A Guide to Contract Structures

DATE PUBLISHED: March 23, 2022

key takeaways

Investing in the right contract structure and its development will help realise project opportunities and protect against costly risks.
The level of control a party seeks over the time, cost and quality of a project, and the requirements of finance, are key drivers in selecting an appropriate contract structure.
Lenders look favourably upon single-point responsibility, which can make a project structure more bankable than splitting responsibility amongst multiple contractors and coordinating the delivery of those work packages. However, the increased cost of a turnkey solution must be balanced against the ability to understand and manage the risks involved.

Why your contract structure matters

The right contract structure will save you time and cost. Engaging early to plan how a project will be structured contractually can help with scoping, budgeting and risk management. The right contract structure can help to capitalise on opportunities and to reduce the likelihood of significant disputes.

Contract selection and preparing an efficient allocation of risk and responsibility within that framework forms the backbone of a construction project. It's also critical to successfully debt financing a project.

When construction projects fall into dispute, the legal costs involved can be significant.
At that point, there can be little option other than to pursue a recovery or defend an action. The costs involved in dispute resolution can be significant. In many cases, these costs could have been ameliorated or avoided through the contract itself.

What are common contract structures for construction projects?

There are many standard and bespoke contracting arrangements used in the construction and infrastructure industry. The characteristics of the following three structures are present in many projects.

Construct (Traditional)

FEATURES AND CONSIDERATIONS

Principal separately procures the full design from design consultants and has full control of design and quality requirements.
As between the Principal and the Contractor, the Principal retains responsibility for the design.
Contractor accepts responsibility for constructing in accordance with the design and specifications for the project.
High levels of certainty, in relation to cost and quality, subject to instructed variations.

DESIGN AND CONSTRUCT

FEATURES AND CONSIDERATIONS

Single point responsibility of Contractor.
Contractor is responsible for the design and construction of the project. This usually includes a fitness for purpose warranty.
Less direct control over design development by Principal.
A bankable structure that offers lenders comfort. High levels of certainty, in relation to time and cost, are subject to variations.

construction management

features and considerations

Principal procures the design.
Principal directly engages all trade contractors required for the project.
Principal engages a construction manager.
Construction manager acts as Principal’s agent to manage the delivery of the individual trade contracts.
High levels of flexibility for time and quality.

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What factors guide contract structure selection?

Set out in the table below are a number of comparative issues that can assist with contract structure selection. There are also multiple pricing and payment options that can be paired with contract structure selections.

Issue	Construct	Design and Construct	Construction Management
Contractor wraps the project risks	Cell	X	Cell
Principal retains significant control of design	X	Cell	X
Construction work quality	X	X	X
Integration of multiple complex works	X	X	Cell
Highest level of bankability	Cell	X	Cell
Highest level of flexibility	Cell	Cell	X
Certainty of price	X	X	Cell
Clarity of remedies	Cell	X	Cell
Most suitable for experienced Principals	Cell	X	Cell
Longest project time (full tender documentation required), with design and construction in series	X	Cell	Cell
Reduced project time, with design and construction in parallel	Cell	X	X
Highest degree of Principal involvement	Cell	Cell	X

Current Trends In the Market

In a market where land values have been increasing, Principals have favoured Design and Construct contract structures in development projects. These contract structures are being used to:

Improve bankability;
Improve access to debt finance; and
Fast-track the design and construction elements of a project in parallel so that project returns can be realised.

A key challenge in a fast-moving market is ensuring that sufficient lead time is included to adequately prepare and negotiate contracts to address risks. At the time of writing, risks of particular note include COVID-19 related risks, cost escalation and availability of certain materials and subcontractor resources.

Achieving bankability

Where projects are being debt-financed, Principals need to ensure at the outset that the contract structure is sufficiently robust to satisfy their financier’s requirements for funding. It's imperative that Principals ensure all project contracts are prepared on bankable contract terms which tie into the funding structure and will meet any conditions precedent to financial close. These include all construction works packages and the design, and technical and project management appointments.

While financiers’ requirements can vary depending on the project size and market, their due diligence will focus on key lender issues impacting the borrower’s risk profile. These include:

Contractual liability limits;
Price and program certainty through the project delivery;
The adequacy of the security package, project insurances;
Control over scope changes and variations;
Performance standards and warranties; and
Termination rights.

Principals should work with their financiers from project conception to understand expectations around funding and to address the requirements of their financiers in contract documents.

conclusion

There is a wide selection of construction contract structures that can be deployed. Choosing the right structure will depend on factors, including the control a party seeks over issues of time, cost, and quality, as well as the requirements of finance.

Investing in the right contract structure and spending time to work through project opportunities and risks at the outset can save significant time and money during delivery and ameliorate the risk of disputes.

get in touch with us!

Our Construction and Infrastructure team has experience in:

Structuring, drafting and negotiating contracts;
working with clients and contractors to prepare and respond to tender documentation;
Carrying out reviews for lenders, Principals and Contractors;
Advising on loan arrangements for lenders and Principals; and
Due diligence for lenders and Principals, including in respect of contract structures.

The next time you're looking at developing or responding to a proposed contract structure for a project, please contact us. We'd love to discuss your project and are always delighted to share our thoughts and insights on the market.

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