Hotel projects and defects - some practical considerations
Real Estate & Construction and Hotels & Leisure
Taking over is a key milestone for any project and, because of its importance, it can be a contentious issue.
Law Update: Issue 359 - Real Estate & Construction and Hotels & Leisure
Euan LloydPartner,Construction & Infrastructure
Taking over is a key milestone for any project and, because of its importance, it can be a contentious issue. In this article, we discuss some key issues and risks that arise both the context of taking over itself as well as what happens after take-over.
The issue of a Taking Over Certificate signifies that the project has been completed in accordance with the contract (other than in respect of minor issues and snags that do not prejudice the use of the works for their intended purpose), thus meaning that the project can be used for its intended commercial purpose and therefore constitutes a revenue generating assets.
At this point therefore, risk passes from the contractor to the owner (who should therefore ensure that suitable insurance is in place), the contractor’s exposure to liquidated damages (i.e., for delay and performance) ends while there is typically a significant reduction in the security held by the owner (i.e., a percentage of the retention monies may be returned while the value of performance security may be reduced or the performance security may even be returned).
While this appears straightforward, complications can arise that can significantly ‘muddy the waters’. In our experience, such complications can include the following factors:
Poorly drafted taking over criteria under the contract so there is uncertainty as to the requirements that need to be achieved in order for taking over to be achieved.
Ambiguous performance testing criteria, which is typically relevant in the context of output related contracts (such as power stations). Again, this creates uncertainty as to the requirements that need to be satisfied.
The parties’ failure to adhere to the contractually agreed procedure, thus giving rise to arguments that, by conduct, the acceptance criteria has been amended (typically on the basis that certain requirements have been waived and the requirements have been made more relaxed).
The owner’s use of the facility prior the satisfaction of the contractually agreed completion criteria. In this regard, some contracts state that the commercial use of a facility demonstrates that it is substantially complete while the contractor is also likely to argue that such commercial use means that it is not in a position to actually complete the works.
To avoid the foregoing issues, it is important to ensure that the underlying contract is clearly drafted, the contractually agreed procedure is adhered to and that the steps taken by either party in the context of taking over are clearly documented.
However, taking over is not the end of the story and it is important that the construction contact contains a defects liability regime that requires the contractor to rectify defects and to undertake items of incomplete works that were identified upon take over or that subsequently become apparent.
The defects liability period should be for a specified period of time. This is typically 12 months from the date of take over (although some contracts provide for the defects liability period to be ‘refreshed’ in respect of defects that are addressed during the defects liability period while it is certainly not unheard of for 24 months defect liability period to apply to MEP works). Further, the employer will usually have the express right to engage third parties to rectify defects or complete outstanding works and to recover the costs from the contractor (i.e., from calling upon performance security retained under the contract) if the contractor fails to do so within a specified timeframe.
Although the actual position is determined by the drafting of the contract, the expiry of the defects liability period usually does not release the contractor from liability under the contract and therefore the contractor remains liable for residual breaches of contract.
That said, the employer can, in theory, still pursue the contractor from breaches of contract for duration of the limitation period prescribed by the governing law of the contract. However, this is only typically viable in the context of major issues (particularly as performance security will have been released upon the expiry of the defects liability period) while most issues will usually have been identified prior to the expiry of the defects liability period, particularly as the project will have been in commercial operation (and therefore ‘road tested’) for 12 months.
This brings into play the concept of decennial liability that generally applies across the GCC. Although there are jurisdictional nuances, the concept generally prescribes that the contractor and the lead designer (including the supervisor) are jointly and severally liable to the employer for defects that cause collapse or that otherwise cause significant structural defects for a period of 10 years from the date of handover (provided that the decennial liability defect is notify by the employer within 3 years of the defect becoming apparent).
Although decennial liability insurance is available, it is generally not mandatory other than in Saudi Arabia. In Saudi Arabia, legislation has been introduced that requires the contractor to take-out and maintain such insurance (in respect of which the terms are prescribed) and, amongst other things, this is a pre-condition for the issue of both the building permit and the completion certificate, as issued by the relevant authorities.
The Contractor’s responsibility in respect of the works clearly diminishes following take-over and the employer therefore becomes responsible for the on-going commercial operation, maintenance and performance of the facility. While different approach can be deployed, it is common for a facilities management agreement or an operation and maintenance agreement to be executed.
The primary rule for any such contract is that the precise scope of the services to be performed by the service provider are clearly set out (typically in a schedule), together with the relevant Key Performance Indicators (or KPIs) which the service provider is required to achieve. Such KPIs should be SMART – Specific, Measurable, Achievable, Relevant and Time based. They need to be clearly defined as well as capable of being assessed objectively.
To ensure single point responsibility, it is important that the service provider warrants that it has carried out all reasonable investigations and inspections of the asset and that the asset is capable of being managed to the standards prescribed by the facilities management contract. This will address the risk of the service provider seeking to blame the building contractor for any deficiencies in the services.
From a practical perspective, it is usually prudent to: (i) have the service provider inspect the asset prior to take over and to attend any tests on completion under the construction contract; and (ii) include an obligation in the building contract for the building contractor to provide the service provider with training for the operation and maintenance of the asset.
Wear and tear is, of course, fact of life and it is therefore important that any facilities management contract makes adequate provision for scheduled maintenance to take place. This is typically performed pursuant to a maintenance plan which has been pre-agreed by the employer (including in terms of scope and cost) and should also be addressed in the KPI regime.
Another key issue concerns the interface with third parties - given that facilities management contracts usually concern operating assets and facilities, it is pivotal that the drafting of the facilities management contract makes it clear that the service provider must not delay, interfere with or disrupt the day to day operations of the asset. How the interaction between the service provider and other contractors on site is managed therefore needs to be considered and documented.
Finally, a hand-back procedure should be clearly documented, which should include a programme for the service provider’s transition out of managing the asset and also include a detailed assessment as to the status of the project. The outgoing service provider may be required to provide its successor with appropriate training as well as a license to use any intellectual property rights to perform the facilities management services going forward.
For further information, please contact Euan Lloyd.
Published in June 2023
