Do contract types determine a project's fate?
Construction contracts have been in the spotlight recently, particularly in the case of Boston’s Green Line extension project. The contractor group, White-Skanska-Kiewit, is under fire, and critics have said the maximum-price contract for the project is to blame for the $1 billion in project cost overruns. But can a contract type really make a project more susceptible to budget disasters, or are there other factors at work?
Different delivery methods
In the construction industry, there are two primary delivery methods, or the way in which a project is designed and then built. There is the standard design-bid-build process and the less conventional, but still widely used, design-build process.
Generally speaking, with the design-bid-build method, the owner contracts with an architect for the project design, then bids out the construction phase. With the design-build method, one entity, be it an architect, contractor, or construction manager, takes on both roles of designer and contractor.
A design-build contract, according to attorney John Agliano, of Bajo Cuva Cohen Turkel, PA, in Tampa, FL, can sometimes be riskier for contractors "because they’re taking on all the liability." On the other hand, Agliano said, "[The contractor] is in a better position to control what happens relative to the project because they control the design."
Because the owner is directly supervising the design-build team in this type of delivery method, according to attorney Michelle Schaap, of Chiesa Shahinian & Giantomasi in New Jersey, the sophistication of the owner should factor in heavily when deciding whether to use a design-build contract.
"Let’s suppose you’ve got a group of doctors that are building a surgery center. They’re not the people that should be overseeing a construction project," she said. "And if they get a design-build contract, who’s guarding the henhouse for them?"
Schaap said the owner can hire a construction manager to assist in the administration of the project, but that manager, although incentivized by payment, still has little risk.
The Construction Financial Management Association recently conducted a study investigating how contractors fare in contract disputes with federal agencies. To their surprise, they determined that "design-build has no advantage over design-bid-build in terms of producing better legal outcomes for contractors."
The CFMA‘s belief going into the study was that the pre-construction collaboration inherent on a design-build project would reduce conflict later on in the project. However, attorney Neil Connelly, of Brown, Gruttadaro, Gaujean and Prato, PLLC in New York said this isn’t always the case, and the CFMA results were no surprise to him. The CFMA finding, he said, "is simply a reflection of the impossibility of anyone to design a perfect project, or to foresee the unforeseeable."
"The best that can be done, and it is almost always found in large construction contract documents, is to provide for dispute resolution that allows the project work to go forward," Connelly said.
Schaap noted another unsurprising result of the CFMA study — the fact that contractors have been less successful in disputes with the Army Corp of Engineers.
"The Army Corp of Engineers, they know what they’re doing. So they can guard the henhouse themselves," she said. "And if they’ve got a design-build situation, they can absolutely oversee what’s going on. They can review invoices, and they can understand what they’re being given."
Varying contract types
Once the owner has determined the delivery method, there is a wide variety of construction agreements the owner and contractor can choose. The most common contracts, according to Agliano, are lump sum, cost-plus with no maximum guaranteed price and cost-plus with a maximum guaranteed price.
A lump sum contract, also known as a fixed price or stipulated sum, is used when the owner agrees to pay one, turnkey price for the entire project. Unless there is a change in the agreed-upon scope of work, the contractor absorbs all the costs and also benefits from any savings.
"It’s designed to fix in all your costs," Connelly said. "You should know your costs in advance. There shouldn’t be any surprises."
In cost-plus contracts, the owner pays all the actual costs of the project plus an additional percentage or markup fee for the contractor’s services. Cost-plus contracts can also include a cap on the dollar amount of costs for the project, or a guaranteed maximum price (GMP). This is a common contract type, particularly with government projects, and is the type of contract used in the controversial Boston Green Line extension project.
Agliano said public works projects are generally GMPs. "You don’t get a blank check with the public trough."
As to whether or not one type of contract is better for a contractor, Agliano said, "If I were a contractor, I would probably always want a cost-plus with no GMP because then I know you’re going to cover my costs, and I‘m going to make my 15% or 20%, whatever margin I can squeeze out. So from a contractor’s standpoint, that makes the most sense."
No matter the contract type, Connelly said American Institute of Architect (AIA) documents are the way to go. "The standard AIA contract is a pretty fair contract. It’s been through the mill, so there’s been a lot of input from both sides, and it tends to approach things in a fair manner," he said.
Are contracts to blame?
Using the Boston Green Line project as an example, can a GMP contract, or any contract, make a project more susceptible to budget overruns as some critics claim?
Even though they’re not involved in the Boston project, Agliano and Connelly said that from the information available, it looks like the fundamental problem in Boston is the lack of a complete set of plans and specifications at the start of the project, not a certain kind of contract.
Connelly said that in a GMP contract, the contractor is normally required to bid out each trade to no less than three subcontractors per trade. The owners can reject subcontractor bids and require re-bidding for any trade, and the GMP is not truly established until 85%-90% of the trades have been bought out.
"So it appears to me that the criticism of the contract method is unfair," Connelly said.
"If the plans and specs are complete," he added, "the prices should be competitive, and the (contractor) can work on negotiating the best price possible. If the plans are still being prepared, the costs can’t be fixed at the start, and the cost is unknowable. A consultant can provide an early guess as to the ultimate cost, but, without complete plans, it is just a guess."
So even though both experts agree the maximum-price contract itself is likely not the culprit in the Boston case, Schaap pointed to an even more insidious influence contributing to the chaos on the Boston project — public perception.
"Now, suddenly the public’s hearing the project’s going to be delayed by a year because they have to rebid." Schaap said the frustrated public is now thinking, "So let me get this straight. You had this great, fast-tracked, cost-efficient [process]. Now you’re telling me that you don’t like the GMP they came up with, even though you knew they weren’t going to come up with it until after the fact. Now you’re going to reengage, and you’re going to revisit it."
She added, "So from the public’s view, even though what the public entity may be doing is practical, responsible and appropriate, the taxpayers are saying, 'Where’s the improved T?'"
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