Breaking contractual habits

Infrastructure cost blow-outs are contributing to adversarial contract disputes, experts say. Roads & Infrastructure explores the need for more collaborative modes of contracting.

Over the past 15 years, Australian governments have spent $28 billion more on transport than they told taxpayers they would, according to a 2016 Grattan Institute report.  

There are multiple factors that could mean cost blowouts are unavoidable – unexpected weather, ground conditions and community objections, to name a few. 

However, when analysing all 836 projects valued at $20 million or more and planned and built since 2001, the Grattan report found 90 per cent of cost overruns were explained by 17 per cent of projects that exceeded their promised cost by more than half. 

While the study paid focus to project costing estimates by governments, project governance is an equally important factor to ensuring projects remain on time. 

The Productivity Commission in 2014 report highlights that governments are sometimes weak at determining what, where and when infrastructure projects should be scoped and constructed. The report attributes this to deficiencies in using coherent decision-making frameworks to assess a portfolio of potential projects, citing inefficient risk allocation between public and private partners. 

When costs and delays reach melting point, there’s been a tendency for aggrieved parties to turn to litigation. 

While cost blowouts are nothing new, experts believe the nature of adversarial contracting is continuing to enable behaviours not in the best interests of
all parties. 

THE MODUS OPERANDI OF CONTRACTING

Scott Langdon, a partner at KordaMentha Restructuring, says an opportunity exists to change the way we think about the contractor-principal-subcontractor relationship. He calls for a bespoke approach to construction contracts. 

As a restructuring partner, KordaMentha maps the way forward for these parties.

Scott Langdon says an opportunity exists to change the way we think about the contractor-principal-subcontractor relationship.

KordaMentha Restructuring sees the worst of the situation where project costs reach a crunch point, which Mr. Langdon says typically leads contractors to work together collaboratively. 

Mr. Langdon says inappropriate risk allocation goes back generations and being combative is therefore in the “modus operandi” (MO) of contractors and principals.

“This is something in the last decade that is heavily born from the construction boom where we had massive mega infrastructure projects set up in the mining sector,” Mr. Langdon.

“Our MO in Australia is over many generations to go to the lawyer’s office, say we’ve got a problem, issue notices under the contract and fight, rather than focus on constructive resolution.”

Mr. Langdon says that contracts need flexibility to account for construction issues, and the MO of contractors and principals needs to be about remedy and solution, instead of arguments. 

However, if they had done so over the life of the project, he says a lot of litigation and cost blowouts could be alleviated. In some cases, behavioural psychologists have been brought to resolve issues. Mr. Langdon says construction contracts he sees end up in litigation far more often than not. 

Mr. Langdon says that unfortunately, it’s only at the challenging end when KordaMentha gets involved and there’s high stress and high consequence of decisions that people have the ability to look inward. 

As international and local debt funders of infrastructure projects want to de-risk as much as possible, Mr. Langdon says that debt providers end up offering the loan under a fixed price, fixed outcome.

These discussions, he says, have led to a spike in engineering, procurement and construction (EPC) contracts, which often leads to blame shifting down various tiers. 

“A hundred per cent of the risk of the construction is then borne by the contractor, which is a relatively asset light entity,” he says. 

He says the risk is often then shifted to sub-contractors and consultants, and then passed down. 

The perfect storm is compounded by multibillion-dollar contracts in a high stakes market where project timelines are crucial. 

 As a consequence, the risk could fall down the bottom end of the chain, opening up the risk of insolvency if the contractor can’t bear the cost. 

He says things go wrong on a regular basis in mega-infrastructure projects, citing the example of the Sydney Opera House – an asset 1400 per cent overvalued. It was originally forecast to cost $7 million, but in the end cost more than $100 million and took more than 10 years to finish.

Mr. Langdon says fortunately government contracts are trending away from EPC contracts in infrastructure as the government is the principal and not reliant on external debt funding. However, each state and territory will take a different approach, with some opting for standard contracts.  

“Government is willing to take on a little bit more risk … and therefore there has been a trend away, but still an EPC contract is a core contract used in the infrastructure space.

“No two projects are the same and so one of my big concepts is that we need bespoke contracts for the bespoke piece of work. It doesn’t need to be an EPC or alliance but we can find a bespoke contract.”

He supports the concept of iterative tendering which sees the contractor brought early into the discussion during the feasibility and design stage to identify the potential risks. Iterative tendering could comprise one-on-one meetings and a brief, allowing contractors to consider the brief and provide feedback on construction challenges, timeframes, risk allocation, authority interface and compliance. This could occur over many months and ensure all contractors understand what they are tendering for. 

Mr. Langdon says this has potential to build camaraderie and ensure the contractor understands the project better, which leads to more accurate pricing. 

“If you speak to contractors, when they price risk in, they can price the same project completely differently depending on how desperate they are for the piece of work.

“If they have a full book of work, they will price the risk tightly, whereas if they’re scarce of future work, they’re willing to take on more work and price the risk much more aggressively and that’s not a good outcome for the project. The risk should be priced regardless of the appetite of the contract.”

Mr. Langdon believes alliance-style contracts, used heavily in the UK, have a greater chance of success than EPC due to the risk allocation provisions in the contract. 

Carlos Rial, the Chief Executive Officer of the Australian Asphalt Pavement Association, says all projects have certain risks and these risks vary from contract to contract.  

“We are seeing in some parts of the country a shift from clients, in particular some government bodies, to transfer more and more risk to the private sector. As construction projects are becoming increasingly large, some in the multiple of billions, the ability to understand this risk and price becomes increasingly challenging,” Mr. Rial says.  

Mr. Rial says that with this we are seeing some providers walk away from pricing projects, leading to a lower competitive market or causing some to overprice the risk or run the gauntlet, hoping not to make major losses.   

“For simple projects where risk can be quantified easily fixed price/schedule projects are appropriate. However, for the most complex jobs risk is best shared between client and contractor,” Mr. Rial says.

“Contracting models such as early contractor engagement and alliances have seen teams between the client, designers and contractors tackle the most complex of projects collaboratively, dealing with issues in a best-for-project manner through innovation and collaboration. The alternative can lead to contractual warfare.” 

He says that all contracting models have their place to deliver good outcomes. Mr. Rial adds that partnering with industry to agree on the most fit-for-purpose model for a given project will lead to the highest quality, lowest price and also maintain a sustainable industry to support clients in the long term.

COMMERCIAL MISALIGNMENT 

Owen Hayford says companies are once again looking at more collaborative delivery models.

In early 2018, Owen Hayford, Partner at DLA Piper and formerly of PricewaterhouseCoopers, produced a report on collaborative contracting. The report links the most significant cause of inefficiencies in the construction sector to a misalignment of commercial interests between project owners and other stakeholders involved in construction project delivery. 

The report’s delivery was timely as it pre-dated Victoria’s big build, and major project delivery in NSW. 

It highlights a number of problems with conventional contracting, including allocation of specific project responsibilities and risk to each participant.

The report attributes the fixed price model to motivating participants to only do the minimum required, even if doing more would result in a better project outcome. It also highlights an issue of a lack of incentives for other participants to contain the cost impact of changes.

Additionally, it says the obligations to co-operate don’t really work. It notes that when a project runs into trouble, the benefits to a participant of blaming others and putting its own interests ahead of the project or other participants could soon outweigh any downsides of breaching an obligation to cooperate. That’s despite the fact that commencing legal proceedings to recover losses arising from a breach of obligation is rarely an attractive or effective remedy. 

The report advocates for more collaborative forms of contracting that embraces a wide and flexible range of approaches to managing the relationship with project owners and participants. 

Collaborative forms of contracting incorporate features designed to overcome the misalignment of commercial incentives, including early warning mechanisms, which alert participants of emerging issues. Furthermore, contracts could include governance arrangements that facilitate collective problem solving and decision making and early involvement of the main contractor and key specialist sub-contractors in the design process. Another feature is an agreement for each participant to waive its right to sue any other participant for mistakes, breach or negligence by another participants, except in the case of wilful default. 

While conventional contacts may incorporate things like early warning mechanisms, the report notes these contracts fail to address the real obstacles to collaboration inherent in conventional fixed price contracts. 

Mr. Hayford says with the civil construction sector being overheated, companies are once again looking at more collaborative delivery models with less risk transfer.

“I think we’ve seen an uplift in disputes and claims as a consequence of contractors losing money,” Mr. Hayford says.

While the model fell out of favour earlier this decade, the report highlights an uplift in government expenditure on public infrastructure in NSW and Victoria will require a collaborative response.

“The reason why I put it [the report] together is I could see the sector was beginning to show similar signs to what we saw back in the early 2000s when the mining resources boom was causing demand for civil engineering services to outstrip supply,” Mr. Hayford says.

“Owners were struggling to get contractors to tender for fixed price contracts and in that environment we saw a lot of alliance contracting and similar forms of softer contracting arrangements.” 

He adds that a focus on minimising costs today to win, compete and stay afloat may have discouraged such investments. 

“The reason why contractors behave why they do and don’t focus on productivity is largely a consequence of government and the way that owners manage and tender their major contracts.” 

THE ALLIANCE MODEL

Mr. Hayford points out the NSW Government released a 10-point plan in June 2018 which included a commitment to procure and manage projects in a more collaborative way. This includes moving away from a reliance on fixed price, lump sum procurement methods and being more open to collaborative contracting models like alliancing. 

Despite the release of the 10-point plan, he says he hasn’t seen collaborative contracting models flow through into the tender documents that government has been issuing to the market.

Mr. Hayford says he has observed a number of alliance style contracts in NSW with cost reimbursement with margin at risk depending on performance against KPIs. But otherwise, he says they are more traditional in nature than an alliance contract with a “no blame” regime and other key features. 

In Victoria, on the other hand, Mr. Hayford says that over the last few years, there’s been a greater preparedness to use alliance-style contracting. In the US, alliance-style contracting is known as Integrated Project Delivery (IDP), which is graining traction. These contracts see the replacement of fixed price with performance-based remuneration regimes, integrated project teams, continuous involvement from all non-owner participants and no blame. 

The report argues the IPD model is best suited to projects with complex risks, interfaces and stakeholder issues difficult to price and allocate. Its also suited to projects at scale where the additional procurement and contract establishment costs are justifiable, in addition to a range of other complex factors. 

“Alliance contracting gives government a whole lot of flexibility in terms of how they change the scope of the project, descope it or deal with issues that they haven’t foreseen such as community backlash or the community wanting changes to projects. 

“Under the alliance you have joint decision making and requirements for unanimous agreement between the owner and non-owner participants.” 

Mr. Hayford says that while there’s been a greater use of collaborative contracting nationally, less of it has been pure alliance style with a requirement for unanimity as part of the governance arrangements. Additionally, he says more contracts are incorporating adherence to early warning mechanisms. 

Ultimately, Mr. Hayford’s conclusion is there is no one-size-fits-all approach to contracting and it will depend on a range of factors, including the project owner’s objectives, characteristics of the project and state of the construction market. 

Mr. Langdon says alliance contracting has potential to lead to better outcomes. He points to a 2009 report by the Department of Treasury and Finance in the Victorian Government that concluded 96 per cent of alliance projects were completed on time or ahead of schedule. The figure is linked to 46 alliance projects which were all valued at more than $100 million. 

His key point is that an identify-and-remedy first approach from the contractor and principal would mitigate project delays.  

“My key message is we can work collaboratively. We have it in ourselves to work collaboratively,” Mr. Langdon says.

An Infrastructure NSW spokesperson told Roads & Infrastructure in January that a number of NSW Government agencies have adopted collaborative contracting models for a range of projects.

For example, Transport for NSW adopted collaborative contracting models in a number of road and rail projects, including the Newell and Barton Highways, Rozelle Interchange (WestConnex 3B), Parramatta Light Rail and More Trains More Services.

On questions of whether fixed price contracts have led to cost overruns, the spokesperson said variations in cost on projects are not in themselves caused by the contracting methodology selected.

“For example, changes in project scope that respond to stakeholder/community input and issues such as unknown ground-conditions and utilities are more directly linked to cost variation on projects. Taking a collaborative approach can occur with fixed price contracts, providing greater scope for the best solutions to be worked through between the government and contractor project teams.”

The spokesperson said improved collaboration is a key focus for the NSW Government and industry to modernise working practices and support a sustainable construction sector.

“Infrastructure NSW leads the Construction Industry Leaders Forum, a joint forum of leaders from industry and the Victorian and NSW public sectors that work together to drive improved collaboration and action around the procurement and delivery of major government infrastructure projects.”

A Victorian Government spokesperson said the government uses different contractual models to be deliver each project, including alliances, fixed price contracts and Public Private Partnerships that focus on meeting the future needs of a growing Victoria.

In response to questions on whether the Victorian Government planned to adopt a similar 10-point plan to the NSW Government, the government highlighted its experience in innovative contracting models across all of its 119 major transport projects. This includes alliances, program alliances, design and construct contracts, market-led proposals, and Public Private Partnerships.

The project alliance model was developed for the Level Crossing Removal Project and is the first time this program model has been used in Australia. Under the model, five alliance contracts are in place to deliver a program of level crossing removals.

In an interview with Roads & Infrastructure, WA Transport Minister Rita Saffioti said the government has already implemented alliance on a range of major projects, including the Thornley-Cockburn Link and new Bayswater Station under METRONET. She said the government has conducted a range of internal workshops on the costs and benefits of alliance versus design and construction (D&C). 

She said choosing one or the other depends on the complexity of the project rather than size. For example, she said the Matagarup Bridge saw some issues with a D&C model, namely due to a reliance on third party infrastructure.

“I was quite sceptical of alliance contracting when I was in opposition because I thought it didn’t guarantee that value for money, but actually understanding the fact is delivering these projects is a shared responsibility. It’s as simple as that,” Ms. Saffioti said.


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