12 minute read
Managing Risk with Contracts
Jeffrey W. King, Outside General Counsel for the WFCA Jeffrey King has more than 35 years’ experience in complex litigation with a focus on contracts, employment, construction, antitrust, intellectual property and health care. He serves as legal counsel for WFCA and other trade associations, and is a LEED Accredited Professional. For more information, contact him at (561) 278-0035 or jeffw@jkingesq.com.
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—Denis Waitley, American motivational speaker and author
Every flooring retailer, contractor, and installer faces risks in doing business. Some may involve damage to a facility, equipment, or inventory. Others may be safety hazards that lead to worker accidents and injuries. There are also the risks of supply chain delays, or material price increases. There is simply no way to eliminate risk from uncertain and unexpected events that could affect success — but it can be managed to minimize the risk.
When a business thinks of risk management, it often focuses on insurance and safety programs. Without doubt, insurance and safety programs are major elements of any risk management plan. There are risks, however, that are neither covered by insurance nor involve safety hazards. These could be unanticipated increases in material costs; a claim for consequential damages because of a delay in getting materials; nonpayment by a customer or general contractor; and a myriad of similar problems. These risks can often be managed by well written contracts.
Contracts
One of the most important risk management tools are the contracts that flooring retailers and contractors enter into with supplier, subcontractors, and customers. These contracts can allocate certain risks so that the party best able to control and manage the risk bear the responsibility. For example, a flooring retailer will want to allocate the risk that someone is hurt while installing the floors to the installation contractor, who is in the best position to provide a safe work site. The flooring retailer or contractor will want to allocate the risk of design errors to the owner, who may have a contract with a designer or insists on installing certain types of flooring. These are the kinds of risks that a contract should address, so that the parties know in advance who is responsible for what risk.
Indemnity Clause: An indemnity provision generally requires one party to pay for losses as a result of claims made by third parties. For example, the contract with the installation contractor should require the contractor to defend and indemnify the retailer against claims of improper installation and for any installation defects. To ensure that the indemnity clause covers all potential costs, the clause should require the other party to “indemnify, defend, and hold harmless” the other party. This requires the responsible party to pay any damages (“indemnify”), to pay the legal fees and costs to defend against any claims (“defend”) and to preclude the other party from filing a claim against the retailer or contractor (“hold harmless”). A standard clause includes such language as:
The parties agree to indemnify, defend and hold harmless the other from any and all claims, actions, damages, liabilities, costs and expenses, including reasonable attorney’s fees and expenses, for death or bodily injury, or the damages to or loss of destruction of any real or tangible personal property arising out of or in connection with the indemnitor’s negligence or willful misconduct in the performance of this Agreement or any amendments entered into pursuant to this Agreement.
Depending on the circumstances, it may be appropriateto specify other allocations of responsibility. For example,if the owner insists on using a certain flooring product,the agreement could provide that:
The Owner has selected and insisted on installing[specific] flooring, and agrees to indemnify, defend and hold harmless the Flooring Retailer/Contractor/Installer from any and all claims, actions, damages, liabilities, costs and expenses, including reasonable attorney’s fees and expenses, if the product fails or is determined to be inappropriate for the use of the flooring product
Every contract should be reviewed to ensure a fair allocation of responsibility.
Insurance: Contractual indemnity provisions included in contracts are only as good as the indemnitor’s ability to pay for its indemnification obligations. Accordingly, when transferring risk through an indemnity provision, it is important to ensure that the indemnitor has, or is able to procure, insurance coverage sufficient to pay for the assumed indemnity obligations. A standard clause often reads:
During the term of this agreement the Subcontractor shall maintain in full force and effect general liability insurance for a minimum of $ XXXX for any one occurrence. Such insurance shall name Flooring Dealer/Contractor as an additional insured but only with respect to this agreement. The Subcontractor shall provide Flooring Dealer/Contractor with evidence of insurance upon request, and shall provide at least thirty (30) days’ prior written notice of material change to, cancellation, or non-renewal of the policy.
Waivers of subrogation: Subrogation allows an insurer to stand in the position of its insured and to sue the other party to recover amounts paid on behalf of the insured. The indemnity provision discussed above allocates responsibilities and risks. Allowing an insurer to recover amounts paid on behalf of a party to whom that risk was shifted would undermine the parties’ intentions. A waiver of subrogation precludes the insurer from seeking reimbursement for amounts paid on claims, and thus prevents an insurer from passing assigned risk back to the other party. In other words, a waiver of subrogation ensures that allocation of risk stays with the insurers as contemplated by the parties.
Where applicable, contracts should include waivers of subrogation to ensure that project risks are transferred in the manner intended by the project participants. A typical subrogation waiver that reads:
Waiver of Subrogation. Each party agrees to waive any and all rights of subrogation against the other party and their insurers for any losses covered by, or required to be covered by, insurance under the terms of this Agreement. Each party agrees that its insurance companies shall have no right of subrogation against the other on account of this release.
The standard AIA contract also includes a waiver of subrogation that can be used. See Standard AIA contractA102.
Force Majeure: Force majeure is an unforeseeable circumstance that prevents someone from fulfilling a contractual obligation. A force majeure clause can excuse a delay, and may allow the retailer or contractor to terminate an agreement. Many contracts include a force majeure or a delay clause, but the language of what is covered can vary. Generally, a force majeure clause covers unforeseeable acts such as “government action,” “acts of God,” “civil disturbances,” “fires,” and similar occurrences. After the delays and cost increases experienced with COVID-19, it is important to cover infectious pandemics and supply chain delays. 1
Either party shall be excused from delays in performing or from its failure to perform here under to the extent that such delays or failures result from a Force Majeure Event. A Force Majeure Event is hereby defined as an event which is beyond a party’s control, could not have been reasonably foreseen when the parties executed this Agreement, and prevents or substantially inhibit performance, and shall include but not be limited to the following: an act of God or public enemies; declared or undeclared war; civil disobedience or disturbance; epidemic or infectious pandemics; natural catastrophes,; fire; order, restraint or prohibition of a governmental authority having jurisdiction over the services of the parties, their agent, officers, directors or employees, or subcontractors; and delays due to such events. Upon the occurrence of a Force Majeure Event Agency shall notify Client in writing of same identifying the reason performance should be excused and an approximate date by which performance can be completed.
Material Price Increases and Supply Delays: The potential of an increase in the cost of materials is a risk for many businesses. An unanticipated price increase in flooring or sundries can turn a profitable sale into a loss. Similarly, potential delays and disruption of supply chains can lead to increased costs or an inability to perform the contract on time. If possible, flooring retailers and contractors should try to lock in its material cost for each project. Recognizing that is not always possible, flooring retailers and contractors should consider including an escalation clause in its contracts with its customers that allows the retailer or contractor to pass on any increase in the goods sold.
The contract provisions, known as a materials price increase clause, often allow a pass through of a cost increase over a certain amount. For example. A material price increase provision often provides that:
When the price for any item of materials to be used on the Project increases _____ percent (__%) or more between Contract signing and materials purchase, Customer shall pay to Contractor, on request, all sums by which the cost to Contractor for any materials item has increased beyond __%, as demonstrated by Contractor. This includes but is not limited to price increases in lumber, plywood, flooring materials, installation materials, fuel, manufactured products and equipment.
Pay if Paid v. Paid When Paid: Subcontracts to supply or install flooring often provided that the retailer, contractor, or installer are paid “if” or “when.” These provisions are generally understood to shift the risk of an owner not paying the prime contractor to the subcontractor. The fact, however, is that there may be a significant difference between a paid-when-paid and a paid-if-paid clause.
The courts in most states consider a “pay-when paid” clause as simply a timing mechanism and generally will not excuse the prime contractor from paying the subcontractor, whether or not the owner pays the prime contractor. The risk of non-payment is on the prime contractor and the courts will generally require payment to the subcontractor within a “reasonable time” after the work is completed.
In contrast, courts generally have found that a “pay if-paid” clause constitutes a condition precedent to the subcontractor’s payment. A pay-if-paid provision means exactly what is says: the prime contractor has no obligation to pay subcontractors unless the owner first pays the prime contractor. This can create a dilemma for a subcontractor. Since the subcontractor has no contract with the owner, court will generally hold that the subcontractor cannot claim a breach of contract against the owner. Some courts have held the subcontractor’s sole remedy is against the prime contractor, who is not obligated to pay until the owner pays it. While the subcontractor may have lien rights against the owner, there are a number of problems with attempts to file and enforce such liens. 2
Consequential Damages: One of the biggest risks for flooring retailers and contractors face on construction projects is liability for consequential damages. Regular damages directly flow from the breach of contract, such as the cost to replace a defective floor. Consequential damages, on the other hand, are damages that flow indirectly from a breach of contract and are typically related to delays in performance or the loss of use of home or facility while repairing defective flooring installation. For example, casino was awarded $14,500,000 in damages for lost profits arising from a delay in remodeling the casino on which the contractor was paid $600,000. Similarly, a condominium owner sought four months of rent at $23,000 a month while defective flooring was being removed and replaced.
It is important that the flooring retailer and contractor include a waiver of consequential damages. The standard AIA contract includes a mutual waiver of consequential damages.
The Flooring Retailer/Contractor and Owner waive claims against each other for consequential damages arising out of or relating to this Contract. This mutual waiver includes:
.1 damages incurred by the Owner for losses of use, income, profit, financing, business and reputation, and for loss of management or employee productivity or of the services of such persons; and
.2 damages incurred by the Contractor for principal office expenses including the compensation of personnel stationed there, for losses of financing, business and reputation, and for loss of profit, except anticipated profit arising directly from the Work.
Every contractor and subcontractor should consider and evaluate the risk of consequential damages on each project. A simple clause excluding consequential damages can read:
Notwithstanding anything herein to the contrary, the Flooring Retailer/Contractor shall have no liability whatsoever for consequential, indirect, delay, special, incidental or liquidated damages whether arising in contract, tort, indemnity, warranty, strict liability or otherwise.
Other Provisions: There are other contract provisions that can help limit risk. These can include waivers of implied warranties, limiting damages to the contract price, restricting remedies, and similar clauses. Some states do not allow such waivers and restrictions. Accordingly, competent legal counsel should be consulted to review the contracts to help minimize risks.
Conclusion
While creating a risk management plan can take time and effort, effective plans can prepare a company to face and minimize risks. The key is to assess and anticipate potential risks and plan for them. Given the potential liability, every flooring retailer, contractor ,and installer should annually review its insurance coverage and its safety programs. The review should include reviewing its contracts with competent legal counsel to ensure that risks are fairly allocated and that the potential costs are minimized. ■
1. For more information on force majeure provisions and anticipated pandemics, see “Contracts in the Age of COVID-19: Some Suggestions to Protect Your Business,” Premier Flooring Retailer (3rd Quarter 2020) at
2. For more information on liens, see “Mechanic’s Liens — Little Mistakes, Big Problems,” Premier Flooring Retailer(2nd Quarter 2020) at https://issuu.com/margolocust/docs/digital_2_-_2020_premier_flooring_retailer_magazin/s/10843888.
Notice: The information contained in this article is abridged from legislation, court decisions, and administrativerulings and should not be construed as legal advice or opinion and is not a substitute for the advice of counsel.
