Construction contracts - don't risk it!

Natalia Sokolov
Solicitor at Clarke Willmott LLP
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Post date: Wednesday, 25th January 2012

Clients, consultants and contractors alike all need to assess and analyse risk when it comes to negotiating contracts. Natalia Sokolov of Clarke Willmott LLP highlights some of the key points to consider.

There are a number of challenges to overcome when facing a construction contract and it is easy to be caught out by issues that could easily have been avoided. At the start of a project, it is important to consider the procurement route, the impact of pre-contract negotiations and works, payment mechanism and retention, insurance requirements and creditworthiness or solvency of the parties involved.

Other issues to consider include:

Liquidated damages: A contract may entitle an employer to a claim for a specified rate of damages, payable by the contractor in the event of contractor delay. The main advantage of this is to set a pre-determined rate upon which to assess damages per day or per week of delay. Liquidated damages also act as a motivating factor for the contractor to complete the project on time. It is important, however, that the rate of liquidated damages does not represent a penalty and to avoid this it should be a genuine pre-estimate of loss suffered and a note of the calculation should be kept.

Insurance: The employer must ensure that there are no insurance ‘gaps’ in the project. Insurance to consider includes (but is not limited to) all-risks insurance, professional indemnity insurance, product liability insurance, employer’s liability insurance and public liability insurance. In terms of professional indemnity insurance, this should be obtained from all parties with a design responsibility in relation to the project, and should be maintained for the duration of the contract/appointment (12 years if it is a deed) at an agreed level. Consider also whether the basis of the insurance, should be on an ‘each and every claim’ basis, or an ‘aggregate’ basis as this will significantly impact on the ability and recoverable sum of any claim. You may need to consult your insurance advisor as part of this process. The insurance clause will also need to be negotiated in the collateral warranty (see below).

Intellectual Property: An intellectual property right seeks to protect the form of the expression of ideas. A construction contract will usually grant a licence to the employer to utilise the intellectual property in the project for the purposes for which such materials were created. The ‘ownership’ of the materials usually remains with the author.

Collateral warranties: These allow a third party (such as a funder, purchaser or tenant), to establish a contractual link with a party who they are not in contract with. It effectively extends the scope of the contract. These documents should be considered in detail against the underlying contract or appointment or if the underlying documents are poorly drafted or non-existence the warranty will be of little or no benefit. In particular, if you are the employer, watch out for net contribution clauses where one party’s liability is limited only to the proportion of blame for which it is responsible. This can lead to expensive claims against multiple parties and the difficulty in apportioning blame can lead to reduced recovery.

Assignment: You may wish to limit the number of assignments in your contract (and warranty) to no more than two which has become as industry standard. Exceptions may be required to deal with group companies and/or funders which will need to be negotiated.

Disputes: You should consider the disputes clause carefully. In the current market, mediation can be a very effective way of resolving disputes. Costs for mediation are typically around £1-£2,000 for the mediator plus your legal team’s preparation time. This is low in comparison to the cost of litigation, arbitration and adjudication. However, note that adjudication cannot be written out or excluded from a construction contract.

Security: Consider whether you (or your funder where applicable) require a form of security under the contract such as a performance bond, retention bond, parent company guarantee or an escrow agreement from the contractor. These are becoming more popular in the current market due to the insecurity surrounding the solvency of companies.

Limitation: Check whether your contract is being signed under hand or by deed. If under hand, liability of the parties under the contract will be limited to 6 years. If by deed, liability will run for 12 years.

Sustainability: There is an increased demand on designers to create sustainable buildings, using sustainable or renewable building materials. The JCT contract, as an example, encourages sustainability and aims to improve the environmental impact of the design of the building itself. In addition, the contractor has an obligation to provide information concerning the environmental impact of the materials selected for use by the contractor, to the employer. Achieving a specific BREEAM rating can also be included as a contractual provision. Obligations can also be placed on the developer by planning authorities, which will be passed on to the contractor and professional team by means of the contractual documentation.

This article first appeared in Development Services & Sustainability Directory 2012. To read the entire publication, click the ebook.

Construction