Horses for courses
Selecting a contracting model which reflects the inherent features of the construction project maximises the chances of success, writes Samuel J Woff.
Selecting a contracting model is a, if not the, major strategic decision of any construction project. The right model manages risk, aligns incentives and sets the project up for success. Yet there is a bewildering array of structures and standard forms that can be selected from, not to mention an infinite number of bespoke arrangements which can be drafted, ground-up, from a blank sheet of paper.
Industry participants inevitable face the question: what is the right model for us? The answer, often, defaults to “reuse a variation of what we used last time”. And while this may be correct, there is a way to be more principled about the decision.
One model which can be helpful is to focusing on two features of the project:
The length of the project; and
The complexity of the project.
Why are these two factors important in selecting a contracting model?
Project Length
The length of the project is a critical consideration, because the longer the project, the more things can, and do, “go wrong”. The ability to manage the fallout of things “going wrong” is a critical feature of any long term construction contract.
On a short term project, like building a treehouse, the number of things that could interrupt the timely attainment of the objective are limited. While the cost and time to complete might deviate slightly from the originally conceptualised position, the derivation is unlikely to be major.
Yet when you are dealing with a long term project, like a infrastructure project intended to be constructed over five years, this is a far longer period of time where things could “go pear shaped”. In part, this is probability: if we accept that events (like severe storms) happen, on average, every X days, the more days the project is stretched over, the more likely the project is to be impacted by (for instance) a severe storm.
But it is also partly a problem of the limitations of knowledge. The future is inherently unpredictable, and the unpredictability expands exponentially the further forward you extrapolate. We might confidently predict the weather this afternoon, but what about the weather on 15 March, in a decade? After a certain point, we loose the ability to sensibly forecast what might happen. And if we can’t predict whats going to happen, we can’t take precautions to manage it (whatever it turns out to be).
With a larger target for adverse events to hit, and a inability to protect ourselves the “unknown unknowns” that the medium to long term future obscure from us (like pandemics), longer projects are far more likely to be derailed from an on-time and on-budget completion. Contracts used for projects of a longer duration must therefore be flexible enough to allow the time for completion, and budget for doing so, to be increased as necessary. Without such a release valve, any contractor embarking on a long-term contract is almost certainly walking into a loss.
Project Complexity
The second factor to consider is the complexity of the project. Simple projects (like treehouses) require minimal, if any design, and therefore issues of “design” will not loom large. If they do, they will be issues of aesthetics rather than function. But on more complex projects, like oil and gas projects, the proper, functioning and safe design of the project will be as important as the actual physical construction. The owner is purchasing design expertise as much as hammers, welders and concrete. Complex projects therefore require more sophisticated ways of dealing with the conception, evolution and ultimate fitness of the design.
The right fit
Combining the factors of duration and complexity gives us four “categories” of project, each which need a construction contract with different features and focus.
Short and simple – Fixed price, construct only
A simple project of short duration, like a garden shed, does not require a complex contracting structure. The contract can (and probably should, and inevitably does) contain a mechanism for increasing the time and cost in certain well-defined circumstances, but the prevailing ethos is one of a fixed price for a well-defined job.
Short and complex – Fixed price, design and construct
A more complex project, but still of modest duration (like a architecturally designed home, or a modest power substation) will require issues of design (which will be important) to be integrated into the contractual structure.
Given the centrality of the design, it is not appropriate for the owner to engage to the designer separately and then simply task the builder with execution. Instead, the design obligation needs to be melded with the obligation to construct, to ensure (1) coherence between the (more complex) design and the physical construction (2) a single point of accountability for the owner in the event of an issue (segregating questions of design and construction can be harder in power substations as opposed to garden sheds).
Yet because the ultimate duration of these projects are not lengthy, it can still be appropriate to insist on a fixed fee, increasable for certain, precisely-defined events, as is commonly the case through EOT and variation mechanisms.
Simple but lengthy – construction management, cost plus
Some projects are inherently simple, but none the less lengthy, such as constructing a border fence, or a highway. While issues of design will not be particularly prominent, and there is little need to integrate such aspects into the construction contract, the length of these projects expose them to contingencies which will almost inevitably increase time and cost, and do so in ways which are not properly predictable in advance. Insisting on a fixed price, while allowing for an increase in cost and time in certain well defined situations, is therefore not appropriate, as the contingencies of Year 5 are not always definable in Year 0.
A more flexible approach is needed. Rather than agreeing on a set, relatively inflexible, fixed-price upfront, it is sensible to adopt a model where the contractor manages the completion of the works, and deals with any challenges, on a cost plus basis. The builder moves away from building a pre-set design in controlled circumstances for a fixed price, in a transactional way, and becomes more of a reimbursed steward of the project as it evolves, and twists and turns, with the unfolding of time.
Complex and lengthy – EPCM, cost plus
Lengthy and complex projects – the ultimate double-whammy. Contracts which govern such projects have a lot of work to do: they must combine a tight and rigorous process of design, with a execution (or construction) phase which is inherently unpredictable owing to the length of time over which it is expected to take place. The appropriate contractual structure must therefore include a tight and accountable design process with a flexible construction phase. An EPCM contract, or engineering, procurement, contract management structure manages to strike this balance, by placing central responsibility on the contractor to develop a complex design (for instance, for a LNG plant), with the inherent flexibility of asking the contractor to usher, on a cost plus basis, through the actual, messy, unpredictable and uncertain construction.
Discussion
The above factors of length and complexity are not the only factors to consider when selecting a model for your construction project. However, they are important. If not considered, there is a risk that the parties will impose a contractual framework on a project ill-equiped to bear it.
The most common instance of this occurring is when an owner insists on a fixed-price for a long term, complex contract. In doing so, the owner seeks to gazump the inherent unpredictability of the future by imposing a fixed price on the contractor to deliver a contract over, say, five years.
But just because the owner’s bargaining power means they can impose such strictures, doesn’t mean they should. By forcing the contractor to commit to a price in inherently unpredictable circumstances, it simply encourages the contractor to increase their upfront price, or alternatively, it encourages fractious claimsmanship over the life of the contract (and afterwards). Either way, the owner ultimately pays a higher price for ostensible upfront cost-certainty. There is a hidden price to seeking to suppress the volatility of the future.
Switching to a more realistic “cost plus” model, while not without risks, if managed properly can result in lower costs overall (as contractors have no reason to include an amount for contingency to their price) and a more harmonious, less claims-driven project. Such an approach also has the benefit of more closely aligning with reality: it accepts the wild uncertainty of the future, rather than seeking to (unsuccessfully) domesticate it.
Conclusion
In deciding what clothes will best fit, it is appropriate to start with the shape of the body. For a construction project, two contours are prominent: project length, and project complexity. And by first measuring where the project sits on each of these dimensions, we equip ourselves to find a construction contract which is a perfect fit.
About the author
Samuel is a leading commercial construction law and construction litigation specialist, advising on complex and high-stakes project and major infrastructure disputes.
Prior to launching his solo (but national) consulting practice, Samuel had more than ten years experience working in private practice at some of Australia’s largest law firms.
Copyright 2023 Samuel J Woff
