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Builders, labourers, tradies or any other contractor in the building and construction industry will often receive a Construction Agreement or Terms of Trade from the Principal. They are expected to sign these documents before starting work. Some clauses that affect your legal rights might be easy to identify, but others can be more difficult to spot. It is common to feel inundated when you review construction contracts. To help, this article explains how to conduct commercial risk reviews for your construction contracts and how to best manage them.

Commercial Risk Reviews

Commercial risk reviews will vary depending on the nature of your project. Some essential factors will include:

  • the scope of work;
  • project delivery and programme requirements;
  • the nature of the relationship between the parties;
  • where the work fits within the broader project;
  • commercial appetite for risk; and
  • the importance of doing the work or completing the deal to the business.

Every contract is different, so it is difficult to drill down on exactly what might be a ‘deal-breaker issue’ in all contracts. As a general rule, a deal-breaker issue is one that:

  • the contracting party must resolve before taking further action;
  • creates risks or liabilities that are unusual for that type of contract; or
  • if it is not dealt with, the issue is likely to have a material impact on the concerned party’s legal rights or obligations. 

The Construction Contract

A construction contract is a binding agreement that relates to the construction, alteration, repair, restoration, maintenance, extension, demolition or dismantling of buildings or structures. It may also have a prescribed meaning under certain legislation, such as Security of Payments legislation.

A construction contract should clearly address:

  • the scope of the work;
  • the contract sum and payment terms. In particular, whether parties will calculate the sum as a ‘lump sum’ or on the basis of a ‘schedule of rates’;
  • termination rights and consequences;
  • extension of time rights;
  • the process for variations;
  • defect rectification obligations; and
  • if any liquidated damages are payable.

Common ‘Deal-Breaker’ Issues

Cap on Liability, Force Majeure, Consequential Loss

The contract should provide that the contractor’s liability is appropriately capped. You would typically calculate the cap on liability with respect to the value of the contract.

Likewise, you will need to ensure there is a force majeure clause (regardless of whether you are the Principal or the Contractor). If you are the Contractor, it is best to include an exclusion of consequential loss. Consequential losses are indirect losses that are remote and do not naturally flow from an event or breach. 

An example of consequential loss is if you were carrying out plumbing work and one of your workers hit electrical wiring. This caused a long-term blackout, and the business lost profits and business opportunities due to an inability to process transactions. This lost profit and opportunity may be considered a consequential loss.

Sometimes it is not easy to spot an exclusion of consequential loss as the contract may not explicitly mention it. You should make sure that, under the contract, you are not legally responsible for consequential loss and other losses of:

  • revenue;
  • profit;
  • use;
  • financial opportunity; and
  • economic loss.

If you are a Principal, consider whether you would like to include a consequential loss exclusion. 

Indemnities

Additionally, given the nature of construction works, there is an increased risk of property loss or damage caused by the works (and personal injury or death). A Principal may seek indemnities from the Contractor in relation to:

  • personal injury or death;
  • property loss or damage; and
  • infringement of third-party intellectual property rights.

The Principal may also seek indemnities for breaches of the contract, and work and occupational health and safety laws by the Contractor or its personnel.

Remember, an indemnity is an obligation for one party to compensate the other for damages, losses, expenses or costs caused by a specific event. Typically, it entitles the indemnified party to recover more than a damages claim would.

Contractors typically seek to delete any indemnity for breach of contract and limit the operation of the other indemnities so that the risk exposure is lower.

Defects and Defects Liability Period

A construction contract will ordinarily contain a defect rectification regime. This will consist of:

  • a definition of “defect”;
  • a specified period during which the contractor must rectify defects (“defects liability period”); and 
  • the process for rectification. 

The defects liability period will reach when the works are completed, often called “Completion” or “Practical Completion.” 

If the Contractor does not finish the work on time, they may be liable to pay liquidated damages. 

Liquidated damages are a pre-agreed dollar amount. Where there is a delay, a certain amount of liquidated damages may be payable for each day the works are delayed. The rate of liquidated damages in a contract must be reasonable and must be appropriate to the losses experienced by the party claiming the liquidated damages as a result of the delay. 

Liquidated damages are beneficial to Principals. It gives them a place to point to in the contract and demand that the Contractor pay the liquidated damages due to their failure to perform or deliver the works on time. Likewise, a Principle can demand liquidated damages without having to initiate a dispute resolution process. 

Including liquidated damages in a construction agreement is favourable to the Contractor because it gives them greater certainty over the risk of not delivering the works by a particular time. If you are a contractor, it is advisable for your contract to include:

  • favourable extension of time provisions;
  • a practical date of completion that gives you sufficient time to complete the work; and
  • procedures that allow you to extend the period for practical completion without penalty.

You should also review the definition of ‘defect’ and ‘defective’. A broader definition of these terms is most beneficial if you are a Principal. Whereas, Contractors would prefer to narrow the definition.

Security 

Contractors often provide security for the performance of their obligations under a construction contract. Security is typically given in the form of bank guarantees or retention moneys. Retention moneys is where a percentage of each payment claim can be withheld by the Principal until it holds a percentage of the Contract Sum as security. 

It is often the case that half of the provided security is returned at practical completion, and the other half is returned at the end of the defects liability period. 

Care of the Works

Generally, the Contractor will be responsible for the care of the works until the date of completion. They also have a responsibility to care for the works if they are required back on the construction site to remedy defects during the Defects Liability Period.

Intellectual Property 

Additionally, it is essential that construction contracts consider intellectual property. The Party preparing the designs or plans for the works should give the other party an appropriate licence to use their intellectual property. Likewise, if you are the Principal, it is important to have a licence that survives termination. This is so you can provide the designs or plans to a new contractor upon terminating your engagement with the original contractor.

Who is Responsible for Designs?

The contract should clearly explain who is responsible for the design of the works. Generally, the arrangement under a construction agreement will either be ‘Design and Construct’ or ‘Construct Only’. The table below explains their difference.

TermDefinition
Design and ConstructWhere the Contractor is responsible for ensuring the suitability of both the design and construction of the works.
Construct OnlyWhere the Principal’s architect or design consultants are responsible for delivering the design of the works under separate services agreements. Then, the Contractor is only responsible for constructing the works per the designs.

Getting Insurance Advice

Often, parties misunderstand clauses relating to insurance in their construction contracts. It is important to run any insurance clauses by an insurance advisor, for example, your insurance broker. Your advisor or broker can help review the insurance clause against your insurance policy to ensure coverage under any relevant policy. 

A typical insurance clause will require that the Contractor ‘effects and maintains’ (at a minimum) certain insurances, as detailed in the contract as a ‘Required Insurance’. The insurance should be with a reputable insurance provider. Furthermore, there is often a condition in these insurance clauses that the Contractor provides, upon request, evidence of the insurance policy in the form of a certificate of currency. If you are the Contractor, it is best to ensure that the type of evidence is specified in the contract as a ‘certificate of currency’.

Key Takeaways 

A construction contract will form the basis of the obligations between a Principal and Contractor. As such, it is critical that you review it carefully to ensure it provides adequate protection, should things go wrong. Knowing key issues to spot when conducting commercial risk reviews is vital. Amongst other elements, a well-drafted construction contract should clearly address:

  • the scope of the work;
  • the contract sum and payment terms;
  • termination rights and consequences;
  • extension of time rights;
  • the process for variations;
  • defect rectification obligations; and
  • if any liquidated damages are payable.

If you need help conducting commercial risk reviews for your construction contracts, our experienced construction lawyers can assist as part of our LegalVision membership. For a low monthly fee, you will have unlimited access to lawyers to answer your questions and draft and review your documents. Call us today on 1300 544 755 or visit our membership page.

Frequently Asked Questions

What is an indemnity?

An indemnity is an obligation for one party to compensate the other for damages, losses, expenses or costs following a specific event. Typically, it entitles the indemnified party to recover more than a damages claim would.

What are liquidated damages?

Liquidated damages are a pre-agreed dollar amount. Where there is a delay, a certain amount of liquidated damages may be payable for each day the works are delayed. The rate of liquidated damages in a contract must be reasonable and must be appropriate to the losses experienced by the party claiming the liquidated damages as a result of the delay.

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