Design and Construct Contracts Good for Developers, Not for Builders

Monday, August 8th, 2016
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When it comes to building disputes, design and construct (D&C) contract disputes are a real conundrum. They are protracted, difficult to disentangle and fraught with unintended consequences.

The D&C animal is a confusing and opaque beast and within the building industry has a tendency to mutate as rarely is one D&C contracting iteration similar to another.

What is D&C?

In its purest form, it is a contract where a contractor undertakes to design and construct a building. This type of contracting also embraces two separate disciplines or skills:

  • design, which is generally associated with the disciplines engineering, architecture and drafting
  • building, which concerns itself with the actual construction of a building

This makes it different to other types of construction contracts. Builders contract to build, engineers engineer, but D&C contractors undertake to deliver an “amalgam” of design concept development, design approval, and construction of the “as built” product. The amalgam however, somewhat like porous mortar, is prone to dissolving when put to the test.

The importance of identifying the two distinct subsets of disciplines within D&C contracts is to prevent any misunderstanding as to the inherently different tasks and, more importantly, risks that fall within the ambit of the professional subsets. Regrettably, in practice confusion does occur as the discreet and separate disciplines of design and build become blurred albeit in a loose coalition.

When the D&C contracting entity is issued, one often finds that a separate design subcontractor has carried out the design. The D&C contractor ordinarily comprises a head contractor that is solely the building arm of the contracting concern. The head contractor contracts out the design task to a design subcontractor, but insofar as the principal relationship is concerned, it inherits the liabilities of the designer.

In building disputes where defects are due to design rather than construction, the contractor becomes the fall guy for negligent design. The plight of the fall guy is worsened if the head contractor has not availed itself of appropriate professional indemnity coverage because it may lack the resources to defend a protracted litigation. The appropriate insurance cover would be a D&C risk policy that, although available, may be difficult to secure. If the contractor cannot get hold of such cover, a strictly commercial construction cover will prove to be an even more illusive quarry.

Thus, it is unlike the insurance typically on offer for designers where the insurer – courtesy of the indemnity – ordinarily funds and assumes conduct of the insurer’s defence and ultimate liability.

Scope of works and risk – how long is a piece of string?

There are very few standard industry D&C contracts. They normally have to be adapted to suit the needs of the given project. The problem with some of the standard contracts is that although they are well-written and comprehensive, more often than not they are incompatible with the particular D&C contractual paradigm. When one tries to reconcile the standard contract with the matrix of the particular project, the euphemism “putting a square peg in a round hole” comes to mind.

I once had to prepare a contract for an oil company for the construction of petrol stations. At first instance, I had resort to a standard form contract, but although the contract was well-crafted, it was unsuitable as it was too detailed. The over detailing emanated from the fact that the client had prepared very detailed in-house designs based on design prototypes. The design input of the contractor was thus limited, hence a plethora of contractual provisions were rendered superfluous and had to be culled.

The two types of D&C models

D&C contracts come in two forms: those with major contractor design input, and those with limited contractor design input. Both of these creatures are profoundly different types of contracts in terms of assumption of risk.

Limited Contractor Design Input

It follows as a matter of logic that the limited contractor design input model is the low-risk option of the contractor. This is because it is the principal who has generated the paramount design ideas and elements not the contractor. The contractor is quoting upon something that is essentially certain, so there are fewer variables. In other words, the contractor has a clear idea of what it is being engaged to construct. Hence, if there is any design litigation, unless the contractor has modified the design, the primary design liability should attach to the owner. Furthermore, the issues will ordinarily be pretty straightforward because the risk apportionment is clear.

Major contractor design input

Conversely, where the contractor elects to carry out the majority of the design input, the risk the contractor inherits is exponentially greater. Regrettably, there is no rule of thumb as to how it can be measured. It depends upon many things, including:

  • the details given to the contractor by the principal at first instance
  • is there rough conceptual documentation?
  • does it comprise drawings that have been vetted by an architect, or is it documentation that was developed over a boozy lunch on table paper?
  • does it comprise plans that have been approved by council?
  • what is the documentation’s status within the constructs of the design continuum? Embryonic? Crude? Advanced?
  • does the briefing documentation have any inherent flaws, will it have to be modified or varied?
  • is the briefing documentation capable of generating council approval?
  • have professional designers prepared it?
  • what are the finishing details like?

This type of contracting model is the Pandora’s box model. It is pregnant with the potential for surprise and unintended consequences. The simplistic and pure definition of D&C contracts is that the contractor does all of the designing, as the term “D&C” would imply. This is rarely the case, however, as the contractor normally carries out only some of the design. Granted, “some of the design” may happen to be greater part of design, but the design embryo or the “mother of the design concept” will always be derived from the principal.

If a contractor is intent on entering into a D&C arrangement when given the barest of design details, then it is axiomatic that the contractor should have the ability to vary the price depending upon the magnitude of the design input and potential changes. It could be commercially suicidal for a contractor to look into a lump sum D&C contract when the design brief is embryonic and parsimonious with respect to detail and conceptual scope.

Ideally, the contract would be priced so that there are two pricing phases: a price for design development and building approval procurement, and then a price for construction. Obviously the construction price should be crystallised as late as possible, remaining mindful of the imponderables and variables that may be encountered during the design evolution phase, not the least of which being council planning department approval. Alternatively, the arrangement should be cost plus, which although anathema to principals, be they developers or Crown bodies, is nevertheless from the contractor’s point of view the safest D&C methodology.

If the contractor is not enamoured with this approach, wanting the price to be fixed at the front end, he or she must be fully aware that the very act of contractual execution may be a defining moment in the ongoing solvency of the company. It may prove to be the precursor to the financial demise of the company on account of the massive assumption of risk.

Typically, a D&C contractor contracts directly with a principal under a fixed price arrangement for design and construct services.

Contractors perform D&C services in one of two ways, either by using the services of an in-house design team or by sub-contracting out the design function.

The in-house approach to D&C

The in-house approach contemplates an in-house design team, whether they be architects, draftspersons, or engineers.

With this approach, prudence dictates that the contracting entity has taken out insurance for the risk amalgam of design and construct. Prudent principals will normally ask for insurance cover that provides comprehensive indemnity for design and construct damages.

If a building dispute arises, the in-house approach will prove to be far less fickle than the outsourced approach, as the contracting entity has imported and embraced the design risk and has internalized the risk. In addition, as it has carried out the design with internal resources, it will be better positioned to confront a liability and fix the problems, knowing that there is no ability to outsource or migrate the risk or the blame.

Outsourcing the design

There is nothing preventing a D&C builder from outsourcing or subcontracting the design component of the contractual brief. This approach raises profoundly different issues with regards to insurance and risk. It normally entails a builder incorporating a company that contracts directly with the principal to render D&C services. The design function is sub-contracted out to an independent designer and the builder ordinarily interfaces with the designer.

In my experience, this method is often associated with a large dose of naiveté on the part of the contractor. Rarely does the head contractor ensure that the insurance cover taken out by the design sub-contractor embraces either the magnitude or the scope of the risk.

In assessing the risk and the amount of professional indemnity, consideration needs to be given to the potential consequences of design negligence upon the project.

The consequences can be forecast by analysing the nature of the project. One of the designer’s primary responsibilities is to ensure the structural design is sound. In a worst case scenario, if the structural design is deficient, it can lead to building collapse. More often, it may lead to partial collapse. The consequences of any type of collapse or serious design malaise are profound. They impact upon completion costs by way of time blow outs, critical path interruption, renegotiations of critical sub-contracts, liquidated damages and union interference.

The net effect is that the very viability of the project and the contractor’s ability to remain solvent may be brought into question. Yet all too often, the contractor may negotiate an indemnity limit with the design subcontractor that is inadequate. Rarely is the negotiated level of design indemnity commensurate with the real risk.

Never forget that under D&C, the contractor assumes the liability of the designer insofar as his obligations to the principal are concerned. The only way the contractor can protect its position is to ensure that the level of design indemnity provided by the design concern can adequately cover of the costs of design rectification and consequential costs emanating from the rectification.

Before a builder enters into a D&C contract, there is a great deal to consider. Questions such as the extent or limit of the design brief and the notion of whether the design component will be kept in house or out of house are critical considerations that can shape the outcome. Consider these issues very carefully before you engage folks.

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