A detailed explanation of what you should know about contracts, from traditional, to non-traditional, to D&B
This week we're tackling the contract practice APC competency, T017. In the final exam, you'll be grilled about standard forms of contract and the key implications that each type places on the contracting parties. Level 1 is about your basic awareness of contract types and level two involves applying this knowledge to projects and showing you have a deeper understanding of the differences between the contract types. Level 3 tests whether you can offer reasoned advice on procurement routes.
Question Explain the fundamentals of a contract agreement and outline the main forms available in the context of the construction sector.
Answer The scope of this first question is quite open and the candidate should seek to start the response on a broad basis, covering the contract fundamentals followed by the types of contract used to formalise agreements in different areas of the sector.
Contract Fundamentals – At the most basic level, a contract is a legally enforceable agreement, normally between two parties. This sort of formal legal agreement is therefore different from other informal agreements that may be made, for example an understanding on site to loan a tool to another party when it is not in use by one’s own team. It is important to recognise this distinction between legal contracts and other agreements and be able to identify the contacts that exist in your area of business, as well as identifying the parties to these contracts and the purpose of the contract.
Contracts are always created for a reason and this is normally to form a commercial relationships between the numerous entities that make up the construction industry so they can work together, construct buildings and make money. Because contracts bind parties and are enforceable via the courts they are the foundation of most commercial arrangements in the construction industry.
There are many forms of contract involved in a construction project. Agreements for consultant services and construction works are contracts as are agreements for subcontract works, the supply of labour plant and material, the employment of staff and the various services required to run a construction site such as electricity and water. Financial agreements funding construction projects, the selling on of a building to purchasers and the giving of third party collateral warranties (sometimes called ‘warranties’) are again all contracts.
Common Types of Contract – As mentioned earlier, there are a wide variety of contract types in use within the construction sector. A number of the key types in more common use are as follows:
• Traditional Contract / Procurement – Historically, this was the most common approach to construction with the project separated into design and construction stages, with consultants leading on design and the contractor taking full responsibility for the management and execution works. A key attribute of such traditional forms is a consultant acting on behalf of the employer as contract administrator.
These contracts are complex, often using legal jargon and difficult to understand. There is a rigid separation of the parties and their rights, obligations and risks, sometimes resulting in a lack of co-operation and encouraging defensive and adversarial behaviour with time and cost problems being left to the end of the project to be resolved. This presents a risk of protracted final accounts and disputes.
Risks are normally passed down the supply chain to contractors and subcontractors and there is usually little opportunity for overlap of design and construction stages. This has led to much criticism that these contracts polarise the parties resulting in inefficiencies (particularly costs to the client) and encourages disputes.
Although there is some truth to the above points, these problems are probably common to many industries and contracts. It is also worth noting that most traditional forms have a long history (over 60 years for the JCT and ICE forms) and are therefore tried and tested and are focused on the client’s main requirements of time and cost certainty.
Traditional forms include most of the JCT and ICE suite, the GC/Works forms and M/F contracts.
• Non-Traditional Contracts / Procurement - The last 20 years has seen the emergence of a variety of new construction standard forms that claim to overcome many of the problems of traditional contracts and traditional procurement. Sometimes referred to as ‘collaborative’ or ‘partnering’ forms of contract, these contracts are very different to traditional forms.
Non-traditional / collaborative contracts attempt to overcome the problems of traditional contracts by introducing some form of collaborative working and trying to unite the various project parties avoiding polarisation. These new forms claim to increase cost and time certainty and remove traditional construction inefficiencies. These are bold claims and are yet to be proved particularly in the courts and an economic downturn. The bottom line with these forms is that they are relatively new in legal and contract management terms. The courts have hinted that the collaborative nature of these forms will be taken into consideration when considering the express obligations in a construction contract.
Non-Traditional forms include the NEC3 suite, the ACA forms and the new (in 2008) JCT Constructing Excellence form.
The NEC3 is probably the most popular non-traditional form at present but requires a very proactive and programme orientated form of contract administration. The PPC2000 is a true multiparty contract with all the key consultants, main contractor and specialist sub-contractors signing up to it. This is a sophisticated and complex contract and requires considerable change to existing contract management thinking. The JCT Constructing Excellence is probably the simplest of the three forms highlighted and may be best for smaller projects and where the parties are not ready for radical contract management required by the NEC3 and the PPC2000.
• Design and Build Forms - This is probably the most popular form of procurement at the moment and design and build forms are available from most of the contract producing bodies. Many standard forms (particularly the JCT forms) also allow the contractor to provide discrete parts of the design although these forms are not true design and build contracts. The PPC2000 is also a form of design and build contract although in a very different contract set up to traditional contacts.
The NEC3 suite does not have a specific design and build form but the Engineering and Construction Contract (ECC) form does allows the contractor to provide design but this needs to elaborated on in the Works Information. The ECC lacks the design and build contract mechanisms of design and build contracts. Such mechanism would have to be included in the Works Information or alternatively it may be better to revert to a traditional design and build form such as the JCT design and build form.
• Management Forms - Management forms of contracts provide for the engagement of a partly who’s sole objective is to manage the works with the vast majority of activities procured through sub contracts. They are very specialist forms of contract and not used very often at present in the UK although were very popular in the 1980s and early 1990s. They are recommended by some specialist consultants and contractors and may be appropriate on large, complex and fast track projects. Specialist advice should always be taken if the client wished to use this type of contract. Two-stage tendering, which is popular at the present, does have some similarities to management contracting.
• Sub-Contracts - Many of the bodies that produce construction standard forms also produce corresponding sub-contracts that are contractually back to back with the main contract. In practice, these sub-contracts are often heavily amended or not used because contractors prefer to contract on their own in-house terms. This can cause difficult interface problems between main contractor and sub-contractor and lead to disputes.
• Framework and Term Service Arrangements - Where a client has on-going or rolling construction programme, such as planned maintenance work by a local authority or the building of houses by a housing association, then a framework or term service arrangement is often appropriate. Such contracts have many advantages including introducing an element of continuity for those contractors on the framework and avoiding repeated tendering (a particular problem for public sector clients subject to public procurement regulations). For the client, there is probably more cost certainty in that prices are agreed upfront and there are savings on tendering costs.
Framework arrangements generally consist of two contracts. The first is the overarching contract which is usually for a period of time (commonly four years in the public sector) and does not guarantee any work. From this contract will drop out works contracts (sometime called call-off contracts or works orders) as and when the client requires construction work.
Term service contracts are a single contract with the client and contractor agreeing a plan or schedule of works to be performed over the period of the contract. This form of contract is probably best for maintenance type programmes where the scope of works is predictable and can be planned in advance.
Until recently, many framework agreements were bespoke forms often prepared by law firms. However a few standard forms have appeared on the market (particularly the JCT, ACA form and the NEC).
Question Comment on the benefits of using standard forms of contract and expand on the key obligations on the parties for a contract form in common use in your area of the sector.
The Use of Standard Forms - Because of the large number of contracts required for even the simplest construction project, standard forms of contract are used in the vast majority of instances. A standard form of contract is a ready made and ready to use contract that can be bought off the shelf or via the internet. Such standard from contracts are normally drafted by professional industry bodies such as the Joint Contracts Tribunal (JCT), the Institute of Civil Engineers (ICE) and Institute of Mechanical Engineers (IME).
The use of standard forms brings a range of benefits including the following:
• They are agreed by various national construction bodies and inherently include an immense body of industry know how and experience
• They are drafted to be flexible and used for a wide variety of construction scenarios
• They have evolved over a long period of time and are therefore tried and tested, including being tested in the courts
• They are drafted by professionals
• They will be familiar to construction professionals and thus time efficient to use
To present a good level of knowledge, the candidate should identify which standard forms are commonly used in their sector and why.
The alternative to a standard form of contract is to draft a one off contractual agreement, often called a ‘bespoke’ contract. Such ‘home made’ contracts carry many risks and are rarely appropriate. The cost of drafting such a contract taken with the additional time for the parties to fully understand its terms generally makes them an unattractive option. There is the benefit that they can be heavily tailored to the situation and arrangements required if the situation is unusual, but in reality such situations are not common when dealing with general construction works.
Key Obligations in a Sample Form – This second part of the question is specific to the candidate’s area of knowledge, however in general the candidate should cover the following areas in their response:
• The contract form they will base their response on
• The current version of that contract
• Outline the area of industry that they have found this contract form to be in common use
• Set out each party to the contract and against each explain their main obligations
• Pick out some key issues to explain the mechanics of the contract in greater detail, these could include:
o How certain key risks such as unforeseen ground conditions are dealt with under the form
o Obligations with respect to dealing with variations
This explanation need not be overly complex. Although the nature of construction contracts varies enormously, at its most basic, a construction contract creates a bargain between two parties generally consisting of one party paying money for construction works or services by the other party. The contract will also allocate risk between the parties and set out various procedures that have to be complied with such as monthly payment, how to deal with change and dispute resolution. Failure to comply with any contract requirement is a breach of contract and the other party may be entitled to damages (normally money). A useful exercise for candidates in preparing for the assessment is to examine a commonly used construction contract line by line and list out the rights and obligations of each party to the contract.
Candidates will enhance their standing with the assessors if they can also identify current changes and trends in the use of standard forms in their area of business. This is because there has been considerable change in both the procurement of construction projects and a significant increase in the variety of construction industry standard forms. Examples of this include the radical changes in public procurement such as PFI / PPP arrangements and the increased use of the New Engineering Contract (NEC3) forms.
Competency Level 3
The Question – Please talk me through an example from your experience of a situation where you have prepared a report which recommends the appropriate form of contract and warranties to be adopted.
Sample Response – The response here is totally based on the candidate’s experience but it should be noted that the competency description is very specific. The text sets out that the candidate should be able to; “Provide evidence of reasoned advice, prepare and present reports on the selection of the appropriate form of contract and warranties for your chosen procurement route. This should include advising on the most appropriate contractual procedure at the various stages of a construction or other contract.”
The candidate should ensure that they respond to this question in a logical and structured manner. The first thing to consider is the nature of the works and the particular needs of the client in terms of their objectives, requirements for flexibility, cost certainty and the like. There may also be specific preferred standard forms and or procurement routes in use by the client.
Expanding on the nature of the client and their needs, the candidate could discuss issues such as private sector clients (and many local authorities) generally favouring JCT forms because they provided a reasonable balance of risk between client and builder allowing a keen market level price and considerable time certainty. Alternatively, that traditionally government bodies preferred a more defensive form such as the GC / Works form, which provided more time and cost certainty but with less flexibility and the risk of a higher contract price. There may also be drivers to use a more collaborative approach and reference could be made to government initiatives in this area and the increased use of the NEC3 and PPC2000 forms). As an example, the Olympics use the NEC3 forms at project level.
Looking at the nature of the works the candidate could discuss certain key risks and how these influence which procurement route and form of contract may be appropriate. For example, the speed of the project and the extent of control over the design which the client requires will influence decisions between procurement routes such as design and build versus traditional. Other factors will affect the contract form, for example commercial developments such as offices and retail often use the JCT forms of contract while civil engineering and transport related work generally favour the ICE and NEC ECC forms. The JCT forms place more risk with the builder with regards to ground conditions as this is seen to be less of an issue with commercial developments. With civil engineering works, ground conditions are generally more uncertain and under the ICE and NEC3 forms, the client shoulders more of this risk.
From the nature of the works and the client requirements, the appropriate procurement strategy can be formulated for the project. There are a variety of construction procurement strategies such as traditional build, design and build and frameworks as discussed earlier. Once this overall strategy is decided then one can start to consider the form of contract taking into account the background factors mentioned above.
Collateral warranties are contracts that extend the benefit of an existing contract to third parties. Again, standard form collateral warranties are available, although bespoke collateral warranties are very common.
The third parties to a construction project are normally funders, purchasers and tenants of buildings. As these third parties will either; finance, own or occupy the building, they will usually want a warranty back to the consultants and builders involved in the project so they can sue them if there are defects and problems with the building.
A similar affect to a warranty can be achieved via the Contracts (Rights of Third Parties) Act 1998 and a good candidate will be aware of this Act although it is not used much in practice.
It is worth noting that the selection of a construction contract and any associated warranties is more a procurement decision than a legal one. The type of contract should depend on procurement objectives and not on the basis that a certain contract is recommended because of familiarity or a legal department. To do this is to ‘put the cart before the horse’ and constrain the unique requirements of a project by the inappropriate mechanisms of the wrong contract.
In response to the level 3 question the candidate should seek to cover the issues raised above in relation to the particular situation they are using from their experience. The response would be enhanced if the candidate can demonstrate they understand that the decision is a balance or trade off between a wide range of factors and that in most situations there is no standard or default answer.