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Healthcare Alert: Construction Contracts for Medical Facilities–Key Legal and Practical Issues

Whether you are constructing a new hospital, medical facility or renovating an existing space, it is important to understand the construction process and have a good construction contract in place. A well crafted construction contract can protect your business from ordinary construction risks and unnecessary liability.

The Construction Process

Understanding the construction process and associated laws are essential to medical facility construction or renovating a medical facility. Working with knowledgeable design professionals will not only help you create the right aesthetics, but will also make sure that the design is compliant with building codes and other government regulations. Building codes address life and safety issues not only for your employees and the general public, but also for your patients. State building and local building codes, the Americans with Disabilities Act (ADA), public health regulations, and local zoning codes all must be addressed in the design and building permit process before construction begins.

While LEED and various green building and energy codes were the exception in the past, they are now the norm. If you plan to achieve LEED certification or incorporate sustainable energy systems in existing facilities, this work should be addressed in your design professional agreement and in the construction contract with your contractor. Whether your project is for new construction or renovations, it is important to address the use of renewable systems, such as: solar electric, solar lighting, geothermal, small wind turbines, as well as other generation systems, such as fuel cell, bio-energy and cogeneration. Other issues to address with your design professional are power supply disruptions and uninterrupted water supply in the event of natural disasters. Building commissioning should be addressed to ensure that the mechanical systems will function as intended and will meet criteria for LEED certification.

In addition, your design professional should help you to understand and address scheduling constraints, the timing involved to secure regulatory approvals; and the cost of labor and materials. 1 Once the design and project budget is prepared, it is time to select the contractor. Many hospitals and other medical facilities require that general contractors be pre-qualified in order to bid on project work. Pre-qualification prior to the project bidding process helps reduce time and costs in reviewing bids from less competent contractors.

One common mistake that medical facilities make is allowing contractors to use their own pre-printed forms. Before you even read their contract, you can anticipate that the contractor has eliminated its liability and risks associated from the construction process. Also, most contractors’ forms intentionally omit language to reduce or eliminate work scope and liability. An experienced construction lawyer can help craft a construction agreement that addresses work scope, liability and schedules, and manages the parties’ expectations.

Construction Project Delivery Methods

While there are several different project delivery methods, there are two common types used for medical facility construction:

  1. Design-bid-build
  2. Design-build

In the design-bid-build method, there are at least three key team members: the medical facility owner, or tenant (hereinafter referred to as the “Owner”), the design professional team, including the architect and structural engineer, and the contractor. The project team members all have different concerns and goals that can undermine the project if not properly identified and addressed. In design-bid-build, the owner has a direct contract with the architect and has a separate construction contract with the contractor. 2 The architect is hired to design the project and act as the Owner’s representative. The contractor is responsible for the complete construction of the project and will hire subcontractors from various trades to perform the work. Common pricing methods include a lump-sum price or a guaranteed maximum price (“GMP”) for the contractor to construct the project. In both scenarios, the contractor assumes the risk that it has properly taken into account the price of labor, material and scheduling constraints.

In the design-build scenario, the Owner enters into one contract with a design-builder for the design and construction of the project. Common pricing for this delivery method is also GMP or lump sum. In this scenario, the Owner does not have the architect acting as its representative as in the case of design-bid-build. Accordingly, this scenario is only recommended if the Owner has its own construction department or hires a third party construction manager to oversee the design-builder’s work.

Key Legal Issues That Should Be Addressed In Your Construction Contracts

A well drafted construction contract will address risks, manage expectations for each party and act as a road map to guide the project team from pre-construction issues to opening the doors to the public. All construction projects pose three general types of risks: physical, financial and feasibility risks. Physical risks include personal injury to workers and others while on the project, injury to the public during and after construction, and damage to other property. Financial risks include risks that the contractor is solvent, promptly pays its subcontractors and suppliers, adheres to the negotiated price, and stays within your budget. Lastly, feasibility risks include having a realistic schedule for construction, which includes managing specially ordered equipment and having a realistic design that is not only attractive and constructible, but also meets government regulations.

Specific risks to Owners include schedule delays, lack of strong management and coordination by the contractor, poor workmanship, contractor’s failing to pay its subcontractors, excessive design changes leading to increase construction costs, union disputes, hidden and contaminated conditions in older buildings, defective workmanship or materials and change order disputes, to name a few. Once you identify all potential risks, a well drafted construction contract will help you reduce those risks, insure the risks; and/or shift the risks to the contractor.

While the type and magnitude of the construction will dictate the length and detail that should be included in the construction contract, all construction contracts should contain key provisions such as schedule, scope, price, workmanship, warranties and compliance with laws. It is important to include a significant level of detail about all of these items to eliminate disputes. Schedule, scope of work and price are also often deal-breakers. Construction accountability, damages, and liability limitations are also major sticking points in construction contract negotiations.

The scope of work will be dictated by the plans and specifications prepared by the architect. Specification language should be mandatory and not optional, which includes material, equipment and furniture that you specifically want incorporated into the project. Substituting materials and equipment from that which was specified is commonly done by contractors to save costs, but could lead to inferior materials.

The construction schedule is also a key element to your construction contract. The schedule should be realistic, contain required commencement and completion dates; and include any critical milestone dates to be achieved. Without a clear schedule, your right to expect a specific completion date can be compromised. Delay issues include timing to obtain a building permit, contractor responsiveness and availability, post-bid design changes; and availability of manpower, equipment and materials. The detailed schedule should identify all deliverables and interfaces. Good schedules eliminate confusion and disputes while unrealistic schedules open the door to litigation.

The construction contract should provide compensation to the Owner for damages due to delays caused by the contractor and its subcontractors. It is common to address this risk by including liquidated damages against the contractor for unexcused delays to the completion date. A well crafted liquidated damage clause can help to compensate an Owner for loss of use of the medical facility, equipment storage fees, temporary facility rental, debt service on bank loans and lost profits.

Warranties on workmanship, materials and equipment are also key issues to address. Once the project is complete, if defective workmanship or materials are discovered, the first and most practical recourse is the warranty provided by the contractor. A warranty covering workmanship, materials and equipment standards, protocol to trigger the warranty obligations; and the warranty duration should all be addressed in the construction contract.

Change orders due to increased construction costs and additional time requests are a frequent topic of dispute. These changes can be a result of design changes, requirements by building officials, delays to schedule, or simply additional work that was not contemplated in your bid documents. Your construction contract should identify compensable changes and the required notice that the contractor must give to you before the work is executed.

Payment disputes are also common in construction. The construction contract should address construction progress payments and documents that are required to be submitted as a condition precedent to the Owner’s payment obligations. Documents can include, among other things, lien waivers, proof of continued insurance coverage, proof of diversity subcontractor participation, warranties, and approvals by the architect for payment.

Insurance and an indemnification provision are crucial to include in the construction contract. The contract should identify the types of insurance required, limits and duration of expected coverage. The contractor should not be allowed on the project site without proof of current insurance coverage for the contractor and all of its subcontractors. There are numerous types of insurance that should be procured depending on the project scope and risks involved.

A properly drafted indemnification clause can shift the risks of personal injury and property damage claims against you to your contractor. Simply put, the contractor should indemnify and hold you harmless for all damages that the contractor or its subcontractors cause. If the contractor constructs the project in violation of building codes, the project could be shut down and government penalties can be assessed against you as the Owner. The contractor should also indemnify you for failing to comply with all federal and local laws in constructing the project. An experienced attorney can address indemnification provisions that protect the Owner from these types of construction project risks.

One must also plan a course of action if the contractor fails to complete the job or abandons the work. The Owner may need to terminate the contractor and hire another contractor to complete the work. In this situation, the project costs can escalate and the project schedule can be severely compromised. Your construction attorney can assist to reduce the impact of these types of costs and delays.

The use of payment and performance bonds should be discussed with your attorney. The performance bond is designed to protect an Owner from a contractor’s poor and faulty workmanship or project abandonment. The payment bond can protect an Owner from a contractor that fails to pay its subcontractors. The only drawback to requiring the contractor to secure these bonds is it increases the construction price due to the bond premium costs.

The use of subcontractors also needs to be addressed in the construction contract. The contractor should identify the subcontractors. More subcontractors on a project mean more risks. Subcontractors can suffer physical injury, inflict injury to others, or violate building codes or other government regulations. Further, an increased amount of subcontractors on a job means increased risk of construction claims.

Hospital systems and other large medical facilities frequently have supplier diversity programs. Contractor and supplier compliance expectations should be clearly stated in the construction project. Additionally, many hospital systems and medical facilities receive public grants or have direct contracts with the federal government. In such case, compliance with small business subcontracting plans should also be addressed.

It is impossible to eliminate all construction risks in a project. However, a knowledgeable attorney can guide you to help plan the project, shift unnecessary risks and protect an Owner from unnecessary liability exposure.

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1 While this article focuses on preparing a solid construction contract, the design professional agreement is also very important to understand and protect Owner interests.
2 The architect normally hires a structural engineer that will address structural loads, occupancy and other structural life safety concerns.

For more information, please contact:

Michelle F. Kantor
312.642.6482
mkantor@mcdonaldhopkins.com

Richard S. Cooper
216.348.5438
rcooper@mcdonaldhopkins.com

or any of our healthcare attorneys by clicking on the link below:

Healthcare Practice

McDonald Hopkins has a large and diverse healthcare practice, which is national in scope. The firm represents a wide variety of healthcare providers, facilities, vendors, technology companies and associations. Our diverse experience enables us to give our clients a unique perspective on the issues that may confront them in the rapidly evolving healthcare environment.

Carl J. Grassi, President
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© 2011 McDonald Hopkins LLC All Rights Reserved. This Alert is designed to provide current information for our clients, friends and their advisors regarding important legal developments. The foregoing discussion is general information rather than specific legal advice. Because it is necessary to apply legal principles to specific facts, always consult your legal advisor before using this discussion as a basis for a specific action.