The cost of construction projects and its overall profitability is critical to its overall success. When reviewing a contract focus must be turned to any clause that has the potential to reduce a contractor’s payment or puts hurdles in front of getting paid altogether.
This final article will explore the third pillar of risk – cost. There is an abundance of clauses in construction contracts that have the ability to affect the contract sum and cost of a project, however, today our focus turns on the more ‘pitfall’ clauses in construction contracting.
Lump Sum vs Schedule of Rates
Firstly, it is critical to ensure the contractor is aware (and the contract clearly specifies) the pricing model which the contract is based (e.g., lump sum, schedule of rates or both).
With lump sum, the contractor is paid a fixed amount regardless of the quantity or cost of resources, therefore, the risk sits with the contractor and must be accounted for in the contract sum. Importantly, quantity and cost of resources can be a source of uncertainty at the outset of any project.
Conversely, under schedule of rates, the principal bears the quantity and cost risk as the parties agree unit rates for the resources required and payment is calculated based on the actual quantities used.
There are pros and cons and an element of risk for all models, and what is most effective is entirely project dependent. Sometimes, a schedule of rates will be combined with a lump sum contract, in that they will price lump-sum for well-defined items (i.e., mobilisation and demobilisation of plant and equipment) and the parties will agree that unknown components as identified in the contract, are to be priced using schedule of rates.
Nothwithstanding the model type adopted, ensure it is known by the contractor as this will escalate other areas for review to ensure the contract sum adequately accounts for the allocation of risk (i.e., if lump sum is adopted the contract must contain a clearly defined scope of works).
Set Off Clauses
Cash flow is essential to a contractor, therefore, look out for set-off clauses included in the contract. Set-off clauses are a contractual mechanism allowing principals to withhold monies earned by contractors by an amount the principal believes the contractor might owe on account of alleged defects or delays.
These monies could effectively be held for years while parties dispute those defect and delay claims that have been set off against the contractor’s payment. Further, some set-off clauses allow principals to set off any amount that they claim under any of their contracts with the same contractor.
Therefore, contractors should reject these clauses to lessen the risk of a reduced progress payment and to ensure potential losses on one project do not impact another profitable project.
Liquidated damages (LD’s) are the principal’s usual remedy for a contractor’s late completion and is often a negotiating point for contractors. With this in mind, to protect the contractor, ensure:
- there is a favourable EOT provision to avoid paying LD’s;
- the LD’s rate is reasonable and represents a pre-estimate of the loss the principal will likely incur if practical completion is missed;
- A cap is placed on the amount of LD’s (i.e., 5% of the contract sum); and
- Ensure that LD’s is the principal’s the only remedy for failing to achieve practical completion (i.e., ensure the clause does not allow the principal to claim both LD’s and other forms of damages particularly if their damages exceed the LD rate).
Limitation of Liability
Commercially, a total cap on liability is the best way for a contractor to limit its total exposure. For example, ensure that the aggregate liability of the contractor to the principal is,
“limited to the amount recovered under a policy of insurance required under the Contractor or is an insurance policy does not respond, no amount exceeding [X]% of the contract sum”.
Note, the percentage of the contract sum may range from anywhere between 0% and 100% depending on the negotiation between the parties.
Consequential loss are those damages not a direct result of the action which caused harm (i.e., breach of contract) but instead are a consequence of that action (e.g., lost profits, loss of use, damage to reputation etc). The ability to seek consequential damages from a party can turn a relatively small-dollar dispute into a potential company killer.
Contractors should be highly cautious and ensure the contract contains a mutual waiver of the right to seek consequential damages against both parties.
In addition, the contract should also include a non-exhaustive list of the particular consequential losses being waived. For example, define consequential loss to include:
“means any special, indirect, consequential or economic loss or damage of any nature including, but not limited to special, exemplary or punitive damages, loss of production, loss of revenue, loss of profit or anticipated profit, loss of contract, loss of business reputation, business interruptions of any nature, loss of opportunities, loss of anticipated savings or wasted overheads”.
Rise and Fall Clauses
The recent increase in global demand for building materials has inevitably led to price rises and unpredictable market fluctuations. Such unpredictability has made trading at a profit more challenging for contractors. Therefore, contractors should consider inserting a rise and fall provision into the contract which will shift the risk of price increase to the principal.
However, principals often want certainty around price before committing to a project and will reject such clauses, therefore, consider making the clause more appealing by:
- absorbing the price increase up to a certain percentage; or
- capping the percentage increase the principal will pay.
Lamont Project & Construction Lawyers
The LPC team has extensive experience and industry knowledge in to assist both principals and contractors to provide the required support and advice with respect to contract review and allocating risk.
If you would like to discuss any matters raised in this article as it relates to your specific circumstances, please contact Lamont Project & Construction Lawyers.
The content of this article is for information purposes only; it does not discuss every important topic or matter of law, and it is not to be relied upon as legal advice. Specialist advice should be sought regarding your specific circumstances.
Contact: Peter Lamont or Stephanie Purser
Phone: (07) 3248 8500
Address: Suite 1, Level 1, 349 Coronation Drive, Milton Qld 4064
Postal Address: PO Box 1133, Milton Qld 4064