The following summarizes an original article, titled One-Sided Contracts: Do They Pay Off?* authored by Ross J. Altman1, Jeffrey R. Cruz2, and Peter C. Halls3. It was published in the Journal of the American College of Construction Lawyers, Vol. 11, No. 1 (Winter, 2017). The Journal is available on Westlaw, where issues may be viewed and searched in the Westlaw database ACCLJ.
Drafters of contracts are naturally inclined to transfer risk to the other party. That approach is common in construction contracts. While the risks that might arise on a construction project are not always predictable, both the owner and contractor recognize that the financial consequences of those risks are often significant. Neither party accepts such responsibility eagerly.
At some point, transferring risk creates one-sided contract terms. The magnitude of a particular risk, or the sheer volume of risks, transferred to the other party can be perceived as excessive. When that imbalance occurs, can be a matter of perspective.
For example, many construction contracts contain a so-called no-damage-for-delay clause. Such a clause provides that the contractor's sole remedy for any delay not caused by the contractor, such as a force majeure event, is an extension in contractual time periods. The clause will prohibit, or at least limit, the contractor's right to additional compensation.
Contractors contend such clauses are one-sided and unfair, as additional costs and expenses are a common and almost inevitable result from a delay in performance of the work. Why should the contract prohibit the right of the contractor to recover such costs and expenses that are not its fault? Owners on the other hand, see such clauses as a bargained for allocation of risk that isn't caused by either party.
Clearly, one's vantage point contributes to whether contractual terms are perceived as fair. Nonetheless, contractual provisions that possess the following characteristics are more likely to trigger a negative reaction and be viewed as one-sided:
(1) transferring risk that can't be well managed by the party to which it has been transferred (e.g., shifting design risk to a contractor);
(2) imposing very high liability for failure to perform adequately (e.g., excessive liquidated damages for delay);
(3) transferring risk that cannot be priced with certainty (e.g., responsibility for unknown concealed conditions);
(4) forfeiting rights that otherwise would be available under the law (e.g., waivers); and,
(5) allowing one party to exercise discretion in an abusive way (e.g., unreasonable approval rights).
It is reasonable to question whether the benefit of transferring risk through one-sided contractual terms outweighs the potential negative reaction from the party that is asked to accept such risk. Surprisingly, little has been published on the topic. As a result, we prepared and submitted a short survey to a number of experienced construction lawyers to probe whether one-sided contractual terms in a construction contract likely would produce adverse consequences.
The lawyers responding to the survey self-identified as representing principally contractors, principally owners, or both on a reasonably frequent basis. The survey was admittedly unscientific, and the 145 responses may not be considered statistically significant. Nonetheless, while perhaps anecdotal, the resulting data is interesting.
The vast majority of respondents, regardless of the group to which they self-identified, believe that including one-sided terms in a construction contract is likely to produce adverse consequences. The responses to survey questions, and additional comments provided by those responding, consistently identified certain problems that one-sided contract terms produce, including the following:
(1) contractors will increase prices to fund contingent risks;
(2) one-sided provisions will discourage contractors from bidding on a project, creating the possibility that only less qualified contractors, or those that don't fully comprehend the risk, will participate in the procurement;
(3) the naturally adversarial relationship between the owner and contractor will worsen, resulting in unproductive or wasteful behavior taken to protect against risk;
(4) increased likelihood of claims;
(5) escalated transaction costs because of the time spent in reviewing and negotiating contractual terms.
The above list summarizes how a contractor might react to terms that excessively favor the owner, but the converse is also true. Terms that excessively favor the contractor will cause an owner to react negatively. For example, an owner may expect a significantly lower price when the owner retains risk, or may be less inclined to work with a contractor that insists on terms that the owner perceives as unfair.
The magnitude of likely adverse consequences is not easily estimated. For example, the quantum of a risk contingency may depend on numerous factors, such as specific contract terms and market conditions. Respondents to the survey, however, appear confident that a premium will be paid for any unbalanced risk transfer.
No lawyer, and in reality no client, questions the need to address risks associated with a transaction, and to allocate responsibility and liability for the consequences that arise from those risks. But when contracts allocate risk through one-sided terms, the benefits may not outweigh the potential for adverse consequences. Although those consequences are difficult to quantify when a contract is drafted and negotiated, the responses to our survey certainly question the wisdom of employing one-sided contract terms without evaluating the potential consequences.
The drafters of contracts might not presume the failure of the parties to perform a contract, but the use of one-sided terms surely confirms that such contracts focus on the consequences of the failure to perform adequately. That is understandable and even appropriate to some extent, but such considerations should not come at the expense of using the contract to facilitate successful completion of a transaction or project.
Indeed, the IACCM studies on Top Terms routinely identify various provisions pertaining to liability, such as limitations of liability and indemnification, among those most commonly negotiated. The same studies, however, also note terms pertaining to the commercial relationship, such as scope, goals, and responsibilities, as the most important for a successful outcome.
That warrants further thought. Indeed, there may be circumstances where one-sided contractual terms are appropriate. But, their use should not be reflexive. There is a price to pay when using such terms, not the least of which might be forfeiting the opportunity to describe and allocate responsibility for a transaction that facilitates its success.
_* One sided Contracts, do they pay off? Dated 6 March 2017 – Ross J. Altman, Jeffrey R. Cruz, Peter C. Halls
ABOUT OUR AUTHORS
Ross J. Altman is a member of Dykema Gossett PLLC in Chicago. He leads the Firm’s construction practice, and has handled projects globally and in many sectors. Mr. Altman also is an adjunct professor at the University of Miami School of Law, in the Real Property Development Program. He is a Fellow and former member of the Board of Governors of the American College of Construction Lawyers. He will be a keynote speaker at IACCM’s Americas Conference, an IACCM event October 11-13 at the Westin Harbour Castle, Toronto, Canada.
Jeffrey R. Cruz, Corporate Counsel with Skanska USA Building Inc., New York – serves as Corporate Counsel to Skanska USA, and is based in New York. He previously was a partner in private practice with well-known construction law firms. Mr. Cruz currently is a member of the Governing Committee for the American Bar Association Forum on Construction Law, and is a Fellow in the American College of Construction Lawyers.
Peter C. Halls, retired partner from Faegre Baker Daniels, Minneapolis, has been active in many professional associations, including the American Bar Association Forum on Construction Law, where he served as Chair of the Division on International Construction Law. He is a Fellow in the American College of Construction Lawyers.