What is a Pre-Construction Service Agreement?
A pre-construction service agreement is "a construction contract under which the contractor provides the owner a specified service in exchange for compensation, with the price of that service being less than the price at which the contractor would perform the work." Wells Fargo Bank, N.A. v. Suntrust Banks, Inc., 2016 WL 6207509, *1 (N.D.Ga.). "The primary purpose of a Pre-Construction Service Agreement is to compensate the Contractor for its services in developing and estimating the cost of the Project, such costs to be included in the base contract price if the Owner and Contractor proceed with the Project." Si-Mer Serv., LLC v. JSC Makeyevka Refractory Plant, 2012 WL 1884180, *7 (Tex.App.—Houston [14th Dist.]).
Lacking contractual detail, some courts define pre-construction service agreements simply as contracts that provide for pre-construction services. Smith v. CMO Mgmt. Group, LLC, 2011 WL 5538257, *6 (Tex.App.—Houston [1st Dist . ])("A pre-construction service contract obligates the contractor to provide preconstruction services.") In this regard, "pre-construction services" refer to certain "consultative services" including, but not limited to: evaluating the costs and feasibility of building the project contemplated by an owner; preparing cost estimates and scheduling for various construction options; identifying construction risks and potential value engineering measures; identifying suitable sources and subcontractors for items to be purchased or used; and, bidding and negotiating sub contracts as well as obtaining the owner’s consent to award such sub-contracts. Id.; Parsons RCI , Inc. v. Pagosa Springs II, LP, 2009 WL 863028, *2 (D.Col.) ("The Preconstruction Services include proposing values for the Project based upon the Owner’s program and schedule and upon the City’s Design, Planning, and Engineering Plans, and developing a cost estimate, schedule, and general outline of the Construction of the Project.")
Essentials of a Pre-Construction Service Agreement
Unlike standard residential purchase and sale agreements, pre-construction service agreements (sometimes called "pre-construction offering" agreements) don’t have a standardized form. Tempting it may be, each municipal development office has its own procedure for approving new developments, including the messaging and requirements about pre-construction service agreements. In virtually every case, it requires specific wording to accomplish the goals desired by the municipality and developer, primarily for the promotion of the development in a timely manner.
Each of the following elements should be included in a complete pre-construction service agreement:
Scope of Work – Identifying the type and style of work to be done is critical in a pre-construction service agreement because it allows the purchaser to understand the size and shape of the development and avoid surprises as construction proceeds. This section would also include details on the exchange of information between the seller and the purchaser at various stages.
Timeline – A complete pre-construction service agreement establishes the timing of the construction phase, including the start date and any penalties for delays in construction.
Budget – Financing and costs are front of mind for many purchasers, especially when exploring the option of buying off plan. A pre-construction service agreement should clearly spell out the costs that will be incurred by the purchaser and any required deposit, including whether the deposit will form part of the sale price or otherwise.
Advantages of Pre-Construction Service Agreements
For clients, the pre-construction service agreement provides two primary advantages, but first and foremost, it minimizes risk. Without a signed agreement, if plans or specs are not delivered on time, or unforeseen conditions are encountered, the contractor could hold the customer liable without having a written agreement that states the risks of pre-construction services will be shared. Secondly, the agreement assures the client that their investment in this process will help to control costs. Without having the expertise of a contractor during pre-design, the likelihood is that the project will cost more than if pre-design with a contractor was employed.
For the contractor, the pre-construction service agreement helps to clarify and define the expectations of both parties. The contractor should take measures to minimize risk for both parties through incentives. Any risks that will be assumed by the contractor outside of their control should be addressed in the pre-construction service agreement. Then, once the final contract is signed, risks can be divided between the parties for better project success.
Legal Factors in Pre-Construction Agreements
When drafting or reviewing a pre-construction service agreement, the following legal considerations should be taken into account:
• If the pre-construction service agreement involves the procurement of any goods, the seller must be registered for GST/HST. Complying with Gst Registration and Hst Requirements.
• The builder or developer will generally seek to recover GST on all or part of the amounts paid to a consultant on the theory that the consultant services are "consumed" or "used up" by the developer or builder. This view may be persuasive depending on the scope of the work performed, but will generally not obtain CRA approval. For purposes of the Goods and Services Tax / Harmonized Sales Tax, the CRA is of the view that construction materials and other supplies are consumed, lost or destroyed when they are incorporated into or otherwise available for use in the construction of real property, but generally not when they are merely provided to a construction contractor.
• If a project is being financed, it will be necessary to ensure that the construction financing documents contain provisions that will permit the "pre-construction" work that is being done under a pre-construction service scope to continue without affecting the overall financing and delays being incurred under a construction financing arrangement.
• Compliance with requirements to pay payroll and other taxes, contributions to benefit plans, and WSIB certifications where applicable. Non-compliance could expose developers or builders to increased costs resulting from certification of the work along with payment of interest and penalties.
• Appropriate complaint resolution mechanisms and dispute resolution mechanisms are essential to avoiding costly litigation.
• Consideration should be given to signing a confidentiality agreement if sensitive information including pricing , payment terms and other proprietary information is to be disclosed between the parties.
• Assignment of the contract or parts of the contract are generally allowed if both parties consent. Where the builder or developer attempts to assign their rights, it should be possible for the consultant to include termination provisions that would allow the consultant to terminate the agreement if the builder or developer assigns its rights without notifying the consultant pursuant to an appropriate provision.
• Limiting liability of the parties may need to be addressed. There are a number of approaches to limiting risks and liability:
o Time limits – Excluding liability for damages where the claim is not made within a particular period of time or where a particular period of time has passed after the completion of the work or the delivery of goods.
o Damages – Excluding or limiting the amount of damages for which a party may be held liable.
o Exclusions: Excluding or limiting liability in respect of particular events: Excluding liability for indirect or consequential damages. This description includes damages as to loss of profit, revenue, use, value, use or other economic advantage, damages to products for which the goods and services are being provided, damages for expropriation, governmental action, penalties, fines, and other damages arising as a consequence of regulatory activity and third party claims against the parties.
• Insurance requirements and other security arrangements.
Pitfalls in Pre-Construction Agreements
Mistakes commonly made in pre-construction service agreements
It’s always good practice to go through the typical mistakes that occur in pre-construction service agreements. The first issue is the degree of engagement that the builder has with the municipality. In most cases, although the work done on the pre-construction services is restricted to the lands being directly developed, the services of the tests and examinations on the offsite lands should be limited to those lands directly adjacent to or contiguous with the site. There may be some circumstances where such testing on neighbouring lands is permitted but in addition to the pre-requisites described above, the builder must obtain the permission of the side land owner in a form that also provides the side land owner with some liability protection. Another mistake is where the pre-construction service agreements try to create obligations of a later date. For example, the builder will insert an obligation to commence work not later than a specified period after the builder receives site plan approval. There should be no contingencies to the pre-construction services being performed assuming that the work is properly defined in the agreement. Another common mistake is surrounding the quality of the pre-construction services. Too often a pre-construction services agreement will provide for non-disclosure of the results of the tests or examinations (other than to those contemplated as part of the pre-construction services) or try to limit the builder’s obligations with regard to the results set out in the pre-construction services report. If the builder is going to be responsible for the costs to correct unfound conditions, the builder is entitled to expect to know the extent of the problem at the earliest possible stage. Another common mistake is where the parties fail to deal with appropriate access. Generally the pre-construction services are going to be a form of test, examination or evaluation involving offsite lands. The agreements should specifically define the nature and extent of the access and contain an express obligation on behalf of the builder to comply with the terms of the access. Somewhat related to that is the issue surrounding the extent of damages on the offsite lands. There can be occasions where significant damage can be caused to the lands as a result of the onsite work. The pre-construction services agreement should contemplate the right of the builder to proceed with the works on the site upon completion of those tests and inspections that are necessary prior to the commencement of work. The next issue is that there can be multiple owners involved in the pre-construction services. Each party should be equally recognized in the process that the rights can only be exercised by the written consent of all parties in the event of an adverse report.
Negotiating an Equitable Pre-Construction Agreement
The power of negotiating a pre-construction service agreement is in obtaining fair terms based on the time that each party spends at the project and also the risks taken by each party. The risk for a Lessee (tenant) is great during pre-construction because they apply significant property and capital improvement costs in addition to committing to a term generally longer than agreed. In other words, the Lessee gives a considerable amount of value upfront with little to no security that the project is a go. The risk for the Landlord (owner) is also substantial, however, generally less so than the Lessee. Once a Lessee has spent time and money and a project is canceled, a Landlord is well within their rights under the Agreement not to reimburse for said time and costs. Whereas, in order for a Landlord to cancel or terminate a Lease under a pre-construction service agreement, "just cause" must be proven.
Negotiating the terms of a pre-construction service agreement , allows a Lessee to better balance the risks associated with pre-construction for both themselves and the Landlord. In fact, notwithstanding any agreement to the contrary, "just cause" may easily be defined as the failure to meet milestone dates, or exceeding a budget for the construction of the space as these "missteps" create additional risk to be borne by the Landlord.
Given that the Landlord’s expenditure is considerably less than that of the Lessee, consider the following provisions be included in the lease if the particular facts of the deal support it:
1. the Landlord will assume all costs incurred in excess of the budget should the project exceed its budget, provided the cap amount is not exceeded; or,
2. the Lessee agrees to share, in addition to the original material terms of the pre-construction services agreement, in all costs that exceed the budget if the Lessee does not provide a set timely schedule on or before June 30 of the year prior to the anticipated commencement date.