So you need to build something, but you are not sure where to start? This article provides a summary of the main types of construction contracts and the factors that influence which is the most appropriate contract in the circumstances.
Key construction risks
It is important with any building works to identify and understand what are the key risks to your construction / building project, to ensure the contract appropriately manages them. Key risks include (but are not limited to):
- Counterparty risk (the risk associated with the contractor – insolvency, capacity and capability);
- Authorities risk (the risk associated with the building work receiving required approvals);
- Design risk (the risk associated with the design delivering the required building work outputs);
- Intellectual property risk (the risk of being able to use the building work as designed and constructed);
- Construction risk (the risk associated with the construction of the building works in accordance with the design);
- Legislative compliance risk (the risk that the design and construction of the building works comply with all laws);
- Cost risk (the risk that the Project will cost more than budgeted, such as through variations or delays);
- Time risk (the risk that the Project will not complete ‘on time’); and
- Project risk (the risk of loss or damage to the works itself, adjacent property or third parties).
Different types of Construction Contracts
There are a range of construction contracts that can be used, and the most appropriate one will depend on the particular circumstances of your building works. The main ones are as follows.
1. Design & Construct (D&C) Contracts
Under a D&C contract, the responsibility for the design and subsequent construction of the work rests with a single contractor. This single line of responsibility means that any design errors, or construction errors, are the responsibility of the contractor (subject to the usual qualifications) and there is no finger pointing that it was ‘a design fault’.
2. Construct only Contracts
Under a construct-only contract, the contractor is only required to undertake the building works in accordance with the design, which is prepared by a design consultant that is separately engaged by the principal. This form of contract provides the highest price certainty for the works, as contractors will price the scope of works reflected in the design.
With separate design and construction contractors, there is a risk of finger pointing and it can be more difficult to establish where responsibility lies for errors. Any design issues will be the responsibility of the Principal (to manage with the design consultant) and will often result in a variation (price, scope or both) to the construction contract.
3. Construction Management and Project Management Contracts
Under a construction management contract, the contractor is engaged to manage the construction of the building works, where the Principal has separately obtained a design for those works. A construction manager engages subcontractors as the agent for the Principal, and is only responsible for ‘managing’ the activities of subcontractors in respect of the building works. This form of contract is often referred to as ‘all care and no responsibility’.
Any subcontractor errors, design issues or non-performances under subcontracts is the responsibility of the Principal, unless they arise from a failure of the Construction Manager to properly discharge their management obligations.
A Project Management contract typically appoints the contractor to manage the entirety of the project, from conception to completion and has (generally) broader responsibility to deliver the project on time and on budget.
4. Managing Contractor Contract
Under the Defence managing contractor contract, the contractor is engaged early to assist with preparing the scope of the building works and planning how it will be delivered (the Planning Phase). This is an important mechanism for complex projects in leveraging the contractors smarts. Once the Planning Phase is successfully completed, the contractor is engaged to manage the delivery of the building works (the Delivery Phase).
Under this two stage contract, the Delivery Phase only occurs once pricing and program are agreed in the Planning Phase and the key outcome is the quality and completeness of the building works. Time and cost are targets only.
5. Major and Minor Works Contracts
Different contracts for major and minor building works are commonplace within the building and construction industry for use depending on the value and risks associated with the building works in question.
There is no hard and fast rule on when to use one over the other, as low value works can be high risk, just as high value works can be low risk. The decision depends on the impact those works can have on the Principal’s operations.
6. Agreement to Design, Construct and Lease (ADCL)
An ADCL is a complex construction contract that combines a D&C contract with the grant of a long term lease on ‘completion’ of the building works. The cost of the building works is borne by the contractor (and/or financier) and is ‘recouped’ through the rental payments under the lease. As such, it is critical to ensure that the trigger for the grant of the lease is unambiguous, and the terms of the lease are clear (all of which is negotiated at the outset).
With the cost of the building works being recouped through rental payments, dealing with variations to the building works is more complicated; and where a financier is involved to fund the cost of the building works, there will be a side deed to manage the financiers risk in respect of the building works, and to ensure the grant of the lease (and rent!).
7. Industry Standard or Bespoke Contract
Whether to use an industry standard contract, or prepare a bespoke contract, for the building works depends on the particular circumstances of the works. An important consideration is the value and complexity of the building works, where higher value and/or complexity works support the use of a bespoke construction contract to best manage risk. The market conditions where the building works are to take place is another important consideration.
Factors influencing the choice of contract
Some of the key factors that influence which form of contract is the most appropriate include (but are not limited to):
- Timing: how quickly the building works are required may preclude some forms of contract being used
- Complexity: some construction contracts are only likely to be value for money if the works are complex
- Scope Certainty: the more uncertain the scope of the works, the less likely it is to use construct-only or D&C
- Stakeholder Engagement: consultation can take time, and the more stakeholder engagement required tends to support contracts with more flexibility regarding time and program
- Time & Cost Certainty: Construct-only or D&C can provide the greatest time and cost certainty
This article was written by Fabio Fior, Partner and Isabelle Lovel, Associate.