Chapter 9 Procurement and Contract Strategy: Risks allocation and

Chapter 9

Procurement and Contract Strategy: Risks allocation and

construction cost

John Adriaanse and Herbert Robinson

1 Introduction

Significant investment is required for the development of construction projects. An

appropriate procurement and contract strategy is therefore necessary to protect such

investment and to achieve value for money for clients and investors who have a stake

over the long-term use of such facilities. However, clients are often faced with the

dilemma of how to procure construction projects and what type of contract to use to

ensure that projects are delivered in the most cost effective and efficient, and most

significantly to ensure that the facilities is fit for the purpose intended. In deciding

what procurement strategy to adopt, it is important to understand the key drivers of

change or factors that will or are likely to affect the particular sector or industry the

project is operating in.

The central dilemma for clients is often how to select consultants and contractors

(with an information advantage) that can act in their best interests in the project. This

information asymmetry gives rise to two fundamental problems. The first is what is

usually referred to as ‘incomplete contracts’, lacking sufficient precision to define the

project, cover the entire scope of work including all possible risks. The greater the

completeness of contract documentation, the lower the potential for dispute, abuse

and opportunism but it is difficult to achieve this in real world contracts. Second, it

creates the potential for abuse and mistrust in the relationships between various

parties.

This chapter examines the link between procurement and contract strategy, the role of

contracts in allocating risks, and the relationship between parties in various types of

procurement as well as the implications for construction cost. It starts with an overview

of the need for an effective procurement and contract strategy. The key risks in relations

to the different forms of contract, mechanisms for the allocation of risks from

traditional architect-led approaches to integrated fast-track methods of delivering

projects are discussed.

2. Procurement Strategy and Contract Selection

Procurement strategy and the form of contract chosen can have a significant impact

on the cost and time overruns in major projects. Procurement involves actors (public

and private organisations such as design and construction firms) and the organisation

of activities (from planning, design, construction to operation and maintenance) to

deliver an asset (Howes and Robinson, 2005). The project stages are generally

sequential but there are overlaps between certain activities such as design and

construction and sub-activities or packages such as concreting and formwork. The

degree of overlap depends on the choice of procurement method. For example, in

traditional procurement, there is very little overlap between the design and construction

stages compared to ‘design and build’ where there is a significant overlap.

Within each stage of the procurement process, different actors involved have various

expectations which can sometimes conflict, create risks with potential cost

consequences. For example, whilst an architect might have a preference for an

innovative approach which poses additional risks, the structural engineer’s proposed

solution could affect the architect’s desired shape and form of the design and the

appetite for risks. Similarly, the services engineer might have a preference for running

service ducts in a particular way or direction but this could affect the work of the fit-out

specialists in terms of patterns or space configuration. The nature of these interactions

and the risks involved in the design process could also affect the construction cost or

budget set by the quantity surveyor or cost engineer.

The nature of interaction of the key actors depends on the procurement option chosen

which defines the actors involved, their role, at what stage they are involved in and the

precise relationship between, for example, the client, architects, structural engineers,

quantity surveyors and fit out specialists. In traditional procurement system, the builder

and facilities management consultant has no input in design which could affect the way

the building is constructed and operated. This is in sharp contrast to other approaches

such as ‘design and build’ procurement with a major input on ‘buildability’ at an early

stage or PPP/ UK PFI procurement system, where the facilities management consultant

has a significant input in the design as a greater emphasis is placed on the functionality

and flexibility of the buildings during use. There is a need to select an appropriate

procurement and contract strategy to govern the relationships between key actors,

clients and consultants, contractors and specialist subcontractors. It is important to

ensure that these two elements are carefully considered as they are intrinsically

linked. First, the procurement strategy provides the ‘direction and speed of travel’ and

second, the selection of the appropriate contract forms reflects the client’s appetite for

risk and ‘level of comfort in the journey’ to deliver a construction project. These are

major decisions which the client cannot afford to get wrong as it will have significant

implications on the costs and the time taken to deliver a project.

The key to a successful procurement strategy and contract selection is to identify the

priorities in the client’s objectives and to plan a journey or path that will deliver the

project on time, within budget and to the required specification. Procurement routes

depend on a range of factors such as the type of project, expected project completion

date, relationship between key parties and the allocation of risks. For example, it is

widely accepted that the traditional procurement method places more risk on the client

but the design and build approach allocates more risk to the contractor. The type of

contracts also plays a key role in the allocation of risk to different parties. Selecting a

construction contract is dependent on a number of criteria which include but are not

limited to the type of work , value of work, expertise of client and amount of control

required, programme requirements and importance of price certainty. The process of

choosing a contract type should therefore satisfy the requirements of the project to

ensure that risk allocation is appropriate based on the needs of stakeholders - clients,

consultants, contractors and sub-contractors.

3. Wembley Stadium Case Study

In October 2000, Wembley stadium was closed and demolished in late 2002 for a

major redevelopment of an iconic stadium. The aim of the Wembley project was to

design and build a state-of-the-art national stadium to be the home of English football

and to host large events such as cup finals and music events and athletics. The roof

structure covers 11 acres, 4 acres of which are movable. The 90,000 seat capacity

makes it the second largest stadium in Europe next to the Nou Camp in Barcelona

with a capacity of 98, 000, but it is one of the largest in the World to have a covering

roof. There are 310 wheelchair spaces and increased capacity for other physical

impaired spectators. In addition, there are 400 media seats, 2,618 toilets and four

banqueting halls, the largest of which can accommodate 2,000.

The procurement system used for the development of the Wembley stadium project

was design and build and the form of contract used was the guaranteed maximum

price (GMP). According to Construction Manager (2006, pp.12), “Politicians

perceive GMP contracts as a panacea for all cost overrun”. The managing director

of WNSL was certain that the project was well defined and was not going to be

subject to many changes (Construction Manager, 2006, p.13). This type of contract

was said to be good for clients who want to make sure they will spend no more money

than they have budgeted for. In Feb 2000, some of the potential bidders such as Sir

Robert McAlpine and Bouyges pulled out of the bidding process because of serious

concerns about the form of contract proposed.

Key Parties

The client was Wembley National Stadium Limited (WNSL) and the architect

employed was Foster and Partners and HOK Sport, one of the world’s leading design

firm and provider of project delivery services. They employ about 1,600 professionals

across America, Europe and Asia. The main contractor was Multiplex Ltd, an

Australian based contractor, part of a group employing over 2,000 people with

established operations in Australia, New Zealand, United Kingdom and the Middle

East. There were also a number of specialist subcontractors involved. The original

steel sub-contractor was Cleveland Bridge but they were eventually replaced by

Hollandia (designbuild-network.com 2006). The mechanical and electrical contractor

was Emcor Drake & Scull and the building services engineering was carried out by

Mott MacDonald. There were a number of other engineers and consultants involved.

Project Implementation

According to sportengland.org (2007), Multiplex had secured a design and build

contract to build the new Wembley Stadium. The total construction cost was put at

£326.5m but by the time the bid had been signed, the cost increased to £445m. In

September 2000 just after Wembley Stadium Ltd had announced that it had chosen

Multiplex Ltd as the contractor, there were delays as politicians argued over what

Wembley should be used for. They also had trouble attracting investors, costs began

to escalate and the design went back to the drawing board several times (Construction

Manager 2006, pp.13). The initial target completion date was to May 2003, but work

started in September/October 2002. The revised completion date set was March 2006

before the May 2006 FA Cup final, by which time the price of the stadium had risen

to £757m. During the implementation, the relationship between Multiplex and its steel

subcontractors, Cleveland Bridge, was problematic. As a result, Cleveland Bridge left

the site in 2004 because they did not believe they would be paid for materials and

there were serious difficulties between the two parties (designbuild-network.com 2006).

According to Construction Manager (2005, pp.19) both parties appeared in a court case on

April 2006. Cleveland Bridge claims that there were serious problems as a result of late

and incomplete design which has caused cost increases and 50.5 week delay. According to

designbuild-network (2006), the two companies sued each other for breach of contract.

Multiplex sued for £45m and Cleveland Bridge sued for £22.5m. In Multiplex Constructions

(UK) Ltd v Cleveland Bridge UK Ltd & Anor [2008] EWHC 2220 (TCC) Mr Justice Jackson

(as he was then), found in favour of Multiplex. Of his long and comprehensive judgment he

said that it was likely to have few readers.

In November 2005, the Construction Manager, under one of its articles titled “more

than a stadium” had an interview with Mike Richardson of the Wembley Stadium.

The tone of an unhappy client was cited as Mike Richardson said;

“We cannot tell them how to build a job or who to use. They’ve got a fixed price

for this job……we are not a risk transfer organisation. Every time we change our

minds they have the opportunity to say that wasn’t in our original price. So the

trick is not to change your mind too often”

In 2006 multiplex had estimated losses rising to £106m according to Construction

Manager (2006, pp. 13). Multiplex intended to claim £150 from WNSL for 560

design changes and according to Construction News (2006, pp.2) Multiplex

confirmed that its losses on the Wembley contract was at £180 million. The stadium

was completed in March 2007 and was ready for the 2007 FA Cup final. The final

construction cost was £798m with an additional time overrun of 12 months.

3. Allocation of Risks and Forms of Contract

The construction of the new Wembley Stadium is a landmark project which has been

controversial and fascinating but raises important issues about how to allocate risks

appropriately. The parties were highly experienced and had access to high level legal

advice. Despite this it spawned at least 25 cases and numerous adjudications. It raises

important questions about the procurement strategy (design and build) and the

secondary process of actual construction. It is imperative that the form of contract is

used to support the procurement method ensuring that it is sufficiently detailed and

clear to accommodate both the client and the contractor’s appetite for risks. If

appropriate decisions about risks allocation are not taken during the early stage of a

project, it can have a significant impact on final cost and duration of a project.

Risks are varied in construction work. Some are known at the time of contracting.

Examples are that the completion date which is crucial e.g. a supermarket or an

Olympic stadium. In others the financial consequences of late completion is known:

in Masons (A Firm) v WD King Ltd & anor [2003] EWHC 3124 (TCC), the parties

knew that if the completion date was not met losses for the year would amount to

£600K. In Copthorne Hotel (Newcastle) Limited v. Arup Associates and anor (1996)

12 Const LJ 402, the risk created by a medieval wall close to the site of piling meant

all the piling subcontrcators inflated their prices to cover the risk.

There are other factors that can also affect the progress of the work. Chief of these are

the unforeseen risks such as: (a) unexpected ground conditions (b) unpredicted

weather conditions (c) shortages of material and skilled labour (d) accidents, whether

by fire, flood or carelessness and (f) innovative design that does not work or proves

impossible to construct. As a result, the allocation of these risks is a very important

part of the contract since these factors always result in additional costs being incurred.

This inevitably raises the question of who should pay (Adriaanse 2010).

Risk and uncertainties are part of construction work regardless of the size of the

project. The selection of a particular form of contract can affect the balance of risks or

can shift particular risks towards one of the stakeholders. There are various forms of

contracts which define the relationship of the parties in a construction contract and

risks allocation through contract clauses and conditions. For example, there are

clauses relating to modification of design or quality where circumstances in which the

work is carried out changes and the consequences for such changes, valuation of the

cost consequences due to design variations, claims where contractors are entitled to

additional payments, dealing with unforeseen events, interim payments for regular

work progress, extension of time, and the cost implication of extension of time which

are all essential in contract management to ensure the smooth running of construction

projects. The precise wording of the clauses is also important as they are potential

sources of conflicts between different parties involved and can lead to delays and cost

overruns.

An appropriate contract form is therefore required to work in conjunction with the

chosen procurement method. The selection of the procurement route will directly

affect the contract options available. There are numerous standard forms of contract

available. However, the most commonly used contracts are the Joint Contracts

Tribunal (JCT) and the New Engineering Contract (NEC). The International

Federation of Consulting Engineers (FIDIC) which is similar to the ICE contract is

used mostly on international projects. Contracts can also be bespoke or tailored to the

specific requirements of the parties but can be costly and time consuming process

compared to utilising the standard forms.

4. Risks and Construction Costs

There are number of approaches used to deal with the problems of risks. For example,

by choosing a particular form of contract, incorporating special provisions in a

contract or by creating or increasing the contingency funds available. Care has to be

taken when considering bespoke amendment to standard forms of contract. They are

usually drafted by a committee drawn from the industry and as such represent a

consensus on the allocation of risk. Amendments need to be made sensitively on order

not to disturb that allocation.

At the heart of the standard form is the doctrine of privity of contract and ways of

dealing with it. At tender stage provisions need to be inserted to provide protection for

the employer and third parties. For the employer, direct warranties are needed to

allocate rights against subcontractors and suppliers (these are additional to that owed

by the contractor to the employer). The JCT family of contracts also allows for the

provision of Collateral Warranties or the use the Contract (Rights of Third Parties)

Act 1999). These also provide protection against contractor insolvency by providing

‘step-in’ rights for the developer or client should this occur. In addition it provides

for termination of the employment of the contractor for specified defaults and most

important for the financial consequences that follow. The contractor is also required

to take out joint insurances to provide cover against construction activities causing

damage to third parties.

There are other types of risk indirectly affecting a project such as disruption to third

party business (e.g. traffic, noise, business closure etc), industry risk which might

affect the entire industry (e.g. national strike involving building workers) and

corporate activities of the design and construction firms involved in a project which

may have serious business consequences.

Risks should be examined at an overall project level as well as a detailed level

looking at specific clauses of a contract. At a project level, if a client is interesting in

price certainty, the lump sum (fixed price) contract would be the most appropriate as

the final cost is determined prior to start of the construction. This contract can be

agreed either ‘with quantities’ or ‘without quantities’. Regardless of the agreed lump

sum cost for the works, any variations to the project will result in additional costs.

There is also the option of using ‘measurement contracts’ where the client retains the

risks as the final contract sum is not agreed until the project is completed. This type of

contract is often used in projects, particularly refurbishment projects, where the extent

of the work cannot be quantified or is not clearly defined at the tender stage. The

client takes the risk regarding the final quantity. If this increases substantially then the

agreed rate for the works would result in a considerable cost increase to the client.

Cost reimbursement (sometimes called cost plus) contracts are also used based on the

cost for labour, plant and materials and an agreed overhead and profit percentage is

added to this amount. This type of contract places a high level of risk on the client to

pay for construction work without sufficient or detailed knowledge of the true cost

which can sometimes provide little or limited incentive for the contractor to keep

construction costs down. There is an alternative incentive based contract such as

guaranteed maximum price (GMP) contracts or pain-gain sharing sometimes called

target cost contracts to provide an incentive for contractors to keep costs down by

sharing the savings made during construction with the client.

Risks should also be examined at the detailed level looking at specific contract

clauses which can affect project performance, design quality and the budget of a

project. Risks can sometimes be eliminated by a complete re-design of schemes or

elements of the design by client’s architect, minimised by choosing a traditional

design rather an innovative design solution, transferred, for example, through design

and build contracts or passed on to specialist sub-contractors. The options to manage

risks will consider the potential costs for risk transfer, containment and risk reduction

policies such as insurance. In practice, the distribution of risk is analysed through a

comprehensive risk matrix or register and appropriate project costs are allowed for or

added (value of risks) during the estimating process. Examples of risk may include

design errors, inaccurate cost estimates, inflation, poor site and ground conditions,

variations in weather, labour availability, hidden defects and quality of materials.

Risk response strategy and appropriate mitigating instruments will be required (see

examples in Tables 1 and 2).

Table 1: Examples of Risk Response Strategy

Risk Strategy

Examples

Eliminate/Avoid

Eliminate potential threats to project e.g. review design

processes, change design, adopt alternative construction

technique or use new materials

Distribute/Share

Introduce a pain/gain sharing mechanism e.g. Guaranteed

Maximum Price (GMP) contract,

Transfer

Does not reduce criticality; move to another party best able to

manage it e.g. contractual provisions or insurance

Use lump sum (transfer to contractor) or

cost plus contracts (transfer to client)

Accept/Retain/Reduce

Other options are undesirable, uneconomical or impossible e.g.

can reduce risk by in-depth site investigation

Risks should be analysed in an organised and systematic way considering the full

impact on programme time and cost overruns. Too often risks are dealt with in an

arbitrary way or ad hoc fashion by simply adding a percentage for contingency on the

estimated project cost. Irrespective of the type of contract chosen (whether fixed

price, cost plus or guaranteed maximum price), there will always be a need for the

client or contractor to avoid cost and time overruns in construction projects. Adopting

a systematic risk management approach to itemise and quantify all the risks involved,

whether it is in the form of measured works in the bill of quantities or special

conditions of contract, is essential to manage project time and cost effectively.

Table 2: Examples of risks mitigating instruments

Risks

Mitigating Instruments

Design

Professional Indemnity Insurance

Cost Overruns

Inflation

Standby Credit

Contingency Funds

Contract Clauses

Delays

Liquidated Damages

Hidden Defects

Contractual Arrangements

Force Majeure

Insurance

5. Procurement systems and Contract Issues

5.1 Architect-led or traditional system

In the architect-led or traditional system, contractors are invited to tender on the basis

of complete drawings, specification and other contract documents defining the scope

of the work. Competitive tendering is based on complete design such as key design

drawings, specification, bills of quantities. Co-ordination by the architect or lead

designer is absolutely critical in relations to specialist contractors responsible for the

building structure (core and shell), services, and the fit -out work or configuration of

spaces and building elements. Co-ordination only links at the design level are shown in

dotted lines below and the other lines reflects the contractual and co-ordination links.

Figure 1: Traditional System

The contractor is selected based on price, and other technical factors such as time for

completion, sustainability, health and safety strategy and project programme. The

lowest tender or best value bid is traditionally accepted, provided all other technical

requirements are met. This process of not involving the contractor until a later stage

removes the benefits of the builders input to the design. The design teams may not be

able to effectively maximise cost and programme savings because the majority of the

design is complete.

The JCT Standard Form contract (SFC 11) now provide for the provision of a

‘Contractor designed Portion’. This allows the employer to place design liability on

the contractor for specified work. In allowing for this, part of the criticism made

above is addressed.

Changes in the work scope (variations) and employer delay are the substantial drivers

in unexpected costs. The SFC JCT 11 deals with delay caused by the employer and its

consequences, as well as delay due to variations, in the same way. Delay due by the

contractor is dealt with by levying Liquidated Damages. The scheme to protect the

right to such sums is provided by the provision of ‘relevant’ events (clause 2.29),

which enable the contractor to make a claim for an extension of time. These are

events which should they occur is at the expense of the employer. What this should

mean in practice is the likelihood of the risks occurring is borne by the employer and

should attract a lower price from the contractor who has not to price for it. In addition,

the contractor is entitled to claim for costs arising which are not covered by any other

provision in the contract. Clause 4.24 lists the relevant matters that entitle the

contractor to these costs. Keating states that it difficult to conceive of circumstances

where the employer under a JCT contract could lose its right to Liquidated damages.

As the Privy Council stated in Phillips Hong Kong v the Attorney General of Hong

Kong (1993) 61 BLR 41 ‘in building contracts...parties should know with reasonable

Client

Architect

Consulting

Engineer

Main

Contractor

Quantity

Surveyor

Specialist/trade

subcontractors

(e.g. Fit-out work)

Specialist/trade

subcontractors

(e.g. Services)

Specialist/trade

subcontractors

(e.g. Shell & Core)

certainty what their liability [for damages] is under the contract’. The scheme for

dealing with damages in construction contracts has been comprehensively analysed by

Adriaanse (Bear 08) in the rule in Hadley v Baxendale (1854) and the standard forms of

contract

The approach taken by the NEC3 contract is radically different to that usually found

in other construction contracts. For a start The Engineering and Construction Contract

(NEC 3) in its Secondary Option clause: Option X7 provides for the employer to opt

to levy Delay (Liquidated) Damages (instead of relying on its common law rights).

Delay and its consequences is managed through ‘compensation’ events. A

compensation event is one that arises through no fault of the contractor. It

compensates for any delay not caused by the contractor (a potentially wide exposure

to risk). Clause 60.1 comprises nineteen events, and unlike other contract such as the

JCT 11, deals with the consequences of the delay and the costs associated with it at

the same time. Quite substantial workload is caused by the operation of the procedure

required to operate the system. In addition the compensation event can also involve

the requirement to give early warning (clause 16) and risk reduction meetings

required by clause 16. Compensation events require:

1. Notification of the event

2. Submission of alteration to the accepted programme together with quotations

for carrying out the work

3. Preparation and submission of quotations (also time and money under clause

63)

4. Implementation of the Compensation events clause 63

Limiting the design liability in the JCT 11 is done by limiting the contractors’ design

liability to that of a professional person and the limiting of consequential loss arising

from such a failure is limited to a sum fixed in the appendix. The NEC 3 also adopts

the same approach.

5.2 Design and Build

Design and build sometimes called ‘package deal’ is a significantly different from the

traditional system. The approach involves a significant overlap between design and

construction activities. The client appoints a ‘design and build’ or ‘develop and

construct’ contractor so there is a single point of responsibility and more significantly

crucial construction input is provided at an early stage, unlike the traditional

approach.

Figure 2: Design and Build Approach

If the design is carried out by the contractor, it limits the client’s responsibility for

design defects by transferring risk from the client to the principal contractor and their

consultants. The client must determine whether the additional cost spent on the

contractor taking the additional risk can be offset by the potential savings. The variant

termed ‘develop and construct’ is where the client has a concept or scheme design

which is completed by the contractor. The use of this variant of D&B procurement

method whereby clients use consultants to design a project up to a particular stage and

then have contractors price the project is sometimes criticised as it can create complex

issues.

Some clients may not wish to become too involved in the design process. The key in

the early stages of a design and build project is to appoint an adviser to develop

appropriate briefing and design concepts to ensure that flexibility in design is

achieved through better coordination of structure, services and equipment, fit-out and

space planning elements. If an adequate brief and a statement of client’s requirements

are prepared, design and build could offer an integrated package to ensure good co-

ordination between the design and construction teams. The D&B contractor is usually

appointed on the basis of pre-qualification and negotiation leading to the agreement of

a guaranteed maximum price (GMP) for a finalised design and specification.

Alternatively, the appointment can be made on the basis of competitive bids usually

consisting of design proposals and lump sum prices. This procurement method does

not offer so much flexibility compared to that of the traditional approach and changes

after the design has been agreed are usually more expensive to incorporate. Often the

client is exposed to the risk of receiving a finished product that satisfies the

Contractor’s Proposals (CPs) in the contract but does not give the client the desired

end product originally anticipated.

Design & build contracts are available for the D&B procurement route. The JCT

Design and Build contract Form contract D&B11, also provide for ‘Changes’ in

Section 5.These are variations in the traditional contract. Changes in the work due to

employer delay are as pointed out above, the main drivers in unexpected costs. Delay

due by the contractor is dealt with by levying Liquidated damages. The scheme to

Client

Specialist/trade

Subcontractors

(e.g. Shell & Core)

Specialist/trade

Subcontractors

(e.g. Services)

Specialist/trade

Subcontractors

(e.g. Fit-out work)

Design & Build

Contractor

Client

Adviser(s)

protect the right to such sums is provided by the provision of ‘relevant’ events (clause

2.26). These are events should they occur is at the expense of the employer. What this

means is that the risks of these is borne by the employer and should attract a lower

price from the contractor who has not to price for it. In addition the contractor is

entitled to claim for costs arising which are not covered by any other provision in the

contract. Clause 4.20 lists the relevant matters that entitle the contractor to these

costs.

A key issue here is design liability. In the Traditional contract, the interface between

design and workmanship is called the ‘fuzzy edge’. Placing design liability on the

contractor is meant to resolve this issue. In practice, the contractor whether employed

under as traditional contract or under a D&B contract neither designs nor builds but

instead manages the process (Adriaanse, CIB World Conference). A view confirmed

by HHJ Lloyd who said in Birse Construction Ltd v Eastern Telegraph Company Ltd

[2004] EWHC 2512 (TCC) that :

‘on virtually all building contracts of any magnitude, the role of the contractor is to

use his management know-how not only to procure the requisite skills but also to

know whether and to what extent they are being provided adequately to meet the

requirements of the contract.’

The Standard forms of contract (JCT/NEC) limit the liability of the contractor, in

design to that of the exercise of reasonable care and skill. By contrast the design

liability of a contractor at common law is that of fitness for purpose. In practice the

contractor will subcontract the design and construction to either professional

consultants or specialist design subcontractors’ (who will in turn employ professional

consultants). The result is that the fuzzy edge is pushed down the chain. The

consequence is best summed-up by Cliffe (Holdings) Ltd v Parkman Buck Ltd (1997)

14-CLD-07-04, HHJ Wilcox QC, OR observed that:

the contractor may supplant the architects in some of their traditional roles as

exemplified under a full (JCT) agreement. In particular, involvement in the

choice and the co-ordination of the specialist systems and sub-contractors, the

integration of those systems, the approval of all drawings and site supervision.

The result may achieve economies and render the tendering contractor more

economic. It does however put a premium upon the strength of the organisation

and experience of the contractor in the enhanced role it plays in such a contract.

Merely by employing an architect in a restricted role, such in this case, can it

expect the architect to compensate for the shortcomings of the other sub-

contractors.

The employer in fact has to balance what it is receiving in its procurement system

from what it thinks it is receiving. If parties are aware of the risk allocation, they will

price their risk and exposure better. This may well mean that the client could abandon

the project. In the well known case of Pacific Associates Inc and anor v Baxter and

ors (1988) 44 BLR 33, hard materials in the underlying soils were not found during

the site investigation. Although the contractor won damages in the resulting

arbitration its losses far exceeded its winnings. Had the client known the true nature

of the site it might well have decided to abandon the project at the start.

5.3 Management contracting

Management contracting is also a slight variation from the traditional system. In this

method, the design process is separated from the construction work but there are

overlaps to speed up the procurement process. The client appoints a design team and

also appoints a ‘manager’ often called a management contractor as a professional

consultant at an early stage of the project usually a contractor who is paid a fee for co-

ordinating the work of subcontractors split into packages.

Figure 3: Management contracting approach

The management contractor supports the client’s design team with construction

expertise to improve the design solutions and the ‘buildability’ of the scheme. The

management contractor is expected to appoint works contractors to undertake discrete

packages of work. The contractual arrangement will be between the management

contractor and the works contractor, however it is important to realize that the client is

duty bound to reimburse the management contractor for all costs incurred. Under this

arrangement, the client mainly carries the risk. A major criticism of this approach has

been the risk aversion by some clients attempting to unload significant risks to the

management contractor. One way of doing this is by insisting that the reimbursement

of package subcontractors will be subject to a maximum tender figure, hence any cost

overrun, other than agreed variations, will be the responsibility of the management

contractor. This has led to adversarial relationships, which has affected the popularity

of this route in recent years. This procurement route has therefore largely fallen out of

favour with some clients in the global construction market, but where conditions are

right it may provide an appropriate solution.

Quantity

Surveyor

Engineer

Architect

Specialist/Package

Subcontractors

(e.g. Shell & Core)

Design team

Management

contractor

Specialist/Package

Subcontractors

(e.g. Services)

Specialist/Package

Subcontractors

(e.g. Fit-out works)

Client

5.4 Construction management

This is a form of procurement which is similar to management contracting. The main

difference is that the client places direct contracts with each of the specialist

contractors and suppliers.

Figure 4: Construction management approach

The expert construction management specialist is appointed as a consultant whose

task is to effectively manage and control the construction process, as well as

integrating the design team. In this manner the client has more direct control over

works contractors and this helps to mitigate the risk associated with management

contracting. This implies that the client is familiar with construction and has a close

relationship with the professional team. The expert construction manager is therefore

appointed as a consultant whose task is to facilitate the integration of the design team

and effectively manage and control the construction process. Overriding influences in

the selection of this route concern the complexity of the project and the strength of the

risk involved.

Both the management contracting and construction management methods of

procurement are in use but their use has declined due to the risks not being clearly

allocated. In management contracting, the employer engages the management

contractor to partake in the project at an early stage. Normally an experienced builder,

the contractor is employed not to undertake the work but to manage the process. All

the work is subcontracted to works contractors who carry it out. Construction

management differs from management contracting in that the employer enters into a

direct contract with each specialist. The employer engages the construction manager

to act as a ‘consultant’ to coordinate these contractors. It is the legal uncertainty and

the exposure to unexpected costs that has made these unattractive to employers.

Quantity

Surveyor

Engineer

Architect

Design team

Construction

Manager

Subcontractors

(e.g. Services)

Subcontractors

(e.g. Fit-out works)

Client

Subcontractors

(e.g. Shell & Core)

6. Alternative Forms of Procurement

The procurement approaches discussed in the previous sections have limitations in

terms of the durability of the relationships between clients, consultants and

contractors. For example, in a traditional procurement, the liability of the contractor

for rectification of defects after practical completion is normally restricted to a shorter

period, usually 12 months. There has been a trend towards other types of

procurement and forms of contract that fosters long-term collaborative relationships

and transferring operating risk for a much longer period during the operational stages

of the facilities or assets (Robinson and Scott, 2009). In long-term procurement

approaches such as public private partnerships (PPP) or the UK PFI model, the

contractor is liable for the delivery of the assets and a wide range of hard and soft

facilities management (FM) services as well as the associated operating risks during

the performance period spanning 25-35 years.

Figure 5: Contractual relationship and agreement between parties in PFI/PPP

The public sector client and private sector consortium (SPV) need to have full range

of skills to complete a PFI/PPP contract. Legal, technical and financial advisors are

Special

Purpose

Company

Private Sector

Consortium

Lenders

Investors

Facilities

Management

Partner

Design and

Build

Partner

Public Sector

Client

Project

agreement

Operating

subcontract

Refurbishment

and/or

construction

subcontract

Loan

agreement

Shareholders

agreement

Direct

Agreement

appointed by the public sector to help define business requirements, develop the

business case, deal with risk transfer, cost and affordability, payment stream,

managing the procurement process, and to negotiate the best contract for the client.

Gruneberg et al (2007) argued that ‘if a supplier has a responsibility for how

something performs, then his or her contractual liability must extend into the

performance period’. This approach has clearly shifted and increased the risks on the

PFI contractor as ‘liability is inevitably extended under performance-based contracts’

(Gruneberg et al, 2007). The PFI process involves exploring risk allocation and the

value of risk transfer compared to the traditional route. There are various risks

associated with planning and design development, construction, and operation of

PFI/PPP projects. For example, design and construction risks are retained by

SPV/contractor but such risks are transferred to the ‘design and build’ subcontractor

where it is a separate firm. Operational risks relating to life cycle costs, innovation

and technological changes are transferred to FM companies/subcontractors. Table 3

shows a simple example of how risk of cost overrun is valued based on the probability

and the cost of the event. The project estimated construction cost is £ 200 million and

the likelihood of cost overrun reflecting various risks is shown to amount to £17

million.

Table 3: Value of risk in PFI/PPP projects

Scenario:

Probability

of event (A)

Cost of event

(B) (£

million)

Value of risk

(£ million)

Projected completed below

budget by £10 m

0.10

- 10

- 1.0

Project completed on budget

0.20

0.0

Project overrun by £20 million

0.40

+ 20

+ 8.0

Project overrun by £30 million

0.20

+ 30

+ 6.0

Project overrun by £40 million

0.10

+ 40

+ 4.0

Risk Adjustment to Project

Cost

+ 17.0

Risk is valued based on (A) the probability of the event occurring and (B) the costs

should the event occur. For each risk event, the process is repeated to arrive at an

estimate of the cost or financial consequences. Typically, PFI projects seemed to

value risk transfer at around 30-35% of construction costs (ACCA, 2004).The UK PFI

model is seen as a durable procurement approach as the responsibility for long-term use

and flexibility of the building is transferred to the private sector based on the output

requirements of the client. The implications are significant for the way design,

construction and operating risks are managed which has created challenges for some and

opportunities for others such as facilities management firms.

7. Concluding Remarks

The building of Wembley stadium used a D&B approach to design and construction. It

is therefore a typical example of a ‘modern’ contract. One that shows how outmoded the

traditional contract is when it comes to modern methods of procurement? The disputes

that occurred were lower in the contractual chain rather than between the employer and

the contractor. It was still a very costly exercise for all parties. The employer also lost

revenue. Perhaps all it demonstrates that fully prepared scope of work will always be

superior to making it up as you go along. No matter the method of procurement, having

a design prepared will always be better than finding out your costs as you go along. A

good example is Plymouth & South West Co-Operative Society Ltd v Architecture,

Structure & Management Ltd [2006] EWHC 5 (TCC). The parties operated with no

clear means of monitoring their costs. This resulted in an overspend of at least £2m in

excess of the Society s estimate of about £6.3m. Knowing who takes the risk matters.

The Wembley project was mired in dispute about delay and the resulting costs.

Ensuring the parties who carries the risk and who has priced for it is a key to a

successful project. As Professor Uff said in the 90

Thomas Hawksley Memorial

Lecture citing Godfrey: ‘a full identification of construction risks and their

management...is part of the management process’.

References & Further Reading

ACCA (Association of Chartered Certified Accountants) (2002) “PFI: Practical

Perspectives” April, Certified Accountants Educational Trust, London

Adriaanse J., Construction Contract Law - the Essentials 3

edn (London: Palgrave

2010) ISBN - 13: 978-0-333-98087-3

Adriaanse J., The Contractors Liability for Workmanship and Design – a matter of

Status or Competence? (Proceedings of the CIB World Building Conference Cape

Town, 2007 ISBN: 1-920-01704-6)

Adriaanse J., The rule in Hadley v Baxendale (1854) and the standard forms of

contract (Built Environment Education & Research Conference - BEAR 2008, CIB

W089, Kandalama, Sri Lanka 2008 ISBN 978-1-905732-36-4

Gruneberg, S., Hughes, W., and Ancell, D., (2007), Risk under performance-based

contracting in the UK construction sector, Construction Management and Economics,

25, 691-699

Howes, R and Robinson, H (2005) Infrastructure for the Built Environment: Global

Procurement Strategies, Elsevier Butterworth-Heinemann, Oxford

Robinson, H.S. and Scott, J. (2009), Service Delivery and Performance Monitoring in

PFI/PPP projects, Construction Management and Economics, 27 (2), 181-197

Construction Manager (2006), Dangerous games, January, pp. 8

Designbuild-network.com. Wembley Stadium, http://www.designbuild-

network.com/projects/wembley/ [Accessed on 27 March 2007]

Construction Manager (2005), They think it’s all over. December, pp. 12-19

Construction News (2006), Multiplex ditches white city but will stay in UK, 24

August. pp.2

Construction Manager (2006), GMP risk was too much, May, p 05.

Construction Manager (2006), No room for manoeuvre, May, pp.12-13

Sportengland (2007) Wembley Stadium,

http://www.sportengland.org/new_wembley.pdf [Accessed on 27 March 2007]

Winch, G., (2000), Institutional Reform in British Construction: Partnering and

Private Finance, Building Research and Information, 28 (2), 141-155

Uff J ‘Risk in Engineering Contracts: is it such a bad thing?’ 90

Thomas Hawksley