CONSTRUCTION LAW FOR PROPERTY LAWYERS
Who don't do much construction law
This paper was delivered to the Property Law Section of the New Zealand Law Society at its annual conference in Auckland on 12 June 2018
"There's no such thing as a free lunch"
Aphorism of unknown origin dating from the 1940s
Introduction
When the pile of papers, worthy of any door stop, hits my desk for a “quick review and sign-off”, two things run through my mind.
First is the old project management adage – you can have fast, cheap and right, but you can only have two.
The second is that both client and contractor have three interests in common:
(1) to have a quality finished product,
(2) at a reasonable price,
(3) delivered on time.
Understanding what these actually mean can be a challenge, not least because the priorities of the parties differ significantly. The client typically has only three obligation – (a) to provide the site, (b) to specify the work and obtain the requisite consents for it to be carried out, and (c) to pay for the work.
The contractor, conversely, has a far greater obligation:
(a) generally to carry out the work which will include - (i) pricing, (ii) specifying goods and materials, and (iii) doing a reasonable amount of detailed design work,
(b) obtaining building consents,
(c) sourcing labour and materials, and
(d) obtaining code compliance certification and providing all warranties for the completed work in accordance with the Building Act.[1]
Traditionally, where construction work is carried out on a handshake, the assumption is that the client has sufficiently defined the work for the contractor and it will be carried out on a lump sum, with no power to instruct variations and with no progress payments being due to the contractor until the work is completed (an entire contract).[2]That approach is no longer realistic.
The reality is that it is a rare event that the work is sufficiently specified by the client and its consultant team for a contractor to price accurately for the work, variations are always required, provision must be made for unforeseen costs (at least where they arise from some “act of prevention or delay” by the client)[3]and the price of construction is such that few if any contractors can carry the cost of construction under the “turn key” arrangements included in an entire contract.[4]
Modern contracting, and that great stack of paper that just thumped onto your desk, provides a framework for the parties to procure construction work which is effectively loosely, or even in some extreme cases inadequately specified, and incompletely priced. It is for that reason that we read of projects being delayed and multiples over estimated cost (see the Christchurch recreation centre for a case where the costings and time escalated to such a point where the Government stepped in and pulled the plug on the project).
In this paper, I will explore the practicalities of reviewing draft contract documents in order to promote the achievement of the objectives in (1) to (3) above, and hopefully to advise on achieving a successful project outcome. I will, in the main, focus on the use of the Conditions of Contract for Building and Construction (NZS3910:2013), published by Standards NZ. This should raise most of the issues you will strike in most contracts.
Contract structure – do I need to read the Specification?
Typically, the bundle of documents hitting your desks will include the following:
(1) Conditions of Tender, with a number of attachments
(2) Schedule 1 – Specific Conditions of Contract
(3) Schedule 2 – Special Conditions of Contract
(4) Specification and Drawings
What is of note is that the documents will refer to adopting NZS3910:2013 (or perhaps NZS3915 or another version of the Standards NZ documents which I have neither the time nor the space to deal with here), but this will not be provided with the stack of documentation. The assumption will be that you already have a printed copy of this document. If you do not, they can be purchased online as a PDF from Standards NZ, or in hard copy. The documentation you have received won’t mean much to you if you don’t have this document.
It is also possible that the documentation may refer to the NZIA SCC form of contract, a FIDIC form, NEC, ICE or an AS4000 series form (from Australia). The underlying principle is the same, whichever form – you need a copy of the contract to make any sense of it.
Forms of contract
Each of the forms of contract are published as standards, which will have been negotiated by various industry representatives. They reflect what these drafting committees believe to be appropriate standard approaches to contract delivery, allocation of risk and dispute resolution – each has its own flavour and flaws. My approach to these forms is that while the forms of contract are “standard”, no project is.
Each project must, ideally, start with a discussion about uncertainty – what do we know and what don’t we know, what are the risks for the project and how should they be handled, how many decisions are outstanding for the client, is there anything outstanding from a consenting perspective (on the broad basis that the client deals with resource consent and the builder gets the building consents and code compliance certification for the completed project)?
It is only once that discussion has been had that the client will truly understand what the project involves, and decisions can be made about procurement procedures, when those procedures might start, what can be priced, what is the best allocation of risk for the project (and how those risks might be reduced), and the extent to which any contractor can give price certainty. Experience shown in the UK and Australia, and my own experiences in NZ, UK and Hong Kong, that the more that uncertainty is reduced and risks managed, the greater the likelihood of a successful project – ie, fewer unhappy clients (because they are better informed), greater certainty on price and timing of delivery, better quality of the end result and a contractor who has been paid what it is fairly entitled to.
It is only once that process has been completed that decisions about forms of contract and amendments to those forms can be made. At the minimum, if you receive a bundle of contract documents, the first thing you should be doing is to arrange a meeting with the client and the consultant to understand the preferences of the client, the risks inherent in the project and the strengths (and weaknesses) of the contractor (if there is one).
In general terms, standard forms fall into a number of categories:
- Employer’s design, contractor constructs – this is the form most commonly used, and what this paper focusses on. NZS3910:2013, NZIA SCC and FIDIC Red Book are the most common standard forms. Under this form, the client takes responsibility for designing the works, and the contractor builds what is covered in the drawings and Specification, in accordance with the National Building Code and the Building Act 2004.
- Design & Construct – under this form, the client provides a performance specification which may include some design constraints (for which the client is broadly liable), and the contractor carries out the design to meet the requirements of the performance specification. NZS3916:2013 and the FIDIC Yellow Book are the most common forms of design and construct contract you will encounter in NZ.
- Turnkey and DBFO etc – these forms of contract are less common, and are used where contractors are to provide financing during the construction period, and potentially also during the operations period. These forms tend to be one-off and are beyond the purview of this paper. At the other end of the risk curve, you may also hear of Alliance Contracts. For these projects, the client, consultant team, contractor and key subcontractors contract at the very early stages of the project, and they work together as an integrated team to finalise the design, build up the pricing and carry out the work under the ultimate supervision of a project alliance board. Ultimately this is cost-plus contracting, where the contractor is effectively guaranteed to recover its costs and a proportion of its margin is put at risk.
In the main, most will encounter a bid-build form of contract, using NZS3910:2013, on a lump sum basis.
Contract Structure
Whether the contract goes to tender or is negotiated, the starting point will be the following:
· Conditions of tender/instructions to tenderers – this document is procedural, providing a brief description of the project, the documentation provided, the documentation required of tenderers and the procedure for submitting tenders.
· Specific Conditions of Contract – these outline the specific information required for the project, like the name of the client, the name of the Engineer, what type of contract it is (lump sum, measure and value etc), whether bonds are required, date of possession of the site, insurance details, percentages for on-site and off-site overheads, due date for completion and damages for late completion.
· Special conditions of contract – any amendments to the General Conditions or additional conditions of contract required by the client. These tend to take precedence over everything else in the contract.
· Specification and Drawings – these describe the project and provide all the detailed construction information which the contractor needs to price and carry out the work.
In an ideal World, taken together, the contractor should be able to consider the requirements set out in the Specific Conditions, any change to the allocation of risk in the Special Conditions and the project description in the Drawings and Specification and price the project accurately. There should be no uncertainty about what is required to complete the works. This never happens!
You may be lucky that the client has instructed you at an early stage, so you can have a time appropriate discussion with the project team. More likely, you will be fighting a rear- guard action to get what you can into the contract, on the basis that the client needs the change, and it can be priced by the contractor.
Typically, the designs will be, at best, 30% complete. That will mean that 70% of the design work still has to be completed, which will also mean a significant part of the price will be at risk until those design decisions have been made.
Finally, there is the client who makes last minute decisions which change the work in the most expensive way. They may be happy that they made these decisions, and they may believe they are timely, but they won’t expect the price increase and the time delay which follows (see cls 9.3 and 10.3 of NZS3910). If price and time certainty are important to the client, then as many of these decisions as can be made prior to award, so they can be priced by the contractor, the better.
The contractor then provides its tender for the work, which will typically include its contract price, the pricing breakdown, exclusions from the pricing and commercial tags or qualifications which need to be negotiated during the tender process.
Once the negotiation is concluded, the client issues a letter of acceptance, which forms the contract. Following the issue of the letter of acceptance, the client’s consultant will (should) prepare the contract agreement, which comprises:
· the Contract Agreement
· the Letter of Acceptance, and schedule of tender negotiations
· the Contractor’s tender, and associated documents (including the Schedule of Prices)
· Specific Conditions of Contract
· Special Conditions of Contract
· Drawings and Specification
This list may vary (see below), but in general terms on the issue of the letter of acceptance, the contract is formed (with the exception of the Contract Agreement, which is prepared after award).
Pricing
All construction contracts offer a number of pricing options, the most common being those shown in cl 2 of NZS3910:2013:
· lump sum fixed price – in this case, the contractor offers a fixed price for carrying out the work. This is what the client pays, regardless of the cost to the contractor.
This is by far the most common option, and the one which presents the greatest difficulty. The problem is that, while the price is expressed as being fixed (something which clients tend to take to heart), the lump sum is rarely, if ever, the price paid.
In all options of all the contracts, the price will be adjusted for events for which the client is responsible (all styled as Variations under NZS3910) or which the contractor could not reasonably have foreseen at the time of tender, for example:
– in a lump sum contract, significant ambiguity in documents for which the client is responsible, omitted items and increases in quantities to such an extent that the rates in the Schedule of Prices are no longer applicable (cls 2.2.5, 2.3.2, 2.3.4 & 2.7.4)
– late issue of drawings and instructions by the client or Engineer (cl 2.7.7)
– damages to adjoining property arising out of carrying out the works (cl 5.4.6)
– dealing with subcontractors appointed directly by the client (cl 5.5.2)
– rectifying damage to the works arising from excepted risks, defined in cl 5.6.6 (cl 5.6.5)
– errors in levels or dimensions shown in survey maps provided by the client (cl 5.8.5)
– unforeseen consent conditions for which the client is responsible (cl 5.11.7)
– change in law (cl 5.11.10)
– utilities not shown in plans (cl 5.13.4)
– protecting treasure (cl 5.14.2)
– late supply of Materials by the client (cl 5.21.3)
– failure by the Engineer to discharge its duties under the contract (cl 6.2.4)
– failure to issue the Practical or Final Completion Certificates (cl 6.6.4)
– suspension of work (clauses 6.7.3 & 6.7.4)
– changes to the scope of the works and directions on how to carry out the works instructed by the Engineer (cl 9.1)
– unforeseen physical conditions (cl 9.5)
– occupation by the client prior to completion of the works (cl 10.7.4)
– rectification of defects for which the contractor is not liable (cl 11.2.6)
– expenditure of work covered by Provisional Sums and contingencies (clauses 12.9 & 12.2)
This list is lengthy, and is not exhaustive. It is important, particularly in lump sum contracts, for the client to understand that the lump sum is not definitive, and it is certainly not what they will be required to pay under the contract.
Even a cursory glance at this list will show that the biggest risks to the lump sum are incomplete designs at the time of tender, client driven variations and unforeseen physical conditions. Yet much of this cost, and delay with associated cost, is avoidable if, prior to award of the contract, the client, Engineer and contractor take the time to make design decisions, finalise plans and carry out site investigations at a time that the contractor can provide a more definitive price, and the client can then rationally consider that price, and make any design or other adjustments necessary to maintain the project budget.
In no case is this more important than in the rectification of defective buildings where all too often the Specification is to bring the building up to the required level of weathertightness and other code requirements, yet the parties have not taken sufficient time to explore the condition of the existing building. These are the projects most likely to run two or three times over the programme and four to five times over budget (and end up in adjudication or arbitration).
· measure and value – under this form of contract, the monthly progress payment is calculated by the Engineer measuring the quantities of work carried out during the previous month, and the contractor then invoicing for that work at the rates set out in the Schedule of Prices (see cl 2.30).
It is critical to note that the price paid by the client is calculated at the rates set by the contractor, rather than the cost to the contractor. Generally (unless there is a significant change in quantities in terms of cl 2.3.4), the rates are taken as quoted by the contractor without adjustment. There is otherwise no basis for looking behind the rates to see what costs and margin went into its make-up.
· cost reimbursement – also referred to as cost-plus or charge-up contracts, under these contracts the contractor charges actual cost of carrying out the work, plus its quoted percentage for On-Site Overheads and (to the aggregate of that calculation) its percentage for On-Site Overheads and Profit.
As can be imagined, a cost reimbursement contract has the potential to be the most efficient (charging only the actual cost), but it also tends to be the most expensive means of contracting as there is little to no cost discipline on the contractor, and the way in which the overheads are applied has the potential to make this form of contracting more profitable for the contractor than it strictly needs to be.
The reality is that absolute price certainty under lump sum contracts is almost impossible to achieve, and transferring risk (not covered by the lump sum contract, as listed above) will never result in the cost savings the more aggressive clients hope to make. It is a rare project that does not result in claims over and above the anticipated contract price, and if the contract does not allow for recovery, most contractors will aggressively look to manufacture other claims or they will look to cost savings in carrying out the work (at the ultimate cost of the client and the project).
The solution to this conundrum in my experience is not to aggressively transfer risk, but to acknowledge that (1) some risks cannot be priced at the outset, and (2) the contractor is entitled to make a fair margin for the work. That suggests that the parties should try to reduce uncertainty and risk before the contract is awarded and they should try to fix those prices which can reasonably be fixed, identify the likely risks to be encountered and agree a pricing mechanism for those risks, and find a mechanism for avoiding as many of the remaining risks as possible.
Some risks will fall to be covered by the variation procedures in cl 9.2, and to be valued in cl 9.3. There is little that can be done about that, but if any such risks can be foreseen, agreeing reasonable rates and testing them as part of the tender procedure helps considerably to keep costs under control.[5]
Who and what is the Engineer? Role of the Engineer
For most lawyers, when they pick up a construction contract, their first reaction is “who is the Engineer”? They have significant responsibilities under the contract, yet they are not a party to it, nor do they sign it. Worse, their role includes designing the works (for which there is considerable professional risk), yet they certify variations (which may be issued to clarify their design omissions or to rectify design errors), approve cost claims by the contractor, certify practical completion and extension of time claims, and resolve disputes (most of which will inevitably turn on the Engineer’s designs and formal decisions under the contract).
By any estimation lawyers are comfortable with, this gives rise to completely unmanageable conflicts of interest. And yet, cl 6.2.1 provides for a dual rolefor the Engineer to (a) represent the client and (b) independently of the parties fairly and impartially make the decisions expected of them under the contract. Most engineers will clothe themselves in their professional reputations, and most contractors will rely, to some extent, on this dual role.
This raises two significant difficulties:
(1) While the Engineer is for all purposes the agent of the client, the client must not interfere with the independent role of the Engineer. To do so would be a breach of contract by the client.
(2) If a potential claim for breach of professional duty does arise against an Engineer, the Engineer will be duty bound to notify its insurers of the potential claim. The insurers will insist that the Engineer makes no acknowledgement of liability or acts in a way which affects the potential claim. This puts the Engineer into a very real personal conflict where it must protect its insurance, yet it must also be independent, fair and impartial, which may well drive the Engineer to acknowledge that the claim arises from its designs or some other failure to perform to the expected standard.
There have been a number of occasions over the years where I have advised engineers where they are conflicted and should advise their insurers. Not surprisingly, while such a notice is critical if a claim is to be maintained, it never goes down well.
The only alternative to this particular conundrum is to recognise that there are only two parties to the contract – the client and the contractor – and to do away with the role of the Engineer altogether. For most of the contracts you will encounter, that is not feasible. You must then recognise that this conflict exists, and either separate the design engineer/architect from the contract administrator in favour of a project manager, or monitor carefully what the Engineer certifies under the contract and on what basis.
Engineer’s appointment
A surprising number of consultant appointments are concluded on a handshake, despite years of advice to the contrary.
The NZ Institute of Architects has its own form of appointment, and the most common form of appointment for engineers is the CCCS/Ingenium form of appointment. Each has its problems which go beyond the scope of this paper. Whatever form of appointment is used, I try to make the following amendments:
· Duty of care – professional indemnity insurance generally refers to breach of professional duty. This is set, typically, by reference to the standard expected of an average engineer or architect, with no particular specialist skill. The problem with this for infrastructure and more advanced projects is that it is that very specialist skill which the engineer has marketed to the client to get the appointment, and it is actually required for the project.
I would typically amend the duty of care provision to record that the engineer/architect holds the skills it held itself out as having before the appointment was made which are also required for the project.
· Scope – the appointment should define the scope of the project, and the extent of the engineer’s/architect’s role.
If I can, I try to get the different phases of the appointment separated into stages – (a) investigation, feasibility, concept, scope review, (b) resource consent and concept design, (c) tender design and document preparation, (d) tender review and award, and (e) contract administration and dispute resolution. I then include in the contract a provision to the effect that the architect/engineer is not to proceed from one phase to the next without formal instruction from the client. The client is also expressly entitled to terminate the appointment at any stage, and appoint another without further payment or compensation to the architect/engineer.
· Payment – clear provisions for payment (including a budget for the project and budget projections against progress), either by reference to rates and lump sums for each stage, should be included.
The obvious risk is that for larger projects, the client pays what is effectively on a rates basis, including for rectifying its own defective work. This can be drafted for, but it is difficult to prove. Where the contractor becomes entitled to a variation as a result of late, defective or incomplete designs or directions, it is relatively easy to provide that the engineer/architect is not entitled to be paid for this part of the services.
Historically, the engineer/architect is the client’s consultant, and they represent the client’s interests. If disputes are likely, then it is important to have at least one project member looking out for the client. More recently, the cost of projects has reached such a level that the consequences of breach of professional standards by consultants are hard to ignore.
It is important, at a minimum, for the client to understand that the Engineer will prepare the designs, will represent the client and will generally perform to the relevant professional standards when doing so; however, there are situations where the Engineer will discharge certain functions under the contract independently and impartially, and for the client to try to instruct the Engineer on how to discharge those functions or to direct the Engineer will be a breach of contract.
Tender or negotiation?
Depending on the client, there are a number of constraints and expectations on how construction contracts are to be let. In somecircumstances, there will be legal obligations to tender, and on how those tenders will be run. Private clients generally have more leeway in how they chose and appoint their contractors.
Whichever option is chosen, there are a number of core principles to be considered:
(1) The ideal is to get the best tender. That rarely means the lowest price. What it means is the best contractor for the project at a price which is fair for the work, with the best chance of a quality outcome, on time and within an agreed budget.
(2) The lowest price will not necessarily give the best outcome.
(3) While negotiation tends to engender a good relationship, the lack of competitive tension tends to raise doubts over whether or not the price is as good as it could have been.
Tender
Most projects tend to be tendered, in the expectation that the contested process will result in better prices. That proposition is hard to deny. However, preparing tenders and going through the process of pricing the work and considering any commercial issues resulting from Special Conditions, is not a cheap or quick process. If contractors are to commit to the process, they need to be assured that their tenders are going to be considered fairly, and there is a reasonable prospect of winning the contract.[6]
For the client and its consultant team, it is important for them to understand that there are legal constraints on how the tender process is to be run. If the client is a public body, then it will typically be required to comply with the Government Rules of Sourcing.
For private bodies, while in the past the tender process has been considered to be a non- binding invitation to treat, it is now settled law that the tender process creates a process contract which binds the parties.[7] Effectively, what that means is that the client, and the consultant team, must follow the procedures laid down in the Conditions of Tender or the Invitation to Tender.
In practical terms, this will mean that if there are evaluation criteria specified which set out how tenders will be considered, then the client is bound to appoint the contractor with the highest evaluation score.
Many problems tend to arise during the tender process, with contractors seeking to game the process to their advantage and clients seeking to appoint their preferred contractor, but at the lowest price. Provided all tenderers are treated fairly and on the same basis (it would be inadvisable, for example, to tell different stories to different tenderers), then the process should be free from challenge.
There can be a tendency to select a preferred contractor (usually the lowest price) on closing of tenders and to work with that tenderer on removing any commercial qualifications and to reduce any contingency the contractor has included in its price. While this is usually welcomed by the contractors, this process fails to make the most of the tender process. It is my preference, if possible, to keep all bidders in the process through to the point where the contract is to be awarded. If each bidder has been encouraged to make the best possible tender for the work, then all bids (hopefully no less than 3 and no more than 6) can be taken to the client for an informed decision. This will mean working with the bidders to improve their bids, so far as possible, but generally this is time well invested.
The downside of this process is that it puts all bidders to what will be unnecessary cost (for the unsuccessful bidders), and it encourages an over enthusiastic acceptance of risk. Once the contract has been awarded, the contractor will go from being cooperative, making more concessions than is sensible to win the work, to more aggressive in protecting profit margins, reducing costs where possible, and lodging claims for additional cost at every opportunity, all to the cost of a successful project.
Tendering is a tried and true process, and most contractors will accept the cost, but it is not without its draw backs.
Negotiation
Conversely, direct negotiation with a preferred contractor is more likely to promote good relationships, and it does provide an opportunity for early engagement with the contractor providing its skills and experience in risk reduction.
Without the competitive tension of a tender process, pricing can become an issue. Most boards of directors and chief executives struggle with the concept of a negotiated price which is not also the lowest price.
The conflict between these two processes turns largely on whether or not there is a reasonable price for the project, and how to secure it.
In the current market, most contractors are in a position where they can turn down tendered projects, electing only to engage in projects by direct negotiation. Similarly, remediation projects can be difficult to conclude by lump sum tender as there are simply too many unknowns.
Direct negotiation should never be discarded outright, provided an open relationship is established between the project team and the contractor, the process is focussed on settling a lump sum on an open book basis, and there is appropriate benchmarking of prices.
It follows that, if the client has doubts about the price, it reserves the right to seek competing tenders from another contractor.[8]
Do I rely on the General Conditions? What should go into the Special Conditions?
General Conditions of Contract
The General Conditions of Contract set out the allocation of risk between the parties, the procedure for carrying out the works, the basis and procedure for payment, and the dispute resolution procedures.
In most cases, these reflect a generally acceptable starting point for all concerned. They are not, however, perfect.
Schedule 1 – Specific Conditions of Contract
The Specific Conditions should be relatively non-contentious. They are a record of the specific information for the project (eg the names of the client and the Engineer) and for things like the value of bonds, the amounts of retentions, the time for completion and insurance arrangements.
Schedule 2 – Special Conditions of Contract
The Special Conditions are the lawyers’ opportunity to change the allocation of risk or to clarify issues which need to be addressed in more detail than what is in the General Conditions.
Rather than simply drafting general principles or new procedures which are in conflict with and purport to override the General Conditions, it is preferable to use the Special Conditions as an opportunity to amend the General Conditions themselves. This will mean reading the General Conditions, identifying what needs to be changed, considering what needs to be altered to meet your client’s specific needs and the needs of the project, and anything that needs to be modified to deal with particular contractor issues.[9]
For NZS3910:2013, I tend to make the following amendments (subject to what the client may also require):
· Contractor warranties – as a signatory to the contract, the contractor is bound to the covenants already spelt out in the conditions of contract. There may, however, be specific warranties (other than those implied by the Building Act 2004) which the client wants specifically included – eg, the performance of the weathertight system. These will need to be dealt with by specific additional warranties which can be included in the contract by Special Condition, rather than by separate document.
· Parent company guarantee – it has become common practice for many contractors to incorporate new companies for new projects, and to then wind those companies up once the projects have been completed and defects rectified. While this is not necessarily sinister, it has also become a means to avoid liability for defective work.
All contractors and consultants, at all levels, will have corporate structures of varying levels of complexity, yet they will bid for work on a “group basis”, meaning that they will ignore the fact that the company offered to contract to do the work is not the company that carried out the work in the marketing documentation, and in fact the project company has only 100 shares (tied up in trusts or related companies) and no assets to speak of.
In these cases, to the disappointment and sometimes rage of the contractor or consultant, I require a parent company guarantee which imposes on the ultimate owner or asset holding company the following obligations:
– to undertake and guarantee proper performance by the contractor of its obligations under the contract,
– not to do anything to adversely affect the contractor’s ability to carry out the works, and to ensure that it is appropriately resourced to meet its obligations, and
– in the event that the contractor defaults under the contract, as primary obligor, to carry out the contract works itself, as if it had been named as the original contractor under the contract.
· Performance bonds– the forms of performance bond set out in Schedules 3 (Contractor’s Performance Bond), 4 (Principal’s Performance Bond) & 5 (Retention Bond) are all conditional performance bonds, which means that demand cannot be made under those bonds unless (a) the contractor acknowledges that the amount demanded is due and owing (very unlikely), (b) the amount claimed under the bond is found to be finally due and owing in arbitration or in court and all rights of appeal have been exhausted (in which case the usual 10% will not be enough).[10]
If a bond is necessary, then they should secure the amount which is realistically likely to be due at the time of demand (for the contractor’s bond, the cost of rectifying defective work, securing the site, terminating the contract and securing a new contractor), they should be in on-demand form (ie, paid on demand by the client without proof or conditions as to the amount demanded or the contractor’s default) and issued by a trading bank.
The difficulty with on-demand bonds is the impact they have on the contractor’s working capital and the risk that an unscrupulous client may make demand without reasonable justification.[11] A reasonable compromise, if one is required, is to require the Engineer’s certification as to the default and the amount demanded before the client can formally make demand. The effectiveness of this compromise will depend on the Engineer understanding what is being certified.[12]
· Subcontracts– in most projects a significant part of the work is undertaken by subcontractors. Clause 4.1.2 provides for the client’s consent to all subcontracting, and this provision is generally sufficient.
Subcontracting does, however, raise two significant issues of concern:
– Project cashflow – monthly progress claims will be made up of subcontractors’ claims for payment, the contractor’s own claims and overheads and margin. Typically, the amount due under the payment claim will be made in the month of claim (the month following which the work has been done).
The amounts included in the claim, due to subcontractors will usually not be due till 60 days or even 90 days following the date of claim. These are not insignificant sums.[13] The resulting buffer of funds built up in the contractor’s accounts are not subject to any trust or other constraint. For the client, what this effectively means is that while it may be paying significant sums for work carried out on its project, those payments may be used to bail out other more pressing projects or to meet other cashflow demands of the contractor unrelated to the project.
The first indication the client will get of a contractor in trouble is when the Engineer reports that the subcontractors are not getting paid. While some contractors maintain that project cashflow is theirs to deal with as they please, this is largely an attitude of days gone by. For most projects, I require contractors to provide a breakdown of their payment claims to show what is due to subcontractors, and to then provide proof in the following month that such subcontractors have been paid. If such proof is not provided, then the payment claim is rejected, and payment suspended. This right should include the ability to pay subcontractors directly, and to deduct such payments from future contractor payment claims.
– Subcontractor’s warranties– a corollary of the cashflow issue identified above is that in many instances, the client will want a direct relationship with critical subcontractors. The first is that the subcontractor warrants that the work is carried out in accordance with the contract; and the second is that, in the event the head contract is terminated, the subcontractor will carry out and complete the subcontract works directly with the client, or a replacement contractor.
· Extensions of time– the General Conditions of NZS3910 are hopelessly vague in dealing with claims for extensions of time. Quite what “fairly entitled” in cl 10.3.1 is anyone’s guess. If there is a delaying event, then most clients will want the contractor to notify the event as soon as it becomes apparent; to reorganise the works to avoid or mitigate the delaying effects of such event (without incurring significant expense); and for an extension of time to be granted only if it will actually delay completion as shown in its programme. If the delaying event is not on the “critical path”, then no extension should be granted.
· Payment claims – the payment provisions in cl 12 are reasonably complete and have been driven by the provisions of the Construction Contracts Act 2002. While this paper is not intended to deal with the provisions of that Act, anyone engaging in the construction industry should be aware of the requirements for payment claims under s 20 and payment schedules under s 21, and the consequences of not complying with those provisions (see ss 22 & 23).
In most projects, there will be a requirement for the contractor to provide bonds, proof of insurance, parent company guarantees, subcontractor warranties, safety plans, programmes and quality plans. Yet there is often little effective sanction for a failure or delay in providing these documents for approval. In practice, linking the contractor’s entitlement to make the first payment claim until these have been submitted for approval can be very effective.
· Retentions – technically, retentions are percentage deductions from progress payments otherwise due to contractors which can be used to rectify defective work. In reality, retentions have become subject to considerable abuse over the last few years, with clients using them as part of the general security for performance and contractors passing the cost down the contract chain by increasing the percentage retained from subcontractors and delaying the release.
The Construction Contracts Amendment Act 2015 was introduced to rectify this problem by imposing a statutory trust over such moneys.[14] While the amendment was probably well intentioned, in practical terms compliance with the new scheme is expensive and complicated. In most cases, I recommend that retentions are dispensed with in favour of an on-demand retention bond (see above), or that the client requires a payment of an appropriate amount (say 3% of the contract price) to be paid on the issue of the Final Completion Certificate.
There may be other more detailed corrections to be made to the contract (for example to deal with the termination provisions,[15]to modify the role of the Engineer or to simplify the disputes procedure), but these will largely depend on the client’s appetite for making amendments to the contract for what might be seen as spurious legal reasons.
Award – do I need to do anything else? Letter of Acceptance
Once all the tender qualifications have been negotiated away, the price adjusted for negotiated changes to the scope of work and the removal of contingencies, the contract will be ready to be awarded. There tends to be an element of excitement and impatience at this point, on the part of all project participants.
The engineer/architect or project manager will be keen to prepare the letter of acceptance, with minutes of meetings, email exchanges and revised documents stapled to the back. While this may be thorough, it also reflects a lack of discipline to properly record what has been agreed – that is all too often determined subsequently by an adjudicator or arbitrator.
If at all possible, any changes to the contract documents arising from tender negotiations should be recorded by agreed amendment to the documents themselves – primarily the Special Conditions, Specification or the Contractor’s tender.
Contract Agreement
Somewhat unusually, the Contract Agreement is then compiled (by reprinting and collating the contract documents, with all agreed amendments included) and signed by the parties.
The only amendment I tend to make to this document is to record the order of precedence of the various composite parts of the contract.
Conclusion
The golden rule, whether acting for a client or a contractor, is to contract only with parties you can trust to deliver what they said they would deliver.
For contractors, this means that the client will pay for the work, will consider and pay all reasonable claims for additional cost, and will provide all consents and design information on time (or allow the contractor such further time as is reasonably required to make up for the delay). For clients, they need to be satisfied that the contractor has the financial resources, skills and access to labour and supplies to carry out the work and that they can deliver the project complete without defects, on time and within budget.
There are times when one party or the other cannot live up to those expectations. That need not be fatal to the project, provided appropriate protections can be put into place.
International experience has been that projects fail for a number of reasons we are seeing in NZ today, including:
(1) lack of skilled resources,
(2) unrealistic allocation of risk in the contract documents,
(3) inappropriate procurement procedures and forms of contract, and
(4) unrealistic expectations of the parties.
The central problem is one of managing uncertainty, and for most projects the best solution is for clients to engage with contractors to understand and to reduce, as far as possible, those uncertainties. This will not necessarily result in a cheaper price, but it will result in a more certain price and more certain delivery.
For lawyers, this raises an uncomfortable approach – to advise their clients on the best outcome, rather than seizing the opportunity to shift risk, squeeze prices through the tender process and play hardball during construction. While this may appeal, and it is opportunistic, it is rarely successful. Either price or quality will pay the price of this opportunism.
As the quote at the top of this paper suggests, nothing comes free.
John Walton
Bankside Chambers
Auckland
30 May 2018
[1]See Part 4A of the Building Act 2004.
[2]See Cutter v Powell(1795) 6 T.R. 320; Appleby v Myers(1867) L.R. 2 C.P. 651; Hoenig v Isaacs[1952] 2 All E.R. 176; and Heywood v Wellers[1976] Q.B. 446, CA.
[3]See Amalgamated Building Contractors Ltd v Waltham Holy Cross UDC[1952] 2 All E.R. 452.
[4]The Construction Contracts Act 2002 formalises this by including the right for the contractor to be paid the contract price by monthly progress payments in the default payment provisions in ss 15-18.
[5]For tunnelling and underground work, the Code of Practice for Tunnelling work provides for the preparation of a geotechnical baseline report which establishes the anticipated ground condition at the time of tender. The contractor is given the opportunity to review the GBR, and if the contractor encounters physical conditions outside the GBR, it can show that it relied on the GBR and that it actually suffered additional cost and delay, then it becomes entitled to additional time and cost pretty much automatically. This approach was used for Watercare Services’ Hobson Bay Tunnelling project, the tunnelling section of which was completed on time and within budget.
[6] In a significant project some years ago for a local authority, tenders were invited from a select group of contractors. None submitted bids. Ultimately, the project was awarded to a contractor who had not been part of the tender process following extensive and detailed negotiation.
[7] See the line of cases culminating inPratt Construction v Transit [2003] UKPC 83.
[8] For the America’s Cup project in the Viaduct Basin in 1996, the contractor was engaged in a two stage appointment – first, to assist with design, consenting and constructability, and second to carry out the work on a lump sum basis. Having been appointed for the first stage, the inevitable expectation was that they would be appointed for the second stage (on a lump sum design and construct basis). The client in that case reserved the right to take the second stage to tender if it was unhappy about the price.
[9] In a recent infrastructure project, questions were raised about the solvency of one of the project bidders. That bidder was also in dispute with the client over another project. The commercial managers were of the view that this bidder should be excluded on solvency grounds. The project team persuaded the client chief executive to award the contract to that bidder on the grounds that (1) the bidder was innovative and good to work with, (2) if the contract was not awarded to the bidder it would probably go out of business reducing the number of specialists to a number of contractors which would reduce tender competition (monopsony), and (3) the concerns over solvency would be managed under the contract by ensuring that the contractor’s cashflow was maintained and work was only paid for which was tested and proven to be in accordance with the contract.
[10] See Trafalgar House Construction v General Surety (1994) 66 B.L.R. 42, and Trafalgar House Construction v General Surety [1996] A.C. 199.
[11] See Edward Owen Engineering Ltd v Barclays Bank International Ltd [1978] Q.B. 159.
[12] See Custom Street Hotel Limited v Plus Construction NZ Limited[2017] NZCA 36.
[13] In the Mainzeal Property and Construction liquidation, while $18 million was found to be owing for retentions, $130 million was owing to unsecured creditors who were largely Mainzeal’s subcontractors who had invoiced for work but not been paid.
[14] See ss 18A to 18I of the Construction Contracts Act 2002.
[15] See the apparent requirement for suspension by the Engineer as a precondition to termination by the Contractor in cl 14.3.3 of NZS3910:2013, discussed at length by the Court of Appeal in Custom Street Hotel Ltd v Plus Construction NZ Ltdreferred to above.