In 2024, many real estate developers pressed pause on new projects. Interest rates for multifamily loans were too high and the office market was still recovering from “work from home,” at least in the Pacific Northwest (where the market remains). Toward year end, falling interest rates breathed life into these harder-hit markets and 2025 looked brighter.

Unfortunately, now the specter of new tariffs is raising anxiety levels. Steel, lumber and appliances, for instance, are commonly imported. Consequently, clients have begun asking how to address tariffs when negotiating construction contracts.

Let’s begin with the legal foundation for fixed price (FP) contracts and guaranteed maximum price (GMP) contracts. Under an FP contract, the contractor is paid a sum certain and bears the risk of costs exceeding that sum, unless it is expressly entitled to a change order. Under GMP contracts, the contractor is paid its approved costs plus its fee, not to exceed an agreed-upon maximum, unless it is expressly entitled to a change order. When either a GMP contract or an FP contract is silent concerning risk for changes in law, including tariffs, arguably the contractor carries the risk by virtue of its fixed or guaranteed price. Standard GMP and FP contract forms published by the American Institute of Architects do not address tariffs expressly, which is why some contractors request changes to these forms.

One way for a contractor to shift the risk of new tariffs back onto the owner is by negotiating for a changes-in-law clause. Generally, tariffs are laws passed by Congress or derived from laws where Congress delegates tariff authority to the president, who then creates the tariff. A contract stating that costs resulting from changes in laws after the contract is executed may entitle a contractor to a change order for tariff-related costs.

Allowances are another way to shift price escalation risks posed by tariffs. Under most allowance clauses, the amount allocated for a product or material is a placeholder. The project owner will ultimately pay the actual cost of the allowance item, whether it goes up or down, and the GMP may be adjusted accordingly through a change order. When lumber prices skyrocketed during the pandemic, many contractors listed their lumber packages as an allowance.

Let’s not forget about the contingency account. There is usually no contingency account in an FP contract because the price is fixed. Under GMP contracts, the price is not fixed. The contractor is paid approved costs and its fee, up to the GMP. Because of this structure, most GMP contracts also include a 2-5 percent (of the GMP) contingency account, which acts as a “buffer” intended for certain costs otherwise not reimbursable on the basis of a change order, including for tariffs. If tariffs are an approved contingency expense, whether the contractor is entitled to apply markup on amounts paid should be considered.

Also, because unspent contingency is sometimes shared with the contractor under a savings clause, even when a contractor is entitled to a change order for future tariffs, owners should consider whether contingency must be exhausted first before the contractor may request a change order for this expense. Otherwise, the owner may have to pay savings out of unspent contingency and pay a change order for tariffs – a potentially painful lesson.

Many owners are comfortable sharing tariff risk but want their contractor to have skin in the game so that interests are aligned. For larger projects, consider sharing risk in tranches. For instance, after contingency is exhausted, the contractor may cover the first $1 million in unexpected costs and the owner covers the balance (without markup). Alternatively, the risk can be split 50/50, including in savings if pricing is ultimately lower than expected. Another lever to adjust up or down is the contractor fee. One could argue that if an owner carries tariff risk entirely, it should receive a reduction in that fee.

Currently, some well-capitalized developers are so concerned about future tariffs that they are considering buying products now under their existing pre-construction services agreements. Insurance, shipping, storage and title are all considerations in early procurement. During the pandemic, one client saved millions of dollars (on a $100 million lumber package) by buying early.

Owners and contractors are aligned in wanting shovels in the ground and successful projects in their portfolios. For some projects, tariffs may be an insurmountable obstacle. For others, there may be enough room for both sides to sharpen their pencils and proceed, by reasonably allocating risk for the right price.

Colm Nelson is a Stoel Rives LLP partner and a member of the construction and design group in the firm’s Seattle office. Contact him at 206-386-7525 or colm.nelson@stoel.com.

The opinions, beliefs and viewpoints expressed in the preceding commentary are those of the author and do not necessarily reflect the opinions, beliefs and viewpoints of the Daily Journal of Commerce or its editors. Neither the author nor the 91��Ƶ guarantees the accuracy or completeness of any information published herein.

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A developer client recently expressed mixed emotions when reflecting on a new project that had been delivered on time and under budget. The investors were happy, and the client had just written a check to the prime contractor for its half of the “savings,” with the other half withheld by the client. At first blush, the client could be charged with taking an unreasonably pessimistic view of its successful project, but upon closer scrutiny the developer’s reservations were reasonable.

Many standard construction contracts, including those published by the American Institute of Architects, include a placeholder for incentives for the contractor, such as early completion bonuses and/or sharing in the project savings, if any. How the savings are calculated varies, but often it is the difference between the guaranteed maximum price (GMP) and the cost of the work. That amount is then allocated to the contractor and owner based on a percentage split between the two. The contractor’s ability to share in the savings can hinge on the contractor completing the project on time. That is, the contractor could deliver the project under the GMP, but it may not earn any savings because it is late.

Through the preconstruction phase of the project, the client and contractor collaborated to refine the scope, develop a schedule, and establish a GMP. As design progressed, the schedule and GMP were vetted, refined, and negotiated. Ultimately, the parties signed a GMP contract with a 50/50 savings split. In the end, the project was delivered approximately six weeks early and almost $1 million under budget. The savings check to the contractor was for approximately $500,000.

From her post-project deliberations, the client’s first reservation was the construction schedule. While delighted that the project was delivered early, she questioned whether her schedule expectations had initially been set properly. Her concern illustrates one of the potential disadvantages of hiring a contractor for preconstruction services and then hiring that same contractor for the project: The contractor created the very baseline against which its own performance would be measured.

Critics of alternative delivery methods, which usually rely on preconstruction services, often suggest it is a “moral hazard” for contractors to establish their own baselines in this way. This is not to suggest that all contractors performing preconstruction services act solely in their own interest – that so many private developers rely on preconstruction services with trusted contractors demonstrates unequivocally that good contractors do add value to a project by, among other things, creating a fair baseline schedule. It merely calls out the inherent conflict of interest in creating the benchmarks against which one’s own performance is measured. In contrast, in a hard bid setting, the owner either provides bidders the expected duration or bidders may propose one in their bids. Durations are then measured against one another.

The client had the same reservations about the GMP. In addition, the client questioned her use of contingency and allowances for the project. Contingency was 5 percent of the GMP and, in the end, most of the shared savings was unused contingency. The biggest risk going into the project was price escalation for lumber. Instead of requiring contingency to be used to cover any such escalation, which was her preference, she reluctantly agreed to treat lumber as an allowance item.

Contingency is usually used for unanticipated costs that are not the basis of a change order. An allowance is a placeholder for a cost that is difficult to quantify. From a developer’s perspective, each approach has pros and cons. When an allowance is exhausted, the contractor will usually be entitled to a change order for additional costs for that item; however, when contingency is exhausted, the contractor is not entitled to a change order for more. Also, while unused contingency may be subject to the savings split, unused allowance amounts usually accrue to the owner’s benefit and result in a dollar-for-dollar reduction in the GMP. That is, if the allowance amount in the GMP is $10 and the actual cost is $7, the GMP would be reduced by at least $3. The contractor fee may or may not also be adjusted. Here, the client’s internal budget included dollars for unanticipated costs outside the GMP, which she used to pay a change order for the price escalation of lumber. In other words, the client paid for the lumber price escalation and she paid for project savings.

When the GMP contract was executed, the client felt confident that her internal budget would not be exceeded and the project would be delivered on time. She was right on both counts. After the project was completed, however, she questioned whether she gave up too much, too early. Moving forward, on the next project, she may keep a second contractor in the wings to provide competitive pricing at 80-90 percent of design. She may also restructure how she approaches savings, contingency, and allowances, by requiring contingency to be exhausted first before signing a change order for overages in allowance items. This would help prevent her paying for allowance overages and savings derived from unused contingency.

Colm Nelson is a Stoel Rives LLP partner and a member of the construction and design group in the firm’s Seattle office. Contact him at 206-386-7525 or colm.nelson@stoel.com.

The opinions, beliefs and viewpoints expressed in the preceding commentary are those of the author and do not necessarily reflect the opinions, beliefs and viewpoints of the Daily Journal of Commerce or its editors. Neither the author nor the 91��Ƶ guarantees the accuracy or completeness of any information published herein.

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Headlines such as “US set for recession next year, economists predict,” from the June 12 edition of the Financial Times, are a reminder insolvency risks are real and should be top of mind when moving forward with new construction projects. But there are ways to mitigate the risks.

Performance bonds, as their name implies, hold a surety jointly and severally liable to the owner for the contractor’s performance of the work. Depending on the bond’s form, if the contractor becomes insolvent and is put into default, the surety can either perform the work itself or indemnify the owner for costs incurred hiring a replacement contractor. Convincing a surety to take over a contract following a contractor’s default is not easy. When sureties do agree, the contractor is often insolvent. Generally, if the surety takes over under a bond, it steps into the defaulting contractor’s shoes.

A payment bond is different. Under this type of bond, the surety is jointly and severally liable to, and/or will indemnify, the owner against claims and liens by subcontractors retained under the prime contractor.  The surety’s obligation to act under the bond may be contingent upon the owner paying the prime contractor in accordance with the contract. When a subcontractor lien is filed, the owner will notify the surety, and in theory, the surety will cause removal of the lien through a lien release bond or otherwise.

In deciding whether to issue either form of bond, a surety will typically scrutinize a contractor’s financials and require the contractor to indemnify and hold harmless the surety against any losses it incurs under the bond.  This is one of the major differences between bonds and insurance policies: insurers cannot seek reimbursement from their insureds for amounts paid out under the policy, whereas sureties can require reimbursement from the obligor (contractor) for any losses incurred by the surety under the bond. Also, insurance policies can be modified only through boilerplate endorsements, and the language is often take-it-or-leave-it.  In contrast, owners have input into how bonds are drafted and should negotiate for favorable language.

The surety may also require personal guarantees from the contractor’s ownership team. Whether a contractor is bondable or not is a “stress test” that can provide a sense of the contractor’s financial health.  If the contractor is not bondable, or has relatively low bonding capacity (i.e., the surety will issue bonds covering only a small dollar value), that could signal a failing grade.

As further protection, owners can consider structuring payments, not based on the contractor’s costs incurred, but based on the contractor hitting milestones throughout the project, so that payments are conditioned on progress. Depending on state law, the owner may elect instead, or in addition, to withhold retainage from each contractor draw. One problem with retainage is that it includes amounts earmarked for subcontractors, and withholding amounts due subcontractors because of prime contractor defaults will likely result in subcontractor liens. For retainage to protect against prime contractor default, it should be withheld from the contractor’s general conditions and/or fee.

Contractors also have tools to guard against solvency risks.  In the standard AIA agreements, the contractor can request proof of financial arrangements for the project from the owner, both before the project begins and at certain times during the project, including when the contractor identifies in writing a reasonable concern regarding the owner’s ability to make payment when due. Sections 2.2.1 & 2.2.2, General Conditions of the Contract for Construction, A201 – 2017 (General Conditions). The owner’s financial arrangements should not materially vary without notice to the contractor. And should the owner fail to provide the information, the contractor can terminate for default. Section 14.1.1.4, General Conditions.

To guard against subcontractor insolvency, more and more prime contractors are acquiring subcontractor default insurance (SDI), which, when triggered, reimburses the contactor against certain costs incurred as a result of an enrolled subcontractor defaulting.  Because subcontractors often work with the prime contractor on multiple projects, if a subcontractor fails, this can have a domino effect, ending in financial distress for the prime contractor. SDI can pass some or most of that risk onto the insurer, for a premium. Some contractors will in turn pass through the cost of the SDI premium and deductible to the owner as a cost of the work. Owners, however, typically have no rights under the insurance, unless both the contractor and subcontractor are insolvent, and therefore many do not agree to pay for this cost and/or markup on the cost. Owners often view the benefits of SDI as duplicative of payment and performance bonds and refuse to pay for SDI on this basis when the project is already bonded.

Contractors typically have mechanic’s lien rights arising from state law, which can provide some security for unpaid invoices, depending on the amount of equity in the project and whether the contractor has priority over the security interests of the project’s lender. However, an often-overlooked tool is what is referred to as a “stop notice” or “notice to lender.” Under some states’ laws, a contractor can issue a notice to the lender of non-payment and, if the lender fails to take certain actions, namely withhold payment to the owner, future payments issued by the lender to the owner become subordinated to any lien recorded by the claimant who issued the notice. Gaining priority ahead of the lender can be the difference between getting paid or not. This tool is not without risk. For wrongfully issuing a notice to the lender, claimants may face exposure for attorney’s fees and costs incurred by the owner and lender, as is the case in Washington.

A year ago, this author wrote about the early impacts of price escalation, which we have seen bleed into 2022. Hopefully, we’ll avoid the recession that some economists are predicting, and my next article will be on a more upbeat topic.

Colm Nelson is a partner and member of the Construction and Design Group of Stoel Rives LLP. He can be reached at (206) 386-7525 or colm.nelson@stoel.com

The opinions, beliefs and viewpoints expressed in the preceding commentary are those of the authors and do not necessarily reflect the opinions, beliefs and viewpoints of the Daily Journal of Commerce or its editors. Neither of the authors nor the 91��Ƶ guarantees the accuracy or completeness of any information published herein.

The post OP-ED: Ways to guard against insolvency risks appeared first on Daily Journal of Commerce.

For instance, I saw at least one project’s price increase by over $10 million in a matter of months due to the precipitous price increase in lumber. The resulting sticker shock was mitigated somewhat by the recent drop in lumber prices. However, the developer and contractor team were not alone in asking whether the project should proceed and, if so, who carries the risk of future price changes and/or supply chain delays.

Generally speaking, under a standard Guaranteed Maximum Price (GMP) contract, such as the American Institute of Architects’ A102/A201 combination, the contractor is guaranteeing its price against price escalations – i.e., this is a contractor risk. This risk allocation can be adjusted through a variety of methods, including the use of: 1, allowances; 2, contingency; 3, savings bonus; or 4, specifically tailored risk-sharing provisions, addressing both compensation adjustments and/or time adjustments.

How allowances and contingency work in concert, and what those terms mean, differs even among sophisticated contracting parties. For many in the Pacific Northwest, an allowance is merely a placeholder for the expected “Cost of the Work.” If the allowance item costs more than the placeholder, the GMP is increased. If it is less, then the owner should get a deductive change order.

However, industry standard forms like the AIA A201 don’t treat allowances this way and in fact state that “Contractor’s costs for unloading and handling at the site, labor, installation costs, overhead, profit and other expenses contemplated for stated allowance amounts shall be included in the Contract Sum but not in the allowances” – i.e., no increase in the GMP for additional time or labor related to the allowance item.

Under the AIA approach, the contractor would get more, for example, for the price of the door, but wouldn’t be allowed to seek an increase for the time it took to install it. Contingency for some owners and contractors is simply padding to cover additional costs of the work until the GMP ceiling is exhausted. For others, contingency is solely for discrete items, and only to be used upon advance written approval by the owner. Many contractors prefer to list price escalations in materials as an approved use of contingency.

When contract discussions become logjammed over risks that neither party can control, finding an outcome where both the owner’s and contractor’s interests are aligned is sometimes the best way to advance discussions. That often means a sharing of risk to some degree, full transparency by both sides, and even sharing in any savings for effective materials and subcontractor buyouts. Alternatively, if the owner is not willing to share in the risk, which is not uncommon, it should expect the contractor to ask for a higher fee for taking on that risk, or price padding on certain line items.

Supply chain disruptions and resulting delays are treated differently and separately from price escalation risks. Unusual delay in deliveries is generally a basis for a contract time adjustment under most industry-accepted contracts. This is important to contractors because, without the adjustment, they could face liquidated damages or other delay liability.

Who pays for the extended costs resulting from the delays is a more difficult question and not squarely addressed in the AIA A201. Owners feel they are already losing money because of the late delivery (time is money), and contractors question why they should carry the costs.

Historically, given the economic risks to the owner resulting from delay, contractors typically agree to limit their recovery to a time extension and/or expressly negotiate a contingency line item to cover this risk. Also, because contractors are in a better position to control timely subcontractor buyouts and coordination of work among subcontractors, including through the use of float, some argue that contractors should carry this risk. In other words, the party in the best position to control a risk should be the party who bears it.

While not uncommon in other industries, insurance products to cover price escalations in materials are not commonly used in the construction industry. However, sensing the stress in the marketplace due to lumber prices, insurance products are now being offered for those interested in “hedging” risk against future price fluctuations. As we work through the consequential effects of the pandemic on supply chains, it will be interesting to see if the use of these products proliferates through the market. As with bonds, which are rarely used on private projects below $100 million, the cost and ability to timely collect on such products will dictate whether owners and contractors are interested in hedging their bets in this fashion.

The opinions, beliefs and viewpoints expressed in the preceding commentary are those of the author and do not necessarily reflect the opinions, beliefs and viewpoints of the Daily Journal of Commerce or its editors. Neither the author nor the 91��Ƶ guarantees the accuracy or completeness of any information published herein.

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Before a project begins, leadership for both contractors and owners want to build trust and focus on delivering a successful project that meets everyone’s expectations. Establishing a positive relationship is hard, however, if the focus of discussions is on who pays the other, and how much, when things go wrong. Besides, there are more important things to figure out first, such as pricing, schedule and entitlements. Risk allocation can be addressed later, when the lawyers are involved, right?

Maybe. But maybe not, especially when it comes to liquidated damages, which is one of the top five heavily negotiated (and litigated) clauses in a construction contract – at least in my experience.

As most people in the industry know, because an owner’s potential delay damages are often difficult to ascertain with certainty at the beginning of the project, the parties stipulate what those damages will be in advance through their contract – in other words, they liquidate the amount of the owner’s delay damages. Liquidated damages are in lieu of actual damages and ordinarily shouldn’t be a penalty, depending on state law. In theory, at least, the benefit of this approach is that it provides both sides with certainty for a risk that is highly uncertain: late delivery. A contractor will know its risk for being late (and may later need to weigh that risk/cost against the cost of acceleration), and the owner may take comfort in the fact that, at the very least, it has a tool to motivate the contractor to stay on task.

There are a number of ways to craft this important risk-shifting clause. Contractors usually try to front-load a grace period into the calculation, before being charged some amount per day (possibly tiered) on a moving-forward basis. Contractors will also try to cap the total amount of liquidated damages to a sum certain (e.g., the amount of their fee) as a liability limitation.

Owners, on the other hand, will want a large liquidated number that captures their lost revenue, lost financing, extended architect fees, insurance, and other carrying costs, among other things. Market forces (namely, contractor leverage) often preclude owners from capturing all of their losses in a liquidated damages clause. But sophisticated owners know that if they don’t capture those losses to a large degree, and the contract includes a broad, mutual waiver of consequential damages, they may have no meaningful recovery for contractor-caused delay.

Given the importance of this clause, when should liquidated damages be discussed?

One school of thought (for private owners) is that liquidated delay damages should be discussed only after the contractor has produced a schedule, which usually evolves until the drawings reach about 90 percent construction documents. Otherwise, the thought is the contractor could submit a schedule with excessive float (intended to absorb contractor-caused delays) that pushes out the substantial completion date beyond what it reasonably should be. In other words, the schedule is pushed so far out the contractor will likely never be assessed liquidated damages in the first place.

Another school of thought is that if an owner waits too long to negotiate a liquidated delay damages clause, the owner could face a closing deadline without a contract in place. This may leave the contractor with more leverage in negotiating delay damages, knowing the owner has no other contractor in the wings if negotiations fail (at least in a busy contractor market). A typical contractor response to the late introduction of a hefty liquidated damages clause is: “I didn’t factor that amount of risk in my fee or GMP. If you want that, my fee will increase.” And that very well could be true. This puts the owner in a pinch because agreeing to a liquidated damages sum that is too small or capped too low can put the owner in a worse position than having no liquidated damages at all. If the amount of liquidated damages is too small, for instance, the contractor may build the entire loss into its fee (or built-up rates) and then have no real contractual motivation to finish on time.

With that risk in mind, some owners address liquidated damages very early on. When issuing a request for proposals (RFP) from contractors during the pre-construction phase, owners frequently request a breakdown of the contractor’s proposed fee, estimated guaranteed maximum price (GMP), general conditions costs (fixed or capped), general requirements/fixed negotiated support services (if different), and schedule. In addition, some owners also include an anticipated range for liquidated damages in the RFP, and ask contractors to include a proposed liquidated damage amount in their RFP response. Owners would argue that this approach gives them the benefit of competition, while giving contractors a reasonable opportunity (and transparency) to develop a competitive fee.

Of course, there is nothing wrong with an “actual delay damages” clause. While proving actual damages may be harder than a liquidated damages calculation, there are many advantages to relying on actual damages. These include less risk of underestimating or overestimating the damages, less haggling up front in contract negotiations, and avoidance of the view by some that liquidated damages “aren’t real.”

There is no “right” approach to delay damages, but timing alone can create leverage in discussions over this important risk.

Colm Nelson is a partner in Stoel Rives‘ construction and design practice group. Contact him at 206-386-7525 or colm.nelson@stoel.com.

The opinions, beliefs and viewpoints expressed in the preceding commentary are those of the author and do not necessarily reflect the opinions, beliefs and viewpoints of the Daily Journal of Commerce or its editors. Neither the author nor the 91��Ƶ guarantees the accuracy or completeness of any information published herein.

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No matter how perfect a set of drawings may appear at the beginning of a project, the scope of the project will invariably change. The easiest and best way to address a change, and its resulting impact on the schedule and contract price, if any, is through a change order mutually executed by the owner and contractor before the change is implemented.

But life isn’t always that easy. Sometimes the cost of a change or its effect on the schedule is impossible for the contractor to calculate. Other times the parties know that additional work is a change but dispute its cost or time impact. Equally prevalent is when parties dispute whether work is a change in the first instance or in fact falls within the original scope of work.

So, what is an owner to do when these disputes arise and the contractor refuses to proceed with the changed work?

If the parties agree that certain work is a change but dispute the associated cost or time, the owner can compel the contractor to perform the changed work by issuing a Construction Change Directive (CCD). For instance, the American Institute of Architects’ standard General Conditions of the Contract for Construction A201-2017 (“General Conditions”) provide the owner with authority to direct changes in the work that fall “within the general scope of the contract” and require the contractor to “proceed promptly” with such changes.

The General Conditions also provide the mechanism for how the contractor will be paid for changes (though they don’t specify how much fee for overhead and profit the contractor should receive).

Developers often modify the AIA form agreement and others to add a layer of specificity outlining precisely how the contractor will be paid for a CCD and disputed claims, typically to remove reimbursement for indirect costs and to identify the exact amount of fee the contractor should be paid for overhead and profit (and sometimes insurance or even related general conditions).

Without authority to issue a CCD or similar right, the owner will be negotiating price and time associated with the change from a position of weakness. This is because the contractor may simply refuse to perform the changed work, unless the owner agrees on the contractor’s terms. Hiring another contractor to perform the change is typically not a realistic option.

If the parties do not agree whether something is a change, issuing a CCD may not be the right approach. By definition, a CCD is for a change. Many CCD forms, including the AIA’s G714-2017, are for when a change is acknowledged. If the owner issues one of these CCDs without carefully reserving its rights, the contractor will certainly argue later that the owner is foreclosed from denying a change has occurred. To prevail upon a claim, a contractor typically has to prove entitlement and then quantum (amount). Establishing entitlement is much easier if the owner, intentionally or not, has issued a CCD acknowledging a change has occurred.

In these situations, then, owners should take care to issue a directive, as opposed to a change directive, to perform disputed work. The contractor, upon receipt of such an instruction/directive, may in turn dispute the instruction and submit a claim in accordance with the claim procedures of the contract, but the contractor may not stop working. Just as owners should take care in issuing directives, contractors must be equally careful in responding to them and timely submitting their claims for additional time and money. Failing to submit a claim promptly in such instances may result in forfeiture of the contractor’s rights, especially in states like Washington that enforce strict claim notice requirements.

Having the ability to order changes in the work is an essential right for an owner. Otherwise, the contractor could refuse to perform the change, giving the contractor undue leverage in negotiating a change order for time and money. A fair contract should allow the owner to issue some changes and include an agreed-upon mechanism for calculating how the contractor will be compensated for the additional work.

Colm Nelson is an attorney in Stoel Rives‘ construction and design practice group. Contact him at 206-386-7525 or colm.nelson@stoel.com.

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