Old fashioned contracts and procurement getting in the way of construction innovation, says expert

Out-Law Analysis | 02 Oct 2013 | 3:22 pm | 4 min. read

OPINION: The construction industry often knows exactly what it needs to do to make projects more efficient, more predictable and more successful, but international legal and procurement practices do not always support the changes that are needed.

Where construction professionals gather, as they did at a recent FIDIC Centenary conference in Barcelona, they discuss and largely agree on what would improve projects: better prioritisation of projects; early engagement with stakeholders about required outputs, and proper scoping of projects at an earlier stage with designers and contractors.

But procurement practices and traditional contractual models in common international use, such as the FIDIC standard form contracts, have not yet evolved sufficiently to make it easy to work in the way most likely to lead to a project's success.

Old fashioned adversarial models of running a construction project have often resulted in cost over-runs, delays and expensive legal disputes. Employers and contractors are increasingly willing to collaborate and innovate to try to find new ways of fixing old problems, but the procurement and legal frameworks available to them may be restricting their ability to do so.

One way that they are trying to do that is by involving contractors earlier on in the design process, asking for the input of potential contractors even before a final choice on who to use is made. This helps employers pick exactly the right contractor by assessing the quality of their ideas and also to start off with what is already a well developed and scrutinised design, which reduces the potential for changes and cost overruns later on.

But in a traditional procurement setting this process exposes contractors to too much risk. It is not clear how intellectual property and confidentiality in the ideas is protected, or how contractors will be reimbursed for time and effort spent on designs that are not selected.

There are bigger issues with innovation. If a contractor comes up with an innovative solution to a problem that saves a lot of money, the result under the construction contract is that this just reduces the project budget and erodes the contractor's profits. The contractor also is not generally paid the costs of preparing his proposals, unless the variation is actually implemented. So there is little incentive to innovate.

What would work far better would be a process which would give greater certainty of recovering the costs of preparing a proposal. If there were a two stage process the contractor could cover the costs of preparing an initial conceptual proposal, the first stage, but if the employer then asked him to proceed to develop these ideas further this should be on the basis of recovery of reasonable costs, possibly subject to a cap. This would be stage two.

There should also be a clear mechanism agreed up front that would allow the contractor to share the benefits of any cost saving that contractor innovation produced. Those cost reductions could be in construction costs, long term maintenance costs or they could relate to wider stakeholder benefits. These are desirable outcomes, but the current standard form contracts on the market offer weak value engineering provisions that make it unlikely they will happen.

FIDIC Yellow and Silver Books offer no set formula, the contractor is left to the determination of the engineer/employer’s representative, and even FIDIC Red Book (construction form), which offers contractors a 50% share of any savings, only does so after taking into account “any reductions in quality, anticipated life or operational efficiencies”. This makes the ultimate 'pot' very uncertain for contractors.

Another major innovation risk that lies entirely with the contractor is to do with fitness for purpose. Doing something new and innovative is inherently riskier than tried and tested routes, but the potential benefits are greater too. Currently all the risks seem to lie with the contractor and all the benefits with the employer.

Under most standard design and build forms, including FIDIC, fitness for purpose liability lies squarely with the contractor. Limited carve-outs for the employer’s design, inaccurate information or testing and performance parameters don’t really come into play when the contractor is undertaking his own cutting edge design and where this is what he Employer has asked for. To share that load, a state of the art defence should be permitted which would shift the burden of proof on to the employer if the contractor can show that it exercised all professional skill and care in the project.

NEC includes an option that offers essentially this solution but this is not catered for in the FIDIC contracts. In fact, it is being suggested that an express fitness for purpose obligation will be added soon to the new FIDIC White Book for consultancy appointments. Whether or not this will be accepted at all in the market place and by PI insurers is one thing. But this seriously undermines the ability of consultants and contractors to innovate.

Is there another way? Yes there is. There are more innovative models on the market but the FIDIC suite does not yet take account of these, and perhaps it should as it enters its second centenary.

Framework agreements and alliances are the best way to harness the innovative potential of contractors and make sure it is in everyone's interests to work collaboratively towards agreed goals.

A framework will operate across a programme of works that includes difficult and straightforward projects and will involve the continuous measurement of performance. These arrangements typically include target cost arrangements for each project and therefore a sharing of risk, often with a slice of any saving being paid into a consolidated pot that is only shared with the contractor at the end of the programme if it has met minimum performance criteria or key performance indicators.

Alliancing goes much further and replaces the traditional adversarial model with the creation of an Alliancing Team that includes the contractor, employer and consultants, and an agreement not to sue each other save in very narrow circumstances or where there is a material change on scope. All parties share in cost and delay overruns against a target, including the cost of remedying defects. So there is a far greater focus on employer and contractor behaviour and collaboration is used to reduce costs; spread risks; promote supply chain efficiencies; promote collaboration; increase operational efficiency, and increase understanding between employer, contractor and designer.

If traditional procurement and contractual mechanisms hope to stay relevant to the modern construction industry they will need to adapt quickly to this more collaborative way of working.

Sarah Thomas is a construction law specialist at Pinsent Masons, the law firm behind Out-Law.com