Hardy ... reducing risk.
Selecting the best procurement method
Michael Hardy* provides an insight into four different procurement methods — the construct-only or traditional basis; the design-and-build route; the two-stage tendering; and the construction management or multi-contracting basis.
01 January 2010
WHILST there has been a turn-around in the region’s building boom, construction and infrastructure projects continue to be developed.
Therefore, it is as important now as ever to ensure that the chosen route of procurement of such projects properly reflects their bespoke nature and the parties’ agreed allocation of risk.
The simplest method of procurement is to appoint a contractor on a traditional or “construct-only” basis. The contractor takes limited or no design risk but builds to its employer’s design, in return for payment. The main advantage of this procurement route is that the overall contract price should be less than what it would have been under, say, the design-and-build route.
The developer would usually look to retain design consultants, whilst separately appointing the works-only contractor, thereby enabling the developer to maintain control over its vision of the design and its integrity. This may be essential on an innovative project, as opposed to a simple “shed” design.
The disadvantage of traditional contracting is that the contractor will not have single-point responsibility for both the design and construction. This means that if problems arise, the developer will be faced with the problem of having to identify which of the contractor and consultants are responsible. If disputes were to arise, the developer can mitigate this risk by including adequate joinder and/or consolidation provisions in its contracts, whereby all parties are “joined” to a single dispute resolution, in order that a single consistent decision can be obtained.
A good example of an industry-standard form of construction contract regularly used in the region for traditionally-procured developments is the Fidic Conditions of Contract for Construction for building and engineering works designed by the employer or the Red Book. It provides for the employer to take responsibility for design but for provisions included to enable the contractor to undertake design responsibility for specified elements of the works (whether civil, mechanical, electrical or construction).
Unlike the traditional route, the design-and-build contractor takes responsibility for design, once engaged. The developer will often have already appointed a team of design consultants before engaging the contractor under this procurement model. Consequently, the contractor will usually require a direct contractual link to the design consultants that have completed the design, which the contractor must take responsibility for. As a result, these consultants’ appointments are often “novated” or transferred across to a contractor.
The disadvantage of the design-and-build route is that, as soon as a design consultant’s employment is with the contractor, the consultant can be pressured by its new employer to reduce costs, impacting on the quality of subsequent design. Consequently, a developer will often insist on a collateral warranty from the consultant post-novation, to ensure that the consultant remains obliged to the developer to carry out the original design. The overall cost to the developer is greater, to reflect the fact that the contractor is taking responsibility for both design and build.
The Fidic Conditions of Contract for Plant and Design-Build, for electrical and mechanical plants, and for building and engineering works designed by the contractor or the Yellow Book, is an industry form frequently used for design-and-build projects in the region. One common difficulty with design-build contracts is the question of allocation of design responsibility where the employer’s requirements also contain some elements of design. In such a case, the Yellow Book seeks to make the contractor responsible for errors in the employer’s requirements, unless they could not have been found by an experienced contractor at tender stage or shortly after the contract is signed. In this way, the Yellow Book attempts to maintain the contractor’s single-point design responsibility.
A further procurement alternative also widely used is two-stage tendering. During the first stage, the contractor is essentially involved as a consultant to help advance design, in collaboration with the design team. It can also tender subcontract works packages as and when they arise, often on an open-book basis. The first stage 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, which is often finalised once a majority 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, the practical reality is that the invitation to tender will likely contain limited information. In turn, the contractor’s bid may be fairly basic with regard to the expected programme and cost estimate. Consequently, the preferred contractor may not be selected on the basis of a firm price, with, therefore, the risk of significant price changes thereafter.
Unfortunately, a contractor can become “entrenched” with two-stage tendering, as it is not subject to competitive pressure. This, in turn, can lead to a lack of cooperation, inflated price 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 and to complete the works under budget and in good time via a pain-share/gain-share mechanism.
The final procurement alternative that this article considers is construction management, in which the developer appoints a construction manager to assist in selecting and awarding individual work packages to trade contractors. The construction manager’s role is essentially limited to advising, as the developer must contract directly with each trade contractor. This is also known as multi-contracting. Consequently, as with the traditional route, there will be no single-point design-and-build responsibility. A further challenge for the developer with this form of procurement is to ensure that:
• The totality of all work packages awarded is comprehensive and sufficient. In other words, with multiple contracts, each trade contractor will have its own scope of work, but, when added together, these must, of course, be comprehensive and sufficient to complete the proposed development;
• There is sufficient sequencing and float between the proposed programmes for each works packages;
• Delay liquidated damages are available and take into account the knock-on effect of one trade contractor’s delay to another;
• Identical or similar dispute resolution provisions are inserted in each contract and appointment. In multiple contract structures, it may be that two or more disputes arise with similar facts. In such a situation, it would be of benefit to a developer if all parties could be “joined” to a single dispute resolution, so a single consistent decision can be obtained. This also applies to traditional procurement where there are separate consultants and a contractor;
• A project management role is allocated in order to ensure that there is successful interface and co-ordination between the various trade contractors; and
• There is sufficient financial contingency for these risks.
All developments are unique and require careful thought from the outset, in order to identify key considerations, such as responsibility for design. All such considerations will undoubtedly impact on the choice of procurement, with pros and cons being identifiable in each alternative procurement route. A developer has a good opportunity to procure and contract from the outset in such a way to ensure that the contract documentation is bankable for either current or future lenders, should the developer wish to dispose of or obtain funding at a later stage. Consequently, the adoption of a carefully thought-out procurement strategy may indeed ensure that the entire project appeals to investors.
* Michael Hardy is a senior associate at Norton Rose (Middle East). 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.
