Practical Law

Last year Build UK (BUK) published its non-binding recommendations on the contract terms its members should (as a minimum) refrain from using. The recommendation had the commendable aim of forming “a new common ground between clients and the supply chain on contractual practice in the construction sector” with the key objectives being “to promote collaboration, encourage a fairer allocation of risk through the supply chain, and deliver better project outcomes”. In my May 2019 blog, Build UK’s recommendation on contract terms: a step in the right direction, I considered each of BUK’s recommendations in the context of then current market practice and concluded that, while there were a few areas that required further clarification, there was little with which I strongly disagreed.

Fast forward 12 months and BUK has published detailed guidance on its recommendations and their implementation, which puts helpful flesh on the bones. In this blog I look at that guidance and conclude that, despite my initial optimism, a number of BUK’s recommendations actually do represent material departures from current market practice that clients may struggle to get on board with.

Fitness for purpose

BUK’s recommendation: Do not include a “fitness for purpose” standard of care for design (except in the process sector).

BUK has helpfully explained this recommendation by reference to the professional indemnity insurance coverage issues that I referred to in my last blog. BUK also suggests that a fitness for purpose requirement may result in higher costs and a more cautious approach to design. The cost point, while probably true, might be something of a red herring, as it is ultimately for clients to decide commercially if they wish to pay more to get more, where that option is available. The suggestion that fitness for purpose could result in “conservative design solutions, stifling innovation, creativity and opportunities to design out costs” is an interesting one. Again, there may a kernel of truth to this, but the creative elements of the design process tend to be the preserve of white collar design professionals, not contractors, and their creativity is usually constrained more by considerations of budget, buildability and planning than by prospective liability. The inability of design and build contractors to pass down fitness for purpose obligations to novated consultants might have been a more pertinent justification for BUK to include under this heading.

In my last blog, I referenced the helpful distinction drawn by my former colleague, John Hughes-D’Aeth, between “guaranteeing a result”, on the one hand, and “fitness for purpose”, on the other. Quoting John, I suggested that there is nothing at all wrong with asking a contractor to produce a building that meets specified performance requirements, but what is objectionable is asking them to produce a building that is suitable for any unspecified purpose that the client may choose to put it in future. BUK do not address this distinction in their guidance. They do use the example of a multi-purpose indoor sports hall being adapted to host ice hockey to illustrate the issues with fitness for purpose, which points to their concerns being centred around the latter scenario. However, it also warns its members against introducing fitness for purpose through performance specifications, giving the example of an energy efficiency rating for a structure. If BUK is suggesting that such requirements should be resisted or qualified, then this is unlikely to find favour with clients, particularly given the occupier market’s current preoccupation with sustainability and green credentials.

Unquantifiable risk

BUK’s recommendation: Do not include extensions of time/loss and expense risk where not reasonably ascertainable for dealing with asbestos, fossils, antiquities and other objects of interest or value, unexploded ordnances and the carrying out by a statutory undertaker of work in pursuance of its statutory obligations in relation to the works, or the failure to carry out such work.

BUK explains this by reference to the fact that any construction project will inevitably involve an element of dealing with the unknown. It suggests that the practice of transferring unquantifiable risks to the supply chain is sub-optimal, as it often means clients paying for risks that do not transpire or contractors being forced to underprice risks and carry losses, all of which has a destablising impact on the market. Instead, BUK recommends a risk management/mitigation approach, including the use of targeted surveys and investigations to better quantify risks and early contractor involvement to facilitate intelligent pricing and programming. This chimes with my previous commentary on this recommendation and reflects the current direction of travel for most well-advised clients, so it is difficult to reason against.

However, I do have some difficulty with BUK’s suggestion that JCT-style contract provisions should be incorporated to allow (sub-)contractors to recover both additional time and reasonable loss and expense in the event their works are delayed by circumstances outside their reasonable control. The concern with BUK’s initial recommendation was that certain of the listed matters would ordinarily entitle a contractor to time but not money under the JCT contracts. It was not clear if BUK were advocating a broader entitlement for contractors than they would typically have under the JCT contracts, so we gave them the benefit of the doubt and assumed not. However, it appears BUK may now be edging towards something akin to a general right for contractors to recover loss and expense for force majeure. This would be at variance with the JCT’s general approach of allowing time but not money for “no fault” delay events and at odds with current market practice, so further clarification from BUK is needed here. This is also clearly of relevance to current discussions around COVID-19 in the context of new building contracts. I doubt that BUK had the prescience to consider global pandemics when drafting the guidance, so it would be helpful to understand their recommendations on this.

“Specified Perils”

BUK’s recommendation: Do not include that “Specified Perils” (as defined in JCT) will not give rise to extension of time where caused by the (sub)-contractor.

Readers should refer to my previous blog for a detailed analysis of this recommendation – a similar analysis is proffered by BUK in its guidance – and I should say at outset that I agree entirely with this recommendation, albeit for different reasons than those posited by BUK. BUK seeks to justify this recommendation by reference to the fact that contractors would have to fund any resulting liability for liquidated damages from its own balance sheet, as this is likely to be an uninsurable risk. However, this is likely to be the case in most instances where a contractor incurs a liability to pay liquidated damages, and the absence of insurance to meet such a liability is not usually sufficient justification for the risk to sit with the client. A more compelling justification might be that overall clients are best placed to manage the consequences of delay arising from Specified Perils and they have the option of insuring against such risks should they consider it prudent to do so (for example, by purchasing delay in start-up cover). BUK allude to this, but do not really offer it in support of their recommendation.

BUK also suggests a compromise arrangement (where insurance is to be maintained by the client) whereby the contractor picks up any excess or deductible where a Specified Peril has been caused by its negligence or default. However, I feel BUK may be conflating two distinct heads of loss here (the cost of repair/reinstatement, on the one hand, and delay-related losses, on the other) and this is the position that I would expect to apply under most negotiated JCT contracts anyway, so BUK are not giving much away here.

Breach of contract

BUK’s recommendation: Do not include a blanket indemnity for breach of contract.

In my previous blog I suggested that BUK were preaching to the converted with this recommendation, since I seldom see blanket indemnities in the lump sum contracts that I deal with. However, judging by BUK’s guidance, it would appear that it has a slightly different view of the market.

In its guidance BUK suggests that “those drafting contracts often seek to include a general indemnity for breach of contract”. I have to say that this is not my experience of the UK market where – with the notable exception of construction management projects, for which general indemnities are an indispensable part of the trade contract patchwork – indemnities are typically limited to specific categories of loss.

However, BUK then goes on to acknowledge that the general industry approach is for indemnities to be reserved for limited and specific categories where there is fault and it is appropriate for the contractor to “own” the risk. The specific examples it gives are losses that are backed off to insurances (presumably it has personal injury/death and damage to third party property in mind here, possibly nuisance and trespass too), tax liabilities, infringement of third-party intellectual property rights, breach of confidentiality and losses arising from certain regulatory/compliance breaches, for example data protection legislation. Failure to comply with third party agreements is conspicuously absent from this list but, otherwise, I would say that it accounts for the usual categories of indemnified loss.

The arguments against indemnities are well-rehearsed. BUK refers in its guidance to the risk of a party’s liability being extended to “include non-negligent damage and indirect or even consequential third-party losses that are remote and were not foreseeable”, which can give rise to insurance coverage issues. However, I would suggest that in most cases the indemnities found in building contracts relate to claims for damages as opposed to a debt, so that the common law rules of remoteness and mitigation will still apply. I consider this distinction in more detail in my blog, The wrong side of the tracks: indemnities and asset protection agreements. BUK also refers to the risk of extended limitation periods. However, in most cases this is unlikely to be the client’s intention. Indemnities are usually included in building contracts to achieve back-to-back liability and reduce the risk of “damages leakage”, not to secure extended limitation periods, so I am sure there is a compromise to be struck here.

Uncapped liabilities

BUK’s recommendation: Do not include uncapped (sub)-contractor liability (save for certain aggregate cap carve-outs such as fraud, misrepresentation, personal injury/death, wilful default).

It is now clear from BUKs guidance that it is recommending overall aggregate caps on liability here, not the specific caps on design liability and the like that I referenced in my last blog. The arguments for and against such caps are, again, well-rehearsed and I don’t intend to go into them in detail here. However, BUK’s suggestion that the risk of uninsured liability (that it describes as uncontrollable and unmanageable for the supply chain) should be carried by the client and mitigated by careful selection of its supply chain members is unlikely to find favour with clients, not least because this is something that they usually rely on the contractor to do.

In the guidance, BUK suggests limiting contractor liability to losses that are covered by insurance, plus a fixed percentage of the contract sum (it tentatively suggests a sum not exceeding the contractor’s anticipated profit for this). BUK also suggests that carve outs should be limited to wilful or dishonest behaviour, or matters that cannot be capped as a matter of law, rather than unintended failures of performance. On projects where potential losses could exceed the level of cover that can reasonably be obtained via the contractor’s normal insurance arrangements, BUK suggests that project-specific insurance arrangements should be considered (it does not say who should bear the cost of this) and that this should inform the limits on the contractor’s liability. It is not clear what insurance arrangements BUK has in mind here, but suffice to say that not every instance of breach or loss under a building contract will be covered by insurance. Is BUK recommending broader as well as higher insurance cover here, or is the suggestion simply that contractor liability for those losses that would not usually be insured against are limited to the “fixed percentage of the contract sum” element of the cap? It would also be helpful to understand how BUK sees liquidated damages/delay damages fitting into this recommendation and if it is amenable to the idea of client termination rights where such caps are reached.

It remains my experience that overall aggregate caps on liability are often requested by contractors, but seldom agreed by clients. Where they are agreed, they are typically set at a level which is a multiple of the contract sum and not usually by reference to project insurances (save in the case of design liability under clause 2.17.3 of JCT DB/clause 2.19.3 of JCT SBC, where the common practice is to set the cap by reference to the contractor’s professional indemnity insurance cover). In addition, such caps are usually subject to much broader carve outs than those posited by BUK in its guidance. Liquidated damages, losses attributable to infringement of third-party intellectual property rights (that BUK recognises are often the subject of indemnities – see above) and amounts recovered under contract insurances (the inverse of what BUK is proposing) are examples of other categories of loss that clients would typically look to carve out of any aggregate cap.

It is exceptionally difficult to legislate for caps and exclusions of liability in the way that BUK has attempted to do here, ignoring project specifics, as it is a highly emotive topic that has broad implications for the bankability and marketability of projects. Contractors are naturally concerned about the destabilising effects of exposure to unquantifiable loss. Clients, while sympathetic, are reluctant to underwrite losses that are attributable to contractor breach or performance failures. All things considered, I would suggest this is a matter that is best left for commercial negotiation and agreement on a project by project basis having regard to all of the project specifics.

Performance securities

BUK’s recommendation: Where the following security is required:

Do not use a pure on-demand performance bond.

Do not use a parent company guarantee (PCG) that does not include a “no greater liability” clause (save for legal costs) and equivalent rights of defence.

Do not use a collateral warranty that does not include a “no greater liability” clause.

This recommendation is pretty self-explanatory and there is not much in BUK’s guidance in this area that I really disagree with, subject to a handful of exceptions and areas where further clarification might be helpful.

The first is BUK’s suggestion that performance security should not be used until all other contractual remedies have been exhausted. I think that, in practice, most well-advised clients will view performance security as a means of last resort. However, the inclusion of a strict condition in, say, a performance bond that all other contractual remedies must be exhausted before a call is made, would slightly defeat its purpose and is therefore unlikely to be acceptable to well-advised clients.

The second is BUK’s suggestion that performance bonds should include a requirement for default and loss to be “established” before the bond pays out. While this is fine in principle, and consistent with the amended ABI bonds that are commonly utilised in the UK market, it would be helpful if BUK could confirm that loss may be established by means of an adjudicator’s decision, at least on an interim basis.

The third is BUK’s suggestion that payment security may not be needed at all due to the fact that contractors are typically paid in arrears and clients have the benefit of the value of work “in hand”. While this should certainly be taken into consideration when weighing up covenant/performance risk, I do not agree that this by itself obviates the need for other forms of performance security.

Finally, I struggle with the proposition that clients don’t need both a performance bond and a PCG, and the implication that PCGs are only of value if the guarantor has a superior covenant to the contractor. The reality is that performance bonds and PCGs perform different functions. Indeed many clients view PCGs, not only as providing short term performance security, but also as long term protection against the contractor entity being stripped of its assets and left without the wherewithal to meet a claim. This is why clients tend to request PCGs from contractors’ ultimate holding companies, even where other companies in the contractor’s group may have deeper pockets.

Perhaps intentionally, BUK does not consider contract retention under the heading of performance security. This is perhaps the most widely utilised form of performance security, so it would be helpful to know what BUK recommends to its members in this regard.

Conclusion

Having now read the guidance that sits behind BUK’s recommendations, my initial suspicions have been confirmed. They promote a paradigm shift away from current market practice that would benefit the supply side of the market to the detriment of the client side. Not surprising given BUK’s membership. While BUK’s aims are commendable and I do agree with some of their reasoning, I think they are over-reaching with these recommendations and will struggle to secure the client buy in needed to establish a new common ground between clients and the supply chain. Consequently, while BUK’s recommendations may serve as a useful checklist for its contractor members, they regretfully fall short of their stated objective.