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It is construction contracting 101: get the contract signed before the shovels hit the dirt. But too frequently the signed agreement becomes secondary to starting work. This is understandable. For both owners and contractors, starting on time is critically important, particularly in the Pacific Northwest where Mother Nature is often the biggest impediment to getting a project completed on time and on budget. Thus, there are times when business reasons dictate starting construction before a final contract is negotiated and signed.

Nonetheless, it is important to revisit the reasons why it is prudent to have an executed contract before work starts. Here are five of them:

1. Negotiation takes time

Oftentimes, parties are willing to set aside negotiation of a contract until after construction starts based on their shared assumption that they will be able to quickly agree on contract terms in the days thereafter. But even when the owner and contractor have an established relationship, this may be an unreasonable expectation. Sophisticated owners and contractors are bound to have significant disagreements. Negotiations that drag on while construction is under way can distract the project team. And both parties may lose leverage on important issues. Meanwhile, the longer that work proceeds without a contract in place, the greater the risk to both parties.

2. Adequate insurance cannot be assumed

Insurance is one of the principal project assets that both the owner and contractor rely on to manage risk that manifests both during construction and in the years after work is completed. But neither the owner nor the contractor should assume that the other party鈥檚 insurance is adequate. The owner will want to ensure that the contractor has adequate liability coverage to protect against losses during construction, as well as 鈥渃ompleted operations鈥� coverage that takes effect after the contractor鈥檚 work is finished (not to mention workers鈥� compensation, employers鈥� liability, and commercial auto, among other common coverages). And because subcontractors typically perform the bulk of the work, the owner will also want to require that subcontractors maintain appropriate coverage. Though often the owner provides 鈥渂uilder鈥檚 risk鈥� coverage that protects the work during construction, the parties could agree that the contractor is to obtain the builder鈥檚 risk policy. When work begins before these responsibilities are contractually established, there is an increased risk that coverage will be inadequate or that there will be gaps.

3. Compensation is more than a number

During the bidding or proposal process, the focus is appropriately on the price for which the contractor will agree to build the project. Generally speaking, it is not until they start negotiating the final contract that the owner and contractor address the specific terms governing the owner鈥檚 obligation to make payments to the contractor. These negotiations include issues such as the procedure for submittal and approval of payment applications, the documentation required by the owner as a condition for making payment (e.g., will the owner require lien waivers from the contractor and all subcontractors?), whether retainage will be deducted from progress payments, the amount of interest to be paid on payments that are late, and conditions for final payment. The agreement on an initial contract price does not address the manner for adjusting the price (or schedule) based on changes in the scope of work or problems encountered during construction. Ideally, these issues are settled before work begins.

4. The earlier the prime contract is signed, the easier it is to ensure key requirements flow down to subcontractors

A general contractor鈥檚 agreements with its subcontractors typically include standard flow-down language that incorporates the terms of the prime contract. Nonetheless, the prime contract also frequently requires that specific provisions be expressly stated in the subcontracts. For instance, when the owner and general contractor agree that disputes between them are to be resolved by arbitration, they will often also agree that the general contractor鈥檚 agreements with its subcontractors and suppliers are to include identical language binding the subcontractors to arbitrate disputes in a consolidated proceeding. If the prime contract is executed after certain subcontracts or supply agreements are executed, then the general contractor may need to amend those agreements to include the required language.

5. The contractor鈥檚 bid may include terms that are not acceptable to the owner

The contractor typically prepares a bid that describes a scope of work, sets forth 鈥渁ssumptions鈥� on which the bid is based, and contains other 鈥渆xclusions鈥� and 鈥渃larifications.鈥� The assumptions, exclusions and clarifications frequently contain legal terms and disclaimers that many owners find objectionable (for example, limitations of liability or waivers of consequential damages) and would never accept in the ultimate contract. But if the contractor鈥檚 bid is the last writing between the parties before work starts, the contractor may have a basis to later insist that such objectionable terms were a material part of the contractor鈥檚 proposal as accepted by the owner 鈥� even if the owner orally manifested an objection to such terms before work started. Having a signed agreement before work starts that expressly excludes such objectionable terms obviously avoids such pitfalls.

Of course, there may be instances where the owner and contractor have no choice but to start work before a contract is finalized. In those cases, it may be preferable to execute a letter agreement that contemplates the execution of a superseding formal contract at a later date.

Zachary Davis is an attorney in Stoel Rives鈥� construction and design practice group. Contact him at 503-294-9410 or [email protected].