A property owner invests large sums of money as well as great faith in a builder who is constructing a custom house. Before the construction begins, owner and contractor should discuss key points, agreeing on such issues as time frame, materials, costs, and contingency plans. A residential construction contract documents those agreements, ensuring that everyone is on the same page, thus minimizing the opportunity for surprises. A well-written, thorough contract is the first step to a successful working relationship.
For the protection of both the owner and the builder, a residential contract should contain the following key terms:
Contract Sum or Price Terms – One of the first decisions to reach is how the builder should charge the owner. The two most common options are fixed price and cost plus payment options. In a fixed price contract, the builder and owner agree to a single, lump sum cost for completion of the construction. The set price combines costs and profits for the builder. This option is advantageous for the owner, who then knows up front what the job will cost. However, if supply costs increase unexpectedly, the builder may lose some or all profit from the job. By contrast, a cost plus contract separates cost of the project from the builder’s profit. The cost includes labor and material while the profit, which is the plus, is calculated separately and listed in the contract as an additional fee. The cost plus option is helpful to the contractor since it protects profits. The owner benefits as well since a fixed price estimate is sometimes inflated initially to protect the builder’s profit.
Commencement Date – As its name indicates, it is the date that the contractor begins work on the project.
Completion Date – This date marks the point in the construction process when the owner is able to take possession of the house, often referred to as “substantial” or “practical” completion. Some minor repairs may not have been completed by this point, but the incomplete work does not prevent the owner from occupying the home. The terms of the contract must provide for an extension of the date in the event of unforeseen circumstances. However, if that completion date is certified, the expectation is that only minimal work remains, and that the owner can occupy the property with little inconvenience. If the contractor fails to meet the contractual Completion Date, the contractor may be required to pay damages to the owner.
Scope of Work – This section of the contract provides an exact description of the work that the contractor will complete. It often includes architectural plans for the builder as well.
Subcontractor Disclosure Requirements – This clause states that the owner is entitled to a complete list of all subcontractors, suppliers, materials, equipment, and other needs of the project. Contact information, including phone numbers and addresses, must also be provided to the owner, all before the subcontractors begin work. The contract also stipulates that any changes of subcontractor names and contact information must be provided to the owner. This information is not only helpful for follow-up repairs and questions, but it also helps to avoid liens filed against the property by subcontractors.
Change Order Procedures – This part of the contract allows the owner to modify plans, also known as “Changed Work.” The owner should provide those modifications in writing. If the contractor agrees to the changes, she or he will then provide an estimate of the costs and an extension of the Completion Date. If the owner requests modifications but does not provide a written request, the contractor may still submit the cost estimate and required extension to the owner. If the owner makes no objection, then the Contract Sum and Completion Date will reflect the contractor’s estimate of cost and Completion Date.
Escalation Clauses – These clauses allow the builder to adjust prices, particularly in force majeure situations, those that are unforeseen and beyond the contractor’s control. Escalation clauses have become even more important during the global pandemic as supplies have been difficult to find and/or prices have increased substantially. The cost of lumber, for example, has increased by 154% since the beginning of the pandemic. An escalation clause is advantageous for the builder because it helps protect profits. It also provides transparency in communicating with the owner, improving interaction and managing expectations.
The terms and clauses of a residential contract can ease the challenges of building a home by defining specific parameters for contractors and owners. A contract should reflect the unique needs of the owner and the project to offer the best protection possible. Working with an experienced real estate or business lawyer helps ensure that building a dream house does not turn into a nightmare.
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