Contract Good Practice. an ACE guide

Transcription

1 Contract Good Practice an ACE guide

2 Contents Introduction Professional Indemnity Insurance Duty of Carer Fitness for Purpose Joint and Several Liability Unlimited Liability Indemnities Liquidated Damages Parent Company Guarantees Performance Bonds Novation Incentivisation Mechanisms Association for Consultancy and Engineering Alliance House 12 Caxton Street London SW1H 0QL T: F: consult@acenet.co.uk Association for Consultancy and Engineering No part of this report may be copied either in whole or in part without the permission in writing of the Association for Consultancy and Engineering. 02

3 Introduction This guide has been prepared as an aide memoir for ACE members who are involved in the negotiation of contracts and contractual terms and conditions. It is intended to highlight those areas which are commonly discussed between clients and consultants and to increase the level of understanding between the parties. Where to go for further information ACE member companies who have further questions about contract terms and conditions can contact ACE on Good Practice The management of risk within the procurement process affects all consultants as they strive to offer clients the best possible service. Clients, on the other hand, seek protection against all known and potential risks on a project. Consultants, accordingly, will generally factor such risks into their fees to cover the risk where possible, whether or not the client has a genuine need for such cover. A consultant s risk portfolio will undoubtedly have an impact on the level of premiums and excesses levied upon the consultant s Professional Indemnity Insurance (PII). The allocation of project risk should be made on an equitable basis. The best outcome for all parties to the contract and the success of the project is for each risk to reside with the contractual party who is in the best position to manage the risk. A sensible liability regime is likely to encourage insurers to continue to provide broad cover into the future. Consultants cannot operate their businesses with uninsured risks. Onerous liabilities will only serve to hasten the withdrawal of cover or further restrictions on its provisions. This cannot be in the interest of either the consultant or the client. Consultants can only meet their liabilities from insurance or assets. Most consultants have few liquid assets; liabilities therefore have to be matched by insurance cover by way of a PII policy. In such a cost conscious climate, it becomes all the more important for both client and consultant to work together to allocate project risks sensibly. Professional Indemnity Insurance Professional Indemnity Insurance Professional Indemnity Insurance (PII) protects the interest of the insured consultant and through them, their client. PII provides cover should a consultant be held liable for damages and a claimant s costs arising from any negligent performance of services or breach of professional duty. In order for any PII policy to be triggered, the claimant (usually the insured consultant s client) has to establish legal liability for the losses that he has incurred. That process is fraught with difficulty because the legal process can be lengthy, uncertain and expensive. PII is not a form of insurance which directly applies to all losses which clients may incur on a project. The majority of PII policies operate on a claims made basis. This means that it is the policy in force when a consultant first notifies a claim to his insurers which applies (or a circumstance that might give risk to a claim). The cover that may have been in force when the work in question was undertaken, or when the alleged act of negligence took place is irrelevant. Consultancy appointments will usually involve periods of potential liability (limitation periods) of twelve years or more. At the same time PI insurance is only normally available for periods of twelve months and on a claims made basis. In these circumstances, should a consultant fail to renew cover, he is effectively uninsured for any work undertaken and services performed at any time in the past. Consequently, the ability of the consultant to reimburse the client for a valid claim may be impaired. Very few consultants would argue against the broad principle that they should accept the legal consequences of any failure on their part to exercise the degree of skill and care ordinarily to be expected of a reasonably competent consultant. It is entirely proper that engineering consultants should accept liability for their own acts of negligence and that of their staff, agents and any sub-consultants they might employ. Contract Good Practice - An ACE guide 03

4 Consultants should be required to carry a reasonable level of insurance to meet their financial liability. In turn clients should accept that the level of PII cover carried by each consultant effectively provides a limit to that consultant s financial liability. In this way, both the client and the consultant achieve a good degree of certainty as to the responsibility of each to the other. As consultants can only realistically fund risk to the extent that they are insured, it should be in a client s interests to take measures to ensure a vibrant, competitive PII market into the future. To achieve this, consultants need to be able to present a risk profile that is reasonable as to amount, certain as to time and based on the discharge of their own responsibilities rather than those of other parties. For high value major projects the provision of Project Insurance may deliver an overall cost saving when compared to the cost of the supply chain providing insurance cover individually. Duty of Care The common law obligation for the performance of services is that of reasonable skill, care and diligence. The test is that of the ordinary skilled and competent practitioner in the relevant profession. However, the use of clauses such as...to be expected of a properly qualified consulting engineer experienced in carrying out work of a similar size, scope and complexity in appointment documents can impose a higher duty of care. The imposition of a higher duty of care means that a consultant is more likely to be in breach of this contractual duty. Basic PII covers only a consultant s common law obligation (reasonable skill, care and diligence). Professional services contract clauses should adopt a reasonable skill and care approach having due regard to the client s brief. This means that the consultant would be subject to the common law duty of care standard, i.e. in accordance with a practice accepted as proper by others in his profession. Fitness for Purpose The Supply of Goods and Services Act 1982 (as amended) imply warranties as to fitness for purpose into building contracts in relation to the materials used in the works and the completed works themselves. This Act however, does not require professionals (i.e. those who provide services) to give such warranties. Professionals are required to use reasonable skill and care in the delivery of their professional services. Fitness for purpose clauses are excluded by PII policies. This means that the consultant would not have any insurance cover for any breaches of a fitness for purpose clause. Exclude fitness for purpose clauses from professional services contracts. Joint and Several Liability The doctrine of joint and several liability originates in the nineteenth century. In essence, it provides that where two or more parties have contributed to the same loss, each is jointly and severally responsible to the claimant for the full extent of that loss. What this means, in practical terms, is that a claimant will have the choice of choosing which party he thinks will be best able to pay damages for the loss suffered. In the construction industry, compensation has often fallen at the feet of those with the deepest pockets, predominantly, those carrying high levels of PII cover. The frequency of claims have an impact on the levels of premiums and excesses (a factor acknowledged by the Office of Fair Trading (OFT) in its June 2005 report The UK liability insurance market ), the principle of joint and several liability is closely linked to the high cost of PI insurance (because of the increased likelihood of being claimed against, irrespective of the extent of culpability). The practical effect of joint and several liability in the construction industry is that the insured consultant, for instance, bears the risk of the insolvency of others who may have been equally, if not more, responsible. This cannot be in the interests of either the consultant 04 Contract Good Practice - An ACE guide

5 or the client. Furthermore, high levels of PII premiums and excesses have a detrimental impact on consultants (and in turn, their clients) as they affect the availability of resources for investment in areas such as recruitment, research and development. The 1995 Latham Report - Constructing the Team - recommended that; in construction cases (other than personal injury), defendants should have their liability limited to a fair proportion of the plaintiff s loss, having regard to the relative degree of blame. Defendants who are only liable for some of the latent damage should not have to suffer 100% liability because other Defendants are unable or unwilling to bear their share of the loss Clients are encouraged to adopt net contribution clauses such as those found in the ACE Agreements. Unlimited Liability Every PII policy has a limit of indemnity. This is the maximum amount that the insurers will pay. The limit can operate either on an each and every basis, whereby the full limit of indemnity under the policy applies separately to each claim which might arise during the period of insurance or on an aggregate basis, whereby the limit of indemnity applies as a single total irrespective of the number of claims notified during the period of insurance. The insurance market does not provide policies with an unlimited amount of PII cover. Whilst the market is comparatively soft at the moment, the insurance market is cyclical and prices will undoubtedly increase again, with costs passed on to clients. One way that consultants can control the cost of PII premium costs is to seek a reasonable limitation of liability. The main asset of most consultants is intellectual as opposed to financial. The effect of this is that consultants can only fund their professional liabilities to the extent that they are insured. The concept of unlimited liability is fundamentally flawed. It is for this reason that consultants are unable to accept unlimited liability. We recommend that the consultant s liability be limited to an amount which is agreeable to both parties, thus providing relative certainty for both parties. A financial cap is not the same as the limit of indemnity under a consultant s PII policy. A consultant s PII policy will have an ultimate limit on the amount that the insurer will pay. The scope of the cap will depend on various factors such as the likely nature and extent of the risks of the project (having regard to size, complexity, etc), an assessment of the damages that could be payable in the event of negligence and any previous dealings between the parties. The duration of the consultant s liability should be clearly defined. Within a framework, it should be related to a number of years from completion of the individual work packages and not from the end of the framework. Indemnities Indemnity clauses usually require a consultant to indemnify, defend, and hold the client or other third party harmless against a list of possible harms. Liability under an indemnity may not depend upon a consultant s negligence or even a legally enforceable claim. Contractual indemnification provisions usually expand a consultant s potential risk far beyond those originally assumed. The result is that the consultant s insurance provision may not be sufficient to cover the wider risks that have resulted from the indemnification clauses as written. Indemnification clauses can allow legal costs and expenses to be recovered which would otherwise have been disallowed by the courts. They can also result in damages payable to the client that may not be recoverable from the consultant s PII because they may not have been properly or reasonably incurred. The ability of the consultant to reimburse the client may therefore be impaired. Indemnity clauses should, as a general rule, be avoided as the law already provides adequate remedies to both the client and any other third parties. However, if an indemnity clause is required, it should relate to a specific list of potential harms in line with the precise Contract Good Practice - An ACE guide 05

6 intentions of the agreement with the consultant and be based on the consultant s negligent acts, errors or omissions. Any indemnity clauses agreed should refer to the consultants direct negligence and for legally enforceable losses only, suffered by the client, rather than third parties. Liquidated Damages Liquidated damages are used in the event of a contractual breach, normally relating to nonperformance. Liquidated damages are, as a general rule, not appropriate for consultancy appointments. Furthermore, because liquidated damages represent a pre-estimate of losses, and not actual losses incurred, they will not be covered by PII policies and therefore, are uninsurable. Losses actually suffered by a client can be passed to the consultant through a normal claim via the consultant s PII. This negates the requirement for liquidated or delay damages clauses in professional services contracts. Parent Company Guarantees Parent company guarantees are provided by parent companies to guarantee the performance of a subsidiary under a contract. Parent company guarantees are only relevant when trading with small subsidiaries whose assets are disproportionate to the size of the commission or where it is a shell (or an otherwise financially unsound company). They offer no value when the subsidiary is correctly insured against contracted liabilities. Parent company guarantees would not be required if the client takes out project insurance or, if the subsidiary is a reputable and financially stable company with the appropriate level of PI insurance. Performance Bonds A performance bond is historically used to guarantee satisfactory completion of a project by a contractor. In the event of non performance the client s monetary loss would be guaranteed up to the amount of the performance bond. Performance bonds are normally applied to contractors and are not appropriate to consultancy appointments. A client will be able to recover any financial loss resulting from the consultant s non-performance from his PII policy subject to the comments previously made in this document. Requiring a consultant to provide a performance bond duplicates the PII cover provision which in turn, increases the cost to the client. The client s risks associated with a consultant s failure to perform is best managed through the provision and maintenance of appropriate levels of PII. Novation The only way in which contractual obligations can be assigned is with the consent of the other contracting party. The mechanism through which this is done is by entering into a new agreement (the novation agreement) in which the third party undertakes to carry out the contractual obligations. Novation is frequently used to provide continuity of professional services while adopting a design and build type of contractual arrangement. This has the benefit of providing the client with a single point of contact and responsibility during the detailed design and build phases. 06 Contract Good Practice - An ACE guide

7 A consultant can be contracted to accept novation when entering into a contract. This is not in the interests of the client or contractual parties to the novated contract. Generally novation results in the client having no independent consultancy advice during design, construction and commissioning. Novation often leads to conflict of interest because a consultant retains contractual obligations to the original client as well as to the contractor as the project progresses. For example, the consultant s original obligation to the client may be predominantly quality and durability related. When novated to a contractor, the consultant s primary obligations may change to buildability, cost and programme. In general, consultants appointed at concept or planning stages should not be novated. Instead, they should be retained as the client s engineer. Where a design and build procurement approach is adopted the contractor should appoint his own design consultant independent of the client. Incentivisation mechanisms Incentivisation mechanisms are used to improve the performance of the client s consultant. ACE supports the use of incentivisation mechanisms as a means of improving performance. Industry best practice should be adopted to provide a clear, transparent and equitable incentivisation mechanism that provides the correct balance of cost, delivery, risk and quality improvement. Contract Good Practice - An ACE guide 07

8 Acknowledgements This guidance was produced by ACE in conjunction with the members of its Water Sector Interest Group. 08 Contract Good Practice - An ACE guide

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