A legal view on tightening up contract terms and using two-stage procurement to route out unrealistically low bids
When there is a downturn in the market, it is often the case that contractors tend to bid low to try to maintain cashflow and turnover. With order books shrinking and fewer projects in the market generally, competition increases which results in diminishing prices and profit. Aggressive competition for the fewer available projects tends to drive down prices for everyone.
Although in theory lower bid prices sound good for the employer, one downside where projects are secured on lowest price is the likelihood of increased claims by contractors to claw back losses. In addition, a loss-making project may eventually force a contractor into insolvency causing increased delay and costs while the employer seeks a replacement contractor.
Even if the project is built-out by the original contractor, the employer might end up with an inferior project to that which was envisaged. Lowest price does not always equate with best quality. For example, there is a tendency to use inferior materials to keep costs down. Indeed, this is one reason for the growth of more collaborative contracts where the focus is on value for money and risk sharing.
What can employers do to protect themselves from bids which are perhaps unsustainable? First, look to the tender process. Ensure contractors tender on an open book basis so that prices are more readily transparent. Clarify where appropriate and seek an explanation if a bid seems to be abnormally low or substantially below the projected costs predicted. This also has the advantage of being able to see whether contractors have front loaded costs.
Also, employers could tighten their contract conditions to make it more difficult to make claims for time and money. For example, the grounds for extensions of time could be cut back and the wording tightened for those grounds that remain. Provisions which lead to costs being payable for delay and disruption could be limited. This could be coupled with the introduction of stringent notification periods.
Additionally, employers could use a hybrid or two-stage procurement route. There are various routes available but the basic principle is that contractor is appointed early following a tender process based on an overall, incomplete design. The design is then worked up with the employer and contractor; and the contractor negotiates prices with the subcontractors.
Once that process is complete the employer requires the contractor to enter into a design and build contract. In this way the employer can be reasonable satisfied of the legitimacy of the contract sum. If a guaranteed maximum price is then included, the cost risk of any increase over and above this price is passed to the contractor. Having already worked up the scope of the design with the contractor, the employer is protected from the contractor seeking to drop quality or standards to manage the cost risk.
Chris Hill is a partner at international legal practice Norton Rose