When confronted by a project delivery method other than the traditional design-bid-build method, owners and contractors must be cognizant of exactly how that changes the project’s risk profile. One obvious risk on every project is whether the project will satisfy the owner’s performance requirements.
Depending on the type of project being constructed, different project delivery methods are better than others in terms of increasing the likelihood the project will function as designed and meet the owner’s and users’ needs. Therefore, it is important that project participants understand how the project delivery method influences the likelihood that the project will perform as required. This is especially true for contractors when their construction contract requires that the contractor guarantee or warrant the project’s performance.
Owners must, therefore, carefully communicate the project goals to the entity designing and developing the project’s plans and specifications. It is vital that the resulting design documents embody the appropriate specifications, are constructible, and coordinated across the various disciplines. To ensure that this happens, owners seek to transfer as much of the project’s performance risk to designers and contractors using contractual performance guarantees or warranties.
The risk associated with providing performance guarantees and warranties vary widely depending upon not only who controls the project’s design but also who specifies and procures the material and equipment to be used, as well as how and when the work is to be completed. In an ideal construction contract, the party who can best control a certain risk will be tasked with managing and eliminating the risk. This is why performance guarantees and warranties are intimately tied to design, procurement, and workmanship issues. As stated earlier, this is yet another reason why it is critical that the project documents clearly delineate each party’s role throughout the design and construction processes.
For example, design decisions regarding materials or equipment should incorporate construction-related considerations. These necessarily include the contractor’s typical means and methods for each scope of work, the contractor’s expertise using a type of material or installing equipment, and the complexity of the material or equipment that is being installed. These considerations need to be well thought out, and the contractor must factor them into its analysis of how much performance risk it is willing to take on.
With all of that in mind, here are a few points regarding performance guarantees and warranties that one should think about when confronted by a few of the different project delivery methods.
With the traditional Design-Bid-Build (“DBB”) method, the owner typically accepts all design-related performance risk. The DBB scenario is one in which the owner contracts separately with the designer and construction contractor, and then provides the contractor with a ready-for-construction set of plans and specifications. Those plans and specifications are, by law, warranted by the owner to be constructible. This is known as the Spearin Doctrine, named after an eponymous United States Supreme Court case that articulated the rule. Spearin is important because, if the owner supplies the contractor with plans and specifications, the contractor must build the project using them. Thus, it makes sense that the owner is responsible for their constructability, and the contractor is responsible for the project being built in conformance with the plans and specifications. The owner controls the constructability risk while the contractor controls the risk that the project does not conform to the plans and specifications.
In terms of minimizing the amount of performance risk the contractor takes on, the DB approach is best suited for standardized projects such as residential or office-building construction. In those situations, it makes the most sense for the contractor to take on most of the performance risk because the contractor is responsible for both the project’s design and construction. If the project involves complex, highly specialized equipment such as medical research facilities or power plants with steam turbines, the owner should be more involved in the design, and the equipment manufacturers and suppliers should take on at least some, if not most, of the performance risk. It is, therefore, important that the contractor pass equipment-related performance risks directly to the manufacturers and suppliers. That way, the party best capable of managing the performance risk is liable for the costs associated with failures to meet the owner’s performance expectations.
The Public-Private Partnership (“P3”) project is a variation on the DB approach. A private entity is responsible for the design and construction of the project, and then, typically, maintenance or operation of the project once it is complete. The most important difference is that, unlike a typical public DB project, the project’s financing is private. The impact of this on the performance side cannot be overstated.
In almost all cases, the private entity financing the project will recoup its investment through availability payments or some other type of payments that are based on the project’s operation. Therefore, the project’s performance is tied directly into a successful design and then construction of the project. With a P3 project, the financing entity, designer, and contractor have an incentive to construct a project that not only meets the performance goals but also minimizes the costs to operate and maintain the project. In these cases, the P3 contract will typically provide a very detailed description of the project’s performance requirements and shift all of that risk to the financing entity who will shift it to the designer or contractor. One very important way this is done is with liquidated damages provisions to shift the financing costs to the contractor for each day the project is not completed and ready to perform as required. These costs can quickly escalate given that most P3 projects are multi-million dollar projects. Any contractor bidding on a P3 contract should closely analyze these provisions to ensure they are aware of how completion and performance standards interact as a trigger for the imposition of liquidated damages.
This project delivery method involves the owner separately contracting with multiple contractors who are then directly responsible to the owner. The important issue to keep in mind is that the performance guarantees or warranties in the contract must be narrowly tailored so they do not invoke performance requirements over which the particular contractor has no control. Warranting another contractor’s work is analogous to warranting the performance of owner-supplied material or equipment. Contractors should avoid providing such warranties because they have no control over the risk that the chosen material or equipment will not perform as expected. As such, contractors in the multi-prime scenario should be held responsible for only the risk that their contributions to the project will not perform as expected.
As one can see, whoever controls the risk that the project will not perform as expected should be the one best able to manage that risk, and it is that party who should contractually take on the responsibility for that risk. Contractors and owners must be aware of how the chosen project delivery method changes that risk profile. Contractors should provide performance guarantees or warranties if they can control that risk within the delivery method being used. An agreement to do otherwise could lead to disastrous results for unforeseen reasons. It is always advisable that a contractor carefully review any contractual provisions discussing performance guarantees or warranties in the context of the chosen project delivery method.