What is a “construction contract”?
A construction contract essentially involves an agreement between an Owner, also referred to synonymously as the client, developer, employer, principal or proprietor (“Owner”), and a contractor under which the contractor agrees to supply work and materials for the construction of a defined project. In return, the Owner agrees to pay the contractor a specified, or ascertainable, price. The Owner (or its architect or other agent) may be responsible for the design of the project or may also be supplied wholly or partly by the contractor.
The Building and Construction Industry Security of Payment Act 1999 (NSW) (“Act”) treats construction contracts as a special category requiring statutory intervention. The introduction of the Act has also fundamentally altered the allocation of risks in construction contracts. For the first time under Australian law a definition of a “construction contract” was incorporated for the purposes of the legislation.
Section 4 of the Act states that a ‘construction contract’ means a contract or other arrangement under which one party undertakes to carry out construction work, or to supply related goods and services, for another party.
‘Construction works’ are defined at s.105 to include a wide range of activities. Section 5(2) excludes certain works and s.7(2) excludes contracts with residential occupiers.
Section 6 extends the definition of a construction contract to any agreement to carry out architectural, design, or surveying work, or the provision of advice on building, engineering, interior or exterior decoration or the laying out of landscape. However, a contract of employment is excluded from the statutory definition.
Popular Types of Procurement Routes
The most common procurement routes fall under two main categories: the methods of delivery; and the methods of pricing.
“Traditional” building projects
A ‘traditional’ building project involves an Owner engaging a designer to prepare the design of the building and once produced, the Owner engages a contractor to build the structure. The contractor only takes responsibility for the work he performs, not for the design which is given to him to implement by the Owner.
Design and build (package deal)
This is an agreement between an Owner and a contractor where the contractor takes responsibility for both the design and construction of the project. The contractor takes over responsibility for all of the duties of the professional team involved in the project, for example, designer, architect, engineer, surveyor.
These contracts are usually “lump sum” or “fixed price” contracts. The advantages with this form of procurement is that the Owner has the benefit of a single point of responsibility for any problems arising from the design and construction and he has certainty regarding price.
Lump Sum Contracts
With a lump sum contract approach the selected contractor would be responsible for performing and completing the works as defined in a settled “scope of works” provided by the Owner for an agreed fixed price or lump sum.
This strategy requires a precise definition of the contractor’s scope by the Owner, a well-documented and agreed allocation of risk between the parties with clear mechanisms for agreeing to any impact changes that may arise such as variations to works and/or materials and price fluctuations allowed for in the contract.
Lump sum contracts also require a significant amount of project planning and definition prior to the tendering and evaluation phases of a project and thus can be deemed to require a ‘long lead time’ before a contract can be awarded.
Owners may find themselves having a reduced influence on the quality of work and unless the scope of work is very specific a contractor may tend to protect themselves with hidden costs to cover its risks.
Cost plus/cost reimbursement contract
For a cost plus contract a contractor would essentially charge the Owner for all the work performed at cost plus an agreed fee usually a percentage of the cost. Whether this fee is with or without an incentive or a cost ceiling or provide for a ‘capped’ limit on reimbursement, would all depend on the type of project and the specific contractual setup selected. The price includes an element of profit and a management fee.
Typical cost plus contracts can be used in ‘front end engineering’ to establish clear scopes of works for tendering or budgeting. This means that the cost plus fee contract is the preferred type of contract for defining the overall scope of a project.
The costs plus contract is also suitable for projects which involve high technical risks where a prudent contractor would not be prepared to accept the work on a lump sum basis. This means that Owners bear most uncertainties for both time and cost and if a non-incentive contract is agreed the contractor can have little motivation to perform efficiently. For these types of contracts Owners should install more intensive project control processes to account for work done against costs incurred.
Turnkey contracts are nearly always awarded on a lump sum basis hence why the expressions turnkey and lump sum are often both used interchangeably. Strictly speaking, the expression turnkey describes the ‘method of delivery’ of a scope of full technical responsibility (design, construction, commissioning and delivery) whilst the expression lump sum encompasses the scope of a commercial and financial responsibility (i.e. the method of pricing). When using the expressions in strict contract definitions, the turnkey and lump sum have to be clearly defined and differentiated.
These contracts are utilised regularly in engineering, procurement and construction projects, known as “EPC contracts”, such as power stations, chemical and other industrial plants.
In practice, a turnkey contract will nearly always be on a lump sum basis because the concept of shifting the technical responsibility to the contractor will make little sense if the agreed contract price and commercial responsibility are not also transferred to it.
Also known as “unit rate contracts” are mostly recommended for projects where the detailed scope is ill-defined at the contract signing but where the overall scope is identified. For example, at the time of contract signing it may be unclear whether a building will have ten or fifteen floors but on the other hand the function and layout of the building and floor types are already known.
This type of contract may be chosen where “fast tracking” is required but often leads to many disputes over work carried out against work measured. Contractors are familiar with these contracts for infrastructure projects such as roads, airports, tunnels, rail and should refuse to enter into fixed rates on material costs for projects with long periods of construction.
In a management contract a project manager takes responsibility for co-ordinating and organising the work instead of becoming directly involved in construction. There are two basic approaches:
- The Owner engages a project manager on a similar basis to that of construction professionals and for a fee the manager undertakes to control and manage the project. Whilst the manager ordinarily supervises the tendering process, the responsibility for construction (and design if a design element is included) lies with a contractor who enters into a contract directly with the Owner; or
- The Owner engages a management contractor to carry out construction works, but the control and management of the project is subcontracted to a works contractor.
In this type of arrangement a company or partnership will be specially created by two or more parties such as a landowner and a property developer for the purposes of the project. Each party will contribute assets, financing, professional and construction skills to bring the project to completion. In this situation the role of Owner is taken by the company or partnership, as the case may be.
Other Types of Procurement Routes
- Partnering/alliance contracting;
- Private Finance Initiatives (“PFIs”) and Public/Private Partnerships (“PPPs”);
- Build Operate Transfer (“BOT”)/Build Own Operate Transfer (“BOOT”);
- Facilities management contracts;
- Framework agreement;
- Development and sale agreements;
- Supply contracts; and
- Letters of Intent.
The contents of this article is intended to provide a general guide to the subject matter and does not constitute legal advice. Ferrer Lawyers always recommend that you obtain legal advice prior to selecting your procurement route or entering into any contract.