Negotiating Infrastructure Project Documentation: Key Considerations for Effective Drafting and Negotiation
Introduction
When people think of construction projects, what often comes to mind are, inter alia, towering high-rise buildings piercing the skyline and sprawling housing developments stretching across vast landscape. However, most would overlook infrastructure projects, which are also a crucial branch of construction and they are poised to dominate Malaysia's construction scene in the foreseeable future.[1][2] This is evident from the development of key infrastructure projects such as the Circle Line MRT3, Penang LRT Mutiara Line, Pan Borneo Highway, Subang Airport Regeneration Plan and the redevelopment of the Shah Alam Sports Complex.
Nevertheless, infrastructure projects are intricate ventures that demand meticulous and strategic planning, comprehensive documentation and expert negotiation by the contracting parties. Whether it involves the construction of transportation networks, energy facilities or urban development initiatives, the success of such endeavours often hinges on the robustness of the contract document governing the contracting parties.
Therefore, a well-structured contract document not only mitigates risks but also ensures that all contracting parties are aligned in order to foster long-term project sustainability and to minimise potential disputes. Below, we will dive into the meat of this article in which we will explore key considerations to ensure effective drafting and negotiation of infrastructure project documentation.
Key Considerations
Essentially, the key considerations of an infrastructure project documentation are as follows: -
(a) Contract Sum;
(b) Work Programme, Schematic Design and Material Specification;
(c) Bonds/Bank Guarantees;
(d) Insurance;
(e) Variation;
(f) Delay/Suspension of Works;
(g) Defect Liability Period; and
(h) Final Account
(a) Contract Sum
Contracting parties typically devote significant time and effort to negotiating the contract sum as it is a pivotal element when it comes to infrastructure project documentation, and it sets out the total financial obligation agreed upon by the employer to compensate the contractor for completing the works.
Nevertheless, contract sums in infrastructure project documentation may encompass various forms, including but not limited to the following: -
(i) Lump sum contract
This is the most common and straightforward contract in the construction industry whereby the contractor agrees to complete the construction work for a fixed price. This structure is suitable for employers under a strict budget and the contractor is allowed to carry out the project pursuant to the approved design as long as the costs are within the budget of the employer. In other words, the contract sum is fixed upon the execution of the relevant contract document and the contractor assumes the risk of any cost overrun (unless otherwise stated in the contract document). On the other hand, the contractor is also entitled to any savings if the costs incurred is less than the fixed price.
(ii) Open-book contract
Via this form and/or structure, the employer has the right to scrutinise the contractor's costs and margins through detailed reporting and access to financial records.[3] The contractor is required to maintain transparency by providing the employer with regular updates and access to the breakdown of all costs associated with each work package, including labour, materials overheads as well as other expenses. Additionally, the employer is accorded the opportunity to verify whether the costs charged by the contractor are both reasonable and directly attributable to the project.
(iii) Cost plus contract
This form of contract sum is typically employed when the scope is not fully defined at the outset and it allows the employer to pay the actual costs incurred during the project along with an additional fee (which is usually predetermined) to cover the contractor's profit and overhead.
(iv) Guaranteed maximum price contract
In this type of contract, the contractor guarantees that the total contract sum will not exceed the agreed and/or specified maximum price, known as the guaranteed maximum price (“GMP”). If the actual cost surpasses the GMP, the contractor is generally responsible for covering the difference, unless the cost overruns are due to changes in the scope of work requested by the employer.
(v) Time and materials contract
Under this type of contract, the contract sum is determined based on the actual time spent by the contractor's labour and the materials used in the project. This form of contract is commonly used when the scope of work is unclear or difficult to define in advance.
Generally, there is no single 'best' structure when selecting the appropriate form of contract sum to adopt. In fact, the selection of an appropriate contract sum structure depends on various factors, including the complexity and scope of the project, the risk appetite of the parties involved and the overarching objectives of the project. Tailoring the contract sum to align with these elements ensures a more effective and mutually beneficial arrangement.
(b) Work Programme, Schematic Design and Material Specification
It is imperative for contracting parties to also negotiate, finalise and include a comprehensive work programme in the contract document to ensure that everyone is on the same page and to ensure that the project is completed on time, within budget and to the desired quality standards.
From a legal standpoint, the work programme establishes deadlines for project milestones and completion. Failure to adhere to these deadlines may constitute a breach of contract and will give rise to remedies such as liquidated damages or termination rights. In the event of delay, it also serves as a benchmark to assess and validate claims for extensions of time.
It is also quite common for the employer to request the inclusion of schematic designs and material specifications in the contract document. This ensures alignment on design expectations and minimises the risk of disputes related to the quality and specifics of the materials used throughout the project.
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(c) Bonds/Bank Guarantees
To ensure performance and timely completion of infrastructure projects by the developer and/or contractor, employers typically require various types of bonds as a form of financial assurance. These bonds are designed to safeguard against potential breaches of contract, delays or failure to meet agreed-upon standards. Ultimately, it provides employers with a reliable financial recourse should the developer or contractor fail to fulfil their obligations under the contract document in question. For instance, the bonds typically requested by employers may include but not limited to the following: -
(i) Performance bond
A financial guarantee serves to ensure that the developer and/or contractor fulfils their obligations and completes the project in accordance with the terms outlined in the contract document. Should the contractor and/or developer fail to meet their contractual responsibilities, including the completion of the infrastructure project, the employer reserves the right to invoke the bond as a remedial measure.
(ii) Design guarantee bond
A financial guarantee provided by the developer or contractor to the employer that the developer or contractor will fulfil their design obligations under the contract document and that the design meets the agreed specifications, standards and functional requirements.
(iii) Maintenance bond
A financial guarantee to ensure that the developer and/or contractor will perform maintenance, repair or rectify defects discovered post completion of the project. This bond usually remains valid until the the expiry of the defect liability period or until the issuance of the certificate of making good the defects for the project (whichever is later).
(d) Insurance
In infrastructure project contracts, it is common for the employer to mandate that the developer or contractor obtains and maintains adequate insurance coverage, which may include the following types of insurance: -
(i) Contractor’s all risk policy
A comprehensive insurance policy designed to provide protection against losses or damages related to contract works at the project site, including third-party claims arising from the construction activities. It may also protect contractors against risks and unforeseen events such as fire, flood, storm, lightning, riot and civil commotion that may occur throughout the project.
(ii) Public liability insurance
This type of insurance is designed to provide coverage for employers, developers and/or contractors against financial liabilities arising from claims made by third parties due to accidents, injuries or damage that may occur in connection with construction activities on the project site.
(iii) Worker’s compensation insurance
A critical form of insurance that offers comprehensive protection for workers on-site where they would receive compensation for medical expenses, rehabilitation and lost wages resulting from workplace injuries or illnesses. Additionally, it provides death benefits to the families of workers who tragically lose their lives while on the job.
(e) Variation
Changes to the scope of works, materials, timeline and other aspects are extremely common in the construction industry. Therefore, contracts must clearly define permissible variations, approval processes and mechanisms for cost and time adjustments to minimise the risk of disputes. Common instances when variations may happen include: -
(i) Changes or modifications in the original design or plans, such as alterations to materials, finishes, layout or structural elements, often requested by the employer or necessary due to evolving requirements;
(ii) Discovery of unexpected site conditions that were not anticipated during the initial planning phase; and
(iii) Changes in local laws, building regulations or government ordinances during the course of the project, including but not limited to modifications in safety standards, environmental regulations, zoning laws or any other legal or regulatory requirements that necessitate variations to the project.
(f) Delay/Suspension of Works
Delays or suspensions can significantly derail projects. To address this, employers typically seek to define acceptable delay scenarios, permissible extensions and compensation mechanisms within the contract. It is also common to include provisions for penalties in cases of unjustified delays or improper suspension of works.
(g) Defect Liability Period
Similar to the standard practice in housing development sale and purchase agreements, the defect liability period is a common feature in infrastructure project contracts. During this period, the developer and/or contractor is contractually obligated to rectify any defects, deficiencies or failures identified at their own expense. This obligation typically extends for a period of 1 to 2 years from the date of issuance of the certificate of practical completion.
(h) Final Account
Furthermore, it is crucial to incorporate a well-defined provision on the final account in the contract document as such provision acts as a comprehensive statement detailing the total cost of the project including the reconciliation of all payments, variations, provisional sums and claims between the developer and/or contractor and the employer. In short, it provides a formal closure to the financial aspects of the contract.
Conclusion
In conclusion, the success of infrastructure projects relies heavily on meticulous planning, clear contractual agreements and expert negotiation. Given the complexity and scale of these projects, contract documentation must comprehensively address critical elements to not only mitigate risks but also ensure that all parties are aligned and committed to the timely and cost-effective delivery of the project. As Malaysia continues to embark on large-scale infrastructure ventures, the importance of robust contract management will remain pivotal in achieving sustainable outcomes and fulfilling the expectations of both the employer and the developer or contractor.
Corporate Communications, Azmi & Associates - 10 December 2024