A construction contract is the foundation of any construction project. But a foundation is only as strong as the ground it is built on. Documents that are incorporated by reference into your contract may lead to unknown risks that are only unearthed when claims or disputes flare-up, or worse, in litigation. Executing a contract without knowing the referenced documents’ terms or failing to preemptively mitigate the risks from these referenced documents is building your project’s foundation on shaky ground.
This article first explains how courts and arbitration panels consider documents “incorporated by reference,” then describes a few issues and subsequent consequences that are typically caused (and litigated) by referencing other documents, and finally suggests actions the contracting parties can take to mitigate these issues.
When is a Document “Incorporated by Reference”?
Construction contracts often refer to numerous other documents besides the base contract such as design and construction plans, specifications, exhibits, addenda, and even other contracts between other parties. When the proper operative language is used, these referenced documents that are “incorporated by reference” become part of the contract, and enforced by courts and arbitration panels, as the document that is ultimately signed.
Proper operative language does not require magic words to incorporate a document by reference into a contract. Generally, the contract must simply identify the document that is to be incorporated by reference and for what purpose the document is referenced. Further, the referenced document usually does not need to be a legal document but can include a project’s plans and specifications. A document can even be referenced and made a part of the contract without providing it to the other party.
Simply put: a document may be incorporated by reference into a contract by expressly identifying the referenced document and clearly stating the referenced document is a part of the contract.
Why Do Parties Use “Incorporation by Reference” Provisions?
Referencing other documents allows the contracting parties to expand a contract’s “four corners.” Parties may incorporate by reference other documents to streamline the contract drafting and negotiating process or as a “belt and suspenders” approach to ensure that the minutia of various technical scopes of work are included in the contract.
A common type of incorporation by reference clause is a flow down clause. “Flow down” clauses in subcontracts seek to ensure a uniformity of obligations down the chain of privity. A flow down clause typically references the prime contract between the general contractor and owner and “flows down” those obligations to apply them in a similar manner between the subcontractor and general contractor. Although flow down clauses typically focus more on legal obligations, they can lead to similar issues and require the same mitigation suggestions as incorporation by reference clauses.
“Incorporation by Reference” May Create Ambiguities
Courts and arbitration panels typically look within the written four corners of a contract to determine the intent of the parties. While each jurisdiction has its own body of law for contract interpretation, a clear and unambiguous contract will typically be enforced as written. Because interpreting a contract is a question of law and not a question of fact, a court may grant summary judgment and avoid a full-blown trial when the dispute can be resolved by interpreting the plain meaning of the contract. And arbitration panels may do the same without an evidentiary hearing. As a result, when a dispute occurs on a project, legal fees may be significantly reduced by avoiding trial or narrowing the scope of the hearing due to an unambiguous contract.
Conflicts created by the additional language from a referenced document may cause what looked clear within the four corners of the contract to become unclear or ambiguous. Ambiguous simply means susceptible to more than one reasonable interpretation. If the ambiguity cannot be resolved within the contract, including all referenced documents, the matter has to go to trial to receive evidence on the proper interpretation.
“Incorporation by Reference” May Incorporated Unexpected Terms
Incorporating documents by reference can inadvertently change or relinquish legal rights otherwise available to one of the parties. For example, a referenced document could extinguish a contractor’s right or preference to litigate a claim in federal or state court by unexpectedly incorporating a requirement to arbitrate. Or, a referenced document could force a party to abide by an unexpected forum selection clause.
Referenced documents could also include project documents that materially impact the expected scope of work. For example, a referenced specification could require that the work only be completed at night even though the parties only verbally discussed day time work. Or, a referenced design plan could require building an embankment when prior discussions never specified a manner of wasting excess materials.
Suggestions to Mitigate Risk
Below are some suggestions to consider to avoid many of the issues that could arise from incorporating other documents by reference into your next contract.
1. Obtain and Review All of the Referenced Documents.
Contracting parties should obtain and review all of the documents referenced in a contract that include commercial and legal terms that may be asserted against them in litigation. Contracting parties in the construction industry will generally be considered sophisticated parties and will not be excused for not pursuing documents that are referenced in its contract.
2. Use an Order of Precedence Clause for Possible Conflicts.
An order of precedence clauses defines how courts and arbitration panels should resolve conflicts between contract documents rather than find the contract ambiguous. Although an order of precedence clause is common in construction contracts, this type of clause is not universal. For example, ConsensusDocs includes an order of precedence in its standard forms while the AIA standard forms do not. [1] In fact, the Associated General Contractors of America (“AGC”) has commented on the AIA’s lack of an order of precedence clause and even suggested resolving this issue by using language similar to the ConsensusDocs’ order of precedence clause. [2]
3. Expressly Identify the Purpose of Document Incorporated by Reference.
A good rule of thumb is to expressly identify the purpose for which documents are referenced. Generally speaking, courts and arbitration panels will strictly construe unambiguous language regarding the express purpose of a referenced document. Expressly identifying the purpose that referenced documents are incorporated provides clarity to the parties and direction to the court or arbitration panel when interpreting the contract.
For example, if the prime contract is referenced in the subcontract to flow down only certain obligations between the owner and general contractor to the subcontractor, the subcontract could identify the specific terms or the types of obligations that are applicable. An alternate option would be, after referencing the prime contract, to specifically exclude the terms that the parties do not intend to flow down. ConsensusDocs 750 includes a version of a flow down clause as part of the standard subcontract.[3]
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[1] ConsensusDocs 200 Agreement and General Conditions Between Owner and Constructor, Section 14.2 Interpretation of Contract Documents; ConsensusDocs 750 Standard Agreement Between Constructor and Subcontractor, Section 13.1 Interpretation of Subcontract Documents.
[2] AGC’s Commentary on the AIA A201 General Terms and Conditions Document, 2017 (July 25, 2017).
[3] ConsensusDocs 750 Standard Agreement Between Constructor and Subcontractor, Section 3.1 Obligations.
The views expressed in this article are not necessarily those of ConsensusDocs. Readers should not take or refrain from taking any action based on any information without first seeking legal advice.
Source: Associated General Contractor
