Digital Feature: The invisible hand in construction projects
In general, most construction projects are noble pursuits.
They all have a higher purpose, be it factories and warehouses providing jobs and therefore a means of livelihood to the local communities or infrastructure catering to the societal needs from schools, offices to hospitals. But the same cannot be said about the various actors involved in bringing a usually lofty vision to reality.
These actors, in project management parlance, ‘stakeholders’ have their own diverse interests, and varying degrees of skin in this so-called game of decisions, with their every move, and every choice, a reflection of their appetite for risk in exchange for some reward.
This tug of war between risk and reward drives every transaction and, therefore, every project. In such a zero-sum construct, it has become second nature for the stakeholders to constantly look for ways to maximize their returns, oftentimes by capitalizing on a slip-up or oversight. In many organizations and industries, this is lauded as a mark of competitive edge in project management and for project managers, this is almost a badge of honor. For companies adopting an ‘all is fair in love and war’ approach to project execution, this is just another day at the office.
As someone who is operating in this field, I have strong (and probably unpopular) opinions on what good project management should be and why, as project managers and professionals, it is important to play hard but also play fair. One tool which enables that in any project or undertaking is also arguably its most misunderstood element – the contract.
Contracts are ubiquitous in the world of projects, and they have been around for centuries. Contracts are invaluable to a transaction, any transaction, but their value remains largely unknown and unseen until a crisis rears its ugly head. In an ideal world, they must lay down the framework that governs the entire execution process in a project, in the same way the constitution does for its country’s citizens.
That is why I call them the ‘invisible hand’ in construction projects. Projects are guided by them and executed through them, yet they never show up during the normal course of business. But like an invisible hand, they are always lurking in the background, gently pulling the strings, nudging all the various stakeholders, one decision at a time.
So, what makes a contract great? A contract is not measured by the number of pages, but rather by its allocation of risk and reward. What makes it fair, balanced and above all, operable?
That is what I attempt to answer in this piece. A fair, balanced and operable contract, at a minimum, should include the following.
- Names, addresses and contact information of the parties. This is contracts 101. This section must identify and include the full legal names and addresses of the parties involved, along with designated contact persons for notices and communication.
- Effective date and term. The effective date is the date from which the contract is official and live. The term is the duration of its validity.
- Scope of work and deliverables. This is the heart of a contract in construction or any other professional field involving goods and/or services. For Goods, this includes a detailed description (or) a direct reference to the specifications as an annexure with information on quantities, quality standards and any other relevant technical data describing the goods supplied. For Services, this section includes a list of deliverables and performance standards, and most importantly, exclusions. A cardinal rule in contracts is that it is as important, if not more, to outline what the seller/service provider does not agree to supply/provide as it is to include what is supplied/provided.
- Obligations of the buyer and seller. If the scope of work and deliverables is the heart, buyer and seller obligations are the soul of a contract. One can think of it as a “to-do” list for both the buyer and seller. This section forms the operational core of the contract by detailing “who has to do what”, ensuring a smooth execution. For a seller/service provider, some common examples are to provide the goods or services as described in the scope of work and deliverables clause, perform services with due care and skill, comply with all applicable laws and regulations, transfer ownership/title upon fulfilment of contract, provide necessary documentation related to the goods or services. For a buyer, this could be to pay the agreed upon price in accordance with the terms of payment, accept delivery of goods or services when they are delivered according to the contract terms, provide free access to the site/resources (typical in construction projects), provide timely approvals, inspect and accept the goods or services, bear the risk of loss or damage after acceptance and comply with laws and regulations as applicable. It’s important these are explicitly stated in the contract to establish accountability and prevent misunderstandings.
- Price and payment terms. This is consistently among the most litigated clauses, at least in construction contracts, where parties actively look to take advantage of each other, and only clarity can ensure a level playing field. This section must cover the total price (mention appropriate currency) inclusive of taxes, duties and shipping/packaging costs. Clear milestones or timelines (ideally both) must be identified for payments. If the payments are linked to milestones (recommended), it is imperative that the milestones are linked to specific verifiable deliverables and not undefined terms, which can be open for interpretation. Now, what makes this section fool proof and fair is the inclusion of the process to be followed for payment i.e. the documentation to be submitted, information to be made a part of the invoice/payment application, comment window to raise objections or disputes that is not unreasonable and the notion of deemed acceptance should there be no objections raised.
- Lead time and completion date. No contract is complete without a completion date. Completion date is the date on which the seller is expected to fulfil his/her obligations as outlined in the contract. Lead time is the time it takes for the goods to be manufactured and shipped or services to be completed. Both the Completion Date and Lead Time are generally indicative in nature and subject to many stipulations which ought to be specified in this section, and are closely monitored by all the parties affected.
- Acceptance criteria. In many ways, this is the single most important section of the contract, especially for the party identified as the seller/supplier of goods and services. In this clause, the Seller and Buyer should agree on the criteria that the goods or services must fulfil for the buyer to ‘accept’ said goods or services. This could mean quality parameters or specific performance metrics that can be inspected, measured and verified by the buyer or any other agency appointed by the buyer. This is a hotly contested area in construction projects where a poorly defined acceptance criterion can leave the seller/service provider exposed to financial risk and even reputational damage if disputes are left unattended. Retainage of withheld funds, which can be a direct consequence of an imprecise definition of acceptance criteria, is common, but it ceases to be if this clause is watertight. Before entering into any contract, it is the seller’s prerogative to ensure that the acceptance criteria outlined in the contract are clear, practical and achievable.
- Representations and warranties. This is an often overlooked portion in contracts, also infamously called the ‘fine print’. It is so easy for the parties to over-promise and under-deliver through the use of inappropriate or worse, factually incorrect language, in this section, which could in turn become costly for at least one of the parties, if things go south. Warranties for goods by sellers must include guarantees provided by the seller regarding the quality, merchantability, and fitness for a particular purpose of the goods. The duration and scope of the warranty should be clearly stated. Warranties for services by service providers must include assurances regarding the provider's skills, qualifications, and the quality/workmanship of their work. Representations are statements of fact made by each party at the time of entering the contract, which the other party relies upon.
- Limitation of liability. How about some damage control? In situations where damages are claimed and such claims are credible, including this in the contract limits the liability (often financial) of one or both parties. However, these limitations are often subject to legal restrictions and should be carefully considered. Usually, it is a specific value and is equal to the total contract price agreed between the two parties or the portion of value that can be attributable to each party (in large contracts involving more than two parties). The value is recommended to be explicitly specified in this section without any ambiguity for this clause to be effective during a claim.
- Indemnification. Indemnification is a crucial component in large multi-party contracts, especially in projects that affect stakeholders outside the buyer and seller – this could include environmental regulators, neighboring properties, local communities, etc. These are the provisions outlining which party will be responsible for defending against and paying for certain types of claims or losses arising from the contract (e.g., claims of negligence, infringement). This section needs to be carefully drafted to ensure fairness and legality.
- Confidential information and IP. If the relationship involves the exchange of sensitive information, the contract should include statements outlining the obligations of each party to maintain the confidentiality of that information. This includes defining what constitutes confidential information and the duration of confidentiality obligations. For engineers, architects and people in the creative fields, intellectual property is sacred and leaving it unprotected is tantamount to professional suicide. It is vitally important to define who owns any intellectual property created or used during the course of the contract (e.g., software, designs, plans, reports). If one party grants a license to the other to use its intellectual property, the scope, duration, and terms of that license should be specified.
- Termination. Every contractual arrangement should be accompanied by an exit strategy for all the parties involved. Any contract unclear on its termination mechanisms is not only incomplete but also potentially damaging for the parties involved. Nobody wants to remain in an unhappy marriage, and it’s incumbent upon the contract to outline the following when it comes to its termination:
- Grounds for termination, i.e., under what circumstances either party can terminate the contract. This could include serious breaches, bankruptcy, or even misconduct.
- Notice period – the required notice period for termination.
- Consequences of termination, i.e., the obligations of all parties involved upon termination. For a seller, this could involve the recovery of payment for all goods and services provided up to that point, while continuing to comply with confidentiality obligations. For a buyer, this could include the return of his/her property and prompt repairs or rework of defective goods or services as outlined in the contract.
- Amendments. This is an underrated and therefore, underused clause in construction contracts as it empowers a party’s ability to manage change. It is well known that changes can be highly disruptive to a project schedule and especially in construction, where numerous tasks are interconnected and interdependent. Changes lead to delays, and delays are the single most frequent cause of disputes between parties. This section outlines how the contract can be modified or amended - usually ,any amendment requires a written agreement signed by both parties. What makes a good contract great is when this section also defines what constitutes a change and how the change is priced or valued. Changes in scope of work and timelines, which are very common in the construction world, and this clause provides a structure for these to be memorialized, guiding all the affected parties through this often painful process.
- Governing law and dispute resolution. Governing law is the jurisdiction whose laws will ultimately govern the interpretation and enforcement of the contract. If all the parties are from the same location, then the choice is already made. For contracts involving parties from different states or countries, a choice is made based on the connection a particular location has to the parties or the goods/services in question. Sometimes, the nature of the relationship is examined to determine the appropriate jurisdiction. For example, big U.S. corporations typically choose Delaware due to its corporate-friendly courts. In an agreement where one party is significantly larger in size, choosing the governing law of the smaller party could be a show of faith. These choices are complicated as the ramifications can be serious, and it is important to consult a contract lawyer before making the decision. Dispute resolution, on the other hand, outlines the agreed-upon process for resolving any disputes that may arise. This could include negotiation, mediation, arbitration, or litigation in a specific court.
A future article will examine the various types of contracts and what may fit your design and/or construction project.
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