Striking a balanced construction contract to ensure successful project delivery

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The construction industry is still grappling with the impacts of COVID-19 on the supply of materials, equipment, and labour due to delays in procurement and long lead times. These impacts have been coupled with a significant increase in the cost of construction materials (including increased procurement costs) as a result of inflationary pressures, rising transport costs, and the increased costs of critical resources such as oil, gas, and coal.

Parties to a construction contract are therefore faced with a significant challenge to ensure that successful projects can be delivered. This is a complex balance that needs to be negotiated and dealt with by parties to construction contracts to mitigate risks.

We have been advising both our developer and builder clients on the need to enter into construction contracts with clear allocation of both time and cost risk and relief. When it comes to risk allocation under a contract, our view is that a party who has better control of a risk ought to bear the risk. For those risks outside the control of either party, they should be shared equally.

Where there are uncertain risks allocated under the contract to the contractor, they will often price tenders with an excessive margin which in effect passes this cost to the principal. The principal bears that higher cost regardless of whether the risk actually materialises. In some cases, the principal may be better served by balancing that unquantifiable risk in whole or part to avoid an inflated tender price that covers these contingencies. One example is by using a hybrid contract where some of the scope is lump sum and some is cost-plus.

It’s our experience that parties may have different objectives that may guide which party is willing to take on which kinds of risk and the contract can be negotiated with this in mind. Also, more balanced contracts are often easier to administer during the life of the project as there are palatable outcomes for both sides avoiding disruptions and excessive claims. A balanced approach may also be enough to minimise the complications caused by parties breaching contracts or becoming insolvent due to increased costs and an inability to claim under the contract.

Fixed-price contracts are widespread in the industry and do not always provide the full range of adjustment mechanisms that are needed to fairly distribute time and cost risks between the parties. Many of these mechanisms only exist by virtue of the contract granting rights to the parties and industry participants cannot rely on legislation and common law to cover these risks.

These mechanisms include:
• extension of time clauses;
• delay costs clauses;
• variation clauses;
• rise and fall clauses;
• force majeure clauses; and
• provisional sum and prime cost items.

Extension of time clauses

An extension of time clause extends the time a party has under the contract to reach practical completion. Ordinarily, the clause will operate where a specified event occurs and a party must provide details of the legal and factual basis of the claim. A common requirement is that the contractor must prove the delay will impact works on the critical path and must not have caused or contributed to the delay.
Common examples of qualifying causes of delay include inclement weather, force majeure events, variations, industrial action, and legislative changes.
There are strict mechanisms requiring claims to be submitted within a certain timeframe of the event and sometimes ongoing requirements to notify for continuing delays. Our contractor clients should be mindful of any time bars in construction contracts.
Receiving an extension of time ensures that parties who are delayed are not exposed to liquidated damages or terminated. Additionally, failing to obtain an extension of time may prevent a party from obtaining delay costs depending on the structure of the contract.

Delay costs

Delay costs (delay damages under AS contracts) are the recovery of extra costs incurred by a contractor due to an increase in the duration of the programme. Usually, an act or breach of contract by the other party is not necessary to establish an entitlement to delay costs, merely the existence of a qualifying cause of delay.
Contractors who obtain an extension of time will avoid the risk of liquidated damages or termination but remain on the hook for the costs they have incurred due to delay. It is crucial to promptly submit a claim these costs.
For further insights into delay costs, please see our article here.

Variation clauses

Variation clauses allow the principal or its representative to positively or negative adjust the scope of works and services, often with associated adjustments to time or cost under the contract.
Variations can also arise out of neutral events not caused by either party such as latent conditions or new legislative requirements.

A positive variation request is made by either party where it considers that the works being carried out fall outside the previously agreed scope of works. Many contracts have strict procedures and timeframes in place for a variation to be formally approved under the contract with the consequence that an invalid request will not provide time or cost adjustments.

Parties should carefully consider the interplay between the extension of time, delay damages/costs, and variation regimes under the contract to ensure they are making the right claims.

Rise and fall risk

Rise and fall clauses account for increases and decreases in the costs of materials or other construction inputs such as labour over the life of the contract with the effect that the contract price remains aligned with prevailing market rates. More special cases may address fluctuations in economic conditions such as exchange rates and taxes.
There are many ways to draft rise and fall clauses. For example, the clause can be drafted so that the parties split the difference in increases or decreases or otherwise introduce percentage or amount caps to provide more certainty. It can also be limited to specific materials or trades.

Including these clauses in your contracts may spark discussions prior to commencing the project to consider alternative materials and solutions that achieve the performance requirements of the project without breaking the bank. It can also lead to less conservative fixed tender prices that are designed to cover the volatility of the market. The upshot is that market conditions have forced contractors to be creative with pricing and solutions to be competitive.

Force majeure clauses

Force majeure clauses (also known as “Acts of God”) exist in recognition of unpredictable events outside the control of either party that have the effect of preventing contractual obligations being carried out. Depending on how the clause is drafted it may either suspend the works or provide an extension of time for the period of the delay. In some cases, it may also provide rights to terminate the contract.
Examples of force majeure events include industrial disputes, pandemics, natural disasters, acts of war, and government action or interference. Our view is that COVID-19 is a special case and should be dealt with separately in contracts as arguably it is no longer an unforeseeable risk.

Force majeure clauses often are listed as qualifying causes of delay or compensable causes under both extension of time clauses and sometimes delay costs/damages clauses.

For more detail on force majeure clauses, please see our article here.

Provisional sum and prime cost items

A provisional sum is an allowance in the contract price for specific items of work or services which cannot be quantified at the time of contract entry such as signage, structural elements not yet designed, and soft landscaping options not finalised. Once they are quantified the Principal or its representative will issue a direction.

Provisional sums can be structured to include a cap on items to provide cost certainty. For example, a clause that states a contractor must notify the principal where the actual cost is likely to exceed 125% otherwise risk being barred from recovering those costs. Alternatively, more contractor-friendly is a clause stating a contractor can claim the difference and margin where the total amount of the provisional sum work is higher or lower than the aggregate of the provisional sum values included in the contract without any cap.

A prime cost item is an allowance in the contract price for an item such as a fixture or fitting not specified at the time of contract entry such as tapware, door hardware, or kitchen appliances.
The advantage of these mechanisms is that any amount above and beyond what is allowed can be the subject of a variation depending on the drafting of the contract.

For an additional overview on some of these issues, please see our article here.

Bradbury Legal is experienced in advising parties on drafting and reviewing construction contracts to ensure that risk and relief is properly balanced. For specialist and tailored advice, please contact a member of our team by phone on (02) 9030 7400 or by email at info@bradburylegal.com.au.

Substantive control – the broad scope of the DBP Act statutory duty

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The scope of the statutory duty of care created by Part 4 of the Design and Building Practitioner’s Act 2020 (NSW) (DBP Act) is clarified in the NSW Supreme Court decision of The Owners – Strata Plan No 84674 v Pafburn Pty Ltd.[1] Section 37(1) of the DBP Act provides that a person who carries out construction work has a duty to exercise reasonable care to avoid economic loss caused by defects—

  • in or related to a building for which the work is done, and
  • arising from the construction work.[2]

In this decision, Justice Stevenson elaborates on the definitions of “construction work” and “a person who carries out construction work” under the DBP Act.

Facts

This case involves a claim brought by the Owners Corporation of a North Sydney strata development. The Owners Corporation claimed in respect of alleged breaches of the statutory duty by both the builder, Pafburn Pty Limited (Pafburn), and developer, Madarina Pty Limited (Madarina), of the strata development.[3] Relevantly, the builder and developer were related entities:

  • Mr and Mrs Obeid are the directors and shareholders of Pafburn; and
  • Mr Obeid is the director of Madarina, and Pafburn is the sole shareholder of Madarina.[4]

Interpretation of “construction work”

The Owners Corporation argued that Madarina owed the duty of care under section 37(1) of the DBP Act, notwithstanding that it had not done physical building work at the strata development. To resolve this issue, Justice Stevenson turned to the definition of “construction work” under section 36(1). This section provides that “construction work” means any of the following—

  • building work,
  • the preparation of regulated designs and other designs for building work,
  • the manufacture or supply of a building product used for building work,
  • supervising, coordinating, project managing or otherwise having substantive control over the carrying out of any work referred to in paragraph (a), (b) or (c).[5]

Justice Stevenson’s analysis focused on section 36(1)(d) of this definition, noting that there are two possible interpretations of “substantive control”. Either:

  • the person must have actually exercised substantive control; or
  • it is sufficient to show that the person had the ability to exercise substantive control, regardless of whether such control was in fact exercised.

Justice Stevenson preferred the latter interpretation of section 36(1)(d); a person will be held to have carried out “construction work” where they were in a position to exercise substantive control, even if they did not in fact exercise that control.[6]

A person will be considered to have the ability to exercise substantive control over building work where they were able to control how the building work was carried out. This is a question of fact which will turn on the circumstances of each case. For example, Justice Stevenson suggested that a developer may have substantive control over building work where it owned all the shares in a builder and the two entities had common directors.[7]

In the present case, the question of whether Madarina had substantive control over the building works (and therefore whether it might owe a duty of care to the Owners Corporation) was left by Justice Stevenson for further consideration in a subsequent hearing.

Interpretation of “person who carries out construction work”

Next, Justice Stevenson considered whether an owner who carries out construction work on its own land may owe the duty of care. Madarina argued that the reference to “a person” in section 37(1) should be interpreted as excluding a person who was the owner of the land at the time at which the construction work was carried out. Madarina said that this interpretation would avoid the nonsensical result that the owner of the land might owe a duty of care to itself.[8]

Justice Stevenson did not accept this argument. Instead, his Honour avoided the nonsensical result by interpreting section 37(2) to mean that the duty is owed to each owner except an owner that has itself carried out the construction work.[9] This interpretation does not affect section 37(1), meaning that an owner who carries out construction work on its land will still owe a duty of care to subsequent owners of the land.

Does the duty extend to developers?

Finally, Justice Stevenson acknowledged that the Second Reading Speech for the Design and Building Practitioners Bill 2019 (NSW) suggested that the duty “does not extend to owners who are developers or large commercial entities”.[10] This suggestion is underpinned by the idea that these entities are sufficiently sophisticated to protect their commercial/financial interests through contract or otherwise. Despite this comment in the Second Reading Speech, there is nothing in the text of the DBP Act which excludes developers or large commercial entities from the scope of the duty of care. Justice Stevenson therefore concluded that the duty of care in section 37(1) extends equally to these entities.[11]

Key takeaways

The decision in The Owners – Strata Plan No 84674 v Pafburn Pty Ltd emphasises the broad application of the DBP Act duty of care. The decision is particularly relevant to parties with shared directors or similar corporate structures to builders who undertake ‘construction works’ for the purposes of the DBP Act. These parties may be held to owe a duty of care, even where they themselves have not carried out any physical building work.

Bradbury Legal is experienced in advising on parties’ potential liability under the DBP Act, including where the parties have not carried out any physical building work. For specialist and tailored advice, please contact a member of our team by phone on (02) 9030 7400 or by email at info@bradburylegal.com.au.

 

[1] [2022] NSWSC 659.

[2] Design and Building Practitioners Act 2020 (NSW) s 37(1).

[3] The Owners – Strata Plan No 84674 v Pafburn Pty Ltd [2022] NSWSC 659, [6]–[10].

[4] The Owners – Strata Plan No 84674 v Pafburn Pty Ltd [2022] NSWSC 659, [4].

[5] Design and Building Practitioners Act 2020 (NSW) s 36(1).

[6] The Owners – Strata Plan No 84674 v Pafburn Pty Ltd [2022] NSWSC 659, [25]–[26].

[7] The Owners – Strata Plan No 84674 v Pafburn Pty Ltd [2022] NSWSC 659, [26].

[8] The Owners – Strata Plan No 84674 v Pafburn Pty Ltd [2022] NSWSC 659, [43]–[46].

[9] The Owners – Strata Plan No 84674 v Pafburn Pty Ltd [2022] NSWSC 659, [52]–[57].

[10] New South Wales, Parliamentary Debates, Legislative Council, 19 November 2019, 1781 (The Hon. Damien Tudehope) <https://www.parliament.nsw.gov.au/Hansard/Pages/HansardResult.aspx#/docid/’HANSARD-1820781676-81076′>

[11] The Owners – Strata Plan No 84674 v Pafburn Pty Ltd [2022] NSWSC 659, [49]–[50].

The Importance of Distinguishing Domestic Works in Construction Contracts- Applying the Victorian Security of Payment Act to Contracts for Mixed-Use Developments

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Overview

The application of the Building and Construction Industry Security of Payment Act 2002 (SOP Act) and the Domestic Building Contracts Act 1995 (DBC Act) were considered in the recent decision in Piastrino v Seascape Constructions Pty Ltd [2022] VSC 20, which emphasises the importance of avoiding ambiguity when drafting contracts, particularly when it involves domestic building work or mixed-use development projects. Clear drafting can protect builders under the SOP Act and limit the likelihood of the contract being excluded under the Act as “domestic building” works.

The Facts

A construction contract was entered into between Seascape Constructions (Builder) and Mr and Mrs Piastrino (Owners). It was agreed that the following works were to be completed:

  1. The construction of four apartments;
  2. Modifications to be made to a hair salon; and
  • The installation of a car stacker.

Following a dispute between the Builder and the Owners, the Builder issued an Adjudication Application under the SOP Act.

The Owners disputed this application on the basis that the SOP Act excludes domestic building contracts as per section 7(2)(b) which provides that the Act does not apply to:

a construction contract which is a domestic building contract within the meaning of the Domestic Building Contracts Act 1995 between a builder and a building owner (within the meaning of that Act), for the carrying out of domestic building work (within the meaning of that Act), other than a contract where the building owner is in the business of building residences and the contract is entered into in the course of, or in connection with, that business.

The determination concluded that the SOP Act did in fact apply and that the adjudicator therefore had jurisdiction to issue a determination under the SOP Act.  The adjudicator’s reasoning included consideration that the Owners were in the business of building residences and that the above exception applied.  The Owners applied to the Court for a certiorari to override the adjudicator’s determination.

Proceedings

Three questions arose when the Court considered whether the exclusion in section 7(2)(b) applied in the above-mentioned circumstances.

Mixed-Used Developments and Domestic Building Work

The first question was whether the exception under section 7(2)(b) regarding mixed-use developments applied. Namely, if there was domestic building work in addition to work of a different nature that had been distinguished in the contract.

Under section 12(2) of the DBC Act, a builder is only entitled to payment for carrying out domestic building work if the builder clearly identifies and distinguishes:

(a) the domestic building work from the other work or reason; and

(b) the amount of money the builder is to receive under the contract as a result of carrying out the     domestic building work from the amount of money the builder is to receive under the contract as a result of carrying out the other work or for the other reason.

It was found that the Contract did not distinguish the domestic building work from any other kind of work.

As a result, the Court applied the “dominant character” test in determining whether the construction works under the Contract were considered domestic building work, upon which the SOP Act would apply to the entirety of the contract. As the Contract involved the construction of apartments, the Court held that the dominant character of work was that of domestic building work, meaning that the exclusion under section 7(2)(b) could potentially be applicable to the contract as a whole.

The Business of Building Residences

Although the Owners had a minor victory in relation to the first question with the Court concluding that the building works were not considered “mixed-use developments”, it was held that despite this, the Owners were in the business of building residences and that the construction contract was entered into in connection with that business. Though the Owners had not previously engaged in the business of building residences, their initial intention of entering into the Contract for the purposes of contracting and leasing the apartments for profit in the future was found to be in the course of business. It was further found that the commercial scale and nature of the project to redevelop the property and the long-term objective of holding the property as an investment aligned with the scope in relation of business of building residences.

Accordingly, the section 7(2)(b) exclusion of the SOP Act did not operate in the favour of the Owners and the application for certiorari to quash the adjudication determination was denied.

 

To Consider

As highlighted in this matter, it is crucial that builders distinguish “domestic building work” as required under the DBC Act. This is to avoid a potential fine under the act, in addition to preventing pecuniary losses in circumstances where the “dominant character” of the work is found to be domestic building work, the consequences of which would potentially lead to the construction contract, as a whole, being excluded from section 7(2)(b) of the SOP Act. Likewise, even when carrying out domestic building work, it is important for principals to consider the nature of the construction contract at hand and be aware that the SOP Act could potentially apply to the project.

Architects and providing an opinion on probable cost

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In a recent decision by the NSW Court of Appeal, Morris v Leaney [2022] NSWCA 95 considered an architect’s duty to advise in the context of estimating renovation costs.

In this case, Mr Leaney, was engaged as an architect to design home renovations for Mr and Mrs Morris. The architect informed the homeowners that they would not be able to achieve their desired renovation scope within their set budget of $300,000.

The architect later provided an ‘opinion on probable cost’ based on a preliminary design that estimated the cost to complete these renovations to be $590,000 (ex GST). The homeowners subsequently revised their set budget to $600,000.

A builder was later engaged and advised that the cost of renovations would exceed $1,000,000. In order to reduce costs, the homeowners decided not to pursue the entirety of their initial renovation scope.

The renovations ultimately cost $780,000. However, the value of the house was only increased by $330,000.

The court held that the architect breached his duty to advise the homeowners on the likelihood of achieving their budget. The architect was expected to inform his clients should he have felt “unable or unqualified to give an accurate estimate of costs” and advise that they “obtain an estimate from a properly qualified professional”.

Nevertheless, the court was not satisfied that the homeowners would not have undertaken the renovations even in the event the architect had informed them that it was not possible to complete the renovations without exceeding the set budget of $600,000.

To Consider

This decision is a timely reminder to architects of the importance of adequately advising clients and, if an architect is unable to accurately estimate the costs of works, obtain estimates of costs by properly qualified professions. This is particularly relevant in the current construction climate where material costs have increased exponentially.

This is also reflected in the NSW Architects Code of Professional Conduct which requires an architect to advise on the likelihood of a client achieving their objectives, having regard to their budget and time requirements. Given a failure to satisfy this requirement can result in architects being liable for significant amounts claimed by clients (as well as legal costs in defending those claims), it is important that architects continually advise on costs as works progress and design changes occur.