Ward ... look at the options.
Region in for new form of contracts?
Is the Middle East ready for a new form of procurement? AMY WARD* believes that given the present scenario the time is ripe to consider new forms of contracts and outlines some of the options.
01 December 2009
THE Fidic (Federation Internationale des Ingenieurs-Conseils) suite of contracts for international engineering works has been the basis of international construction contracts in the Middle East for many years.
A recent survey by Norton Rose revealed that around 94 per cent of respondents currently use Fidic contracts with many using the Fidic Red Book reflecting the strong preference for traditional procurement. However, 52 per cent did not believe that such contracts provided flexibility with many perceiving it as being too adversarial.
This apart, the recent upheaval in the market has led to a serious review by many of the choice of procurement. Also, some may argue that any inherent weaknesses in the Middle East construction industry could be overcome by a change in the standard form of contract.
Against this backdrop, one cannot overlook the opportunity to consider whether the region may be ready for a new form of procurement.
Traditional procurement
Traditional procurement has found favour in recent years as it enables a developer to maintain control over its vision of the design and its integrity. Further, traditional contracting tends to result in a lower overall contract price than, say, using the design-and-build form of procurement, as contractors do not need to price any premium for taking design risk. However, traditional contracting does have its disadvantages:
• The contractor will not have single-point responsibility for both the design and construction. This means that if disputes arise, the developer would have to pursue both the contractor and its own design team, as both will generally blame the other. Whilst traditional contracting is still the most common procurement method in the Middle East, it has fallen out of favour elsewhere as it is notorious for claims and the time and cost benefits of other structures are felt to outweigh the design control benefits;
• It can result in longer procurement times as the design must be completed before the contractor can start on site if the developer wants to drive the lowest possible contract price; and
• It can be difficult to fast-track a development as the developer is required to provide a fully-advanced design to the contractor before construction of the project can commence.
New form of procurement
When considering a new form of procurement, a developer should consider the following issues before selecting an appropriate form for a particular project:
• Philosophy: Is the developer risk averse and wanting to achieve the maximum risk transfer or does the developer want to adopt an innovative approach to procurement? Does the developer want to use an incentives-based approach or use contractual disincentives to drive performance?
• Resources: Does the developer have sufficient internal resources and experience to manage the procurement? If not, then a project management-based contract would not be appropriate nor would construction management, which requires the developer to manage a large number of interfaces;
• Market conditions: Twelve months ago, contractors were better able to dictate terms and were unwilling to accept lump-sum contracting. Today, the balance has moved back in favour of the developer and lump-sum contracting is firmly back on the agenda; and
• Commercial priorities: The developer needs to prioritise what it considers to be the most important — quality, cost or time. No one form of procurement enables developers to prioritise each equally.
Other options
If control of design is not critical, the developer might also consider the following options:
• Entering into a design-and-build contract for the works and novating the design consultants to the contractor, whilst appointing a team of ‘monitoring’ consultants to oversee and ensure the integrity of ongoing design, post novation. However, the overall cost to the developer is greater, reflecting the fact that the contractor is taking responsibility for both design and build so will charge a premium for carrying out due diligence on the existing design and for taking responsibility for it (in addition to the extra costs to the developer of engaging the monitoring consultants); or
• Entering into a design-and-build contract, passing design responsibility to the contractor, whilst retaining the design consultants and requiring them to provide collateral warranties to the contractor.
These options would result in the developer losing a degree of control over the design but would give it the benefits of design-and-build contracting and, in particular, single-point responsibility.
There are an increasing number of projects in the Middle East being developed using such models. However, the certainty provided by a design-and-build contract may well be offset by higher outturn costs as contractors will charge a high risk premium relative to the real risks transferred.
Depending on how critical early completion is, different structures can be utilised to accelerate completion. The basic one-stage structure of going out to tender when the design is complete (on either a traditional or design-and-build basis) is generally the least aggressive on programme. This is because the design and construction phases do not overlap. Therefore, one way of addressing this is to consider an alternative form of procurement such as two-stage tendering.
Two-stage tendering
This is one of the most popular ways in which to accelerate completion by having overlapping design and construction phases. During the first stage of two-stage tendering, the contractor is essentially involved as a consultant and helps advance design in collaboration with the design team, whilst developing a detailed programme and cost plan. It can also tender subcontract works packages as and when they arise, often on an open book basis.
However, this phase is generally financed via a cost reimbursable payment structure, not fixed fee.
During the second stage, the contractor and developer seek to negotiate and agree a fixed-price contract (generally on a design-and-build basis, but it is possible to use a traditional contract as well) which is often finagled once 70 to 80 per cent of subcontractor work packages have been tendered.
The advantage with two-stage tendering is that the contractor can be appointed at an earlier stage and, therefore, be involved with design from the outset, thereby fast-tracking the development and possibly introducing efficiency savings as well.
However, there are risks associated with two-stage tendering. The practical reality is that the invitation to tender will likely contain limited information. In turn, the contractor’s bid may be fairly basic, particularly regarding the expected programme and cost estimate. Consequently, the preferred contractor may not be selected on the basis of a firm price with the risk of significant price changes thereafter.
In addition, once the contractor has been appointed, competitive tension is lost and the contractor is not incentivised to reduce its costs when agreeing the lump sum price for the second stage. This, in turn, can lead to a lack of cooperation, inflated prices and general resistance to accepting risk allocation. One solution to reduce this risk is to incentivise the contractor to provide the best second-stage price via a pain-share/gain-share mechanism.
Two-stage tendering is gaining popularity in the Middle East and can ease the path to a lump-sum solution. The general increase in competition for work amongst contractors is also likely to assist in ensuring the contractor does not inflate prices.
Whilst the traditional form of procurement has previously found favour in the Middle East, it is clear that once a developer has finagled on its objectives for the project, it may benefit from considering other forms of procurement, such as design-and-build and two-stage tendering, when considering procurement options for its construction projects.
* Amy Ward is an associate at Norton Rose (Middle East) LLP and is based in Abu Dhabi. Legal queries related to the construction sector can be addressed to Norton Rose (Middle East) LLP through Gulf Construction magazine at editor@gulfconstructionworldwide.com.
Norton Rose Group has had a presence in the Middle East for nearly 30 years and has advised developers, lenders, and contractors in relation to the legal aspects of a wide variety of construction and infrastructure projects in the region.
With a combined team located in both the Bahrain and Dubai offices, Norton Rose (Middle East) LLP is able to provide both contentious and non-contentious support to financiers, developers, contractors and specialist contractors in the region.
