Project Alliance Agreements – what contractors and other non-owner participants need to know
To the uninitiated, Project Alliance Agreements are ‘strange animals’. This article provides some pointers on what contractors, designers and other non-owner participants should consider before entering into a Project Alliance Agreement (or other collaborative or relational forms of contract that incorporate features from the project alliance model)
Types of Alliances
This article focuses on the project alliance model, being an alliance formed for the design and construction of a specific project.
Other common forms of alliance include:
program alliances: alliances formed to complete a program of projects;
strategic alliances: long term alliances, often extending beyond a particular project;
O&M alliances: alliances covering the operation and/or maintenance of an asset or group of assets.
Alliance Participants
Australian Project Alliance Agreements divide the parties into two categories:
the owner; and
the non-owner participants or NOPs (for short).
Sometimes there may be only one non-owner participant, but more commonly there will be a number of non-owner participants, to cover all the skill sets that are needed to complete the project. Other non-owner participants might include:
the designer;
other specialist contractors or builders;
key suppliers;
the proposed operator and/or maintainer of the asset; and
specialist risk managers and other consultants.
Alliancing in a nutshell
In a nutshell, alliancing can be described as a contractual arrangement that has been designed to overcome various undesirable aspects of traditional construction contracting. It typically involves:
a single multiparty agreement between the owner and the non-owner participants;
the engagement of the civil construction contractor and other non-owner participants at a much earlier stage in the planning and design phase of a project;
the collective sharing of risks and rewards associated with the project between the alliance participants (rather than the allocation of specific risks to specific participants);
a three-limb payment regime that seeks to align the commercial interests of the non-owner participants with the project outcomes that the owner is seeking;
unanimous decision making; and
a no-blame regime; and
‘open book’ transparency.
I expand on each of these elements below.
Two phases
Project alliances usually comprise two phases:
the alliance development phase; and
the project delivery phase.
During the alliance development phase, a project proposal, including detailed scope of works, target cost, other KPIs, fee and gainshare/painshare regime is developed by the NOPs for the approval (or otherwise) of the owner. It’s only when the project proposal is approved by the owner that the participants proceed to the project delivery phase.
Sometimes, each phase will be covered by a separate agreements:
An Alliance Development Agreement (ADA) for the development phase; and
A Project Alliance Agreement (PAA) for the project delivery phase.
Other times, both phases are addressed in a single agreement, which comes to an end if the project doesn’t proceed beyond the alliance development phase.
Commercial Framework: 3-limb remuneration regime
The remuneration regime for the non-owner participants typically involves 3 limbs:
the owner reimburses all direct costs and indirect project specific overhead costs actually and reasonably incurred by each NOP in undertaking the project, including if such costs exceed the costs included in the agreed target cost.
each NOP will be entitled to an amount on account of profit and contribution to corporate (or non-project specific) overheads. This limb-2 amount is often called the “Fee”, and is typically a lump sum amount, based on amount of profit and contribution to overheads that the non-owner participant would expect to receive for ‘business-as-usual’ (BAU) performance of the work covered by the NOP’s reimbursable costs component of the target cost.
each NOP will be entitled to a ‘gainshare payment’ from the owner, or will be liable to make a ‘painshare payment’ to the owner, depending on how the alliance performs against the agreed target cost, target completion date and other agreed KPIs. This way the NOPs can generate a better than BAU margin if the alliance performs well. Conversely, the painshare payment will eat into the Fee, and hence reduce each NOP’s margin, if the alliance performs poorly.
The maximum painshare payment a non-owner participants can be required to pay is often limited to the amount of its limb-2 Fee. This way the worst-case outcome for a non-owner participant is that it recovers its costs but makes no profit or contribution to its corporate overheads.
Importantly, the KPIs for all non-owner participants are based on whole of project outcomes, rather than outcomes on the scope performed by the relevant NOP. This encourages each NOP to do what’s best for the entire project, rather than what’s best for its scope of work. This incentivises greater collaboration between the NOPs than occurs under traditional contracting models where the financial performance of each NOP turns on the performance of its scope of work rather than whole of project outcomes. This helps with projects involving the integration of different systems from different suppliers.
The participants commit to an ‘open book’ arrangement under which each participant has broad mutual access and audit rights. The primary intent is to ensure that the costs that are reimbursed to the NOPs have been actually and reasonably incurred, and that they don’t incorporate any amount on account of margin or contribution to corporate overheads.
Further detail on the commercial framework is provided below, where I discuss the issues that a non-owner participant should consider when tailoring the commercial framework to a particular project.
Key issues for non-owner participants
For non-owner participants, the key issues that you should focus on when considering an alliance contract are:
the no-blame regime;
the commercial framework of the alliance including your potential liability under the contract;
the capabilities of the team members proposed by other participants, given the “we all win, or we all lose” nature of the arrangement;
whether you will have the ability to participate in important decisions that will affect its gainshare entitlement or painshare liability;
the ‘open book’ nature of the arrangement; and
the selection process – competitive or non-competitive?
I expand on each of this issues below.
No blame regime
Most alliance contracts will include a ‘no blame’ regime, under which each participant agree that it will not be entitled to bring commence litigation or arbitration against any other participant, except in limited circumstances.
Errors, mistakes, poor performance, breach of contract and negligence by a participant are usually expressly covered by the no-blame clause, and so will not entitle any other participant (including the owner) to bring a claim against the defaulting participant.
The intention of this approach is to avoid the adversarial ‘claims’ culture associated with traditional contracts. Because the no blame regime removes the option of blaming and suing others when problems arise, it encourages the participants to find solutions instead (to minimise the negative impact that the issue may have on its gainshare or painshare payment).
The no-blame regime can also encourage participants to accept stretch targets and adopt highly innovative approaches in the pursuit of extraordinary outcomes, without the fear of being sued if things go wrong.
The limited circumstances in which claims are permitted vary from contract to contract. They are usually limited to ‘wilful’ (ie deliberate) default by a participant (but excluding any error of judgment, mistake, act or omission, whether negligent or not, which is made in good faith), and various other specific situations.
As a non-owner participant, this no-blame regime means that you will not be able to recover from any other participant any reduction to the ‘gainshare payment’ that you receive, or any increase to the ‘painshare payment’ that you becomes liable to pay, due to the negligence or non-wilful default of another participant. Accordingly, you need to take care to ensure that the alliance team members proposed by the other participants in your alliance are capable of properly performing the tasks allocated to them.
Liability and collective sharing of risks
Generally, all project risks are shared between the owner and the non-owner participants, until each NOP reaches its painshare cap, at which point the remaining cost and other risk impacts fall exclusively to the owner.
Accordingly, as a non-owner participant, you will become liable to make a painshare payment to the owner, if project risks result in poor project outcomes against the agreed KPIs. Under most Australian alliances, the potential painshare payments of each NOP is capped at the amount of the NOP’s fee. In this worst-case scenario, you would:
be reimbursed for all of its direct costs in connection with the alliance;
be liable to make a painshare payment to the owner equal to the amount of your Fee; and
therefore, receive no amount on account of profit and contribution to corporate overheads.
Some owners consider that the maximum painshare payment should be capped at an amount that exceeds the NOP’s fee.
Sometimes, the owner or a NOP will retain sole responsibility for consequences of particular risks.
Commercial framework
The usual ‘generic’ commercial framework for an alliance was explained in above. It will be tailored for each project. Issues that non-owner participants should consider in tailoring the commercial framework are explained in this section.
Reimbursable costs: What costs will be reimbursable, and what costs will be covered by the limb-2 contribution to corporate overheads? The alliance contract will define the costs that are reimbursable. As mentioned above, the reimbursable costs are generally defined in the alliance agreement to mean:
all direct costs and indirect project specific overhead costs actually and reasonably incurred by the NOPs (and the owner, if applicable) in the performance of the work, but
excluding any contribution to profit or corporate (or non-project specific) overheads.
Opinions can differ on whether certain costs should be treated as reimbursable costs, or should be treated as covered by the contribution to corporate overheads within the limb-2 fee. Contentious items can include:
plant and equipment for the project office;
professional development programs for members of the project alliance team;
costs of entertaining alliance staff (in excess of government department standards); and
costs incurred by the ALT members in performing their duties (including attendance and travel).
The classification of costs as either reimbursable or corporate overheads needs to be discussed and agreed on each alliance.
Some costs (such as annual leave, training leave, bonuses etc) may be reimbursed progressively based on estimates, with an adjustment to reflect actual costs as audited at project completion.
Fee: Contribution to corporate overheads and profit will be covered by the limb 2 fee. For most NOPs, the fee will usually be a fixed amount based on the NOP’s component of the reimbursable costs included in the target cost. For some NOPs, such as the designer, the fee may be calculated as a % of its actual reimbursable costs. It is common for owners to ask NOPs to bid their proposed fee (or how it will be calculated when the target cost is agreed) during the selection process. Some owners seek to establish the NOP’s fee post selection by auditing the NOP’s business-as-usual fees for comparable projects.
Gainshare/Painshare: The gainshare/painshare regime will typically be developed by the owner. It is commonly separated into:
a cost component – resulting in a gainshare payment to the NOPs, or painshare payment from the NOPs, calculated as a proportion of any cost saving, or cost overrun, relative to the target cost; and
a non-cost component – resulting in a separate gainshare payment to the NOPs of an amount for performance against non-cost KPIs that is better than BAU, or a painshare payment from the NOPs to the owner for performance that is worse than BAU.
A well-advised owner will seek to link any gainshare payments to KPIs that actually deliver improved value to the owner if better than BAU is achieved. The maximum potential gainshare payment for performance against the non-cost KPIs is usually funded by the owner, based on the owner’s assessment, before the agreement is executed, of the additional value that better than BAU will create for the owner, and the proportion of that value that the owner is prepared to share with the non-owner participants. It can also be funded from the owner’s share of any cost savings.
The owner’s assessment of the outcomes that will create value for the owner is usually described in a document called the owner’s value for money (VfM) statement, which is shared with potential NOPs at the commencement of the alliance selection process.
As a NOP, you should satisfy yourself of the ability of the alliance to satisfy the target cost and other KPIs, as a failure to do so will reduce your profit and contribution to overheads.
You should also consider whether the alliance agreement includes an appropriate mechanism for adjusting the target cost and other KPIs for events that are beyond the control of the NOPs, such as the exercise by the owner of any ‘reserved powers’ (see below) or other unforeseen project challenges. It is common for Australian alliance agreements to only provide for such adjustments in response to a variation directed by the owner if the variation is “significant”.
Finally, you should satisfy yourself that the cap on your potential liability to make a painshare payment is commercially appropriate.
Decision making
Under the pure alliance model, all project decisions are made by the participants unanimously, with no deadlock breaking mechanism. Such decisions would include design decisions, selection of materials, construction methodology, allocation of tasks between participants, engagement of subcontractors, changes to the TOC or other KPIs in response to change events and the like.
The requirement for unanimity means that no decisions can be made without your agreement. But it also means every other participant has a veto right.
The approach is designed to force consensus decision making. Inability to make timely decisions will result in delays, cost overruns and other detrimental outcomes against the agreed KPIs, resulting in a reduction to potential gainshare payments, or an increase in painshare payments, which provides a commercial incentive to resolve impasses.
But the absence of a deadlock breaking mechanism could also render the parts of the contract, or potentially the entire document, a legally unenforceable ‘agreement to agree’. This outcome could see you lose the benefit of the no blame regime, and your entitlement to payment of your direct costs. Accordingly, it is common for most alliance agreements to include a deadlock breaking mechanism to deal with an inability to reach unanimous agreement.
A common approach is for the issue to be elevated through the alliance governance structure to the Alliance Leadership Team. If it can’t be resolved by the ALT within a specified period of time, it can be referred to an independent expert who:
receives submissions from each participant on the issue and how it should be resolved; and
is required to choose one of the solutions proposed by a participant, which then becomes binding on all participants, and
is not entitled to devise its own solution.
It is thought that this approach will drive the participants to avoid extreme positions in their submissions, for fear that the expert will prefer the less extreme position of another participant. It should also drive each participant towards an agreed consensus position, rather than risk the imposition of another participant’s position.
Reserve powers
Many owners are reluctant to give up control of certain decisions. Accordingly, it has become common for Australian alliance contracts to reserve certain decisions to the owner. Usually, the ‘knock-on effect’ of such reserved decisions on the TOC, target completion date and other KPIs must be determined by unanimous agreement, or via the deadlock breaking mechanism. However, some owners may also seek to determine these matters as well. Non-owner participants should resist such attempts.
Common “reserved powers” include:
the decision to suspend all or part of the works;
the power to vary the works;
any decision the owner determines is necessary following any event which significantly impacts on the works or the achievement of the owner's VFM statement;
any decision regarding any actual or threatened legal action, litigation or third party claims arising out of or in connection to the project;
any decision to enter into any subcontract which is a sub-alliance or is otherwise not subject to a fixed price;
the decision to terminate the agreement, where the owner has a right to do so.
Management structure
The usual management structure adopted for an alliance comprises the following:
Owner and Non-Owner Participant corporations – as parties to the agreement.
An Alliance Leadership Team (ALT) – one or more senior executives from each participant. Akin to a company board.
An Alliance Manager – an individual, selected by the ALT to lead the alliance, who reports to the ALT. Usually, a highly experienced project manager from a NOP, who chairs the AMT. Akin to a CEO.
The Alliance Management Team (AMT) – the management team, comprising members selected from the owner and NOP organisations. Akin to a Divisional Executive Group. Typically, all members of the AMT are senior executives from each participant.
The Alliance Project Team (APT) – staff and workforce.
The NOPs can use subcontractors, rather than their own staff, to perform their tasks.
Open book transparency
Alliance agreements typically require each participant to:
maintain all records and other documentation that relate to the works in accordance with good accounting practices, standards and procedures;
fully disclose any corporate or other objectives or affiliations that could reasonably be considered to have an adverse impact on the achievement of the owner's VFM statement or the alliance objectives; and
make their records and other documentation available to each other (or each other's nominated auditor) on request.
Usually, the obligation to make records and documentation available does not apply to records or documentation that are confidential lawyer/client communications.
Whilst this arrangement can initially be alarming for many contractors, most contractors in the Australian market consider it acceptable in light of the capped downside of an alliance arrangement.
Selection process
The non-owner participants are often initially shortlisted based on non-price criteria, such as credentials, experience and demonstrated ability to collaborate effectively in an alliance contracting framework. The owner and the non-owner participants then jointly develop a project proposal covering the following four interdependent components:
Project Solution – design solution and construction delivery method that will be used to deliver the capital asset requirements set out in the owner’s VfM statement;
Proposed Team – which covers the capability and capacity of the NOPs, and the culture of the integrated owner/NOP alliance project team;
Proposed Commercial Arrangements – the remuneration framework (including definitions of ‘reimbursable costs’ and ‘corporate overhead’), proposed fee, proposed gainshare/painshare regime, and other proposed Project Alliance Agreement terms;
Target Cost – commonly called the target outturn cost or TOC, including detailed breakdown and risk profile.
It has become common in the Australian market for owners to develop project proposals with two competing groups of non-owner participants before selecting the successful group with whom the owner enters into the final Project Alliance Agreement.
For non-owner participants, the cost of participating in such processes can be expected to be greater than the cost of tendering traditional contracts. The process is also likely to require much greater input from your senior management. The owner will usually enter into separate Alliance Development Agreements with each group of non-owner participants, and agree to partially or fully reimburse the project proposal development costs of each group. Full reimbursement of project proposal development costs is also typical for non-price selection processes. The reimbursement is usually conditional upon the transfer to the owner of all intellectual property rights relating to the design and delivery solution that was created during the alliance development phase.
The owner will typically select the preferred NOP group by reference to the requirements set out in the owner’s VFM statement. It will select the team it believes has the best potential to optimise VfM for the owner.
Selection processes for project alliances tend to be tailored to each project, particularly the level of detail to which project proposals need to be developed before the owner selects its preferred group of NOPs. For instance, some owners will:
make the selection before a project proposal has been commenced (non-price selection), or before it has been fully developed (partial price selection), and
then work exclusively with the preferred NOP group to fully develop the project proposal, and
then decide whether the project will proceed to the project delivery phase.
Accordingly, selection processes for Australian alliances tend to fall into one of the following three categories:
Non-price selection: where the preferred group of NOPs is selected before a project proposal has been commenced:
Partial-price selection: where the preferred group of NOPs is selected based on a partially developed project proposal; and
Full-price selection: where the preferred group of NOPs is only selected after two groups of NOPs have tendered fully developed project proposals.
The current policy of Australian governments it to adopt the full-price selection method. A partial price selection or non-price selection process requires an exemption from the policy, which if sought, is usually sought as part of the business case approval process.
The usual approach is for the owner to select the full NOP team at the same time. But sometimes owners will determine that a better VfM outcome may be achieved by selecting the non-owner participants progressively. For example, the owner may decide to select the designer or a key supplier, before selecting a contractor to join the alliance.
Comparison of procurement activities and milestones in selection process
Comparison of milestones in NOP selection process
Almost every Project Alliance Agreement is different
Almost every Project Alliance Agreement is different. Some depart materially from the “pure” alliance model. You should not assume that every Project Alliance Agreement reflects the principles set out in this article. You should obtain specific advice on each agreement.
Contact Owen if you’d like further information.
