11 Essential Clauses for Construction Contracts in HOAs

Vital Construction Contract Provisions

There are essential clauses that should be part of every construction contract between a homeowners association and its contractors. These key terms give the association substantial legal advantages in the event of a dispute, mediation, arbitration or lawsuit arising from the construction project. These protections can only be secured by using a properly drafted agreement supplied by the association, or by negotiating with the contractor to include these clauses in the form of contract that the contractor provides (Learn about common contract clauses HOAs should avoid). Sadly, many associations routinely sign the contractor’s contract form without change, placing themselves at a strategic disadvantage.

Type I Indemnity - Protection from Liability

Indemnity is the concept of shifting the risk of a loss from one party to another. There are many forms of indemnity. One common form is referred to as “Type I.” A Type I indemnity protects the association and construction manager from liability against any claim, liability, lawsuit, loss, damage, or expense, including attorney’s fees, arising out of the contract, including personal injury, death or economic loss. The key aspect of a Type I indemnity is that the legal protection applies whether or not the association or its agent is alleged to have contributed to the damages. It excludes only damages or injury caused by the sole negligence or willful misconduct of the indemnitee. It shifts the risk of a lawsuit to the contractor and its insurance carrier.

Contractor's Insurance

Contractors should be required to maintain proper levels of workers compensation insurance and comprehensive general liability insurance. The contract must require that the association be named as an additional insured on the policy, and that evidence of such insurance be provided throughout the performance of the agreement. As some liability insurance companies prohibit contractors from performing work for common interest developments without a special endorsement, it is important for the contract to require, and for the association to verify, that the insurance is applicable for the planned work. The endorsements under which associations are named on the contractor’s policy vary. The association should consult with its insurance professional or attorney to assure that the association’s rights under the contractor’s insurance are maximized. A mere certificate of insurance is insufficient.

Contractor's License

Work on a project for which the combined value of labor, materials and all other costs on one or more contracts exceeds $500 is required to be performed by a licensed contractor (Business & Professions Code Section 7030.5) The contract should state the contractor’s license number and the license categories held. It is easy to verify that the contractor has the appropriate category of license, and that the license is current and active, at the website maintained by the Contractors State License Board.

The association is deemed to be the employer of an unlicensed contractor for purposes of workers compensation liability and certain tax filing responsibilities. For example, if an employee of an unlicensed contractor is injured while working in an association, the association may be sued for the employee’s lost income, medical treatment and rehabilitation expenses. The hiring of an unlicensed contractor also is below the standard of care required of community association directors and therefore could give rise to a claim by the corporation against the directors for any damages that result. The potential risk here is enormous. Directors must only engage licensed contractors for any project or series of projects costing more than $500.

Entity Status

The true legal name of the contractor must be stated in the contract. That name must correspond with the contractor’s license. A routine check should be made to determine whether the contractor is in good standing with the California Secretary of State. Corporations or limited liability companies that are suspended cannot legally enter into contracts. Both issues can be researched quickly at the website of the Secretary of State. It should be noted that limited liability companies cannot hold a contractor’s license.

Accurate Scope of Work

Far too many contracts have an insufficient description of the labor and materials that will be provided under the agreement. The contract should include a detailed specification of the services and materials being purchased so that the performance of the contract can be objectively measured. In construction contracts of any significant magnitude, plans and specifications should be prepared by an architect or engineer. Clarifying the scope of work is a good way of confirming the parties expectations about exactly what their respective duties and rights are under the contract.

Details of Warranty

The specific terms of all labor and material warranties must be included in the contract. The agreement must state the duration and scope of the warranty. For example, the roofing contractor’s warranty can protect against defective materials only or may also cover the cost of repair of damages from leaks to the building and residence interiors.

Retention Agreement

Construction contracts should provide that the progress payments to the contractor are subject to a retention, typically ten percent of the amount due. The retention is held until a defined date after completion of the contract, as security for the contractor’s obligation to assure that all subcontractors and material suppliers have been paid. Without such payment, these “strangers” can record and enforce mechanics liens against the common area and/or the separate interests, even if the association had no agreement with them.

Completion Deadline

The contract should set a start and completion date. Consideration should be given to a liquidated damages clause, establishing a daily penalty for late completion. In the absence of a completion date, the law imposes only a requirement of completion within a “reasonable” time.

Necessary Disclosures

Labor Code Section 2810 requires that construction contracts between property owners and contractors include certain disclosures which are intended to protect the employees of the contractor. The information is required to be supplemented if there is material change to the agreement, and the owner and contractor are required to keep the written contract for four (4) years. Among the information mandated for inclusion are the employer identification number of the contractor, workers’ compensation information, specification of vehicles to be used by the contractor, the number of workers to be employed, the number of independent contractors who will be used, and their license numbers. The association can incur material financial liabilities if this Section 2810 is violated.

Permission to Terminate

An association may terminate a contract if the contract permits it or if the contractor materially breaches the agreement. Proving a material breach of the contract is often difficult. Therefore, to protect the association’s right to terminate a contractor at any time, it is necessary to include a clause permitting termination without the necessity of proving “cause” (a provision sometimes called termination for “owner convenience”). These clauses are reciprocal, however. There are contracts where the association does not want the contractor to have the right to terminate without cause, however; so careful consideration is necessary with regard to termination for convenience. Further, even if the association has the right to terminate without cause, it may still be held responsible for payment of some portion of the contract, including profit earned to the effective termination date.

Attorney’s Fees Clause

Under California law, the party to a contract must bear its own attorney’s fees in enforcing it unless there is a special statute providing for the recovery or a provision in the contract providing for the recovery of attorney’s fees. Generally, the association will be the party enforcing a contract; so an attorney’s fees clause should always be considered in a contract with contractors. By law, attorney’s fees clauses are always reciprocal; therefore a board should consider whether the clause may be used against it. The association may be able to improve its right to recover all litigation expenses if it includes in this clause the right to recover not only attorney’s fees and costs but also the fees and expenses of expert witnesses, whether or not those experts’ fees are otherwise recoverable by statute.

Dispute Resolution

The construction contract can require that the parties meet and confer in good faith prior to the filing of any dispute resolution process (mediation, arbitration or litigation).

Construction contracts frequently contain a binding arbitration clause. Consideration should be given as to whether or not binding arbitration is in fact in the interests of the association. This clause waives the right to trial by court and trial by jury, the right to have the decision determined in accordance with California law, and the right of appeal, among other important rights. In addition, there are reports of certain arbitration that have been longer and more expensive than a trial in court. Another drawback to binding arbitration is that all of the parties who are potentially responsible for the claim, damage or injury, cannot be brought together to resolve the issues at one time.

An alternative to binding arbitration is non-binding arbitration. The main disadvantage of this procedure is that the parties may spend considerable time and money presenting their case and then have to re-litigate it in court, if the arbitration award is rejected.

Mediation is a procedure whereby a neutral party endeavors to broker an agreement between the two sides. Knowledgeable and experienced mediators can be very effective in resolving disputes without the necessity of litigation. Consideration should be given in construction contracts to a clause requiring that an effort be made to mediate.

Conclusion

A checklist of key construction contract terms will assist boards in negotiating better contracts. Legal review of construction contracts is prudent to assure that the agreement is complete and to customize the agreement to an association’s advantage based on the specific materials and services being provided.


Jeffrey A. Barnett is an association attorney with legal offices in San Jose. He is a member of the Legal, Central Coast and South Bay Resource Panels, the ECHO Legislative Committee and a past member of ECHO's board of directors. He also frequently speaks at various ECHO seminars and writes for the ECHO Journal.