Contract terms allocate risk, whether or not all parties fully grasp how, while shaping the claims and disputes that all too often follow. On major capital projects worldwide, the impacts are quantified in the Fifth Annual CRUX Insight Report.
HKA consultants investigated 1,600 projects worth more than $2.13 trillion across 100 countries over a five-year period up to the end of July 2022. Analysis of their findings shows sums in dispute amounted, on average, to more than a third (35.1 per cent) of capital expenditure per project. Claimed extensions of time would prolong schedules by more than two thirds (68.6 per cent), typically adding 16.5 months to programmes.
No less significant is the diagnosis of the underlying causes. Change in scope may be inevitable on major, complex projects, but the industry is failing to manage this challenging process. Design conflicts are closely related to this top-ranking cause. Incorrect, late and/or incomplete designs are highly prevalent in all regions of the world, while in Europe design errors overtake scope change.
Contract interpretation
Complexity, however, cannot justify the other most recurrent trigger for claims and disputes worldwide. Contract interpretation issues are eminently more avoidable.
Ensuring clarity on responsibilities and liabilities is the principal aim of contractual agreements. If properly and clearly drafted – including documents, drawing lists and specifications – the contract should not be a source of conflict. The fact interpretations continue to clash can most often be explained only by lack of effort, time or money, if not competence, during contract preparation and staffing. In practice, insufficient time is probably the main reason, perhaps compounded by lack of training, or language skills where project teams are multinational.
Two caveats should be added. In the UK, contract misinterpretation has been reducing over time. What was the second most common factor in disputes pre-2020, has since fallen to ninth in the ranking. This fits with our recent experience supporting projects. Across Europe, greater care is being taken in compiling clear contracts.
We have observed parties are managing contracts more closely and stringently – defensively ensuring terms are unambiguous. On the other hand, commercial management has become cash-driven; the focus appears to be on managing money and cashflow rather than value analysis of progress against planned programme.
Force majeure
As anticipated in our previous annual CRUX Insight report, our consultants in the field have been dealing with more force majeure and ‘change in law’ events and their consequences.
Contractors have sought to recover additional costs, sometimes also invoking price escalation or ‘cost adjustment’ clauses. As more owners successfully push back against claims that events triggered by the pandemic were ‘unforeseen’, contracting parties are exploring other legal options and seeking remedies outside the contract. In certain jurisdictions, common law doctrines of frustration or material adverse change or hardship can provide grounds to claim relief.
Employers are refining contract terms on change of law and force majeure, which deserve special scrutiny. Contracting parties must ensure they strike a fair balance, given the probability of fresh outbreaks of coronaviruses and extreme weather events.
When drafting relevant contract provisions, it is important to consider lessons learned (what did and didn’t work) and whether a further outbreak would fall within the contractual definition of force majeure. Typically, this will only cover unforeseeable events and future covid-19 events may be excluded.
Questions that need to be considered include: Should future pandemics be explicitly included within the scope of force majeure? Can changes in law give rise to a contractual force majeure event? Will government guidance, regulations and circulars, which have a material impact, also qualify? Should new covid-19 events be included or treated entirely separately from the force majeure regime? Also, should a separate clause allow entitlement to a claim not just for time, but also compensation in certain circumstances?
Contracts need to reflect the known risk of future pandemics. However, it would be a retrograde step for risk management if contractors are made to bear a disproportionate share.
Regional variations
The prime causes of claims and disputes recur worldwide, but significant variations emerge in the CRUX Insight regional analysis. Some examples:
· Africa: In line with wider political moves to combat corruption, stronger governance processes and contract administration are needed to promote transparency – from procurement through to claims management. Often these processes are in place but not fully understood or observed.
· Americas: As rising costs squeeze margins further, more contractors are finding relief from sympathetic arbitrators or, in some cases, owners who choose to settle unsupported claims.
· Asia: A contracting culture averse to conflict and claims is changing. The administration required by certain contract forms is flushing claims out earlier in projects. In time, we expect a shift to more technical disputes.
· Europe: Many problems, including those revolving around design, contract interpretation, management of subcontractors and contract administration, can be avoided by doubling down on proven best contract management practices.
· Middle East: Analysed over time, projects are distressed by the same top factors, change in scope and late or incomplete design information. No other region shows such consistency or longer overruns. While payment procedures tend to be strictly applied on contracts, other contractual deadlines are routinely missed.
· Oceania: The root cause of many conflicts, including disputes involving design and management of subcontractors and interfaces, lies upstream in the planning, development and procurement of projects.
Looking forward
It is to be hoped increased emphasis on contractual clarity continues. There are also positive signs mediation and alternative dispute resolution avenues are becoming more popular in various jurisdictions. In a tighter financial environment, more cost-effective options should have greater appeal than litigation and arbitration.
Recent legislation heralds significant changes in several countries. Regulation of fire safety has been beefed up in the UK; developers, designers, contractors and construction product manufacturers face increased liability for defects. Prompt payment rules will be applied more widely in Canada. Employers in the Middle East, namely in states within the Gulf Cooperation Council (GCC) must adjust to labour mobility following full or partial dismantling of the Kafala framework.
However, certain deep-seated behaviours will continue to drive conflicts. Without a fundamental change of approach, complex projects delivered in a fast-track environment will continue to be entangled in the persistent causes CRUX highlights. Even, or especially, in turbulent times, project owners can achieve much greater certainty if they get the business case right in the first place. Pushing ahead for an early start before designs are mature, ultimately works against the interests of the employer and entire supply chain.
As with covid-19 and force majeure, parties should consider the commercial reality of who is best placed to shoulder the burden of damaging events. In an era of heightened uncertainty, risk allocation assumes even greater importance.
Legal and cost estimating teams must review forms of contract and amendments rigorously. Contractors should be aware of the need for price adjustments and/or cost indices to reflect increases in market rates for materials, transportation and labour.
Volatility in the global economy may persuade employers in jurisdictions where Engineer, Procure and Construct (EPC) contracting is the norm to embrace a more collaborative approach. This could deliver significant benefits in risk management.
If all parties, including subcontractors, engaged in open discussion before contracts were executed, they could identify risks, agree appropriate contractual provisions and contingency plans and costs, if needed. Thorough pre-contract due diligence by contracting parties can also mitigate supply chain risks.
With or without collaboration, parties can test assumptions and identify contractual blind spots. Stress-testing the contract before it goes live gives both parties the opportunity to understand how key provisions may work in practice. Either they then amend terms or put in place working practices to support compliance with the contract and optimise project delivery.
Not all conflicts can be avoided. Contracts should set out clear mechanisms to be used jointly by the employer and contractor to resolve them and avoid disputes.
Michelle Metz and Paul Cacchioli are Partners at HKA, the leading global consultancy in risk mitigation and dispute resolution hka.com
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