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Subcontractor Beware: Five Commonly Misinterpreted Contract Terms

The internet age allows both homeowners and contractors to have a contract in hand in moments. Contracts come in all different forms and can include several clauses and terms that can be confusing. Whether a contractor has used the same set of documents for the entire duration of his or her career or they just recently got started using a form set recommended from a peer, it is important to understand what parties are agreeing to before work begins. Avoiding misinterpreting a clause at the beginning of a project goes a long way in ensuring a positive outcome for all parties involved once the work is complete. 

Here is an explanation of five commonly misinterpreted items on a contract in order to have a better understanding of what is being agreed to when parties sign on the dotted line.

1. Incorporation Clauses.

The incorporation clause can be taken literally in its meaning. It exists in order to incorporate other documents into the agreement. The key is knowing what documents are being incorporated via the clause. A well written incorporation clause will make reference to the other documents that are becoming part of the agreement. It is always best to review all of the documents being incorporated via this clause. This is especially true for any subcontracting agreement. An incorporation clause in a subcontracting agreement may incorporate an agreement between the general contractor and the contracting party with terms and conditions that fall far outside the subcontractor's scope of work. Any contract with an incorporation clause should signal to the parties to review the agreements being incorporated.

2. Pay-if-Paid vs. Pay-when-Paid

The pay-if-paid and pay-when-paid clauses are also especially relevant for subcontractors. A pay-if-paid clause states that a general contractor only has to pay a subcontractor if the general is paid for the work. A pay-when-paid clause states that upon receiving payment for the work, a general contractor will then pay a subcontractor. Signing a contract with either of these clauses moves the subcontractor down the line when it comes to being paid for the work done. In order to ensure payment for work provided, avoid contracts with these clauses, especially a pay-if-paid clause.

3. Change Order Requirements

Minnesota law requires that all change orders provided by licensed residential contractors be in writing. Many contracts will explicitly state the same but it is important to enforce this clause in practice. When a job starts, parties must not focus solely on the finish line. This can lead to a situation where a change in the scope of work is agreed upon orally but never put into writing in the interest of time. If a dispute arises once the work is complete, proving a change was approved without the necessary paperwork can be difficult. Always ensure change order clauses are enforced, even if it means extending a project window.

4. Indemnification and Defense Clauses

The indemnification clause is a powerful tool that should be included in any construction contract. Essentially, the clause requires one of the contracting parties to take responsibility for liability resulting from a third-party claim against the other party in the contract. Indemnification clauses come in all shapes and sizes and can be broad. If you are unclear about the scope of an indemnification clause in your contract, contact your attorney for an explanation. Sometimes the indemnification clause includes language about defending against a third-party claim or such a clause may appear on its own. The key difference between the indemnification and defense clause is that a defense clause calls for the party agreeing to it to pay all the legal fees incurred as part of the lawsuit. A stand-alone indemnification clause calls for a contracting party to pay a third-party judgement. The difference in cost can be substantial.

5. Mechanic's Liens

A mechanic's lien allows a contractor to attach a lien on a piece of property as a means to preserve a remedy for non-payment upon completion of the work. In Minnesota, a contractor should always provide a pre-lien notice in a written contract in order to preserve its mechanic's lien rights. If the notice is not provided via the proper means outlined in Minn. Stat. § 514.011, the contractor loses its right to file a mechanic's lien.

Contracts are often long and difficult to comprehend but it's important to know what is being agreed upon before signing.Follow the tips above for clarity but if questions remain, be sure to seek counsel in order to understand what your responsibilities are.

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