Striking a balanced construction contract to ensure successful project delivery
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.