If you are looking to engage a contractor to carry out construction, fit-out or repair and maintenance works, there are several key provisions that you need to be aware of as an in-house counsel. Vitally, you need to address cost considerations in construction contracts to reduce the likelihood of budget blowouts. It is near inevitable for a construction project to involve some cost escalations, whether they be as a result of changes to the scope of the works or unforeseen events. You can mitigate some, but not all, of these escalations under a contract. It is also possible to reduce the probability of other costs arising during the procurement and pre-contract stages of a project. This article explains how to reduce cost escalations on your upcoming construction project and protect your business from responsibility to cover those costs.

Procurement of Construction Contracts

To reduce your costs, it can often be helpful to:

  • obtain quotes from multiple contractors; or
  • carry out a competitive tender process.

You will need to consider whether to engage: 

  • a contractor to carry out both the design and construction of the works; or 
  • design consultants such as architects and engineers, then hire building contractors separately. 

Even where you elect for the latter, you can make the contractor responsible for both the design and construction aspects . This can be achieved by engaging them under a design and construction contract. The benefit of this model is having a single point of responsibility and liability for any defects, which can be beneficial and cost-saving in the long run.

However, a design and construction contract will come at a cost premium in the short term. This is because the contractor is incurring increased risk. You need to balance these issues when making cost considerations in construction contracts.

Contract Pricing

You can procure construction projects based on several different pricing models. The most common are:

  • lump sum, being a fixed figure representing the price for the works that is subject to any adjustments according to the contract, such as for variations;
  • schedule of rates, whereby the contractor prices the works based on quantities of materials and labour, following a schedule of hourly or daily rates provided by the contractor; and
  • cost-plus, which includes the actual cost of the claimable construction works (such as labour and materials), as well as the application of the contractor’s margin on top of such costs.

Choosing a lump sum pricing model is the most common and will generally provide for the greatest cost certainty. Alternatively, you might use a cost-plus sum where you want to prioritise the quality of the works over the cost. 

Your contractor might include a schedule of rates in a lump sum contract to be used in pricing variations to the scope of works. However, contract sums based solely based on schedule of rates pricing tend to be more common in infrastructure projects, as opposed to commercial fit out projects, for instance.

Scope of Works & Variations

Any cost considerations in construction contracts will clearly relate to the actual work that your contractor will complete. A construction contract will require your contractor to perform a scope of works under the contract documents. There is always potential for this scope to change during a project, including where:

  • there is a change to the designs or construction works as directed by your business, requested by the contractor or due to a discrepancy in the contract documents (for example, changing a certain material or requesting additional or less work);
  • latent and unforeseen conditions arise on the site, which could not have reasonably been foreseen by a competent contractor at the time of tender;
  • there are changes in law or the requirements of an authority, resulting in necessary amendments to the design or construction works (for instance, a cladding product being determined illegal for use).

There are ways to reducing the potential variations on a construction project, including to:

  • ensure the contract documents, designs and specifications for the project are complete, comprehensive and accurate, to reduce the risk of gaps and inconsistencies; 
  • make the contractor accept the risk of any gaps and inconsistencies in the contract documents;     
  • expressly limit the contractor’s entitlements to claim variations under a contract; and
  • insert ‘no claim’ provisions in the contract in the event of certain events or circumstances, including those which you could reasonably expect the contractor to take responsibility for (such as where the contractor has prepared the designs and needs to change the construction works as a result of an error in their design).

Liability

As with any contract, a provider of goods or services will typically ask for the inclusion of provisions relating to its liability, including: 

  • a limitation of liability;
  • an exclusion of consequential loss; and 
  • for the concept of proportionate liability to apply. 

These provisions relate to the level of responsibility the provider is willing to accept for any defects or errors in their work. In principle, construction contracts are no different. However, there are aspects which, according to market standards, apply differently in a construction setting.

It is market standard to include a mutual consequential loss exclusion, which protects both you and the contractor from responsibility for any indirect impact on your respective businesses arising out of the contract. Most contracts also include a provision which reduces each party’s liability proportionately to the extent the other contracting party caused the relevant liability.

However, to make the construction contracts more favourable to your business, you should (at least at first instance) seek to exclude the operation of the relevant proportionate liability legislation, where possible. This is obviously beneficial for you, particularly when there are multiple contractors or consultants involved on a project and you want a single point of responsibility.

When it comes to indemnities and liability caps, however, construction contracts differ somewhat from other commercial contracts. The following clauses provide guidance on what is generally a market accepted position.

Example Indemnity Clause

Despite any provision to the contrary, to the maximum extent permitted by law, the Contractor is liable for and indemnifies and holds harmless the Principal for and against all Claims suffered or incurred (or which may be suffered or incurred) by the Principal, arising out of or in connection with:

(a) a breach of this Contract by the Contractor;

Drafting tip: A Contractor will generally (and reasonably) reject a broad indemnity for breach.

(b) any personal injury or death;

(c) any property loss or damage; 

(d) any infringement of any third party’s rights (including but not limited to intellectual property rights); and

(e) any negligent act or negligent omission of the Contractor or its personnel,

arising out of or as a consequence of the carrying out of the Works, but the indemnity will be reduced proportionally to the extent that the negligent act or negligent omission of the Principal or its personnel (not being employed by the Contractor) may have contributed to the relevant Claim. 

Drafting tip: This proportionality wording is reasonable to extend to the Contractor, noting it is limited to the Principal’s negligence.

Example Limitation of Liability Clause:

1.1(b) Subject to clause 1.1(b), to the maximum extent permitted by law, the Contractor’s aggregate liability arising under or in connection with this Contract will be limited to $[insert] OR [insert]% of the Contract Sum.

1.1(b) The limitation of liability in clause 1.1(a) will not apply where the Contractor is liable for any Claim:

(a) that is recoverable under a policy of insurance effected or maintained (or required to be effected and maintained) pursuant to this Contract, limited to the relevant amount of insurance required by this Contract;

(b) for any infringement by the Contractor or any of its personnel of any intellectual property rights;

(c) arising out of the death or personal injury of any person;

(d) arising out of a breach of confidentiality or privacy by Contractor or any of its personnel;

(e) arising out of fraud, wilful misconduct, wilful default, gross negligence or criminal conduct by Contractor or any of its personnel; and/or

(f) arising out of property loss or damage, 

Drafting tip: The Contractor will generally push back on this carve out to the limitation of liability. It is generally market standard and reasonable for a contractor’s liability for property loss or damage to fall within the liability cap (on the basis that hopefully it will be recoverable under an insurance policy and given the relatively high risk of such loss or damage in a construction setting).

in which case, the Contractor’s liability for any such Claim will be unlimited.

1.1(c) This clause 1.1 will survive termination or expiry of this Agreement.

Key Takeaways

Whenever making cost considerations in construction contracts, you must attempt to mitigate escalations. However, you cannot necessarily manage costs solely through the careful drafting of your construction contract. Efforts early on in a project can reap rewards from a cost perspective, including:

  • determining the right procurement model for the project;
  • ensuring the contract documents are accurate; and
  • sourcing several quotes or tendering.

It is also a good idea to:

  • ask that the contractor indemnifies you for any damage that they suffer during the course of the project; and
  • carve out limitations to the contractor’s liability where possible.

If you would like legal assistance drafting or reviewing a construction contract, contact LegalVision’s construction lawyers on 1300 544 755 or fill out the form on this page.

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