What is a Pre-Construction Agreement?
A pre-construction agreement is a contract entered into between a builder and a homeowner prior to the commencement of any work on a new build of a residential dwelling. Typically, it is regarded as an offer by the builder to enter into a contract for the sale of a residential unit or home once the construction has been completed. Once the building work has been performed to the specifications of the pre-construction agreement, a purchase and sale agreement for the property is executed. In many jurisdictions, the pre-construction agreement must also indicate the total cost of the construction of the house or residential unit. Typically, the buyer deposits some money during the time that the unit is being built . The builder then agrees to deliver the completed residential unit to the buyer for possession and occupancy at a later date.
More simply, a pre-construction agreement is an agreement that binds the builder to sell the residential unit or house to the owner once it has been completed. The price of the unit is usually fixed at the time that the pre-construction agreement is entered into. However, the unit remains unbuilt until later on in the construction process. Accordingly, the buyer takes on the risks of the unit not being completed within the time frame contemplated by the pre-construction agreement, or the unit being completed but still not being able to pay the price stated in the pre-construction agreement.
Key Elements in a Pre-Construction Agreement
As with any contract, the fundamental components of a pre-construction agreement can be tailored to meet your specific needs. Nevertheless, not every contract is created equal. The following elements are crucial to ensuring the agreement provides a framework for the project:
Cost Estimate
A reliable cost estimate should take into consideration materials, labor, and other contractor fees. Because your contractor will be drawing up plans before the design is finalized, you will need to sign off on these plans with the understanding that this is merely an estimate. Any major changes you make after approval of the final plans may result in additional costs, so make sure to agree upon a system that works for you both regarding change orders. Use these two tips as a guide:
Timeline of Work
Depending on the size of the project, the timeline for a construction job could be as short as a few weeks or as long as several years. Whatever the timeframe, all parties should have a good sense of when each major stage of the process will begin and end.
Of course, weather and other unforeseen circumstances can prolong the time necessary to complete the work. For this reason, include a clause that addresses how to deal with time overruns.
Plans
Your agreement should also clearly describe the nature of the project. This is where it becomes important to consider the changes that may be made over the course of construction. A hefty change order policy may not be worth it if few alterations are expected during the process.
Addenda
Once contract negotiations are complete, a pre-construction agreement will usually be executed in the form of an addendum to a construction contract. Generally, each party will attach any relevant documents pertaining to the project, such as floor plans and a list of materials used.
Benefits of a Pre-Construction Agreement
One of the primary advantages of a pre-construction agreement is certainty. Whether you are a developer, municipality or heritage property owner, a pre-construction agreement allows you to know, in advance, the estimated costs and risks associated with your construction project. Unlike an empty lot, a property with a home on it may be cost prohibitive to demolish. A pre-construction agreement with the builder or contractor will include the demolition cost in the overall pricing. It also allows developers to take advantage of the current market price of construction materials. If you do not have a pre-construction agreement and decide to proceed on the basis of a set monthly cost with an estimated labour and materials component, you run the risk that the cost to build each component (such as framing) will be higher per week as construction progresses. So if the cost of steel went up over three months, you would end up paying more than you would have had you locked in the cost of steel at the outset.
Pre-construction agreements also work as a two-way street. Developers are typically responsible for connecting the utility services to the site before being issued a building permit. However, it makes sense from a construction and scheduling perspective to have the power company do bulk trenching in advance of permitting. The same applies to water and other services. In the absence of a pre-construction agreement, a developer may not want to risk paying the extra costs associated with service connection trenching. However, with a pre-construction agreement in place, the builder or contractor can have the required connections and site clear before the contract value is finalized.
If you are conducting a competitive bidding process, pre-construction agreements ensure that the bid price is the final price. That is because the bid price will generally be based on the agreed upon scope of work found in the pre-construction agreement. Otherwise, bidders may inadvertently price components they are not responsible for but factor it in to the overall price because they are not clearly aware of the scope of work in relation to other work on site.
Legal Issues Relating to Pre-Construction Agreements
A pre-construction agreement, as with any legal contract, must reflect the intent of the parties and comply with the exigent requirements of the law. The agreement should be carefully drafted to avoid unintended omissions that delay, or potentially derail, the project altogether.
For example, while title issues are mostly outside the control of the developer, a lender or developer would want to ensure that the pre-construction agreement terminates upon discovery of defects in title. The agreement should also vary from the agreement that may be used to buy land for residential purposes, such as a land purchase agreement for residential properties under the Real Estate and Business Brokers Act, 2002. Furthermore, as a practical matter, a larger or more expensive development may involve multiple agreements. These agreements would be drafted with more detail than the initial pre-construction agreement.
In some cases, special provisions are required from an environmental perspective. Programs to advance land remediation include the Brownfield program, Site Remediation and Assessment Program (SRAP), and programs offered by the Ontario Ministry of Environment, Conservation and Parks Special Purpose Account program. Eligible costs under these programs may include site investigation, characterization and remediation work. The pre-construction agreement should therefore include financing arrangements that address these special programs.
Any developer will want the appropriate environmental indemnities to ensure that they are not liable for new environmental liabilities that arise as a result of construction or development activity. Provisions relating to the payment of property taxes and capital cost contributions (CCCs) should also be addressed.
Any pre-construction agreement should also expressly address the proper dispute resolution mechanism in the event of a dispute. The simplest option is for the parties to undertake to complete negotiations in good faith prior to moving the dispute to court. It is sensible to provide the parties with the option to mediate or arbitrate the dispute.
Any pre-construction agreement must be reviewed by legal counsel with experience in commercial real estate development to ensure that the documents have been properly prepared, comply with the law, and accurately express the intent of the parties.
Common Issues with Pre-Construction Agreements
Several challenges persist when it comes to drafting pre-construction agreements. The most common issues include: ambiguous terms, incomplete specifications and client’s evolving needs.
Ambiguous terms in an agreement create misunderstandings between parties which is why it is critical to avoid language which does not adequately describe a particular service. Failure to provide adequate details of the scope of work will usually result in disputes and a breakdown in the contractual relationship.
Incomplete specifications will not allow a contractor to properly cost a project or know what is expected from the client . Many times clients think that by not providing adequate details of the scope of work in their specifications they can get a lower price. However, the client often does not account for how much extra money the project will cost once the project begins, due to changes in the contract documents.
Contractors do not like change orders and clients do not like paying for a change order. If the contract documents do not clearly describe the scope of work, contractors will often have to make assumptions which could result in a contractor underbidding a project. To ensure the project runs smoothly, clients should be fully compliant with the specifications.
Pre-Construction Agreement and Construction Contract
A Pre-Construction Agreement is not the same as a construction contract. The construction contract is what the contractor enters into with the owner to build the project. A Pre-Construction Agreement is entered into between the owner of an undeveloped piece of land or existing building and the contractor before any type of construction activity begins. These agreements can benefit both owners and contractors. They can be an asset for an owner to lock in a contractor and gain experience and knowledge in the construction industry upfront so that there are no surprises as the project progresses.
They can also be an asset for contractors to secure a contract for work prior to construction and before they submit bids to sub-contractors for the project. It allows contractors to understand the project and the needs of the project owner. It allows for an understanding of exclusion and inclusion of items. This can be a substantial benefit to a contractor who is preparing bid proposals for sub-contractors. It also allows for pre-bid buy-outs to be approved by the owner if concerns arise as to the pricing in the bid proposal. Additionally, the Pre-Construction Agreement outlines the scope of the work and the timeline for construction. Normally, these agreements will include a detailed scope of work excluding items if owners wish to exclude items. Owners can insert any qualifying language they wish to make clear what is and what is not included.
Negotiating a Pre-Construction Agreement
When entering into a pre-construction agreement, whether as a customer or a builder, it is important to understand what you would like to achieve out of the agreement, and your respective responsibilities. Knowing where you want to end up will help determine how you approach the negotiations. In order to ensure that the pre-construction agreement meets your objectives, here are some suggested areas to review and formally agree upon:
Take the time to read and understand the agreement in its entirety before you sign. Doing so will allow you to understand what you are agreeing to as well as setting you up for a strong negotiation position to get any provisions you may have concerns with modified.
Once you have had a chance to fully review the pre-construction agreement, discuss any concerns you may have with your realtor, customer care representative or sales representative. Ask them to explain any provisions that you may not fully understand.
This is an area to be cautious with. Know the obligations you are entering into, and fully understand your obligations to the purchaser/builder. It is easy to get caught up in the excitement of a new home. While we do not have a crystal ball and cannot anticipate what issues may arise in the future, it is likely that your agreement will impose financial obligations on the parties if certain things were to go wrong. If appropriate warranty provisions are not included and you have no recourse against the builder, you may be left to meet additional financial obligations yourself.
Importance of a Lawyer in Pre-Construction Agreements
A lawyer’s role in a pre-construction agreement is critical. The lawyer will play an important role in the drafting of your pre-construction agreement and/or the review of the prepared and existing purchaser pre-construction agreement. If the developer’s lawyer drafts the pre-construction agreement, your lawyer will need to review the agreement’s terms, negotiate on your behalf if necessary, and/or appropriate depending on the state of the transaction. Drafting of the pre-construction agreement can be paid for by you under your lawyer’s retainer agreement, or can be absorbed by the developer as part of their "closing" costs . Your lawyer will likewise review the pre-construction agreement at the appropriate time, prior to or upon the signing of the regular Agreement of Purchase and Sale.
In the event a potential purchaser has not yet signed a pre-construction agreement, a lawyer’s role in a new development project may be limited to a negotiation of legal terms regarding your intended purpose in the property to include or exclude specific legal terms within the pre-construction agreement. Without a pre-construction agreement, a lawyer’s role is usually to advise a potential purchaser of the legal necessities of a pre-construction agreement, and possibly the negotiation of specific terms in the regular APS to secure the intended purpose.