Why Do We Need a Contract?
Why do we need a Contract?
When you are employed as a builder – there is a perception of what the client is contacting you to build. Clients pay architects and have spoken to consultants and think they are getting something however the documents illustrate something that is not their dream. The client has a vision and expectation that might not be realistic or the builder could have underperformed. But that expectation is extremely important to manage and deliver.
How a client employs a builder depends largely on the size of the project, complexity, and risk. My experience in executing and tendering is mainly with projects from the tens of thousands to less than $50M in various contract forms in both commercial and residential sectors.
In Australia, all of these contracts MUST be based on an Australian Standard however the issue you get is with “amended contracts” that lawyers have omitted or re-written a base contract to within an inch of its former existence (a designer contract).
A contract is basically a written document outlining a mutually agreeable outcome for both parties, commonly known as a “Terms of Agreement”. My experience with contracts has been good however I have heard some horror stories from both client and builders.
My experience is if you communicate with clients through the project, you sign a contract at the start of a project just to keep everyone honest for the “just in case moment”. Then a contract gets placed in a draw and only comes out when you need to remember when you can place in a progress payment.
Everyone has bad days and sometimes due to no one’s fault things can just go bad. So if you have a dispute under the contract, You have three ways to go:
- Be an adult and be fair and work things out;
- Go to arbitration;
- Go to Civil Court (and if you are really keen and you haven’t gone bankrupt there is also the Supreme Court of Australia;
The expression about civil action “Only the Lawyer Win” comes to mind.
So if a dispute does happen and a basic contract/terms of the agreement is not in-place – it gets very messy.
The basic premise of our legal system will always lean to the entity that seems to be the victim. So if there is an expectation of final finish or outcome and the client is unhappy – then a dispute can escalate quickly into a very costly experience for all.
Now – you are a small building company with a contract with “Ma & Pa Kettle”, Our legal system reverse a simple term “King of your own Castle” – What this means, if you are seen as an expert and trading to a client the “Kettles,” our legal system protects the little guy (in theory). So if there are a dispute and logic hasn’t succeeded, the builder always wants to go to arbitration and not to civil court.
In arbitration, you deal with an expert in a particular field and the best chance to plead a case in a reasonable environment. Now if arbitration does not work and you as a builder go to civil court, you are now guilty until proven innocent. The chance of business winning in civil court against he “Kettles” is small.
Then if you are a business contracting to another business – company law kicks in and again arbitration would normally be the desired outcome. However, when you are in this situation with ABN against ABN (say a builder and a developer) the law is a little evener. Sadly – who is right and fare doesn’t matter, who has the best lawyer does.
In short – In an ABN against ABN – who has the most money normally wins.
Communication and honesty will normally keep you out of court but if you do go to the court – if you haven’t got an Ironclad “Terms of Agreement” and the person on the other side has got dollars in there pocket with the intent to use it – you’re screwed.
As I mentioned most Australian Standard contracts are pretty fare for both client and builder. The building industry organizations such as MBA and HIA have also got general contracts that are basically the Australian standard however push the parties into an arbitration situation before a civil court.
You will then have a large organization that has a designer contract produced by a legal team. This type of organization has its contracts stacked in the clients favour and basically the builder signs it or they will find another builder who will.
This is what the industry calls a designer contract and has sent many building companies to the wall. To avoid this type of client and don’t sign any designer contract without doing a full legal review first.
But as a rule – Stay away from designer contracts – always lean to Industry contracts.
If the two Party don’t have good communication prior to a contract signing,
It’s probably a good idea not to enter into a contract.
When entering into a contract – I would suggest the use of standard industry and mutually acceptable contract, make sure that both parties understand what they are signing and once the contract is signed ensure that excellent communication follows and don’t promise anything you can’t deliver.
The best contract is one you sign to keep everyone honest and place it in a draw once signed and then only bring it out of the draw when you need to get paid or you execute the completion of said contract.
What Contract Should I Use?
The quick answer is either an Industry-standard contract or and Australian stand contract, however, there are also different types of Terms of Agreement to address the size of the project and if the project has been fully designed or need a design component included.
The majority of contracts start from an Australian standard and can also be amended to suit the author. If you do come across an amended contract – it is always good to request a review of the original contract before it was amended. But when you can see a contract has been amended by a lawyer – make sure you get expert advice before entering into any such documents. Amended contracts should be treated with the same caution as a designer contract. Be aware.
When entering into an agreement to supply services a basic “terms of the agreement” should be agreed. If you get into a dispute and you do find yourself in front of a magistrate – a “terms of agreement” is the first this he or she will request. If you are considered an expert in a said field – a signed term of the agreement is the only thing that may say you in a civil suit.
So on many small services trades or suppliers – you can sometimes see an attached Terms of agreement on the back of Purchase order. After that, you have small medium-sized contracts to address multiple types of projects. There are also contract that are spilt into two types of contract or offer incentives.
The main contracts used in building can be grouped into the following:
Purchase Order –
Larger than a tax invoice however has a basic term of agreement. Normally used for smaller services or purchases.
Minor Works Contract –
Low complexity contract for a particular scope of works & no design over the short term.
Lump Sum or Hard Dollar
Mainly for a fully documented project. Normally design costs not included over a longer term or negotiated tender. Any variable prices addressed as provisional sums or PC Items.
Design & Construct Contract –
Complex contract with a design scope and a performance scope agreed normally from an approved development scope. A D&C contract would traditionally take documentation from DA to CC and then into occupation (OC).
Hard Dollar / Lump Sum Contracts
Hard dollar contracts/tenders are in theory fully documented and when a builder tender these types of building with all the docs presented – it becomes a race to the lowest price. But the documents are never fully documented and a builder will have clarifications and exclusions. So if the documents are not ever perfect, often items that have not been designed. Builders start to start using words like allocations, allowances or provisional amounts to address these unknowns. Generally speaking, the client has paid for a set of drawings that have normally acquired a construction certificate. But these CC drawings are not actual Construction Coordinated documents. So if there is any item not coordinated or not detailed correctly this opens the door for a Contracts Manager to issue variation under the contract.
So the client takes on the full design risk. Some builder makes a career of winning projects at very low margins with the knowledge that there are opportunities for variations during the construction phase. These types of builders tend not to have a lot of return business from there clients however this is a strategy widespread through the industry. This type of practice is not good for the industry.
Sometimes you will find a client may say there are only 3-4 builders tendering – then you find out during a tender that is 3 times the original number of tenders. For a builder, hard dollar tenders are normally a race to the cheapest price. So if you find out that the client hasn’t been upfront, I think I wouldn’t be too hard on the builder using a variation strategy.
Design & Construct (D&C) Contracts
As noted above – D&C Builder can price from a number of locations within the design phase but normally from after the DA has been approved, however, this can vary with clients, especially so if you have a pre-existing business relationship or you are building to a Formula or Clients briefing document.
On the other hand – a hard dollar contract would normally be engaged after the CC has been issued or even better a stamped set of drawings with the notation “ISSUED FOR CONSTRUCTION”. The better the coordination and detailing of the documents – in theory, the client has less risk.
A D&C contract could be based on a Client Brief and the documents could be nonexistent or very schematic, the builder could be contracted to manage and mitigate the full design and developed in a collaborative environment.
The big difference between a hard dollar tender is this:
- With a hard dollar tender – you only price what is on the drawings and don’t wear any risk associated with items missing on drawings and any buildability issues. (Anything missed will a variation later).
- A D&C builder will then take those same drawings and prices in all the build-ability issues and generally, everything missed off the documents and wears all the risk everything not excluding or clarified.
If you wish to read more about
Tender Process – Click Here
What Are the Different Contract Variables?
Hard Dollar with Variables
Hard dollar Contracts/tenders are if theory fully documented and when a builder tender these types of building with all the docs presented – It becomes a race to the lowest price. But the documents are never fully documented and a builder will have clarifications and exclusions.
The big difference between a hard dollar tender is this:
- With a hard dollar tender – you only price what is on the drawings and doesn’t where any risk associated with items missing of drawings and any buildability issues. (Anything missed will a variation later).
- A D&C builder will then take those same drawings and price in all the build-ability issues and generally, everything missed of the documents and wears all the risk everything not excluding or clarified.
Often builders will receive tenders at the varying stages of design and documentation. Hard dollar / Lump Sum contracts can still use if a project if it hasn’t been fully designed. The builder split all the known costs and address the unknown costs using a few methods including:
- Hard Dollar with Provisional Sums / PC Items
- D&C Hard Dollar – Principle Design Brief tender including all design and Building.
- Negotiated Tender – Still a Hard Dollar with all the variable costs negotiated a risk register.
- Split Hard Dollar / D&C Contract – Hybrid of both contracts.
Hard Dollar with a D&C Component Contract – As it sounds this is a contract may have a Lump sum price on the majority of the work with a smaller portion that needs a redesign or an additional stage. This can be addressed via a split Hard dollar contract with a D&C component or you can use a “Provisional sum or PC Items” to address these variable unknown costs. (Using this system means the Builder has no risk and the Client holds all the risk).
I have always struggled with the concept of a Lump sump contract having variable costs?
Only saying…
Hard Dollar Contract (including D&C Content) – A tender can basically be D&C in natural however the actual Contract is still Hard dollar. The builder will manage the design consultants, mitigate approvals, and finally build a project to a clients design brief. A good example of this type of contract is The Government GC21.
This contract addresses the scope as a minimum performance however leaving “the how?” up to the builder. The bad part of the GC21 is anything that has been notified to the tendering builder must be priced even if obscure. The contract asks the builder to take all risk associated with Latent conditions (hidden stuff) – however, this can normally be negotiated out of the contract conditions.
Negotiated Tender – This can sometimes happen as a Lump sum tender and then the builder will either then negotiate a price for additional works and absorb into a lump sum price effectively absorbing all the risk.
Another way to address the clients risk is to price a Risk Register. The client and builder then agree who is going to wear the risk. The agreed items are then included in the lump sum and the builder holds the risk on these absorbed items. Obviously, the client holds the risk of any excluded items is addressed as a variation under the contract.
Design & Construct (D&C) Contracts
As noted above – D&C Builder can price from a number of locations within the Design Phase but normally from after the DA has been approved, however, this can vary with clients, Especially so if you have a pre-existing business relationship.
Refer to The Design Phase below – Note a D&C could ask to tender from Process 1 to after 4.
So we have established a D&C builder will manage the design consultants, mitigate approvals, and finally build a project to a clients design brief. The “Principle Design Brief” is a performance document highlighting the client’s needs, or design Intent. So when you have a reasonable amount of time you then go about constructing a price considering all the variables within the clients brief and site-specific requirements.
Now, what if the client hasn’t the time for a formal D&C tender. In this situation, a client may have enlisted the services of a Quantity surveyor to produce a cost Plan.
The client can proceed a few ways but could ask for a few builders to submit a cost plan to ratify the Quantity Surveyors numbers. The cost Plan would be submitted in a set manner to compare “Apples for Apples” from builders. The builder would quote on all set costs including Preliminaries, Overheads, and margin. The consultant fee, authority fees, and trade cost would be variable. basically a “do and charge or Cost Plus” contract.
All the variable cost would have an agreed margin across all trades. (with a minimum margin capped).
Construction Management (CM) contract
- Preliminary costs – Quoted
- Overheads and insurances – Quoted
- Consultant costs – Estimated
- Authority Costs and Inspection Fees – Estimated
- Trade costs – Estimated
- Margin – % Quoted
CM Contract with Guaranteed Maximum Price (GMP)
The client may then choose to ask the builder to price a risk register and adjust the trade costs adjusted to reflect a worst-case scenario. Now if the client says I will accept that price as a maximum price if you as a builder can take on all the risk. This contract would be GMT.
- Preliminary costs – Quoted + Risk = GMP
- Overheads and insurances – Quoted + Risk = GMP
- Consultant costs – Estimated + Risk = Quoted GMP
- Authority Costs and Inspection Fees – Estimated + Risk = Quoted GMP
- Trade costs – Estimated + Risk = Quoted GMP
- Margin – Quoted
The trick to the GMP is based on the drawings at the time of tender with an agreed Client brief. If the client changes brief or adds items to the scope this would still be a variation over and above the GMP.
CM Contract with Profit Share
As per the GMP listed above, the client may then choose to ask the builder to share the risk and as an inventive, to each, both builders and clients may enter into an agreement where that share any profits and losses in the trade estimate normally at 50%. The fair way is to share both losses and wins, however most clients will only share the wins. (this is one of the reasons I am not a fan of this type of deal.
- Preliminary costs – Quoted
- Overheads and insurances – Quoted
- Consultant costs – Estimated + riskless 50% Profit Share
- Authority Costs and Inspection Fees – Estimated + risk less 50% Profit Share
- Trade costs – Estimated + risk less 50% Profit Share
- Margin – Quoted
Again the trick to the CM with the Profit share contract is based on the drawings at the time of tender with an agreed Client brief. If the client changes brief or adds items to the scope this would still be a variation over and above the Agreement.
If you wish to read more about
Tender Process – Click Here
Why do we need a Contract? – Click Here