Doing business in the UK – a guide to the construction industry
Contents Construction in the UK
1 2 6 8
What’s happening in themarket
Procurement options
Finance
Public Private Partnerships (PPP) Standard forms of contract
10 16 18 24 27 34 36 38 42
Contractual issues
Insurance Regulation
Dispute resolution
Industry organisations
Global infrastructure key contacts
Glossary – common construction legal terms
Construction in the UK The UK has been at the forefront of the international construction industry for decades and remains one of the largest construction markets in Europe. Despite the significant industrial and financial challenges of the last decade, the UK market is now experiencing a period of significant growth and optimism, with strong recognition at government level of the vital contribution that it makes to the broader UK economy. An evident trend in recent years is the
2.2m x There are 2.2 million people employed in the sector
influx of overseas investors and contractors to the UKmarket. These companies often have diverse operations in a number of jurisdictions, and so stand stronger in times of economic hardship, with less exposure to the highs and lows that affect individual domestic markets. It is unsurprising that an increasing number are choosing the UK as a place to do business, due to its reputation as an industry leader in construction, its relative financial strength and stable political environment, and its world class regulation. However, for those considering entering the UKmarket, the procurement and regulatory environment can seem complex and daunting. In this guide, we set out the basics for doing business in the UK construction industry and look at key factors that overseas businesses should be aware of.
200,000 x There are more than 200,000 construction companies trading in the UK
6% of the UK’s
The market accounts for
annual economy bringing in a total of GBP 109 billion As seen October 2015
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What’s happening in the market? The importance which the UK Government attaches to infrastructure and construction has been highlighted by the creation of the National Infrastructure Commission , an independent body of senior figures drawn from politics and industry, with a remit to develop a long term strategic plan to build effective and efficient infrastructure in the UK, and to make recommendations to the Government accordingly.
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In launching the Commission, the Chancellor of the Exchequer, George Osborne, said:
The Commission will publish a National Infrastructure Assessment later in the current Parliament, setting out its overview of the UK’s priorities for the next 30 years, but it has already produced reports on three specific areas: • Smart Power – this sets out the innovations in storage, demand management and interconnection (between the UK and other European countries), which are necessary to achieve a more efficient, flexible and secure electricity network • Transport for a World City – this considers how to address London’s pressing need for additional transport infrastructure, as the capital becomes a “mega-city” by 2030, with a population exceeding 10 million. In particular, it endorses the strategic case for Crossrail 2, a north-east to south-west rail link to complement the new Elizabeth Line (Crossrail 1), which is due to commence operations in 2018 • High Speed North – this recommends that the North of England should receive significant investment in transport connectivity between its major cities – the so-called “ Northern Powerhouse ” of Liverpool, Manchester, Leeds, Sheffield, Hull and Newcastle – in order to reduce journey times, increase capacity and improve reliability. Key objectives include upgrades to the M62 motorway between Liverpool, Manchester and Leeds, and the creation of “HS3”, comprising enhanced rail connections, initially between Leeds and Manchester. This will link into the northern sections of HS2 (a north-south, high speed rail connection currently in development) A key role in the delivery of this investment in the North will be played by the recently created Transport for the North (TfN) , a collaboration between local authorities in the region, which has the objective of developing a co-ordinated transport strategy, and which is due to become a statutory body by 2017 To complement the National Infrastructure Commission’s focus on strategic planning, the Government has also created a new body to oversee and improve the actual delivery of major government projects. This is the Infrastructure and Projects Authority (IPA) , which brings together the expertise of two previous bodies - Infrastructure UK (IUK) and the Major Projects Authority. The IPA has set out the Government’s priorities for infrastructure delivery for the next five years in its National Infrastructure Delivery Plan (NIDP) . This updates and replaces the previous National Infrastructure Plan (published by IUK), and outlines details of GBP 483 billion of investment to 2020-21 and beyond, in over 600 projects and programmes across all sectors in the UK. In short, the NIDP seeks to identify “what will be built and where”, and the IPA will report annually on progress in its implementation. Infrastructure isn’t some obscure concept – it’s about people’s lives, economic security and the sort of country we want to live in. That’s why I amdetermined to shake Britain out of its inertia on infrastructure and end the situation where we trail our rivals when it comes to building everything from the housing to the power stations that our children will need.
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Alongside the economic infrastructure that was the focus of its predecessor (principally transport, energy, communications, waste and water), the NIDP also covers large-scale housing and regeneration projects, as well as key social infrastructure (schools, hospitals and prisons). Its highlights include the following: Roads: in 2015, Highways England, the Government’s delivery body for the Strategic Road Network (SRN) in England, was given increased independence and a committed funding stream, in order to deliver an ambitious programme of upgrades and renewals over a five year period, via a comprehensive Road Investment Strategy (RIS). The NIDP confirms this investment of GBP 15 billion, with over 100 major schemes to be completed or in construction by the end of this period. Plans for a second RIS will also be developed, supported by legislation for a new Roads Fund, which will use direct revenues from Vehicle Excise Duty to provide long term funding certainty. Rail: the NIDP outlines the basis for the Government’s claims that it is implementing the largest rail modernisation programme since Victorian times. This includes the completion of the Elizabeth Line, the start of construction on HS2, and the development of plans for both Crossrail 2 and HS3 (following the NIC’s endorsement of each). Airports and ports: the NIDP outlines a package of road and rail projects to support private sector investment in airport and port capacity. The position on airport expansion around London, however, is less clear-cut. Whilst a new runway at Heathrow has been supported by an official commission, the issue remains controversial. The Government has accepted that greater
aviation capacity is required in the South East, but a final decision on whether the new runway is at Heathrow or Gatwick is not now expected until summer 2016 at the earliest.
Energy: the Government has taken a new direction in its energy policy
– seeking to achieve security of supply and decarbonisation, but in a way that puts consumers first and increases competition. This means that, whilst the UK has developed a strong renewable energy market (in onshore and offshore wind, biomass, energy fromwaste, and solar), the Government is now reducing its level of support to these industries, as they mature and costs reduce. At the same time, it intends to phase out the UK’s remaining coal-fired power stations, in favour of cleaner gas-fired plants, and is supporting an ambitious programme to replace the UK’s fleet of nuclear reactors, with new facilities planned at Hinkley Point in Somerset, Wylfa in North Wales, and Sellafield in Cumbria. All three rely heavily on international investors and contractors, with Chinese investment, in particular, being key to the vanguard project – EDF’s new reactor at Hinkley. Water and waste: water and sewerage services in England and Wales are provided by private sector companies that are subject to economic regulation. The stand- out project in the sector is the construction of the Thames Tideway Tunnel – a “super- sewer” that will protect the River Thames from pollution, by addressing the problem of overflows from the capital’s Victorian sewers. Works get under way in late summer 2016 and are due for completion in 2023, at a total estimated capital cost of GBP 4.2 billion (at 2014 prices). The project will be financed by an independent infrastructure provider, but with the benefit of a Government support
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package to deal with those exceptional risks which the private sector is not able to cover at an affordable price. Flood defence: there are currently around 2.4 million homes and businesses at risk of flooding in England, and climate projections indicate that this number is likely to increase in the future. As a result, the Government is funding a GBP 2.3 billion 6-year capital programme which will deliver more than 1,500 schemes to mitigate this risk, as well as providing increased funding of GBP 700 million for flood defences and resilience. Housing and regeneration: the UK is facing an unprecedented shortage of affordable housing, due to underinvestment in the sector by successive governments. The NIDP sets out a range of measures designed to support large-scale housing supply and regeneration – by, for example, releasing public sector land for development, streamlining the planning process, and delivering additional infrastructure to support and facilitate new sites. The Government will add impetus to these efforts by directly commissioning several thousand new homes on public land, in a departure from the sector’s usual reliance on large private sector developers, and it has indicated that it will establish joint ventures with construction companies and financial partners to do this. Its Homes and Communities Agency will obtain outline planning permission on sites that it owns, and then look to enter into joint ventures with private partners. As projects are delivered, and returns made, the intention is that project equity will be released to be reinvested into other sites.
More generally, the Government is seeking to persuade construction companies to take a more focused approach to housebuilding, and to see it as an integral part of the wider infrastructure market in the UK. Social infrastructure: the Government is committing over GBP 48.6 billion to major capital investment in the education, health and prison sectors. Whilst most new schemes will be funded frompublic resources, the NIDP indicates that private finance will also be considered – via the PF2 procurement model (the successor to PFI) – where it offers value for money to do so. Devolution: the NIDP summarises a number of initiatives which are designed to transfer control over infrastructure investment and delivery to local regions. A key vehicle for this is the Devolution Deal . In return for additional funding and extra control over policies and budgets in transport and other areas, cities such as Manchester and Liverpool will elect their own mayors, in order to provide accountability for the exercise of these new powers, and to work with local or combined authorities, such as TfN.
Robert Meakin Partner, London T: +44 (0)20 7876 4249 E: robert.meakin@clydeco.com
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Procurement options
A number of procurement strategies have been developed in the UK market, with the appropriate choice for each project depending on variables such as the desired level of risk transfer, the expertise and resources of the client, the extent of initial design development, and the available sources of funding. Some of the main procurement options are outlined below.
Traditional procurement The traditional procurement route involves the client separately appointing a design team (eg architect, mechanical and electrical engineer, structural engineer) under direct contractual appointments, and maintaining this direct contractual relationship throughout the project. The client appoints the contractor separately under a building contract. Design responsibility rests with the design team, and the contractor has a responsibility to build to their design. Although the contractor has no overall design responsibility, he may design discrete specialist items. Design and build With design and build, the responsibility for carrying out most, if not all, of the design, and the risk in the design, is passed to the contractor. The contractor may carry out design in house, or may appoint his own design team. Alternatively, the design team appointments originally entered into by the client may be novated to the contractor, allowing for continuity of design.
Hybrid and variant versions of of such single point responsibility include: – BOT (build, operate, transfer) – DBO (design, build, operate) –– EPC (engineer, procure, construct) In major civil engineering projects, contractors may form unincorporated JVs to undertake large works packages (assuming joint and several liabilities to their client, and allocating responsibilities between themselves through a JV agreement). Management Management procurement involves a fast track approach which allows work to progress very quickly, but provides little cost certainty. The main types are: – Management contracting This approach overlaps the design and construction stages, allowing early parts of construction to be started before the design has been completed. The management contractor is appointed by the client early in the programme, and his role is to manage the overall contract in return for a fee. The contracts for
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Framework agreements A framework agreement seeks to establish, as between a client and its contractors or suppliers, the terms that will govern any contracts that are subsequently entered into during the period for which the framework agreement is in place. It sets out the general terms under which more specific orders or contracts will be placed or “called off” and – provided that the initial framework arrangement has been tendered in compliance with EU public procurement rules – it has the advantage for public bodies and utilities of avoiding the need to repeat such compliance for each subsequent call-off. Early Contractor Involvement (ECI) ECI is used in two-stage tendering, and is promoted as a way of achieving an integrated approach to design, with the contractor being retained during the early stages of the project, when design is being carried out, so that its specialist knowledge may benefit the design process. The contractor contributes to the development of the design at stage 1 alongside the design teammembers – generally on a cost reimbursable basis – and will then submit a lump sum bid for the contract works at stage 2, based on a well- defined scope. When implemented properly, ECI has the advantage of achieving a realistic and comprehensive price for the works, which both reduces the risk of subsequent claims and variations, and gives the contractor an appropriate margin. Public Private Partnerships Public Private Partnerships cover a range of structures under which the private sector is involved in the delivery of a public service (see Public Private Partnerships (PPP)).
individual work packages are entered into by the management contractor and the individual subcontractors. Final costs cannot be ascertained until the final work package has been awarded – Construction management This is also a fast track strategy, similar to management contracting. Here, the contracts for the subcontractors are placed directly between the client and the subcontractor, and the client needs to have a high level of involvement during both the design development and the construction phases of the work. As with management contracting, the final costs will only be known, once the final works elements have been awarded Partnering Partnering is a broad term referring to a more collaborative management approach to contracting. An overarching partnering agreement may be used, together with one or more contracts relying on one of the more conventional methods of procurement referred to above. There are also standard form contracts which adopt a partnering approach (see Standard Forms of Contract ). Alliancing Like partnering, alliancing is based on a collaborative approach. It relies on the creation of an integrated and collaborative team from across the supply chain. Client outcomes and requirements are agreed, and risks and returns are normally shared between the participants. Alliancing requires commitment from all participants to ensure that the requisite cultural and behavioural approach is maintained.
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Finance
Financing methods and structures for construction projects will vary depending on a number of factors, including the type and value of asset being constructed, the applicable procurement arrangement and transaction structure, whether the project is being procured for the public sector or by a utility, and the applicable regulatory environment.
Project finance For complex, capital-intensive and long-term infrastructure projects (including private finance or PPP projects – see Public Private Partnerships below), project finance may be used. The key feature of a project financing is that it involves the provision of third party debt finance on a limited recourse basis, advanced to a special purpose borrower, meaning that lenders will generally only have recourse to the assets of the project and not to the shareholders or to assets outside the project. In order for project financing to be viable, the revenue generated from the assets constructed, once operational, must be sufficient to pay the costs and expenses of operating and maintaining the project, to repay the lenders, and to provide a return to the project company and its investors. The level of equity to be contributed by the sponsors of a project will depend on the nature of the project and requirements of the lenders. Sources of debt Debt finance is provided by a variety of sources, including commercial banks, international financial institutions (such as the European Investment Bank (EIB)), institutional investors (pension funds and life insurers) and infrastructure funds.
Historically, commercial banks have been the largest source of project finance debt, but liquidity constraints following the financial crisis, together with the long term impact of regulation on commercial lenders’ cost of long term funds, have reshaped the lending environment, resulting in increasing diversity of providers and capital structures. Investors and financiers may also provide subordinated debt directly or through funds, which may themselves have complex debt and equity capital structures. Depending on the size of the project, finance may be provided by a single lender, or a group of lenders put together for the purpose of the specific deal (a club deal), or through The issuance of listed bonds has also been used to finance large scale projects, although the use of this technique was adversely affected by the demise of many monoline insurers following the credit crisis. More recently, alternative credit enhancement structures such as EIB’s Europe 2020 Bond Initiative have been used to achieve the higher investment grade credit ratings typically required to access the long term bond market. formal syndication. Capital markets
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Financiers’ security and quasi-security Security Typically, lenders in a UK project financing will take a fixed and floating charge over the assets of the project company and also a charge over its shares. If the lenders need to enforce their security, this structure helps them to take control of the project, in order to preserve its revenue-generating capacity and, if that fails, ultimately to enforce against the project’s assets (although the residual value of the assets on a breakup basis is typically relatively insignificant). Taking comprehensive security over the project company’s assets also helps to protect the project company from any third party claims. Quasi-security are designed to function in tandemwith their security. In particular, they will have direct agreements with the key counterparties of the project company (eg the purchaser/offtaker and the supply chain contractors) which will include step-in rights. Step-in rights are used to permit lenders to take over a project contract, by The lenders will also typically have the benefit of contractual structures which Regulated Asset Base model In privatised regulated industries (eg energy, water, airports, rail), infrastructure is financed using structures which are linked to the nature of the economic regulation (ie the regulatory asset base – RAB – model). Similar structures are used to finance assets which are not subject to economic regulation (eg ports), but which are considered to have similar economic characteristics and risk profile. Property finance Real estate developments may be financed
‘stepping in’ to the shoes of the project company in order to remedy the situation if, due to a default by the project company, the relevant project contract is at risk of termination. They also entitle the lenders to transfer the relevant project agreement to a nominee or a replacement project company in the event that the lenders have to enforce their security. Direct agreements may also contain undertakings or collateral warranties in favour of the lenders from counterparties relating to performance of their obligations in respect of the project. The lenders will also require all the project cashflows to pass through designated bank accounts and will enter into an accounts agreement with the account bank which will give the lenders various rights in relation to the accounts, including the right to take control of the accounts and if necessary direct the application of proceeds if the project company is not complying with its obligations. Robert Franklin Legal Director, London T: +44 (0)20 7876 4242 E: robert.franklin@clydeco.com under a range of structures and from a variety of sources. Financing may be provided by equity, bank loans and subordinated debt, allowing a borrower to purchase and/or develop a property. The financing will be secured against the property being purchased and/or developed and the cash flow generated by the property (ie rental income), once the development has been completed. Emphasis is placed on monitoring the property throughout the development phase and thereafter ensuring that the value and condition of the property are maintained.
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Public Private Partnerships (PPP)
Public-private partnerships cover a range of structures under which the private sector is involved in the delivery of a public service.
Within that range there are permutations which vary as to: • The nature of the asset • The nature and the extent of capital expenditure • Ownership of the asset • Responsibility for operation and maintenance of the asset • The way in which the private sector partner is regulated • The source/s of revenue for the private sector partner Some PPP structures are associated with procurement models which involve project-specific capital expenditure. These include projects under the UK’s Private Finance Initiative (PFI) programme which commenced in the mid 1990s. Some 800 projects have been procured under the programme, mostly in the period up to 2010 and across a broad range of sectors, including healthcare, education, accommodation, defence, rail, water/waste, emergency services, streetlighting, social housing and leisure. In the case of roads, the UK Highways Agency (now Highways England) operated a similar programme. In a typical PFI project, a public sector body (eg a government department, health trust or local authority) enters into a long term project agreement with a private sector partner for
the design, construction, financing, operation and maintenance of a facility or amenity that will be used by the public, such as a school or hospital. Alternatively it may be used for the delivery of a public service, such as serviced accommodation for use by the procuring authority. The private sector partner is responsible for obtaining finance for the initial design and construction stage, the majority of which typically consists of long term third party debt, and in return the public body pays a fee (the “unitary charge”) on an ongoing basis for the facility and for the services provided, but only once construction is complete and the facility is operating to the required standard. The unitary charge will cover debt service, operating costs and maintenance reserving, together with an equity return for the project sponsors. The unitary charge will be subject to deductions, should the private sector partner fail to operate and maintain the facility to the required standard. At the end of the project agreement term the asset will generally remain with the procuring authority, except in cases where there is life left in the asset and it is no longer needed by the procuring authority. The UK PFI model is designed to be compatible with project financing, in order to facilitate a competitive cost of capital, and nearly all PFI projects are financed in this way. Consistently with limited recourse
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by a desire on the part of the procuring authority to keep the debt off its balance sheet. However this is not considered to be a legitimate justification. In 2013 the present government, following a review of PFI, made some adjustments of a non-fundamental nature to the model to address certain criticisms, and rebranded PFI as Private Finance 2/PF2. There has been only a limited pipeline of new deals coming to the market since 2010, as a result of both constraints on public spending following the financial crisis and also a shift away from social infrastructure development (which was the primary driver of the original PFI pipeline). It is possible, however, that PF2 – or a further iteration of the PPP model – will be more widely used in coming years, if fiscal constraints are relaxed by the Government. PFI – guidance and legislation Unlike many other jurisdictions, there is no specific legislation in the UK governing the operation of PFI. There has, however, been extensive guidance and standardised drafting issued by Her Majesty’s Treasury (HMT), and this has been updated a number of times over the history of PFI and PF2. Compliance with this guidance has been mandatory for procuring authorities and bidders, subject only to sector specific derogations. The overarching HMT guidance has, in turn, been developed into sector- specific standard form contracts.
principles (see Finance above), the private sector partner – usually a consortium comprising a building contractor, an operator and frequently a financial investor (typically a fund) – sets up a special purpose vehicle (SPV) for the purposes of the project (the “project company”). The project company will enter into the project agreement with the procuring authority together with a suite of subcontracts passing down its design and construction, and operation and maintenance, obligations to the relevant operating subsidiaries of its consortiummembers. The principal justification for using the PFI model is that it is capable of providing the public sector with value for money compared with a conventional procurement. Although the cost of funding in a PFI project is generally higher than in a conventional procurement, this is offset by the benefits of transferring certain risks to the private sector – particularly construction risk and lifecycle risk. Whether or not the benefits of risk transfer outweigh the additional cost of funding depends on the facts and in particular the nature and size of the project. In order for the use of PFI to be approved, the procuring authority is required to demonstrate that it will deliver overall value for money through detailed financial modelling and the production of a “public sector comparator” using an established methodology for ascribing a monetary value to the transfer of risk to the project company. There may also have been cases where the use of PFI may have been partially motivated
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Despite the absence of a dedicated legislative framework for PFI, a number of pieces of enabling legislation have been required, mainly in to order to provide comfort to the private sector in relation to specific issues, such as: • Local Government Act 2000: This made it clear that a local authority has the power to do anything which is likely to achieve the promotion or improvement of the economic well-being of their area, including entering into PFI contracts • Local Government (Contracts) Act 1997: This provides a mechanismwhereby a certificate provides confirmation that a local authority has power to enter into a particular contract, once the three month period for a legal challenge by way of audit or judicial review has passed (and provides the counterparty with compensation, if any such audit/review sets the contract aside) • National Health Service (Residual Liabilities) Act 1996: This made it clear that the Secretary of State could not exercise his statutory power to dissolve an NHS Trust without ensuring that its liabilities were assumed by a creditworthy successor entity • National Health Service (Private Finance Act) 1997: This is broadly similar to the Local Government (Contracts) Act 1997 but applies to NHS Trusts
Building contract issues The structural context of a PFI project impacts on the provisions of the design and build contract and the position of the contractor in a number of ways including: Direct agreement in favour of the lenders : see Finance above. Direct agreement with the procuring authority : The procuring authority will require the D&B contractor to enter into a direct agreement including certain collateral warranties and giving the authority the right to step in to the D&B contract if necessary, but only after the lenders have been repaid. Interface agreements :Defects in the D&B contractor’s completed works have the potential to create disruption and additional costs in the operation and maintenance of the facility in question, and to expose the project company to deductions by the authority for availability and performance failures. As indicated above, the project company will seek to pass down these risks to its operation and maintenance contractor, and – to avoid being caught in the middle of a dispute between its supply chain as to ultimate responsibility for such issues – it will normally require the D&B contractor “interface agreement” with it. This will allow the project company to allocate deductions based on an initial good faith determination, and then leave the subcontractors to seek recourse against each other in the event that they disagree with the allocation. and the operation and maintenance contractor to enter into a tripartite
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Equivalent Project Relief : An anomaly in the context of the impact of legislation on PPP is the fact that the main project agreement between a public authority and the SPV is carved out of the payment and adjudication requirements of the “Construction Act” (see Contractual issues and Dispute resolution ), but the subcontracts between the SPV and its supply chain are not (subject to a limited exception). This mismatch in payment and dispute resolution procedures in the contractual chain has given risen to complex contractual mechanisms (known as Equivalent Project Relief) which are designed to mitigate and manage the risk to the SPV of inconsistent findings as between itself and the public authority, on the one hand, and itself and its subcontractors, on the other. Force majeure : The circumstances in which force majeure relief is available will reflect the standard project agreement and are very limited. Liquidated damages and termination sums : The liquidated damages provisions under the D&B contract will need to compensate the project company for lost revenue plus any additional costs under the operating contract as a result of the delay. The termination sum will need to be sufficient to cover the cost of replacing the defaulting D&B contractor.
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• Prequalification The authority creates a longlist of bidders to provide outline solutions • Shortlist The authority shortlists bidders (usually three or four) based on their outline solutions • Detailed bids solutions. The authority then selects the final (usually two) bidders to continue dialogue with • Final tenders Once the authority believes that all elements of the project have been fully negotiated, they close dialogue and call for final tenders • Preferred bidder appointment Following preferred bidder appointment, the bidder and authority can only clarify, specify and fine tune the bid. Substantial changes are not allowed, and changes must not distort competition or cause discrimination • Financial close Those on the shortlist are invited to enter dialogue and provide detailed
Performance support : Lenders will typically require there to be a parent company guarantee from a creditworthy parent, together with a third party performance bond for a proportion of the contract price from an investment grade financial institution. Dispute resolution : The project company will want the D&B contract to include a mechanismwhich ensures that disputes under the project agreement and the D&B contract relating to the same subject matter are resolved consistently. PFI/PF2 – procurement The procurement process used for most PFI or PF2 projects is competitive dialogue under the Public Procurement Regulations. This is part of the EU public procurement regime (see Public Procurement ), and seeks to ensure that value for money is enhanced and innovation promoted by maintaining a competitive element throughout the substantive negotiation of a project, whilst giving effect to the principles of equal treatment, non- discrimination and transparency. The key stages of competitive dialogue are as follows: • OJEU notice A notice about the project is placed by the public authority in the Official Journal of the EU
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Other PPPs Other PPP structures which involve major capital expenditure include regulated utilities (such as power and water) and regulated transport infrastructure such as airports and rail. The terms on which these entities contract are influenced by the regulatory regime which applies to them. They are required to comply with the procurement regime in the Utilities Regulations, which is less prescriptive than the procedure outlined above for PFI projects. The recent GBP 2.3 billion Thames Tideway project was a complex hybrid under specific enabling legislation (the Floods and Water Management Act 2010) under which the EPC element of the project was competed separately from the ownership of the infrastructure provider established by Thames Water to construct and operate the asset. Examples of other hybrids include the London Underground PPP and Heathrow Terminal 5.
Robert Franklin Legal Director, London T: +44 (0)20 7876 4242 E: robert.franklin@clydeco.com
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Standard forms of contracts
There are a variety of standard form contracts in use in the UK. The main industry providers are listed below, together with examples of their contracts.
Engineering works The main providers are:
The appropriate choice of contract in each case will depend on various factors including: – Nature of the works – Parties – Preferred procurement method – Approach to risk allocation – Costing and pricing mechanism Standard forms are usually amended to procure a more favourable risk allocation for the employer. It is rare to use a standard formwithout any amendments, especially on larger projects. Building works The Joint Contracts Tribunal (JCT) provides a suite of standard form contracts, which are the most commonly used forms for UK building projects. The leading forms are the Standard Form of Building Contract (SBC) and the Design and Build Contract, both of which are commonly used for large projects. Although the JCT Major Projects form is specifically designed for use on large projects, it is currently less widely used. There are a number of other JCT forms for use on smaller, less complex matters – ranging from intermediate value projects to minor commercial works, and finally to domestic works undertaken by homeowners and occupiers.
Institution of Civil Engineers (ICE), which publishes the NEC3 suite. This includes the following options: – Priced contract with either Activity Schedule or Bills of Quantities (Options A and B) – Target cost contract with either Activity Schedule or Bills of Quantities (Options C and D) – Cost reimbursable contract (Option E) –– Management contract (Option F) The NEC form of contract is also used for building works, although it is predominantly an engineering form. The Institution of Chemical Engineers (IChemE), provides the following standard forms designed for process plant projects: – Lump sum (the Red Book) – Reimbursable (the Green Book) –– Target cost (the Burgundy Book) The Association for Consultancy and Engineering (ACE) and the Civil Engineering Contractors Association (CECA), who jointly publish the Infrastructure Conditions of Contract (ICC). This includes the following forms: – Design and construct – Measurement – Target cost –– Ground investigation
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The ICC contracts are intended for use on civil engineering and infrastructure projects, and are intended to replace the ICE conditions of contract (which were previously used on engineering projects, prior to the introduction of the NEC forms). Partnering The main standard form contracts for partnering are: – Project Partnering Contract 2000 (PPC 2000) –– JCT Constructing Excellence In addition, JCT provides a non-binding partnering charter, and NEC3 also includes an option to incorporate partnering procedures into its standard form (although, unlike PPC2000, NEC does not provide a multi-party partnering contract). Other contractor forms There are a number of other significant forms available, for example: – GC/Works for government/public sector projects: these forms have not been revised for some time, and need amending to take account of current law – IMechE/IET model forms (MF/1): used specifically for mechanical and electrical works – – NFDC (National Federation of Demolition Contractors) : used for demolition works Consultant appointments The main providers are: RIBA –– RIBA Standard Agreement 2010 (2012 revision): Architect
–– RIBA Standard Agreement 2010 (2012 revision): Consultant –– RIBA Concise Agreement 2010 (2012 revision): Architect –– RIBA Domestic Project Agreement 2010 (2012 revision): Architect –– RIBA Sub-consultant Agreement 2010 (2012 revision) ACE –– ACE Agreement 1: Design –– ACE Agreement 2: Advise and Report –– ACE Agreement 3: Design and Construct –– ACE Agreement 4: Sub-consultancy There is also an ACE Short Form, published in 2015, and ACE Agreements 2009 edition, second revision: Amendment sheet (May 2015), which addresses changes required by the introduction of the Construction (Design and Management) Regulations 2015 (see Regulation below). NEC –– PSC: NEC3 Professional Services Contract, April 2013 edition –– PSSC: NEC3 Professional Services Short Contract, April 2013 edition NEC have published guidance on complying with the Construction (Design and Management) Regulations 2015, but do not produce amendments, as the contract does not include express provisions dealing with specific legislation. If such a clause is required, it can be inserted as a bespoke ‘Z’ clause.
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Contractual issues
Whether standard form or bespoke, contracts for major construction and infrastructure projects in the UK tend to be complex, and subject to significant negotiation prior to their execution.We set out below a snapshot of some of the issues and risks that are most commonly encountered by contracting parties.
Price and payment The price, the length of the payment period, and the way in which both anticipated and unforeseen increases in costs are managed is of key concern to contracting parties. Methods of payment vary according to the nature of the contract. The four main types of payment are: – – Lump sum A pre-agreed sum that the contractor will be paid to carry out either a stage of or the whole of the works that are required under the contract (subject to adjustment for certain supervening events – including variations – for which the contractor may receive additional monies) – – Measurement The work is measured and valued according to a schedule or formula – – Prime cost Payment is made for the cost of labour and materials used – – Cost plus Payment is by prime cost, as above, plus an added percentage for profit
The risk of price fluctuations in the market is usually borne by the contractor. Some UK standard form contracts include fluctuation provisions, but they are often amended to exclude these provisions. Certain aspects of payment under the contract, such as instalments and notices of sums due, are dictated by the Housing, Grants, Construction and Regeneration Act 1996, as amended by the Local Democracy, Economic Development and Construction Act 2009 (the Construction Act ). If the parties to a contract fail to incorporate provisions which comply with the requirements of this legislation, then the relevant sections of the Scheme for Construction Contracts (issued pursuant to the Act) will apply to their contract. Contractors may seek to mitigate the risk of non-payment by requiring the client to provide a bond by way of security. In the current market, contractors may request such bonds for high value or high risk projects. Project bank accounts provide security for the supply chain on larger projects. This mechanism requires the client to make payments due under the main contract directly into a single bank account.
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Excluding liability The contractor can seek to exclude certain types of liability (except for death or personal injury) by including a suitable exclusion clause in the building contract. The inclusion and extent of such a clause will depend on the respective bargaining strength of the parties but, typically, the exclusion of indirect or consequential loss is a key aim of negotiation, as these losses are generally the most unpredictable and can be high. What is deemed to be consequential loss, however, turns on the individual facts of a case, and the courts have found that even loss of profits may be a direct loss in certain circumstances, thus allowing its recovery despite the existence of an exclusion of consequential loss. It is therefore important that the types of losses that the contractor is seeking to exclude are carefully defined in the contract, rather than reliance being placed solely on phrases such as “indirect” or “consequential”. Standard form appointments published by bodies representing consultants (see Standard forms of contract ) tend to be favourable to the consultant, and contain net contribution clauses. These seek to limit the consultant’s liability to the client, by negating the doctrine of joint and several liability. Under this doctrine, where there is a problem with a project and a loss is suffered by the client, the latter may sue any or all of the parties responsible. This means that a client may bring proceedings against a single party, rather than have to sue all those involved, but still recover 100% of its loss. A net contribution clause seeks to reverse the effect of this doctrine, by providing that each party will only be liable for the proportion of the loss that is attributable to its fault.
Authorised signatories for the client and the contractor then release funds directly to the supply chain in the amounts contained in the contractor’s breakdown. This is beneficial in that it builds trust in the supply chain and speeds up payment. Design risk/site risk In traditional procurement, the contractor assumes responsibility for construction, but generally not for design. In design and build projects, the contractor assumes responsibility for design as well. The risk is managed by novating the design consultant appointments to the contractor when the building contract is signed. This ensures single point design responsibility and gives the contractor control of the design process. The contractor may also seek to offset design risks by: – Limiting its liability under the contract – Avoiding liability for design work procured by or on behalf of the client (where not the subject of a novation to the contractor) –– Ensuring that adequate levels of professional indemnity insurances are maintained There is no standard approach to risk allocation for unforeseen ground conditions. Typically, the client instructs a ground survey, but seeks to pass the risk on to the contractor. If this is the case, the contractor usually requires a letter of reliance or collateral warranty from the ground surveyor to cover this risk. The contractor may also protect its position by procuring its own surveys.
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Caps on liability Caps on liability are common in
be said to be “at large” – ie the contractor’s obligation will now be to complete the works within a reasonable time. In the event of a delay to completion of the project for which the contractor is responsible under the contract, liquidated damages (LDs) are commonly provided for. LDs enable parties to fix in advance an amount payable for each day, week or month of contractor delay. This has the advantage for the client that it need not prove its actual losses flowing from the delay in question in order to make recovery, and it has the advantage for the contractor of acting as a limitation on its liability for delay. In order to be enforceable, however, the level of the LDs must not be so extravagant that they constitute a penalty. In the case of simple delay-only LDs in construction contracts, they can usually avoid penalty status by being based on a genuine pre-estimate of the loss that may be caused by a delay. In the case of more complex provisions, however, or where the loss cannot be estimated, then the underlying test is whether the secondary obligation (to pay LDs) is out of all proportion to the legitimate interest that the employer has in enforcing the primary obligation (to complete the project on time). If a delay is the responsibility of the client under the contract (eg a breach of contract by the client, or a variation to the scope of the works), then the contractor is usually entitled – in addition to an extension of time – to additional loss and expense incurred as a direct result of the delay. In the case of a neutral event, which is neither party’s responsibility, the contractor will usually be awarded an extension of
construction projects, particularly where agreeing to cap the contractor’s liability can achieve a lower price for the client. Such limitations of liability may sometimes be agreed at a sum no less than the level of professional indemnity insurance that the contractor is required to maintain. Caps may apply in the aggregate, so that the client has a single source to draw from in the event of any claims, or on an each and every claim basis. Another approach is for contracts to contain express caps on the total loss recoverable from the contractor (although losses covered by insurance or comprising liabilities to third parties, such as indemnities for property damage and intellectual property infringements, may well be stated to fall outside these caps). The contractor may also require separate caps in relation to warranties and/or third party rights that are offered to other parties with an interest in the project. The key to fixing any cap on (or exclusion of) liability is to ensure that it is clearly worded, as any uncertainty may be construed against the party seeking to rely on the limitation (known as the “contra proferentem” rule). Delay and disruption Most construction contracts provide for an agreed completion date, and a mechanism for extending time in the event of certain project delays. If there is no such extension of time mechanism, and the client causes the contractor to be in delay (by, for example, instructing a variation), then the agreed completion date will fall away and time will
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time, but will not receive any additional payment, so that the risk of delay is shared between the parties. Variations The mechanism for dealing with variations to the works will depend on why the variation is required in the first place: – Client variations: Under most standard form contracts, the client has the right to instruct variations to the works, for which the contractor is entitled to additional time and money. The contractor may also be entitled to raise reasonable objections to material changes, where, for example, they would conflict with necessary consents, or increase the cost of the works beyond a predetermined threshold –– Contractor variations: Except in the case of value engineering proposals, where the contractor may be entitled to share in any consequent cost savings for the project, the contractor will not be entitled to additional time or money for variations which it originates (due, for example, to the need to correct the consequences of an error), and will be liable for any delays and additional costs caused by them Subcontractors Unless otherwise agreed, the contractor is liable for the whole of the works, whether or not all or part of the works is subcontracted. The main contract may set out specific terms that must be included in the subcontracts – for example, a requirement to maintain adequate professional indemnity or product liability insurance, and a copyright licence to enable the client to use documents related to the works.
Carefully drafted payment provisions within subcontracts, as well as in the building contract, are central to maintaining good relationships within the supply chain, and ensuring the success of construction projects generally. Most standard forms have an accompanying
sub-contract form, whose terms are consistent with the main contract.
Main contracts for large or complex projects often specify approved subcontractors to be used, or require client approval to be obtained
before works are subcontracted. The client’s relationship with the subcontractors is conducted via the
contractor (eg client will not be able to pay a subcontractor directly in circumstances where the contractor has become insolvent, as this is contrary to insolvency law). Depending on the nature and size of the project, subcontractors may be required to provide collateral warranties, or third party rights, in favour of the client and certain third parties, such as purchasers or tenants of a development. Bonds Examples of the most common forms of surety bonds used in the context of construction contracts are: – Performance bond: this requires proof of a breach by the contractor and of resulting loss to the beneficiary, if a call is to be successful. In some versions, known as adjudication bonds, an adjudicator’s award is specified as a condition for a successful call. Liability under a performance bond is normally limited to a percentage of the contract price
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