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Construction Law, Contract Administration

Freedom of contract meets its match: Pay If Paid Clauses

by Andrew Ness

Cash-flow from lender to owner to construction manager to subcontractors is the lifeblood of any construction project. And maintaining a sufficient flow of funds is essential to every construction manager’s ability to manage the job. Contract provisions requiring a contractor or subcontractor to continue to work, even if the right to payment is disputed, mean little to the fate of the project if subcontractors cannot meet payroll.

As a consequence, who will bear the risk of non-payment has becomes a frequent negotiation point, particularly so during periods of economic uncertainty. Imagine that two sophisticated corporations spend thousands of dollars and hundreds of hours of the best legal talent available to negotiate a contract for the construction of a large project to be located in the United States. The negotiations are lengthy and contentious; they are the very definition of ‘arms-length’.

As with all negotiations, the give and take often involves an adjustment to the contract price in exchange for amendment of a certain risk allocation or other material term. At the end of the long process a final deal is struck and the contract is executed. Imagine further that as part of the negotiations, the contract price was increased in exchange for a “pay-if-paid” clause, i.e., a clause that says the construction manager has no obligation to pay the subcontractor for work, unless the owner first pays the construction manager for that work. Under these circumstances, where there is no reason to question the validity of the contract, it would be natural under general principles of U.S. contract law, where “freedom of contract” supposedly reigns, to expect that all of these contract provisions would be enforced as written.

But the aforementioned negotiations involved a third-party. A party that was silent during all of the negotiations, but who gets the final say regarding every provision she wants to influence: public policy. And in some states, public policy will invalidate a provision to share the risk of non-payment through a ‘pay-if-paid’ clause.

In New York, for example, the Court of Appeals (New York’s highest court) has held that a “provision which forces the subcontractor to assume the risk that the owner will fail to pay the general contractor is void and unenforceable as contrary to public policy.” West-Fair Electric Contr. v. AETNA, 87 N.Y.2d 148 (1995). The basis of the Court of Appeals decision was New York State’s mechanics’ lien law, which provides that subcontractors have the right to file a lien against real property to which they have contributed manpower or material to improve. Because a pay-if-paid clause threatened that right, such clauses were found to be contrary to public policy. So much for freedom of contract!

 

Kluwer Construction Blog

Contract Administration

How “Fit” is your Contract?

by Sarah Thomas

As lawyers, we want what is best for our client. We will fight for that additional clause or that tricksy wording that will give our client that added protection that may, someday, prove decisive in an argument with the contractor or the employer.

One issue that lawyers often fight quite savagely over (but in that overly courteous way beloved of lawyers) in construction contracts is the inclusion or exclusion of a fitness for purpose obligation on a contractor or architect. But do we know what we are fighting over? What will happen if fitness for purpose is not expressly included? And what is the real effect of including a fitness for purpose obligation? Will it be implied into your contract anyway? How does this affect insurance?

Reasonable skill and care

In English law, in the absence of an express or implied fitness for purpose obligation, designers are required to exercise reasonable skill and care in their design. This means that the design must meet the standard expected of a competent professional designer. So, why not rely on this standard of care? Why do employers spend many hours arguing with contractors, insisting that they accept a fitness for purpose obligation rather than a reasonable skill and care obligation?

The simple answer is that fitness for purpose is a stricter and tougher obligation for the designer to meet. A reasonable skill and care obligation essentially requires an employer to prove that the designer has been negligent. This requires the employer to show that the design fails to measure up to the standard of a competent professional designer.

But how does the court decide what the standard of a competent professional designer would have been? Well, as with a great deal of legal questions, the answer will, unhelpfully, depend on what a competent professional designer would have done in the circumstances. This question will need to be decided by a judge or arbitrator, taking into account evidence from expert witnesses. This subjective element of the standard of reasonable skill and care, and the need to prove that what has been designed is below that expected in the industry, is one of the principal reasons why many employers push for a express fitness for purpose obligation.

Fitness for purpose

The contractor’s acceptance of a fitness for purpose obligation effectively means that that it is guaranteeing that the design will meet the requirements (whatever they may be) of the employer. That being the case, the employer merely needs to prove that the completed building does not work as intended; there is no need to show that the design has been negligent. For example, if an architect were asked to design an office building, and within that building the suspended stair that was part of that design was found to shake when used, then the employer would only have to establish that the stair shakes when used. The onus would then be on the architect to demonstrate that its design was indeed fit for purpose but the stairs were not constructed as designed – e.g. the steel or glass used in the stair were not as specified. However any argument that a reasonable architect, exercising skill and care, could not have foreseen the failure of the stairs when used in this way would, where there is a fitness for purpose obligation, fall on deaf ears.

Similarly, where a fitness for purpose obligation is subsumed into a contract to design and build say, a desalination plant, then that contractor is normally guaranteeing that, once constructed, the plant will be able to produce, say, 10,000 litres of clean drinkable water per day. If it fails to do this, in that the plant can only produce 5,000 litres of clean water, or if it produces 10,000 litres of water that is not drinkable, then the contractor has failed to build a plant that is ‘fit for purpose’.

Of course I appreciate that in most design and build contracts of this nature the performance guarantees are spelt out anyway – so why the addition of express fitness for purpose? The employer is already effectively guaranteed that the end product will meet its needs by the inclusion of performance tests and guarantees.

What’s your purpose?

What both parties must be wary of is whether or not there is a clear indication in the contract as to what the employer’s purpose actually is. In the absence of a clear statement as to the employer’s purpose, the intended purpose will usually be assessed and determined by a court or arbitrator based on the facts. This places additional onus on the contractor to push for inclusion of a stated purpose or employer’s requirements and then to scrutinise them to ensure that the purposes are narrowly and specifically defined. For the employer such an “open-ended” clause gives him comfort that the contractor may still have to meet wider purposes of the building or plant that are not necessarily spelt out in the contract in the performance requirements. Thankfully for contractors, a number of those standard forms that still use express “fitness for purpose wording” nevertheless tie it to purposes expressly set out in the contract. For example, clause 4.1 of the FIDIC Silver, Yellow and Gold Books (Conditions of Contract for EPC/Turnkey Projects, Design and Build and Design Build Operate) contains the following provision:

“When completed, the Works shall be fit for the purposes for which the Works are intended as defined in the Contract.”

So, we have a clear and explicit fitness for purposes obligation placed on the contractor but tied to the purposes “as defined in the Contract”. The parties just need to be clear where these are in the Contract and (certainly for contractors) that they are narrowly and precisely defined.

Implied purpose

There is the potential (at least under English law) for a fitness for purpose obligation to be implied into a contract, absent an express fitness for purpose obligation. Where a contractor is tasked with carrying out all the design under a design and build contract, a fitness for purpose obligation will often be implied into the terms of the contract (George Hawkins v. Chrysler (U.K.) Ltd. (1986). Also see the Supply of Goods and Services Act 1982 (UK) which sets out that, when a customer indicates (expressly) that goods are wanted for a particular purpose, or where it is obvious (implied) that goods are suitable for a particular purpose, and a seller supplies them to meet that requirement, the goods should be fit for that specified purpose). Contractors unwilling or unable to take on a fitness for purpose obligation in their design and build contract should therefore look to include wording which expressly excludes fitness for purpose.

As to whether a particular Civil Law jurisdiction will imply a fitness for purpose or similar obligation on a contractor in a design and build contract will very much depend on the codified document setting out the law in that jurisdiction. For example, the German Civil Code includes a provision which implies that a contractor will provide a product that is fit for its intended purpose, while under UAE Civil Law there is no implied fitness for purpose requirement.

Fitness for purpose and insurance: The elephant in the room?

One of the main reasons why fitness for purpose obligations are often fought over so vehemently, is due to the impact that such an obligation has on the designer’s professional indemnity insurance. The vast majority of PI policies available to contractors and architects contain express exclusions such that any assumption of a fitness for purpose obligation will result in the designer not being covered under the PI policy.

So how do you deal with this issue of PI insurance dictating the risk allocation of your contract?

One technique that employers have used when faced with this scenario, is to remove any explicit reference to fitness for purpose from their contracts. For example an employer could amend clause 4.1 of FIDIC Yellow or Silver Books with something along the following lines:

“When completed, the Works shall comply in all respects with the requirements of the Employer as defined in the Contract.”

It is interesting that the more recent IChemE International Form of Contract (First Edition 2007) adopts this approach, recognising the problem with using explicit fitness for purpose wording – see for example clause 3.4 of “The International Red Book”.

The advantage of using the above wording from an employer’s point of view is that it has the same power and effect of a fitness for purpose clause, without the stark (and easily identifiable and word searched) term ‘fitness for purpose’. Contractors, on the other hand, should be wary of this type of ‘fit for purpose by stealth’ approach, particularly if their PI policy excludes cover for fitness for purpose. They may look at extending their PI policy in this instance, or alternatively they should look at counterbalancing the risk taken by seeking to limit their overall liability under the contract.

Your experience?

So, what has been your experience with fitness for purpose clauses? Do you push for their inclusion, or push for their exclusion? How have you balanced the competing forces of a fitness for purpose obligation with the strict terms of an insurance policy which excludes their use? All comments welcome.

 

Kluwer Construction Blog

Contract Administration

Heading for India? Some Issues to Consider…

by Sachin Kerur

With construction activity in India now worth $50 billion per annum and accounting for around 6% of Indian GDP, India is an attractive market for contractors.

The construction sector in India employs around 40 million people. The granting of ‘industry’ status to the Indian construction industry by the Indian Government has resulted in fast track procurement procedures and enabled construction companies to obtain crucial working capital at market rates. As a result, institutional investors have re-rated many Indian construction stocks and many joint ventures are being discussed with foreign construction companies.

Before plunging head long into this rapidly growing sector, here are four issues for contractors to consider for developing a coherent development plan to take advantage of the opportunities in India:

Consider: A Local Presence

For the serious players, a physical presence in India is recommended over a fly in fly out approach. A local presence helps the development of relationships with clients and key contacts in the local industry and also allows the monitoring of the supply chain or a joint venture partner. The intelligence that can be gained by such a presence is invaluable.

Consider: Structuring the Vehicle

A prime choice of corporate vehicle is an incorporated, limited liability company which can be set up as wholly owned subsidiary under the Companies Act 1956 (an Indian statute) or through a joint venture company, usually with an Indian partner. This will be treated as a domestic company, and will allow for post-tax profits to be repatriated to the foreign parent (usually as dividend payments).

It is also possible to set up unincorporated entities. These are principally liaison or representative offices, branch offices or project offices. But beware – the liaison/representative and branch offices are unsuitable as a vehicle for the carrying out of construction work. The former is not allowed to carry out any commercial activities in India and a branch office will not be authorised to carry out construction work.

A project office can be an attractive vehicle if the foreign company is only planning to execute a specific project in India rather than planning for a permanent presence. It will be treated as a foreign company but has the advantage that, with the permission of the Reserve Bank of India, it may send any surplus of the project outside India on completion.

Consider: Taxation

A key factor in deciding whether to go for an incorporated subsidiary/joint venture or a project office is taxation.

A project office will be treated as a foreign company and taxed accordingly. The basic tax rate for foreign companies ‘resident’ in India is 40% (plus surcharges and cess). Compare this with an incorporated subsidiary/joint venture company, which will be treated as a domestic company for tax purposes, and is taxed at a basic rate of 35%.

If a foreign company is not ‘resident’ in India, the tax imposed will depend on the nature of the company’s income earned from a business connection in India or from Indian sources. The Double Taxation Agreement between UK and India could also be relevant in this context.

However, these figures can only ever be a guide, and the advice of a local tax lawyer is essential before deciding on a structure.

Consider: The Local Rulebook

Contractors should be sure to familiarise themselves with the regulations relating to labour (of which there are numerous in India), tax, land use, building permits, plan approvals, work inspections and work certificates. It is very important to obtain advice from locally based advisers in relation to these issues in advance of any venture.

India’s construction sector is growing rapidly, and investment is becoming more and more attractive. To maximise the opportunities on offer, a clear and concise plan at the outset is vital – plus a little help from the local experts!

 

Kluwer Construction Blog

Contract Administration

Key points while entering into a joint venture in the Middle East

by James Bremen

The use of joint ventures or consortiums are attractive because they allow contractors, consultants and financiers to team up and offer owners a single interface for all needs of a project.

Owners are increasingly requiring that consortiums be formed to provide a single point responsibility and to ensure bidders have the ability to perform the scope of work.

In light of this development, this article seeks to highlight some of the key legal and practical issues, which should be considered when entering into a joint venture or consortium agreement. The term “consortium” is used throughout the article to refer to both “consortium” and “joint venture.” …

Contract Administration

Dubai construction sector ‘in big trouble’

The construction industry in Dubai has no chance of recovery in 2010 and the emirate’s real estate operators too were likely to face difficulties over the coming months, said an industry expert.

Those construction companies which are solely operating in the Dubai are in for big trouble, Khaldoun Tabari, vice chairman and CEO of  Dubai-based engineering contractor Drake & Scull International, was quoted as saying in Arabian Business. …

Contract Administration, Project Management

Be careful when you terminate a contract

In the current economic climate, there is growing interest in whether a contract can be cancelled, if one party is no longer able to fulfil its obligations due to financial difficulties.

A basic principle of contract law is that the contracting parties must perform their obligations with good faith and in a manner consistent with the contract. However, subject to this basic principle, a party to a contract that is subject to UAE law, can seek to end the contract in one of three ways: …

Project Management

Manage Political Problems as Issues

Manage Political Problems as Issues
The larger your project gets, the more you will find that the issues you encounter are more and more political in nature. The issues have to do with the use of resources, project direction, project deliverables, how the project should be run, how the project impacts people, etc. The resolution of these issues requires you to gain consensus among people that have differences of opinion. In other words, the resolution requires you to recognize and work in office politics.
Generally speaking, politics is all about interacting with people and influencing them to get things done. This can be a good thing, a bad thing, or a neutral thing, depending on the tactics people use. The behavior of people can make office politics good or bad. Let’s consider some examples of how utilizing political skills might be good, but can also be bad.
You are able to move your ideas forward in the organization and get people to act on them (good), by currying favor, suppressing other opposing ideas and taking credit for the ideas of your staff (bad).
You have an ability to reach consensus on complex matters with a number of different stakeholders (good), by working behind the scenes with people in power, making deals and destroying people who don’t get on board (bad).
You receive funding for projects that are important to you and to your organization (good), by misrepresenting the costs and benefits, and by going around the existing funding processes (bad).
You develop a reputation as someone who can get things done (good), by using legitimate and illegitimate tactics and by walking over people that get in your way (bad).
The point of the examples is to show that influencing people and getting things done in a company bureaucracy is a good thing and the general term of “office politics” can have good connotations or bad. However, the typical use of the term is used to describe the shady methods that are used to get things done in the company bureaucracy.
It is not uncommon for a project team to be impacted by office politics. This can occur when there is a difference of opinion on the project deliverables, requirements, scope change requests, risk perceptions, etc. Are these differences of opinion caused by office politics, or just a legitimate and valid difference of opinion between people who both think that they are representing the best interest of the company?
Dealing with office politics is not a standard project management process. However, once the politics start to impact the project adversely, the situation should be identified as an issue, since the resolution is outside the control of the project team. You can’t utilize a checklist to resolve political issues. Political problems are people-related and situational. What works for one person in one situation may not work for another person in the same situation because people, and their reactions, are different. Identifying the problem as an issue will bring visibility to the situation and hopefully get the proper people involved in the resolution.
Generally, project managers need to become good at identifying and trying to resolve political issues. There are three areas to work on.
Try to recognize situations and events where politics are most likely to be involved. This could include decision points, competition for budget and resources, and setting project direction and priorities.
In general, deal with people openly and honestly. When you provide an opinion or recommendation, express the pros and cons to provide a balanced view to other parties. Make sure you distinguish the facts from your opinions so the other parties know the difference. You should always try to communicate proactively with all stakeholders.
If you feel uncomfortable with what you are asked to do, get your sponsor or your functional manager involved. They tend to have more political savvy and positional authority, and they should be able to provide advice and cover for you.
If you feel good about what you are doing, how you are influencing and how you are getting things done, then you are probably handling office politics the right way. If you feel guilty about how you are treating people and if you have second thoughts about the methods you are using to get things done, you are probably practicing the dark side of office politics.
tenstep.com

The larger your project gets, the more you will find that the issues you encounter are more and more political in nature. The issues have to do with the use of resources, project direction, project deliverables, how the project should be run, how the project impacts people, etc. The resolution of these issues requires you to gain consensus among people that have differences of opinion. In other words, the resolution requires you to recognize and work in office politics. …

Contract Administration

Regulation shapes revolution in Gulf sustainable buildings

Abu Dhabi will make sustainability compulsory from 1 January. The argument that the Gulf doesn’t care about the environment is false. Abu Dhabi’s new building code, regulations that make sustainability compulsory in all buildings and major retro-fits throughout the emirate, come into force on 1 January 2010.

They will set a minimum standard for all the elements involved in project delivery, from the design of new buildings to the way redundant structures are demolished. This encompasses energy efficiency, water use and the wider environmental impact of construction. …

Construction Law, Contract Administration

The Cash Cow

On demand’ guarantee bonds are a typical form of contractual security in the UAE construction industry, particularly on large projects. Their use in theory, is to afford the employer with secured funds from a surety, in the event the defaulting party does not perform under a contract or becomes insolvent.

Prior to the onset of the liquidity crisis last year, the general attitude of an employer (as a beneficiary) would have been to threaten the encashment of a bond to impose commercial pressure on a contractor to perform. A call upon an on-demand bond would have been made if strictly necessary e.g. in the event of material or persistent default. …

Contract Administration

The Importance of Documents During the Crisis

It is undeniable that UAE is now facing the onslaught of the global financial crisis. Although UAE’s oil revenue has cushioned the impact of the crisis to some extent, the speed in which the impact of the crisis is spreading across the real estate and construction industries, particularly in Dubai, is unprecedented.
The number of construction projects being scaled back or even suspended is on the rise. Consequently, we have been receiving an increasing number of enquiries and instructions from employers and contractors involving suspension and termination issues. Inevitably, some projects will fall into dispute whenever a party decides to suspend or terminate the contract. A dispute or a chain of disputes may occur at any level, be it between the master developers and sub-developers, sub-developers and its consultants or contractors, or down to the level between the contractors and its sub-contractors and suppliers. …

Construction Law

Arbitration and civil procedure

by Dennis Brand

I think it is fair to say that occasionally some thought is given as to enforcement of the arbitration award, but rarely if any real thought is given to the jurisdiction of the local courts, either as to any challenge to an arbitration award or its enforcement.

Unlike many jurisdictions, the UAE does not have an arbitration law; in 2008, a draft arbitration law was in circulation, but as of today it is still in draft form. …

Contract Administration

Precast Concrete

WHEN used as a construction system, precast concrete offers several advantages that range from improved quality to safer, long-lasting structures, says the Riyadh-based Al Rashid-Abetong (ARA), which has been serving the Saudi market for more than three decades.

The advantages of precast construction, coupled with the inherent benefits of concrete, provide a superior building material that has been proven the world over for several decades.

“Precast systems offer significant savings in construction, thanks to earlier completion dates, inbuilt fireproofing, reduced formwork, scaffolding, reduced wet trades and increased budget control,” says Munir Sultan, assistant sales and marketing manager. …

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