Sharing is Caring: Gainshare and Painshare Payment Models

Traditional payment mechanisms in construction contracts typically involve lump sums or schedule of rates. These are known measures for all involved in the construction industry and have been commonplace in the “adversarial” style contracting models that dominate the Australian infrastructure landscape.

However, parties are increasingly turning to alternative contracting approaches in an attempt to drive better project outcomes. As part of the pursuit, parties have taken steps including:

1. integrating collaborative or co-operation principles into adversarial contracts;
2. adopting collaborative contracting models, which often include no-blame regimes; and
3. utilising a payment model which includes Gainshare and Painshare (Gainshare/Painshare Regimes).

Adversarial Contracts

Adversarial or traditional contracts are often the default contracting approach for construction contracts in Australia.

Whilst these contracts may be subject to negotiation and include tailored risk profiles, they are largely a known commodity for contracting parties.

However, an adversarial contract typically places parties in opposing positions, as their interests are not aligned and all parties will focus on risk mitigation and minimisation.

The consequences of this approach can mean that parties:

1. seek to negotiate favourable risk profiles under the contract, shifting risk to the other party;
2. are defensive and focused on preserving their contractual rights and protections (throughout both negotiations and project delivery); and
3. may readily find themselves in disputes when something goes wrong, especially it is an unknown risk neither party wants to accept responsibility for under the contract.

In an effort to mitigate the risk allocation, Contractor’s may also include allowances for the risks in their price. This directly results in the Principal paying more, despite there being the possibility the given risk may never arise.

The aggregate effect of the above results in parties being incentivised to prioritise their own interests, instead of what is best for project or delivers value-for-money.

Collaborative Contracting

Collaborative contracting places an emphasis on cooperation between the parties and joint decision making.

A focus on transparency and open communication allows for the sharing of information that promotes pre-emptive problem solving and allows for the parties to develop solutions that are centred around best-for-project and value-for-money outcomes.

To reinforce these objections, parties may opt for “no blame” regimes that seek to mitigate risks around disputes. Whilst there are ordinarily exceptions to these regimes, their incorporation can provide significant initial value to early-stage project success.

Notwithstanding this, these regimes may face challenges as issues arise across the duration of the Project. As costs increase and timelines extend, parties may find themselves pointing fingers and trying to allocate blame (even if collaborative principles are enshrined in contract documents).

These issues may be overcome by senior leaders of both parties setting the standards in their respective organisations. However, the significant departure collaborative models present from traditional approaches may require additional training for Project teams, as the parties shift their mindset from risk mitigation to cooperation.

Traditional Payment Models

Gainshare/Painshare Regimes allow parties a transparent payment model that aligns with collaborative contracting principles, though this payment approach may still be used on traditional (adversarial) contracts.

Contractors are typically hesitant to provide a transparent payment model because it gives additional information to the Principal (which may be used against the Contractor moving forward, like for example, as part of variation pricing).

This means Contractors typically favour lump sum or schedule of rates contracts.

Under these models, the Contractor is not typically required to provide a breakdown of the lump sum or schedule of rates, by reference to their direct costs. Whilst breakdowns may be provided, they are not intended to be transparent (e.g. verification of costs by reference to subcontractors or suppliers).

Similarly, these models will adopt rates for personnel that have been built up to include allowances for overheads and profit.

Practically speaking, the Principal is not permitted the opportunity to interrogate, verify, or audit, the Contractor’s costs in performing the works (or identify what specific allowances have been made for overheads and profit).

Gainshare/Painshare Regimes

In contrast, Gainshare/Painshare Regimes are often underpinned by payments for:

1. the direct costs incurred by the Contractor from subcontractors and suppliers;
2. the actual costs of personnel (which may be subject to certain multipliers that consider other personnel costs, such as leave); and
3. a specified allowance for profit and overheads.

At its heart, this represents a cost-reimbursable regime that provides that the Contractor will not be over-compensated (or under-compensated) and the Principal will only pay for costs that are actually incurred.

However, a cost reimbursable regime will not, in isolation, incentivise the right behaviours.

Hence, Gainshare/Painshare Regimes allow for parties to share in any underrun, or overrun, against the Target Cost.

This ensures that Contractor’s remain incentivised to keep costs to a minimum, as they share in any underrun (and overrun). Similarly, Principals are incentivised to ensure they provide Contractor’s all relevant information and materials to effectively deliver the project, as they will retain benefit in part of the underrun, or share in any overrun.

The Target Cost will also be subject to adjustments, like a traditional Contract Sum would be, to allow for the treatment of variations or other risks that the parties agree should rest with the Principal. This means that merely adopting a Gainshare/Painshare Regime will not mitigate the need to properly ensure risk allocation, as this will play a significant factor in the Contractor’s ability to achieve (or underrun) the Target Cost.

Example Of A Gainshare/Painshare Regime

An example of a Gainshare/Painshare regime is provided below:

Gainshare / Painshare	Parameters	Parties Entitlement
Gainshare	Underrun against Target Cost of more than 10%	Contractor entitled to 0% and Principal entitled to 100% of underrun
Gainshare	Underrun against Target Cost of less than 10%	Contractor entitled to 50% and Principal entitled to 50% of underrun
Painshare	Overrun against the Target Cost of less than 10%	Contractor liable for 50% and Principal liable for 50% of overrun
Painshare	Overrun against the Target Cost of more than 10%	Contractor liable for 0% and Principal liable for 100% of overrun

This example provides a circumstance where up to 10% of any overrun or underrun is shared equally between the parties, and anything outside of those parameters would rest with the Principal (which allows them to retain 100% of the benefit, but also means they are liable for 100% of any overrun).

This shift to 100% effectively functions as the gainshare (or painshare) “falling off a cliff” and shifting all of the benefit (or liability) to a specific party.

Parties should carefully consider how the Gainshare/Painshare Regime will work in their given contract, as it may be argued that where either the gainshare or painshare shifts to 100%, this may limit the incentivisation and positive behaviours the model is intended to drive.

Practical Considerations

Where parties wish to develop or utilise a Gainshare/Painshare Regime, careful consideration needs to be given to various practical matters. These include:

1. Contractual Drafting: Gainshare/Painshare Regimes will often require detailed tailored drafting to specifically cover the commercial agreement reached by the parties in how underruns and overruns are to be treated. In addition to this, the drafting will need to address what costs will be recoverable (and what will be captured in the Contractor’s Fee (or margin)), how claims are to be made (including the source records that need to be provided with each claim), and how any on-cost multipliers will be calculated;
2. Collaborative Contracting: Whilst Gainshare/Painshare Regimes do not need the contract itself to be collaborative in nature, this is an approach often preferred by the parties. To facilitate this, the parties need not just consider the Gainshare/Painshare Regime that will apply, but also how the contract will enshrine collaborative principles and obligations. In preparing this, consideration may be given to how risks are managed (and their impact on any Target Cost), the joint administration and decision-making processes that will be adopted, and any reserve decision making powers that the Principal may seek to retain. In addition, to further incentivise collaborative behaviours, parties may consider the adoption of a “No Blame” regime, though this may need to be supplemented by certain specific exclusions (for a limited number of circumstances where the parties wish to retain other rights);
3. Downstream Contract Management: Contractors will need to carefully consider the interaction between an upstream Gainshare/Painshare Regime and downstream traditional contracting approaches. Furthermore, if Contractors do seek to flow through Gainshare/Painshare Regime downstream, then this will need to be carefully considered against the specific risk profile of each subcontractor’s (or consultant’s) scope of works. This may need to include incentivising downstream parties to engage in the collaborative approach, as smaller scopes of works may not lend themselves to detailed Gainshare/Painshare Regime or collaborative contracts (especially if downstream parties are not familiar with these approaches);
4. Treatment of Risk: The apportionment of risks will remain an issue for the parties, whether they elect to proceed with a Gainshare/Painshare Regime under a traditional or collaborative contract. However, how these contracts treat risks, with respect of the payment model, may have a material impact on the initial established (and overall outcome) of the Project. Whilst all parties will typically seek to minimise their risk profile, parties may realise the best results where Contractors adopt known risks, and Principals accept unknown risks. This provides less pricing certainty for Principals, but ensures Contractors do not include speculative allowances for unknown risks, which may never eventuate, that artificially increase the Target Cost. The end result of these increases to the Target Cost may result in the parties realising (and sharing) a gainshare based on risk allowances never eventuating. Hence, both parties may be protected where risks are fairly apportioned, and unnecessary or speculative allowances are not incorporated into the Target Cost;
5. Treatment of Contingencies: Given the transparent build-up associated with Gainshare/Painshare Regimes, Principals should be conscious that Contractors will likely still seek to include a lump-sum style value for possible contingencies (and the various risks they accept under the Contract). Whilst Principals may seek to obtain a breakdown of how this figure is calculated (and what allowances are specifically being made), Contractors may be hesitant to provide this information. Parties should carefully consider then how contingency is intended to be treated as an element of the Target Cost.

If parties fail to properly take into account the above factors, it may result in difficulties in the implementation (and ultimate effectiveness) of any given Gainshare/Painshare Regime.

Where matters are addressed proactively, parties can avoid preliminary disputes and disagreements about the intended operation of certain provisions and how risks are meant to be treated.

Lamont Project & Construction Lawyers

The Lamont Project & Construction Lawyers team has extensive experience drafting and managing Gainshare/Painshare Regimes. Lamont Project & Construction Lawyers can leverage this experience to provide the required support and advice for matters of all scopes and sizes.

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 and 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.

Contract: Peter Lamont or Ryan Bryett

Email: peter@lpclawyers.com or ryan@lpclawyers.com

Phone: (07) 3248 8500

Address: Level 2, 349 Coronation Drive, Milton Qld 4064

Postal Address: PO Box 1133, Milton Qld 4064