September 1, 2015 posted in Construction, Design and Engineering
When I started in sales some 30+ years ago, many of Austin’s design and construction projects were completed under a simple agreement between Austin and Owner. Austin’s standard agreements were simple layman’s contracts that explained costs, payments were based on Advance Fund Schedules (we were paid in advance for the work to be performed), limitations of liability and warranty, and cost protections the Owner and Austin agreed upon. Over the years, use of this simple contract migrated to AIA forms, AGC forms, and now to Consensus Docs.
Each of these sets of agreements are considered fair and reasonable in the marketplace and help set the industry standards for the sharing of the risks and responsibilities that are inherent in a capital project. However, the fair and reasonable concept seems to be getting replaced by, “How much can we get them to accept?”
While I get that this is the essence of any negotiation, it is important to remember that an agreement between an Owner and a Service Provider is not a singular one-time transaction. It governs the working relationship that is the foundation for a successful project.
A one-of-a-kind project (and I can make the argument that every project is unique) carries with it risks that are substantial. Those risks emanate from sources that the service provider has absolute control over, some control over, and absolutely no control over. The ideal contract structure should place the greatest burden on the service provider for those risks they have the greatest control over, and the least burden for those that they have no control over.
A recent Engineering News Record cover article focused on the increasing risk Owners are expecting contractors to accept, supporting the sense that the trend is real and is one causing a great deal of concern.
For example, the Contractor has normal control over schedule, cost and quality. It is acceptable, and in most cases preferable, that Liquidated Damages be included in the contract for schedule performance. With the exception of unusual fluctuations in market pricing, such as skyrocketing material pricing, Cost of the Work is also under the Contractor’s control and he should be expected to manage that risk with reasonable contingency and profit-at-risk. Likewise, quality of the work is under the Contractor’s control and he should be expected to assume the responsibility for providing an appropriate level of quality.
However, recently we are seeing Owners expecting Contractors to take on significantly more risk, including consequential damages, such as loss of profits, business and reputation if something goes wrong on a project. Those damages are exceedingly difficult to properly quantify and assign to an action by the contractor. While this can be done, only the largest of contractors can absorb the legal costs associated with this process. In other words, it may not be the consequential damages that put the contractor out of business, but the legal costs associated with defending their position.
Another trend is that more Owners are asking the contractors to procure Builder’s Risk Insurance. In the industries we serve, this has typically been an Owner-purchased insurance policy, as it is the Owner’s property that is being insured. We will do this as a convenience to the Owner, with the stipulation that if a claim is necessary, the deductible is a “Cost of the Work” and does not come out of our profit. So far, Owners have been accepting of this approach. So, while it is fully understandable to expect Owners to work to shed risk, it should also be equally understandable that Contractors also need to limit the risk they take.
Ultimately, what will determine the eventual trend is the marketplace. My hope is that reason will prevail and tools will be created by the risk management industry to respond to the trend. Several years ago, there was a trend to put professional services up for reverse auction online. The marketplace determined that one also.
“The laws of the marketplace are physical laws, and they don’t become suspended in a crisis any more than the law of gravity does.”
“The thing about markets, and I think the thing people don’t understand about that, is markets are not kind, but they’re very efficient. So when the marketplace determines an inefficiency in the system, it corrects that, and a market system that’s left alone will reward good behavior and punish bad behavior.”