No contractor (the “Contractor”) is perfect.  Some work will fail inspection and need to be redone (“Rework”).  Other defects will only be identified after the project’s completion, necessitating a warranty claim (“Warranty Work”).

What’s the difference between Rework and Warranty Work?  After, all, in both cases, the Contractor’s work has failed to meet the standards of the agreement and needs to be repaired or replaced.  The easiest way to understand the distinction is one of timing—when was the defect discovered.  Rework includes all defects identified prior to the Contractor’s receipt of a completion certificate.  In agreements with multiple completion certificates, this may represent either mechanical, substantial, or final completion—whichever date commences the warranty period.  The Warranty Work provisions apply only after the Contractor receives the applicable completion certificate.

Rework is less of a concern in lump-sum agreements, pursuant to which the Contractor is paid a lump-sum for delivering a completed project.  In such cases, the Contractor is compensated for results, as and when work is accepted by the project’s owner (the “Sponsor”). The more Rework required to obtain acceptance, the less profit for the Contractor. The lump-sum Contractor protects itself from Rework exposure by including the estimated cost of rework in its lump-sum price.

Rework becomes more contentious in cost-reimbursable contracts, which may lack clarity on the handling of Rework.  In such cases, it is important for the Sponsor and Contractor to discuss various types of Rework and the extent to which the Contractor will be reimbursed for Rework costs and expenses.  Approaches to Rework in reimbursable contracts include:

• No compensation for Rework. The Contractor is not reimbursed for the cost of Rework, effectively paying for Rework from its fee or profit. For example, the agreement could include a provision stating that the Contractor is only entitled to be paid “Compensation,” defined as: “the portion of the contract price that the Contractor has earned for completion of work in accordance with the scope of work, the specifications, and the other requirements of the agreement.”  Rework is, by definition, not in accordance with the scope of work and the specifications—otherwise it would not have to be remedied.  The agreement also can prohibit payment for specific categories of Rework, such as weld defects, concrete defects, abandoned bores, and failed horizontal directional drills.  See Construction Energy Development for definitions of weld defects and concrete defects.  If the Contractor is not being reimbursed for Rework, then the Contractor should build into its profit percentage the estimated cost of Rework (since some will be incurred).
• Rework deductible. The Contractor also can negotiate one or more deductibles for certain types of Rework, such that Rework is reimbursed up to a ceiling (typically based on the estimated amount of Rework that could be expected from a Contractor following good engineering and operating practices).  For example, the Contractor may be compensated for repairing weld defects to the extent the weld defect rate is less than 1%.
• Partial reimbursement for Rework. Contractor is reimbursed for only part of the cost of Rework such that it shares in the loss.  For example, Contractor may be reimbursed for only 50% of its costs and expenses for Rework.
• No fee for Rework. The Contractor is reimbursed for its out-of-pocket costs for the Rework but does not receive any fee or profit for the work.
• Indemnity for Rework.  The strongest remedy against Rework is requiring the Contractor to indemnify the Sponsor for Rework.  In such a case, not only does the Contractor not get paid for Rework, but it must reimburse the Sponsor for any costs it incurs, such as secondary inspections and x-rays.

The enforcement of Rework exclusions can be problematic, though. When the Contractor invoices for its crews, how does the Sponsor identify and separate the regular work from the Rework? Rework is typically identified by inspectors in the field. But once detected, the Sponsor needs to track the cost so that invoices can be adjusted. In the case of a drilling subcontractor, for example, it may be easy to exclude the costs for dates on which a failed drill was being advanced. For other types of Rework, the Sponsor can estimate the cost of the Rework and deduct it from the next invoice (based on, for example, how many crews were undertaking the Rework and for how long).

Each of the above approaches to Rework incentivizes Contractors to get the job right the first time.  Construction agreements should avoid a regime in which the Contractor is reimbursed for all of its costs and expenses of Rework, including its fee or profit.  In such a case, the Contractor may actually be incentivized to incur Rework costs—as the amount of its profits increase.

Rework is discussed further in my new textbook, Construction Energy Development.

About the Gaille Energy Blog.  The Gaille Energy Blog discusses issues in the field of energy law, with weekly posts at http://www.gaillelaw.com.  Scott Gaille is a Lecturer in Law at the University of Chicago Law School, an Adjunct Professor in Management at Rice University’s Graduate School of Business, and the author of three books on energy law (Construction Energy Development, Shale Energy Development, and International Energy Development).

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