Schedules to construction contracts – don’t overlook them
Real Estate & Construction and Hotels & Leisure
While significant time and effort is typically taken to negotiate and agree on the terms of construction related contracts.
Law Update: Issue 369 - Real Estate & Construction and Hotels & Leisure
Euan LloydPartner,Construction & Infrastructure
While significant time and effort is typically taken to negotiate and agree on the terms of construction related contracts (i.e., such as concession agreements, construction works contracts, O&M/FM contracts and services agreements), the schedules to these agreements are important and often include prescribed forms of performance bond, parent company guarantee, advance payment guarantee, collateral warranty, novation agreement and interface/coordination agreement, which are self-standing and important agreements in their own right.
From experience however, schedules are not always afforded sufficient attention, and sometime receive little more than a cursory review on the misplaced assumption that they are ‘mere boilerplate’ and are of secondary importance.
Predictably, this fallacy can easily return to ‘bite’ unwary parties, and, in this article, we provide a brief overview of some key issues for stakeholders to bear in mind when reviewing schedules (of the nature referred to above) from a legal perspective.
From the outset, it is critical to ensure that each schedule has actually been incorporated into and forms part of the underlying agreement – indeed, a contractor may well argue, with a fair degree of credibility, that it is under no obligation to provide, say, a performance bond or a collateral warranty (even if a form of performance bond or collateral warranty is contained in a schedule) unless there is an operative clause in the conditions of contract that imposes a clear contractual obligation on the contractor to provide such performance bond or collateral warranty (and without which the employer’s protection under the underlying agreement would inevitably be compromised.
Further, assuming that the schedules have been properly incorporated into the agreement, it is important that the relevant schedules (to the extent that they constitute self-standing legal agreements) are actually executed – in practice, it is not unusual for this exercise to be neglected and, in our experience, it can be a challenging (and frustrating) exercise to procure the execution of schedules once the project is underway.
The execution of schedules can be incentivized by making the delivery of executed key schedules (such as the performance bond) a condition precedent to the effectiveness of the underlying agreement or to any payment entitlement arising while, as a ‘catch-all’ solution, the provision of certain schedules (such as collateral/manufacturer warranties) could be stated to be a condition precedent to the issue of the taking-over certificate.
Assuming that incorporation and execution of the relevant schedules has been satisfactorily addressed, a snapshot of a few key points for different stakeholders to look out for is below.
Advance payment guarantee/performance security From the outset, the identity (including from a creditworthiness perspective) of the entity providing the security needs to be acceptable to the beneficiary, while the governing law and dispute resolution provisions of the form of security need to be carefully considered, including by reference to the place of incorporation of this entity to ensure that the beneficiary of the security can enforce its terms quickly and easily.
In the context of an advance payment guarantee, the contractor will be eager to ensure that there is a clear mechanism for the value of the advance payment guarantee to reduce in line with the recovery of the actual advance payment as well as ensuring that the value of the performance security decreases (i.e., halves) upon the issue of the taking-over certificate (or even expires).
Conversely, the employer will be concerned to ensure that there is nothing to dilute the principle that the form of advance payment guarantee/performance security is expressly payable on first demand (i.e., by excluding references to the form of security being subject to the ICC Rules of Demand Guarantees).
Parent company guaranteesThese instruments are particularly relevant in the context of larger projects and/or if there are concerns regarding the financial strength/resources of the main contractor.
Predictably, contractors are reluctant to agree to procure guarantees from their parents (or other group entities) because this will expand risk exposure across the group. However, this requirement can be non-negotiable and, if so, the scope of the parent company guarantee needs to be tailored to align with the actual support and contribution that the parent can actually make (i.e., a performance related undertaking will not be realistic if the parent has no physical presence in the jurisdiction where the project is being constructed), while appropriate limits on liability (that should align with limits on liability under the underlying contract and prevent ‘double recovery’) should be negotiated.
A further issue for the beneficiary of a parent company guarantee to carefully consider is the appropriate governing law and dispute resolution mechanism so as align with the physical location (and location of the assets) of the parent.
Collateral warrantiesAlthough common-place in various common law jurisdictions, collateral warranties are less established in MENA (although their prevalence is increasing) and, by way of brief explanation, a collateral warranty is an instrument that bridges a gap created by the absence of privity of contract, creating a direct contractual relationship between entities that are not the party of an underlying agreement (i.e., between the employer and a key subcontractor/supplier (who is in a direct contractual relationship with the main contractor)).
As such, a collateral warranty allows the beneficiary (i.e., the employer) to bring an action, in contract, against the subcontractor/supplier if the subcontractor/supplier breaches the underlying subcontract, causing the employer to suffer loss (i.e., in other words, the beneficiary may pursue the subcontractor/supplier directly (as opposed to routing its claim through the main contractor).
From the beneficiary’s point of view, it is important to ensure that the underlying form of subcontract/supply contract is sufficiently robust (as a collateral warranty is only as strong as the underlying agreement that it is ‘collateral’ to), while key considerations from the standpoint of the subcontractor (i.e., the party providing the collateral warranty) include ensuring that: (i) the number of recipients of collateral warranties is limited (i.e., such that only parties who have a legitimate and proportionate interest in enforcing the underlying subcontract); (ii) liability is adequately addressed; and (iii) assignment is restricted.
Novation agreementsNovation agreements tend to be most relevant in a design and build or EPC context (i.e., when the employer engages a design team to undertake initial design works/FEED pending execution of the main construction/EPC contract, whereupon the initial design appointments/FEED contract will be novated to the main/EPC contractor, thereby creating single point responsibility as far as the employer is concerned).
A novation agreement concerns three parties (i.e., the employer, the designer and the main contractor), each of whom has different concerns – for example, the designer will need to be comfortable with the identity of the main contractor (including from a creditworthiness and commercial perspective) and will typically require to paid up to date by the employer (whereupon the employer will require that it is released from all liability to the design consultant).
For its part, the main contractor will need to be satisfied with the terms of the underlying design appointment (i.e., as the main contractor will be assuming the role of the designer’s employer and may need to enforce the appointment (and, as such, any performance security that the designer has provided to the employer should also be transferred to the main contractor)) and, from a practical perspective, the main contractor will typically require a high degree of comfort that the design deliverables provided to date are satisfactory and that the designer has the skill, expertise and resources to continue to properly perform its design obligations.
Interface agreements An increasing number of construction contracts and design appointments require the contractor and designers to collaborate to co-ordinate and manage the interface between their respective works and services.
A significant issue from the perspective of the contractor and designers is that they typically lack the authority to issue instructions to the other participants and mutual agreement in situations regarding interface and coordination is often, difficult to achieve.
Accordingly, contractors and consultants need to be wary of agreements of this nature and a better approach is often for the employer, who invariably has a contractual relationship with all relevant stakeholders, to take responsibility for and to address coordination and interface issues.
Notwithstanding the foregoing discussion, it almost goes without saying that integral commercial and technical terms (i.e., in respect of pricing/payment, work/services, the employer’s requirements/the project brief and the bill of quantities/schedules of rates) underpin any agreement and it is customary for some or all of these terms to be set out in schedules. It is therefore imperative that an agreement is reviewed holistically, including from a legal, technical and commercial perspective.
For further information,please contact Euan Lloyd.
Published in June - July 2024
