Drafting Construction Contracts: How to Avoid Risks at the Contract Drafting Stage?

In managing construction projects, the creation of a binding contract is fundamental. Key elements like intention to create a legal relationship, legal capacity, genuine consent, and legality are usually straightforward. However, complexities often arise in areas such as offer and acceptance, consideration, and certainty of terms. These elements can lead to ambiguities and disputes. To mitigate risks associated with construction delays, it’s crucial to employ pre-emptive strategies during contract drafting. This involves clear articulation of terms, comprehensive risk allocation, and including foresighted clauses. These strategies create a robust framework to address potential causes of delays, ensuring adherence to project timelines. The article delves into the pre-emptive strategies that can be employed during the contract drafting stage to mitigate the risks associated with construction delays. This crucial phase in contract formulation, often underestimated, holds the key to safeguarding against unforeseen challenges and ensuring project timelines are adhered to. We will explore how clear articulation of terms, comprehensive risk allocation, and foresighted clauses can serve as vital tools in constructing a robust framework that anticipates and addresses the multifaceted causes of construction delays.

Table of Contents

Which Clauses Lead to Most Risks and Disputes in Construction Contracts?

In construction contracts, several clauses can pose significant risks, requiring careful attention and management. These include:

  • Clarity and Consensus on Offer and Acceptance: Often, large-scale construction projects begin and even complete without clear consensus on the contract terms or the documents forming the contract. This lack of clarity can be due to administrative inefficiency, oversight, or sometimes strategic ambiguity. The negotiation and finalisation of a building contract, which can span several months, hinge on clear agreement. Disputes frequently arise in the construction industry over whether a contract has been concluded and, if so, what the terms are. Questions such as whether the parties intended to contract, the certainty of agreed terms, and the sufficiency of acceptance are crucial in determining the existence and enforceability of a contract.
  • Ambiguous Scope of Works: Disputes are common over contract terms, especially in the interpretation of agreed-upon language. If terms are too uncertain, the contract or parts of it may be non-binding. Written contracts in commercial projects are meant to eliminate ambiguity, but disputes can still arise, especially when contracts are not in writing.
  • Uncertainty about Important Contract Terms: For a binding construction contract, essential terms such as parties, price, time, and description of works must be agreed upon. Construction contracts often face uncertainty due to their complexity, the extent of risk allocation, and the integration of various documents (like plans, specifications, and programs) which might be inconsistent.
  • Risk Allocation: Construction contracts are meant to pre-define the allocation of project-related risks. However, problems arise when risks are assigned to parties unable to manage them or when profit margins do not reflect assumed risks. The principle that risks should be borne by the party best able to manage them is often not followed. Clear identification of risks and obligations is essential to avoid disputes.
  • Eventuality of Non-Performance/Frustration of the Contract: The recent trend in insolvencies in the construction industry highlights the lack of flexibility in contracts to adapt to unforeseen risks. Fixed long-term agreements often do not account for variables like inflation, leading to disputes and financial losses. Better planning and inclusion of ‘escape mechanisms’ in contracts are necessary to accommodate unexpected scenarios, as seen during events like the Covid-19 pandemic.
  • Payment and Cash Flow Clauses: Payment issues are a perennial problem in the construction industry. Despite laws like the Security of Payment Act aimed at improving payments to subcontractors, late payments and disputes remain common. A cultural issue exists where subcontractors often refrain from legal action against contractors to preserve future work opportunities, leading to a power imbalance and neglected payment obligations.

These clauses and issues highlight the importance of precise, thorough contract drafting and negotiation in the construction industry to minimise risks and disputes.

Avoid Poorly Drafted Contracts: How to Stay Away from Risky Contractual Clauses?

Balanced Contract Drafting

In the context of drafting construction contracts, it’s crucial to start by aligning the contract with your client’s objectives. This involves a deep understanding of the factors that typically lead to increases in cost and time in construction projects, as well as recognising which aspects of the project are inherently riskier than others. The goal is to formulate contract conditions that safeguard the parties’ interests without unnecessarily inflating tender prices due to the transfer of risks that might never materialise. Achieving this balance requires a detailed understanding of construction law as well as the potential risks involved in the project, which can lead to more favorable outcomes for all parties involved in the project.

Following Best Practices for Good Faith Negotiations

Negotiations in construction contracts should be conducted in good faith, focusing on fair risk allocation and efficient cash flow management. Often, during the negotiation stages, there is a tendency to offload as much liability as possible, disproportionately impacting subcontractors with unmanageable risks and leading to legal disputes. This is indicative of a lack of responsibility in the industry, with principals, developers, and head contractors frequently creating agreements heavily in their favor, neglecting the long-term ramifications for the project. Therefore, these parties should engage in more responsible contract negotiations, ensuring fairness for all involved, which is crucial for addressing the issues commonly encountered in construction contracts.

Holistic Tender Evaluation

When it comes to tender evaluation, it is essential to consider more than just the price. Contractors should evaluate potential suppliers based on a range of criteria including their ability to resource the project adequately, meet delivery deadlines, and their financial stability. While pricing is an important factor, selecting the lowest bid without considering these additional factors can lead to challenges later in the project, such as supply disruptions or quality issues. Therefore, a comprehensive approach to tender evaluation, which goes beyond cost considerations, is vital for the smooth execution and success of the project.

Effective Risk Allocation to Manage Construction Contracts

Effective risk allocation is a critical aspect of drafting construction contracts, requiring principals and contractors to plan and allocate project risks in a fair and reasonable manner. A key area that needs attention is planning for delays caused by factors beyond the builder’s control. These often-neglected risks should be accounted for in contracts to ensure that liability is fairly distributed, particularly when delays arise from external circumstances outside the builder’s influence.

Recent trends in construction contracts have shown a tendency to limit the builder’s entitlements for extensions of time or delay costs, typically only allowing for these in cases of breaches, acts, or omissions by the principal. This approach often unfairly burdens the builder with costs associated with common risks such as weather-related delays or supply chain disruptions. Such risk allocations are neither reasonable nor practical, as they make the builder liable for circumstances beyond their control, potentially leading to unnecessary claims and disputes.

The negotiation of risk allocation should be guided by common sense and a sense of fairness. It is essential that the risks assigned to a builder or any party are within their control and management capacity. This approach not only fosters a more equitable distribution of responsibilities but also minimises the likelihood of disputes, contributing to a smoother project execution and a more collaborative working relationship among all parties involved.

Inclusion of ‘Rise and Fall’ Clauses to Avoid Risks

A “rise and fall” clause in a construction contract is a provision that allows for the adjustment of the contract price in response to changes in the costs of materials, labor, and force majeure scenarios related to the construction project. This clause is designed to address the risk of cost fluctuations over the course of a project, especially in long-term contracts where such changes are more likely. The “rise and fall” clause in construction contracts primarily addresses the fluctuations in costs rather than directly dealing with delays. However, it can indirectly help manage the impact of delays in construction projects in several ways:

  • Financial Stability for Contractors: By adjusting contract prices according to changes in material and labor costs, a “rise and fall” clause helps maintain the financial stability of contractors. This financial predictability can be crucial in situations where delays occur, ensuring that contractors are not financially overburdened by increased costs during the extended period.
  • Incentive to Continue Work: Delays often lead to increased costs. A “rise and fall” clause can provide an incentive for contractors to continue working on the project despite delays, as they know that significant cost increases will be compensated.
  • Reducing Disputes Over Costs: Delays can lead to disputes over who bears the extra costs incurred during the extended period. A well-drafted “rise and fall” clause can pre-empt these disputes by providing a clear mechanism for dealing with cost escalations, thereby reducing the likelihood of legal disputes and further delays.

The key to avoiding construction delays is in the careful drafting of contracts, emphasising clarity and comprehensive terms to balance risk. By focusing on clear, precise, and comprehensive contractual terms that reflect a balanced risk allocation, stakeholders can significantly reduce potential conflicts and streamline project timelines. This level of diligence in contract formulation is not just a best practice but a critical strategy in the construction industry to avoid litigation and unnecessary dispute resolution. For those involved in construction, understanding these contract complexities is crucial. PBL Law Group specialises in creating effective construction contracts to protect your interests and ensure timely project completion. Reach out to us for expertise in contract law and safeguard your construction projects against delays and disputes.

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Authored by

Raea Khan

Director Lawyer

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Raea Khan Circle
Director Lawyer
Raea Khan

Raea is Managing Director and Principal Lawyer for PBl Law Group. Raea assists clients with major projects, property developments, construction and strata law.

He has worked in Western Australia and Queensland assisting with expansion projects in the energy and resource sector and now predominately advises clients in Strata and Community Association matters.

He is a member of the Australian College of Strata Lawyers where majority of his work is advising developers and owners corporations with dispute related minor and major defects, strata governance and common property litigation. He is proficient at leading negotiations and meetings.

Raea has a particular interest in the commercial aspect of any dispute and always tries to weigh up the risk, reward and benefit of legal proceedings at each different stage.

Raea enjoys all forms of competitive sport, including Crossfit and actively participates in Triathlons, representing Australia as an age group athlete. He was a member of Red Head Surf Lifesaving club.

  • Strata Law
  • Construction & Major Projects
  • Commercial and Business Law
  • Planning & Environment Law