Most contracts require companies to provide warranties on their work for at least a year - sometimes much longer. Knowing exactly what you're guaranteeing is critical to protect yourself and your business.

By Janice Kaspersen

Until they're faced with a warranty claim, many contractors don't give much thought to the exact wording of the warranty clauses in the contracts they're signing. Although standard contract wording differs depending on the state, city, county, or company that generated it, it often consists of boilerplate language that doesn't seem open to negotiation.

There are, however, key things you can watch out for to protect yourself. It's always wise to talk to an attorney about your particular situation. But becoming familiar with the ins and outs of warranty clauses can help you become less dependent on your attorney to scrutinize every contract, minimizing the time and fees you spend.

What a Warranty Is - and Isn't

The distinction between a warranty issue and a liability issue is an important one. It can actually be easier to defend yourself against a liability claim. "A warranty is essentially a guarantee, which is totally different from any other claims that are brought into the contract," explains Drew Colby, a construction lawyer with Brody, Hardoon, Perkins and Kesten in Boston (www.construction-lawyer.com). What are commonly referred to as liability issues fall into two general categories: negligence and breach of contract. "Both of those require some degree of culpability on the part of the person against whom damages are sought, where a guarantee does not. It doesn't require finding negligence. There is no 'reasonable standard' that's involved - did you act as a reasonably prudent contractor would under the circumstances? With a warranty, it either works or it doesn't work, and if it doesn't work, you pay for it, regardless of the reason. So warranties are really a tough issue for the contractor that issues them."

Guarantee Only Your Own Work

One of the first things to watch out for is the scope of your warranty, especially if - as is often the case with subcontractors working on one part of a large project - you'll be working in an area where others also have access.

"Make sure that the wording doesn't encompass work that you're in fact not responsible for," cautions Jim D'Orazio, chief operating officer of D'Orazio Infrastructure Group in Oakville, ON. "One of the things we've run into in the past is we go in and do our work, then the electrical contractor will come by and dig his electrical trench for his conduits and his ductwork. After he's done I put my asphalt down. There's a settlement, and lo and behold, it's over the electrical trench. That's an expensive fix. Who's responsible for it?"

"You don't want to put yourself in a position where you're being held accountable for somebody else's problems. If you're the general contractor on the job, you can't avoid it, but if you're somebody out in the field, you can," says Colby. "Make sure that other people's work is specifically excluded from your own." Problems that arise after the job is finished can unexpectedly land on a subcontractor. "When the site contractor is no longer in business or doesn't have the means to litigate that issue, the other party - who might have a much smaller or lesser involvement in the problem - is left holding the bag."

Dean Vanderpool, director of contracts for Nicholson Construction Company in Bridgeville, PA, points to a situation that is true for many grading and excavation contractors. "A lot of our work is built upon knowledge gathered by others, such as the geotechnical engineer who does a ground survey, which includes the borings for studying the geologic conditions of the soils. If that engineer has made mistakes in his geotechnical investigation and later on the structure begins to experience deformations because the ground subsurface conditions weren't as they were predicted to be or as they were spelled out in the bidding documents, then we have an argument as to whether our warranty should apply." Although repairing the work and any collateral damage is expensive if your warranty has to cover it, the legal expenses of fighting the warranty claim can also be prohibitive.

"It's a very big issue," agrees Andy Wolf, vice president of McCarthy Improvement Company in Davenport, IA. One way to prove who is responsible for what is to photographically document the project at different stages, as McCarthy Improvement routinely does. "Common? No. Good practice? Yes," says Wolf. He cites one instance in which a utility company claimed McCarthy had hit an underground line. "We had photographic documentation that the line was still intact as we were backfilling the trench that we had put in. So in that instance it came in very handy."

"Be very cognizant of what's happening on your site," advises D'Orazio. "Know where the trenches are, where other services might be, and when these people are doing the work. If you had to use all granular backfill and some yahoo comes in and starts digging through your granular backfill and hits native material and mixes it all up, and then it doesn't consolidate properly and you get a settlement, quite clearly you've got a really long and pointy finger to direct at somebody if you have documented proof."

Thorough photographic documentation can benefit the project owner as well as the contractor by recording conditions on site at each stage of construction. D'Orazio Infrastructure Group won the design-build contract to provide sewer and water services from Oakville, ON, to the growing town of Milton to the north, which sits in a major corridor between the United States and Canada - a project worth $30 million Canadian and the largest ever of its type in the country. The contract calls for D'Orazio to have a digital camera on site at all times, available not only to his own construction managers and quality-assurance people but also to the region of Halton, the governing municipality. "I have I don't know how many disks full of pictures," notes D'Orazio.

Term Limits

A one-year warranty period is standard for most jobs. Some federal projects require two-year warranties, but five- or even 10-year warranties are not uncommon. Make sure the terms are spelled out exactly. "If your contract states that the warranty begins at the time you begin construction and continues for five years after the date of completion, you could be on the hook for as long as 15 years" on a lengthy project, says Vanderpool. That's especially true for a grading and excavation contractor or ground-improvement specialist such as Nicholson Construction, which is often the first company working on the site. "We try to limit the warranty to one year from the date of substantial completion of our work on the project. Within that year they will certainly know if any of the foundation structures or subsurface structures that we've built are going to fail."

Indemnity: Passing On the Risk

An indemnification provision in a contract essentially requires you to accept responsibility - or at least a portion of it - for someone else's work. Indemnification provisions vary from state to state, so it's important to find out what your state allows. If you're a subcontractor, know exactly what kind of indemnification provision you're signing up for when you sign a contract. If you're the general contractor on a project, consider passing along the appropriate responsibility to your subcontractors.

Colby, who worked in the construction industry before graduating from law school, teaches seminars to help contractors protect themselves through properly worded contracts. "If I'm a subcontractor and I've got a general contractor that's handing me a contract that says I have to indemnify them for their own negligence or for their own misconduct on the job, that's going to change the cost of my bid on that job. It might make me not want to bid the job at all," he says.

"We're finding that more and more contractors want to pass the risk of failure or the risk of liability on to their subcontractors so that the owner and the contractor enjoy what I call the 'catbird seat', or what I would say is a risk-free contract," observes Vanderpool. "The first front we have for protecting ourselves is to ensure that we negotiate our subcontracts and our contracts to limit the liability we face in indemnity agreements. And we back that up by making sure that we limit the effect of the warranty. We only indemnify the owner, contractor, architect, and others to the extent that the problem is caused by some fault or negligence on our behalf." It works both ways: "Often we're required to also indemnify or give warranty for the people who work under us, so we have to be very careful to pass that on to our subcontractors in proportion to what their part of the work will be."

Fair Dealing?

Chris Larsen, owner of C.V. Larsen Company in Santa Rosa, CA, reports that his company has never had a warranty claim. He attributes the fact not to luck but to thorough preparation and an open line of communication with the project owners. "Having good communications with the owner to begin with is essential, right from the preconstruction conference. Should something pop up, who are we going to deal with? They need to know that we're going to deal with them fairly. Then together we'll work out the solution, whether they have an outside engineering consultant or the project was engineered in-house, we'll work with the engineers to remedy whatever is the obstacle."

In addition to grading, excavation, and pile-driving work, the company constructs water and wastewater treatment plants with complex mechanical components. "We include time in our bids for facility start-up and operations and maintenance training for the project owners," Larsen says. "You can't just load up and leave. With a mechanical type of project there has to be some training involved for the owner to take it over. The more they know about their project, the better able they are to maintain it." And the better the maintenance, the less likely they are to encounter unexpected problems.

Anticipating potential problems and owners' needs is always a smart policy, but sometimes it takes more than good communication and goodwill to ensure that the general contractor or owner will deal fairly with you. The safest way to ensure your rights is to make sure they're spelled out in the contract. Contract negotiation, for many, is one of the most daunting aspects of the job.

Negotiating the Contract

Some companies, glad to win a bid and in a hurry to get started on the work itself, rush through the contract signing. "Contractors, by and large, care about the scope of the work and the price," states Colby. "And it's the other stuff that kills them. I can't tell you how many times I've been in a situation where the contractor says, 'I've done this by handshake my whole life. I've worked with this particular subcontractor for 25 years, and I've never had a problem.' Well, that's like saying you haven't died. Eventually, it's going to happen."

"I think the subcontractor - and the smaller the subcontractor, the worse it gets - is in a worse position to set himself into a fair contract than the larger subcontractors, contractors, or construction managers. The subcontractor is the last piece of the contractual daisy chain, and often they are basically told to take it or leave it. The contractor will go out and find somebody else to do the job who doesn't want to negotiate the subcontract," says Vanderpool. He adds, "Don't be turned away at the door with that kind of intimidation."

Preliminary work on the negotiation process can actually start long before you ever see the contract - not with your acceptance of the job but with your initial bid. "The proposal document that every subcontractor puts out is probably the most important document they will ever write because not only does it convey the price, it also conveys the scope of work and the terms and conditions that price is predicated on," notes Vanderpool. "If properly written, it reserves a right to negotiate any subcontract they're going to sign commensurate with the terms and conditions in the proposal document." In other words, spell out right from the start what your conditions are, not only for warranties but also, for example, payment provisions stipulating that interest will be charged for outstanding late payments. "When we construct a proposal, we have certain inclusionary language that requires the proposal document to become a part of any subcontract agreement that's put forth.

"If you, as a ground contractor, require that the geotechnical information be accurate, state that in one of the terms and conditions of your subcontract" adds Vanderpool. For example, you might reserve the right to submit a differing site condition claim if you disagree with the geotechnical information the owner or construction manager provides.

When Things Go Wrong

Best intentions notwithstanding, disputes do arise. Both parties should spell out well in advance how problems will be handled, with the goal of avoiding a lawsuit and court proceedings. "It should be part of the contract," advises Colby. "In addition to the scope of work and the dollar amounts, there should be some sort of dispute resolution provision. That can take the form of an arbitration provision or some sort of a mandatory mediation provision that is a prerequisite to arbitration. But they should agree in advance what they're going to do if a dispute comes up, because courts of law are not great places to resolve construction problems. Jurors and judges often get bored. Moreover, the finders of fact often have great difficulty grasping the technical issues necessary for them to decide who wins or loses."

To Litigate or Not?

Even if the outcome is successful, litigation will cost you - in money, time, and lost profits. "The courts are probably the last place you'd really want to be forced to go," Vanderpool states. "It involves attorneys, discoveries, depositions, expert witnesses. The other thing a court date will involve is a lengthy process in which to get the dispute resolved. And then of course it can always be appealed, so you can be in court for a long time. While you're resolving the dispute, any monies you have due to you on the project never get paid, so the interest alone on that money can effectively eat up any profits you had in the project."

D'Orazio recalls a $3-million hospital project involving more than a million dollars of excavation work. "We had an area of fill that was within a building envelope, and the fill was suspect." The contract documents and soils report actually identified the fill as suspect and stated that it would be used or replaced at the discretion of the owner and the geotechnical engineer. The owner made the decision to use the existing fill rather than replace it with more expensive granular backfill.

"We went in, did our work, compacted it, and had reams of compaction tests from the owner's representative certifying that the fill was compacted to the specified density." Nevertheless, reports D'Orazio, "there was a section of the fill that failed. They had to remove part of the concrete floor slab and pressure-inject unshrinkable fill, a sand-concrete mix that will permeate and fill any voids. And then they had to repour the floor." The fix cost more than $60,000, for which the owner held D'Orazio Infrastructure responsible.

Although he believes his company would have prevailed in litigation, D'Orazio says, "We decided not to fight that particular fight. I chose not to go to court and spend $50,000 and then get a $60,000 return. The claim amount was at that break-even point - should I litigate or should I not litigate? There's a cost to litigate, both the financial burden and the time it takes for us business owners and managers. You can spend more productive time doing more profitable things."

Alternatives to Litigation

Several dispute-resolution processes, short of litigation, can satisfy both parties as long as everyone agrees on the method to be used. A step below litigation is binding arbitration, a potentially faster but not necessarily cheaper course. The contract may specify a particular organization to provide such services if the need arises. The American Arbitration Association, for example, has a pool of arbitrators or "roster of neutrals" available with expertise in a number of different fields, including the construction industry. Choosing a reputable organization is essential if you go this route. "You need somebody who has experience in this area because it's pretty technical at times," advises Colby. "And you need a good arbitrator, because it's unlike a court decision where you can appeal it. Arbitration's pretty much it. Once that panel or single arbitrator reaches a conclusion, the case is done. At that point it's virtually unappealable."

Similar to litigation, arbitration is expensive: American Arbitration Association filing fees range from $500 for small claims to $7,000 for million-dollar-plus claims, in addition to daily administration fees and - except in the smallest of claims - hourly fees for each arbitrator. Attorneys might or might not be involved, and often, as Vanderpool points out, "It still involves depositions and discovery and expert witnesses. The only thing that arbitration does is to shorten the length of time that you're waiting to get on the docket to be heard. If it's binding, it also helps that there are not any appeals to follow through."

A third means of resolving disputes is mediation. "The mediator tries to negotiate a reasonable settlement, usually a Solomon's type decision where you'll take part of the responsibility and they'll take part of the responsibility," explains Vanderpool. Although mediation saves court costs or arbitration fees and is usually much faster than either of them, "mediation doesn't really care about the fairness of the issues," he says. "It's more about 'How much pain will you endure to get this solved today?' It doesn't have to do with the rightness or wrongness of the situation as much as it has to do with 'How much are you going to pay to make it go away?'"

Vanderpool prefers a fourth alternative: the dispute resolution board (DRB). He describes a typical DRB process: Each party in the dispute chooses, from a list of industry peers, one board member. Those two members then choose a third, and this three-person board hears and decides the issue. The board convenes within 30 days, receives written documentation and listens to oral presentations from both parties, and generally reaches a decision in 90-120 days. The process is relatively inexpensive because the parties usually represent themselves, forgoing attorneys, expert witnesses, testimony, and depositions.

Few contracts specify the DRB process as a dispute resolution mechanism, however. Vanderpool estimates 95% of the contracts he sees call for arbitration instead, and it's difficult for a subcontractor to renegotiate that part of the contract. "If the owner-contractor or the owner-construction manager have already agreed to an arbitration clause, they want to carry that arbitration clause through the remaining contracts and subcontracts. They want the owner to put in an arbitration clause for the construction manager. The construction manager then wants to bind the follow-on contractors to the same arbitration clause so that, if they have to, they can combine proceedings."

Know Your Contract Language

Vanderpool is well versed in all the legal issues a construction firm faces - he was director of risk management for another company prior to joining Nicholson - and has taught in-house courses for senior staff, project managers, engineers, and estimators. He believes all companies, even small ones, should have someone in-house who understands contractual language, "who can become contract savvy and work with an attorney to understand what the various clauses mean, what the various phrases within those clauses mean, and how to negotiate a fair contract that proportionally shares the risk."

One- to three-day courses in contractual law, taught by attorneys who specialize in construction law, are one avenue to learning about contract language. Industry newsletters and publications, such as Construction Claims Monthly and Construction Company Strategist, are another.

Companies that take the time to learn the basics can greatly reduce their risk, Vanderpool maintains. "They're so involved in doing the bidding and then getting into the production phases that they often don't take the opportunity to become contractually smart also. Some of us are so busy driving down the road that we forget to stop and get gas."

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