For many years contractors in this country worked “on a handshake” agreement with other contractors they were familiar with. Written construction contracts were simple, if they existed at all, with most agreements being verbal. But back in those days, persons and businesses treated and interacted with each other on a higher moral code than what exists today.

Today, in a constantly changing and complicated legal climate, large general contractors are forced to hire in-house risk managers to handle contract and insurance compliance, assuring that every “i” is dotted and ”t” crossed. Most subcontractors either have their own in-house designee, or they attempt to navigate the legalese on their own. Regardless of where you’re at in the proverbial food chain, construction contracts rule the day.

The Purpose of Contracts

I thought we might take a moment and explore what construction contracts are, the purposes they serve in the industry, what control you might have over the process, and the reason why having the right insurance is critical. While this will be done with a broad brush, consult your attorney regarding local laws that may apply in your given state.

Consider the situation of a company, we’ll call them ABC Drywall and Plaster, based in Somewhereville, USA. While ABC is well established in their area, known for quality work and prompt delivery, until a few years ago they really didn’t pay much attention to the construction contracts associated with their jobs. They would sign them and start the job, without really reviewing the document to be certain the terms and conditions were something they could live up to. Nor did they really understand the legal weight they carry.
One day, the GC of a certain project called and explained that their insurance was inadequate in three different areas, and they had a specified number of days to get the issues resolved. “How big of a deal is it really,” he asked. The GC’s answer was that they would be withholding payment until the issue was rectified. I’d say that’s a pretty big deal.

Unfortunately this happens far too often. Some subs feel that if signing the contract is requisite to being awarded the job, why bother reviewing it? If they have no choice in the matter, what’s the point? While this may be partly true, they have more control than they think, which we’ll get to in a moment.

ABC learned the hard way that what they agree to in writing binds them contractually, as well as materially. Now, they review each contract. When they get one that seems a bit complex or they’re entertaining participating in an OCIP (wrap), they forward it to their attorney and to other business partners who may be able to weigh in on various components. A second set of eyes never hurts.

What is a contract? It’s a legally binding agreement involving two or more parties that set forth what the involved parties will or will not do. The best type of agreements are written, although oral agreements do hold up in certain and limited circumstances. There needs to be competent parties, a mutual agreement to provide some sort of benefit to each other, the purpose of the contract must be legal in nature, and there must be an exchange that takes place (“I’ll do that if you’ll pay this.”). The purpose of a contract is to define the intent of the parties, provide a written record, force everyone to clarify the details, and provide documentation and guidance in case of a dispute. Contracts attempt to force transparency. Simply, when all else fails, the contract is the road map to resolution.

What information is contained in a contract? This is difficult to answer because, while there are standardized contracts in the industry, many are proprietary to the company that utilizes them. Often they have been crafted by their attorneys and are based not only on the expectations relative to that project, but also from past experiences. Typically, they include the scope of the work, the timeline wherein the work will be performed, performance and safety conditions, payment and retention details, an insurance section, and an indemnification clause.

Who drives the contract process? The owner/developer will contract with the GC, who in turn will contract with the subs, who then may choose to contract with sub tier contractors, etc. The risk typically gets transferred “downhill.” Architects and engineers usually contract with the owner/developer.

What if I see something I don’t like? This takes us back to the situation of our sub, ABC. During a particular contract review, they determine that the GC was asking for $5 million in total liability limits to be carried by all subs. ABC at that time had a policy with $1 million each-occurrence limit, and a $2 million each-occurrence umbrella limit, giving them a total of $3 million in liability limits for each occurrence.

The contract was small, and only entailed some exterior work around the entrance to a building that was mainly decorative in nature. After realizing that the additional premium generated by increasing his limits would alter the profit margin on the job, ABC’s owner called the GC and asked if they would be willing to live with his $3 million limit. (This is a business decision where he had weighed the risk and felt that his current limits would be adequate relative to the exposure created from his work). The GC agreed to his request. What ABC did from there was critical. He did not sign the current contract, assuming that everyone would remember the conversation. Instead, he asked for the contract to be revised and sent over for his signature.

What is the relationship between insurance and the contract? The insurance section outlines what you must provide in the way of insurance coverage. Usually, this section can be very detailed, asking for certain limits, coverage, endorsements, verification that certain exclusions do not apply. It is usually in favor of the asking party, although certain components will include protections for both parties. What this section calls for are not recommendations, they are contractual requirements and must be taken seriously.

In some ways, the vagueness of insurance certificates leads to some difficulty in this area. For example, if the contract you are signing, for a project that includes drywall and EIFS, specifically states in the insurance section that no EIFS exclusion can exist on your policy, and there is one, there’s no way for the GC to really verify that without actually getting a copy of the policy. The certificate of insurance never gets that detailed. But the fact remains you have an exclusion, which means the insurance company is not covering EIFS-related losses. While GC’s are becoming savvier these days and asking for more clarification, certificates are sent all the time that unintentionally give the impression that certain coverage exists.

What must be remembered is that acceptance of your certificate does not constitute acceptance of your policy’s terms. It is your responsibility to be sure your policy complies with the requirements. In the end, if your insurance does not respond to an incident that arises, the contract will still require action on your part, but at that point it may be on your own dime.

Insurance sections can be lengthy, and you more than likely will need to consult with your insurance representative. One area that’s often overlooked is the required AM Best rating of your carrier. This seems insignificant, but if a rating of A- VIII (see for more information on how they rate carriers) or above is required, and the carrier you are with has a rating that is lower–or has no rating at all–you are out of compliance. Contractors have been asked to leave jobsites in the middle of their work because someone at the GC’s insurance department discovered a discrepancy. One risk manager, when asked about AM Best rating compliance, responded that a higher retention would be held if they discovered a sub was not in compliance.

How can subcontractors be sure the insurance they are purchasing will comply? One way is to pull 7 or 8 contracts you’ve signed recently for companies you regularly work with and have your broker review them. Your broker should be familiar with the language and forms being requested, and can gear their marketing on your behalf to only carriers that can deliver the needed terms.

What if we are not using a contract with our subs? Call your attorney and ask if they have some experience in creating construction contracts. If you don’t have one, ask for a referral. There are also standard contracts that exist which can act as a good starting point, such as what is available from AIA (

While insurance policies can’t fund all your contractual obligations, such as penalties for not performing your duties satisfactorily, it is there to respond to your indemnification obligations. Review the terms of your contracts to know what you are responsible for, and what will be required in terms of your insurance. Ask questions, and consult your business partners. When shopping for insurance, do not settle for anything less than a policy that complies with all your usual contractual needs. The insurance industry as a whole is offering some of the best terms and pricing we’ve seen in years. Even if it means a little extra premium, avoid headaches in the future by making the right choice today. W&C