Illinois Construction Claims January 17, 2002

Moderator/ Faculty Chair: Joseph G. Bisceglia JENNER & BLOCK, LLC

Faculty

James A. Vroman Donald S. Horvath Vincent E. Lazar

Timothy W. Burns Jeffrey L. Richman Anthony C. Porcelli Gregory M. Boyle Terence G. Banich

JENNER & BLOCK, LLC

One IBM Plaza Chicago, IL 60611

312-222-9350

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TABLE OF CONTENTS

PART II: COMMON CONSTRUCTION DISPUTES ...................................................................... 24 A. BID DISPUTES................................................................................................................ 26

1. Selecting a Contractor or Vendor ......................................................................... 26

2. Mistakes in Bid ..................................................................................................... 28

3. Bid Protests ........................................................................................................... 28

4. Bid Bonds and Sureties ......................................................................................... 29

B. DELAY............................................................................................................................. 30 1. Schedule Slippages ............................................................................................... 32

2. Cost Overruns ..................................................................................................... 33

3. Controversy on the Job Site ............................................................................... 33

4. Shop Drawing Problems..................................................................................... 34

C. EXTRAS / CHANGES..................................................................................................... 34 1. Type of Changes .................................................................................................. 35

2. Constructive Changes ......................................................................................... 37

3. Procedure for Implementation of Change Orders........................................... 39

D. CONCEALED CONDITIONS / DIFFERING SITE CONDITIONS.............................. 40 1. Material Difference ............................................................................................. 45

2. Damages ............................................................................................................... 46

E. DEFECTIVE PLANS AND SPECIFICATIONS............................................................. 47 1. Implied Warranty of Plans and Specifications...................................................... 47

PART III: MECHANICS' LIENS......................................................................................................... 52 A. MECHANICS’ LIEN MUST COMPLY STRICTLY WITH THE ACT AND MUST

BE 52 C. WAIVERS OF LIEN ........................................................................................................ 57 D. ALLOCATION AND/OR APPORTIONMENT OF LIEN CLAIM................................ 58 F. ATTORNEY’S FEES....................................................................................................... 59 G. AN OWNER’S REMEDIES AND DEFENSES .............................................................. 59

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H. MECHANICS LIENS ON PROJECTS WITH PUBLIC FUNDS................................... 60 I. FORECLOSURE AND PRIORITIES.............................................................................. 60

PART IV: LITIGATION OF CONSTRUCTION CLAIMS .............................................................. 62 A. LIABILITY OF THE PARTIES....................................................................................... 62

1. Owner/General Contractor.................................................................................... 63

2. Subcontractors....................................................................................................... 71

3. Architects and Engineers ...................................................................................... 75

B. DAMAGES....................................................................................................................... 78 1. Damages – From a Contractor’s Perspective ................................................... 79

2. Damages – From the Owner’s Perspective........................................................... 88

C. ARBITRATION: AN ALTERNATIVE TO COURT LITIGATION........................ 91 1. What is Arbitration? What are its Advantages and Disadvantages?.................... 91

2. Drafting the Arbitration Clause ............................................................................ 93

3. The Effect of Arbitration Clauses ......................................................................... 94

4. Commencing Arbitration – How and Against Who?............................................ 95

5. Waiver of the Right to Arbitrate ....................................................................... 97

6. Overturning an Arbitrator’s Award in a Court of Law......................................... 99

7. Summary ............................................................................................................. 100

D. USE OF EXPERT WITNESSES.................................................................................... 100 1. Why Use an Expert? ........................................................................................... 101

2. Retaining the Expert ........................................................................................... 102

3. Ideal Characteristics of an Expert ....................................................................... 103

4. Preparing the Expert ........................................................................................... 103

PART V: INSURANCE COVERAGE FOR CONSTRUCTION CLAIMS .................................. 104 A. TYPES OF POLICIES (TYPE OF COVERAGE) ......................................................... 104

1. Comprehensive General Liability (CGL) Insurance.......................................... 104

2. Owners and Contractors Protective (OCP) Liability Insurance.......................... 104

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3. Worker’s Compensation and Employers’ Liability Insurance Policy ................ 105

4. Architects’ and Engineers’ Professional Liability Insurance.............................. 106

5. Construction Wrap-Up Insurance ....................................................................... 106

B. TYPES OF POLICIES (WHAT EVENT TRIGGERS COVERAGE)........................... 106 1. Claims made........................................................................................................ 106

2. Occurrence.......................................................................................................... 107

C. TYPES OF POLICIES (LEVEL OF COVERAGE) ...................................................... 107 1. Primary................................................................................................................ 107

2. Umbrella ............................................................................................................. 107

3. Excess ................................................................................................................. 107

D. THE STRUCTURE OF THE INSURANCE POLICY .................................................. 107 1. Declarations Page................................................................................................ 107

2. Insuring Agreements ........................................................................................... 108

3. Definitions........................................................................................................... 108

4. Conditions ........................................................................................................... 108

5. Exclusions ........................................................................................................... 109

6. Pre-Printed Terms and Endorsements................................................................. 109

E. INTERPRETING THE POLICY.................................................................................... 110 F. DEFECTIVE CONSTRUCTION CLAIMS................................................................... 110 G. NOTABLE EXCLUSIONS............................................................................................ 111

1. Exclusion for expected or intended injury .......................................................... 111

2. The ...................................................................................................................... 112

3. Worker’s compensation exclusion ...................................................................... 112

4. Own-Product and Own-Work exclusions ........................................................... 112

5. The Sistership exclusion ..................................................................................... 113

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6. The Design Defect exclusion .............................................................................. 113

H. ADDITIONAL INSURED ISSUES............................................................................... 114 PART VI: BANKRUPTCY AND CONSTRUCTION CLAIMS .................................................... 117

A. BANKRUPTCY BASICS .............................................................................................. 117 1. Bankruptcy Is Federal Law................................................................................. 117

2. Commencing a Bankruptcy Case........................................................................ 118

3. Types of Bankruptcy Cases ................................................................................ 119

4. Major Players ...................................................................................................... 124

5. Property of the Estate.......................................................................................... 126

6. Automatic Stay.................................................................................................... 127

7. Discharge ............................................................................................................ 128

B. CLAIMS......................................................................................................................... 130 1. Types of Claims in Bankruptcy ...................................................................... 130

2. Filing Proofs of Claim ........................................................................................ 132

3. Mechanics Lien Claims..................................................................................... 135

C. EXECUTORY CONTRACTS ..................................................................................... 142 1. Assumption of Executory Contracts ................................................................... 143

2. Assignment of Executory Contracts to Third Parties ......................................... 144

3. Rejection of Executory Contracts ....................................................................... 144

4. Time for Assumption or Rejection ..................................................................... 144

5. Special Bankruptcy Considerations .................................................................... 145

D. CLAIMS AGAINST THIRD PARTIES ........................................................................ 147 1. Letters of Credit .................................................................................................. 147

2. Bonds .................................................................................................................. 148

3. Guarantors/contracting Parties............................................................................ 149

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4. Owner/Contractor Retainages............................................................................. 149

5. Successor Liability.............................................................................................. 150

PART VII: ANTICIPATING & RESOLVING ENVIRONMENTAL CLAIMS........................... 155 A. INITIAL DETERMINATION – BROWNFIELD V. GREENFIELD........................... 155

1. If project site is a greenfield, was any Environmental Site Assessment (ESA)

performed? .......................................................................................................... 155

2. Brownfield Site ................................................................................................... 162

B. LIABILITY ISSUES ...................................................................................................... 166 1. CERCLA/RCRA Liability .................................................................................. 166

2. The Peculiar Issue of Special Waste................................................................... 169

3. AIA Provisions.................................................................................................... 170

C. BRIEFLY – OSHA CONSIDERATION/SAMPLING.................................................. 170 1. Worker Exposure Issues ..................................................................................... 170

2. Periodic Sampling may be required/prudent....................................................... 171

3. Care/Control of Stockpiled Soil.......................................................................... 171

4. Signs/Recordkeeping .......................................................................................... 171

5. Another Reason to perform Due Diligence ........................................................ 171

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Construction Claims Seminar Faculty

A description of Jenner & Block's construction law practice and the Jenner & Block Construction Law Group Report

may be found at www.jenner.com by running a search for the word "construction".

Joseph G. Bisceglia, jbisceglia@jenner.com Joseph G. Bisceglia, a partner in Jenner & Block, where he has practiced since 1975, is Chair of the Jenner & Block Construction Law Group. He has extensive experience in all facets of construction dispute resolution and litigation. He is co-author of seminar materials entitled Construction Claims Under Illinois Law, published by The Cambridge Institute (1991). In addition to his extensive experience in construction law, he has broad experience in virtually every type of complex civil litigation in both federal and state courts. He is a recognized expert in federal and state civil practice and procedure and trial practice, and has taught, lectured and published extensively in the area of civil litigation. He is an Adjunct Professor of Trial Advocacy at the John Marshall Law School in Chicago (since 1985.) He is active in numerous bar associations, including the Illinois State Bar Association, in which he has served, for example, as Chair of its largest Section Council (on Civil Practice and Procedure), as co-chair of its Committee on Supreme Court Rules, as editor and frequent contributor to the ISBA newsletter Trial Briefs, and as a member of the ISBA’s Committee on Judicial Evaluations (which investigates and evaluates Illinois judges for election and retention.) He is also a member of the Board of Directors of the Chicago Chapter of the Federal Bar Association, and a past-President (1992-93) of the Justinian Society of Lawyers. He has received numerous honors and awards for his bar association work and activities. James A. Vroman, jvroman@jenner.com Mr. Vroman is a partner in Jenner & Block who has been practicing law for over 20 years and for the last 14 years has concentrated his practice on environmental law. He has extensive experience in a wide variety of

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environmental matters. Mr. Vroman has represented clients in dispute resolution proceedings involving allocation issues before mediators and arbitrators. He has counseled transactional clients on environmental considerations in corporate and real estate matters and he has extensive experience in counseling clients remediating or marketing “brownfield” properties. He is a member of the Environmental Law Committee and Environmental Litigation Subcommittee of the ABA’s Section of Natural Resources, Energy and Environmental Law and a member of the Energy Bar Association. Mr. Vroman received his J.D. degree, magna cum laude, from the University of Illinois, where he was the Articles Editor of the University of Illinois Law Forum and was elected to the Order of the Coif. Donald S. Horvath, dhorvath@jenner.com Donald S. Horvath is a partner in Jenner & Block’s Chicago office. He is a member of the Firm’s Real Estate Practice. Mr. Horvath has represented major lending institutions, developers, and corporations in commercial mortgage and construction loan transactions, construction contracts, ground leases, sale-leaseback and synthetic leasing (off balance sheet financing) transactions, and acquisitions and sales of real property. Mr. Horvath also represents landlords and tenants in lease negotiations for office, commercial, industrial and retail space. He recently has represented a joint venture in connection with the development, leasing and construction financing of an approximately 1,500,000 square foot mixed-use office and retail development. He also has recently represented a Fortune 500 company in connection with the sale and leaseback of certain of its office and industrial facilities located throughout the United States. Mr. Horvath has represented corporations and developers in land use and zoning matters in the city of Chicago and surrounding suburbs. He also has represented corporations and developers in connection with obtaining tax increment financing for plant expansions and commercial developments. Mr. Horvath graduated from the University of Illinois at Urbana-Champaign in 1980, earning a bachelor’s degree in accounting. He has been a CPA since 1980. Mr. Horvath obtained his J.D. degree from the Illinois Institute of Technology/Chicago-Kent College of Law in 1984. He is a member of the Real Property Sections of the American and Chicago Bar Associations and has given lectures for the Illinois Institute of Continuing Legal Education on construction finance and other real estate-related topics. Mr. Horvath is a member of the bars of the State of Illinois and the United States District Court for the Northern District of Illinois. Mr. Horvath joined the firm in 1989. Prior to joining the Firm in 1989, he was an associate at Mayer, Brown & Platt.

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Vincent E. Lazar, vlazar@jenner.com Vincent E. Lazar is a partner in Jenner & Block's Commercial Law Department, specializing in business reorganizations and commercial litigation. Significant representations have included the Chapter 7 trustee in the liquidation of Stotler & Company, the nation's largest commodities brokerage bankruptcy case, the Chapter 11 and 7 trustee of TUSA, Inc., a national car rental company, and Harrah's Jazz Company, the owner of the land-based casino in New Orleans. He currently represents the owners of Liberty House, Inc., a Hawaii department store chain, in its Chapter 11 reorganization proceeding, as well as the parent company of The Babcock & Wilcox Company, a commercial power-generating equipment manufacturer, in its asbestos claims related Chapter 11 bankruptcy proceeding. Mr. Lazar also has significant experience representing owners, contractors and sub-contractors in construction disputes arising both in and outside of bankruptcy cases. Timothy W. Burns, tburns@jenner.com Mr. Burns is a Jenner & Block partner who has represented major U.S. policyholders in insurance coverage litigation, including litigation of claims of over $1 billion against numerous insurers relating to damage allegedly caused by leaking plastic pipe fittings. Earlier in his career he tried construction defect cases on behalf of housing contractors. Mr. Burns is Co-chair of the Directors’ and Officers’ Liability Insurance Subcommittee of the Insurance Coverage Litigation Committee of the American Bar Association Section of Litigation. He graduated with highest honors from the University of Missouri School of Law, where he also was Associate Managing Editor of the Missouri Law Review. Jeffrey L. Richman, jrichman@jenner.com Mr. Richman is a partner at Jenner & Block who concentrates his practice in commercial real estate law and has represented borrowers and lenders, purchasers and sellers, landlords and tenants, contractors and developers of office, retail and industrial properties. Mr. Richman has represented a Chicago-Area developer in connection with the negotiation of a construction contract and an architect's agreement for the development of a 38-story office building in the Chicago Loop, he has represented a major corporation in connection with the disposition of numerous discontinued manufacturing facilities in various states (which transactions often involved significant environmental issues), and he has represented a Fortune 500 corporation in connection with the acquisition and redevelopment of its corporate headquarters building. He also represented a developer of a 100-acre multi-use property, assisting with the structuring, negotiation and documentation of sales, joint ventures, and leases. And his experiences in loan transactions have included representing a lender in connection with a construction loan for a commercial and residential property involving tax increment financing. Mr. Richman is a 1991 graduate of Harvard Law School, where he

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earned his J.D. degree, cum laude, and he is a member of the Real Property Section of the Chicago and American Bar Associations. Anthony C. Porcelli, aporcelli@jenner.com Anthony C. Porcelli is a member of the Jenner & Block Construction Law practice group, specializes in complex civil litigation, has represented owners in complex construction-related disputes, has tried several cases in Illinois, and has litigated numerous other cases in state and federal courts throughout the country. Mr. Porcelli is admitted to practice law in Illinois and has been a member of the Trial Bar of the District Court for the Northern District of Illinois since 1997. He is a 1991 graduate of the University of Notre Dame, magna cum laude, with a Bachelors Degree in Business Administration. Mr. Porcelli graduated from Northwestern University School of Law in 1994, cum laude, where he served as an executive editor of the Northwestern Journal of Criminal Law and Criminology, and he is a member of the American and Illinois Bar Associations. Gregory M. Boyle, gboyle@jenner.com Gregory M. Boyle is a member of the Jenner & Block Construction Law practice group, practices in the areas of general civil and criminal litigation, and has represented owners, contractors and subcontractors in construction-related disputes. He is the author of an article entitled “Claims Against Architects and Engineers: Architect/Engineer Can Be Liable in Tort for Economic Loss if Engaged Solely to Provide Information and Not Ultimately to Construct Something Tangible” in the Jenner & Block Construction Law Report and has lectured on mechanics’ liens at the Illinois Housing and Development Authority. Mr. Boyle received his law degree, cum laude, from Harvard Law School, and he is a member of the American Bar Association and the Chicago Council of Lawyers. Terence G. Banich II, tbanich@jenner.com Terence G. Banich II joined the law firm of Jenner & Block in 1999 as an associate and concentrates his practice in general civil and criminal litigation, as well as construction litigation and health care regulatory compliance. He is a member of Jenner & Block’s Construction Law Group and has represented general contractors and subcontractors in mechanics’ lien disputes. Mr. Banich received his J.D., cum laude, from Loyola University Chicago, and he is admitted to practice in Illinois, California and the District of Columbia.

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ILLINOIS CONSTRUCTION CLAIMS

JANUARY 17, 2002

PART I: KEY CONTRACT PROVISIONS AND AIA CONTRACTS

Donald S. Horvath Jeffrey L. Richman Brian L. Howard

JENNER & BLOCK, LLC One IBM Plaza

Chicago, Illinois 60611 (312) 222-9350

The legal rights of the parties involved in a construction dispute are determined primarily

by the terms of the contract into which they have entered. The strength or weakness of their legal

position is determined in large part by the terms of that contract.

Set forth below is a discussion of certain key provisions found in construction contracts.

This list is not meant to be exhaustive, but is meant to touch on some of the more critical issues that a

party faces when entering into a construction contract. In addition, because the use of AIA Document

A101-1997, Standard Form of Agreement between Owner and Contractor (the “A101”), and AIA

Document A201 - 1997, General Conditions of the Contract for Construction (the “A201”), is so

prevalent, treatment of these key provisions in the A101 and A201 is also discussed.

A. SCOPE OF WORK

The basis of any construction contract is the scope of work (“Scope of Work”) clause.

The Scope of Work clause describes the basis of the contract - it defines the work that the contractor

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expects to perform and the product that the owner expects to receive. Accordingly, the Scope of Work

clause should be as specific as possible. Any vague or ambiguous terms will invite problems as the

project progresses.

From the owner’s perspective, however, there are certain broader requirements that are

appropriately included in the Scope of Work clause. For example, the owner will want to require the

contractor to “comply with all applicable codes or laws”. A contractor reasonably could agree to this

provision, but the contractor will want to avoid other broad standards, such as a requirement to perform

the work “to owner’s satisfaction.”

Typically, a Scope of Work clause will incorporate drawings, plans and other

specifications. This permits the owner to adequately specify what it expects from the contractor. The

parties should be careful, however, to ensure that the various drawings, plans and specifications

incorporated in the contract work in harmony with one another. In addition, the parties should establish

a hierarchy of documents to determine which provisions control in the event of a conflict between any

two provisions.

The AIA Owner-Contractor Form requires that the “Contractor fully execute the Work

described in the Contract Documents . . . .” (AIA Document A101, Article 2). The contract documents

are then listed in Article 8 of AIA Document A101. The drafter of the contract should be very careful to

list each of the contract documents specifically and accurately (including draft numbers and dates). Any

ambiguity or error could cause conflict between the owner and the contractor.

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Interestingly enough, the AIA Form does not provide for a hierarchy of documents. The

rationale is likely that a hierarchy of the contract documents is not necessary, because, pursuant to the

AIA form, it is the architect’s obligation to interpret the contract documents.

B. PAYMENT PROVISIONS

The “other half” of the principal consideration contained in any construction contract is

the payment clause. Payment clauses in construction contracts must strike a balance: the owner does not

want to advance too much money to the contractor because the contractor will not have the proper

incentive to complete the work, but the contractor will be expending funds and advancing dollars to

perform the work. Accordingly, the parties should devise a system whereby the owner makes progress

payments to the contractor, but holds back enough money so that the owner retains the leverage to

ensure that contractor completes the work.

1. Progress Payment Clause

A progress payment clause (“Progress Payment Clause”) will need to specify the

procedure and timing of payment, including any prerequisites to the funding of the construction draw.

Specifically, the Progress Payment Clause should require the contractor to present an application for

payment to the owner, which includes the contractor’s sworn statement, partial lien waivers, and any

other documentation desired by the owner or the owner’s lender. The owner (or its architect) will then

review the application and the work for which payment is requested and then make payment to the

contractor of such amount of the application as is approved within a certain period after approval of the

application. Payment is often made through a construction escrow with a title company, and the owner

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may make arrangements with the title company to obtain a title insurance policy in favor of its lender

with coverage over mechanics liens.

2. Mechanics Lien Protection

Owners generally require that the project be completed free and clear of mechanics liens

in favor of the general contractor and all subcontractors that perform work on the property. However,

770 ILCS 60/1.1 provides that any contract which waives mechanics lien rights in advance of

construction is unenforceable. See discussion infra Part III, Section C. Thus, an owner should require

its general contractor to agree to complete the project in a lien free manner. The general contractor will

likely agree to do so, as long as the owner pays the amounts requested by the general contractor in each

application for payment (subject to the retainage provisions of the contract). As such, the general

contractor should agree to indemnify the owner against liens in favor of the general contractor and all

subcontractors. Although the general contractor may agree to waive lien rights under each progress

payment, it may be more difficult to get the subcontractors to agree to waive their lien rights (as

subcontractors may not be paid by the general contractor at the same time as the owner pays the general

contractor). However, it has become common practice for title insurers and lenders to accept so-called

30-day trailing lien waivers from the subcontractors on a project when the general contractor delivers a

lien waiver for the current application for payment and provides an indemnity for the amounts payable

to subcontractor.

With 30-day trailing lien waivers, the subcontractors waive their lien rights for the

immediately preceding draw request. In this scenario, the exposure for the title company (and

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presumably the lender) is only for the amounts paid to the general contractor (and by the general

contractor to its subcontractors) for the current draw request. If the contractor is financially strong, its

indemnity should be sufficient to cover any liens filed by subcontractors for the preceding draw.

Accordingly, the title company generally is prepared to “cover over” the potential mechanics liens for

the 30-day period, since it can enforce its indemnity from the contractor if a subcontractor files a

mechanics lien. If the contractor is not financially strong and the title company will not accept its

indemnity, there are two other ways to secure title insurance over mechanics liens for the current

application for payment. First, the owner can give its indemnity to the title company. This may be

acceptable to an owner if it is comfortable with the general contractor and the contract contains

sufficient retainage to cover the liens that could be filed for the applicable draw request. Second, the

owner could require direct payments to the subcontractors by the title company administering the

construction escrow. In this case, the subcontractors should be prepared to waive their lien rights for the

applicable draw request because they will have been paid directly by the title company at the time the

application for payment is submitted.

3. Retainage

Typically, Progress Payment Clauses include a “holdback” or “retainage” of ten percent

(10%) of the amount owing to the contractor. The retainage will not be paid to the contractor until

substantial or final completion of the project. Generally, the retainage will represent much of the

contractor’s profit margin, and thus be a proper incentive to complete the project. The owner should be

aware, however, that the contractor, knowing that there will be a retainage, may price the job higher to

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offset any costs incurred by the contractor due to such retainage. A solution proposed in Section 5.18 of

the A101 is that the retainage may be reduced or limited prior to substantial completion. For example,

the retainage could be “capped” at a particular level or certain amounts could be paid out in intervals.

4. Final Payment

The contractor is generally entitled to final payment upon substantial completion of the

project. This means that the project is useable for its intended purpose, but certain punchlist items may

still need to be completed. Similar procedures should be observed with respect to final payment as they

are for progress payments. In addition, the owner should create a punchlist and have a holdback for any

incomplete items. If the architect is inspecting the project on behalf of the owner, the contract may

provide that the architect will determine the amount of any holdbacks. Finally, the contract should

provide how and when the holdbacks will be distributed.

Under Paragraph 5.2.1 of the A101, final payment is to be made not later than thirty (30)

days after (i) contractor has fully performed its obligations (subject to its obligation to correct work

under Article 12 of the A201) and (ii) a final certificate for payment has been issued. This provision is

quite clear as to how final completion is achieved. Because of potential liability issues, the architect

may be reluctant to certify that the contractor has satisfactorily completed the work. As a result, this can

lead to delays in final payment, which in turn can lead to disputes between the owner and contractor. As

set forth above, a potential solution to this issue could be to agree to make the final payment thirty (30)

days after the architect issues the certificate of substantial completion (as opposed to the final certificate

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for payment), so long as the owner withholds certain amounts for punchlist items that must be

completed to achieve final completion.

Certain contracts contain provisions waiving all claims of one party or the other upon

final payment, see infra Part V, Section C. These provisions raise major problems for both parties, and

the attorney should make every effort to delete these clauses to the extent that they pertain to that

attorney’s client.

5. Pay when Paid

“Pay when paid” provisions may also be common in contracts between a general

contractor and its subcontractor (or between subcontractors and sub-subcontractors). Such a provision

makes payment of the general contractor by the owner a condition precedent to payment of the

subcontractor by the general contractor. A “pay when paid” provision is favored by general contractors

because they do not want to be in a position where they have to pay a subcontractor, but have not

received the funds to do so from the owner. On the other hand, such provisions are dangerous for

subcontractors, because they may perform the work required of them, but then not get paid because the

owner has defaulted under the contract with the general contractor. For a further discussion of “pay

when paid” clauses, see infra Part IV, Section A and Part VI, Section D.

C. CHANGES AND EXTRAS

In most cases, some changes to the plans and specifications or the contract will be

necessary before completion of the project because of errors, omissions, or aesthetic concerns. Disputes

over changes and extras create many disputes and careful planning in the contract stage is vital, see infra

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Part II, Section C for further discussion. Accordingly, a contract should include a change order clause

(“Change Order”), which provides the owner with a mechanism by which it is permitted to require

alterations or additions so long as it agrees to compensate the contractor for the additional work. If a

contract does not include a Change Order clause, the owner may need to enter into a formal amendment

of the contract each time there is some need for a change to the plans and specifications or the Contract

Terms.

With respect to Change Orders, a contract should establish a procedure pursuant to which

(a) Change Orders are requested/cancelled and (b) compensation and time of payment is determined.

With respect to compensation, obviously the parties cannot always anticipate the cost of a particular

Change Order, but they can specify the amount of the fee to which the contractor will be entitled.

Furthermore, a contractor will want the contract to provide whether there will be any restriction on the

type, extensiveness or timing of a Change Order. Without such a restriction, the owner could change the

whole nature of the project by Change Order. Finally, the parties often agree that all Change Orders will

be in writing. This can help reduce the likelihood of future disputes.

The A201 sets forth several procedures by which a party may request changes in the

work. They are (i) a Change Order, (ii) a Construction Change Directive, and (iii) minor changes in the

work.

1. Change Order

A Change Order, as described in Section 7.2 of the A201, is a written document signed

by the owner, contractor, and architect setting forth their agreement with respect to the change in the

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Work, any adjustment to the contract time, and any adjustment to the contract sum. Using a Change

Order is the preferred method, because the agreement of the parties is set forth in a written agreement.

If the owner wants the right to make changes outside the scope of work, the owner must specifically set

out his right to do so in the contract. See infra Part II, Section C for further discussion.

2. Construction Change Directive

A construction change directive (“Construction Change Directive”) is a written order

prepared by the architect and signed by the owner and architect directing a change in the work prior to

an agreement on the adjustment to the contract time or contract sum. This method is useful if for any

reason the parties need to expedite the work and do not have time to gather the necessary information on

price. Nonetheless, at the earliest possible time thereafter, the parties should finalize the changes to the

contract price and time by way of a written Change Order.

3. Minor Changes in the Work

The architect may order minor changes in the work not involving an adjustment to the

contract sum or the contract time. This could be problematic because the architect specifically has the

power to bind the parties to such minor changes.

D. CHANGED CONDITIONS

A major variable in construction contracts are concealed or unknown site conditions.

Such conditions can result in major changes in the cost and timing of the performance of a contract. As

an initial matter, the parties should be advised to do a pre-construction inspection of the site to ascertain

the condition of the property in advance. In any event, contractors generally desire to insert a clause in

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the contract that provides that the parties will adjust the price and timing of the contract if the contractor

discovers an unforeseen condition. This clause may be refined by describing, to the extent possible, the

type of conditions that are included or excluded from the Scope of the Work. If the contractor insists

upon adding such a clause, the owner may desire to perform a subsurface investigation and require the

contractor to review the results of the investigation prior to the execution of the contract. If a subsurface

investigation is performed, the contract should specifically provide that the contractor acknowledges

that it has reviewed the subsurface investigation report and taken it into account in making its bid. The

subsurface conditions described in the report should not be treated as unforeseen conditions under the

contract. In addition, the parties should attempt to list, to the extent possible, any other types of

conditions that should be included in or excluded from the Scope of Work. The contract also should

include a provision describing how to deal with any changes to the contract required by unforeseen

conditions that arise and that have been excluded from the Scope of Work. See infra Part II, Section D

for further discussion.

Section 4.3.4 of the A201 provides that if the parties discover concealed or unknown

conditions, the architect will recommend an equitable adjustment in the contract sum or contract time or

both. Also, see infra Part II, Section D. Under this provision, the architect is the initial decision maker

and as the initial arbiter. This means that the architect will provide the parties with an estimate of any

change to the contract sum and contract time, and then, if the parties cannot agree to the adjustment in

contract sum and contract time, the matter will be “referred to the Architect for initial determination.”

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E. TIMING

A construction contract should always specify the time of commencement and the time of

completion of the project. Further, the contract should provide that if the contractor does not complete

the project within the time allotted, then the owner should be entitled to certain remedies (e.g. liquidated

damages for each day of delay). The contract also should provide, however, that the time period for

completing the project is subject to equitable adjustments for reasons such as (a) delays caused by other

parties (but not the subcontractors), (b) acts of unrelated third parties, (c) Force Majeure, and (d) Change

Orders/Changed Conditions. See infra Part II, Section B for further discussion.

Article 3 of the A101 provides for a set contract time, “subject to adjustments of the

contract time as provided in the Contract Documents” Subparagraph 8.3.1 of the A201 provides that if

the contractor is delayed at any time “by an act or neglect of Owner . . . or by changes in the Work, or by

labor disputes, fire, unusual delay in deliveries, unavoidable casualties or other causes beyond the

Contractor’s control, or by delay authorized by the Owner pending mediation and arbitration, or by other

causes which the Architect determines may justify delay, then the contract time shall be extended by

Change Order for such reasonable time as the Architect may determine.”

The reasons for delay are not unusual, but this provision causes confusion with respect to

any change in timing. From a reading of this provision, it would seem that the architect has the ability to

determine what may justify delay and how much additional time is appropriate. Nonetheless,

Subparagraph 8.3.2 provides that claims relating to time shall be made in accordance with the applicable

provisions of Paragraph 4.3 (which means that the architect will initially decide the matter, and if the

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parties cannot agree, such decision is subject to arbitration). Moreover, Subparagraph 8.3.1 also

requires that the contract time be changed by Change Order, which as stated above, requires the

signature of the owner. As a result, the parties might consider a simplification of this paragraph by

stating that the parties will either agree on a Change Order, based on the architect’s recommendation, or

the matter will go to arbitration.

F. NO DAMAGES FOR DELAY

A careful owner will want a so-called “no damages for delay” provision which provides

that the contractor shall have no claim for compensation or damages arising from any delay caused by

the owner or its agents. If such a clause is contained in the contract, contractor’s sole remedy in the

event of delay should be an extension of time during which to perform the work. These provisions are

generally enforceable in Illinois, See Gust K. Newberg, Inc. v. Illinois State Toll Highway Authority,

153 Ill. App. 3d 918, 506 N.E. 2d 658, 664 (2d Dist. 1987); J&B Steel Contractors, Inc. v. C. Iber &

Sons, Inc., 162 Ill. 2d 265; 642 N.E.2d 1215 (1994), but the owner may wish to specifically enumerate

the delays that will be covered by this clause. Such a clause may not be enforced if the delay results

from the owner’s bad faith or gross negligence. See Bates & Rogers Construction Corp. v. Greeley &

Hansen, 109 Ill. 2d 225, 486 N.E.2d 902 (1985); Mellon Stuart Construction, Inc. v. Metropolitan Water

Reclamation District of Greater Chicago, 1999 U.S. Dist. Lexis 5376 (N.D. Ill. Apr. 19, 1995).

On the other hand, the contractor will want to remove the no damages for delay

provision. If the owner is insistent upon including this provision in the contract, the contractor may try

to reach a compromise by proposing a liquidated damages clause (e.g. the owner will pay a fixed

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amount for each day of delay caused by the owner). The contractor may argue that such a provision

gives the owner cost certainty, but protects the contractor from economic loss resulting from any delays.

The A201 does not contain a no damages for delay provision. In fact, Subparagraph 8.3

specifically provides that “Paragraph 8.3 does not preclude recovery of damages for delay by either

party under other provisions of the Contract Documents.” Accordingly, absent modification, the owner

could be liable for substantial damages.

G. LIQUIDATED DAMAGES

Many contracts will provide for some form of liquidated damages if the contractor fails to

deliver the project in a timely fashion. The purpose of such a clause is to deal with the breach of

contract in a specific fashion. Such a clause should specifically set forth the amount of damages, the

date upon which damages begin to accrue, and the time when damages cease to accrue. See infra Part

IV, Section B. A contractor should insist that the contractor will not be liable for any delays caused by

the owner.

The amount payable for each day should be a reasonable estimate of actual damages.

Whether this amount is reasonable is determined at the time the contract was executed. In determining

such amount, the owner should be aware that liquidated damages generally preclude actual damages.

Accordingly, the owner should consider all possible damages that may arise from the late delivery of the

project, including any leasing or financing issues. The contractor, on the other hand, must be concerned

about its ability to meet the timing requirements set forth in the contract. If the contract is aggressively

scheduled and the damages are high, such a liquidated damages clause could be ruinous to the

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contractor. To address this concern, the contractor may want to negotiate a cap on liquidated damages,

which could be expressed as a percentage of the contractor’s fee. In addition, although liquidated

damages likely preclude the receipt of any other damages, the contractor will want the clause to state

that the liquidated damages are paid in full satisfaction of all of the owner’s actual damages resulting

from the contractor’s delay. Note that some recent decisions of the Illinois courts have held that a

liquidated damage clause that allows a party the option to seek actual damages or liquidated damages

may be unenforceable. Grossinger Motorcorp Inc. v. American National Bank & Trust Co., 240 Ill.

App. 3d 737, 607 N.E.2d 1337 (1992); Catholic Charities of the Archdiocese of Chicago v. Thorpe, 318

Ill. App. 3d 304, 741 N.E.2d 651 (2000).

H. SUSPENSION

Under Paragraph 14.3 of the A201, the owner may suspend the work in whole or in part

for such period as the owner may determine. The contract sum and the contract time will be adjusted for

increases in cost and time caused by the suspension, unless (i) performance would have been delayed by

any cause for which the contractor is otherwise responsible, or (ii) an adjustment is made or denied

under another provision of the contract. Other than increasing the contract sum and the contract time

upon such suspension, the contractor’s only recourse is that it may terminate the contract and receive

damages if the project is suspended for the lesser of 100 percent of the total number of days scheduled

for completion or 120 days in a 365 day period. This provision is convenient for the owner, but causes

problems for the contractor. For example, including this provision without modification can adversely

impact the contractor’s ability to schedule and bid on other projects.

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I. TERMINATION

1. For Cause

Every contract must set forth circumstances under which a party is permitted to

terminate. Each party will need to have the right to terminate “for cause,” which is the right to terminate

if the other party is not adequately performing its obligations under the contract. For example, the

owner will want the right to terminate the contract if the contractor is performing substandard work, and

the contractor will want to the right to terminate the contract if it is not being paid in a timely fashion.

2. For Convenience

An owner may also want the right to terminate “for convenience.” This means that the

owner may terminate the contract for any reason or for no reason at all. Such a clause is useful if the

owner enters into the contract well in advance of commencing construction and then concludes that it

does not wish to go forward or if the contractor wants to avoid the administrative difficulties of a

“termination for cause”. In effect, the termination for convenience is a way to add cost certainty to an

owner’s decision to break the contract. On the contractor’s side, if such a clause is contained in the

contract, the contractor should be very careful to spell out the owner’s obligations to the contractor if it

elects to terminate for cause. At a minimum, the contractor will want to require the owner to pay for (1)

completed work, (2) work in progress, (3) expense of termination, and (4) some amount for lost profit.

Under this scenario, the owner will be able to stop construction and limit its obligations, but the

contractor will be entitled to the benefit of its bargain. Some owners may, however, take the position

that “lost profit” should not be included in the calculation of damages, because it gives the contractor the

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entire benefit of the contract without requiring the contractor to use its resources to complete the project.

See infra Part IV, Section B for further discussion.

3. Work Stoppage

Pursuant to Section 14.1.1 of the A201, the contractor may terminate the contract if the

work is stopped for more than thirty (30) days because of: (1) a court order requiring that the work be

stopped; (2) an act of government which requires all work to be stopped; (3) the architect’s failure to

issue a certification of payment, (4) the owner’s failure to provide evidence of its ability to fulfill its

obligations under the contract. In addition, the contractor may terminate the contract for certain delays

or failures caused by the owner. If the contractor terminates the contract for such reasons, it is entitled

to recover from the owner “payment for Work executed and for proven loss with respect to materials,

equipment, tools, and construction equipment and machinery, including reasonable overhead, profit, and

damages.” This provision is for the most part reasonable, although the owner may wish to remove the

failure to provide financial information as a default and it may wish to increase the minimum time

period work stoppage.

4. Owner Termination

Pursuant to Paragraph 14.2, the owner may terminate the contract if the contractor (1)

persistently fails to supply sufficient skilled workers or materials, (2) fails to make payments to

subcontractors, (3) persistently disregard laws or ordinance, or (4) is otherwise guilty of a substantial

breach of a provision of the contract documents. The major change that the owner may wish to make is

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that the right to terminate should not be based on the contractor’s “persistent” failure. If the contractor

has breached the agreement, the owner should have the right to terminate.

Pursuant to Article 14.4, the owner may terminate the contract for convenience. If the

owner terminates the contract for convenience, the contractor is entitled to receive payment for work

executed, and costs incurred by reason of such termination, along with reasonable overhead and profit

on the work not executed. As discussed above, this generally is a fair way to approach the issue.

J. RISK SHIFTING CLAUSES

As a general matter, parties should be responsible for the risks over which they have

some modicum of control. Parties often try to allocate and re-allocate risk among the parties, sometimes

attempting to transfer the risk from one party to another. Although the practice of transferring risk from

one party to another may seem counter-intuitive at times, the clear and explicit allocation of risk will be

helpful should a dispute arise.

1. Accuracy of Documents

An example of a common owner-friendly risk shifting clause is that the owner will want

to disclaim the accuracy of the project documents and require that the contractor warrant that the plans

are sufficient to perform the work. The logic is that the contractor, who presumably is the party with

greater expertise, will be forced to examine the project documents, and will be responsible if there are

any problems. On the other hand, unless the contractor was involved in the design of the project, the

contractor will want this responsibility to remain with the owner and/or the architect.

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To strike a balance between these competing interests, an owner and a contractor could

reasonably agree that the contractor is obligated to review the project documents and to discover any

problems that a contractor would reasonably discover. This concept makes the contractor responsible

for its review of the project documents, but only to the extent of its expertise.

The A201 seems to favor the contractor. Under Section 3.2.1, the contractor is required

to review the contract documents at each stage of the work. This review, however, is for “facilitating

construction,” and not for discovering errors or omissions in the project documents. If the contractor

discovers errors or omissions, it is required to report them to the architect. This provision is problematic

because it provides no standard of care. Accordingly, a contractor will only be responsible for errors

and omissions of which it has actual knowledge, which, in the event of a dispute with contractor, may be

virtually impossible for the owner to prove.

2. Warranties and Indemnities

Other examples of risk-shifting clauses are warranties and indemnities. Typically, the

owner will want to require a general warranty from the contractor regarding the work and the materials

used. This warranty should be drafted so it is specific as to scope and duration. The owner will also

want to require an indemnification clause in which the contractor indemnifies the owner from various

liabilities arising out of the performance of the work. When reviewing an indemnification clause, a

party must consider any risks for which it is not carrying insurance. In addition, it is important to note

that in Illinois, “every covenant, promise or agreement to indemnify or hold harmless another person

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from that person’s own negligence is void as against public policy and wholly unenforceable.” 740

ILCS 35/1. Also see infra Part II, Section E for further discussion.

Section 3.18 of the A201 is a relatively reasonable indemnification clause. The owner

may want to add, however, an indemnity from the contractor for violations of laws and ordinances,

mechanics liens and security interests of suppliers, and methods of construction.

In the A201, the architect seeks to shift substantial responsibility and obligations away

from the architect. Section 4.2.2 provides that the architect “visit the site appropriate to the stage of

Contractor’s operation” to become familiar with the work, keep the owner informed about progress, and

to determine in general if the work is being performed in conformance with the contract documents.

This section should be pointed out to owners, because owners may expect a much greater amount of

supervision. Such services may be available from the architect, however, but at an additional cost to the

owner. Moreover, in Section 4.2.3, the architect disclaims any responsibility for failure to perform the

work in accordance with the requirements of the contract documents. Although the contractor should be

responsible for the performance of the work, the inclusion of this provision also means that the architect

is disclaiming any responsibility that it may incur through its inspections.

Another provision that contains a parallel review obligation/disclaimer is Section 4.2.7.

This section provides that the “Architect will review and approve or take other appropriate action upon

the Contractor’s submittals such as Shop Drawings, Product Data and Samples, but only for the limited

purpose of checking for conformance with information given and the design concept expressed in the

Contract Documents.” Emphasis supplied. On the other hand, pursuant to Section 3.12.6, “Contractor

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shall not be relieved of responsibility for errors and omissions in the Shop Drawings, Product Data,

Samples, or other similar submittals by the Architects’ approval thereof.” These provisions assign risk

related to the shop drawings and other documents to the contractor.

K. ARBITRATION

The issue of dispute resolution should be considered in every contract. The proponents

of arbitration approve of the efficiency and cost-effectiveness of the procedure. Opponents of the

procedure complain that, for example, because of more limited discovery and fewer strategic options,

arbitration may be a detriment, especially in more complex disputes. Moreover, the lack of formal

discovery can lead to a harsh result, because arbitration is final and non-binding. See infra Part IV,

Section C, generally, for further discussion.

The initial reaction of an owner is generally to delete the arbitration clause. The logic is

that the owner wants to maintain the freedom to determine its own remedy, and should a dispute arise

and the parties want to arbitrate, they may agree to do so.

A potential solution to accommodate both the proponents and opponents of arbitration

may be to have arbitration for only certain disputes. For example, arbitration could be limited to

disputes under a certain dollar amount. Alternatively, the contract could provide for mediation or non-

binding arbitration, which would have the advantage of the efficiency of arbitration, but give appeal

rights to the parties.

The A201 contains extensive provisions regarding arbitration, which could lead an

attorney to believe that the AIA is a great proponent of arbitration. Nonetheless, note that Paragraph

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4.6.4 of the A201 states that the architect may not be joined in any arbitration, unless it has given its

written consent. This creates the possibility that if there is a question of fault between the contractor and

the architect, the owner would have to incur the costs of two arbitrations and these two arbitrations could

potentially lead to different results. An owner may want to consider modifying this provision so that all

parties can be made parties to one proceeding.

Moreover, the architect is inserted as an unofficial arbiter in numerous disputes among

the parties. Section 4.4.1 of the A201 provides that “Claims, including those alleging error or omission

by the Architect . . . shall be referred initially to the Architect for decision. A decision by the Architect

shall be a condition precedent to mediation, arbitration or litigation of all Claims.” First and foremost,

the very fact that the architect is deciding claims against the architect has no application in this setting.

Either the architect and the owner will address the dispute or they will need to arbitrate the matter.

Adding an opportunity for the architect to “decide” on any claims against the architect is a needless

prerequisite to arbitration and has no place in the contract. To a lesser extent, the architect’s role as

arbiter generally is superfluous. This procedure seeks to accomplish in a formal manner matters which

could otherwise be accomplished in a less formal manner. In other words, if a dispute cannot be

resolved among the parties without involving an arbitrator, a ruling from the architect as a prerequisite

to mediation, arbitration, or litigation may be unnecessary.

L. ASSIGNABILITY

Under Illinois law, a construction contract may not be assignable by the contractor

without the owner’s consent. Nonetheless, the owner should provide in the contract that the contractor

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cannot assign its obligations under the contract to ensure that it has the absolute right to approve a new

contractor. On the other hand, the owner may wish to preserve for itself the right to assign its rights and

obligations under the contract. This should be acceptable to the contractor, although it may want to

require certain financial information from the assignee as a condition to the assignment. In any event,

the owner’s ability to assign the contract is particularly important because if the project is being financed

by a lender, the lender will require a collateral assignment of the contract. Should the owner default

under the loan, the lender may then want to assume the contract. Accordingly, the owner will want to

require an affirmative covenant from the contractor that it will perform for the lender and that it will

cause all of the subcontractors to perform for the lender.

Paragraph 13.2 of the A201 provides that neither party may assign the contract without

the written consent of the other, provided that the “Owner may, without consent of the Contractor,

assign the Contract to an institutional lender. . . .” This paragraph raises two issues that the owner may

want to consider. First, the owner may want to be able to assign the contract to anyone, not just the

lender. Second, the owner agrees in Subparagraph 13.2.2 that the lender “shall assume the Owner’s

rights and obligations under the Contract Documents.” The owner will want to either strike this

provision or make sure that its lender is willing to assume the owner’s obligations if the owner defaults

under the loan.

M. FLOW DOWN PROVISIONS

In contracts between the general contractor and its subcontractors, the general contractor

often includes a “flow down” provision, which requires the subcontractor to perform all of the general

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contractor’s obligations to the owner under the owner/general contractor agreement with respect to the

subcontractor’s work. This assures the general contractor that, if the subcontractor’s work does not

comply with or fulfill the general contractor’s obligations to the owner, then the subcontractor will be

liable for such failure. See infra Part IV, Section A, Paragraph 2 for further discussion.