Clients and contractors face unprecedented levels of uncertainty in bringing forward new projects during the pandemic. Simon Rawlinson of Arcadis examines the options available to help manage the risk
01 / Introduction
Procurement practice is always important, but in the midst of the covid-19 crisis it is taking on an even greater significance. Clients and their project teams have so far focused their collaboration on addressing challenges with existing schemes. Alongside ensuring that all construction work can proceed safely, however, it is time they began considering starting new projects, which will rely on defining how future risks will be allocated.
Procurement is the gateway to future turnover, establishing the terms by which projects will be delivered. Usually the risks are well understood, but this is no longer the case. Rarely have levels of uncertainty associated with construction investment been higher, potentially making negotiations much more complex and time-consuming. In order for the construction sector to commence its recovery, it is vital that clients and their contractors can agree terms as quickly as possible. This is likely to require compromise.
It is natural that all parties will be risk-averse in the current market, but it is essential for the health of the entire sector, ranging from material producers and builders merchants to specialist contractors and self-employed operatives, that work continues to flow. Similarly, clients will need to be more proactive in their management of risk and reward if they are to take investments forward. A worst-case scenario would result in vital work being delayed because the client and project team cannot agree on terms that reflect the realities of post-covid working.
This article focuses on how risk and reward can be balanced successfully through the procurement process. It focuses on client actions taken to manage risk effectively through both the contract and management best practice. A proactive approach is increasingly necessary in circumstances where normal contractual arrangements cannot be relied upon to assure certainty of outcome.
Procurement practice is by necessity very diverse and depends on both the type of client – private or public – and the complexity of a project. For example, the government’s “build, build, build” programme relies on investment to deliver the levelling-up agenda and enables the public-sector infrastructure clients to provide their supply chain with the certainty of a large and secure pipeline. However, some public sector clients use frameworks that limit the options they have with respect to both choosing supply chain partners and varying contract terms. Private sector clients, on the other hand, will have a different set of constraints associated with finance, governance and the laws of supply and demand.
The construction sector has been particularly affected by the covid-19 pandemic, highlighting the importance of a future pipeline of work. Office for National Statistics (ONS) data published in August reports that while the UK economy shrank by 20% in Q2 of 2020, construction activity fell by 35%. The ONS also highlighted that orders in Q2 fell by 50%, with no sector being immune from a collapse in future prospects. This means that the industry is potentially sitting on a time bomb, with distressed projects in one hand, and the growing risk of a fall in future workload in the other. Clients that can bring forward projects under current circumstances will make a huge difference in underpinning activity levels – supporting capacity ahead of a more widely based recovery in demand.
02 / Balancing risk and reward on post-covid projects
Risk allocation is a critical function of procurement, requiring a negotiation between a project’s risk exposure and the premium that a client is prepared to pay for its transfer. Clients have often had to accept progressively more risk as the costs of risk transfer increase in a rising market, either by modifying contract terms or by adopting different strategies such as construction management or an alliance.
In rising markets, high levels of project demand associated with an active market enable contractors to increase their allowances for risk. Conversely, when workload falls, the ability of contractors to fully price for risk is reduced, potentially creating problem projects for the future.
Covid-19 has pulled the rug from under this complex and dynamic aspect of contracting. Not only has the risk profile changed beyond recognition, but some of the traditional risk transfer mechanisms such as insurance have also been found wanting. Now that some of the impacts of covid-19 on productivity are better understood, the focus of risk will shift to future consequences of the pandemic, such as local lockdowns or supply chain failure. This could potentially result in projects being delayed by wrangles over contract terms.
Many clients interviewed by Arcadis this summer would prefer existing risk allocations to remain in place. This partly reflects a desire to maintain the status quo, while also accounting for exposure to significant changes in market conditions aligned to market demand and asset value. At the same time, these clients are increasingly aware that they rely on a stable, resilient supply chain for the delivery of their projects. They recognise that subcontractors in particular are unlikely to have the resources to deal with the consequences of further disruption. In addition to considering relief measures such as accelerated payment, more clients are open to considering the sharing of covid-19 risks, either limited to time and relief from delay damages, or in some cases to costs as well.
There are other options that can be built into contracts – giving the supply chain more flexibility around specification and timing of the work, for example. This will enable the supply chain to mitigate some costs associated with future disruption while being able to maintain some progress. In order to make this work, the collaborative spirit that has characterised the industry’s response to the crisis will need to be embedded into future contracts.
Greater flexibility over risk transfer, however, introduces another contractual issue that did not exist during the first phase of the pandemic. The consequences of the covid-19 pandemic are no longer unprecedented. Both contractors and clients have experience and data that can be used to both assess risk exposure and also to recalibrate their baseline. Clearly, what contractors and clients allow for in the future could form the basis for complex disputes, so it is increasingly important to make sure that all parties are clear about the detailed basis of their agreement.
03 / Proactive measures – future-proofing for covid-19 and the wider downturn
We have established that supply chain stability could be at risk from future covid-19 events and that contracts could be delayed by complex discussions associated with the allocation of these new risks. Sticking with the status quo could lead to the worst of both worlds: a shortage of workload due to procurement delays as well as projects with vulnerable supply chains signed up to unsustainable but enforceable contract terms.
Action needs to be taken quickly. There is plenty of evidence that the pandemic is moving into a second phase, which could result in further disruption. Furthermore, there are signs of increasing financial pressure on contractors, including EY’s recent analysis of profit warnings in the sector as well as suggestions that access to credit is tightening.
The combination of these two factors highlights the need for two sets of actions in connection with project procurement:
- Contract provisions to deal with a major, disruptive outbreak
- Measures to support supply chain resilience.
Many discussions in connection with existing contracts will be focused on the applicability of force majeure provisions. As covid-19 is now a known unknown, force majeure is unlikely to be a remedy for the consequences of future outbreaks. The default is that risk will sit with the contractor unless specifically stated. As a result, it may be necessary to amend the contract to align it to the now established covid-19 risk.
A Construction Leadership Council (CLC) taskforce has drafted guidance on future-proofing new contracts, building on previous best practice guidance designed to support the collaborative resolution of disputes. The guidance is designed for use with JCT and NEC contracts and has model clauses covering four elements:
- Definition of a pandemic
- Entitlement clauses such as a relevant event/relevant matter under JCT
- Treatment of time and cost associated with a delay
- Provision for suspension/termination of the contract related to a potential covid-19 delay.
The delay provisions allow for three options: time only, time and full allowable cost, and a third option that gives time and a predetermined share of loss and expense.
The advantage of the CLC’s approach is, first, that it is a standard which is easily understood and straightforward to incorporate into most contracts, whether amended or not. Secondly, the clauses require the parties to be clear about the scope of disruption envisaged – which is much more transparent than a force majeure provision. Finally, the approach is clear about how costs will be allocated and also requires “best endeavours” to be used in the event of disruption.
However, adoption of these clauses will in most cases result in a shift in risk transfer from contractor to client. Given that future lockdowns are expected to be local and will be supported by better tracing technologies, this may be a risk that clients are more willing to share on a defined basis. This will not only help to protect the supply chain but may also accelerate contract negotiations. However, such a transfer should be accompanied by a renewed focus on the definition of the baseline and on record-keeping so that the risk is managed.
Other measures that can be introduced to support the supply chain have mostly focused on payment. The public sector led the way with generous support terms set out in the PN02/20 guidance that was in force until the end of July. Many clients have provided similar support by improving payment terms, increasing payment frequency, and in some cases releasing retention early. Anecdotal evidence is that terms for the supply chain have also improved.
Other ways in which clients can provide greater flexibility to the supply chain will typically be associated with scheduling, giving a contractor greater flexibility to programme work around disruption caused by covid-19. An example of this could be some flexibility with deferring the date of possession – should this be adversely affected by a covid-19 outbreak – enabling the contract to be reset in line with an agreed revised programme. Similar flexibility could be introduced in connection with specified product substitutions or at practical completion, allowing for example some delayed but non-essential work to be completed after sign-off. All of these approaches highlight that the intelligent application of the contract can protect the client’s interests while also providing relief from unintended consequences of the drafting of a standard contract.
These measures are a small but vital part of the industry’s recovery. The collaborative approach being promoted by the CLC is important for so many aspects of the recovery plan – ranging from the expanded adoption of innovation to a greater focus on the whole-life outcomes of construction investments.
04 / Covid-19 procurement plan
Project procurement is critical for the industry. Without a healthy pipeline of profitable projects, the supply chain will not be able to rebuild its finances, for example paying off debts and deferred payments that have been accumulated during the depths of the crisis.
Projects are let on a one-by-one basis, and given the heightened risk profile in the market at present, there is a risk that many will not proceed quickly enough to deliver the investment needed or to secure the health of the supply chain.
A consistent approach to the procurement process will expedite the appointment of contractors – enabling much-needed revenue to flow into the supply chain at the earliest opportunity. The five-stage plan developed by Arcadis supports this consistent approach.
1. Prioritise the programme
♦ Review the development plan, prioritise the most important investments and commit to their development
♦ Review project value criteria and allow for new priorities such as supply chain resilience if they improve project outcomes
♦ Focus resources on investments that are most likely to deliver benefit
♦ Increase certainty of them happening through explicit prioritisation
♦ Update value criteria in line with changed circumstances – eg identifying circumstances where a risk premium has additional value
♦ Aligns the procurement programme to post‑covid practicalities
♦ Focuses on ensuring that priority procurements take place
♦ Facilitates early discussions on potential value trade-offs for inclusion in the contract strategy
2. Refresh the procurement strategy
♦ Rethink the procurement strategy to account for post-covid circumstances (eg risk appetite or ability to resource bidding)
♦ Use knowledge of the circumstances of the delivery team to tailor a project opportunity to the capability and interest of the preferred supply chain
♦ Maximise interest in the opportunity
♦ Minimise risk that supply chain will not respond due to misalignment with market appetite
♦ Procurement plan is informed by a practical understanding of opportunities and constraints rather than a generic approach
♦ Ensures that bidders will prioritise the opportunity
♦ Minimises risk of drop-out during the procurement event
♦ Confirms that any specific requirements of the project can be accommodated by the proposed teams
3. Engage with the supply chain
♦ Increase engagement with preferred suppliers to maintain access to capability
♦ Hold open conversations on critical aspects of post-covid performance and productivity
♦ Build an understanding of the extent of risk that can be held in the supply chain
♦ Sustain position as a priority client
♦ Build foundation for collaborative working
♦ Build a common understanding across potential suppliers of the optimal commercial package
♦ Keeps the project opportunity in mind
♦ Prepares for working in a higher-risk environment
♦ Enables proposed value trade-offs to be tested with suppliers in advance of the procurement
4. Design and implement the procurement event
♦ Design a commercially sound and straightforward process that will attract the right bidders
♦ Secure more involvement from the supply chain
♦ Increase levels of transparency
♦ Ensure that the opportunity is competitive and that it is a must-win opportunity
♦ Gain a deep understanding of the capability and stability of the wider project team
♦ Establish a well-defined baseline for project management
♦ Attracts the right team on the right terms
♦ Helps to ensure the resilience of the project delivery team
♦ Project starts on the basis of a clear, shared understanding
5. Record events and manage risks proactively
♦ Raise the project management effort to match the heightened project risk
♦ Put in place the right resources and skills
♦ Implement CLC project records procedures
♦ Actively use additional contract provisions to mitigate any covid-19 impacts through best endeavours
♦ Proactive response to the heightened risk associated with covid-19 and recession
♦ Ensure accountability for critical PM activities
♦ Create a common record of project events to enable a transparent approach to dispute resolution
♦ Ensure collective action to mitigate disruptions
♦ Reduces risk of expected outcomes not being met
♦ Avoids business-as-usual approach
♦ Protects interests
♦ Enables all parties to be held to account for their actions
♦ Delivers the intended contractual outcome
05 / Conclusions
Although the industry is rightly focused on ensuring that existing projects are delivered safely, it also needs to make sure that the forward pipeline is maintained and that contracts do not expose individual parties to unsustainable risk. The impacts of covid-19 are increasingly understood and, as a result, the parties need to state clearly how impacts will be managed if future disputes and disruption are to be prevented. The CLC model terms provide a consistent approach that can be adopted across the industry. The Arcadis five-point plan establishes a broader approach that will help to ensure projects are well set up for the market. Proactive management is a key part of the plan and, however projects are procured, good management of contract provisions and records will be essential to ensure that the fair allocation of covid-19 risk can take place without resort to a disputes process.
Looking forward, this collaborative approach to procurement will support the wider adoption of industry change that is essential to improve both industry productivity and asset performance. Post-pandemic procurement practice could lead to a far more significant shift in industry practice and behaviours.
With thanks to Andrew Beard, Hugh Crighton and Jonathan Harris of Arcadis for their insights. Also acknowledged is the work of the CLC’s Disputes and Collaboration working group, led by Steve Bratt of the ECA, and contributions from David Bebb of Fenwick Elliott