Hitting pause — successful contracting in an uncertain market

The construction industry has faced various struggles since the onset of the pandemic. Recent reports confirm that medium-term commercial construction, specifically, has a cloudy forecast at best. There are juxtaposing perspectives in the industry. The July AIA Consensus Construction Forecast Panel expressed optimism concerning the overall construction outlook for 2023, with a 6 percent growth projection. Conversely, multiple construction analysts, such as Fannie Mae Economic and Strategic Research Group, have updated their reports to predict a construction recession starting in late 2023, especially in the residential sector.

Mixed messaging has created an uncertain climate for construction projects either under way or in the early planning stages. This uncertainty may result in investors and construction lenders placing financing plans on pause until these issues are resolved, causing loan commitments to lapse, permits to expire, and the need for workforce redeployment. Developers, design professionals, and contractors should consider addressing these issues directly in their discussions and contracts to avoid surprises and later disputes. Here are some areas of negotiation that can be pursued in this new, uncertain landscape.

Suspension

Most design and construction contracts either are silent regarding the consequences of project suspension or include a brief window for reconciliation before suspension reaches the draconian result of contract termination. Developers should consider pushing this suspension window out and directly addressing with their contractors and design professionals what happens in the interim if the project is put on hold. Contract counterparties should consider and address such delays’ financial and practical impacts. For example, if the parties anticipate the design and permitting phase might be followed by an uncertain gap before the commencement of construction, the use of a construction manager/general contractor contract structure might make sense, especially where procurement and subcontract bidding does not take place until the dominos of the finance chain are falling into place.

Downsizing

In an uncertain environment, projects of a particular size or use that ultimately do not pencil out might still ultimately make sense if reconfigured or downsized. Careful front-end planning allows for such adjustments, including use of phased construction or additive and deductive alternates, allowing for pre-agreement on pricing and schedule change mechanisms instead of wholesale renegotiation of contracts at the time of change.

Financial assurances

Standard commercial construction contract forms allow contractors to require proof of developer financing as a starting condition and, in some cases, a violation of continuing work. Savvy developers will delete such provisions. However, the issue remains real if the project schedule requires procurement or significant work before ultimate project financing is secured. If financing problems arise, the parties should consider approaching the issue in stages – for example, requiring proof of financial resources only as needed to fund the current stage of construction.

Procurement

For many modern projects, the specter of inflation calls for procurement of materials before all financing is secured; an uncertain market only amplifies this issue. Contract parties should consider the effect of possible project suspension or abandonment before large procurements are made. Factors such as reservations, deposits, and agreed supplier termination fees can mitigate the risk of a large purchase being delivered to the site or project warehouse, ultimately with nowhere to go.

Mothballing

If demolition, excavation, or construction has commenced at the time of project suspension, the project will need to be shut down, secured, and made ready for future resumption. Advanced planning for site maintenance, security, weatherproofing, and insurance, including which party is responsible for and controls such matters, can be critical for a successful project pause.

Termination

Some paused projects will not resume. In these cases, the developer will need to terminate its contracts for convenience since it will not have grounds to terminate for breach of contract. Surprisingly, many nonstandard construction contracts do not give the developer an express right to do so. Form contracts that include such a termination right may have financial provisions that render termination payments punitive. In these cases, the parties should work through fair termination and payment provisions that render the design professional and contractor whole but also recognize it is nobody’s fault if the project does not go forward.

Ensuring a project’s contracts plan for uncertain financial climates is key to getting stalled projects off the ground. However, sometimes circumstances arise, and steps must be taken to protect design professionals, developers, and financiers. Adequately planning for uncertain financial climates and circumstances will help keep projects on track or address those that have stalled.

— Christopher M. Walters is a partner at Ball Janik LLP.