How to avoid litigation
Concerns of Project Managers
Jon M. Wickwire Feature Editor
Reprinted with permission from The Australian Project Manager. vol. 11. no. 6., November 1991.
R.W. Quick, Morris Fletcher& Cross, Solicitors
Litigation and its attendant expenses are frequent subjects of complaints by American businesses and project management personnel. The following article was authored by an Australian solicitor and presents a perspective on litigation from the standpoint of contract documents and general conditions promulgated by the Master Builders Federation of Australia, Building Owners and Managers Association of Australia, and the Royal Australian Institute of Architects. The article identifies recurrent causes of claims arising from projects in Australia including an owner's focus upon the lowest bid; fast-tracking of construction; the use of bills of quantities; and “prolongation claims” by contractors and subcontractors. In addition, the article discusses strategies for the reduction of claims and disputes in the Australian building and construction industry. The perspective of Mr. Quick may clarify our own strategies and efforts to reduce claims and disputes associated with construction.
Principals on sizeable projects have in recent years faced an increasing number of claims for additional payment over and above that priced and agreed at the outset. Claims, disputes about them, and litigation have become so common that out of the construction industry has grown a secondary industry of professionals expert in formulating and defending claims. This article considers some of the ways in which claims and litigation arise, and outlines one of the ways in which claims and litigation may be avoided or minimised at the outset of a major building or engineering project—namely, by getting the contract documentation right.
The article should also serve to introduce two extensive research papers. The first (referred to here as the AFCC Report) entitled “Strategies for the Reduction of Claims & Disputes in the Construction Industry” was published in November 1988 by the AFCC. The second (referred to here as the NPWC/NBCC Report) entitled “No Dispute—Strategies for Improvement in the Australian Building & Construction Industry” arose out of the AFCC Report and was a report of an NPWC/NBCC Joint Working Party published in May 1990. The AFCC Report identifies some major sources of claims and disputes* as:
- The quality of contract documentation, including problems arising from late supply or errors, omissions and ambiguities in such documentation (the greatest causes of claims and disputes);
- Attempting to “fast-track” construction on a traditional lump sum fixed price contract;
- Basing a traditional lump sum fixed price contract on the lowest bid;
- Allocating risks however unforeseeable to the contractor;
- The use of bills of quantities (a significant cause of claims);
- The use of nominated subcontracts;
- Latent ground conditions (a common claim in major construction works);
- Prolongation claims by a contractor, subcontractor or supplier, particularly where the costs of delay have not been quantified and pre-stated (again a common claim);
- Variations (a major source of claims).
The Report identified some particular features of claims or the procedures available to deal with them as contributing to disputes or litigation over them:
- Untimely presentation of claims;
- Poor quality claims;
- The role of the architect or engineer as superintendent;
- The inadequacies of dispute resolution procedures.
One recurrent cause of claims is acceptance of the lowest bid, the principal's focus on price alone to determine the successful contractor. Focusing on the lowest bid to the exclusion of other matters is shortsighted. The lowest bid may have a margin of 3 to 5 percent or less, yet building or engineering projects are almost invariably prototypes. It is as rare for there to be repetition allowing an increase in skill or economy as it is rare for projects to allow contingency allowances of time or money for any problems which occur in design and construction. There is thus no margin for disruption or contract administration delays such as those in valuing variations or in payment. The AFCC Report therefore recommended acceptance of the “lowest acceptable” price, and that bids 15 percent below a properly prepared estimate or the next lowest tender price should be rejected unless the contractor was able to establish that his price was not unrealistically low and that he could properly carry out the work at his price. The “lowest acceptable” price allows consideration to be given to matters including conformity with the tender documents, the contractor's financial capacity, his track record, claims history and the tender program. The NPWC/NBCC Report, whilst not prepared to recommend a change from the system of accepting the lowest bid, noted that ACS and some State Government construction agencies have been emphasizing “value for money,” an approach which may result in the rejection of the lowest tender and is consistent with the AFCC Report's recommendation for acceptance of the “lowest acceptable” price.
The Principal's Complaints
The AFCC Report recognised that both principals and contractors have complaints about claims.
The principal complains that with a large “end of contract” claim it is difficult to verify the facts on which the claim is based. Conversely, he complains that where the contractor must give a warning of a claim and comply with notification and time limitations, these increase the principal's cost of administration of the contract and prompt the contractor to “snow” the superintendent with paper to protect his position, creating the breakdown of communications on site. The principal is also heard to complain that claims are of poor quality, not clearly revealing the facts the contractor is relying on as a legal basis of liability, nor giving a proper explanation and justification of amounts claimed, although the principal is unable to settle a claim if the contractor fails to state its vital elements.
The Contractor's Complaints
Contractor's complaints focus on:
- The refusal by the principal to provide relevant information such as site information or tender information;
- The principal's failure to accept justified tender qualifications or to consider problems or claims likely to arise in construction;
- The principal's lack of appreciation of the contractor's financial vulnerability to matters such as delay or to claims by subcontractors;
- The principal's refusal to negotiate on claims forcing matters into dispute where the legal process is used to delay or avoid meeting claims.
GETTING THE DOCUMENTATION RIGHT
What Getting the Documentation Right Means
The AFCC Report identified errors or ambiguities in contract documentation and its late delivery as the greatest cause of claims disputes and litigation. Both the AFCC and NPWC/NBCC Reports make detailed recommendations on how to improve the quality of documentation. Getting the documentation right means, among other things:
- Ensuring that the principal's commercial objectives and performance requirements for the project are adequately defined in a brief to design consultants;
- Paying design consultants realistic fees for the work which they are required to undertake, and allowing them sufficient time to undertake the work;
- Getting design consultants to agree to reduce their fees if there are cost increases during the construction period for which they are responsible;
- Coordinating the work as a whole of the design consultant so that ambiguities in the documents they prepare are eliminated. A related aim should be to ensure that design is coordinated with construction;
- Making the allocation required of contractual obligations and risks and ensuring the contract documentation accurately records this allocation;
- Avoiding routine use of bills of quantities in tendering, and making sure such bills are measured from completed tender documents in accordance with an agreed method of measurement;
- Minimizing or avoiding the use of the nominated subcontract system. Options to the system include providing a list of acceptable specialist subcontractors to the contractor or engaging the subcontractor separately and putting an obligation for coordination on both the subcontractor and the builder, or entering into one of the alternative contracts such as construction management or project management;
- Trying to anticipate and quantify delay and delay costs;
- Avoiding standard form general conditions of contract in “fast-track” projects and making clients aware of the implications of varying work; and
- Considering how disputes are best resolved. In particular this means considering possibilities such as providing for mediation as a preliminary step in the resolution of any disputes, providing for a contract adjudicator rather than the superintendent administering the contract to resolve disputes during the construction process, or providing for procedures such as non-binding expert appraisal to ensure a negotiated settlement.
Although the balance of this article concentrates upon the contract documentation, it should be clear from this that getting the documentation right does not merely mean getting the general or special conditions of contract right. It means trying to ensure consistency and clarity in all documentation from the principal's brief to the designers, through contract documentation, to documents produced to effect the proper administration of the document such as instructions, correspondence or programs. The principal's brief to the designers, for example, may not become a contract document at all, but it may well be the source of much litigation if it does not accurately document the principal's objectives and requirements. This is because if the brief leaves the principal free to develop his objectives and requirements as the project proceeds, there is an obvious danger that the contract documentation will not reflect them and that principal and contractor will be left to litigate what the objectives and requirements are.
Who Should Draft the Contract Documentation?
It is surprising how often the parties to substantial projects fail to allocate the necessary time, money or professional advice to getting the contract documentation right at the outset. Uncertainty created by inappropriate or illstructured documentation creates a situation of increased risk to all parties to the project. In “fast-track” projects in particular, the aim of minimizing delays in the finalisation of the project may be undermined by contractual problems which seem inevitable from the documentation itself.
Although lawyers have had a professional monopoly over the drawing of other contracts, the drafting of building or engineering contracts has traditionally been the work of design consultants in the construction industry. The technical content of much of such documentation justifies this role. Increasingly, however, lawyers are being used to help draw the special or general conditions in such contracts. There are at least two reasons for this. The first is that it is becoming clear that proper contract drafting is a complex exercise which, if not done properly, can lead to enormous potential risks for the consultants as well as the parties to the contract because of the potential risks to those parties. The second reason is the large number of “one-off” contracts, largely building contracts, being entered into. Design and construct contracts, detailed design and construct contracts, guaranteed maximum price contracts, project management contracts and construction management contracts are but a few of the alternative contracts being used in an effort to find a more satisfactory alternative to the lump sum tendered contracts. These contracts are not standard form contracts with an equitable or predetermined share of obligations or risks. They are the result, in each project, of separate negotiation making it vital to have legal advice in their choice and preparation. Risk allocation is an important legal and commercial matter.
How Do You Choose the Conditions of Contract?
At least three determinants shape a building or engineering contract: the price; the work, including its specification or quality; and the time for performance of the work. The price can vary from a fixed price lump sum to “cost plus.” The work can vary from fully documented work to work which the contractor has the responsibility to design either wholly or to a scheme design and performance specification. The extent of the responsibility for design particularly influences the choice of contract. In a traditional construction contract, the contractor assumes little responsibility for or risk in relation to the design. His obligation in such a case is merely to execute the works as designed, with no warranty as to fitness, the purpose, or as to the efficacy of the design.1
A company or organisation may have its own standard form of conditions of contract. There are, however, a number of industry standard forms of general conditions in current use for the construction of capital works and for the supply or installation or both of electrical and mechanical equipment and other major items of equipment.2
These industry standard forms are lump sum and schedule of rates contracts suitable for designed or substantially designed projects. Properly used they have advantages noted by the NPWC/NBCC Report, including familiarity, precedents as to their interpretation and a recognised and usually equitable allocation of risk, all of which tend to reduce the risk of claims, and litigation. They may, however, be inappropriate when the project is a “fast-track” project, that is one in which design is developed as construction proceeds, or the project requires a “one-off” contract. Where amendments and modifications are required to a standard form to suit the requirements of a project, consideration should therefore be given to drafting conditions of contract tailored to the needs of the project rather than using a standard form or attempting to effect significant changes to the risk allocation it establishes by extensive amendments or lengthy special conditions.
A major project will usually require a number of contract strategies resulting in a range of contracts from traditional fixed price contracts through to design and construct contracts.
It is clearly a commercial decision on the part of the principal whether or not to use a company standard form, an industry standard form, or project-specific conditions of contract. However, there should be a well thought out reason for departing from industry standard forms and if the needs of the project require the use of a contract other than an industry standard form the contract conditions should be carefully drafted so that, among other things, they accurately define the allocation of risks or obligations.
Structuring the Contract
It is of vital importance to make the contract serve the needs of the particular project and not the other way about, but clear project objectives and requirements are necessary to ensure this. That means, as we have seen, a clear and comprehensive brief from the principal.
An adequate contract structure also requires the drafter to consider what documents to treat as forming part of the contract and what mechanism to use to resolve the explicit or implicit ambiguities or contradictions which are the greatest source of claims and litigation.
The typical building or engineering contract on a major project will include not only documents such as the General Conditions and Special Conditions to which we have referred, but a multitude of others from Specifications, Drawings and Bill of Quantities to Conditions of Tender, completed Tender forms and the results of post-tender inquiries or programs. Considering what documents are to be treated as part of the contract means considering and documenting which of such documents are to be treated as forming part of the contract.
The documents to be treated as having contractual effect, drawn up by different specialists, must be carefully scrutinised to ensure consistency and remove possible uncertainties.
Because all inconsistencies and uncertainties will not be eliminated it is important to include a priorities or precedence clause which relates to all of the various documents together comprising the contract and which regulates the order in which resort is to be had to documents to resolve conflict between them. Incorporating such a clause in terms broad enough to relate to all the documents intended to have contractual effect will minimise disputes as to the definition of the works constructed.
Identifying and Allocating Risk
The project contract, according to traditional legal theory, represents a charter negotiated between the parties whereby the risks associated with the particular project are assumed by one or other of them as a result of the imposition of responsibility by the provisions of the contract. In the absence of express provision in respect of a risk, the responsibility for that risk is determined by application of common law principles to the contract so that, for example, a contractor normally bears the risk of unforeseen ground conditions. Hence, where a risk has not been identified and allocated a contract or may look carefully at the documentation and construct an argument which will allow him to recover in respect of the risk which has occurred. Whether he will be successful will depend upon how well the contract has defined the allocation of risk.
All this obviously makes it important at the outset to define the risks associated with the venture so that when they happen, the parties can determine their rights. Litigation is more likely to arise where the contract documents either do not deal with a risk occurring, or do not clearly allocate that risk. Risk allocation is, however, an important matter for the parties as well as the lawyers. It should be determined by them at the outset on a commercially sound basis. The guiding principle in risk allocation ought to be that the party best equipped to deal with the risk should shoulder it. This means not only forecasting eventualities such as unforeseen site conditions, delay, inflation or the failure of subcontractors or suppliers, but also considering which party, if any, has the ability to control it and weighing the ultimate consequences of the choice of risk allocation on the project cost.
The rules formulated by Max Abrahamson, an international construction lawyer, which underpin and support this guiding principle, were espoused both by the AFCC and the NPWC/NBCC Reports, and the latter attempted a Risk Allocation Model, by which obligations or risks can be weighted arithmetically for or against a party so that the parties to a contract can determine almost mechanically who should bear them.
One of the causes of the proliferation of claims, disputes and litigation is the quality of contract documentation. In recognizing this the NPWC/NBCC Reports noted a view that the quality of such documentation had been reducing over recent years, with a lowering of the level and detail of documentation standards. Raising the level of quality is a matter which can be attacked by design consultants as well as lawyers in a number of ways including considering carefully the use of industry standard forms, structuring the content of the contract or contracts chosen so that they serve the needs of the project and paying particular attention to the principles underlying, and the consequences of, risk allocation. In these and other matters, the AFCC and NPWC/NBCC Reports have pointed a way to reducing the proliferating claims, disputes and litigation which set principal against contractor, designer against contractor or principal, contractor against subcontractor and thus obscure the dependence each ought to have on the other in achieving a shared commercial objective of project delivery at a fair price. For that reason, if no other, the Reports merit the closest study.
1. Cable (1956) Ltd. v. Hutcherson Bros Pty Ltd (1969) 43 ALJR 321.
2. The principal current standard forms are:
- NPWC3 – 1981: General Conditions of Contract promulgated by the National Public Works Conference and used for both building and civil engineering works by Commonwealth and State Governments and their instrumentalities;
- JCCA&B – 1985: General Conditions of Contract for Major Building Works promulgated jointly by the Master Builders Federation of Australia, Building Owners and Managers Association of Australia and the Royal Australian Institute of Architects;
- AS2124 – 1986: Australian Standard General Conditions of Contract for Civil Engineering Works;
- AS2987– 1987: General Conditions of Contract for the Supply of Equipment With or Without Installation; and
- S3557 – 1988: General Conditions of Contract for the Supply of Equipment;
These are head contracts, but standard forms of subcontract have been developed for use with some of them such as SCJCC, SC NPWC3 and AS2545– 1987.
*For a comprehensive list of the recurrent claims, the reader is referred to M. McDougall: “How to go about the Complex and Arduous Claims Process” (1 986) 2 B.C.L. 216.