Common terms and issues in construction contracts
What are the Common terms and issues in construction contracts?
Here Katherine Keenan, an Associate in our Construction, Engineering and Projects Team, gives an introduction to common terms and concepts in construction contracts.
This includes looking at common standard form contracts, including JCT, NEC, OCC and FIDIC contracts, the way building contracts are classified and what the common themes are.
For more information, please contact Katherine Keenan or your usual Charles Russell Speechlys contact.
This webinar is an introduction to common terms and concepts in construction contracts.
Let’s start by briefly looking at common standard form contracts. You have the JCT which is published by the Joint Contracts Tribunal, NEC the New Engineering Contract, OCC, infrastructure conditions of contract and this replaced the long-standing ICE conditions of contract in 2011. You have the IChemE Institution of Chemical Engineers and FIDIC International Federation of Consulting Engineers. And FIDIC is most commonly used for international construction and infrastructure projects. But for more information on JCT, NEC and FIDIC contracts please check out the other webinars in this series.
Regardless of which standard form building contract you use, building contracts broadly speaking can be classified in two ways, both of which will be important factors for choosing the form of contract. Firstly, method of payment for the works. You have can lump sum, fixed price contracts for carrying out the works, remeasurement or unit price which is based on a bill of quantities, cost reimbursement or cost-plus, this is where the contractor is actually paid for what it incurs. And we’ll come on to explain each of those in a little bit more detail shortly.
Now the second way to classify building contracts is by the extent of the contractor’s obligations. For example, design and build which can give the contractor single point design responsibility, traditional where the employer keeps control of the design and the design team, or construction management or management contracting where separate packages can be let to multiple contractors.
While moving on to common themes and construction contracts there are three common themes which apply to all building contracts regardless of which form you use. Time, quality and price. It is generally said that it’s very difficult to achieve all three aspects on a project. One aspect is often compromised. For example a project may be achieved on time and at a low cost but the quality of the work may have been compromised. When selecting a contractor from tender returns the cheapest option may not be the best option if an employer wants the project to be completed on time and of a high standard of workmanship he may have to pay more to achieve this.
So let’s take a look at price first of all. As mentioned earlier there are a number of different ways in which the cost of the works can be determined by a particular contract including lump sum, which is fixed price. So for a pre-agreed price, the contractor agrees to execute certain defined building work. The lump sum is usually subject to adjustment for variations, a visual of some items and fluctuations in the cost of labour, materials or other costs. However fluctuation provisions are often omitted from the building contract.
We’ll come on to look at variations in more detail later. But under lump sum contracts, the contract should have detailed provisions to deal with what happens if the contractor cannot carry out the works for the lump sum. And this may be due to a variety of factors. True lump sum contracts are advantageous to employers as they give them certainty of the price of the works. However lump sum contracts involve risk for both parties. If the as built quantities differ from the contract price in a contractor’s favour then it will make more profit. Conversely if as built the quantities are greater than contained in the lump sum, the employer will receive a more expensive product than it has paid for. To avoid such an outcome the parties should ensure that they describe the work for the contract sum in great detail.
Secondly let’s look at remeasurement or unit price. Here the contractor is paid a price for each unit element of work carried out and identified at the time of contracting. The bill of quantities provides a schedule of rates and units of measurement. The contractor is usually bound by the terms of the contract to carry out work in excess of that stated in the bills of quantities if it is necessary to complete the works as it can be difficult to estimate quantities at the outset of a project. The parties may enter into a measurement and value contract where the contractor is entitled to be paid for the work it carries out at the rates in the bill of quantities or modified bill rates to take account of any special features of the work. The contractor will be entitled to a reasonable rate if there is no rate specified.
And thirdly cost reimbursement or cost-plus. Here the contractor is entitled to paid the actual cost of the works as performed plus an additional amount in respect of its overheads and profits. Now this type of fee arrangement is rarely used as it can be said that there is little incentive for the contractor to work efficiently or minimise costs under these types of contracts. On the positive side it can allow for a quick start on site as there is not likely to be any drawn out negotiations on the contract sum. It is only the contractor’s percentage of profit that needs to be agreed.
So is the contract sum the price you pay? Well not necessarily. Most contracts allow for the employer to instruct variations and also include mechanisms for a contractor to apply for more money in certain circumstances. In fact the final price paid may be very different to the original contract sum. Unfortunately disputes over payment and final contract sums are very common in the construction industry.
So do all of the works need to be finished before the contractor is entitled to any payment? The answer is usually no and under the Housing Grants Construction and Regeneration Act there is a statutory entitlement to periodic payments in certain construction contracts that meet the criteria. And the contract will often entitle the contractor to payment in instalments which can become payable when a certain date or milestone is reached.
Well let’s take a look at variations in more detail. So what are variations or extra work? Well whether something constitutes a variation depends on the factual background. Variations are necessary or desirable due to the very nature of construction and engineering works. The employer’s needs may change. The contractor may discover something about the works which means that further or different work is required. Or it may transpire that the agreed works cannot be carried out. So what are instructions? An instruction from the employer may or may not constitute a variation. Most standard form contracts expressly provide that the contractor is obliged to comply with all instructions. Can a contractor object to an instruction? Some contracts allow the contractor to object to an instruction in limited circumstances usually to maintain fairness to the contractor. Will the contractor be entitled to more time and money if a variation is instructed? This will depend on the terms of the contract and the circumstances. Under most of the JCT contracts for example a contractor is entitled to claim additional time and money if the employer instructs a variation or change which is a clearly defined term but tends to be a change in the employer’s requirements or the addition or omission of works, the alteration of the kind of standard or materials or goods, or where there is a change in the working conditions such as limiting hours or access to site.
Now let’s move on to look at time. So construction contracts usually identify a specific date for the commencement and completion of the works. The contractor is often under an obligation to proceed regularly and diligently in order to complete the works on or before the completion date. It is common for contractors to produce a programme showing how it will meet the completion date and set out the progress of the works. Many contracts will include detailed requirements of a contractor to carry out the works and specify standard by which this obligation should be adhered to. For example, many of the JCT contracts require the contractor to use its best endeavours to prevent delay in the progress of the works. If the contract does not stipulate a completion date, the contractor is required to complete the works within a reasonable time. If the fixed completion date has elapsed and there is no mechanism in the contract for dealing with the delay event caused by the employer, time is said to be at large. This means the work must instead be completed within a reasonable time. The parties will almost always want certainty of an agreed completion date and most contracts provide for adjustments to the completion date in certain circumstances. These are often referred to as extension of time clauses. So what is an extension of time? Many contracts list out the various grounds which may entitle the contractor to claim an extension of time, in other words an extension to the date for completion. And most contracts establish a contractual procedure for dealing with the contractor’s claim for an extension of time. These provisions are often heavily negotiated and can generally be split into one of two categories. Firstly, if the delay was by the employer or others, for example the employer instructs changes to the works, variations, the employer prevents the contractor from carrying out the works. Or secondly, delay which the contractor is not responsible for under the contract. Usually factors outside the parties’ control such as exceptionally adverse weather, exercise of a statutory power after the base stage, force majeure or loss or damage to the works caused by a specified peril such as flood or fire, and these are just a few examples.
So what happens if the contractor doesn’t complete the works by the completion date? If the contractor fails to complete the works within the prescribed time and has not made any successful extension of time claims, the employer can claim damages for a breach of this obligation. If any of the delay is the responsibility of the contractor, then the employer would be entitled to claim from the contractual completion date as adjusted by any extension of time granted until the date when the contractor has actually completed the work. In these circumstances the employer can look to recover either liquidated and ascertained damages, known as LADs or LDs, and this is where the parties have pre-agreed at the time of entering into the contract a rate of damages payable for each week or day of the contractor’s delay. In the absence of LADs, general damages. The employer can claim against a contractor for its actual losses caused by the delay.
Now because the instruction of changes to works by an employer is a regular occurrence in construction, standard form building contracts incorporate change mechanisms and extension of time clauses which should in theory prevent a contractor from arguing that time is at large and avoiding liability to pay liquidated damages. So why do we have liquidated damages? Well, disputes in construction can be very complex and bringing a claim for general damages tends to be expensive and time consuming. To try and avoid costly disputes down the line, parties often agree at the outset a suitable level of damage upfront for delay to the project. And this rate the employer will be entitled to claim if the contractor is in breach of particular obligations.
LDs are not only used for delay damages they can be used as compensation for failure to meet other targets or requirements. So what happens if there is a delay? Who pays? Well this will depend on the circumstances and contractual provisions. Who has caused the delay? Did the employer instruct variations? Were the instructions late or inadequate? Were there delays on the delivery of materials to the site? Were there unforeseen circumstances which might entitle the contractor to an extension of time?
Now let’s look at the third element of building contracts: quality. So most contracts will specify the standards, the materials, goods and workmanship to be achieved by the contractor. The contract documents, namely the employer’s requirements, will go into greater detail. Most contracts include requirements as to the type and quality of materials to be used. For example, materials may need to be in accordance with the good practice in a selection of construction materials which is published by the British Council for Offices. The materials will need to be in accordance with British or local standards and codes of practice. And the materials should not generally be known to be deleterious or prohibited at the time of incorporation into the works. And in light of the Grenfell tragedy it is becoming more common for detailed requirements of standards of materials and prohibitions on using certain cladding materials. So who monitors the quality of projects? Well this will depend on the type of building contract. Often the employer will appoint an architect or an employer’s agent, often a surveyor, to check the quality of materials, goods and workmanship and to certify practical completion of the works. And regardless of which contract you use, there is usually a mechanism for checking, testing and inspecting the works and workmanship throughout the project.