Standard forms of partnering contracts The ultimate contractual commitment? Part 4

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1 Standard forms of partnering contracts The ultimate contractual commitment? Part 4 This is the fourth in a series of articles being published in CES comparing the terms of some of the different standard forms of partnering contract currently available. The first article in the series provided an introduction to partnering by identifying its ethos, history, aims and so on, and by setting its fundamental difference to conventional (confrontational) contracting forms. The second article set out how the relevant different standard forms of partnering contract address the corporate and personnel commitment to partnering. The third article considered how the forms address issues related to time. This fourth article considers how the forms address issues related to the cost of the project to the client and associated safeguards, together with the value to the contractor and associated incentives. Following the pattern in the previous articles, the forms are considered in the same order and in isolation from each other. It may be necessary for the reader to consult the previous articles in the series to understand some of the terminology used in relation to the general structure of the arrangements. PPC2000 As previously noted, the Association of Consultant Architects Standard Form of Contract for Project Partnering (PPC2000) envisages two distinct phases of a project; pre-construction under the project partnering agreement and construction under the commencement agreement. The project price is an agreed maximum price, which may be defined as the price for the project payable by the client to the constructor, and is to be developed and agreed during the pre-construction phase after the signing of the project partnering agreement and prior to signing of the commencement agreement. So, unlike most traditional forms of contract in which the contract price is effectively only the starting point from which the contractor s various entitlements for additional reimbursement commence, with this style of contract, it is clearly set out, right from the outset, that all the collaborating parties have the joint ultimate objective of coming in under the agreed maximum price. It is supported by detail in the price framework and comprises the following: Constructor profit, central office overheads and site overheads. Amounts built up through approved business cases for constructor proposals in respect of direct labour packages (work done by the constructor itself) and approved business cases in respect of preferred specialists (work done by specialist subcontractors, suppliers and subconsultants approved pursuant to single source proposals, without specialist tenders). Amounts built up through approved results of specialist tenders. Provisional sums (for all work remaining to be priced during the construction phase of the project). Risk contingencies approved after joint risk management processes (for risks priced by the constructor).

2 The agreed maximum price is subject to increase or decrease in accordance with the agreed change procedure (clause 17) and in the event of claims for listed unforeseeable instances of delay or disruption (clause 18) and any specific mechanisms stated in the price framework. However, the word 'maximum' is a reminder that the partnering team should continue to seek to make savings in the agreed maximum price wherever possible. Incentives may be set out within the partnering document or subsequently recommended to the client by the core group. Whilst there are no prescribed incentives, the form clearly envisages that the incentive schemes will provide for any cost savings, demonstrable added value and cost overruns to be shared between the relevant partners, and these are addressed in a little more detail in the next article in this series. A change (clause 17) may be in all or any part of the project by way of addition, omission or variation of any kind, or by way of expenditure of a provisional sum. Any partnering team member may propose a change to the client at any time, provided it is demonstrably in the best interests of the project; and the client may propose a change to the constructor and the other partnering team members at any time. If the client approves a change proposed by a partnering team member, it is referred to the constructor as if it were the client s proposal, thereby triggering the valuation process. The constructor submits a change submission in response to the client s proposal, comprising the constructor s proposals as to any effect on the agreed maximum price and any effect on the progress of the project and date of completion. The client shall seek to agree the submission with the constructor and responds within five days by either instructing or withdrawing the proposed change. If the change is instructed, but the client and constructor have not agreed the time and/or cost implications within 20 days of the instruction, the client s representative shall ascertain the cost and/or time effects of the change. The effects are to be ascertained on a fair and reasonable basis, utilising wherever possible relevant periods of time in the partnering or project timetable and prices for similar work in the price framework, and the constructor is notified accordingly. In the event that the constructor disagrees with the notified cost and/or time effects, it gives a notice of dispute within a further 20 days, failing which the agreed maximum price and date for completion are adjusted in line with the client s representative s assessment. If this all sounds rather prescriptive, then that is because it is! But it is, like the NEC requirements, a considerable practical aid to driving the parties to collective commitment to help each other and meet the necessary timescales to avoid insidious disagreement from establishing and then festering. If any of the relevant unforeseeable events of delay or disruption (clause 18) occurs and gives rise to an extension of the date of completion, the constructor is reimbursed on the basis of the site overheads that have been agreed, within the price framework, to be time-based. Where any of the relevant unforeseeable events occurs and properly requires unavoidable additional work or expenditure, the cost effect is to be calculated on an open-book (a defined term in the contract, see below) basis and does not include any profit, central office overheads or loss of profit on other projects. PPC2000 adopts an open-book approach to the actual cost, which is defined as:

3 ...involving the declaration of all price components including profit, central office overheads, site overheads and the costs of materials, goods, equipment work and services, with all relevant books of account, correspondence, agreements, orders, invoices, receipts and other relevant documents available for inspection. Open-book approaches are adopted in the construction phase for the calculation of unavoidable additional work or expenditure under clause 18 as noted above, and also for adjustment of any provisional sums that have been included within the agreed maximum price. Details, such as trade discounts and other financial benefits derived from the constructor's arrangements with its own supply chain, should also be disclosed when calculating the agreed maximum price. Whilst this may sound rather intrusive when judged against traditional arrangements, the approach to open-book under PPC2000 is explicitly more open than open-book arrangements under other partnering forms. Within the context of the agreement of the agreed maximum price itself, the open-book principles are also adopted for the presentation of the business cases and so on, noted above. There is also the option, by agreement within the price framework, for a fully open-book approach to be adopted throughout the project and that all or part of the agreed maximum price will be paid to reimburse actual expenditure by the constructor whether or not limited or linked to any shared excess or shortfall against a target cost. In this case, the open-book approach will be used to calculate all payments due. SPC2000 The terms in the Standard Form of Specialist Contract for Project Partnering (SPC2000) are generally back to back with those contained in PPC2000 in the way that would be expected from a subcontract written to be used by the constructor (contractor) as the method for employing its specialists (subcontractors). TPC2005 The terms in the Standard Form of Contract for Term Partnering (TPC2005) are generally consistent with the terms of PPC2000. NEC3 The issue of the outturn cost of a project to the employer is a declared fundamental aspect of the overall management of a project under any of the various optional forms of the Institution of Civil Engineers Engineering and Construction Contract third edition (NEC3). The forms are drafted such as to encourage collaboration between the employer s agents (the project manager) and the contractor. However, in adopting a partnering approach to a project, or a programme of projects, involving a wider participation than just employer and contractor, the NEC X12 partnering option provides the standardised mechanism for achieving that collaboration. The form of the contract cost and its subsequent adjustment is dependant on the primary option used for the own contract under the partnering umbrella. Option A: Priced contract with activity schedule

4 Essentially a lump sum contract; the final sum is the total of the prices for all activities. Option B: Priced contract with bill of quantities A remeasurement contract; the final sum is based on the actual quantities of completed work valued at bill rates. Option C: Target contract with activity schedule A target contract with a lump sum base; the final sum is the defined cost plus or minus a share of any saving or excess compared to the target. Option D: Target contract with bill of quantities A target contract with a bill of quantities base; the final sum is the defined cost plus or minus a share of any saving or excess compared to the target (which is remeasured based on the actual quantities of completed work valued at bill rates). Option E: Cost reimbursable contract The final sum is the defined cost plus the fee. Option F: Management contract The final sum is the defined cost plus the fee. The above schedule of options demonstrates a reducing degree of price certainty from A to F and, in consequence, an increasing level of risk for the employer following the same scale. The adjustment to the contract sum (total of the prices) to reflect change is by way of compensation events in all of the options. Compensation events are those events for which the contractor becomes entitled to an assessment of both the financial and time implications of a change, the assessment of which reflects one of the more radical departures that the NEC has taken from traditional principles. The assessment of the financial effect is based not on the contents of the activity schedule or bill of quantities, as the case may be, but is based on the actual or forecast defined cost using the schedule or shorter schedule of cost components. The premise behind this is that the contractor should be neither better off, nor worse off, for the change occurring; it is questionable about whether this premise has been achieved. Furthermore, it is intended that the financial and time effects of compensation events are pre-assessed contemporaneously and implemented within strict time limits, rather than being agreed and recognised retrospectively (and argumentatively!) as is usually the traditional method. Compensation events may be notified by either the contractor or the project manager, generally depending on who is better placed to be aware of the change. For example, the project manager should give notice of a compensation event arising from an instruction. If the project manager considers that the change may have an impact on time or cost it may instruct the contractor to provide a quotation for dealing with the compensation event. The contractor then has three weeks to submit the quotation and the project manager a further two weeks to respond by accepting the quotation or requesting a further

5 quotation which must be submitted within a further three weeks. In the event that the project manager fails to reply in time to a quotation, the contractor gives notice and if the default continues, the quotation is treated as having been accepted. The contract also provides for the project manager to assess the compensation event without the contractor s input if it considers that the contractor has not assessed it properly, or failed to submit a quotation within the required time or at all. The contract contains two negative incentives to the contractor: Firstly, if the contractor fails to give an early warning of any matter that might develop into a compensation event, then the assessment will be based on the costs that would have been incurred had the early warning been given. Secondly, if the contractor fails to notify a compensation event within eight weeks of becoming aware of it, the contractor is not entitled to cost or time, unless the project manager should have given the notification (again there are points of view which question whether this factor is legally robust). However, in practice these are not as clear-cut as they might appear and may require a detailed objective review of all of the surrounding facts before the proper implication of any apparent failure to give notice can be determined. As we have always said, collaborative partnering contracts do not automatically spread Disney-dust over the project; differing points of view still have to be thrashed out. The partnering forms simply provide a much more conciliatory and collaborative framework within which the traditional arm-wrestling still has to take place. The implementation of the compensation event results in the activity schedule or bill of quantities being adjusted accordingly and will impact on the cost to the employer and the value realised by the contractor. For main options C and D, the target is the total, as revised by the compensation mechanism of either the activity schedule (option C) or the bill of quantities (option D). The target cost options adopt an open-book approach for the assessment of the defined cost, which is not actual cost but is the cost of payment due to subcontractors plus the cost of components in the schedule of cost components, less disallowed cost. The fee is added to the defined cost to arrive at the price of work done to date (PWDD). The contractor is incentivised to keep its outgoings to a minimum by the use of a pain/gain share mechanism whereby the PWDD is compared to the adjusted target as the basis for the calculation of the share of any difference and the following generally applies: If the PWDD is less than the target, then the saving is shared between the employer and contractor in the specified proportions. If the PWDD is more than the target, then the extra cost is shared between the employer and contractor in the specified proportions. The contractor is obliged to keep the records of accounts and proof of payments of defined cost, communications relating to subcontractor s compensation events and any others stated in the works information. The contractor must allow the employer s project manager to inspect all such records and accounts.

6 An unusual feature of NEC (which was covered in more depth in our third article relating to time) relates to acceleration. Most forms of contract use the term acceleration to refer to the mitigation of delay in an attempt to complete the project on time. NEC, however, uses it to mean a formal shortening of the time allowed for completion, i.e. potentially the extended time to which, other things being equal, the contractor would have been entitled to if the requested shortening did not exist. This is arguably a much more contractually precise approach. The employer s project manager only has the power to request that the contractor submits a quotation to accelerate; it cannot instruct acceleration against the contractor s wishes. Partnering option X12 The X12 option itself does not contain any specific provisions relating to project cost; these are dealt with under the own contracts that are brought together by the use of X12. X12 does however have a collective incentive to performance that is unique within the range of forms under consideration. Where one partner lets the employer down for a particular target by poor performance, then all of the partners lose their bonus for that target. If the employer tries to prevent a target being met, it is in breach of clause 10.1 to act in a spirit of mutual trust and co-operation. Such collective responsibility is laudable but it is less popular with the insurers of individual parties' insurance cover. This is because insurers will cover their insured's liability but such liability may be triggered by default of another, not the insured. This issue can be addressed by putting in place a project insurance policy to cover all of the project participants. JCT Constructing Excellence and Project Team Agreement The Joint Contracts Tribunal Constructing Excellence and Project Team Agreement (CE) provides two payment options; target cost and contract sum. The target cost is agreed between the employer and the contractor (except that this form of contract describes them as the purchaser and the supplier) and will include allowance for risk. There is also the facility to introduce a guaranteed maximum cost which is the agreed upper limit that is recoverable by the supplier. The target cost option takes an open-book approach, i.e. records of actual costs are maintained by the supplier in a fully auditable manner and are made available to the purchaser whenever reasonably required for purposes of verification in connection with the project. The purchaser has to act reasonably, but may object to costs incurred by the supplier if they either constitute excluded costs, as defined, or are in excess of the amount that the supplier is entitled to receive since the cumulative actual cost exceeds either the target cost or guaranteed maximum cost. The contract provides (within section 7) that: If the actual cost is less than the target cost, then the saving is shared between the client and supplier in the specified proportions.

7 If the actual cost is more than the target cost, then the extra cost is shared between the client and supplier in the specified proportions. Any actual cost in excess of the guaranteed maximum cost is wholly borne by the supplier. Where the contract sum option is chosen, the parties will need to agree a payment schedule showing the payments due by reference to completed activities and/or milestones, or to progress against the project programme or any other method of assessment as may be agreed. Taking a leaf out of the NEC approach, there is also the further option to provide for the contract sum to be subject to remeasurement, in which case the amount of the contract sum will be an estimated sum based on rates and/or prices set out in the payment schedule. The payment schedule should show the dates on which the remeasurement will take place, the basis of the remeasurement and the rates or prices to be used. This remeasurement option has been included to allow flexibility in relation to the engagement of suppliers or subcontractors where it is either considered more cost effective or convenient to arrange payment in this way. The target cost and guaranteed maximum cost (if any) or the contract sum, as the case may be, are subject to increase or decrease in accordance with the conditions of contract. In essence, risks that are not reasonably foreseeable, beyond the control of the supplier and not referred to in the risk allocation schedule are relief events, the financial consequences of which are added to the cost or sum. If a relief event occurs, or is likely to occur, the partner who becomes aware of it shall immediately notify the other, and they shall co-operate in agreeing the best means of dealing with, and in mitigating, its effect. Not later than 10 business days after the notification, the supplier shall provide a statement setting out the effect that the relief event shall have on the cost of performing the services and/or the date or dates for completion. The purchaser and the supplier shall use reasonable endeavours to agree the effect of any relief event and shall co-operate to agree any action that mitigates any adverse effect. Once the effects are agreed or decided, the parties shall confirm, in writing, any change to the target cost and guaranteed maximum cost (if any), or to the contract sum and/or the date or dates for completion. As an incentive to the supplier, the purchaser shall, when considering the effect of any relief event which it was not aware of, take into account any delay on the part of the supplier in notifying the occurrence of a relief event after the date it became, or should reasonably have become, aware of it. The third article in the series that addressed the time provisions has already reviewed, in detail, the provision for the contract to provide damages for late completion and bonuses for early completion; the former reducing the payment to the supplier, the latter increasing the payment. Partnering charter non-binding The JCT partnering charter, as the above full title suggests, makes reference only to a non-binding list of objectives to be achieved by the partnering team, which are to be measured against performance indicators that are to be established as part of the partnering process, such as:

8 Commercial - Add value and enhance reputations. - Create incentives for maximising the rewards of all parties. - Provide transparency and certainty of information. - Provide feedback. Conclusions The impact of change can upset any carefully established balance of cost to the project client and value to the project contractor once the project moves from the state of euphoria that represents the conclusion of any pre-commencement courting of the parties to the reality of delivering a project within the modern construction environment. The way in which changes are dealt with is, therefore, a measure of the partnering spirit of the form. The various forms approach the contract sum in different ways; both PPC2000 and JCT CE provide for the relevant parties to the contract to set the amount through joint endeavours, whereas NEC assumes the amount is set by other, competitive, means. All the forms address the question of transparency of cost incurred by way of an open-book approach to the verification process, although the approach in PPC 2000 is more open than under the other partnering forms. The forms adopt a collaborative approach to assessing the financial effect of any changes; bringing an element of fairness to the process by basing the assessment on the additional cost incurred so that both parties, theoretically, are neither better off, nor worse off, for the change occurring. Incentives are used, in the main, to ensure compliance with contract procedures, although they may also produce a positive effect by driving down cost to the benefit of the project client and consequently increasing the profit margin of the project contractor. As we have commented previously, the partnering forms of contract differ from other traditional forms of construction contract in that they are designed to cater for change in a way that avoids conflict and promotes collaboration. As we hope will have become clear from a review as to how the forms address cost, the partnering provisions of these forms set a framework that survives the commercial rigours of the real contracting environment by seeking to be transparent about how the cost of the project is arrived at, in providing a series of safeguards for the client and incentives for the team who work with the client to deliver the project within budget. The Partnering Team cdrp@committees.cices.org The Partnering Team comprises members of the institution s Contracts and Dispute Resolution Panel. Led by John Bacon, ICES past president, the members are Mike Rowlinson, a director at Alway Associates, Jonathan Hosie, partner in the construction and engineering practice of Mayer Brown, and Steven Williams, an associate director at Turner and Townsend.