June 26, 2006

In trying to develop articles for this newsletter, we have tried to pick issues that are both topical and interesting. So why would we devote an article to “papering” a construction file, a topic that is just about as exciting as watching grass grow and not as much fun. Simple. Because almost every time we get a call about a new matter, within the first 10 minutes of the conversation, we are likely going to ask “did you get that in writing?” And the answer we receive, along with the actual documents that may exist, will probably, in most cases, be determinative of the matter. In our experience, proper documentation significantly determines the outcome of any dispute, regardless of what actually happens on a project.

This article therefore highlights some common areas where documentation problems can occur and outlines various issues that should be addressed during the different phases of construction. While this article does not address every situation that may arise, it does provide some general guidelines that, if followed, will substantially improve your ability to protect your rights should a dispute arise.

Pre-Construction. Everyone involved in a project, be they an architect, owner, developer, construction manager, general contractor or subcontractor should make sure that before they become involved in a construction project, they address at least three issues: (1) all necessary parties are properly licensed or registered to perform the work or services in question; (2) all parties have reviewed and understand copies of all documents, including any supplemental terms and conditions or plans and specifications, related to the project; and (3) they understand and have taken appropriate steps to protect their lien and bond rights.

First, before bidding for any work on a project, all contractors and subcontractors should have an appropriate and active contractor’s license. All design professionals should be appropriately registered in the state where the project is located. All owners/developers should ensure that the contractors, construction managers, and design professionals they are contracting with are properly licensed and registered. In Arizona, if a contractor enters into a contract or performs work on a project without a proper license, the owner/general contractor can void the contract and avoid paying for the work, even after millions of dollars of work has been done. See Crowe v. Hickman’s Egg Ranch, 202 Ariz. 113, 116, 41 P.3d 651, 654 (App. 2002). Moreover, if a contractor or design professional fails to obtain and maintain the proper license or registration, that may mean they lack the skill, training or expertise necessary to perform the work or services in question adequately. Basically, confirmation of proper licensing and registration is a must.

Second, all parties must make sure before entering into a contract that they are familiar with all relevant contract terms and conditions, including any general and supplemental conditions and all other related contracts that may impact the project. For instance, if a general contractor (“GC”) has a development contract, and its subcontracts incorporate the development contract through flow down provisions, the subcontractor should review the GC’s development contract before entering into its subcontract. Similarly, if the owner-architect contract has a binding arbitration clause, the owner better ensure that its contract with the GC has a similar clause, and that both the architect and GC contracts allow joinder of all parties to the dispute. Otherwise, the owner may be forced to arbitrate with the architect and litigate with the GC. “Supplemental” documents and/or provisions can, and in many cases do, add or modify requirements in contracts that the party entering it would not necessarily agree to ordinarily (particularly related to issues like indemnification, payment schedules, insurance requirements, no damages for delay clauses, and related issues). Therefore, it is important that before entering a contract, all parties know what their rights and obligations are under them. In fact, you should consider having an attorney review any contract before signing it, because an ounce of prevention is worth a pound of cure.

Third, if involved in a construction project, all parties should protect their statutory lien and bond rights by properly serving Preliminary 20-Day Notices (“Prelim Notices”) or similar notices required by the pertinent state statutes. In Arizona, a proper Preliminary Notice contains the following: (1) a general description of the work being performed; (2) the name of the contractor providing the work; (3) the name of the entity who contracted for the work; (4) a description of the jobsite sufficient for identification; and, (5) certain other statutory language. Similarly, there are statutory provisions for attaching a professional services lien on property for design professionals.

At the same time, if you are either a GC and/or owner/developer, you should set up a system to collect and record all Preliminary Notices received on any project, so that you can ensure you obtain proper lien waivers during construction. This should include some type of chart or index that notes who served the Prelim Notice, what type of work they are performing, who they are performing that work for, and the value of the work they anticipate providing to the project. Then, as payment applications are submitted, a GC/owner/developer can compare the application to this chart to ensure that all proper lien waivers are submitted. The GC and owner should also compare their charts to make sure that everyone who has lien rights on a project is getting paid, and that proper lien waivers are being collected. Lien waivers can also be useful to defend against claims that invariably spring up at the end of a project.

Documentation During Construction. During construction, all parties involved in construction should: (1) memorialize all changes to the Contract in writing; (2) keep a daily log of work performed, site conditions and anything that occurs on a daily basis on each project; and (3) make sure to provide payment applications, objections to work listed on those applications, and payments in a timely manner.

First, any changes to a project, whether it is an additional scope of work, changes to shop drawings, RFIs, ASIs, authorizations to proceed in a certain manner, or minor deviations from plans or specifications, should be documented in writing. While, in a perfect world, this would mean a formal change order with an appropriate stamp from all parties and multiple signatures, including a new approval from the architect, we realize this is often impossible during construction. Moreover, making sure the change order itself addresses or reserves delay, acceleration, on loss of efficiency claims is, itself, very important. That said, documenting changes, even in the form of a hand-written note or e-mail to the owner at the time work is authorized can be invaluable in resolving disputes later. While claims can be successful without documentation, it is much more difficult and expensive. Again, an ounce of prevention is worth a pound of cure.

Thus, all parties should use a pad of paper or a laptop or Blackberry or an agreed upon software the parties share (or even a Dictaphone that can later be transcribed) at all times so that, as changes arise, they can document them, even if the documentation is not complete. For example, if a change is estimated, but the exact cost is not known, documenting the fact the change was discussed and approved (or not approved yet) is substantially better than waiting for the cost figures and then forgetting to document it at all. Similarly, if a developer notices that construction is falling behind, is defective, or is not going according to plans, sending a simple letter confirming the need to get back on schedule or to correct the work in a timely manner, or outlining what the parties agreed to do, can be the determining factor in deciding whether a dispute is won or lost. These documents can also be given to the home office to allow for more accurate accounting and billing on a project.1

Second, keeping a daily log of what happens on a project can be an invaluable tool both during and after construction if a claim arises. Daily logs allow architects/owners/developers/GCs and subcontractors to evaluate whether a project is moving along on schedule, to protect them from claims related to delays, acceleration, or defective construction, and/or to give them the ability to prove that their actions were appropriate in dealing with others on the job. These logs do not have to be comprehensive – they can just hit some highlights like the schedule for the day, who was on-site, when they arrived, what work they performed and/or did not perform, and how the site looked at the end of the day. Taking just five minutes to do this every day during the project can save hundreds of thousands of dollars later. If, for example, a subcontractor is failing to provide the proper size and experience of work crews on a regular basis, a developer or GC who notes that in a daily log taken during the regular course of business will be in a much better position to either put additional pressure on a subcontractor to complete its work in a timely basis, or to terminate the subcontractor, than if no log exists. Similarly, if a GC or owner fails to have a site ready for a subcontractor to perform its work when scheduled, having a contemporaneous log makes it much easier to prove increased costs if a dispute arises. Moreover, if a big issue arises, consult with your attorney immediately regarding documenting the situation. Photos and videotaping the project may be appropriate and invaluable at that point. Consulting with an expert through your attorney, may also be prudent at that time.

Third, submitting timely and completed payment applications will make the project move along much more smoothly. In Arizona, the Prompt Payment Act establishes a mandatory payment schedule for all private construction projects over 60 days, unless the parties formally opt out of the Act.2 That schedule kicks in once a payment application has been submitted. Thus, if a GC submits a payment application on the 1st of the month, the owner must inspect the work and either accept it or provide a written objection to unacceptable work listed on the application by no later than the 15th, 14 days later. If the owner or architect provides a written objection, they are able to withhold payment for the amount objected to until the work is done properly. This allows for issues to be addressed as they arise, and only being forced to pay for approved work.

However, if no written objections are made, the application is deemed accepted and approved by law, and the entire amount is due by the 22nd, 7 days later. If a written objection is made, the owner can withhold payment, but only enough to reasonably cover the objected to work. After the GC has been paid, it must pay its subcontractors/material suppliers by the 29th, again 7 days later. Any owner/contractor who fails to comply with these dates is in material breach of contract, and the other party can stop work, terminate the contract, and file suit for damages, interest, fees and costs.

Submitting appropriate payment applications is crucial to ensuring prompt payment, and prompt responses allow owners/architects to ensure that construction is proceeding as required by the plans and specifications. In other words, complying with the Act should allow all parties to move projects along on a more timely basis and help prevent small disputes from turning into large ones. If you are unsure of what your obligations are under the Act, you should contact a knowledgeable construction attorney. Failure to understand and comply with the Act can put you in a straight jacket where you will need a magician in addition to your attorney.

Closing Out the Project With Documents. Obtaining documents to close out a project also depends a lot on your role in the construction. Obviously, you should have your attorney incorporate what you want to obtain at the time of close out into the contract in the first place. As an owner, before making a final payment or releasing any retention monies, you or your architect should: (1) conduct a final inspection and provide the GC with a punch list of items to correct before final payment will be made; (2) make sure you have all applicable warranty documents and required permits; and (3) ensure you have copies of final lien waivers from all parties that served a Prelim Notices upon you. By doing so, you can ensure that you have a complete, properly permitted and encumbrance-free project.

Similarly, as a GC, you should obtain three things: (1) final sign-off and approval on all work, including a completed punch-list, indicating the project is complete and you are entitled to final payment; (2) copies of the same final lien waivers from all of your subcontractors; and (3) final payment of all monies due, including all retention and change order monies, before you provide a final unconditional lien waiver. By obtaining these three things, you ensure that the owner has accepted the project, has no current claims for obviously defective and/or incomplete work, and that all payment disputes are resolved before leaving the project.

As a subcontractor, you should ensure you provide final lien waivers from all of your subcontractors and suppliers to the GC, and that you obtain final payment. The sooner that this information is provided, the sooner you may be able to be paid for this work and move on to the next project.