The Shifting Sands of Contract Drafting, Interpretation, and ApplicationBy Alex Iliff, Peter Halls, and James Tedjeske
CONTRACT DRAFTING
In the wee hours of litiga-tion, after months have been spent haggling over contract terms that seemed perfectly clear at the outset, after tears have been shed in disputes over issues beyond dispute, after parties of sterling rep-utation have been deemed irredeemable in their oppo-nent’s eyes, a person might think, “Why even bother drafting the contract? Next time, we’ll just shake hands.”
Please build this for us. We will pay you.Certainly, say no more.
It is a tempting thought, but few have the fortitude to see it through. The written contract is still the standard, and parties are ever hopeful that their next contract will have none of the holes found in all of the previous ones.
The first section of this article examines the need for a contract and lays out a few of the reasons why contracts appear not to be worth drafting. It then explains the jus-tifications for a written document. The second section of the article builds from the assumption that parties will not abandon the written contract and offers advice on avoiding some of the most common pitfalls in contract drafting.
Why Have a Written Contract?There are many ways to understand the purpose of a written contract. Long ago, the Eighth Circuit wrote that “the purpose of a written contract is to furnish a record of the terms of the agreement of the parties not easily impeached, and thereby to avoid subsequent disputes and conflicting testimony and claims regarding its terms and their meaning.”1 Nobody knows how many times a clearly written contract has prevented a dispute from going to court, but given how frequently contracts fail to prevent disputes, the classic understanding is only satisfactory up to a point. Some would argue that a written contract exists to “set the stage,” creating a framework of under-standing without drawing perfectly clear boundaries for all situations. Or, as another thinker might have said long ago, written contracts are the worst way to arrange rela-tionships between parties, except for all the other ways that have been tried.
In this section, we attempt to weigh the usefulness of a written contract, beginning with the limitations and con-cluding with the advantages.
Limitations of the Written ContractChief Justice John Roberts of the US Supreme Court recently admitted that he does not read the fine print of Internet licensing agreements.2 No doubt the drafters of those agreements would like to believe their words have some effect, but if contracts are so long or complicated that no one really reads or understands them, of what use are those contracts?
With so much effort put into it, how can a written contract serve no purpose? In the licensing agreement ex-ample, the problem is obvious: many people would assert it is preposterous to think a person should read and be bound by a 50-page contract governing his purchase of the download of a single song.3 In construction contracts, the question of whether a written contract is of value requires closer inspection. In construction projects, the parties have reason to be heavily invested in the transac-tion, and frequently both sides are sophisticated, enriched with years of experience, and impoverished by the cost of gaining that experience. And still, many fundamental problems with written construction contracts remain. In this section we review eight of them.
Conflict Between Contract Language and PracticeHow many times have lawyers investigating a dispute found that the processes and procedures followed on a construction project bore no resemblance to what is
Alex Iliff practices law with Dorsey & Whitney LLP, Minneapolis, Minnesota. Peter Halls is a partner of Fae-gre Baker Daniels LLP, Minneapolis, Minnesota. James Tedjeske is the Vice President Legal for Kvaerner North American Construction, Inc., Canonsburg, Pennsylvania.
described in the contract? Perhaps it would be better to ask, how many times have the parties followed the pro-cesses and procedures exactly as set forth in a construction contract? Typically, there are many detailed provisions in a construction contract describing payment procedures, change order procedures, insurance requirements, sub-contracting requirements, and dispute procedures. Often these terms come from industry forms or from person-nel that are involved only with the front end of a project, not its implementation. For example, a lawyer may have some terrific language from a contract prepared for one client that he or she then uses for a new client. The lan-guage might even be reviewed by the new client and the other contracting party, but not necessarily by the people that will be involved in implementing the language on a day-to-day basis. The owner and contractor’s project managers and superintendents that were not consulted or involved in the negotiation of the contract come in later and typically run the project according to their personal customs and preferences or according to their company’s established internal procedures, regardless of what the contract says. They either do not want to bother to read the complicated contract terms and figure them out, or they do not care and want to do things their way despite the terms in the contract. When the parties deviate from the contract terms, their actions can be held to have modi-fied the terms of the written contract.4
Unavoidable AmbiguityAmbiguity is unavoidable in at least two ways. First, at the time of contracting, it is impossible for the parties to determine exactly how they would address a particular sit-uation without knowing what the particular situation is. The parties may attempt to define general rules to govern the construction process, such as providing notices, allow-ing for inspections, addressing how the inevitable process of changes will be handled, and allocating responsibility for damages. Contracts also try to define what the par-ties will not do, such as defining a maximum level of risk a party will accept, limiting liabilities of the parties, or other key concerns. Many situations are foreseeable, and those are the situations addressed in most contracts. Until a particular unforeseen situation arises, the parties cannot say for certain how they would like to handle it.5
This concern may be likened to Justice Potter Stewart’s famous statement about pornography: “I know it when I
see it.”6 Justice Stewart’s statement is commonly viewed as somewhat of a joke, but it was intended as a representa-tion of humility, an admission that it was impossible to formulate a perfect rule ex ante.7 Likewise, in construction contracts, it is likely a fruitless endeavor for parties to at-tempt to develop in advance clear rules for every situation. Before the parties actually experience a problem they have not anticipated in context, they cannot determine how that problem should be addressed.8
The second reason ambiguity is unavoidable is the nature of conflict. When all is going well with a project, parties may find it easy to agree that their contracts are models of clarity. Necessity is the mother of invention, however, and when a party finds itself in a difficult posi-tion, lawyers are summoned and often are able to find am-biguity in unexpected places. Once the lawyers get hold of an agreement, many businesspeople feel that the certainty of meaning they once possessed is lost for the duration.9
Impossibility of Addressing Every Potential IssueMany construction projects are immensely complex—with durations measured in years of performance through winters of snow, springs of rain, and summers of blister-ing heat. Without the benefit of clairvoyance,10 parties have choices: (1) adopt flexible terms like “material,” “rea-sonable,” or “best efforts”; (2) define rock-hard lines such as “more than 10%,” “longer than five working days,” or “more severe than 150% of the average precipitation ex-perienced in the affected location in the past 20 years”; or (3) leave gaps. The first option is subject to the inevitable ambiguity discussed above. The second might be harder to negotiate and induces the parties to fight to achieve the defining event to gain the promised relief. The third may seem the most frightening, but it is also inevitable. At a certain point, the cost and time required to address every potential issue and to allocate the possible risk for those issues in the contract become too large, and the parties must leave certain questions unanswered. As a result, judi-cial or arbitral gap-filling is commonly seen as an essential function in contract interpretation.11
Inescapable RulesParties frequently include numerous limits, exclusions dis-claimers, and other strong provisions in their contracts, only to find those provisions do not accomplish what they had hoped. Prominent examples include the implied war-ranties of habitability and adequacy of specifications, each of which can be exceedingly difficult to disclaim no matter how strong the provision in the contract.12 Like-wise, many states have enacted laws forcing the parties to use the law of the state where the construction takes place no matter what the contract says,13 barring parties from requiring lien waivers in advance of payment,14 and bar-ring parties from providing for indemnification of a party for losses caused by its own negligence.15 Thus, in some cases, even where parties are in clear agreement and the words are perfectly clear, neither their agreement nor the
Written contracts are the worst way to arrange relationships between
parties, except for all the other ways that have been tried.
words to document that agreement are effective in altering the baseline rule.
Contract Drafting Requires Time and MoneyThis point needs little explanation. Whether or not law-yers are involved, negotiating and drafting a contract re-quire significant resources, which may potentially delay the start of a project or occupy project principals at a time when their abilities could be used elsewhere. By contrast, handshake agreements rarely take months.
Friction Over Irrelevant ProvisionsThe flipside of the impossibility of addressing every issue is that parties are also sure to spend a great deal of time addressing issues that will never be a problem for anyone. Such negotiations may generate acrimony between proj-ect participants at the very outset of a project, before the parties’ actual performance ever becomes an issue. The truth is that most contract terms are never used, and the parties start and finish performance without ever reading the contracts they have paid their lawyers to write (and those contracts turn out to be the best contracts ever writ-ten because they never had to be read).
Excess TermsHere, we do not mean that a party may end up paying too much for a project or otherwise suffer from poor negotiat-ing strategy, but rather that the process of drafting a con-tract may bring ideas to the parties’ minds that would not have occurred to them otherwise or may deal with issues that the parties never actually discussed or agreed upon. For example, a party may agree to indemnify the other party in cases of joint negligence or waive consequential damages, not because such provisions were demanded by the opposite party, but rather because the provisions ap-peared in a model document the parties used during ne-gotiations. Likewise, the presentation of contract drafts or the effort and concentration required to put a written agreement together or respond to a draft may generate ideas for provisions that otherwise would have been left unaddressed.
Requiring Written Contract May Be OffensiveJust as the relationship between parties may be strained by the process of negotiating a new contract or a change to an existing contract, in some cases, it may be strained by merely requesting that it be written, especially a request that it be written before any work is done. There are those who claim formalities are unnecessary, that they should have to give nothing more than their word. When required to put their word on paper, they may feel slighted and in-sist on reciprocal written commitments from the other party.
Benefits of the Written ContractWritten contracts are enforceable, and even terms that are not read or fully appreciated by one party will be given
effect absent special circumstances.16 The software and Internet licensing agreements mentioned above are one example, as courts routinely enforce them despite their length and the cursory review users are inclined to give them.17 In the construction context, contracts are fre-quently lengthy and may incorporate specifications and other standard-form contract documents, but even if the contract contains far more material than any person would like to read in a few sittings, the parties will still be bound by its terms.18 “A contractor must stand by the words of his contract,” the US Supreme Court held in 1875, “and, if he will not read what he signs, he alone is responsible for his omission.”19
Clarity Is PossibleFor all the despair described above, it is likely that the ma-jority of terms in a contract serve their purpose without contention. The most basic terms are frequently impervi-ous to even the most diligent lawyering. Terms establish-ing the price, time of delivery or performance, payment cycle, and unit prices are prominent examples. By estab-lishing these fundamentals of the deal, parties can ensure that their disputes will mainly occur at the margins.
Ambiguous Terms May Set Outer BoundsAlthough certain terms may not be as specific as the parties would like, they may be sufficient to prevent enforcement of a completely contrary rule. Thus, a provision barring another party from recovering consequential damages or setting a financial limit on damages might be destined for dispute, but it might at least prevent a party from claiming the most onerous consequences of a breach.
Unwritten Contract May Be UnenforceableAt a more practical level, many contracts are unenforce-able unless they are put in writing. A prominent example in the construction industry is the common rule that oral contracts are unenforceable pursuant to the statute of frauds if, by their terms, they cannot be performed with-in one year.20 Likewise, under the Uniform Commercial Code, a contract for the sale of goods for the price of $500 or more is generally not enforceable unless it is in writ-ing and signed by the party against whom enforcement is sought.21 Even where oral agreements are not expressly
The flip side of the impossibility of addressing every issue is that parties are also sure to spend a great deal of time addressing issues that will never be a problem for anyone.
barred, strict rules of interpretation may make them very difficult to enforce. For instance, courts have held that a contract providing for indemnification “must be strictly construed to avoid reading into it a duty which the parties did not intend to be assumed.”22 If an agreement to in-demnify is not in writing, courts applying this rule might be very reluctant to enforce it.
Written Contract May Be Necessary to Overcome Default TermsA common justification for written contracts is that they are needed to change the default rules for a given agree-ment. These often include “silver bullet” words or phras-es, such as “time is of the essence,” “protect, defend, in-demnify and save harmless,” and “without prejudice.” As noted above, gap-filling is a prominent judicial function in contractual interpretation, and much of that gap-fill-ing function consists of developing and applying default rules or enforceable terms that circumvent or change such rules. In addition, there can be statutes that provide de-fault rules. If parties do not wish such default rules to ap-ply to them, they are best advised to put their decision in writing.
A prominent example of a “default rule” that parties frequently change is the common law rule that contrac-tors bear the risks of differing site conditions. This cre-ates a number of problems that parties frequently address by contracting to shift the risk onto owners.23 Parties also regularly agree to “waiver of subrogation” clauses, which is a change made in order to avoid litigation where insur-ance covers a loss.24 Progress payments are another ex-ample, as parties agree that payment should be made in installments, rather than in a lump sum at the beginning or end of a project.25
Drafting Written Contract Can Be Useful Project PlanningAlthough the process of drafting a contract can be costly and long, it also constitutes a valuable planning process. As the parties consider and debate which terms to include in the contract and how to word them, they are forced to consider and plan how they will perform on the proj-ect. The parties will address issues such as which party will be responsible for addressing various situations that
might arise in the future, the processes the parties will use to manage and administer the project, the consequences of failure or unforeseen events, and the limits of their own ability or appetite to accept risk and consequences. If parties discuss and agree on who will have responsibil-ity for various contingencies that might arise, it is more likely those contingencies will be addressed promptly and efficiently as they arise. If the parties discuss and agree on procedures for the proper flow of information and documentation in advance, it increases the likelihood that these processes will proceed efficiently and in a manner that makes sense for both parties. As a result, holes that may have proven costly in the long run can be plugged at an early stage.
A key function of contracting is to require parties to provide information to each other so the parties can use that information to allocate responsibilities and risks. For example, the obvious role of representations and warran-ties is to create consequences for inconsistent behavior, but such provisions also constitute carefully constructed communications regarding the contracting parties’ under-standing of their own circumstances. A contracting party is less likely to agree to a particular contract term unless it believes it can abide by that term; thus, agreeing to that term constitutes a valuable, formalized piece of informa-tion for the opposite party.26
Proof of the Deal Is Stronger When in WritingEven outside of examples of contracts that cannot be en-forced, some oral agreements may run into simple proof problems that render them unenforceable as a matter of practice. In the best of times, agreements for complex commercial projects contain too many terms for any indi-vidual to remember everything accurately, and memories are of even less value if the individuals involved are no longer available. Once a project fails and expensive litiga-tion looms, parties’ memories of an agreement are signifi-cantly less likely to match, whether there is an innocent disagreement or someone has succumbed to the tempta-tion of changing the terms when there is no documenta-tion to disprove oral testimony. At that point, having “a record of the terms of the agreement of the parties” that is “not easily impeached, and thereby to avoid subsequent disputes and conflicting testimony and claims regarding its terms and their meaning,” as the Eighth Circuit wrote, may be the preferable solution—at least for the winning party.27
Particular Interpretation ProblemsResolving Conflicts Between Prime Contract and SubcontractsMinor differences between the prime contract and sub-contracts can create major problems. For instance, where the prime contract requires a general contractor to do more than the subcontract requires a subcontractor to do, the resulting “scope gap” is a likely source of conflict. The general contractor will often expect the subcontractor to
If an agreement to indemnify is not in writing, courts
applying this rule might be very reluctant to enforce it.
honor the broad obligations in the prime contract, while the subcontractor will want to limit its performance to those items specifically set out in its subcontract. The sub-contractor might not expect to be responsible for provid-ing things that are generally applicable to the entire proj-ect, such as safety personnel, medical facilities, or lifts and hoists. The owner and general contractor will face project paralysis, the subcontractor will feel disadvantaged, and the general contractor will face a high likelihood of li-ability from both parties. As another example, consider a case where a prime contract contains a requirement to arbitrate, while a subcontract does not. If a dispute arises in connection with the subcontractor’s work, the subcon-tractor may nonetheless be able to stand by or proceed in parallel via litigation while the owner and contractor work through the dispute resolution process, with the subcontractor adjusting its litigation strategy based on the outcome.
One way of addressing this problem is the use of “in-corporation by reference” and “flow-down” clauses in the subcontracts. Incorporation by reference clauses simply state that some or all of another document is incorpo-rated into the contract at issue. Flow-down clauses are similar (similar enough that they are frequently treated as a type of incorporation by reference clause), providing that the subcontractor assumes toward the contractor all obligations the contractor assumes toward the owner and architect.28
Although straightforward in theory, three key concerns arise in the implementation of these clauses. First, par-ties occasionally fail to provide the language needed for effective incorporation. Second, if a subcontract expressly incorporates a particular portion of the prime contract, it is not always clear whether related terms of the prime contract are also incorporated. Third, a subcontract may state that the prime contract is incorporated generally, or that the subcontractor assumes the same obligations as the contractor assumed, but many terms of a prime contract make no sense when applied to the relationship between the general contractor and a subcontractor, leav-ing a court or other adjudicator to sort out which should actually apply.
Addressing the first concern—the language required to effect incorporation—is a matter of determining the level of “reference” needed to successfully incorporate a document. In general, courts hold that merely mention-ing another document is not enough to incorporate it. Instead, the incorporating document must expressly state an intention to be bound by the terms of the collateral document.29 The collateral document need not be con-temporaneous or signed, but it is likely to require that the subcontractor be provided with a copy of the document being incorporated, which may contain other information that is sensitive and has to be redacted.30
The leading answer to the second question—whether incorporation by reference of a particular term also incor-porates related terms—is that incorporation by reference
is only effective as to the particular purpose addressed in the incorporation provision.31 This was the situation in the most prominent case to address incorporation by reference, the US Supreme Court’s 1916 Guerini Stone Co. v. P.J. Carlin Construction Co. decision.32 There, the subcontractor agreed to carry out its work “agreeable to the drawings and specifications made by the [owner’s] architect.”33 The Court held that this provision only in-corporated the drawings and specifications, not the other provisions of the prime contract, establishing a rule that “a reference by the contracting parties to an extraneous writing for a particular purpose makes it a part of their agreement only for the purpose specified.”34 The Guerini holding has since become the prevailing rule.35
For the third question—how to determine which claus-es to apply in the case of a general flow-down or incorpo-ration by reference clause—most courts have declined to develop a bright-line answer. Instead, the general rule is that incorporation by reference is only effective for those provisions that have a reasonably clear and ascertainable meaning.36 Where courts have established clear rules, they have divided contract provisions into those that relate to the nature of the work and those that are administrative or procedural. In S. Leo Harmonay, Inc. v. Binks Manu-facturing Co., Inc., the court found that incorporation clauses in a subcontract “bind a subcontractor only to the prime contract provisions relating to the scope, quality, character, and manner of the work to be performed by the subcontractor.”37 Accordingly, the court held, more administrative or procedural clauses—in that case, a “no damage for delay” clause—did not apply.38 A simi-lar tendency arises among courts dealing with flow-down clauses, as they frequently hold that flow-down clauses are effective for provisions related to the scope of work, if not always the others.39
A few practice pointers flow from these rules. First, parties should recognize that merely referring to another contract is unlikely to be effective to incorporate it by ref-erence. They should clearly state that they intend for it to be incorporated by reference. Second, if there are particu-lar terms the parties want to be certain are incorporated, they may wish to identify such terms expressly because a general incorporation by reference or flow-down clause may not be effective for all terms. This suggestion is sub-ject to reasonableness considerations, as going to great
In general, courts hold that merely mentioning another document is not enough to incorporate it.
lengths to identify particular provisions could defeat one of the principal purposes of incorporation by reference and flow-down clauses, which is to save the parties the trouble of having to spell out contract terms in one docu-ment that have already been provided in another. Third, subcontractors may wish to demand that any flow-down clause be reciprocal, meaning the subcontract should re-quire the contractor to assume toward the subcontractor the same obligations that the owner assumes toward the contractor.40
Order of Precedence ClausesIt is common in contracting to include a clause establishing an order of precedence among the contract documents in case there is a conflict among their respective terms. This seems particularly sensible for large construction projects, where the array of contracts, specifications, drawings, computer models, subcontracts, schedules, change orders, amendments, and other materials create innumerable op-portunities for inconsistency. Nonetheless, the American Institute of Architects (AIA) has chosen not to include an order of precedence clause in its standard forms, in-stead providing that contract documents are meant to be complementary:
The intent of the Contract Documents is to include all items necessary for the proper execution and completion of the Work by the Contractor. The Contract Documents are complementary, and what is required by one shall be as binding as if required by all; performance by the Con-tractor shall be required only to the extent consistent with the Contract Documents and reasonably inferable from them as being necessary to produce the intended results.41
However, the AIA does recognize that an order of pre-cedence may be justified in certain circumstances, so its Guide for Supplementary Conditions, A503-2007, pro-vides the following model language:
§ 1.2.1.1 In the event of conflicts or discrepancies among the Contract Documents, interpretations will be based on the follow priorities:
.1 Modifications.
.2 The Agreement.
.3 Addenda, with those of later date having
precedence over those of earlier date..4 The Supplementary Conditions..5 The General Conditions of the Contract for
Construction..6 Division 1 of the Specifications..7 Drawings and Divisions 2-49 of the Specifications..8 Other documents specifically enumerated in the
Agreement as part of the Contract Documents.
In the case of conflicts or discrepancies between Drawings and Divisions 2-49 of the Specifications, or within or among the Contract Documents and not clarified by Addendum, the Architect will determine which takes precedence in accordance with Sections 4.2.11, 4.2.12, and 4.2.13.
Some commentators have argued the general preference should be in favor of including precedence provisions like this one.42 When preparing such provisions, however, par-ties will want to carefully consider which provisions they consider to be high priorities and then rank the docu-ments in a way that prevents their documents from be-coming buried.43
Limitation of Liability ClausesThere are a number of different types of limitation of li-ability clauses. The most common variety excludes some combination of “indirect,” “special,” “consequential,” and “incidental” damages. When drafting a limitation of liability provision, parties need to be aware of two things. First, they need to know the vocabulary. There are several categories of damages that may be limited or allowed, and parties must fully understand them in order to compre-hend, at least in theory, what they are protecting them-selves from or giving up. Second, they need to recognize that, regardless of how clear the categories are in theory, in practice it can be very difficult to determine what dam-ages fit in which categories.
For the purposes of a liability limitation clause, the basic categories of damages are direct, indirect, special, consequential, and incidental.
• Directorgeneraldamages:Theterms“direct”and“general” damages are frequently used interchange-ably. They include damages that necessarily or natu-rally flow from a breach. If any intervening acts are required to cause the damage, then it is not direct. Or, as one major treatise puts it, general damages include “damages that would follow any breach of similar character in the usual course of events.”44
• Indirect, special, and consequential damages: Al-though there are slight variations, these three terms are generally treated as having a similar meaning. They include damages that occur as a result of a breach, but only because of the particular circum-stances surrounding the breach. A typical defining characteristic is that such damages result from some intervening cause, rather than being the necessary
It is common in contracting to include a clause establishing an order of precedence among the contract
documents in case there is a conflict among their respective terms.
consequence of the breach.45 It is important to note that indirect, special, and consequential damages are not recoverable unless they were foreseeable at the time of contracting—even in the absence of a damages limitation provision.46 Parties often con-fuse this point, mistakenly arguing that indirect, special, and consequential damages are defined by being unforeseeable at the time of contracting. As a result, they believe they can overcome a provision barring recovery of indirect, special, or consequen-tial damages simply by proving their damages were foreseeable. Williston shows the error in this reason-ing, explaining that consequential damages “include those damages that, although not an invariable re-sult of every breach of this sort, were reasonably foreseeable or contemplated by the parties at the time the contract was entered into as a probable re-sult of a breach.”47
• Incidentaldamages:Dependingonthebodyoflawthat governs the particular transaction at issue, in-cidental damages may be considered to be separate from indirect, special, and consequential damages. Under the Uniform Commercial Code, incidental damages are defined as follows:
Incidental damages resulting from the seller’s breach include expenses reasonably incurred in inspection, receipt, transportation and care and custody of good rightfully rejected, any commercially reasonable charg-es, expenses or commissions in connection with effect-ing cover and any other reasonable expense incident to the delay or other breach.48
At common law, such damages could be a subset of consequential damages.49 Under the U.C.C., however, in-cidental damages are arguably distinct from consequen-tial damages.50 As a result, for contracts that involve the sale of goods, contract drafters who want to exclude all damages other than direct damages should be sure to list incidental damages in addition to consequential, special, and indirect damages.
Although the terms appear in huge numbers of con-tracts, including many standard construction contracts, the contours of the above categories still vary widely from court to court and case to case. As Bruner & O’Connor put it, the term “consequential damages . . . does not ad-mit of any consistent interpretation.”51 The ample gray area between the categories of damages means limita-tion of damages provisions do not always reduce litiga-tion costs because plaintiffs often feel justified in seeking a wide range of damages, even if defendants feel those claims are clearly prohibited.
Thus, while drafters may not be able to foresee every kind of damage, they should take care to exclude (or in-clude) damages they can readily identify beforehand. Per-haps with this purpose in mind, the AIA expressly identi-fied several examples of damages that were excluded by
the mutual limitation of damages provision in A201-1997, General Conditions of the Contract for Construction, making sure they fall within the definition of consequen-tial damages, including, among others, damages incurred by the owner for rental expenses, lost profits, lost financ-ing, and damages incurred by the contractor for compen-sation of office personnel, lost financing, and lost profits, other than profits arising directly from the work.52 These examples were retained in the 2007 version of the docu-ment.53 Adding other types of damages to the list of those included within the definition of excluded consequential damages is particularly beneficial if one can easily foresee the possibility of the other party incurring these damages. These additional items could include loss of product or power; cost of replacement power or product; and in-creased costs of operations, maintenance, or insurance. The list can expand as the market may bear and as bright and energetic attorneys create new ways to package old damage claims trying to avoid these disclaimers.
Indemnity ClausesIndemnification provisions operate to protect one party by allocating certain risks of loss to another party. In the case of construction contracts, the indemnification provi-sion typically obligates the indemnitor to indemnify the indemnitee for losses the indemnitee suffers while acting for the indemnitor’s benefit.54 In some cases, these provi-sions are mutual, as the parties agree to indemnify each other against losses caused by their actions. A drafter may choose to use a narrow indemnification clause provid-ing indemnification for losses caused by the indemnitor’s negligence, or it may choose a broad clause providing in-demnification for all losses, including losses caused by the indemnitee’s own negligence.55 Likewise, a provision may apply only to bodily injury, death, or property damages, or it may cover losses caused by breach of warranty, will-ful misconduct, criminal behavior, or simply “any and all losses.”56
For the most part, courts enforce indemnity clauses and seek to interpret them in accordance with their plain lan-guage.57 However, as previously mentioned, many states have some form of statutory or judicial rule in place pro-hibiting or disfavoring indemnification for harms caused by the indemnitee’s negligence.58 Some states prohibit in-demnification of losses stemming from the indemnitee’s sole negligence, while others prohibit indemnification of losses stemming from any negligence of the indemnitee,
Indemnification provisions operate to protect one party by allocating certain risks of loss to another party.
even if another party’s negligence contributed.59 In some cases, states choose an evidentiary bar, holding that they will not allow indemnification for losses caused by the in-demnitee’s negligence unless the contract contains clear evidence that it provided such a right.60 Given this varia-tion, a drafter should familiarize himself with the specific state’s rules that could possibly govern a claim made un-der the indemnification provision before putting together an indemnification provision.
In addition to ensuring that its indemnification pro-vision is enforceable, a party accepting such a provision should review its insurance policy and even submit the wording to the carrier in advance to ensure that its in-demnification provision is acceptable to its insurer. Some commercial general liability policies list particular kinds of contracts for which they will provide coverage.61 For ex-ample, some insurers will not insure a policy that provides for indemnification of a party for its own negligence.62 Others may balk at covering indemnity losses resulting from provisions that are not mutual or are not designed to place the risk on the party that is in the best position to control it.63 Most policies will not indemnify for losses to the work being performed simply because it is determined to be defective. A drafter should therefore take care to en-sure that its indemnification provision does not conflict with any applicable insurance policies.64
Differing Site Conditions ClausesFor contractors bidding on a project, one of the great-est risks is that the conditions of the site will prove to be significantly different from what they expected. Such cases frequently lead to “differing site conditions” or “changed conditions” claims, meaning some physical condition—soil composition, geological structure, building materials, and the like—ultimately proved to be different from what was expected. Differing site conditions are frequently bro-ken down into two categories: Type I conditions, which are conditions that are different from what was indicated in the contract documents, and Type II conditions, which are conditions that are different from what a party would typically encounter given the type of project or other circumstances.65
Contractual “differing site conditions” or “changed conditions” clauses address this problem by providing that the owner expressly assumes the risk of differing site conditions. Therefore, if a contractor can establish the
existence of differing site conditions, it is entitled to an equitable adjustment in the form of compensation for the added cost of dealing with the changed conditions (such as the use of additional piling, foundation changes, and added cost of de-watering) and the resulting delay and, in some cases, an extension of the time for completing the work.66 From the contractor’s perspective, this approach reduces a project’s risks, while from the owner’s perspec-tive, it functions to reduce the cost of the project by reduc-ing the need for a contractor to include a contingency in its bid.67
The chief difficulty in interpreting a “differing site condi-tions” clause is, of course, determining when site conditions have changed enough to trigger the provision’s compensa-tion and time adjustment terms. For Type I changes—those in which site conditions vary from what was indicated in the contract—this determination requires a review of sev-eral elements, including what was indicated in the contract documents, whether the actual conditions differed ma-terially from what the contract documents provided, and whether the contractor should have foreseen that the actual conditions would vary from the contract description (that is, whether the contractor “reasonably relied” on the con-tract documents).68 For Type II changes—those in which the conditions differed from those typically encountered—the determination requires a review of the site conditions that were reasonably anticipated and then a comparison of those conditions to the actual site conditions.69 Both of these investigations involve significant testing of the site, expert analysis, and the uncertainty and expense of potential litigation as parties try to sort out what the con-tractor should have reasonably expected, what is typical in similar projects, and what the contract documents actually indicated. Thus, while differing site conditions provisions may reduce initial costs by reducing initial bids, they leave a number of problems in place.
In that light, parties have employed several common tactics for limiting liability related to changed site con-ditions. These include provisions requiring the contrac-tor to inspect the site and disclaiming liability for any differing site conditions the contractor should have rec-ognized during that inspection.70 For instance, the con-tractor may be required to assume the risk of naturally occurring obstructions such as rock, while the owner ac-cepts the risk of unknown man-made obstructions, such as buried foundations or utility lines. Similar provisions require contractors to closely review contract documents and identify any obvious errors.71 Such provisions may be very effective in generating additional information that prevents subsequent differing site conditions claims, but there are limits on their effectiveness. Most impor-tantly, the parties may still disagree as to whether the contractor should have discovered the condition during its investigation. In addition, a contractor will often be relieved of liability under such a provision if the owner had actual knowledge of the site conditions, opening an-other avenue for dispute.72
Parties have employed several common tactics for limiting liability related to changed site conditions.
Contract Interpretation at TrialIn general, questions of contractual interpretation are re-solved by judges on summary judgment motions, so they never reach a jury. Moreover, the “four-corners” rule of contractual interpretation generally bars the admission of extrinsic evidence in interpreting contracts, so there is frequently no evidence for juries to weigh in a contract in-terpretation case. In fact, Richard Posner argues, the pur-pose of the “four-corners” rule is to limit the role of juries because courts want to prevent juries from ignoring the plain language of a contract to reach their desired result.73
Where extrinsic evidence is admissible, most courts hold that juries are required to determine the evidence’s existence and importance.74 The stated rationale for this division is that an ambiguous contract presents a factu-al question as to the intent of the parties in entering the contract.75 Courts typically instruct the jury on assessing the purpose of the contract as a whole, the rules of con-tract construction, and extrinsic evidence of intent and meaning.76
In some cases, yes, the drafter can be called to testi-fy as to intent. In fact, historically, the testimony of the person who drafted the contract may have been given particular weight as to the parties’ intent in certain con-texts.77 Recently, however, courts have looked at such evi-dence much more skeptically. If they allow the evidence in at all, courts tend to view such testimony as likely to be subject to charges of bias.78 This skepticism fits with the common rule that if the meaning of an ambiguous contract term cannot be determined by any other means, it is to be interpreted against the drafter, under the rule of contra preferentem.79 Of course, this doctrine has had the power to generate new contract provisions, usually saying that the contract was drafted by both parties and neither should be considered to be the drafter, even if the contract has been drafted 100 percent by one side.
Proceed With CareMovie mogul Samuel Goldwyn famously opined that “a verbal contract isn’t worth the paper it’s printed on.” As is clear to many parties who have been through contract liti-gation, however, some written agreements may be worth even less, especially considering what the parties actually had to pay for the paper. That said, few parties are willing to start a complex construction project based on a hand-shake alone. Perhaps they do so for academic reasons, or perhaps simply because they follow the advice of Finley Peter Dunne: “Trust everyone, but cut the cards.” In either case, parties would be well-served to consider some of the difficult issues and provisions identified above and then proceed with care.
Endnotes1. Bailey v. Lisle Mfg. Co., 238 F. 257, 266 (8th Cir. 1916).2. Debra Cassens Weiss, Chief Justice Roberts Admits He
Doesn’t Read the Computer Fine Print, ABA J., Oct. 20, 2010, www.abajournal.com/news/chief_justice_roberts_admits_ he_doesnt_read_the_computer_fine_print. As stated in the
article:Answering a student question, Roberts admitted he doesn’t
usually read the computer jargon that is a condition of accessing websites, and gave another example of fine print: the literature that accompanies medications, the AP story reports.
It has “the smallest type you can imagine and you unfold it like a map,” he said. “It is a problem,” he added, “because the legal system obviously is to blame for that.” Providing too much information defeats the purpose of disclosure, since no one reads it, he said. “What the answer is,” he said, “I don’t know.”
3. And yet the buyers are bound by such agreements. With the long user and licensee agreements, at least one side—the seller—has definitely read and carefully crafted the agreement, and the courts have frequently enforced them. See, e.g., ProCD, Inc. v. Zeidenberg, 86 F.3d 1447, 1449 (7th Cir. 1996) (noting that “[s]hrinkwrap licenses are enforceable unless their terms are objectionable on grounds applicable to contracts in general); CoStar Realty Info., Inc. v. Field, 612 F. Supp. 2d 660, 669 (D. Md. 2009) (citing cases in the context of Internet “clickwrap” agreements). Although Supreme Court Chief Justice Roberts has admitted he does not read these agreements (see supra note 2), that is not the same as saying that he would not enforce such agreements.
4. See, e.g., Lively v. Drake, 629 S.W.2d 900 (Tenn. 1982) (holding that subsequent course of dealing could serve to mod-ify terms of a written contract). But see Deerfield Commodities v. Nerco, Inc., 696 P.2d 1096, 1109 (Or. Ct. App. 1985) (holding that the court could not adopt an interpretation of a contract that was contrary to the contract’s clear provisions based on par-ties’ course of dealing).
5. See Claire A. Hill, A Comment on Language and Norms in Complex Business Contracting, 77 Chi.-Kent L. Rev. 29 (2001).
6. Jacobellis v. Ohio, 378 U.S. 184, 197 (1964). 7. See id. (“I shall not today attempt further to define the
kinds of material I understand to be embraced within that short-hand description; and perhaps I could never succeed in intelligi-bly doing so.”); Hill, supra note 5, at 33 n.8.
8. See AM Int’l, Inc. v. Graphic Mgmt. Assocs., Inc., 44 F.3d 572, 575 (7th Cir. 1995) (“[C]larity in a contract is a property of the correspondence between the contract and the things or ac-tivities that it regulates, and not just of the semantic surface.”); Richard A. Posner, The Law and Economics of Contract Inter-pretation, 83 tex. L. Rev. 1581, 1597 (2005) (“[A] contract’s words point out to the real world, and the real world may con-tain features that make seemingly clear words, sentences, and even entire documents ambiguous.”).
9. “I said there was a society of men among us, bred up from their youth in the act of proving, by words multiplied for the purpose, that white is black and black is white.” Jonathan Swift, GuLLiveR’S tRaveLS pt. 4, ch. 5.
10. Perhaps the only reliable advice on predicting the future for construction lawyers is this, from author John Sladek: “The future, according to some scientists, will be exactly like the past, only far more expensive.”
11. See Posner, supra note 8, at 1,584–85.12. See, e.g., Centex Homes v. Buecher, 95 S.W.3d 266 (Tex.
2002) (“We agree with the court of appeals that the implied warranty of habitability cannot be waived except under limited circumstances not implicated here.”); United States v. Spearin, 248 U.S. 132 (1918) (the implied warranty of the adequacy of specifications “cannot be overcome by the general clauses re-quiring the contractor, to examine the site, to check up the plans, and to assume responsibility for the work until completion and acceptance”).
1998 Supp.). See also Dresser Indus., Inc. v. Page Petroleum, Inc., 853 S.W.2d 505 (Tex. 1993) (discussing Texas’s strong “fair notice” requirements for agreements providing for indemnifica-tion of a party for its own negligence).
16. An example of the special circumstances is where a court has permitted the admission of parol evidence, and it is shown that the promisor knew or should have known that the promisee did not understand the promise as he did. In that case, the un-derstanding of the promisee would prevail. See Interform Co. v. Mitchell, 575 F.2d 1270, 1276 (9th Cir. 1978). See also, e.g., Bat-ter Bldg. Materials Co. v. Krischner, 110 A.2d 464 (Conn. 1954) (identifying “accident, fraud, mistake [and] unfair dealing” as grounds for excusing a party from reading terms expressly incor-porated into a contract).
17. Supra note 3 and accompanying text.18. See, e.g., 566 New Park Assocs. v. Blardo, 906 A.2d 720
(Conn. App. 2006) (“The contract was clear that A205 was being incorporated by reference. It was the defendants’ responsibility, therefore, to become familiar with all the terms of the contract, including terms incorporated by reference.”).
19. Upton v. Tribilcock, 91 U.S. 45, 50 (1875).20. See, e.g., Minn. Stat. § 513.01 (1986); wiS. Stat. § 242.02
(1987).21. U.C.C. § 2-201(a). Note that the U.C.C. provides certain
exceptions, relaxing requirements for contracts between mer-chants, specially manufactured goods, and goods that are ac-cepted by the buyer, among others. Id. § 2-201(b), (c).
23. See infra notes 70–71 and accompanying text. 24. 4 phiLip L. bRuneR & patRiCK J. o’ConnoR JR., bRuneR
& o’ConnoR on ConStRuCtion Law § 11:192 (2010).25. 3 bRuneR & o’ConnoR, supra note 24, § 8:2. Progress
payments are just one of a number of ubiquitous aspects of con-struction contracting that only exist because parties found ways to contract around the default rule. Change orders, for one, exist because parties sought a way around the common law rule that parties must go through a full offer-and-acceptance to make a change in the project. See 1 bRuneR & o’ConnoR § 4:3.
26. See Hill, supra note 5, at 45–46.27. Bailey v. Lisle Mfg. Co., 238 F. 257, 266 (8th Cir. 1916).28. See 2 phiLip L. bRuneR & patRiCK J. o’ConnoR JR.,
bRuneR & o’ConnoR on ConStRuCtion Law § 5:126 (2002); the ConStRuCtion ContRaCtS booK 9 (Daniel S. Brenna et al. eds., 2008).
29. See, e.g., Kanter v. Boutin, 624 So. 2d 779 (Fla. 4th DCA 1993).
30. 11 wiLLiSton on ContRaCtS § 30:25, at 233–34 (4th ed. 1999).
31. 2 bRuneR & o’ConnoR, supra note 28, § 5:126.32. 240 U.S. 264 (1916).33. Id. at 266.34. Id. at 277.35. See, e.g., A.F. Lusi Constr., Inc. v. Peerless Ins. Co., 847
A.2d 254, 262 (R.I. 2004) (listing cases).36. 11 wiLLiSton on ContRaCtS, supra note 30, § 30:25, at
234.37. 597 F. Supp. 1014, 1024 (S.D.N.Y. 1984) (emphasis in
original), aff’d without op., 762 F.2d 990 (2d Cir. 1985).38. Id.39. bRuneR & o’ConnoR, supra note 28, § 5:126. For addi-
tional discussion of incorporation by reference and flow-down clauses, see T. Bart Gary, Incorporation by Reference and Flow-Down Clauses, ConStR. Law., August 1990, at 1.
40. See, e.g., the ConStRuCtion ContRaCtS booK, supra note 28, at 9. See also Gary, supra note 39, at 46–47 (discussing subcontractors’ efforts to enforce flow-down provisions in their favor).
41. General Conditions of the Contract for Construction, A201-2007, para. 1.2.1.
42. See Richard M. Shapiro, The 1987 AIA A201 General Conditions: An Owner’s View, 24 ReaL pRop. pRob. & tR. J. 523, 527 (1989–90).
43. See Susan L. McGreeny, The Myth of the One-Year War-ranty and Other Construction Warranty Issues, 19 pRob. & pRop. 41, 44 (2005) (noting that drafters of the prime contract will want to “include a clear order of precedence clause to assure that the warranty wanted is the one that controls”).
44. 24 wiLLiSton on ContRaCtS § 64:12 (4th ed. 2002).45. See, e.g., Otis Elevator Co. v. Standard Constr. Co., 92
F. Supp. 603, 609 (D.C. Minn. 1950) (identifying various dam-ages as consequential because “other circumstances enter the picture” between the breach and the loss).
46. The most famous example is the Hadley v. Baxendale case, in which a delay in the delivery of a mill crankshaft resulted in lost profits for the mill. The court held that the carrier did not have reason to know delayed delivery would result in lost profits, so the mill could not recover. 156 enG. Rep. 145 (Ex. 1854). It is important to keep in mind that the question of foreseeabil-ity is concerned with whether the harm was foreseeable at the time of contracting, not at the time of the breach. See bRuneR & o’ConnoR, supra note 28, § 5:115, at 202–03.
47. 24 wiLLiSton on ContRaCtS, supra note 44, § 64:12.48. U.C.C. § 2-715(2) (2001).49. See Commonwealth Edison Co. v. Allied Chem. Nuclear
Prods., Inc., 684 F. Supp. 1429, 1433 (N.D. Ill. 1988); dan b. dobbS, Law of ReMedieS § 12.16(4), at 379 (2d ed. 1993).
50. Compare U.C.C. § 2-715(1) (defining incidental damages), with § 2-715(2) (defining incidental damages). See also Gaynor Elec. Co. v. Hollander, 618 A.2d 532, 534 (Conn. Ct. App. 1993) (finding that a provision that barred recovery of consequential damages did not bar recovery of incidental damages).
51. bRuneR & o’ConnoR, supra note 28, § 5:115, at 206.52. AIA Document A201-1997, General Conditions of the
Contract for Construction, § 4.3.10.53. AIA Document A201-2007, General Conditions of the
Contract for Construction, § 15.1.6.54. See, e.g., Robert L. Meyers & Debra A. Perelman, Risk
Allocation Through Indemnity Obligations in Construction Con-tract, 40 S. CaR. L. Rev. 989, 990–91 (1989).
55. See bRuneR & o’ConnoR, supra note 28, § 5:87.56. Meyers & Perelman, supra note 54, at 992–93.57. See, e.g., Richard D. Brown & Mara E. Fortin, An Intro-
duction to Interpretation of Express Contractual Indemnity Pro-visions in Construction Contracts in California and Nevada Law, 32 MCGeoRGe L. Rev. 1019, 1021 (2001); Roger W. Stone & Jef-frey A. Stone, Indemnity in Iowa Construction Law, 54 dRaKe L. Rev. 125, 131 (2005). There are some variations in the “plain language” rule, as some states strictly construe indemnification provisions against the drafter or, in some cases, in favor of the indemnitor. See, e.g., Brown & Fortin, supra, at 1026; Stone & Stone, supra, at 132.
58. Though this is the primary kind of unenforceable clause, there are others. For instance, an “open-ended” indemnification provision (that is, one that is not bounded by time or amount) may not be enforceable against the US government under the Anti-Deficiency Act. See, e.g., EI Du Pont de Nemours & Co., Inc. v. United States, 365 F.3d 1367 (Fed. Cir. 2004).
59. See Allen H. Gwyn & Paul E. Davis, Fifty-State Survey of Anti-Indemnity Statutes and Related Case Law, 23 ConStR. Law. 26, 26 (2003) (listing, as of 2006, 18 states in the first category and 16 states in the second).
60. See, e.g., Brown & Fortin, supra note 57, at 994; Stone & Stone, supra note 57, at 132.
61. Meyers & Perelman, supra note 54, at 998–99. 62. See, e.g., David B. Ratterman, Managing Risk: Insurance
and Indemnity Clauses in Construction Contracts, Mod. SteeL ConStR. (Apr. 2003). Cf. Meyers & Perelman, supra note 54, at 999 (explaining that more insurers are providing coverage for such clauses as fewer courts are agreeing to enforce them).
63. See Ratterman, supra note 62.64. In the alternative, to reduce the chances coverage will be
denied, a party may consider purchasing contractual liability coverage in addition to its standard CGL coverage. See Meyers & Perelman, supra note 54, at 999.
65. See, e.g., AIA Document A201-2007, General Conditions of the Contract for Construction, § 3.7.4; Gregory H. McClure, Differing Site Conditions: Evaluating the Material Difference, 15 pub. Cont. L.J. 138, 139–40 (1984).
66. See SMith, CuRRie & hanCoCK’S CoMMon SenSe Con-StRuCtion Law 250–51 (4th ed. 2009).
67. See, e.g., Iacobelli Constr., Inc. v. Cnty. of Monroe, 32 F.3d 19, 23 (2d Cir. 1994); SMith, CuRRie & hanCoCK’S CoM-Mon SenSe ConStRuCtion Law, supra note 66, at 250; Steven B. Lesser & Daniel L. Wallach, The Twelve Deadly Sins: An Own-er’s Guide to Avoiding Liability for Implied Obligations During the Construction of a Project, ConStR. Law., Winter 2008, at 15.
68. See, e.g., Int’l Tech. Corp. v. Winter, 523 F.3d 1341, 1348–49 (Fed. Cir. 2008); SMith, CuRRie & hanCoCK’S fedeRaL GoveRnMent ConStRuCtion ContRaCtS 259 (5th ed. 2010); Jef-frey M. Chu, Differing Site Conditions: Whose Risk Are They? ConStR. Law., April 2000, at 5.
69. SMith, CuRRie & hanCoCK’S fedeRaL GoveRnMent ConStRuCtion ContRaCtS, supra note 68, at 262; Chu, supra note 68, at 5.
70. See Timothy S. Fisher et al., Top Ten Most Important Clauses of a Construction Contract, 72 def. CounSeL J. 250, 257 (2005); Lesser & Wallach, supra note 67, at 18.
71. See Fisher et al., supra note 70, at 257.72. See Lesser & Wallach, supra note 67, at 18; Fisher et
al., supra note 70 at 257 (noting that owners should be certain to divulge all information in their possession at the time of contracting).
73. See Posner, supra note 8, 1596–97; 3 E. aLLan faRn-SwoRth, faRnSwoRth on ContRaCtS § 7.2, at 223 (3d ed. 2004) (the party that presents spoken words against a written contract tends to be viewed as the underdog, and “jurors tend to favor the underdog in spite of the unreliability as evidence of spoken words when given months or years later”).
74. See, e.g., Klapp v. United Ins. Grp. Agency, Inc., 663 N.W.2d 447, 454 (Mich. 2003) (“Where a contract is to be con-strued by its terms alone, it is the duty of the court to interpret it; but where its meaning is obscure and its construction depends upon other and extrinsic facts in connection with what is writ-ten, the question of interpretation should be submitted to the jury.”) (quoting O’Connor v. March Automatic Irrigation Co., 218 N.W. 784 (Mich. 1928); Berryhill v. Hatt, 428 N.W.2d 647 (Iowa 1988)).
75. 11 wiLLiSton on ContRaCtS, supra note 44, § 30:7, at 87–91.
76. Id.77. See Papineau v. Gurd, (1851) 2 Grant, Ch. (U.C.) 515;
Bullen v. Renwick, (1862) 9 Grant, Ch. (U.C.) 202.78. See, e.g., In re Friedman, 64 A.D.2d 70 (N.Y. App. Div.
