Expert insights with Peter Paradise, Director, Paradise Charnock O'Brien, and Daniel Tassone, Associate, Paradise Charnock O'Brien
We are often asked what a Contractor can do to improve its bargaining position when negotiating construction contracts. While the odds are often stacked against Contractors, Principals are usually sympathetic to a corporate position put to them by a Contractor early in the procurement process, reflecting the Contractor's fundamental reference point on certain key risks. It is good corporate governance and compliance for all Contractors to have a company wide red-flag position concerning these key risks. This article raises some of these red flags and explores potential positions and outcomes.
1. Incomplete schedules, appendices and attachments
The body of a construction contract is inextricably linked to the scope or specification of the works to be constructed. Most of the variables in a construction contract are buried in the back of the document. The body of the contract often cross refers to a schedule or appendix that is either incomplete or not suitable for what is intended. The missing information is usually required for important matters such as a claim for extension of time or to determine an access date. Without it, the Contractor may be ineligible to lodge an otherwise valid claim.
A good red-flags strategy paper requires a compulsory review of all attachments, appendices and schedules to a construction contract before execution. A sign-off system is developed to ensure that all attachments are complete prior to implementing the contract.
2. Extensions of time
A Contractor is usually required to complete works under a construction contract by a specific time; this is known as the Date for Completion. If the Contractor is late, it may be liable for liquidated damages or even termination.
Extensions of time to the Date for Completion for things that are outside the control of the Contractor are therefore critical to the Contractor in managing its risk. Extensions are usually given for:
the delay caused by Principal;
variation directed by Principal;
breach of term or suspension by Principal;
force majeure; and/or
Unless a standard form contract is being used, a good red-flags policy requires an extension of time for the occurrence of any event which is in the control of the Principal. The purpose of the Extensions is to preserve liquidated damages and prevent the contract from being frustrated. An important aspect of successfully applying for an Extension is that the work which is being performed is done so within the required timeframes as stipulated in the contract. Any application for an Extension can only be applied for due to external factors which are beyond the control of the Contractor. An Extension is usually not granted due to any underperformance regarding the works required to be performed by the Contractor.
For neutral events, other mitigants may be considered including the length of the program and whether insurance covers any part of the claim before determining whether an extension of time is required.
3. Ownership of the float
Float refers to the unallocated time in a critical path network under the Contractor's construction program. A Contractor who owns the float can therefore use this unallocated time to absorb a delay caused by the Contractor or for uncontrollable delays such as wet weather. If the Principal owns the float, any unallocated time is absorbed by a delay caused by the Principal. Under this scenario, the Contractor is only entitled to time or money once any such unallocated time has been fully utilised including for a breach of the contract by the Principal.
It is becoming more common for the Contractor to own the float in Australia provided any claim for delay by the Contractor is to a critical path event. This is a middle ground position that allows the Contractor to control its risk.
A red-flags strategy would compel the Contractor to own the float and be granted an extension of time for any prescribed delay which affects a critical path item. It is, however, difficult to identify who owns the float in a construction contract. To preserve the float for the Contractor, the wording set out below for the grant of the extension of time should exclude the deleted text. If the words are not excluded, the Principal will own the float.
The Contractor will be entitled to an extension of time to the extent the Contractor is delayed in achieving Completion by the Date for Completion.
4. Damages for delay
A no-damage-for-delay clause typically allows a Contractor to obtain an extension of time for an excusable delay on the project (i.e., a delay not caused by the Contractor), but precludes the Contractor from obtaining an increase in the Contract Sum due to such delay.
No-damage-for-delay clauses should be avoided. At the very least damages for delay should be paid by the Principal for a breach of the contract (and in particular a delay to access). Where the contract does not include a no-damages-delay clause, it is usually the case that each party to the contract is responsible for the delays they have caused.
5. Indemnity for breach or negligence
At fault indemnities for loss usually arise from a breach of the contract by the Contractor or for the Contractor's negligence in performing the work. Caution is required to ensure that the breach is of the contract only and any negligence is related to the works themselves. Appropriate insurance should be in place to protect against the loss. A Contractor should always compare the insurance and indemnity provisions of the contract. A Contractor must ensure that its insurance covers all things for which it is providing an indemnity for. In the event this is not properly considered, and a liability issue arises where an indemnity has been provided, the Contractor will bear all costs relating to the loss for breach of the contract and the Principal will be entitled to recover any such loss and seek a remedy under the contract. A Contractor must properly navigate and understand its insurance policy to ensure there are no exclusions in its insurance policies which may prevent cover of any at fault indemnities it has provided to the Principal.
A red-flags strategy may allow at-fault indemnities to be accepted by the Contractor; however, they must only arise from a breach of contract or negligence by the Contractor. Any loss that can be recovered under the indemnity must be capped to the limitation of liability and subject to the exclusion of indirect and consequential loss (see below). Any contribution to the loss by the Principal's breach of contract or negligence should also be excluded. It is prudent to ensure that the Contractor's insurance policies cover any such breach or negligence by the Contractor.
6. No-fault indemnities
No fault indemnities usually arise for loss 'arising from,' 'in connection with,' 'relating to' the performance of the works or the project. These broad indemnity obligations do not depend on proof of negligence or breach of contract – it may be sufficient to trigger indemnity obligations if the loss is (somehow) related to the work, even without negligence or breach of contract. These indemnities require even more caution than indemnities for negligence or breach of contract.
No fault indemnities should only be accepted where they relate to events that are covered by insurance such as:
· death or personal injury; and
· property damage.
No fault indemnities occasionally also relate to third-party claims. The Contractor should avoid any such indemnification given it has no control over it. If the third-party claim arises from a breach or negligence of the Contractor, then it will be covered by the at fault indemnity described above.
The Contractor should avoid any indemnification related to third parties, given it has no control over it.
It is important to ensure that the Contractor is insured for any such loss and that appropriate caps on liability and exclusion of indirect and consequential loss exist elsewhere in the contract. The indemnity should also only apply to the extent the loss is not caused or contributed to by the Principal's breach or negligence.
7. Limitation of Liability
In construction contracts, a total cap on liability is the best way for a Contractor to limit its total exposure with respect to liability, capping the total loss which the Principal may recover from the Contractor in the event of a breach. Exposure to unlimited damages under a contract is usually unacceptable, particularly where the Contractor is an entity of substance. Whilst unlimited loss is usually accepted by a special purpose vehicle that has a limitation of liability at law equal to its share capital, Contractors of substance must protect themselves from unlimited exposure by agreeing to a monetary cap on liability equivalent to a percentage of the Contract Sum.
Whilst it will vary from project to project, the range of limitations are usually between 100% and 40% of the Contract Sum (depending on the identity of the Contractor, whether liquidated damages fall under a separate cap and the size of the Contract Sum).
The only items that should be fairly excluded from limitations of liability are:
· fraud and wilful misconduct; and/or
· insurance proceeds received from the insurer.
8. Liquidated damages
Liquidated damages are the Principal's usual remedy for late Completion by the Contractor. At common law, liquidated damages can be no more than the genuine pre-estimate of loss the Principal will suffer by the failure to complete the works on time.
A red-flags strategy would require all contracts to contain a cap on liquidated damages. The cap should be the lesser of 10% - 15% of the Contract Sum and the aggregate daily amount required to reach the sunset date (if applicable).
9. Indirect and consequential loss
A Contractor may insist upon a complete exclusion for damages for loss of profit, loss of use and business interruption etc, or alternatively seek to cap any such exposure to the limit of any applicable insurance. The law has developed recently in this area and a blanket carve out of indirect and consequential loss may not achieve the effect a Contractor requires. It is recommended that rather than excluding 'indirect and consequential loss' per se, the Contractor seeks to exclude specific heads of loss – whether they be direct or indirect.
It is recommended that rather than excluding 'indirect and consequential loss' per se, the Contractor seeks to exclude specific heads of loss – whether they be direct or indirect.
A red-flags strategy would dictate that the contract should contain an exclusion of 'Excluded Loss' defined to include indirect and consequential loss AND specific heads of loss whether direct or indirect including:
· loss of profit;
· loss of production;
· loss of revenue;
· loss of use;
· loss of business opportunity;
· business interruption;
· wasted expenditure; and/or
· finance charges.
It is important to ensure that the drafting in the contract states that the heads of loss excluded are so excluded whether they be 'direct or indirect' given recent case law has held that some loss of profit and loss of opportunity amounted to direct losses and were therefore claimable by the Principal against the Contractor.
10. How can we help you?
Paradise Charnock O'Brien can help you develop your own red flags strategy to provide consistency in managing risk across your organisation. A sound internal policy will ultimately save your business time and money. It is good corporate governance and compliance for all Contractors to have a company wide red-flags position with respect to these key risks.
For a further discussion, call or email us to see what will work for you.
Peter Paradise, Director Daniel Tassone, Associate
Paradise Charnock O'Brien. Delivering results. Differently.