Procurement principles – is it time for a Spring clean?


Procurement principles – is it time for a Spring clean?

Construction and engineering contracts are the formal expression of an agreement

made between the parties. Such contracts often not simple, and are rarely contained

in a single document.

The quality and precision of contract and associated documents can help (or hinder)

a successful project. It is important that they define the involvement of the various

parties, their relationships with each other and the layers and levels of obligations,

liabilities and rights between them.

All too often lack of time, lack of planning or lack of understanding leads to contracts

that do not do reflect those points. In the event of a dispute, the parties have to ask

the courts (or another third party, such as an adjudicator) to decide what the

agreement was that was actually put in place.

Do we really need paper?

Construction and engineering projects often involve a dozen or more different

commercial organisations, each with different roles needing different, skills and

expertise. It is critical that the understanding of each contribution to the whole project,

their tasks, rights and responsibilities and their interaction and co-ordination with all

of the others are fully and precisely defined. With large amounts of money and long

timescales involved, misunderstandings can be very expensive.

The only safe way is to document everything so that the various players can each

understand their part and play it properly.

Unfortunately, many projects encounter changes and problems, and these can lead

to claims and disputes. Many claims arise from poorly-prepared contracts which

inadequately define obligations or rights, but proper contract preparation can go a

long way in preventing and managing the risk of disputes.

Such risk management through the use of contractual agreements rests on ensuring

that the fundamental parts of the deal are crystallised by the drafting, and that all the

documents are:

·

 

Certain;

 

·

 

Clear; and

 

·

 

Consistent.

It is unreasonable, and asking for trouble, to expect any organisation or person to

 

carry out their role or their task if what is expected of them is not fully agreed and

 

unambiguously described. In the event of disputes arising, missing or poor

 

documentation can prevent recovery of losses: what matters is not what happened,

 

or what should have happened, but what can be shown to the courts to have

 

happened.

 

 

BPE Solicitors LLP

Construction & Engineering – Spring newsletter 2011

The best time

The most important time to use documents to get the project right is before tender

stage – before any organisation (be it a professional, a contractor, or any other) is

asked to provide a fee or quote.

Inadequate information in the issued documentation at this stage is the most

common cause of disagreements of obligations and budget overruns in the industry.

If the tender or proposal documents clearly state what is required and on what terms,

then the professional or contractor can decide whether or not they wish to tender at

all, and exactly what activities and risks they are pricing for.

The most important time for accuracy is when the agreement are actually executed.

Proposals and tenders are usually the subject of some negotiation, and it is essential

that these changes are reflected in the documents which the parties execute.

Building and engineering contracts

Usually, the building or engineering contract is the central document in the suite that

defines the responsibilities, rights and liabilities of a capital project. Such documents

set out which party is undertaking what in respect of either the construction alone, or

the design and construction, of the main works.

Building and engineering contracts are often based on published model or standard

forms. They are widely available, but few of them are suitable for every project

completely as published.

Depending on procurement route, there can be one or more building or engineering

contracts on one project: for example, in construction management there may be a

dozen independent trade contracts, whereas in design and build there will be one

main contract and a number of sub-contracts. For property development schemes,

the contract for the construction of the external structure or building is the main

agreement, with building services subsidiary to that, but in manufacturing or other

processing facilities where particular engineering expertise is fundamental to the

project, the building itself is often sub-contracted.

The published building and engineering contracts all have things about them that are

for and against their use, but there are some issues that need to be considered on all

projects when deciding what type of contract should be used.

The most important issues are first, to make sure that the contract is appropriate for

the client’s risk and procurement strategy, secondly, to make sure that it is

appropriate for the works being let, and finally to make sure that its payment

provisions accord with the purchaser’s intentions.

Works requiring the contractor first and foremost to ensure some performance

specification is achieved (and this can include anything from HVAC systems in an

residential apartment block to output levels in an petroleum refinery) cannot be

contracted using a building contract: it is necessary to allow for the specification of

the performance requirements and to cover the situation if the requirements are not

met.

Similarly, a process-based performance contract is inappropriate for a small civil

engineering job such as re-surfacing a car park: the contract needs to deal with

issues such as ground conditions or adverse weather in a way inappropriate for a

multi-million pound pharmaceutical facility.

Payment provisions can very between contracts, between projects involving the

same purchaser, and between phases of the same scheme. If time is more important

than cost, the design phase of a project can be undertaken on a reimbursable or

cost-plus basis, and the execution phase on a lump sum, guaranteed maximum price

or target cost basis. Repeat projects, for example roll-out of a refurbishment

programme across retail sites, could be partnered to take account of increased

efficiencies. Anything is possible, but purchasers need to be aware that departure

from industry norms can increase risk to the contractor, which will increase costs.

There is still no such thing as a free lunch!

Professional appointments

Most building, and many engineering, projects involve professional design and/or

management consultants. It is as important to get the terms of the appointments of

the consultants right as it is the building or engineering contractor – more so in the

case of traditional procurement routes, since the professionals are the only ones

doing the design.

The two most important issues in respect of the appointment of consultants are the

integration of services across the project, and the integration of design liabilities. The

agreements with consultants, contractors, design sub-contractors and others should

fit together like a 3-D puzzle, with no overlaps and no gaps.

Lists of services must be consistent and fully meshed between consultants – it is

important that no two consultants think that they are responsible for undertaking the

same services, and equally that there are no services that no consultant expects to

do. Gaps and overlaps can cause significant cost and time overruns: the former

leads to duplication of fees, and uncertainty over design liability; and the latter leads

to design problems (particularly at the boundaries) and delays, re-design work and

other problems while the gap is dealt with.

It is because of this that the published standard forms of appointment, although

individually sound, do not work well together across a project. Each of the

professional bodies produces their own standard forms, and neither the terms nor the

services integrate either with each other or with the common building and

engineering contracts. Problems with gaps or overlaps in the services can be sorted

out “on the hoof”, although not usually without cost or time penalties, but problems

with design liability can take years to become apparent. In addition, of course, the

standard form appointments are written for the benefit of the members of the

professional bodies, and so are rarely to the overall benefit of the purchaser.

Collateral warranties

Collateral warranties, also known as duty of care deeds, are the primary vehicle that

the construction industry (and the engineering industries, but to a lesser extent) uses

to deal with the legal doctrine of privity of contract.

English law did not until recently permit a party who is not one of the contracting

parties to a contract, even if benefiting from the contract, to sue under it. For

example, if an organisation purchased a manufacturing facility and it transpired that

there were problems with the structure, the new owner could not take action against

the responsible parties. If the developer has set up a one-off company for the

development, with no assets, for example, or that was no longer trading, the owner

would have no real option for recovery as under the doctrine of privity he could not

recover from the designers that the developer had engaged.

Although the doctrine of privity has to a large extent been eroded by the Contracts

(Rights of Third Parties) Act 1999, it is still not always certain that tenants,

purchasers or the like would always be able to recover, and to what extent. The

construction industry continues to use collateral warranties to deal with the issue, and

generally contractually excludes the effect of the Act. That said, however, the 2005

suite of JCT contracts does have the option of using the provisions of the Act for

recovery instead of warranties.

Collateral warranties vary enormously in their terms. The most contentious issues are

always net contribution and limitation of liability clauses, together with copyright

licences, assignments and levels of the standard of duty of care. Each can be

negotiated depending on the relative commercial power of the parties, but there is

little point in giving or accepting warranties that are not backed by professional

indemnity or product liability insurance, to an appropriate level. In the event of

problems few organisations have sufficient assets to cover the beneficiary’s losses.

One of the most common problems with warranties is that the appointment or

contract on which any such agreement rests is missing, incomplete, or inconsistent

with the terms of the warranty. A warranty is usually only as good as the agreement

from which it springs, so it is important to ensure that these exist and are properly

executed.

Performance bonds

Performance bonds are often demanded of contractors as a form of surety for the

complete and correct execution of the works governed by the contract. They come in

two forms; on-demand bonds (which need no agreement to the default); and other

forms which need the contractor to agree to the existence of the default. Both types

will require the purchaser to demonstrate to the bondsman both that there is default

and the extent of the loss.

Performance bonds are usually for 10% of the contract sum. Since they represent

monetary recompense – cash – performance bonds are usually favoured by

purchasers over other forms of guarantee.

Parent company guarantees

Parent company guarantees are the usual alternative to performance bonds. The

main difference is that this form of guarantee is not for financial compensation, but is

a guarantee that in the event of default the parent company will complete the

obligations of the defaulting party. Favoured with contractors, as these guarantees do

not have a direct cost associated with them, this form of security is only of any use if

there is a parent company at all, and is then only of any value if the parent company

is itself financially (and technically) sound. Purchasers often prefer not to take these

instead of a performance bond, because in the event of a default they do not

necessarily want part of the same organisation to continue to be involved.

Letters of intent

Every year the construction and engineering industries waste millions of pounds and

put projects at risk through poorly-drafted letters of intent, and every year the courts

hear cases on the subject.

Whilst the letter of intent is an essential tool which allows contractors to order longlead

items, or start design work, or even get on site, it should only be used as a

temporary measure whilst some terms are finalised, or whilst the actual contract

documents are prepared for execution.

If the letter of intent does not define what the terms will be when executed, how far

the purchaser is financially liable before execution or until a specified date, what each

parties’ obligations are in the interim, and what insurances are required then in the

event that contracts are never formally executed, or if a problem arises before

execution, either party could be at significant risk of uncertainty over what has

actually been agreed.

Legally, letters of intent fall into one of three categories: the courts will find that the

letter constitutes an ordinary contract, with the terms being defined in the letter – and

not necessarily being what one or both parties has expected; an “if contract” where it

is clear what the terms would have been had they actually been executed; or a

quantum meruit agreement, where the client pays the contractor “as much as he

deserves”, with the amount being determined by the courts. None of these options is

ideal, lacking as they do contractual – and budgetary – certainty, but the “if contract”

is what should be aimed for.

The overriding message is to keep on top of your agreements and, if in doubt, get

them checked. Investment now could save thousands in legal costs during a later

dispute.

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