Construction traps and solutions for development projects

Transcription

1 Construction traps and solutions for development projects Joe Bellhouse BrookStreet des Roches LLP Nick Woodruff Arcadis APS Project Management 15 June 2011

2 About the speakers Joe Bellhouse Joe Bellhousee joined BSDR as a partner earlier this year and brings with him over 25 years experience of Construction & Engineering practice, including commercial property development, advising on the terms and consistency of professional appointments, civil engineering and infrastructure, dispute resolution and advice on standard industry contractt forms. joe.bellhouse@bsdr.com Telephone: Nick Woodruff Nick Woodruff is an Associate Director with ARCADIS APS, part of ARCADIS UK. He has been involved in the Construction industry as a project manager for almost 25 years. In the past he has worked for Bovis and Laing Construction before joining Arnold Project Services in Currently he is involved in a number of superprime residential projects with both developers and private clients. nick.woodruff@arcadis-uk.com Telephone: Disclaimer The information and commentary on the law given during this seminar and contained in thesee notes is providedd free of charge for information purposes only. All reasonable efforts are made to ensure that any information and commentary are accurate and up- by to-date, but no responsibility for accuracy or for any consequence e of relying on it is assumed BrookStreet des Roches LLP or any member or employee thereof. The information and commentary does not and is not intended to amount to legal advice to any person in relation to any specific case. Any attendeee at the seminar or other user of these notes is advised to obtain specific, personal legal advice about any specificc case and not to rely on the information or comments in these materials. No responsibility is accepted for any loss arising from inaccurate or incomplete information, however caused.

3 1. Choice of procurement (get it right from the start) 1.1 Traditional Procurement with or without Contractor Designed Elements the Design Team is engaged by, and stays with, the Employer for the duration of the project; the design should be completed prior to tendering the construction project; the Employer engages the selected main contractor to construct the project to the design provided by the Employer s professional design team; certain elements of detailed design may be undertaken by the selected contractor; the building contract is administered by the Architect or a Project Manager engaged by the Employer Pros: a) Employer controls design, specification and quality throughout b) Design and specification complete before final building contract tenders c) Competitive build cost pricing with no contingencies for design and other risks Cons: a) In many projects a substantial amount of important detailed design falls to the contractor and suppliers, so real design control may be illusory b) If design and specification is not coordinated and complete in detail prior to concluding the Building Contract with the selected Contractor, it will get messy with delay, extra cost and quality problems c) Complex liability and lack of one point liability d) Confrontational? 1.2 One Stage Design and Build Procurement the Employer may engage professional designers and establishes an outline brief for the project and requests proposals from selected design and build contractors; the bidding contractor s proposals are reviewed and one of the design and build contractors is selected and engaged by the Employer; if necessary the design team are usually novated to the design and build contractor at the execution of the building contract; the selected design and build contractor completes its design and constructs the project in accordance with the terms of a design and build contract Pros: a) one point responsibility and liability and clear risk division between two parties b) Contractor responsible for total coordination of design and construction c) Funders like it because of apparent simplicity and risk transfer d) Cost and programme certainty Cons: a) Pricing unlikely to be transparent b) Premium paid for general risk transfer from Employer c) Design to a price d) Quality reliant on the strength of the Employer s Requirements e) Lack of flexibility 1.3 Two Stage Design and Build Procurement the Employer first engages a professional design team; -1-

4 1.3.2 that design team establishes a design for the project to a reasonably detailed design stage; design and build contractors are selected and requested to tender on the basis of the detailed design brief established by the Employer; the design and build contractors bids are reviewed and the selected design and build contractor engaged by the Employer; the design team engaged by the Employer is novated to the design and build contractor; the Project Manager remains engaged by the Employer and acts as the Employer s agent and administers the design and build contract Pros: a) Same as above. b) In addition, Employer has early control and development of the design process c) An improved programme can be achieved by the overlap of design and tender periods Cons: a) Same as above. b) In addition, novation of the Employer s design team to the design and build contractor does not always work well in practice c) The design and build contractor can exploit the single action negotiation during the second stage d) No incentive for the design and build contractor to drive down the costs during the second stage 1.4 Construction Management Procurement The Employer engages the professional design team and a professional project manager The Employer contracts directly with a number of different trade contractors for designated work packages some of which will include detailed design there is no main contractor Pros: a) Flexible and allows compression of the design and construction period b) Can make an early start on site c) Design may proceed in tandem with construction activity d) Direct pricing from trade contractors and avoidance of main contractor overheads, attendance, and profit mark-up e) Direct control over trade packages Cons: a) Needs continual high attention and input by Employer b) Needs really excellent and consistent project management to coordinate design production, programming and efficient coordinated working of the trade contractors c) Multiple targets and complex liability d) Difficult to adequately address liquidated damages for delay across many trade contracts e) If the project management, Employer input and timely design production falters or fails, it all becomes very messy heavy extra costs, delay and quality problems f) Funders will need convincing -2-

5 1.5 Management Contracting Procurement The Employer engages the professional team The Employer engages the Management Contractor The Management Contractor acts as project manager and receives a fee and also engages and contracts with all trade contractors, but the Management Contractor has very limited liability to the Employer under the management contract. Most trade contract issues and money claims are passed through to the Employer in terms of liability Pros: a) Early start on site b) Integration of design and construction skill at the earliest stage c) Single point of contact and communication d) Flexibility to introduce changes e) Employer has control of design development Cons: a) Management contractor has no responsibility for cost and little incentive to minimise costs b) Lack of cost and programme certainty c) Possible duplication of management fee and services of trade contractors d) Ultimate responsibility for settling disputes with trade contractors rests with the Employer and his advisers 1.6 Selected Standard Form Contracts JCT Contracts a) Major Project Construction Contract Rev b) JCT 2005 Design and Build Contract Rev c) JCT 2005 Standard Building Contract with Quantities/Approximate Quantities/Without Quantities Rev 2, 2009 d) JCT 2005 Intermediate Building Contract with or without Contractors Design Rev e) JCT 2005 Minor Works Contract with or without Contractors Design Rev NEC 3 (The New Engineering Contract) Other forms of Contract a) PPC 2000 b) JCT 2005 Constructing Excellence Contract Rev c) FIDIC (engineering/process plant international) d) IChemE (engineering/process plant) e) MF/1 (engineering/process plant) 1.7 Why amend Standard Form Contracts? To alter division and placement of risk To deal with omissions or lack of clarity To deal with specific project issues Otherwise, if it ain t broke, don t fix it! -3-

6 2. Payment and suspension 2.1 Construction Act 1996 Changes Current as at June 2011: a) Part II Housing Grants, Construction and Regeneration Act 1996 as enacted and in force from 1 May 1998 subject to the change to Section 113(2)(a) made by the Enterprise Act 2002 (Insolvency Order 2003, SI 2003/2096) (Construction Act 1996) b) Scheme for Construction Contracts (England and Wales) Regulations 1998 (SI 1998/649) (1998 Scheme) brought Construction Act 1996 into effect from 1 May 1998 and set out implied terms for payment, suspension and adjudication New anticipated in effect 1 October 2011: a) Construction Act 1996 amended by Part 8 of the Local Democracy, Economic Development and Construction Act 2009 (LDEDCA 2009) LDEDCA 2009 received Royal Assent on 12 November What are we waiting for? a) New subsidiary legislation to update or take the place of the Scheme for Construction Contracts (England and Wales) Regulations 1998 (SI 1998/649) (1998 Scheme) b) The new subsidiary legislation is expected to be concluded soon (a consultation has been concluded). It is anticipated those new Regulations will bring Part 8 LDEDCA 2009 into force and modify the 1998 Scheme on and from 1 October The changes affect: a) Payment rules b) Suspension rules c) Adjudication rules Changes to Adjudication are summarised at section 6 below 2.2 Payment & Suspension Current Construction Act 1996 as enacted 1 May 1998 to 30 September 2011 a) Check the Construction Act 1996 applies to the contract in question. This paper assumes that Act applies. b) Relevant provisions i) s109: stage payments ii) 110: adequate mechanism and payment notice iii) s111: withholding notice iv) s112: right to suspend v) s113: no pay-when-paid except insolvency vi) s114 power to make Scheme vii) s115/116: service of notices and periods of time c) implied terms of the 1998 Scheme (Part II) take effect where contract terms do not exist or are non-compliant d) see attached diagram Payments HGCRA 1996 as Enacted and table of comparisons Summary of Changes in Statutory Payment Regime New - Construction Act 1996 as amended 1 October 2011 and onwards a) Amended provisions i) s110(1): dates for payment and definition -4-

7 ii) s110(1a) to (1D): conditional payments iii) s110a: payment notices iv) s110b: default payment notices v) s111: requirement to pay notified sum vi) s112: suspension b) see attached diagram Payments HGCRA 1996 as Amended and table of comparisons Summary of Changes in Statutory Payment Regime 2.3 CIS Scheme The Construction Industry Scheme (CIS) is a special tax deduction scheme first created in 1972 for deducting tax at source from certain payments relating to construction work. The CIS was most recently revised in 2007 with the aim of: a) Reducing the regulatory burden on construction businesses b) Improving compliance by construction businesses with their tax obligations c) Helping construction businesses to get the employment status of their construction workers right The current framework is set out in: a) The Finance Act 2004 (Chapter 3, Part 3). b) The Income Tax (Construction Industry Scheme) Regulations 2005 (SI 2005/2045) (as amended) (CIS Regulations 2005) The burden of the CIS falls mainly on those making the payments, who make deductions where obliged to do so at one of two specified rates The focus of the CIS is on payments for labour. Payments only fall within the scope of the CIS if they are made under a "construction contract" (section 57, Finance Act 2004). An agreement is deemed to be a construction contract if it is a contract: a) Relating to construction operations, which is not a contract of employment b) Where one party is a sub-contractor and the other party is a contractor Generally, CIS applies to all payments under a construction contract. There are exceptions, including: a) Payment of a reverse premium (that is, a payment by a landlord to a tenant, for example, for fit out costs as an inducement for taking the lease) (Regulation 20, CIS Regulations 2005). b) Payments by some classes of contractor for construction work on a property which they use for their own business (Regulation 22, CIS Regulations 2005). c) Payments by a charity or by certain schools (Regulations 21 and 24, CIS Regulations 2005). d) Payments by a public body under a PFI arrangement (Regulation 23, CIS Regulations 2005) A contractor is either: a) A "contractor" within the meaning of section 59 of the Finance Act b) A person who sub-contracts works that it is obliged to perform under a construction contract The list of persons who are treated as contractors in section 59 of the Finance Act 2004 is extensive. It includes not just those in the construction business, so called mainstream contractors, but also any person carrying on a business which includes construction operations, such as a property developer or a builder and further any person carrying on a business at any time: -5-

8 a) if its average annual spend on construction operations is more than 1 million in the three years ending with the end of the period of account before that time; and b) the person has not satisfied HMRC that the expenditure on construction operations has been less than 1 million in each of three successive subsequent years If a contractor is the person making payment under the contract, then a subcontractor is the person receiving that payment. A party to a contract will be a sub-contractor under the CIS if (Section 58, Finance Act 2004): a) It is under a duty to the contractor to carry out the construction operations or to provide its labour or the labour of others to carry out construction operations or to arrange for others to carry out construction operations; or b) It is answerable to the contractor for the carrying out of the operations by others (whether under a contract or under other arrangements) The definition of sub-contractor is wide. It catches those actually doing the work, but also others who are answerable to the contractor The rate of tax that must be deducted by a contractor depends on the status of the sub-contractor and this provides an incentive for the sub-contractor to register with HMRC under the CIS. Three situations are possible: a) The sub-contractor is not registered and the contractor must deduct tax at 30% from payments to the sub-contractor (labour element). b) The sub-contractor is registered and the contractor must deduct tax at 20% from payments to the sub-contractor (labour element). c) The sub-contractor is registered to receive payments gross in which case the contractor will make payments without any tax deduction at all The tax deducted by the contractor is effectively treated as a payment on account of certain tax obligations of the sub-contractor A contractor's key obligations under the CIS are: a) Registering with HMRC b) Verifying the identity of its sub-contractors c) Deducting tax from payments to sub-contractors unless registered to receive payments gross d) Providing written statements to sub-contractors e) Keeping records f) Making monthly returns to HMRC g) Notifying HMRC of certain changes to its business The definition of contractor under this legislation defines whether in any particular case the Employer under a building contract is a contractor for the purposes of CIS. If it is then has the obligations outlined above. Also, it is possible to be subject to deductions in surprising circumstances. For example, a tenant under an agreement for lease who makes payments to a developer (who will be the landlord) during the construction period in respect of tenant s fit out works, where the developer is responsible for carrying out those works under one building contract covering category A and category B works. In that case, the reverse premium exception does not apply and unless the developer is registered to receive payments gross, the tenant should make appropriate deductions from payments. 3. Security and insolvency 3.1 Retention Remains a standard requirement of Employer/funders although Contractors like to avoid it if possible -6-

9 3.1.2 Traditional cash retention (3-5%) - v - retention bond Security issues for Employers and Contractors a) Fiduciary account provisions b) Can a project account help? 3.2 Bonds and Guarantees Retention bonds see above Performance bonds a) On demand it s probably a dream b) Conditional i) ABI form of bond guarantees payment up to bond amount where the contractor is liable under the building contract and defaults on payment long stop arrangement ii) Is it possible to do better? I) Interim payments II) Use of adjudication as well as courts Parent company guarantees a) Where available and good covenant, should be considered b) Subject to covenant, some advantages over bonds i) Guarantee of contractor s liability under the contract subject only to the limitation of contractor s liability under the building contract ii) May include step-in arrangements 3.3 Third party rights Collateral warranties a) Provides direct rights to interested third parties b) Separate agreement executed as a deed and actionable by the beneficiary. The terms are collateral to the principal contract and subject to limitations in that contract. So it is important to have a copy of the principal contract with the collateral warranty. c) Where possible obtain the executed collateral warranties at the same time as the principal contract is executed or novation agreements are executed. d) Production of subcontractor warranties often cause difficulties and expense. Consider if they are really needed and there potential worth. If needed, procure obligations placed on contractor. Allow for withholding of money as sanction and encouragement Use of the Contracts (Rights of Third Parties) Act 1999 a) Statutory exception to the privity of contract rule b) Use of the Act is still the exception rather than the rule in construction projects. Use with subcontractors is problematic c) A useful alternative when set-up properly with clear third party rights schedules in the relevant principal contracts. Can provide for subsequent written notice to trigger the rights, e.g. where the class, but not the particular beneficiary, is known at the time the principal contract is executed. d) Avoids the need for separate agreements, which require execution by the relevant parties. The third party rights arise under the principal contract automatically by operation of the Act -7-

10 e) For this reason, where third party rights are not intended to be given the principal contract should always include an exclusion of such rights 3.4 Project accounts Separate trust account established for the project Money from Employer/Funder paid in to prime the account and against certification under the building contract Money paid out directly to main contractor and directly to each principal subcontractor against certification Avoids delayed or non-payment by main contractor to subcontractors Protection for Employer, main Contractor and subcontractors on insolvency of other parties but there are costs of setting-up the account and its administration 4. Insurance options If the project involves works to existing buildings or is new-build, but of sufficient value and complexity, consider Employer Project Insurance Work on existing buildings a) Where possible, extend buildings insurance to provide all risk insurance for the works b) Delay in completion insurance c) Public liability insurance d) Contractor cover required by law, e.g. employer s liability New-build - Employer Project Insurance v - Contractor procured insurance a) More efficient and comprehensive coverage of risks without costly gaps b) Employer is in control of the claims process throughout and insurance proceeds c) Control over who is insured d) Easy flip to buildings insurance on completion e) Funders will like it f) Contractor needs to maintain its insurances required at law, e.g. employer s liability g) Insurance coverage may include: i) Works all risk insurance ii) Delay in completion insurance iii) Public liability insurance iv) Product liability insurance v) Non-negligent damage insurance vi) Latent/inherent defects insurance Professional indemnity insurance a) For the benefit and protection of the insured b) Renewable annually c) Claims made basis (date of claim is key, not date of event) d) Beware imposing strict liability the PI policy is unlikely to respond Whatever scheme of insurance is put in place, check it is in place and current (some insurances are renewable annually) -8-

11 5. Variations, delay and defects 5.1 Managing variations, delay and defects 5.2 Variations, Delay and Defects Variations a) Real Employer variations and design development b) Contract deemed variations Other causes of delay Notice provisions and making written notice a condition precedent to entitlement Extension of time/time at large Liquidated damages for delay a) Reasonable pre-estimate of loss or penalty? b) cap on damages for delay Patent defects and the defects liability period Latent defects Latent/inherent defects insurance 6. Dispute resolution 6.1 Adjudication and Construction Act changes See section 2 above on the general background s107: this section is repealed. So the Construction Act 1996 as amended will apply to oral construction contracts and partly oral construction contracts from its effective date, expected to be 1 October Therefore, disputes arising on oral contracts or oral variations to written contracts may be adjudicated under the statutory scheme. In such cases, it seems likely that there may have to be short hearings before the adjudicator to allow the adjudicator to hear direct testimony. Note that in order to avoid the application of the 1998 Scheme as amended, certain provisions regarding the administration and rules of adjudication must be in writing s108(3a): a new provision allowing the adjudicator to correct his decision so as to remove a clerical or typographical error arising by accident or omission s108a: prohibition on Tolent clauses. The intention of this provision is to prohibit the imposition of a contractual provision that requires the losing party in adjudication, who also started the adjudication, to pay the other party s costs. Such an agreement can be made after the giving of a notice of adjudication. It is also permissible under the contract to give the adjudicator power to allocate his fees and expenses between the parties. However, the drafting of s108a is unnecessarily contorted and may have the unintended consequence of not prohibiting such provisions when the contract provides expressly for the adjudicator to allocate his fees and expenses and a Tolent type provision is also included. It is likely that the Courts will uphold the intention of the provision but we will have to wait and see In connection with the above changes, note the effect of the date of particular construction contracts. If a main contract is executed and dated on, say, 28 September 2011 and various subcontracts are executed and dated on or after 1 October 2011, then the amended provisions will apply to those subcontracts but not the main contract. In particular, if some of the later subcontracts were made orally or partly orally, a dispute under those subcontracts may be taken to adjudication. 6.2 Expert witnesses - update Expert witnesses have until very recently enjoyed immunity from suit for breach of duty in giving expert evidence in connection with legal proceedings. The rule that -9-

12 has existed for hundreds of years has now been overturned by the Supreme Court by a majority of 5 to Jones v Kaney [2011] UKSC 13 Joe Bellhouse, BrookStreet des Roches LLP -10-