Contracts and Risk Mitigation in Today’s Changing Construction Landscape

Jessica: All right. Thank you. We are here today to talk about a topic we haven’t really gone into in too much detail in the past podcast, but it’s something that is really taking over kind of the news cycle with our industry and something that as a construction consultancy, we are more focused on than ever. Something that’s constantly coming up in our internal meetings on our job site meetings, we are gonna be talking about all things, contracts and legal. In today’s market, the days of set timelines, expected material pricing, and even a reliable workforce pool to pick from has really become a thing of the past.

We’ve learned over the last couple of years, how significant the project contract can be the legal side of building, like I said, is just taking over our mind space. We’ve really found out how important that fine print can be for owners. We have our advocates in house that have been pounding on doors and in telling us that for years, but it’s really now grabbed everyone’s attention.

I want to introduce Sonny Jester and Kristen Pyle. Sonny was a construction attorney for more than 25 years before he moved into the consulting role which he’s been in for what nearly 16 years now. In both these roles, focus was on risk assessment, claims analysis. He would, and still does really dives into these complex projects that we’re seeing pop up everywhere.

He evaluates all these subjective estimates that are coming in, identifies and corrects all this ambiguous contract terms that we see popping up. In these legal documents that are now getting scrutinized and more eyeballs than ever. So he is one of our main sources to protect owner’s interests as we go into these contracts.

Welcome Sonny. Thank you for joining us. I know this will be a very interesting conversation. And we also have Kristen who is an advocate for owners and developers as well. She’s constantly looking at ways to minimize these project pitfalls, best ways to allocate the risk across partners on these projects.

Really, I guess guys today’s goal. I would love to just have a conversation and provide some fresh perspective on what is going on in today’s industry, and hopefully provide some actionable takeaways that’ll help owners avoid disputes altogether, I guess is the main goal, right? We don’t wanna get there to really help keep these projects moving in the right direction on the contract and legal side.

Thank you both for joining today and welcome.

Sonny: Thank you.

Kristen: Thank you.

Jessica: So without wasting too much time, let’s just dive right in. When you’re first sitting down with an owner, a developer, what are the first couple topics you wanna discuss? You wanna get out of the way?

Sonny: I think you wanna identify what’s driving the project. Obviously you’ve got an owner and developer have an intent sort of an idea concept in their mind of what they want to happen, but for that to work you have to identify what is their primary driver. What’s pushing them on the project with things like schools, for example it’s butts in seats the first day that you have to be open.

So it’s time focused. Some owners are driven by cost. Some are driven by brand considerations. If you’re a hospitality project, for example, and you have a flag that is putting their name on the front of your building, They’re going to have sets of criteria that, that you’re gonna have to meet.

I think you have to ask that owner, to be honest with you about what it is they think drives that project. Kristen, any thoughts on that?

Kristen: My number one was honesty. Be honest about what your intentions are for the project, and then help us craft the way to get you there by putting clear, concise contract terms in aligned with that focus.

The other piece. I think that we often miss is that sometimes it’s not just a single owner, it’s an owner made up of multiple stakeholders. And so understanding their intentions as well and what they need to see in terms of deliverables from an owner, deliverables from the project, basically where their focus is, if we can bring that to the forefront of a project, it certainly helps us plan a good way to get that understanding communicated to the team members. And then contract language to support it.

Sonny: And a big piece of that honesty has to be making sure if you’ve got equity investors or lenders that they’re around the table, also talking about what their drivers are because for a lender or an equity investor, it may be ROI.

It may be making sure that change orders are minimized. So their drivers may be slightly different than the owner or developers. So it, I think honesty is the critical component. I think you’re right. So you may have, instead of one driver, it may be five drivers with all the partners involved. And you might ask during that conversation, at honest conversation, if you tell me that your driver is time, are you willing to pay more to achieve those milestones?

Jessica: And where are the rooms for compromise?

Sonny: Absolutely.

Jessica: Okay. So once you have those main drivers identified where do you go from there? Assuming they were honest with their drivers.

Sonny: I think to the topic of the conversation, which is what kind of contract do you want to use? I’m seeing a rise of bespoke contracts.

People have always used AIA in the Caribbean and South America, FIDIC contracts, et cetera. Consensus docs, they’re  all of these forms, but I’m seeing a rise in owners and developers hiring their outside council to develop their own suite of contracts, their own bespoke contracts. So you wanna look at what type of contract and it’s amazing sometimes.

How much people don’t understand about the difference I’m stunned constantly. When an owner who may be a, an experienced developer or a lender asks what’s the difference between a cost plus contract and some other contract. What’s the difference between a GMP, a guaranteed maximum price and a lump sum, you have to know the difference. Otherwise, back to the beginning concept risk allocation cannot occur properly, which is the role of a contract, unless, what kind of delivery methodology you want to use.

Kristen: Exactly. If I had a dollar for every time, someone says that they have a GMP contract and I get into it and it’s a lump sum.

It’s, I’m just beside myself because what they’re agreeing to. It might say one thing on a header, they, if they don’t have legal counsel and they don’t review it themselves and they don’t understand the difference, they can be in a whole world of trouble. So we’re seeing that now more than ever too, where the contractors, providing the base form of contract and it’s already written in their favor and it maybe doesn’t align with what the owner’s goals and objectives are or what their equity partner or lender’s objectives are.

And so they start off on the wrong. So it’s how do you get aligned immediately rather than starting in the wrong place? I, and negotiating backwards

Sonny: don’t want to devolve into war stories here, but several years ago worked for a lender who was lending on a healthcare project. Won’t mention where whatever, but wanted to know whether they should have any input into the type of contract.

And the owner and contractor. Negotiated what was in effect on a lump sum. And the lender said, why does that matter to me? And I said, because you, if you wanna have any say over where the money goes, how it is spent any control over cost of the work, if you have a lump sum contract, you’re handing that contractor the money saying, bill me, whatever you can bill me for this amount.

You lose control. And I’m not saying that you should, it should be, an adversarial situation between lender owner, contractor or design team or whatever, but everybody has to have their rules in place, have to have their roles in place so that they know, yes, I can spend your money. And yes, I may ask for a change, but you’re entitled to know why and the contract method, the delivery methodology can influence whether they have to tell you why.

Kristen: Exactly.

Jessica: So you mentioned a couple of these contract method. Cost of work, EPC, I’ve heard we have the GMP. What are the top level differences? Why would someone benefit one over the other, just from your experience?

Sonny: You want to grab that first?

Kristen: Sure. From a straightforward perspective, if you are entering an engagement with the general contractor, there’s two, I would say the most prevalent contracts in the industry are a GMP cost of the work, plus a fee with a guaranteed maximum price or alternatively, a lump sum agreement. The biggest difference between the two of ’em is that a guaranteed maximum price delivery method assumes that the price includes everything on the drawings, the construction drawings and specifications and everything reasonably inferrable there from.

So if you have a door, it’s got a knob because it’s reasonably infer that you’re going to have to open and close that door. Alternatively, if you’re going into a lump sum agreement, it is just what’s on the contract documents and specifications, nothing reasonably inferable.

Jessica: So it’s not assuming you need a knob.

Kristen: If it’s not drawn, you don’t get it.

Sonny: That’s right.

Kristen: Very simple and straightforward, but it really relies, it pushes construction document completion. So drawings and specifications is back onto the owner.

Jessica: So the risk is put back on the owner?

Kristen: Basically the owner’s responsible for complete drawings and specs.

So if the owner does not have the expertise to understand if they have complete drawings and specs, because they’re not an architect and they don’t do page flips every day or alternatively, they don’t have the time or they are, don’t have an understanding of what the delivery method is. They can be in a world of trouble because they don’t understand what should be on the drawings and what’s included in the contract zone. So in a lump sum agreement, you might not have exclusions that says a doorknob is specifically excluded, but if you don’t have a hardware schedule, it doesn’t matter. You did not buy it. You’re not combing through the subcontractors assumptions and qualifications looking for where the gaps in those bids are because they’re only pricing what’s shown.

So the GMP is a, it’s a favorable delivery method for owners who again, don’t have that time or expertise component, and can’t be combing through the drawings to make sure that they’re a hundred percent complete, by the way, I’ve never seen a package of drawing specs that’s a hundred percent complete. Not to say that I haven’t had a lump sum agreement without change orders, but nonetheless you start relying on a relationship with the contractor rather than the contractual document.

But a GMP it’s just more favorable in the sense that for instance I have coverage. If there are gaps in the documents. And right now in the industry, as we’re seeing architectural teams and engineering teams get stretched, we’re finding more and more gaps and holes in those drawings and specs. So that risk transfer’s coming back to the owner because of the nature of the environment that we’re operating in.

So again, it’s all about figuring out the best delivery method, not only in the context of the owner’s goals and objectives, but in the context of what’s happening out in the market. And what is the most favorable way to get from point a, to those goals and objectives at the end of the project.

Sonny: And it’s not just cost. If you’re in a lump sum agreement and you haven’t drawn door handles on your doors it affects your schedule because if you haven’t ordered it then you’ve got time impacts. And the old adages construction is really time and money, but since time is money is really only money, but if it affects your time it’s gonna cost you money.

It’s gonna affect your driver. If your goal is to finish on time or to finish on budget or both if you don’t choose the right methodology, it will impact that. And the other side of the coin is to protect the owner and to protect the lender on occasion is that cost of the work factor is huge because it carries with it either explicitly or implicitly, the right to audit, pay applications.

And that, that if you’ve paid a pay app, Particularly in a contract where it’s express, you have the right to go back and look at it again frequently, depending on the law in the state where you operate to go back and say I paid you, but it now turns out that’s not really the right material, or you substituted without permission.

And you can go back and look at that and rectify or reconcile your costs as you go along again, a risk allocation factor.

Jessica: So when you guys are talking about this risk allocation and knowing what we’re up against today, in the construction industry with time and schedules and materials, and who knows if a port’s gonna be open or not, or how long and everything that’s going on, what has changed with risk allocation? Has anything changed? Is it just more of a topic or have things really changed? I change.

Sonny: I don’t think the concept has changed. I think the applicability of the concept to a construction project and construction documents has changed because now where people might have thought traditionally, okay.

The risk of long lead time materials we understand is mine. I get it. Now does force majeure play into that with COVID and shutdowns and supply chain issues. So it’s now a factor while it was just something that people did allocate risk. Okay. You’re responsible for cost overruns or I am. It’s now a real thing.

It’s not dollars and cents. It’s tens of thousands, millions of dollars that can be impacted. So I think the focus on risk allocation is more acute. Not necessarily the concept.

Kristen: I completely agree. My notes say, contractors have a blatant aversion for risk these days. It’s true because, and I say that because what we’re seeing is some creative text from council or, internal council at our clients that, or at our contractors that say, I get a carve out for all of these things that are quote unquote outside of my control, whether they really are, or they are not. And that’s the tougher part to approach because they’re coming off of projects that have stalled have major delays.

That they’re in litigation with owners on. And so the natural tendency is to swing the other way with this aversion because businesses have lost money because they didn’t have, this carte blanche protective language that covered them when there were things that were going on that they maybe couldn’t explain.

So a traditional force majeure language is written around unforeseen circumstances that are outside of the contractor’s reasonable control, but there’s a lot of getting in what you’re saying is that this acute pain that they’re feeling based on their recent experience on projects, dealing with the same thing.

Sonny: Yes. You mentioned earlier EPC and EPCM contracts, which is more on the industrial side, on the process focused rather than the building focus side of things. And for those who don’t know, EPC is engineering, procurement and construction. EPCM is the engineering procurement and construction management.

It’s a big deal because EPC contracts that the EPC contractor has the risk of money. EPCM, the owner still holds that risk. In most cases, it will depend again, the lawyers will litigate forever on the terms of contract, but generally speaking, that those are the differences. It goes to what Kristen’s saying.

You need to know, is your guy building it or just designing it in an industrial setting? And same thing can go to commercial. You go to design, build versus design bid, build who then owns the risk of the design changes, which is again, a risk allocation factor.

Jessica: So talking about all of this let’s break it down into two sections.

So when we’re talking about allocating risk, from a time perspective, what are the best ways? And then when you’re talking about allocating risk from a cost escalation overrun standpoint, what are the best approaches with the perspective of, we’re always trying to protect the owner?

Sonny: I’m an advocate of really good scheduling specs. You have to tell the contractor what you want. You can go overboard. I worked with a public entity years ago, actually spoke with their in-house construction lawyer at a conference, and we were talking about scheduling specifications and he indicated that his scheduling spec was 16 pages long. That’s absurd, but 16 sentences long is not enough either. It needs to be somewhere in the middle and you need to spell out. It needs to say, what kind of software do you want to use? You need to preserve the right in the owner to get that schedule in native format so that you can evaluate the logic.

And you need to have some contractual clauses back to our topic. Depending on the state law, no damages for delay or you only get time, you don’t get money concepts, liquidated damages. I will tell you I’m seeing a lot of chagrin these days over parties who have mutually waived consequential damages for projects that are time driven.

If you’re building an apartment complex, your driver is going to be, or probably one of your major drivers is going to be rental date. When can I put people in there paying me money? And if you don’t have good contractual provisions, good scheduling risk allocation there, you’re gonna lose money.

And liquidated damages are one way to fix that. But I’m finding people who don’t have liquidated damages or have insufficient liquidated damage. And then have waived consequential damages. And the end result is you have no matter how you allocated the risk of being late, it has no consequence.

So back to your question, I think you need to have really good scheduling specs. You need to make sure that the schedule is done well in your contract ought to provide that you have oversight and periodic reviews of those schedules, but you also need to have consequences built into that schedule for time.

Kristen: I also think you need someone managing it and holding them accountable. Recently, we had a client who’s in trouble and they said they’ve never given me a CPM schedule. CPM means critical path method schedule. So it’s a particular way of tying logic ties that you know refer to areas that are critical to the construction schedule, to continue progress in the way that makes sense to build it correctly.

And it was required via the contract, but on the administration side of that contract, they just didn’t have anyone paying attention. And so they had never received one. And they never required it. And so then trying to enforce those requirements later in a project is nearly impossible because you’ve let them operate in a way that didn’t make sense and you didn’t hold them accountable to what you’ve spelled out clearly in writing for the parties at the onset.

Sonny: And you need to make sure, as you say it, somebody oversees that it knows what they’re doing. Kristen and I our staffs had a chance to work together on a project a year or so ago. It was pre COVID and the contractor submitted a CPM quote unquote schedule, but they didn’t give it to us in native format.

So we requested or to the owner requested it. And once we got the native format, we realized that they had artificially constrained the critical path. So it wasn’t the real critical path. It was artificially constrained. As I say, the logic didn’t flow. You have to be able to call BS on the schedule when it’s appropriate.

And I think owners don’t know how to do that. They shouldn’t have to they’re developers, but you need somebody who can look at that schedule pretty quickly and say, wait a minute, I have a problem here.

Jessica: So with that in mind, when we’re talking about process and procedure and procurement, what are some considerations that owners need to be thinking about in terms of protecting themselves and in today, World of high risk. It seems.

Sonny: A lot of states have laws on this. Texas higher education, for example requires that the winning proposal, be selected based on most qualified, best qualified. And they’re not allowed to look at price until the best qualified is chosen. A lot of people think you can’t choose the most qualified or best qualified proposal until you look. Cause I, I worked in Trinidad for a year working with the government and we were proposing new methodologies for.

We actually were proposing pre-qualification of contractors. And we suggested that they go to a bid process whereby they took the proposals chose, which was the best, and then opened a separate envelope in which the price was. And if they couldn’t agree on price, they then go to second. And they actually said the client actually said we can’t evaluate, which is the best proposal until we know how much it costs.

That’s absurd. On its face, it’s absurd, but it’s not unique to Trinidad. I find that across the United States, very routinely you must know what you’re looking for. Best qualified, lowest cost. Somebody who’s done it before. You don’t want a guy who builds storage facilities, building a research medical research facility.

You just don’t. Can they do it? Sure. It happens all the time, but it also happens all the time that they can’t. So you need to make sure you’re getting the most qualified.

Kristen: I a hundred percent agree. I think it’s a focus on the team, right? We’re hiring contractors, we’re hiring architects and contractors for the expertise that they bring to the table.

And their repertoire of previously successfully completed work for other owners in the same sector of work. And we have many qualified, very highly qualified contractors in the industry, but it’s the focus on the team. You can have a wonderful reputation as a contractor, but if you’re only people that are available are people who’ve never done the same project before the owner is at a disadvantage.

If they’re selecting that team because in many ways they’re paying their hard earned dollars to essentially train someone on how to build their product.

Sonny: And a great point. I’m sorry to interrupt you, Kristen. But in an interview I encourage owners. If you’re in an interview process, a shortlist process, and you have a team sitting across the table from you in one of your shortlisted proposals, you ask them, are you in fact going to work on this project?

How many other projects do you have that you’re working on? To establish that you’re getting the team that you’re interviewing.

Kristen: And we also have a focus that we don’t get the salesman in the room for those interviews. We actually call them working sessions, because if you’re going to undertake a large scale project for a significant duration of time, you need to spend some time getting to know the team that you’re going to potentially be working with.

Yes, because they’ll be with you in the trenches. They’ll be with you on the day to day, and they’ll be with you in the hurdles that you will inevitably face given just what’s happening in the market. If you only look at it from a procurement standpoint of materials, suppliers, subcontractors, if you only looked at it from that standpoint, we already know that we are facing some pretty big mountains in the upcoming months and years.

So why not take that extra time to really vet the team that you want to select and want to work with? The other piece that we often try to stipulate in agreements is that team will be committed unless they leave the employment of that contractor. Why? Because nothing is more catastrophic than taking all of the history of everything learned and the relationship, and then sending it off to another project.

And then trying to backfill that intimate knowledge of how the pricing exercises went down, the leads at the subcontractors and how you take that and move it forward with a new person. Now there, if you think about team formation, that new person has to come in and plug in and then decide how they’re gonna operate, and then try to integrate into a team you’re already at a disadvantage.

There’s enough hurdles in designing construction to not have losing team members as a part of that equation.

Sonny: And that’s so timely because if your project has been suspended or shut down for a period of time and you come back to restart, you need to make sure you’ve got the same team. Otherwise you need to reevaluate your budget and your schedule.

Those that’s a risk avoidance issue. And back to our general topic, risk allocation that sit down with the team is so critical because that is a claims avoidance technique. If you have good team members, even if you have a dispute or a disputed change order request. For example, if you sit in a room around a table with a team that you work with every day and talk about it, you’re more likely to resolve it, then have to call the lawyers and go to court.

Kristen: Exactly.

Sonny: Or arbitration.

Kristen: Exactly.

Jessica: With everything that is going on in the marketplace today, As we look to wrap up this discussion. I know we could go on for another couple hours knowing you both. What is your number one top takeaway that you would like to leave people with really knowing where we’re at, where it’s gonna be going the next couple months.

And like you said, Kristen, and maybe next couple years, where should people really be focused with risk allocation? If they were to walk away of one or two things from this discussion.

Sonny: Don’t be afraid to have the hard discussions at the beginning. They’re easier then than they are at the end. If you want something in your contract, if you think you need something, ask for it.

And if the contractor or the design team or whoever it is, you’re negotiating with, can’t do it. They’ll tell you and you can work out. But if you don’t raise it on the assumption that everybody’s gonna sing kumbaya all the way through the project, you’re going to be disappointed at some point. So avoid the risk at the beginning rather than have to resolve it at the end.

Kristen: That’s exactly right. And I would say have enough time to adequately prepare when it is a concept in your client’s mind, you should start thinking about risk allocation, contract delivery method, and ultimately how you are going to ensure that they all align, at least on a philosophical level of getting them from where they are today to where they wanna be at the end of that project. But it’s the time everybody, I think that’s the trouble we see team members get into is that it’s go. We just pulled it off the shelf and we’re reinstituting.

And now we’re six months late. Can you deliver six months early? And so it’s having those tougher conversations, but having adequate and appropriate time to really align them in a way that makes sense. And then obviously there’s a significant amount of effort. If you can condense the amount of time that you have negotiating and get to the real heart of what we call deal breakers of, are we going to be able to do business together or is there something that’s written in this agreement that you will refuse to accept?

And then how do we clear that hurdle or, electively dismiss the top rank firm and move to the next and start those negotiations. It’s getting that clarity faster than a four to six month negotiation process, which usually is a product of going through a legitimate procurement process is being able to see transparently where those deal breakers are from multiple firms.

And then in tandem with that selecting the best qualified or, the goals and objectives of your delivery ahead of time and in advance, nothing’s worse than rushing to get through a contract and just saying just leave it as is we’ll take that language as is and not thinking through what the allocation of that risk is, but really means until you have to pull it outta the drawer because someone’s in a fight later down the road.

Sonny: And I would add to that simply saying, even though we work a lot for owners sometimes the best risk allocation is hiring a contractor, knowing that they can actually do the job and that the owner shouldn’t be the, contractor, even if you have multiple primes, for example the owner’s hiring a contractor for a reason.

They’re good at what they do, let them do it, but just make sure you have the rule book in place to govern that performance.

Jessica: I like that. All right. Thank you both. And hopefully listeners can take one or two bits of this information, walk away with something new that they’ve learned, or maybe even just rethinking about how things have been going currently for them and what they can do next time or even what conversation they need to have next at their next project meeting. Thank you both have a wonderful day and I’m sure we will have an update on this as we move through the next several months and have to navigate what we’re going to be facing. So thank you.

Kristen: Thank you.