or be sure someone else on the team does.

Ensure that a contract administrator is appointed. Many clauses become dangerous only because some step required to be taken within a specified time was not done, such as the delivery of a notice. There should be one individual on the project team charged with tracking compliance in an ongoing way.

Get professional assistance early. Consulting a lawyer, insurance broker and risk management advisor at the front end is cheap insurance compared to the costs of attempting to repair a problem later.CCE

Geza R. Banfai, LL.B is a Partner at Blaney McMurtry LLP in Toronto. He is a certified specialist in construction law, and a Fellow of the Canadian College of Construction Lawyers.