How principals can effectively manage defects and delays in projects
The current construction landscape is characterised by more insolvencies, fewer contractors and contractual mechanisms with less practical force.
Defects and delays in construction and infrastructure projects have long been a thorn in the side of principals. Historically, however, principals have been in an excellent position to seek remedies by virtue of a much stronger bargaining position during initial contract negotiations.
While that bargaining strength remains, principals now face the real prospect of a contractor becoming insolvent or being unable to rectify defects. In that case, achieving meaningful remedies may be a lost cause.
Trends that have led to difficulties for contractors include:
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A significant increase in material and labour prices coming at the same time that many contractors are still recovering from the impacts of COVID-19.
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Greater risk due to legislative reforms in the wake of the Opal and Mascot Tower incidents. For instance, the Design and Building Practitioners Act 2020 (NSW) has caused many operators to consider whether the increased – and often personal – liability resulting from these reforms is worth the marginal profits they are making.
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Contractors regularly tendering for projects with little or no margin to either stay competitive or "keep the wheels turning”. In this environment, projects become unprofitable as soon as there is an unanticipated expense and the number of insolvencies goes up.
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A shortage in the availability of subcontractors who are even less insulated from the factors above than their larger counterparts. A consequence of this is that should one subcontractor become insolvent, finding a replacement is likely to be difficult.
What should I do?
The contract will be the main source of a principal’s rights and of each party’s obligations. Contracts will vary in their details but will usually include provisions regarding defects and delays.
Defective works
The key contractual mechanisms that protect principals against defective works are:
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the defect liability period and security
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set off and step-in rights
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warranties and indemnities.
These either allow a principal to compel a contractor to rectify defects or, alternatively, allow the principal to rectify the defects and attempt to recover costs from the contractor.
One difficulty principals are increasingly facing is contractors unable to rectify defects because of cashflow issues, labour shortages or material issues. In these situations, a principal will usually have recourse to the contractor’s security but there may be a shortfall between actual rectification costs and the value of that security.
To minimise the risks associated with this, principals should:
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actively engage with the contractor during the project, attend project meetings and ensure that quality control measures are being followed throughout the project so that potential issues are identified early
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consider whether variation claims are reasonable and fairly assessed
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consider whether the value of security is appropriate to the risk
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undertake due diligence before committing to a major project in order to confirm the sound financial state of the contractor and obtain suitable guarantees from parent companies
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seek appropriate insurances including an adequate level of construction risk insurance.
Project delays
The key contractual mechanisms protecting principals against project delays are:
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delay notices
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notifications and claims for extensions of time
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liquidated damages.
As with defects, these mechanisms may be of little practical use if the contractor becomes insolvent. Practical steps a principal can take to mitigate these risks are similar and involve:
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proactively monitoring the construction program against actual works
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considering whether extension of time claims are reasonable and being fairly assessed
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attending project meetings and having open discussions to progress the project
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considering whether early intervention is possible through step-in rights
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ensuring the head contractor and subcontractors are paid on time (after confirming subcontractor statements are accurate)
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considering whether a lack of progress is a symptom of contractor insolvency.
In the current climate, principals who do not take these steps are putting themselves at risk of being caught out by subcontractor insolvency and projects running over time and budget. While such delays and costs may be the legal responsibility of the contractor, the principal will still be left to deal with significant costs themselves (financial and reputational) resulting from delays and defects.
Authors: Mario Rashid-Ring and Nicholas Kallipolitis