Why Construction Arbitration is Complex? (II)

In the first article of this series, we looked at the general reasons why construction arbitration is considered complex.

In this second article, we dive into the core of the matter: construction contracts.

• What documents form part of a contract and what is their role?

• What types of contracts exist depending on the relationship between client and contractor?

• How do different model contracts affect risk allocation, final costs, and the origins of disputes?

  
  

Understanding construction contracts is key to understanding why disputes in this field are so unique—more technical, with broader legal and financial implications.

Every contract has its own complexity derived, in each case, from the nature of its subject matter.

Let us consider, for example, that the sale and purchase of a house is not the same as the sale and purchase of an oil tanker, both being a sale and purchase contract. In the case of construction contracts, we will see in this article their general characteristics and their different types according to the different relationships existing between the client and the contractor.

In the following articles we will see the reasons why these contracts are complex. I am already anticipating that this complexity is due to the nature of their subject matter, the different types of contracts used in international construction, the various forms of pricing -which influence the way they are performed and the distribution of risks-, and the influence of the existence of multiple-related-parties with diverse interests.

The construction contract

Like any contract, a construction contract requires at least an agreement with the intention of creating a legal relation and valuable consideration.

The contract identifies who are the parties that enter into the agreement and consideration is the mutual promise of the parties to perform work and to pay for it, respectively.

The dfinition of the work to be performed requires the inclusion in the contract of several complex technical requirements that must be met to achieve the purpose for which it is entered into, which is the performance to be carried out by the contractor.

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Considering how the relationship between the client and the contractor is organized, construction contracts can be of different types.

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Regardless of its format, a construction contract is composed of several documents:

• The contract or the agreement itself is where the basic terms of the relationship between the parties are agreed upon, such as identification of the parties, nature of the works and price. 

• The general conditions of the contract usually regulate in more detail the rights and obligations of the parties including commencement and completion dates, risk sharing, procedure for introducing variations to the contract or the project, penalties, indemnities, the procedure for resolving disputes, guarantees or insurance. Very often in international projects the parties use standard forms of contracts which contain their own general conditions which may be tailored, to some extent, to the needs of the parties and of the project. We will see the standard form of contracts in a later article.

• The special conditions complement or amend the general conditions, and they usually prevail over the general conditions in case of conflict between them.

• The specifications detail the technical requirements of the work, the materials to be used and, sometimes, the methods the contractor shall use to achieve the final product.

• The drawings are also part of the contract, whether provided by the client or prepared by the contractor. When they must be provided by the client, he is responsible for delivering with enough time so as not to delay the work. Sometimes the contractor is responsible for providing detailed drawings.

• The schedule establishes the sequence and timing of performing of the various phases or tasks required for the execution of the works and sometimes is part of the contract. This document is important because it allows the client to check whether the execution of the works is progressing as planned.

• The bill of quantities is a list of work to be done together with its measurement. In some contracts the bill of quantities is prepared by the client, and the contractor prices the units. In other contracts, the bill of quantities includes a price for each unit and the sum forms the final price to be paid to the contractor. Depending on the type of contract, its function is also to determine the amount of work executed at a given time and the interim price to be paid for it to the contractor.

Types of contracts

Considering how the relationship between the client and the contractor is organized, construction contracts can be of different types.

In construction-only contracts, the client contracts separately with another professional to carry out the design of the project. He also hires the person who will oversee the performance of the work, who may or may not be the same person who drafted the project; and, finally, contracts the execution of the works to a construction company. 

Through this system, the client controls the entire design and construction process, ensuring that the result meets its objectives.

The disadvantage of this system is that the client assumes the risk of the project, i.e., if there are deficiencies or omissions in the project, he must approve a modification of the contract, with the consequent modification of the price and, if applicable, of the completion date.

This means that the client has less certainty about the final cost of the work. The separation between the designer and the contractor who performs the works gives rise to many debates on the scope and interpretation of the project, which may affect the completion date as well.

In the design-build contract, also called turnkey contract, the contractor makes both the design and the construction and, therefore, assumes both risks and is responsible for delivering a final product ready for use or operating with certain performance characteristics in the case of industrial plants. The advantage for the client is that the contractor assumes all design and construction obligations.

There is only one person responsible for the delivery of the final product functioning as agreed, so the project progresses more quickly.

However, the client will not be able to modify the project, and the contractor always passes on the risks he assumes in the price, so it is not cheaper for the client.

However, since the contractor usually develops a preliminary base project drawn up by the client, if the client makes changes or redefines the requirements, the project will have to be modified and, therefore, the price and time for completion may change.

This type of contract is typical of projects in which the client wants to receive a plant of any type operating and meeting certain requirements. The contractor is responsible for everything necessary to ensure that the plant is delivered operating as agreed in the contract.

Sometimes it is common to use the so-called turnkey contracts with a fixed price for the construction of a building, without the project being drafted by the contractor, but delivered by the client.

The client seeks to have certainty regarding the final price and the contractor will not be able to claim any modification that may be necessary due to deficiencies in the project. In these cases, turnkey contracts are not used for their intended purpose.

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In collaborative contracts all parties involved in the construction collaborate from the very beginning in the design of the project and during its execution.

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Project management is a form of contract management whereby the client engages a project manager who coordinates the execution of the design and construction. The project manager acts on behalf of the client and makes decisions on behalf of the client and engages the designer and contractor.

Under this system, the design and construction phases can overlap, as the project manager can order the execution of certain contracts as the design progresses when the project is divided into phases.

It is common in these contracts for several contractors to be involved, each one in charge of executing a phase of the work. This way of managing the contract has the disadvantage that the client, through the project manager, assumes the risk of interference between contractors.

Finally, there are the collaborative contracts in which all parties involved in the construction collaborate from the very beginning in the design of the project and during its execution.

The client, the designer and the contractor are involved from the very beginning in the development of the project and a community of interests is created to collaborate in the success of the project, thus preventing the parties from clashing.

These contracts are intended to eliminate the existence of opposing sides with conflicting interests, and conflicts are reduced because problems are raised as soon as they arise and all parties have an interest in resolving them early.

The contract must contain the actual agreement on the interest in working collaboratively, the commitment to transparency, the agreement to share risks and benefits, as well as the methods for carrying it out.

This type of contract requires a major cultural change in all parties involved.

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