Rethinking risk and claims management on Australian infrastructure projects
Australian State and Federal governments have committed a record $120 billion to fast-track infrastructure projects over the next decade. Achieving this level of infrastructure delivery will be challenging given the stress that the Australian civil engineering sector is already under.
This article summarises the insights that we shared during a webinar on:
market conditions and trends;
how these feed into structure and strategy around contracting; and
how claims and disputes are managed down the track.
A recording of the webinar can be accessed via the link at the end of this article.
Market conditions
Tendered prices that owners are presently receiving for the design and construction of infrastructure projects are considerably higher than expected by the owner – in some cases up to 50% higher.
There are several causes of this, but the key causes seem to be:
higher contingencies on account of risk and
high labour costs combined with a very small talent pool; and
increased commodity costs, in particular steel.
Steel prices have been steadily increasing for the past 6-9 months as rapid construction and industrial recovery from COVID-19 lockdowns has outpaced sluggish capacity restarts and the effects of very harsh second lockdowns – particularly in China and throughout Europe – to manage second and third wave outbreaks.
The first two causes – risk and labour costs – are more causative of tender estimate blow-outs, as commodity costs will eventually correct themselves.
In relation to the contingencies on account of risk, it seems that contractors are now more fully pricing the risks that project owners are seeking to transfer to them.
Do the higher contingencies mean owners are transferring more risk to their contractors?
The simple answer to this question is yes, but the real answer is more nuanced, for several reasons.
Firstly, the trend with risk allocation in construction contracts over the last few years has been towards more contractor-friendly risk allocation – more relief events and more compensation events.
As such, the higher contingencies are not on account of the risk allocation being more onerous. Rather, they are mostly on account of the projects growing in size and complexity.
Large, complex projects, often involving the integration of multiple systems and technologies from different suppliers, are inherently more risky than smaller, less complex projects. So, while the risk allocation may have become more contractor-friendly, the quantum of risk that contractors are being asked to manage has grown are a result of projects becoming larger and more complex.
Indeed, the quantum of construction risk involved in today’s mega projects is now so great that the tier 1 construction contractors won’t take it by themselves. They need to form joint ventures with their tier 1 competitors to spread the work and the risks between them. This, together with mergers and consolidation of Australian contractors, has resulted in less competition in the Australian market for mega projects.
When you combine this with:
a rise in demand for the services of tier 1 contractors in the Australian market;
a long history of contractors incurring significant losses on Australian mega projects; and
foreign ownership of our top tier contractors causing them to become more internationally focussed in their pursuit of work opportunities,
you can see a variety of reasons reason why contractors are more fully pricing the risks.
Impact of market conditions on contracting strategies
Some owners are still grappling with what higher tender prices mean.
In the first instance, owners will respond in the usual ways – projects will either be split into stages, delivered over longer periods of time or de-scoped, and some less urgent projects will be delayed or eventually cancelled.
Rather than it being all doom and gloom, the current situation provides opportunities to consider the current market and rethink how we deliver our major projects and perhaps get a bit creative.
The infrastructure delivery market is dominated by a very small pool of tier 1 contractors. How project owners treat risk is fundamental to increasing and improving competition in this market.
We should be looking for ways to improve engagement with the tier 2 contractors, and how mega-projects might be broken up into multiple contract packages that minimise interface risks and creates opportunities for smaller contractors to participate.
We might also consider what we need to do to encourage more overseas contractors into the Australian market, particularly those that are experienced in the types of major projects that we are delivering so that we can leverage that experience and knowledge. Again, this will require us to rethink our current approach to risk and bring it in line with what those contractors are used to in other parts of the world.
Another relatively easy opportunity is to improve early contractor involvement in the design process.
A particularly sensitive area for contractors is utilities. Utilities are rarely located where the as-builts show them to be, or even installed as they are meant to be. Contractors are not keen to accept the risk for utility adjustments, especially where they are being asked to guarantee the principal’s documents which have been shown to be unreliable, and have little or no opportunity to undertake their own investigations. Accordingly, there is an opportunity to risk-share with contractors around utility adjustments, or for principals to engage directly with the utility providers to better manage utility adjustments on major projects.
New approaches to managing interface risk
Owners are increasingly appreciating that their preference for a single point of accountability for the full D&C scope is either not possible or not affordable on a complex mega project because:
the risks associated with successfully integrating the multiple systems is simply too great for any single contractor, and
contractors are more fully pricing (rather than under-pricing) the risks.
Accordingly, government agencies and other owners are looking for innovative ways by which the owner can share the integration risks with its contractors, and incentivise each contractor to look beyond the successful delivery of its contract package and towards the successful delivery of the entire project.
Owners are increasingly appreciating that the practice of putting fixed price contracts in place for multiple interfacing contracting packages actually creates financial disincentives to the cooperation that the owner needs from its various contractors to integrate the various contract packages and make the entire project work, on time and to budget.
Under a fixed price contract, every dollar that a contractor spends cooperating and interfacing its works with the works of the other project participants is one dollar less profit that it will make on its contract package. As such, it will only cooperate and collaborate to the extent necessary to deliver its scope of work. There is no reason for it todo anything more, to make it less expensive or quicker for other project participants to deliver their scope, unless it is paid for doing so.
Owners are seeing this and are looking to develop more sophisticated commercial frameworks and risk sharing arrangements, to better align the commercial interests of the other project participants with the whole of project outcomes that the owner is wanting to achieve.
We will therefore continue to see a shift towards more collaborative forms of contracting that incorporate more nuanced commercial and risk sharing frameworks. We will also see innovations in how these more collaborative forms of contracting, which have been used on publicly funded projects to date, can be combined with private sector finance.
Claims and disputes – the usual approach
Construction is an inherently risky activity. Construction contracts will always entitle the contractor to claim extra time and/or extra money on account of risks beyond its control, and contractors will always wish to exercise these entitlements. So, we will always see claims for extra time and extra money under traditional fixed price, fixed time contracts.
There is, however, considerable scope for industry improvement in how principals and contractors resolve these claims, when they are not immediately accepted in full by the principal
What typically happens now, is the principal – whether at the owner level, or at a head contractor level – rejects the claim, usually in full on the basis of the principal’s belief that the contractor is not legally entitled to bring such a claim, or on the basis that the amount of extra time and/or money claims by the contractor hasn’t be adequately substantiated.
The contractor then typically continues to assert its claim, but doesn’t issue a formal notice of dispute in accordance with the contract, because it doesn’t want to elevate the dispute beyond above the project team at this point in time – usually for “relationship” reasons.
Often, the claim isn’t progressed by the project team. Instead, it just sits in the background until the end of the construction process and is either dropped or reagitated at the time the contractor is required to submit its final claim under the contract. At this point it is often bundled up with a bunch of the other unresolved claims that have been allowed to fester, and it becomes much larger and more complex claim that the parties cannot resolve amicably mostly because of the expectations that have by then been created on each side with their management regarding the value of the claim.
A better way to manage claims and disputes
Suggestions for contractors:
Contractors should write for their audience and provide better composed claims that are capable of justifying acceptance. Claims worth tens if not hundreds of millions of dollars will certainly be escalated many levels above the person to whom they are addressed. They need to put more thought into what is going to compel those people to consider their claims.
If your claim has been rejected and you disagree with its rejection, act immediately and make inquiries as to what information they might need to consider the claim. If you don’t act on it straight away, the principal – quite reasonably – will assume that its rejection has been accepted and the matter has been resolved.
Don’t wait until the end of the project to make claims, not least because the claim might be time-barred. Claims should be made as and when issues arise and not wrapped up with many other issues in a global claim at the end.
Suggestions for principals and owners:
Correspondence from principals often fails to detail the reasons why a claim is being rejected or setting out what information they need to carry out a proper assessment. If you are rejecting a claim, you must be clear as to the reasons why. If the contractor parks its claim for a period and reagitates it much later, having a detailed written record of your initial assessment can be a very powerful defence.
If a claim is capable of being resolved in part, then try to reach agreement on what can be resolved as early as possible. Don’t leave what can be resolved now until later because experience has shown that claims will only ever grow in value.
During tender negotiations, make all necessary inquiries to ensure that you understand the assumptions that underpin the contractor’s program and pricing.
Keep better records during delivery, particularly around the contractor’s progress and productivity. This information will help you understand the true value of the contractor’s claim.
Be more observant to the “signs” of potential claims – are there issues that are raised at every meeting, or seemingly small issues that are minute-ed every month or every week, that never seem to get resolved? This can provide an early indication of issues that the contractor may wish to agitate later down the line.
Timely resolution of claims
If a contractor’s claim is not accepted by the principal, the contractor’s interests are sometimes best served by not immediately progressing the claim and instead reagitating the claim at a later point in time when it might be more difficult for the principal to defend it, or when it can be combined with other claims.
It can be difficult for principals to stop contractors from pursuing this tactic. If the contractor doesn’t respond to the rejection of its initial claim by making the claim again, or by referring it to the dispute resolution process, there’s little the principal can do, as most contracts don’t provide a mechanism that forces a claimant to either progress, or abandon forever, claims that have been properly notified but rejected.
All parties would be better served by adopting contractual mechanisms that force the parties to either progress or abandon claims that have been properly notified, absent good reasons why it is premature to do so – a ‘put up or shut up’ mechanism (or we could call it a ‘no parking’ mechanism).
Another approach to achieving timely resolution of claims is to hold regular scheduled issue resolution meetings involving senior decision makers, facilitated by a Dispute Board. Dispute Boards have proven to be a very cost-effective mechanism for resolving issues and avoiding disputes on construction projects in Australia.
Dispute Boards have been used on over 100 projects in Australia, with an aggregate value exceeding $50 billion. On only 25 occasions has an issue been formally referred to the Dispute Board for a decision. All other issues have been amicably resolved by the parties with the real-time assistance of the Dispute Board. And of the 25 issues that have necessitated a decision from the Dispute Board, none have been subsequently referred to arbitration or litigation. Rather the Dispute Board’s decision has been accepted, or the parties have thereafter settled the issue.
Finally, parties can avoid disputes in relation to claims for in increase to the fixed price or extensions of time by taking alternative, non-traditional approaches to cost and time risk. Indeed, parties could go even further and include a ‘no-blame’ clause in their contract (as per pure alliance agreements), and instead rely on the more sophisticated commercial and decision-making framework of an alliance contract, to drive best for project outcomes and minimise litigation and arbitration.
Conclusion
Successful delivery of infrastructure in Australia’s current market requires more sophisticated and nuanced approaches to the sharing of project risks, to better align the commercial interests of non-owner participants to the project owner’s objectives. It also requires a more strategic and pro-active approach to the management of claims and resolution of issues.
Webinar recording
You can access a recording of the webinar, and read the associated chat, via this link
