Practical Law

In the current overheated commercial property market, we are seeing ever more lively debates about who should take the risk of defects in existing structures on refurbishment projects. As landlords look to refurbish properties in order to capitalise on rising rents and owner-occupiers choose to tart up their existing premises rather than pay those rising rents, good contractors are in high demand and can afford to take a much more risk averse approach to this aspect of contract negotiations. Whereas, a couple of years ago, contractors might have been commercially motivated to price such risks competitively in order to win jobs, the pendulum has now swung back firmly in favour of contractors.  This has led to a general lack of appetite to accept any risks that are difficult to price.

Delivery risk v performance risk

The debate in relation to existing structures is usually centred on what one might term the “delivery risk”; that is, the risk of delay to the progress of the works arising as a consequence of unforeseen conditions in the existing structure, coupled with the cost of remedial works needed to complete the project or to bring the existing structure up to the required standard. However, as important to many clients (if not more so) is the “performance risk”. That is, the risk that the completed works will not meet the contractual performance requirements or of defects appearing after completion as a result of inadequacies in the existing structure.

Recent experience acting for an owner-occupier of office premises illustrates two things:

• There is a range of possible options that might enable a contractor to price and take on one or both of these risks.
• These risks, while not mutually exclusive, do not both have to be allocated to the same party.

Possible solutions

Allow me to set the scene. A client (I’ll call him X) owns and occupies an existing office building. X intends to refurbish and, as part of his plans, proposes to retain and re-utilise the building’s existing structural frame. So far, so good. X explains that he wants his contractor to assume both the “delivery risk” and the “performance risk”. Specifically, if X decides to sell the refurbished building instead of occupying it himself, he would like to be able to do so with the benefit of a full design warranty that wraps both the retained structure and the new works. Slightly trickier! On testing the market, X quickly realises that there is a distinct reluctance among tendering contractors to take on these risks, so he asks about the range of possible workarounds.

Looking first at the “delivery risk”:

• X could engage his contractor on a two-stage basis and give him early access to the site. This would enable the contractor to inspect and satisfy himself as to the condition of the existing structure before submitting a second stage tender that included the risk of unforeseen structural conditions.
• If X’s contractor is concerned about the interface between the existing structure and the new works, the answer may again be a two-stage arrangement, under which the contractor checks the new works’ design during Stage 1. This would allow him to satisfy himself in relation to matters of design co-ordination and to flag up issues of concern as the design develops.
• Finally, if the existing structure is being stripped out or partly demolished under a separate contract, the contractor may be nervous about the condition in which the structure will be handed over to him. The answer in these circumstances may be for X to assign the benefit of the strip out contract to the contractor, so that he has direct recourse for any issues with those works.

Turning to the “performance risk”:

• X could appoint the team that built the existing structure to design and construct the new works. Provided the existing structure is not too old, they may be willing to provide a full design warranty in relation to the completed project.
• X could instruct his structural engineer to interrogate the original calculations and “as-built” drawings for the existing structure and to warrant their sufficiency for the purposes of the new project. Under the proposed design and build procurement route, the contractor will take a novation of the structural engineer’s appointment and may therefore feel able to warrant the existing structure as part of his overall design warranty.
• Finally, X could agree to meet the cost of any remedial works to the existing structure that the contractor or the structural engineer reasonably considers are needed in order to bring it up to standard. Again, this should help to give the contractor the comfort he needs in order to accept the performance risk in relation to the completed project.

In the end, after prioritising his commercial objectives, X decided that the “performance risk” was the one he most wanted the contractor to accept, so that, if he decided to sell the building at some point in the future, he would be able to offer the benefit of a full design warranty. In order to persuade the contractor to take on this risk, and after assessing the worst case scenario, X agreed to assume the “delivery risk”, including meeting the cost of any remedial works needed to bring the existing structure up to scratch.

While an express design warranty in relation to the existing structure and its interface with the new works would have been ideal, X’s contractor was unwilling to offer this. In the end, X had to rely on the usual design and build contractor’s warranty that the completed works would comply with the performance specifications included or referred to in the contract documents. Being satisfied that these specifications were not qualified or limited in relation to the existing structure, X was content that this gave him the full design warranty that he was looking for.

Final thoughts

Discussions about the allocation of delivery risk and performance risk show no sign of abating and, although this example is fairly specific, the principles outlined and the possible workarounds can clearly be applied more broadly. For example, they could apply to projects that are built on existing structures (a podium) or to internal refurbishment projects where there is an interface between a tenant’s fit-out and a landlord’s base build works.