CONSTRUCTION CONTRACTS Volume 3
One of the most important aspects of a development project is preparing a suitable construction contract that is appropriate for both the project in question, and the contracting parties involved.
An old adage from years gone by, is that a contract is a document that you simply sign and place in the bottom drawer and forget about. You need not open the drawer, unless an issue starts to crystalise. We emphasise this could not be further from the case.
A construction contract needs to be considered and administered effectively (and appropriately), from the date of execution, and every day thereafter, up until final completion – not just for the benefit of one, but all parties.
In this volume of the White Associates (WA) Education Series, we take you through some commonly asked questions and touch on a sample of key contract and contracting fundamentals, as well as identify some common contract deficiencies.
What is a construction contract really used for?
A professionally prepared construction contract will set out the guidelines and terms which govern the conduct of the parties during the project, and the wide range of events that may and can occur throughout a project’s lifecycle. They comprise payment processes, variation processes, insurance specificities, programme particulars, defects obligations, dispute resolution mechanisms, among other things.
A construction contract sets out the specific terms; comprising obligations, provisions, conditions precedent and more for the mechanisms above, they detail processes that form the contractual framework which all parties must work within.
In effect, the construction contract is the rulebook, as such, for both parties to follow.
Do you really need a construction contract?
WA provides a range of quantity surveying and advisory services on developments ranging in size from $500,000 to $1,000,000,000. No matter what size or scope of project, a construction contract is a non-negotiable requirement.
Notwithstanding this, we (and you also) may still get a client that questions why, or argues against, entering into a written Contract with their Contractor (for various reasons).
The reality is, pursuant to the Building Act 2004, residential building contracts are required for any construction works in excess of $30,000 (including GST) where a Contractor is contracting directly with a ‘homeowner’.
One should certainly not wish to engage in any form of construction project in excess of the $30,000 project value without having a record of what outcomes are required, what obligations and rights are imposed, or afforded, to each party, the terms of engagement, etc. We liken a construction project without a contract to driving a car on the road with no road code in place. Each party will conduct themselves in a way they see fit without a framework to guide the journey.
What forms of contracts are out there in the construction market?
There are various standard forms of construction Contracts which are New Zealand specific:
- NZS3910:2023 (most recent version of the NZS3910 suite of contracts)
- NZS3910:2013 (most commonly used form)
- NZS3915:2005 (more abbreviated form of NZS3910 with no Engineer to the Contract requirement)
- NZS3916:2013 (design and build contract)
- NZIA (less common – Architect administers the Contract)
- Master Builders Contract (Residential Building Contract 2018 – RBC1 New Build) (reasonably common on smaller scope residential projects)
- New Zealand certified builders contract (less common – smaller value projects)
Project specific circumstances will dictate the most optimal way and form to be utilised.
What types of construction contracts can be used?
There are various models under which a project may be Contracted, of the common ones being:
- Lump sum fixed price;
- Cost reimbursement;
- Target price;
- Design and build;
- Guaranteed maximum price.
Each contracting model has its their own positives, negatives, and optimal use-cases. Accordingly, generalisations are hard to make due to each project having different desired outcomes, circumstances, technical requirements and other, where risk allocation has to be catered.
The most commonly used type we encounter is lump sum whereby a borrower is desirous of a fixed price entry point, based on the contract documentation in hand at that point in time.
What is the most commonly used form of contract in New Zealand?
The most commonly used forms of Contract are those provided by New Zealand standards, being NZS3910, NS3915, and NZS3916, among others.
NZS:3910 accounts for nearly 80% of construction contracts written in New Zealand. It’s designed to be suitable for “most contracts, most of the time” (NZ Standards, 2023). These projects include a mixture of civil engineering and construction and vertical construction developments.
We find that the balance of contracts are concluded using Master Build, Registered Builders Contracts, and NZIA Contracts. These forms of Contract are typically less common, and reserved for, traditionally, smaller value residential projects.
Will the NZS 3910:2013 construction contract still be used now the NZS 3910:2023 contract has been completed?
There is still a substantive number of NZS3910:2013 forms of Contract afoot at the time of writing.
NZS3910:2023 was authored to supersede the 2013 version, with the 2023 revision of NZS 3910 is the first substantial revision in a decade.
As such, it is envisaged that there will be a natural transition from 2013 to 2023 version Contracts; however, there will remain a number of Contractors and Principals alike that may be more comfortable with administering the 2013 (or other reason), where the 2013 revision may still be used and relevant for a time to come. We are already assisting in the administration of 2023 version NZS3910 Contracts for Principals where their previous projects were contracted via the 2013 form.
Overall, we agree that the 2023 Standard is a step in the right direction in terms of risk allocation and aligning the industry standard form with current market conditions.
As with most projects, some level of special conditions are inevitably necessary to reflect bespoke project parameters and facilitate project specific risk allocation.
Given the already substantive and detailed articles and musings from the industry in respect of the key changes from NZS3910:2013 to NZS3910:2023, we refer you elsewhere for commentary on these key changes. Please note WA is available to provide specific guidance/presentations to your funding team, should you desire further insights in this regard.
When would an NZS 3915 contract be used?
Typically, a NZS3915:2005 standard form of construction contract is used on smaller value projects, where it would be economically inefficient for an independent certifier and contract administrator to be engaged (in the context of NZS3910:2023).
We find this construction contract to be quite suitable in many instances where WA have added special conditions to accommodate a wide variety of project types and scenarios. Astute borrowers with contract administration knowledge often prefer this contract setup which enables them to perform the Principal’s representative role. Again, this may be more economically efficient for suitable Borrowers.
Please note on higher value and more complex developments an independent certifier is recommended to administer the contract to create more fair and balanced outcomes.
Who should prepare and draft a construction contract?
Once a standard form of construction contract is decided by the parties, it is recommended that a construction contracts specialist is engaged to complete this task. This is in tandem with a quantity surveyor, engaged as a commercial advisor, to cover cost and bespoke technical construction matters a particular project may need set up.
With any contract, we view it through the lens of whether it is commercially acceptable from a Funders perspective, to ensure this is encapsulated in the final draft.
White Associates advisory department undertake this scope of services and has helped set up many Funded projects, with a tailored construction contract for each circumstance.
Can you (should you) leave a standard form of construction contract unamended?
Standardised construction contracts enable cost savings and a reduction in manual effort; however, we hold the view that at least some amendments are likely needed to provide for the consistency of terms and to cater the risk allocation appropriately for the project in question. Most projects have a bespoke element to them, or nuance, that would require a modification to the standard terms. It is also important to note that some of the older construction contracts (i.e. NZS3915:2005) need to be amended to reach what would be deemed a commercially acceptable format for current market conditions, standards, funder requirements and customs.
What does White Associates look for in a construction contract?
Key facets of a construction contract we look for are performance measures, payment provisions, extension of time provisions, variation mechanisms, funder security provisions, dispute provisions, and Principal obligations. We will also form a view as to whether the risk profile is balanced.
An example of an unbalanced risk profile would be the Contractor taking on ground risk for a very low risk premium. We have found that instances such as the aforementioned can lead to unfavourable outcomes, whereby contractor default and insolvency result as a consequence.
We also strive to ensure that Borrowers comprehend their construction contracts, the reasons for incorporating the performance measures, as well as the contract framework, to ensure obligations and risks are fully understood. Undertaking the bank funding representation role, we see a range of onerous terms, and contract deficiencies. The ones we most often see include:
- The company entity noted in the contract being incorrect
- The contractor’s performance bond wording not being in line with funders expectations
- The Engineer to the Contract (in NZS3910:2013) is not an impartial person
- Separable portion handover ambiguity
- The documents to be incorporated into the contract (drawings specifications, consents, reports) have not been considered in their entirety
- Separate contractors (subcontractors the Principal may need to enter site and perform work during the contract duration) have not been considered – this includes service providers such as Vector, separate fitout contractors, house builders, etcetera
- The defects liability retentions value is capped at an unreasonable level for the value of the project
- The construction programme is not comprehensive, and does not identify the critical path
- The working days included in the contract do not align with the construction programme
- The insurance section is not filled out correctly, which results in the level of insurance being inadequate
- There is no provision for liquidated or general damages, with the Principal effectively waiving its right to all damages relating to late delivery of the contract works under the contract
From a birds eye view, the question we find ourselves answering with every contract, is whether the contract has the requisite suite of mechanisms that would be deemed commercially acceptable, and appropriate to deliver the project in question.
Is the form of contractor’s performance bond important in a construction contract?
A question that often arises at the contract execution stage of a project is whether a bond should be required, and whether the form of bond is important.
Many principals elect requiring a Contractor to provide a form of ‘security’ by way of contractor’s performance bond, and in short, the form of this bond is imperative.
There are a variety of forms of contractor’s performance bonds. An example of standard New Zealand forms of Contractor’s performance bonds are cash or deposit bonds, insurance (surety) bonds, bank performance bonds, on demand bonds, and conditional performance guarantees.
It should almost always be the Principal’s preference for the on-demand bond, should this form be satisfactory to the bondsman and contractor. An on-demand bond is a type of bond whereby the bond provider (usually a bank) is required to pay out the bond amount on demand, without certification from an independent party as for whether the contractor has defaulted.
It is well regarded that this form of bond is a more ‘straightforward’ form of security for the client, as it allows them to receive payment without having to go through a lengthy, or costly claims process.
Calling on a bond is relatively straightforward when the bond is an ‘on demand bond’ as opposed to other conditional bonds, which may be problematic, given calling on a bond is usually defended and often ends up in formal dispute proceedings.
Bond wording is paramount, and it is highly recommended that bond wording is reviewed by a construction specialist to ensure the bond specifics are acceptable.
Is administering the contract in accordance with the construction contract terms important?
Administering the contract in accordance with the construction contract terms is extremely important. Failure to do so could result adverse consequences.
We find contract administration a key area that is often managed deficiently, or erroneously, which requires careful monitoring (especially in our capacity as a bank funding representative). We believe it is necessary for more education to be placed on contract administration, as many borrowers (Principals) and their advisors/ professionals do not adhere specifically to the contract provisions – which can in some circumstances lead to Principal default.
First prize is the Principal and its advisors administering the contract strictly in accordance with the contract conditions. This ensures the sanctity of contract remain as originally contemplated and stipulated in the contract (particularly to rights to remedies being retained).
In the event a dispute arises and the Principal has not administered the contract correctly, the Principal may find themselves in a position which may result in an unfavourable compromise (economic, or otherwise) by necessity, due to its conduct resulting in a waiver of its rights.
We have seen many occasions where a client (Principal) believe they have a strong case for Contractor default, however, the Principal has then surprisingly found themselves in default as well, which limits their options.
What should be done if a dispute is likely to occur in a construction contract?
WA would recommend that a construction disputes specialist be engaged to ensure that the Principal’s (client’s) rights and remedies to the Contract are not prejudiced or waived. WA can assist in this regard and undertake an initial analysis of the situation by performing a project health check thereby assessing whether the Principal has met its contract obligations, before deciding on a resolution, or avoidance strategy.
Where the Principal or its agents have not met their obligations, engaging into a settlement, or commercial consideration discussions may need to be constructively contemplated more strongly than the litigation, or private dispute mechanism routes.
Notwithstanding intent, dispute resolution processes are expensive and this must be taken into account when contemplating the most effective dispute resolution strategy.
Overarching Musings
Taking a birds eye view, there are a myriad of matters concerning construction contracting and as it relates to key contract terms, risk allocation, obligations, among other things.
It is always recommended that contract specialists be engaged in the preparation of a contract to ensure that your rights are protected, the contract is fit for purpose, and commercially acceptable.
One process we find absent in many projects is the review of the contract by a commercial specialist, for example, a quantity surveyor, who may be more well versed on more bespoke commercial considerations, industry standards and trade practice.
Above all else, a professionally prepared contract ensures that risk sits with the party best placed to manage that risk, thereby reflecting acceptable commercial outcomes for both.
Disclaimer
The content of this article is general in nature and not intended as a substitute for specific professional
advice on any matter and should not be relied upon for that purpose. It is current as at the date of publication only.
Darin Bayer
Director, Project Finance Representative
dbayer@whiteassociates.co.nz
021 128 7363
Justin Bearne
Associate, Project Finance Representative
jbearne@whiteassociates.co.nz
021 667 551