This evening I participated in an online panel discussion that lamented the Australian construction industry’s current approach to risk allocation and procurement and asked whether it was time to punt the lawyers.
My response was that lawyers have a lot to answer for in terms of the contracts that they draft. The contracts that most construction lawyers draft are:
- overly biased towards their client – trying to achieve ‘wins’ by obtaining better than usual commercial terms;
- much longer and more complex than they need to be; and
- too simplistic in their binary approach to the allocation of risks
Construction lawyers have an essential and valuable role to play in establishing suitable contractual arrangements for a project. The laws that apply to construction projects and contracts are complex, and industry participants need the assistance of highly trained and experienced lawyers to navigate these laws. So, punting the lawyers would be a mistake. It would be akin to attempting to engineer a bridge without the assistance of an engineer.
But industry participants should find and use lawyers that understand the complexity of construction, and the need to create contractual arrangements that reward and encourage the cooperation needed between owners, designers, contractors, subcontractors, suppliers and other participants for successful project outcomes.
Those who participated in the discussion immediately related to the first two problems that I identified with the contracts that lawyers draft. It was the third problem – drafting contracts that are too simplistic in their binary approach to the allocation of risks – that required further explanation.
Boiled down, the deal under simplistic, traditional construction contracts is:
- You’ll deliver the scope that I’ve asked for and manage all the associated risks, and
- I’ll pay you a fixed price for doing so.
Everyone in the industry understands this binary “fixed price, fixed scope” arrangement. It’s simple, easy to put in place, and owners can achieve outstanding commercial terms by competitively tendering the contract. It’s not very often that you’ll see an Auditor General criticising a government agency for procuring goods or services in this way.
And this simple “fixed price, fixed scope” arrangement can work well if:
- the contract covers all of the works needed to complete the project, and
- the contractor is in a position to deliver the works without the assistance of third parties.
The problem is many construction projects are more complex than this.
For example, the works that the contractor is to deliver may be just one of a number of contract packages that the owner is procuring to complete the project. In this scenario, the owner will likely need its separate contractors to cooperate with one another to coordinate and integrate their respective works.
If you are one of the contractors, every dollar of additional cost that you incur in coordinating and integrating your works with the works of other contractors will reduce your profit margin, so you will want the other project participants to do the coordinating and integrating. There is no incentive for you to cooperate with any other participant, other than to the extent necessary to deliver the contract package for which you are responsible. There is no incentive for you to adjust or resequence your proposed works, in order to generate better cost or time outcomes for the owner or any other participant, unless you are paid extra for doing so. So why would you?
And even if you are responsible for delivering 100% of the works required to complete the project, you will typically engage subcontractors and suppliers to deliver parts of the works under similar binary “fixed price, fixed scope” contracts. These fixed price subcontracts create the same commercial dynamic, between you, as head contractor, and the subcontractor, and between interfacing subcontractors and suppliers. Each subcontractor and supplier is commercially incentivised to deliver the works for which it is responsible for the lowest possible cost, even if that increases costs for or delays you, the owner or other project participants.
By putting the commercial interests of each project participant in opposition to the commercial interests of the owner and the other project participants, these traditional “fixed price, fixed scope” contracts encourage adversarial behaviour, rather than the collaborative behaviour the owner needs to achieve ‘best for project’ outcomes.
So, returning to the question, industry participants shouldn’t punt the lawyers. Rather, they should seek out lawyers that understand these commercial dynamics, and are capable of developing contractual arrangements that:
- actually reward project participants for the project outcomes that generate value for the owner (and penalise them for outcomes that destroy value); and
- by so doing, encourage the cooperation and collaboration needed to achieve the project outcomes that the owner is seeking; and
- by so doing, also achieve the rewards (i.e maximise profit) that the non-owner participants are seeking.
How to create contracts that encourage collaboration
The discussion included various questions around the connection between contracts, and the collaboration that complex projects require.
Whilst collaboration can be achieved notwithstanding the form of contract, traditional “fixed price, fixed scope” contracts create contractual obstacles to collaboration for the reasons explained above. Put simply, they make collaboration harder.
Contracts can be rewired to make collaboration easier. Such contracts have come to be called ‘collaborative contracts’. There is actually a ‘spectrum’ of collaborative contracting models, which differ depending on the number of ‘pro-collaboration’ mechanisms they incorporate. Some of the more important ‘pro-collaboration’ mechanisms are discussed below. (For more information on these and other ‘pro-collaboration’ mechanisms, see my detailed report on Collaborative Contracting and Procurement via the link at the end of this article.)
Align commercial interests
The most important pro-collaboration mechanism is to align the interests of the non-owner participants with those of the project owner. The interests of the non-owner participants are to maximise profits. The interests of the project owner are more complex. To align the two requires the following steps:
Step 1: Work out what will create, or destroy, value for the project owner. Common examples include:
- cost – minimise WOL project cost
- time – earlier, or timely, completion
- quality – availability and reliability of asset is better than expected
- stakeholders – needs and desires of stakeholders (customers, neighbours/community, other parts of owner’s organisation) are exceeded
- sustainability – expected sustainability outcomes are exceeded
These become your Key Performance Indicators (KPIs).
Step 2: Work out how to reward (or penalise) the other participants for creating (or destroying) value for the owner.
A common approach is to adjust the profit margin that the other participants generate by reference to value for the owner that the other participants create or destroy.
The process for doing this is usually as follows:
- Step 2A:Work out how to measure performance against each KPI. What level of performance is business-as-usual (BAU)? Better than BAU is a ‘win’. Worse than BAU is a ‘lose’.
- Step 2B: Estimate the quantum of extra value the owner will obtain for different levels of ‘win’ or ‘lose’ against each KPI.
- Step 2C: Work out what proportion of the extra value or loss should be shared by the owner with the other project participants.
- Step 2D: Work out how the shared extra value or loss should be allocated between the other project participants.
It is best if performance against each KPI is measured across the entire project, rather than across contract packages, as doing so will motivate each project participant to do what is needed to improve the performance of the entire project (so long as the reward it will receive for doing so covers its additional costs). There is no point in rewarding a particular project participant for good performance outcomes on its contract package, if those outcomes adversely affect the delivery of other contract packages and thereby destroy value at the whole of project level.
Early involvement of the contractor and other project participants in the planning and design phase of a project can generate significant benefits for project. By involving contractors, subcontractor and suppliers in the planning and design activities, owners can improve the buildability of a projects, generate cost savings and reduce delivery risks.
Industry participants should therefore encourage owners and their lawyers to develop procurement processes and contracts that facilitate the early involvement of project participants that can generate value for the owner during the planning and design phase.
Owners need to take care, however, to:
- remunerate participants for their efforts during the planning and design phase in a way that motivates them to generate value for the owner, and at the same time
- preserve the owner’s ability to engage others if it believes it will achieve better project outcomes by doing so.
Governance / decision making
Good project outcomes depend on good decision making. Contracts should therefore encourage good decision making practices, and discourage bad decision making practices.
Good decision making is supported by:
- good information;
- clear objectives; and
- expertise and, where necessary, independence, of decision makers
Accordingly, lawyers should draft contracts that:
- encourage project participants to (a) notify one another in a timely way of issues that require decisions; and (b) provide the decision makers with good information:
- encourage decision makers to make their decisions in a timely manner
- provide mechanisms for obtaining a decision where the appointed decision maker fails to make it;
- where necessary, provide clarity for decision makers on the objectives that their decision is to achieve
- appoint appropriate decision makers.
Reducing contract length and complexity
Earlier I mentioned the need for construction contracts to be more nuanced, in response to the inherent complexity of the many construction projects. But this doesn’t mean that the contracts themselves need to be complex. Good contracts, including those dealing with complex situations, are succinct and clear.
The template contracts that Australian governments are currently using on construction projects have become overly long and overly complex.
By way of example, the legal terms of a Victorian PPP contract presently under procurement run to over 800 pages. The technical specifications are a further 650 pages. And that’s for the RFP version of the contract, before it has been populated with the winning consortium’s proposal.
The length of this contract, and the associated complexity that comes with it, is unnecessary. By way of comparison, the legal terms for PPP contracts for urban toll road projects that were signed early in my legal career, were only 100 pages in length.
800 pages of legal terms and conditions is simply too much for any normal construction industry participant to absorb and comprehend. Project participants need legal advisors at their side every step of the journey, to help them navigate the contract and understand what it requires. Decision making under the contract slows as the decision makers obtain legal advice. And lawyers need hours, not minutes, to provide the advice, and satisfy themselves that they’ve taken all relevant parts of the contract into account.
This state of affairs is clearly counter-productive. It has arisen because:
- most lawyers are happy to “add” to past or standard form contracts, in an attempt to address past problems for their client or to make the risk allocation more favourable for their client, but
- they lack the confidence to “delete” what’s already there. If they aren’t 100% sure what the full impact of removing words might be, they leave them there – just in case.
Owners need to find and use lawyers that have the ability and confidence to document deals succinctly and clearly, and punt those that can’t.
The construction industry won’t improve procurement and risk allocation practices by simply punting all the lawyers. Lawyers have an essential role to play in establishing suitable contractual arrangements on for a project, and helping industry participants to navigate and understand how the law applies to them.
Instead, industry participants should find and use lawyers that understand the complexity of construction, and are capable of developing contractual arrangements that encourage the cooperation and collaboration needed to achieve good project outcomes.
Want to learn more? If so, you might be interested in:
- A video recording of the discussion – see below