MDL’s Antony Eaton runs you through the issues to be aware of
The best contractual strategy for a project is entirely dependent upon the nature of the owner and of the project under construction. That’s because:
- who is involved
- what is being constructed, and
- how it’s being constructed
…will typically determine how the risks associated with delivering the project will be allocated. And ultimately, contracts are all about risk allocation for a price.
In this news post the MDL Construction Law team will unpack the various contractual strategies that are available to you. We’ll talk about the pros and cons of each, and pass on some vital pointers to help you choose the right strategy for your situation.
Fixed price construction contracts
With smaller projects, typically an owner will engage a Design Consultant to prepare a detailed design and then put that design out to tender to obtain a fixed price construction contract.
However, in instances where the proposed project is particularly large or detailed, or where extensive and expensive design works are required, the owner may not have sufficient funds to pay for these preliminaries. In such situations, this form of contract is likely to be unsuitable.
What’s more, this form of contract also means that the overall time to complete the project is extended, with the risk and responsibility for its delivery divided between the designer and the builder.
Engineer, Procure and Construct contracts (EPCs, or Design and Construct)
EPCs are more frequently used in project works, particularly in the mining industry. Additionally an owner may further contract a Process Engineering Design (PED) contractor at the front end to work with an engineer engaged under the EPC contract to design (in concert with the EPC engineer) a specific and technically unique part of the project.
For example, where the project is to deliver a complex mechanical mining process, frequently the PED Engineer will design that component of the plant and then work with the EPC Contract Engineer to build the plant around it.
Again, care needs to be taken in this contracting process in relation to the PED contract because licensing and insurance can frequently be issues. This applies to a lesser extent under the EPC contract, because often independent subcontractors and suppliers who contract with the EPC contractor are not using proprietary technologies and are not limited in their liability.
Engineering, Procurement and Construction Management (EPCM) contracts
Alternatively, the nature of the owner or the project may be better served by an Engineering, Procurement and Construction Management (EPCM) contract. This contract limits the EPCM contractor’s main liabilities to negligence in the performance of the design work, and negligence in managing the procurement and construction of that work. This is because the EPCM contractor is the owner’s agent, and the owner contracts directly with suppliers and trade contractors.
Note that the EPCM contract relationship delivers a less attractive risk profile for the owner, because the EPCM contractor is significantly reducing its liability. The owner can typically expect an overall costs reduction in delivering the project if the owner has expertise in the area of contract administration.
This commercial advantage comes with the risk of poor coordination between the trade contractors, or the risk of delay that one trade contractor causes another. Where these risks arise, it is likely that the owner will be subjected to claims by subcontractors.
Although the owner may make a claim against another subcontractor for an indemnity for the other subcontractor’s claims against it, litigation involving three (3) or more parties is slow and expensive, and where major subcontractors are involved, may jeopardise the entire feasibility of the project.
Early Contractor Involvement (ECI)
In recent times ECIs have become increasingly popular, regardless of whether the owner opts for an EPC or an EPCM. As its name suggests, an ECI form of contract allows the contractor to become involved with the owner’s initial design consultants.
Working collaboratively in this manner leads to an abbreviated tender process, so the owner selects the contractor for an initial stage to develop and design plans to produce a risk adjusted price, which is the price for the contractor to complete the following stage (ie the final delivery of the project). Obviously at the completion of the initial stage, the owner is free to ask alternative contractors to price the project.
Like any other contract, risk allocation with an ECI can vary greatly from project to project and from one extreme to the other regarding the contractor’s liability, whether there is a fixed date for completion with liquidated damages being imposed, to costs plus arrangements where there is no fixed time nor costs for that matter.
Alliance Contracting: a collaborative alternative to traditional arrangements
Of all the above contractual arrangements, my personal favourite is actually none of them. It’s Alliance Contracting, defined by Mr Tony Abrahams in his presentation Project Alliancing: Does it work? and reported at (1999) 15(2) Building Australia 33:
“Essentially, alliancing is a collaborative, incentive–driven method of contracting, where all the participants work cooperatively to the same end, sharing the risk and rewards of bringing in the project within time and under cost, whilst respecting principles of good faith and trust”.
The concept is relatively simple: the aim being to create an organisation between parties that will manage the project. Typically, an Alliance Agreement will have a board that controls the project, an integrated development team drawing on the best available resources from each participant, and clear commercial arrangements between the parties regarding payments and liabilities.
Typically a board would include representatives from the designer, the contractor and the owner, with no single casting vote. This means that the owner does not have absolute control if there is disagreement.
In my view, it’s this compromise that ensures that there is agreement. Note however that there are proponents of Alliance Contracting who recommend that unanimity be required to remove control from the owner; however this may not always suit the owner or particular projects. Consequently Alliance Contracting is not suitable in all cases.
The best method of contracting for a particular project or particular owner will always be a function of the distribution of risk for a price. There ought never be an unacceptable difference between the expected and observed outcomes of a project. This is the definition of failure, and can lead to devastating effects like the collapse of the West Gate Bridge over the Yarra River in 1970.
Getting it wrong: the West Gate Bridge tragedy
The West Gate Bridge Project was procured in the late 1960’s by a private company, the Lower Yarra Crossing Authority, which was vested by enabling legislation with appropriate powers to finance, construct and operate a toll bridge.
The original contract for fabrication and erection of the steel box girder spans of the bridge was a traditional form of contract, in that it engaged Consulting Engineers to prepare the designs and supervise construction after the contracts were put to tender based on those plans.
In this scenario, the contractor had no contractual mechanism to enforce compliance by the consulting engineers, and ultimately calculations and specifications were never provided by them, leading to the contractor falling seriously behind its program.
This lead further to the Authority engaging another contractor on a costs plus basis, but in that contract the contractor had no responsibility for engineering decisions relating to the final erection stresses in the bridge.
Following yet further delays caused by the change in the contractor, there was significant time pressure on the project.
Ultimately a Royal Commission determined that it was these time pressures which lead to some serious errors in judgment, in particular using two half spans jacked into position and joined along the longitudinal centre line.
This method – which was previously untested anywhere in the world – resulted in a mismatch between the camber of the two half spans, which the contractor attempted to correct by weighing the mismatch down. However this weight caused a buckling in the upper flange near the middle of the span, and when 30 bolts were removed from a transverse splice in the upper flange, the span collapsed, killing 35 people.
The Royal Commission ultimately concluded that “…the basic cause of the tragedy at West Gate was the design inadequacies which lead to the safety margins being much too low, and certainly lower than the specified values”.
Further, the Commission made specific reference to the inappropriate contractual arrangements which had caused disastrous confusion between the roles and responsibilities of the contractor’s employees and the engineer’s staff.
Getting it right: the National Museum of Australia success
By comparison, the Commonwealth of Australia delivered the National Museum of Australia Project – for the first time ever – by implementation of an Alliance Agreement.
The Agreement was between the Department of Communications, Information Technology and the Arts; the ACT Government; the architects and landscape architect; the building and services contractors; and the exhibition designer.
All alliance partners were jointly responsible for the achievement of quality, timely completion within the budget, and design integrity. Some of the fundamental terms of this agreement were that:
- A “quality” pool of $3M gain share was available to the commercial alliance partners for constructing facilities to an “outstanding” quality, with a $2M pain share penalty if it achieved only “business as usual” quality;
- Costs savings were distributed 70% to the Department and 30% to the commercial partners, whereas costs overruns were distributed reversely;
- Time pain share was that the commercial alliance partners would incur a late penalty of $1.9M from the first overdue day, increasing to a maximum of $3.5M (and there was no bonus for completing the facilities early because they were needed to celebrate the Centenary of Federation in 2001); and
- The importance of maintaining design integrity was reinforced amongst the commercial alliance partners, so that if that design integrity was not maintained, they would lose their normal profit entitlements.
Collaboration was the key motivating and operational characteristic which defined the delivery of this project. Alliance team members shared office facilities and constantly met on site in order to ensure cost-effective and efficient construction.
A number of commentators have stated that their experience from having been involved in the Alliance Agreement for this project was critical to its success. They add that the project may otherwise not have been delivered by traditional contracting methods.
The project finished on time and on budget with “outstanding” quality and design integrity. Everyone got paid.
Further considerations with international contracts
Even if the parties have agreed on the allocation of risks, whether under an Alliance Agreement or otherwise, there are a few other legal barriers that need to be contemplated when drafting the contract in order to correctly allocate that risk.
For example, where some of the contracting parties or the projects themselves are international, there may be barriers and uncertainty with regard to a domestic party enforcing any Judgement it may obtain in another jurisdiction.
International Arbitration under the New York Convention goes a long way to help in such circumstances. With over 140 nations participating in the Convention, it makes the enforcement of an award in a foreign jurisdiction relatively straightforward.
This form of arbitration has additional benefits because it has rigidly enforced case managed processes, yet also great flexibility to deal with its own procedures, thus allowing for cheaper and faster resolution of disputes.
Be aware of differing legislative regimes
On the domestic front, Australia has state-by-state-by-territory legislative regimes which regulate liability between contracting parties. This legislation has eroded the Common Law basis which provided owners with an added level of comfort (when say the designers and contractors both jointly and severally assume liability for the works performed together).
In circumstances where one of the contracting parties may not have had the financial resources to recover moneys from, the owner could take comfort that the other more financial party would pay because it was contracted to be jointly and severally liable.
Now however, in Queensland for example (unlike some other states), proportionate liability cannot be contracted out of. Consequently, even if the contract states that both parties are jointly and severally liable (which would otherwise allow 100% recovery from either of the parties), the legislative regime now apportions that liability to determine who the responsible party is – and more particularly, to what degree.
However, in a recent High Court case decision in Selig –v– Wealthshore  HCA18 (a finding under the Corporations Act concerned with misleading and deceptive conduct), the High Court held that a Plaintiff may recover 100% of their loss from a Defendant, even if the wrongful conduct of the other contracting party had contributed to that loss.
It is arguable that because a finding in respect of misleading and deceptive conduct under the Corporations Act involves a higher degree of moral accountability, that this decision seems fair.
However, it is noteworthy that under that Act it is also sufficient to prove in the alternative that the person knew or ought reasonably to have known that a Statement was false or misleading. This then may also be pleaded in the alternative as an apportionable claim, even though it may not involve the same level of moral culpability.
The proportionate liability legislation throughout Australia, the inconsistent manner in which it may be contracted out throughout the country, the above High Court decision enlivening the potential for apportionable claims under regimes which uniformly adopt the Corporations Act, all combine to create an imperative on each participant in the contract to ensure that they have appropriate insurance in place which correctly reflects the risk allocation agreed to in the contract and fully insures all parties so that in the event that a Claim is made, that risk is covered.
A case study in contracting strategy
I recently acted on behalf of a small Republic constituted by some islands in the Pacific Ocean in respect of major civil works.
Because of the specific nature of the site and access to it, significant consideration had to be given to the logistics of site establishment, let alone the actual performance of the onsite works.
This was done in an environment where the Republic had a very low risk tolerance, and the nature and scope of the works to be performed were relatively simple.
Consequently, after reviewing the engineer’s materials and advices and having spoken to representatives on behalf of the Republic, it was clear that the traditional form of contracting was appropriate.
Talk to us about the right contractual strategy for your project
In practice, I can repeat my introduction to this blog post.
Choosing the best contractual strategy is entirely dependent upon the nature of the project under construction, and the nature of the owner in determining the risk allocation and the price a client is prepared to pay for that allocation.