By Paul Buetow, partner, and Sonia Ginders, solicitor, Kensington Swan’s Construction and Major Projects Team.
Our construction industry has been plagued with issues in recent years, with solvency failures leading to the liquidation of several large contractors.
In response to these woes, a common theme has emerged in the buzzwords of industry commentators, of the transfer of risk from principal to contractor. The allocation of risk is specific to the terms of each contract.
It is often inappropriate, high risk clauses, or the absence of other clauses, that can lead to increased exposure and result in large losses for contractors.
This article identifies some key clauses contractors should look out for when signing up to contracts. While this list is by no means exhaustive, the clauses identified are commonly found and should be considered as part of any contract review and negotiation.
At a minimum, contractors should be aware of their impact and understand their consequences, so that they enter into such clauses ‘with their eyes wide open’.
A time bar clause sets in place strict time frames that a contractor must comply with. A failure to comply with these time frames could be used by a principal to reject a claim, irrespective of whether the claim has merit.
Time bar provisions are commonly found in the notice provisions for variations, extension of time claims, and raising disputes. By way of example, if a contractor receives an instruction that it considers to be a variation, a time bar could require that it must notify the Engineer within five working days of the instruction being given, and that a failure to do so means the contractor cannot recover the cost of that variation.
Other key points to note about time bar clauses are:
- For a principal to deny a claim based on a time bar, the clause must clearly state what is conditional, and the consequences if that precise condition is not fulfilled.Look out for the following phrases (or similar) when reviewing a contract
- ‘Compliance with the forgoing is a condition precedent to…’
- ‘The Contractor shall be entitled to a Variation unless / except where / on the condition that…’
- ‘The Contractor shall not be granted a Variation and shall be barred from making a claim where …’
- If a contractor does accept a time bar clause, it should be comfortable that the timeframe is reasonably achievable. For example, look at the time period for a claim to be lodged – 20 Working Days is better than 5 Working Days. Also look at the point from when the time runs. Rather than running from the original event, it may be better to agree to a timeframe that runs from knowledge of the claim.
Non fault based indemnities
A high risk clause often found (even in some industry standards) is a contractor indemnity. Indemnities are a risk allocation tool used in contracts, where one party agrees to hold the other harmless (or cover the other party) for loss that has been suffered.
The scope of an indemnity depends on its wording. A contractor can indemnify a principal for almost anything, if it is clearly and expressly provided for in the contract. In contrast to a claim for damages, the principles of remoteness (how likely the loss was to occur), contributory negligence (who contributed to the loss) and mitigation (what steps have been taken to minimise the loss) may not necessarily apply if a principal seeks to recover its losses under a broadly worded indemnity.
The indemnity provisions in NZS 3910:2013 are very wide. For example, 7.1.1 provides that the loss ‘has to arise out of or [be] a consequence of the construction of, or remedying defects in the Contract Works’. This means the principal can claim for losses due to acts or omissions of the contractor, rather than a default or breach by the contractor of its obligations under the contract.
Contractors should review indemnity provisions, consider how widely they are drafted, whether the scope of the indemnity can be insured for, and what limitations can be placed on them. Contractors should also ensure that any indemnity is reduced to the extent another party contributed to the loss – see for example clause 7.1.4 of NZS 3910:2013.
Uncapped liability clauses
Another common risk area for contractors is agreeing to high risk clauses, without any limit or cap on the scope or amount of the contractor’s liability. Claims under provisions such as contractor indemnities can quickly blow out if there are no limits in place.
There are various ways liability can be limited, if the drafting is clearly expressed and covers the relevant events and liability. For example, a contract may:
- Impose a monetary liability cap. This could be a cap per event, or a cap for all claims under the contract;
- Specify a liquidated sum (or specific sum) as the sole remedy for a breach;
- Limit the time period for which a claim can be made; or
- Exclude indirect and consequential losses, such as loss of profit or loss of opportunity.
Fitness for purpose obligations
Contractors should also be wary of fitness for purpose clauses, and avoid warranting that works will be fit for purpose where they do not have the necessary skill, judgement or influence over the purpose being warranted (for example, a contractor to a build-only contract warranting a hospital will be fit for medical practice).
The practical effect of these clauses is that the contractor may be liable for damages for breach of contract if the works are not suitable for their intended function or purpose. This can be regardless of whether or not the contractor was negligent or if it has complied with the specification.
If there are fitness for purpose warranties in a contract, contractors should make sure the purpose is clear and the time the warranty will apply is stated. Contractors should also check with their brokers whether insurance cover can be obtained. Often insurance policies will not cover the contractor’s liability for duties beyond the exercise of reasonable skill and care.
Finally, contractors should ideally address their obligations through clauses that provide that the work will be undertaken with all due care and skill (see clause 5.1.4 and 5.9.2 of NZS 3910), rather than providing that the works will be fit for their intended purpose.
Assumption of design responsibility in pure construction contracts
Contractors are also commonly entering predominantly build-only contracts (e.g. NZS 3910), that require the contractor to take on significant design responsibility through the special conditions or contract specification.
If a contractor is responsible for the design for a project, it should be clear about the scope of its design responsibilities, price for the design risk it is taking on board, and consider whether NZS 3916 should be used.
Build-only contracts should be carefully checked to see what design obligations are imposed. For example, while NZS 3910 provides for some design obligations and for design of temporary works, special conditions and contract specifications can bring in design obligations that go beyond minor design, such as the responsibility and risk of design development, and warranties to the adequacy of the design.
These additional clauses create a risk that issues with design will be pinned on contractors, and claims made for breach of contract or negligence.
Another design risk that can cause additional costs for contractors is signing up to contracts on the basis of a partially developed design. Contractors should check the state of the design at the time of tender, and consider any tags, and amendments to price and programme for the works depending on how complete it is.
Ultimately if there is a significant design component to the works, NZS 3916 or another design and build contract should be used. If you are taking responsibility for design, make sure to check:
- How the design is being done. For example, are contracts being novated or are you engaging designers yourself;
- What limits of liability are in place; and
- Whether you have insurance cover for Professional Indemnity claims.
This article only touches on the issues that can arise in respect of these clauses, and the relevant considerations that should be made. If you have any further questions in respect of this topic, please contact the writers.