The last 20 years have seen a radical transformation in how major mining infrastructure projects are delivered. In the early 1990s, the traditional hard dollar adversarial contract gave way to ?partnering? which sought to focus on the parties? relationship. By the end of that decade, relationship contracting was taken to its next level with the parties delivering projects together as an alliance.
Recent economic events have had a dramatic effect on the resources industry, with many projects cancelled or deferred. Against this economic backdrop, will the way in which projects are delivered also change?
This article compares the features of traditional contracts and alliance contracts and consider which best meets the needs of the present times.
TRADITIONAL VERSUS NON-TRADITIONAL
Traditional contracts generally contain the following features:
(a) The price to perform the works is either a fixed lump sum or a schedule of rates or a combination of these.
(b) There is a definitive end date (or date for practical completion) by which the works must be completed, and if the contractor fails to meet this date, liquidated damages are payable by the contractor to the owner.
(c) There is an allocation of risk between the parties which sets out what things the contractor can claim an increase in price and those things which it cannot.
(d) If the works fail to achieve their design capacity, the contractor will be in breach and the principal will be entitled to damages which may also be liquidated.
(e) A dispute process that provides for either litigation or arbitration.
The best known examples of this method are the Australian Standards 2124 and 4000, or their design and construct derivatives, AS 4300 and 4902. Such documents have a long history and have industry acceptance. However, like any generic document these should be considered as a starting point as the risk allocation is an industry considered position of where risks should lie and may be inappropriate to a particular project.
These traditional contracts compare with alliance contracts, which generally contain the following features:
(a) The contractor is paid its costs and overhead to perform the works, but its entitlement to profit depends upon it satisfying pre-agreed key performance indicators (KPIs).
(b) Risks are not allocated but rather shared between the parties. If an unforeseen event occurs, the parties will determine the best way to deal with it.
(c) There is a ?no blame? policy even if a party commits an error or is negligent.
(d) Except in limited circumstances, there is no recourse to litigation.
How do each of these models deal with the most common problem under a process engineering contract, namely the failure of the plant to perform at its design capacity?
In large process engineering projects there is little room for error. A failure of the plant to perform at its design capacity will generally mean a loss of production and a loss of profit. Under the traditional design and construct model, this failure will be the contractor?s responsibility and the contractor must rectify the problem at its cost.
A failure to rectify will generally entitle the principal to damages and in some cases the right to terminate. If the contractor fails to pay these damages, the principal may enforce its rights in the court, or through arbitration if it is using the Australian Standards contracts, since arbitration is the default dispute resolution process for such contracts.
Failure to perform is treated differently under an alliance. Unless the failure to perform is due to some deliberate or intentional act by the contractor, then the principal will not have any claim against the contractor. It will still be the contractor?s obligation to rectify, but unlike the traditional model, the contractor will be paid its costs in rectifying the problem.
What then is the incentive for the contractor to rectify the problem? The answer is found in the setting of the KPIs and what the contractor must achieve to be entitled to its profit or a bonus. Well thought out KPIs will make the achievement of performance criteria, time and cost a prerequisite to any profit or bonus entitlement. The contractor?s incentive to achieve these entitlements is hopefully sufficient to enable performance. However, the alliance cornerstone of ?no disputes? means that a principal with a poorly performing conveyor is likely to be left without any legal redress if the problem is unresolved.
WHICH IS THE BEST MODEL FOR THE PRESENT TIMES?
The importance of price certainty in any project is crucial. Unless a company has the balance sheet to fund a large project, then it will find that many of the previously available sources of funding have dried up. Those that can get financing will find stricter conditions from financiers. Does alliancing deliver price certainty?
As we have seen, alliance contracts remunerate the contractor on effectively a ?cost plus? basis. The extent of the ?plus? depends upon the contractor?s performance against KPIs. In contrast, the traditional lump sum price is effectively fixed subject to any variations or other claims, depending on the risk allocation.
Industry experience suggests that most alliance contracts come in at or around their estimated cost (or what is usually referred to as the Target Cost Estimate or TCE). One reason for this is that the TCE is often developed by all parties over a period of time and often reflects a more considered and realistic price for the works. Compare this to a lump sum, which is usually put together by a contractor in a short tender period with allowances made for foreseen risks.
Therefore while there might be greater integrity in the TCE, it is possible that we will see a return to lump sum pricing models where the contractor takes the risk on price to satisfy the need for greater cost control.
Changing economic conditions will also bring a change in the balance of power of the risk allocation. The plethora of projects being developed and the consequent lack of resources over the last few years has, to some extent, allowed contractors to gain a more favourable risk allocation than they traditionally have.
With contractors? order books drying up, there will be greater competition and keenness to win projects. This is likely to see some contractors more willing to accept risks to win projects. In these circumstances, it is important that proper risk assessments are still undertaken as a contractor losing money is likely to bring claims against the principal, which is likely to lead to disputes. Somewhat ironically, it was this scenario which alliancing through its ?no blame?, ?no disputes? process sought to eliminate.
CONCLUSION
The complexity of large mining projects means that they need to be delivered through the best means possible. What is the best means depends on a number of factors, including the scope of what is being built, the principal?s attitude to risk and the likely project risks. The wave of alliancing has swept through all sectors of industry. However, with external factors now dictating the need for price certainty, traditional methods may once again rise to the surface.
Michael Rochester is a partner in law for McCullough Robertson Lawyers. Email: mrochester@mccullough.com.au