Scott Stiegler, Vinson & Elkins
This is an extract from the third edition of GAR’s The Guide to Construction Arbitration. The whole publication is available here.
Construction contract arrangements
Construction contracts come in a variety of bespoke and standard forms. They cover a range of differing scopes of works and services from pure consultancy services right through to complete EPC turnkey solutions. Contracting arrangements can include design and build, consultancy services, EPC turnkey, operation and maintenance, project and construction management, front-end engineering design, ‘early contractor involvement’ (single or multiple), alliancing framework agreements, as well as longer-term models such as build, own, operate and transfer, and other similar arrangements. There are also a number of ancillary construction contracts such as those for joint venture arrangements, independent verifier roles and other similar supporting functions.
As a consequence of such a broad range of potential scope of works and services, there are a variety of domestic and international institutions that have and maintain their own particular sets of standard form contracts. While there are widely known institutions such as the Joint Contracts Tribunal (JCT) and the International Federation of Consulting Engineers (FIDIC) that produce and maintain their own contract suites, there are also a variety of specialised industry bodies that prepare and maintain more particular suites of construction contracts, such as Oil and Gas UK, which produces the LOGIC suite of contracts, the Institute of Chemical Engineers (IChemE), the Institute of Electrical Engineers (IEE), the Association of Consultant Architects (ACA), the Royal Institute of British Architects (RIBA) and the Institute of Civil Engineers, which produces the widely recognised and regarded NEC3 contract.
Standard building contracts
A standard building contract is typically confined to the construction of the works only. The employer is generally assisted by an architect, engineer or other construction professional to translate the employer’s requirements into technical documents upon which prices can be sought. It is common for detailed tender documents to be prepared and for there then to be a competitive tender process from which the employer can select the best contractor for the works.
Flexibility also exists around how the contractor can be paid for such works. For example, payment can be based on a simple lump sum for the performance of the defined works only or perhaps on a cost reimbursable basis where the full extent of the scope of works is not clearly defined at the outset of the project.
Design and build contracts
The typical and historically traditional position for standard building contracts is in more recent times less reflective of most modern construction projects. It is not uncommon for employers to seek construction services on a design and build basis, that is, it is for the contractor to review the employer’s requirements and itself develop a suitable and compliant design and to execute the works in accordance with that design. In this situation, the contractor is responsible not only for the design of the works, but also the packaging and letting of the trade packages for the performance of the works itself. This places additional risk on the contractor (for example, time risk with procurement and insolvency risk with the supply chain) that could be seen as passing the risk to the party best placed to manage it, but may also leave the employer facing a higher contract price as a result.
This contracting methodology does have a number of benefits, such as the following:
- As the design and construction of the works are provided for under a single contract, there is a single point of responsibility. This potentially may have an impact of reducing (or at the very least clearly allocating) the design and construction risks of the project.
- By having the contractor develop its own design, it allows the contractor to develop its own means and methods for executing the works. This, in turn, could benefit the parties as the contractor may employ methods that it is more familiar with and reduce the overall cost of the works and the time for its performance for the employer.
- Time for procurement can potentially be reduced. Again, as the procurement aspects of the works are all being managed by the contractor who is also developing the design, procurement lead times and other requirements (importation requirements, for example) can be considered early on in the project.
- Performance of the works can, in some circumstances, be improved given the overall responsibilities placed on the contractor. The incentives on the contractor are also heightened in situations where liquidated damages can be imposed for delayed performance or where performance bonds or retention bonds are provided by the contractor. However, having overall responsibility for performance can also potentially drive negative behaviours in lump sum arrangements where the contract price agreed does not reflect a proper estimate of the works at tender.
With these advantages, there are also a number of potential disadvantages:
- As the risk associated with the design and construction of the project is passed to the contractor, it is very likely that the cost of this risk will be reflected in the eventual contract price, resulting in a higher cost to the employer.
- The employer may feel a lack of control over the detailed design and construction of the works as this is, again, a matter for the contractor. Furthermore, the employer inputting into these areas may also lead to claims from the contractor for additional costs as a result of what could be instructions from the employer to carry out the works differently to how the contractor had originally planned or to perform additional works outside the original scope.
- While performance of the works may arguably be improved, there is also an incentive for the contractor to carry out the works to the minimum compliant standard at the minimum cost, thereby maximising its potential profit.
- Depending on the scale of the project, there may be risks of lack of competition in the market, especially for more specialised projects.
- Contractors could be motivated to make claims against the employer to alleviate themselves from the transfer of risk.
- While the transfer of risk may be appropriate in particular circumstances, contractors will quite often demand that there be overall limitations on liabilities and other restrictions on the passing of risk.
Design and build contracts are complex contracting arrangements and a careful and thorough understanding of the technical requirements of the project and the risks associated therein is needed by all parties.
A consultancy services agreement is designed for the provision of engineering or design services to an employer or contractor. Insofar as it applies to engagements by an employer, consultants, such as an architect or engineer, are typically engaged early on in the development of the project to assist with matters that could include scope definition, risk identification, preparation of tender documents and other general project issues. When retained by a contractor, the scope of a consultant’s role is generally professional in nature and is more than likely related to the design aspects of the contracted works.
Project management contracts
For larger construction projects, there is often a need to have a professional construction manager involved from the employer’s perspective. While this can sometimes be done by way of a consultancy services agreement, more sophisticated arrangements do exist. One such example is the ‘engineering, procurement and construction management’ (EPCM) contract.
The benefits of this arrangement include that it may reduce the overall cost of the works in terms of limiting the risk contingency normally applied by contractors as well as potentially having advantages in procurement. There are also advantages in that the employer retains control over design aspects. Conversely, there are added risks, the main being that the risk of design remains with the employer. The key to success in this arrangement is a good understanding of the project and having thorough and detailed project planning and management.
Build, own, operate, transfer
A build, own, operate, transfer (BOOT) contract is form of public-private partnership (PPP) project model in which a company undertakes a large development project (usually infrastructure-related projects such as toll roads and bridges) under contract to a public-sector partner, such as a government agency. A BOOT project can be seen as a way of developing a large public infrastructure project with private funding.
The BOOT model works by the public-sector partner contracting with a private developer (more often than not a large corporation or consortium of businesses with specific expertise relevant to the project) to design and implement the project. The public-sector partner may provide, for example, some limited funding or some other benefit (such as tax-exempt status) but the private-sector partner generally assumes the risks associated with planning, constructing, operating and maintaining the project for a specified period of time. During that time, however, the developer charges customers who use the infrastructure that has been built to realise a profit. Again, a toll road or bridge is a typical example. At the end of the specified period, the private-sector partner transfers ownership to the funding organisation, either freely or for an amount stipulated in the original contract. Such contracts are typically long term and may extend to 40 years or more.
Traditional construction contracts are generally structured around the consequences of failure and allocation of risk. Alliancing agreements challenge this traditional approach and are incentive-based relationship contracts. Under this contracting arrangement, the parties agree to work together as one integrated team with a culture of cooperative decision-making, risk sharing, ‘no blame and no dispute’ and financial transparency.
In an alliance agreement, the owner, contractor and designer are all parties to one project agreement. Project development is driven by a cooperative board of management made up of representatives of the parties, with a mandate to deliver the project in accordance with agreed goals and alliance principles. While risk is said to be shared, the ultimate risk does lie with the project owner. The alliance model is driven by a target contract cost and a target completion date, with the purpose of these targets being to drive pain or gain sharing in the decision making. The contractor is incentivised as its profit margin is dependent on performance.
Another unique aspect is the ‘no blame’ culture in that the alliance parties release each other from all liability except, in most cases, for wilful default or gross negligence. The philosophy on disputes is that rather than spending time and energy on apportioning blame and developing costly claims, a more efficient approach is for the parties to work cooperatively to overcome problems and risks that have manifested themselves during the life of a project.
With such a wide variety of possible arrangements, it is inevitable that there are a multitude of different potential and interested parties in construction projects. As a result, the particular parties and their roles and responsibilities in these contracting frameworks must be clearly understood and defined.
Parties to a construction contract
As explained generally in the sections above, there are a variety of contracting methods and arrangements that the parties may wish to consider when considering the requirements for a construction project. This, in turn, leads to the possibility of various potential parties and interested parties in construction projects. The sections below discuss briefly the most common parties in construction projects.
The ‘employer’ is the contracting party for whom the work is carried out and is typically the owner of the land upon which the work is carried out. The employer can also be referred to as the ‘owner’, ‘client’, ‘purchaser’ or even the ‘developer’. For the purposes of this chapter, the term ‘employer’ will be adopted.
An employer can take many different forms and is largely dependent on the nature and scope of the construction project being undertaken. The employer need not be a professional construction or development organisation. Indeed, in some circumstances the employer is not a professional construction or development organisation and is, rather, represented by a professional team to undertake the role of the employer under a contract. This is not an uncommon situation and is reflective of the need to have competent and appropriately skilled construction contract professionals filling the shoes of an unsophisticated employer. This situation is also reflective of the need to have such a skillset when dealing with sophisticated contracting, building and engineering organisations.
The role of the employer varies depending on the nature of the contract entered into. For example, an employer could be expected to play a more passive role under a design and build lump sum contract, whereas it could be expected to play a more active role in a cost reimbursable or, indeed, a front-end engineering design contract.
The ‘contractor’ is the contracting party responsible for carrying out the works. Depending on the type of construction contract, the contractor can either perform the works itself or elect to subcontract part of the works to specialist subcontractors and designers. The nature and scope of works under the particular construction contract will dictate the role and responsibilities of the contractor. However, where an element of design is involved, it is quite common for the contractor to subcontract this role out to a specialist designer, architect or engineer.
The engineer or employer’s representative
For contracts of even moderate value or importance, it is not uncommon for the employer to engage an ‘engineer’ or ‘employer’s representative’ to assist the employer in the management of the contract. For the purposes of this chapter, the term ‘employer’s representative’ will be used. The employer’s representative is precisely as the name implies, the representative of the employer for the purposes of the contract.
The employer’s representative is generally a specialised engineering professional such as a project manager or quantity surveyor. More often than not, the role of the employer’s representative, while fulfilled by a named individual, is supported by a team of engineering or construction professionals who have likely been involved in the project prior to the execution of the contract with the contractor. The team supporting the employer’s representative have usually worked with the employer to prepare the specification for the works and the tender documents, may have advised on various issues such as risk, insurance arrangements and contracting methodology, and are likely to have involvement in the letting and review of the tender submissions for the works. As such, by the time the contract is executed with the contractor, the employer’s representative is generally very familiar with the project, the requirements of the works and the contract.
Following the execution of the contract with the contractor, the duty of the employer’s representative is to, in the broadest sense, supervise the execution of the works by the contractor to ensure that such works are completed in accordance with the requirements of the contract. The role of the employer’s representative therefore includes such tasks as assessing payment claims, reviewing the performance of the works in light of the contractual programme, considering and monitoring the works to ensure compliance with the contract specifications and other quality requirements, identifying any defects in the works, reviewing and assessing claims made by the contractor, such as requests for variations and extension of time and other events specified in the contract that give rise to potential entitlement (such as, for example, claims for force majeure, adverse weather and unforeseeable ground conditions). As the employer’s representative holds such an important position as the employer’s agent, the employer’s representative therefore also owes a contractual duty of professional care to the employer.
Subcontracting the works to trade or design subcontractors is a common feature in modern construction contracts. This may be for reasons attributable to the specialist nature of the works or simply the need for additional resources or labour. Whatever the reasons may be, the requirements and restrictions around subcontracting are typically dealt with in detail in the contract. For example, rarely is the contractor allowed to subcontract the entirety of the works to another contractor. Furthermore, requirements may be placed on the engagement of lower-tier subcontractors, such as flowing through key contract terms, requirements for collateral warranties or additional guarantees, or even a requirement to allow the employer to audit the books of account of the lower-tier subcontractor.
Specialist professionals, including architects, quantity surveyors, project managers and other consultants
There are a variety of other professionals who may have involvement in construction projects. The type and nature of the project and contracting framework will define the level of involvement that these professionals may have.
The traditional role of the architect was that of the principal’s representative as well as the designer of the works. The law regarding the obligations on construction professionals has, therefore, developed from this initial position. However, the role has evolved over time and in larger projects, it is usually performed by other construction professionals such as engineers or project managers.
While not an exhaustive list of all activities an architect could be expected to undertake, the duties of an architect could be expected to include the following:
- undertaking a review and assessment of the site (in particular, geological and geotechnical characteristics of the site) to advise on ground conditions;
- advising an employer to the use of the land and any limitations thereon, such as planning and development matters, rights of adjacent owners or restrictive covenants and other access issues that may have an impact on the performance of the works;
- advising the employer of project execution issues, such as design development, cost planning and indicative programming;
- preparing preliminary concept designs and initial specifications for the performance of the works, whether for an approval process, cost planning or for tender purposes;
- advising on project risk identification and potential contracting methodology;
- preparing documents for and thereafter managing the tender process for the works, including a review of the submitted tenders and providing recommendations and analysis of the submitted tenders; and
- monitoring the execution of the works by the contractor and, in some situations, acting as a certifier of the works.
The role of a quantity surveyor is to estimate the quantities for the works to be performed (i.e., to survey the quantity of material, equipment etc required in order to execute the works). A quantity surveyor can be engaged at the beginning of a project to assist the employer in preparing the tender documents or to review tender submissions where a bill of quantities has been prepared. This role is particularly important if the employer is seeking a fixed-price, lump-sum contract. A quantity surveyor can also be engaged to assist with the ongoing needs of the project, such as assessing the measurement of payment claims and claims for variations to the scope of works.
In larger or long-running construction projects, project managers are often retained by both the employer and contractors in order to assist in the day-to-day running of the works and the management of the contract. While a project manager is someone who has originally trained as an engineer or quantity surveyor, the role of a project manager is administrative and managerial.
The role of a project manager may cover many of the activities traditionally performed by an architect. For example, project managers may have a greater role in cost planning and analysis from a project feasibility perspective, have a contract management role and may well indeed have a level of input from a procurement aspect. These duties are, of course, variable and are dependent on the contracting framework with the contractor.
There are a myriad of other consultants that can provide services in construction projects. For example, the works may require the specialist advice of an electrical, mechanical, structural or hydraulic consultant. Many consultants also exist in the fields of building certification, fire, security, acoustics and safety. The input given by consultants is obviously driven by the specific works, but in many larger projects it is not uncommon for employers to retain the services of consultancy engineering firms who typically have a variety of differing consultants from which to draw upon.
Other possible interested parties, including funders and insurers
The increase in complexity and risk associated with projects, the growth of ‘mega projects’ and the differing and varying roles of parties and third parties in construction projects has led to the importance of appropriate risk identification and insurance coverage. Indeed, the construction industry is subject to higher degrees of uncertainty and risk than many other sectors.
In planning projects, employers, insurers and their respective specialist advisers ought to consider, inter alia:
- what the nature and likelihood of the risks relevant to the project are;
- how risk is to be allocated between the parties – will it be transferred, shared or assumed;
- what insurance protection is to be provided by the employer and what is to be provided by the contractor; and
- when the insurance programme is to start and finish.
There are obviously a range of insurance policies available in the construction market and these can be customised to suit the needs of the particular project. The most common policies are ‘contractor’s all risk’ policies, typically covering physical damage to the works, as well as professional indemnity insurance policies, which are typically intended to cover professional design issues. Other insurance policies cover public liability, workers’ compensation and, in some Middle Eastern countries, decennial liability insurance may also be necessary.
The complexity and risk associated with certain projects also impacts on the potential funding that may be available. Typically, the long-term financing of infrastructure and industrial projects is based upon the projected cash flows of the project and is secured by the project assets. The level of funding and how it is provided is again driven by the specific project and its circumstances.
Subscribe here for related content, breaking news and market analysis from Global Arbitration Review.
Covering commercial and investment arbitration, Global Arbitration Review is the unofficial broadcaster for members of the international arbitration community, keeping them feeling up to date and informed.