The Components of a New Home Construction Contract
A new home construction contract should be a clear, unambiguous, complete, and detailed outline of the intent of the builder and buyer. In a typical new home construction contract, there are eight parts that must be in the contract for it to be enforceable. The main components and clauses are as noted below:
- Scope of Work
- Price and Payment Terms
- Time of Performance
- Changes to the Work
- Inspections and Acceptance of Work
- Drawings, Building Codes, and Permits
7 . Warranty and Liability of the Builder
8. Termination of Contract
From previous post, new home construction agreements (also known as agreement of sale) are generally used when purchasing new residential and inexpensive commercial buildings. After the buyer and builder review and agree upon all items and terms, the agreement requires both parties to sign (or execute) the document. Once the document is signed, the agreement is legally binding on both buyer and seller.
The Legal Rights and Obligations
The New Home Construction Agreement creates legal rights and responsibilities for both the builder and the buyer. While the builder has a responsibility to build the home in conformance with the plans and specifications of the agreement, the buyer is responsible for paying the amount due under the agreement against the builder’s performance. The builder is also responsible for completing the home in a timely fashion.
The builder has other rights as set out in the agreement. For example: It is important for the buyer to understand that the builder’s rights will generally be superior to those of the buyer. This means that the builder will have more rights than the buyer and those rights will usually have priority or come first in time. For example, any amount due under the agreement and secured by the mortgage will usually have priority or come before the buyer’s interests in the home. The same is true for any registered lien against the land arising from the sale.
The builder can enforce a mortgage registered against the land and, given that the mortgage is the first claim, can sell the land and keep any funds received from the sale. For example, if the builder is owed $400,000.00 and the seller sells the property for $500,000.00 pursuant to a foreclosure action, the builder would receive $400,000.00 of the funds paid to the seller pursuant to the sale. Any amount above the mortgage will usually be paid to the buyer (for example, the remaining $100,000.00). As a result, it is very important that the buyer know the relationship between the builder’s rights and the buyer’s obligations when entering into the New Home Purchase Agreement.
The Risks Involved and How to Minimize Them
Both buyers and sellers are exposed to certain risks when entering into an agreement to have a new home constructed. Risk is inherent in any construction project, but with the right measures both parties can work to mitigate common risks. Delays: When it comes to construction projects, delays can happen for a variety of reasons, some within the builder’s control and others out of their hands. Many builders include time commitments in their agreements to avoid any ambiguity as to how long they have to complete the job. However, it is not uncommon for delays to occur, and some builders add clauses to their agreement to outline circumstances under which they will not be liable for delays. It’s important to know that standard time frames are dictated by regulating bodies such as the Tarion Warranty Corporation. Read your new home contract carefully, paying particular attention to the section on time frames and delays. Ensure you understand what the builder is committing to regarding completion and what happens if they fail to meet the deadline. Cost Overruns: One of the most well-known risks when building a new home is cost overruns. These occur when the final bill is greater than the original quote, and this is either as a result of unanticipated costs or design changes. To avoid this scenario, ensure you read the invoice carefully and understand exactly what is being charged. For example, find out if the registered price is for labour and materials only, or if it also includes architectural design costs, permits, and consultants to give you a better understanding of the full cost of the project. You may be able to eliminate the risk of cost overruns by agreeing to a fixed price for the entire job (including labour) prior to beginning construction, however this will depend both on what you are having built and the builder’s willingness to agree to a fixed price.
Negotiation Considerations for Buyers
- Review all disclosures before accepting a new home construction builder contract;
- Produce a complete and signed Realtor/buyer agency representation agreement. If you did not use a realtor and are buying a spec home, recognize that there is a possibility that the builder representative may be on both sides of the deal;
- Never sign a blank or incomplete offer;
- You need to close. The builder does not need to close. Ask for any mutually acceptable incentives to sign and close;
- Always make the subject to section of your agreement contain a right to cancel. This way the request for modifications will not be seen as waiver;
- Seek a realtor/broker commission offset or no brokerage commission at all;
- Insist on a binding financing appraisal contingency clause;
- Include a contingency phrase such as "bearing special approval" or "subject to financing approval" to avoid being locked into an exclusive deal without the benefit of a financing contingency;
- Create an anticipated completion date in the contract. Do not rely solely upon the build-out period;
- Negotiate a cap on builders’ costs to control your closing costs.
What You Should Know About Amendments and Change Orders
Amendments and change orders refer to any changes that occur to the construction agreement after the agreement is signed by both parties. For example, a lot owner may wish to have a different type of window installed in their home than what was outlined in the contract. If a lot owner pays the builder for the cost of the new window, such an amendment should be in writing and signed. If the builder agrees to provide the new window at no additional cost to the lot owner, then it might be sufficient to just obtain a written endorsement from the builder.
Changes to your builder permit can affect your agreement: Since all residential construction is subject to approval by a building permit office, a change in the design of the proposed home or any of the contemplated improvements can set off a chain reaction in which your builder may attempt to renegotiate terms to the agreement. In many instances, the builder may attempt to use the revised building permit as a reason to alter the price to the construction agreement . To limit your liability for "new" costs, be sure to confirm in writing with your builder that any amendments to the building permit will be updated to reflect any changes to the original contract. However, a change to the building permit may affect other aspects of the agreement. For example, the new or revised permit may necessitate a larger footprint of the structure and therefore a higher material cost.
Errors and omissions in the contract can also impact the bottom line. For example, if you request a change to one aspect of the home and it creates problems for another aspect of the home, your builder may try to charge you for the cost of correcting the new problem. While you can get around this situation by discussing the addition or change with your builder and revising the entire agreement, down to the square footage and square foot price, however, this type of coordination requires close attention to detail and can set off a chain reaction in which nothing is known for certain until months after the project starts.
How to Sign and Finalize the Agreement
The process of finalizing a new home construction agreement typically begins with a review of existing documents and the discussion of any proposed changes. For most buyers, reviewing the existing agreement is a formal process. It can be completed in a substantial effort by legal counsel to review the existing standard form agreements. Any proposed changes will generally be discussed, and the buyer may be asked to sign specific addendum(s) that formally incorporate the proposed changes into the existing agreement.
Many buyers do not have legal representation when they are looking at homes in new construction. However, it is always recommended that a buyer involve a lawyer when completing their review. Unlike more general residential real estate transactions, new home transactions are complicated and have many unique issues. For instance, there are clauses in these contracts that hold builders harmless for defects. There are clauses that can extend provisional closing dates, as well as clauses that potentially extend the closing date for defects that are not repaired before closing. Not to mention that you may be having work completed years after the agreement is signed. Having an experienced lawyer review the contract on your behalf, and explaining the consequences – positive and negative – of various clauses could save you thousands of dollars down the road.
This particular process can also drag on. The buyer’s lawyer may draft a substantial amount of addendum(s) that include a multitude of changes to the standard form agreements.
Upon completion of a review and revisions, the finalized construction agreement is signed by all parties. This process will usually include a single date signed by all parties (the date of which is often simply written in by hand) or a numbered date on each addendum.
Construction Contract Disputes and How to Resolve Them
Disputes often arise between builders and buyers of new homes. These disputes can arise because the builder failed to build according to the plans or specifications, it could have been that the buyer’s request for a change or alteration mid-construction was not properly executed, or disputes could arise for other reasons. Regardless of the reason of the dispute, almost every builder and purchaser will be forced to address possible alternative forms of dispute resolution.
Many agreements have language that require the parties to first sit down to try to resolve any disputes, during what is often referred to as a "cooling off" period, and if that does not work to try to mediate and negotiate a settlement. While many people do not view it this way, "cooling off" periods are often required as a matter of law to ensure both parties have had an opportunity to review the issues carefully and decide if insisting on their position is worth the expense of fully litigating the dispute.
If the parties are unable to reach an agreement during their cooling off period, several other procedures are frequently incorporated into the construction agreement that may be common. Many agreements require mediation , a process by which each party designates a representative who will do their best to try to reach an understanding with the other party. The parties usually agree that once they have chosen their representative a specific time will be given (often 30 or 60 days) for them to meet and work out the ambiguity in the contract. If the parties cannot self-resolve their dispute using this procedure, some construction agreements then require binding arbitration, often by a specific organization chosen at the time of entering into the agreement(s), with specified costs. Binding arbitration requires all parties to submit their positions to a panel or single arbitrator to make the final decision as to the outcome of the dispute. Many times the decision must be accepted as final by all parties, unless the decision otherwise provides for a right to appeal to the civil courts. Arbitration decisions can be appealed by the losing party only on the basis of fraud, corruption, duress or coercion exercised upon or through the arbitrator. No appellate review is permitted and courts will not substitute their judgment for that of the arbitrator.