The Projects and Construction Review: Collaborative Contracting
The construction industry has long suffered from poor productivity growth and high levels of disputation. The causes of poor productivity growth are many, and include extensive regulation, site-specific complexities, fluctuating demand for construction services, inexperienced buyers, the fragmented nature of the industry and underinvestment in technology. But perhaps the most significant cause of inefficiency and the high levels of disputation in the construction industry is the misalignment of interests between project owners and other project participants caused by traditional contracting methods.
Traditional contracting methods typically involve the non-owner participants tendering a lump-sum price based on the owner's proposed allocation of responsibilities and risks. Each non-owner participant has strong incentives to perform the contract package allocated to it well, but is far less invested in how other participants perform their contract packages. The project becomes a collection of sub-projects, with each non-owner participant rewarded by reference to the timely completion, within budget, of its sub-project, rather than the performance of the entire project.
Indeed, late or poor performance by one participant will often excuse other participants from the need to strictly fulfil their obligations, or entitle them to claim additional money from the owner. Accordingly, when things go wrong, the participant's financial interests are often served by blaming others and defending contractual positions, rather than working collaboratively to overcome the problem.
Further, when a non-owner participant is paid via a lump- sum price, it is financially motivated to minimise the cost of performing the agreed scope or activity to maximise its profit. This is so even if doing more would reduce the owner's total costs or otherwise result in better outcomes for the owner. If the owner wants a participant to do more than the bare minimum required, to overcome a problem or achieve a better outcome, or to coordinate and integrate its works with those being delivered by other non-owner participants, the owner will typically have to compensate that participant for its additional costs, to restore its profit margin. There is little in a traditional construction contract to incentivise non-owner participants to deliver outstanding performance in areas that deliver value to the project owner. Traditional contractual incentives, such as liquidated damages and performance security, provide only negative incentives to ensure compliance with minimum requirements.
Finally, traditional procurement prefers a sequential approach to project scoping, design and construction. The scoping and design of conventionally procured projects is generally completed, or well progressed, before the owner calls for tenders from constructors. Engaging a constructor to provide input during the scoping and design process to try to make the project easier and less costly to build, or to fast track the project by overlapping the scoping, design and construction phases, can result in that constructor being seen to have 'the inside running' for subsequent tenders of the construction work. This can adversely affect the owner's ability to run a highly competitive tender process for the construction work, and result in the owner paying a higher construction price.
It was out of these commercial realities that the concept of collaborative contracting (also referred to as relationship contracting) was born. The concept embraces a wide and flexible range of approaches to overcome the misalignment of interests associated with traditional contracting, including the following:
- contractual commitments to cooperate and act in good faith;
- early warning mechanisms designed to alert other participants to emerging issues so that solutions can be developed and agreed before the issue worsens;
- early involvement of the main contractor and key specialist subcontractors in the scoping and design process;
- more nuanced approaches to the key risks of cost, time, quality and liability;
- governance arrangements that facilitate collective problem-solving and decision-making;
- payment arrangements that financially motivate each participant to act in a manner that is best for the project, rather than best for that participant; and
- at the most collaborative end of the spectrum, each participant waiving its right to sue other participants for mistakes, breach or negligence (other than wilful default).
Thus, collaborative contracting is best viewed as a spectrum of contracting models, depending on the positions adopted in relation to cost, time, quality, liability, decision-making and other factors.
As governments navigate through the uncertainty of covid-19, one thing is clear: the economic vehicle leading their response will be powered in many cases by the engine of infrastructure investment. Specifically, many governments want 'shovel-ready' construction projects where work can commence immediately to create new jobs. Collaborative contracting provides a mechanism that allows more immediate progression, since it can bypass the lengthy procurement process that is symptomatic of traditional fixed price contracting methods. Its flexibility allows for a project's scope to be a work in progress, contractors to be selected based on experience and capacity, and work to commence. Projects that would not otherwise be shovel-ready can become shovel-ready quicker.
This chapter focuses on three contemporary approaches at the more collaborative end of the spectrum: alliancing, the managing contractor and the delivery partner model.
Alliancing (sometimes referred to as integrated project delivery) represents the high-water mark of collaborative contracting. An alliance is a collaborative structure in which the parties share risks (rather than allocate them) and work together to deliver agreed project outcomes.
Alliance contracts, in their purest form, incorporate six key elements as follows:
i Single, multi-party contract
The project owner, and the other key project participants such as the designer, the civil works contractors and the systems providers, enter into a single, multi-party contract rather than a series of separate head contracts, subcontracts, supply agreements and so on.
ii Early involvement
The project alliance agreement is generally signed at an early stage in the project planning phase, often before the scope of the project is settled and well before an owner would traditionally engage contractors and systems suppliers. The non-owner participants (NOPs) are often selected based on non-price criteria such as credentials, experience and demonstrated ability to collaborate effectively in an alliance contracting framework. The owner and the NOPs then jointly develop the scope of work, programme, cost estimate and other key performance indicators (KPIs) against which the performance of the alliance will be measured. Sometimes the owner will develop these items with two competing teams of NOPs before selecting the successful team.
The remuneration regime for the NOPs typically involves three limbs:
- first, the owner reimburses all direct costs incurred by each NOP in undertaking the project, including when such costs exceed the agreed target cost;
- then each NOP will be entitled to an amount on account of profit and contributions to corporate overheads. This limb-2 amount is often called the fee, and is typically a lump sum amount based on the amount of profit and contribution to overheads that the NOP would expect to receive for business-as-usual performance of the work it is expected to perform; and
- finally, each NOP will be entitled to a gainshare payment from the owner, or will be liable to make a painshare payment to the owner depending on how the alliance performs against the agreed target cost, target completion date and other agreed KPIs. This way the NOPs can generate a better than business-as-usual margin if the alliance performs well. Conversely, any painshare payment will eat into the fee, and hence reduce each NOP's margin, if the alliance performs poorly.
The maximum painshare payment an NOP can be required to pay is typically limited to the amount of its limb-2 fee. This way, the worst case outcome for a NOP is that it recovers its costs but makes no profit or contribution to its corporate overheads.
Importantly, the KPIs are based on whole-of-project outcomes rather than outcomes on the scope performed by the relevant NOP. This encourages each NOP to do what is best for the entire project rather than what is best for its scope of work. This incentivises greater collaboration between the NOPs than occurs under traditional contracting models where the financial performance of each NOP turns on the performance of its scope of work rather than whole-of-project outcomes.
The financial incentives to collaborate under an alliance model help with projects involving the integration of different systems from different suppliers.
Project decisions, such as the final design and construction methodologies to be adopted, the sequencing of tasks, deciding what materials will be used and whether any works will be subcontracted, typically require the unanimous agreement of all alliance participants. Sometimes the owner may reserve certain decisions for itself, but on the basis that the knock-on effect of such decisions on the target cost and other KPIs will be determined by unanimous agreement.
v No blame
Alliance contracts typically include a 'no blame' clause under which each participant agrees to waive its right to bring legal claims against another participant, including if the other participant is in breach of its contractual obligations or is negligent. The only real exception to this is typically for wilful (i.e., deliberate) default by the wrongful participant.
The no blame clause removes the ability of participants to blame and sue one another when things go wrong. Instead, their desire to minimise the painshare arising from mistakes and poor performance motivates all participants to help the alliance to overcome the problem, regardless of who was is at fault.
vi Shared risks
Finally, under this arrangement all project risks are essentially shared between the owner and the NOPs until each NOP reaches its painshare cap, at which point the remaining cost and other risk impacts fall exclusively to the owner.
However, the owner has a contractual framework under which it only pays additional amounts on account of risks that actually occur. Because the direct costs of the NOPs are always paid by the owner, there is no need for the NOPs to include a contingency for risk in the fixed price they would charge if engaged under a fixed price contract, which the owner pays whether or not the risk occurs.
Hybrids and long-term alliances
As with any contractual model, there are always variations. For example, there are alliance contracts that do not fully embrace the no blame concept, or that allow decisions to be made other than by way of unanimous agreement. These 'impure' alliances have come to be referred to as hybrid alliances.
It is important to recognise, however, that these hybrids are no less valid than a pure alliance model. They simply reflect the fact that there is no one-size-fits-all option when it comes to contracting strategies. What is important is that the parties understand the nature and limitations of the particular contracting model that they are adopting.
Alliance principles can be applied to a single project or longer-term programmes covering a series of projects. The principles can also be applied to longer-term arrangements for the operation, or the through-life support, of an owner's infrastructure investments.
III The managing contractor
The managing contractor is an innovative structure that shares some of its characteristics with design and construct (D&C) contracts and others with the agency relationships and project management roles seen in the construction management models.
The model originated in Australia and has been used extensively by the Australian Department of Defence and a variety of private sector owners. The managing contractor is responsible for the design and construction of the project from feasibility right through to the commissioning stage. The arrangement usually involves the owner entering into one contract with the managing contractor, which then subcontracts all its design and construction obligations.
This differs from the construction manager model in which the owner contracts with a manager to provide project management services only, and then contracts directly with each of the other project participants. Under the managing contractor model, the managing contractor is legally accountable to the owner for the delivery of the project, not just for managing its delivery.
The managing contractor can be distinguished from a more conventional lump sum D&C contractor in two key aspects: role and risk.
Although the managing contractor accepts legal responsibility for the design and construction of the project, its key role is project management, as it is usually obliged to subcontract all its design and construction obligations. The only services carried out by the managing contractor itself, using its in-house resources, are the management and advice services provided throughout the project, and the provision of on-site preliminaries such as hoarding, plant and sheds.
A key difference between this model and a conventional D&C contract lies in the degree of control that an owner retains over the selection of subcontractors. While a D&C contractor has autonomy to appoint subcontractors of its choosing, a managing contractor must undertake subcontracting in close consultation with the owner, who will retain the ultimate authority to approve or reject tenderers. This right is consistent with the obligation falling upon the owner to reimburse the managing contractor for costs incurred in the design and construction.
Another important difference between a managing contractor and conventional D&C contractors is the point in the project development process at which they are engaged by the owner.: the managing contractor is appointed much earlier.
The project would normally proceed as follows. First, the owner invites tenders from potential contractors for management services and defined common site facilities. Once a successful tenderer has been chosen as managing contractor, it will coordinate the feasibility stage of the project, including hiring any consultants required and providing advice to the owner as needed. If the project does not progress past the feasibility stage, the contract may be terminated.
Next is the design phase; this will be carried out by the managing contractor, from design brief through to detailed documentation. Throughout this process, the managing contractor will consult closely with the owner, who has the final say on all decisions made. The managing contractor will first prepare a design brief that must be approved by the owner. Tenders for the design subcontract will then be invited. Although the managing contractor can recommend a candidate, again the final decision is subject to the owner's approval.
When the successful tenderer has completed the design, this must again be approved by the owner before construction can begin. This procedure differs from a conventional D&C arrangement, under which the owner minimises its involvement in the design phase to avoid diluting the D&C contractor's design liability and affecting any warranty for fitness for purpose.
During the construction phase, the managing contractor has a variety of responsibilities, which include:
- advising on the appropriate contract strategy for each package;
- managing the tender process and award of packages;
- engaging subcontractors to execute the construction work;
- programming and timetabling the construction work;
- supervising the construction to ensure it accords with design specifications;
- managing and administering the subcontract;
- instituting a system of cost control;
- managing community relations; and
- managing industrial relations on the project.
Consistent with the philosophy of collaborative contracting, the process of selecting construction subcontractors is performed by the managing contractor in close consultation with the owner. Again, the owner exercises significant control over the decision through its right to finally approve a nominated candidate; this procedure is identical to that used in the selection of a design contractor.
The final stage of the project in which the managing contractor is involved is the commissioning phase, during which the contractor coordinates the handover of the project and ensures any defects that have become apparent during the defects liability period are rectified.
The other feature distinguishing the managing contractor from a D&C contractor is the risk it bears. The managing contractor is exposed to lower risks in terms of both cost and time than a conventional D&C contractor.
In respect of cost, while a D&C contractor is normally remunerated with a lump sum, a managing contractor is generally remunerated on the basis of a combination of lump sum and reimbursable components. The purpose of the lump sum component is to pay for management services and site facilities, and allows the contractor to extract a profit. The owner separately reimburses the managing contractor for all amounts paid by the managing contractor to subcontractors and consultants. This remuneration arrangement shifts all the project cost risks onto the owner, except those relating to management services and site facilities. The managing contractor is only reimbursed for any costs that it incurs reasonably. Costs incurred from unauthorised variations, rectification of defects, breaches of contract or wrongful acts by the managing contractor that give rise to liability to third parties are usually excluded from the reimbursement regime.
Time-delay risk is often also borne by the owner. The managing contractor will only have a 'soft' time for completion obligation, in the sense that it will be required only to use its best endeavours to achieve a target date. Accordingly, a failure to achieve timely completion will not expose a managing contractor to liability for liquidated or general damages so long as it tries its best to achieve the target date. However, because the managing contractor is paid a fixed lump sum for its management services, it is clearly in its own commercial interest to achieve completion as early as possible to preserve its profit margins. The incentive for timely completion is not the threat of damages claims but the alignment of commercial interests.
The managing contractor model allows for early involvement of the contractor in the project, with close collaboration throughout. This means that the owner is able to achieve completion of the project in the manner it desires, using a spread of industry involvement and expertise but without the need for high-level management commitment. The owner can share some of the risks associated with a major construction project with a contractor and can achieve maximum flexibility in determining the elements to be included in a project and the design of those elements. At the same time, it provides the owner with the management expertise of a contractor organisation to assist and advise upon the design and construction of the project while planning for and remaining within a target time and cost for delivery of the project.
IV The delivery partner model
The delivery partner procurement model combines elements of the managing contractor, alliancing and engineering, procurement and construction management (EPCM) models. The delivery partner model enables a client to supplement its internal project management capabilities by engaging one or more delivery partners to assist the client with project planning, programming, design management and construction management services.
By engaging this expertise, the client is able, with the assistance of its delivery partners, to adopt a sophisticated client procurement strategy involving direct engagement of suppliers and subcontractors, as opposed to engaging a major contractor to manage this process. This can result in significant cost savings and other benefits for the client.
The remuneration regime for the delivery partners is similar to the three-limb remuneration model for alliance contracting with reimbursement of actual costs, a fixed fee covering profit and contribution to corporate overheads, and a gainshare or painshare payment. As with alliancing, better than business-as-usual project outcomes (measured against pre-agreed KPIs) will result in a gainshare payment by the client to the delivery partners, and poor outcomes will result in a painshare payment by the delivery partners to the client. Again, the maximum potential painshare payment is usually capped at the amount of the limb 2 fee, or a significant portion of it.
Unlike alliancing but similar to the managing contractor model, the delivery partners are precluded from performing design and construction services, which must be competitively tendered (unless the client specifically agrees otherwise). The client retains control or significant input over the appointment of subcontractors and suppliers, similar to the managing contractor model. However, the delivery partners bear less risk in relation to poor performance by subcontractors and suppliers than a managing contractor. The delivery partner's liability to the owner for poor performance by subcontractors and suppliers is limited to any reduction in the gainshare payment (or an increase in the painshare payment) that occurs as a result of reduced performance against a KPI. The owner has a contractual relationship with each subcontractor and supplier, and looks to them directly if they breach their contractual obligations.
The model has been employed successfully in the context of publicly funded infrastructure projects and was first used by the UK government in the construction of infrastructure for the London Olympic Games in 2012, where the complexity of the project and time-critical date for completion meant a more traditional delivery model was considered unsuitable. A delivery partner enabled the Olympic Delivery Authority (ODA) to acquire the necessary expertise if ever the ODA did not have the time to find and engage personnel of the required calibre to meet the time requirements. A wide range of infrastructure was required: key Olympic venues such as the velodrome, aquatics centre, media centre and Olympic village, as well as two kilometres of new sewers and 265 kilometres of ducts for new utilities. The project was ultimately a success, being delivered three months early and under budget.
Since then, the delivery partner model has received attention in Australia as a delivery method for government infrastructure projects, and was used to deliver the Woolgoolga to Ballina Pacific Highway Upgrade (W2B) – one of Australia's largest regional infrastructure projects. Like the London Olympic venues, the W2B project is a time-critical major project involving the duplication of approximately 155 kilometres of the Pacific Highway to create a four-lane divided road at an estimated construction cost of A$4.36 billion.
The delivery partner model was chosen for the W2B project because it avoided the need for the Government Road Authority to procure and deliver five separate packages of work sequentially. The Road Authority's business-as-usual procurement models and internal resources would have necessitated the work being divided into five packages, which could be procured and delivered sequentially. It was considered that aggregating the work into a smaller number of larger packages would result in a small field of potential tenderers and sub-optimal competition.
By adopting the delivery partner model, the Road Authority expected to achieve significant time and cost savings through repackaging the work and tendering packages on a trade or activity basis, responding to a logical sequencing of work across the entire project, unconstrained by package boundaries. Essentially, with the assistance of its delivery partners, the Road Authority was able to implement a sophisticated client procurement strategy similar to what a tier-one contractor would implement, without having to first engage such a contractor under a traditional D&C contract and pay the associated risk premium that such a tier-one contractor would build into its fixed contract price for the management of the procurement and integration risks.
The associated downside of this model, of course, is less certainty about cost and timing when the client contractually commits to the project. The client ultimately bears these risks without the protection that a traditional D&C contract with a tier-one contractor would provide. However, this risk is mitigated by the model's alliance-style gainshare and painshare regime, which financially motivates the delivery partners to help the client manage these risks effectively. The margin paid to the delivery partners for their services is also less than what would have been charged by a tier-one contractor for wrapping the delivery risks, on account of the lower level of risk borne by the delivery partners.
The model is gaining broader acceptance in Australia, having been deployed on a number of significant projects, including the Sydney Metro project, Sydney's second international airport and various NSW water projects. The model is well suited to major infrastructure projects in which the client desires time and cost outcomes that cannot be achieved via traditional procurement models, and is prepared to embrace and manage the associated integration and other risks with the assistance of capable delivery partners.
In markets such as Australia where industry participants want to 're-set' the way they do business and allocate risks, collaborative contracting provides a range of alternatives to the traditional contracting methodologies. By seeking to align the interests of the parties and develop a culture of collaboration to replace one of conflict, collaborative contracting can create a team of organisations that is engaged and motivated to solve problems and achieve better than business-as-usual results in the areas that deliver value to the project owner and improved productivity growth across the industry. If this heightened engagement and motivation is also applied to create 'shovel-ready' projects, governments will be better placed to revive economic growth from its covid-19 hibernation.
1 Owen Hayford is the founding principal of Infralegal.