Construction contracts: are they any different to contracts for materials & labour

It was not until recently that that law did not treat construction contracts as a special class of contract but merely as part of a larger category known as “contracts for work and materials”. Construction contracts are unique in the sense that negotiations continue throughout the project. You could say that a construction contract is one long negotiation from beginning to end.

Lord Diplock in Modern Engineering (Bristol) Ltd v Gilbert–Ash Northern [1974] AC 689 described a building contract as:

“an entire contract for the sale of goods and work and labour for a lump sum price payable by instalments as the goods are delivered and the work done. Decisions have to be made from time to time about such essential matters as the making of variation orders, the expenditure of provisional and prime cost sums and extension of time for the carrying out of the work under the contract.”

Lord Diplock was referring to a contract made using a standard form of building contract; such contracts usually make provision for interim payments at regular intervals as the work proceeds, whereas a contract that is described as entire is a product of the common law. It may make provision for progress payments, but it requires the contractor to complete all its work before any entitlement to payment arises, although this has now changed due to the Building and Construction Industry Security of Payment Act NSW 1999 (“Act”).

HHJ Newy OR in Emson Eastern v EME Developments (1991) 55 BLR 114 at p125, described the differences:

“I think the most important background fact which I should keep in mind is that building construction is not like the manufacture of goods in a factory. The size of the project, site conditions, the use of many materials and the employment of various kinds of operatives make it virtually impossible to achieve the same degree of perfection that a manufacturer can. It must be a rare new building in which every screw and every brush of paint is absolutely correct.”

These factors make a construction contract different from a contract for materials and labour, or for that matter most other types of contracts. A construction contract has many unknowns such as the design of the project, the ground conditions, time and the length of the project, its complexity and size, projects are usually one-off’s, multiparty nature of the project with numerous sub-contractors used to carry out the project, the price agreed and the amount of work done, although agreed, may change as it proceeds and they can involve quite complex payment structures especially where the scope of works cannot be easily ascertained.

Both elements of a contract for materials and labour are usually known; namely, what materials to purchase and how many men to deliver and/or assemble. It is the uncertainty of construction contracts that makes them unique.

Ordinary rules of the law of contract apply but this is subject to an important caveat. Legislation passed following the NSW Parliament Joint Standing Committee on Small Business Report: Security of Payment for the NSW Building Industry in 1998 that has treated 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 given by Lord Diplock 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.

All construction projects have distinctive characteristics, very different to contracts for materials and labour, which can be surmised as follows.

1. The unique nature of the works

The majority of construction projects produce unique structures. There is no time to iron out the problems by continued testing for a perfect product to be ready for mass production. The length of the contract is a risk. Projects vary in the time needed for completion, from days to years. During that time the risk allocation agreed at the time of contracting can substantially change. This is especially so with regard to the availability of materials and their cost.

2. Multi-party contracts

The number of participants, the parties in the project and the corresponding length of contractual chain can cause their own problems. The risk of insolvency increases the longer the chain. The triangular relationship (cost, time and quality) is inherent with conflict. The contracting parties have different perceptions of how these factors of their relationship interact. The contractor wants the best quality at the lowest cost in the shortest amount of time whereas a subcontractor might forego quality seeking variations to increase his contract price which in turn may affect time.

3. Split responsibility for specification and/or design

Projects are built after engaging an architect and engineers from the several disciplines and subdisciplines of engineering. The responsibility for the project predominantly lies at the feet of the architect and engineers. However, sometimes it is not that easy to determine with whom the responsibility bears.

4. High degree of inter-activity between purchaser and supplier

These days’ construction contracts have the added feature of constant intervention by an advisor or consultant on behalf of the employer to ensure that the design and ultimate construction are in accordance with the plans in order to avert possible design and building defects.

5. Numerous changes to the original scope of works

This is found in every construction project. Budget constraints, evident design flaws or unforeseen risks such as ground conditions call for changes in the scope of works. There are provisions for variations in all construction contract forms, a feature that is not prevalent in most other contracts.

6. Programming complexity and dependency on other activities/suppliers

Technological complexity ranges from the familiar, well known materials and trades through to highly complex facilities involving multiple interacting sub-systems. Regardless of its technological complexity any reasonably sized project involves a high level of organisational intricacy. This arises because there are many specialised skills and professions with contributions to the process. This is further exacerbated by the contract forms which are generally weak on the obligation of programming and only call on the contractor to perform a certain obligation by a particular date.

7. Site specificity

The total specifics of the site can never be known until construction works are commenced. A change in the ground conditions from that anticipated in the geological report would give rise to variations in the scope of works and ultimately in the value of the contract.

8. Interaction with neighbouring fixed infrastructure

Other matters affect the construction process such as planning laws, insurance, funding issues and utility companies.

9. Weather

This affects most if not all construction projects. Most contracts leave this risk at the sole discretion of the contracts administrator but sometimes fairness and appropriate exercise of that discretion is not transparent. This is one of the most disputed issues in construction contracts.

10. Product quality and latent defects

Liabilities for defective workmanship and for faults in design are constant reminders of the risks associated with construction contracts. A contract for materials might have this element but it is quickly remedied by the order of new material. However, with a construction contract this aspect is not always easy to ascertain. Due to the large number of parties involved each would be seeking to lay fault on the other. The lack of co-ordination between design and construction is a common source of dispute. Much of the innovation in procurement systems of recent years stems from creating ways of minimising the effect of this clash.

11. The voluminous amount of evidentiary material

Construction projects generate an enormous amount of documentation. Due to the numerous parties involved and the constant need to clarify and protect one’s self interest you will find high levels of communication by all. A diligent and prudent party to any construction contract will have meticulous notes and evidence to justify all conduct otherwise you could leave yourself open to unwanted claims.

12. Ownership of materials

The distinction between contracts for materials and labour, and construction contracts matter as to the question of ownership of those materials and who retains title. Subject to any agreement, the materials supplied become the property of the owner once they have become affixed to the works. Prior to the time of incorporation, the materials remain the property of the contractor. If the materials are brought onto the site by a subcontractor but not incorporated into the works, title to those materials will not usually pass to the main contractor until the subcontractor has been paid for them.

13. Payment mechanisms

Payment arrangements are usually complex, and determination of payment is performed by the architect, engineer or quantity surveyor. The Act now provides for progress payments for all construction contracts. Unlike buying goods, it is not simply the case where an invoice is issued, and payment is then rendered.

14. Risks

Construction contracts are also about the prior allocation of risk. Standard forms of contract try to allocate risk equitably between the parties. The payment provisions of the Act can be described as an attempt to introduce a measure of equity into the contractual relationship between contractor and sub-contractor. Although contracts for materials and labour have some element of risk, construction contracts invariably always have risk and many factors affect the progress of the work.

Unforeseen risks include unexpected ground conditions; inclement weather; a shortage of material or skilled labour; accidents, whether by fire, flood or carelessness; innovative design that does not work or proves impossible to construct.

15. Dispute Resolution

Usually an engineer or architect will decide a dispute between the parties, but in most cases the independence of the engineer/architect is questionable. Negotiation and mediation are engaged or sometimes these options are overlooked, and one party will activate the arbitration clause in the contract or commence proceedings before the courts. Arbitration has long been the traditional default method of dispute resolution in the construction industry. It is now included in many, if not all, of the standard forms.

Notwithstanding, s.32(1) of the Act allows for either party to re-agitate before a court or tribunal the matters that were the subject of the adjudication.


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 entering into any contract.