Do You Really Want to Contract with the Greater Fool?

One of my typical roles as an owner advisor is to review proposed construction management at-risk (CMAR) and design-build contracts from a commercial perspective—i.e., what’s the likely marketplace reaction to the contract and is the contract consistent with the philosophy behind collaborative delivery? I am continually amazed by what I see. For example, on two of my current public design-build projects, the RFP versions of the contracts:

  • Made design-builders responsible for consequential damages
  • Gave very limited rights for time and cost relief for events beyond the design-builder’s reasonable control
  • Contained substantial, uncapped, schedule liquidated damages
  • Made the design-builder responsible for not only managing the performance of the owner’s other prime contractors, but for their delays in performance
  • Obligated the design-builder to a far-reaching and uninsurable indemnity
  • Provided that all disputes would be fully and finally resolved by the owner’s chief engineer, with limited appeal rights

When I pointed out my concerns to the project’s legal team, the reaction was one that I have heard for years: “Yeah, whatever. Let’s see how the marketplace responds. They can price the risk in their proposal.”

The reaction by the short-listed proposers was predictable. Some warned that certain provisions would result in a “no-go” decision to continue in the procurement. Some expressed concern that they were being asked to price essentially non-quantifiable risks, and that if they did try to price them, the budget could be materially impacted. While the legal team made changes to some provisions, they thought proposers were bluffing on others and essentially stood ground. The result? Several strong teams dropped out of the competition, leaving only one short-listed proposer for one project and two for another. Those that remained in competition told the owner that the budget was exceeded. We’ll know the final cost impact when we open the price proposals in a month or so.

How could this happen? Owners should know, particularly in today’s contracting environment, that the best contractors and designers will not “bet the company” by signing up to bad contracts, particularly on large, challenging projects. The carnage wreaked on Fluor, Granite, Skanska, and others because of huge losses on fixed-price design-build transportation projects has been ample warning.

Owners should know that while some teams might decide to price certain risks, others will not. Owners should know that it costs proposers a lot of money to develop competitive proposals, and that some proposers are backing out of projects because of concern they could ultimately lose to “the greater fool”—a proposer that undercuts them on price by placing little contingency in for project risks.

Is it really in the owner’s best interest to contract with that greater fool? Will that help promote the benefits of collaborative project delivery where trust, cooperation, and give-and-take is expected on our projects? The answer is somewhat rhetorical, but should be clear. Owners should want the best contracting teams to propose and win their projects. It makes no sense to want otherwise.

My personal view is that it is not that hard to put out a contract that reasonably protects the interests of both parties on CMAR and design-build projects—even when those projects involve big dollars and are complicated. But it can be hard, as owners’ teams are often in silos, and there is institutional pressure (often from legal and procurement departments) to create one-sided contracts that create bad results. However, for those owners who want to improve their contracting experiences, here are a few basic thoughts:

  • Put yourself in the contractor’s shoes. Everybody should know what the typical contract “hot buttons” are—waivers of consequential damages, reasonable indemnity obligations, workable change order provisions, fair dispute resolution processes, etc. Ask yourself whether you would agree to accept the risk you are asking from the contractor. If you wouldn’t, what makes you think they will or should?
  • Don’t start off with an extreme contract so that you can negotiate to some middle ground. Because we know the typical contract “hot buttons,” it makes no sense to start with a contract that we know is not achievable. It is a waste of time and only results in more legal fees as the parties ultimately negotiate to what everyone should have known before is the right result. But perhaps more importantly, it may affect the market’s view of who you are as an owner, including whether you are naïve, one-sided, or other less than admirable characteristics. If your legal team is telling you to start off with a one-sided contract, ask them to give examples of current projects where those “hot buttons” have been accepted as is.
  • Understand the implications of the contract your legal team is drafting. Too many owners say, “It’s up to the lawyers to do the contract stuff.” Certainly lawyers can and should do the drafting of the contract. But CMAR and design-build contracts are not mortgage documents, which I venture to say are never looked at by anyone after they are signed. They are administered day-to-day by non-lawyers for both parties, and they should be readable and understandable to them. Moreover, the owner’s project lead should not be letting the lawyer control/dictate commercial terms. The owner’s non-legal project team should be keenly aware of all major commercial terms and if there are any “hot buttons.” It can then make informed decisions on how to address these concerns.
  • Don’t try to “win” the contract negotiations. I often hear an owner say “we won” the contract negotiation on a given project. What truly is a “win” anyway?  On one of my international petrochemical projects, the commercial team for my client “won” a great concession from a major EPC contractor—a “no fee” contract for construction management services. The contractor only got paid its reimbursable costs plus an audited home office overhead rate. They patted themselves on the back for years. But relations between the parties broke down over time, as the contractor managed a project that had no fee (like moving key people away). The parties are now in a nine-figure dispute that is being arbitrated. What was the root cause of the problem? The owner “won” on fee negotiations. Contract terms (particularly those on collaborative project delivery) don’t need winners and losers; they just need to be clear and reasonably protect the interests of both parties.

While lots more could be discussed on this subject, I will end with this thought. Think about what your contract would look like if your most trusted friend was building something for you. Would you even have a written contract? But assume you did. How comfortable would you, or your friend, feel if you required him to sign a 100-page contract that shifted major unknown risks to him? Would that be good or bad for the relationship? Good or bad for the project? Again, somewhat rhetorical answer.  Hopefully you get the point.

Take me at my word; I’m not in any way suggesting that public owners work on the basis of a handshake or just assume all risks. But I am suggesting that many public owners give no meaningful thought to the impressions they leave on their contracting “partners” through their contract approach and language. We can do a lot better.

About Michael C. Loulakis, Esq., FDBIA, President, Capital Project Strategies, LLC

Mike Loulakis is an at-large director of the WDBC and provides project delivery, procurement, and contracting services to public owners on their capital projects. He is widely published on collaborative delivery topics and has been the author of Civil Engineering magazine’s “The Law” column since 1981. Mike can be reached at mloulakis@cp-strategies.com.
Topics: CMAR, Collaborative Delivery, Contracts, Design-Build, Uncategorized.

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