In general terms construction contracts (especially those relating to international projects) have usually a complex structure for both technical and other reasons (just consider, for instance, cultural and linguistic differences among the parties). Such complexity is even more relevant if we consider contracts for the construction of infrastructures or industrial and productive plants.
It generally takes a few years to complete this kind of works and such long period of time makes it even more difficult for the parties to cooperate, since certain of the contractual initial conditions may change (just consider labour costs or raw materials price) or because part of the management changes over the time.
Good "project management" rules are essential for a positive outcome of the project and to reduce litigations to a minimum risk.
From a legal point of view there are some basic rules that, if duly followed, help to reduce construction dispute or minimizing the risk of controversies between the Owner and the Contractor.
Clearly there is no 'one size fits all' approach for any contract. Just consider the differences between:
- the construction of infrastructures (a bridge, a dam, a railway); and
- the construction of production plants (a factory, a power plant);
- a contract for the supply and the installation of (even complex) machinery; and
- an EPC contract.
However, there are some general rules that allow, if duly applied, to minimise the risk of litigation.
B. How to reduce construction disputes: the first 5 essential rules
First, good project management rules imply that everyone involved in the contract (project manager, contract manager, document controller, in-house lawyer) act in an interdisciplinary and cooperative way.
Turning now to the basic but essential rules, they can be summarized as follows:
1. ANALYZE the contract in its entirety. In International Construction projects, the contracts are "self-regulating", meaning that they include (or try to include) every aspect of the relation between the parties to avoid discussions and disputes as much as possible, so every clause has its weight. The contracts are usually very complex, but (often) the good thing is that usually they are based on standard contracts (i.e. FIDIC, ICC or LOGIC) widely used internationally;
2. EXAMINE very carefully some specific clauses that are often read too quickly. For example, clauses that regulate:
- the Scope of work (ie the real object of the contract): it is on the basis of the Scope of Works (including specifications) as described in the contract that the correct or incorrect performance of the Contractor is evaluated;
- the payment terms and their relationship with the construction timescale (negative cash flow is one of the first causes of contract failure);
- the bonds that should be provided by the Contractor or by the Owner and their conditions (unconditional bonds at first demand are the most common and their unfair or abusive calling can cause the failure not only of the contract but of the contractor itself);
- the changes in the Scope of Work (if the procedures for change orders or variations are not well regulated by the contract, there is a true risk to end up with a dispute);
- the completion and pre-completion tests (various disputes arise from late or unjustified execution of the tests or from the failure to properly regulate the procedure and the timing for their execution);
- the termination of the contract and in particular the precise identification of the causes that entitle the parties to terminate the contract and the compensation that the Contractor is entitled to receive in case of termination of the contract without reason or at the Owner's convenience;
- the dispute resolution clause which too often is not analysed with due care and the result is that, for instance, construction disputes for a huge project are to be resolved by local Courts which might not have any specialization in complex construction projects;
- applicable law. Also in such case the contract must be analysed having in mind the law which governs the contract since there might be certain legal provisions which apply notwithstanding what is provided in the contract.
3. KEEP written and accurate documentation of every event related to the contractual relationship. Too often when dealing with the Owner, a Contractor believes that a phone call is better than a formal letter. Not only it is recommended to keep track of the correspondence with the Owner, but also to take note of any kind of event and meeting (both internal and with the Owner or the suppliers) through detailed minutes of meetings. In case of disputes, only a punctual and precise "documentary records" of the facts will allow you to reconstruct (and prove) the events;
4. NOTIFY immediately to the Owner any kind of event that gives you the right to extend the completion term or to demand any increase of contract price. Start a dialogue (which should be supported by appropriate documentation) to prevent any possible controversy. Under many standard contracts (i.e. FIDIC contracts) there is a precise timing to file a claim. Be sure to include a timing also in your contract bearing in mind that, under the applicable law, the Contractor might lose its right to submit any claim due to statute of limitation;
5. KEEP always the project timeschedule updated and use it as a live record of the events that have any impact on the execution of the project. This will allow you to prove any event that caused a delay and any related responsibility. The timescale shall not be considered as a "static" document, that can be left aside once filled out. Instead, it is one of the fundamental instruments to prove that an event might have caused a delay and to recognize any connected responsibility.
C. Some of the most frequent causes of disputes in International Construction Contracts
In general terms, in (but not only) an international construction contract, the Contractor's goal is to maximize, in a legitimate way, its profit. On the other hand, and in an equally legitimate way, the Owner wishes to spend as little as possible.
This might be the first cause of conflict between the parties.
In more practical terms, there are various reasons to explain the high level of construction disputes (in addition, as said, to cultural, legal and linguistic reasons):
- the persistent crisis in this sector pushes Contractors to accept at-cost (or even loss making) agreements in the hope of raising some more funds from the Owner over time through claiming;
- the description of the project, provided by the Owner, might be inadequate or generic (or it is mis-read by the Contractor). As a consequence, the Contractor offers a price that it is often not enough (if no changes occur) to bear the costs of the works done or to be done;
- an unsophisticated management (for technical reasons, or for the lack of adequate resources) often causes difficulties in relation to both timing and proper execution of the works;
- the Owner might delay the acceptance of the work (either reasonably or not), causing a further increase of the costs that the Contractor will not easily recover.
international construction contracts are complex agreements for various reasons, technical or purely contractual. Just consider the fact that they relate to the construction of plants or complex infrastructures.
Furthermore, such contracts are subscribed by parties with different cultural backgrounds. The cultural factor has a certain impact in the management of international contracts (just think, for example, about an agreement signed by an Italian and a South American, Arab or Indian party).
No doubt that one of the winning elements of any contract is to try to comprehend the cultures you are dealing with, understanding the differences between the Owner and the Contractor.
That being said, the above mentioned rules are rules of good sense that, unfortunately, only a few times are found to be carefully followed.
However, on the basis of practical experiences, it can be said that they are a basic tools to limit the rising of disputes that might cause severe damaging effects on the parties.
This is the first of a series of articles that we will publish on the management of construction contracts. If you wish to stay updated subscribe to our Blog.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.