We have all heard the story before: a contractor on a development made a huge windfall when the price of steel and concrete plummeted as a result of the global economic slowdown.
The disgruntled employer then started to squeeze the contractor by denying variation and extension of time claims and delaying payments. Indeed, payments may have been delayed by the employer because they were genuinely experiencing financial difficulties. Next thing, the parties are in a costly and lengthy dispute. So how do we avoid this story being repeated over and over? The answer for both contractors and employers alike is to consider a renegotiation of the contract between them.
As you will be aware, many of today's construction contracts in the region are lump sum, fixed or unit price contracts and can take at least 12 months or more to complete. These contracts are typically based on material prices estimated at the beginning of the project; hence, both the contractor and the employer can be adversely affected if material prices surge up or down unexpectedly. Renegotiation in this context can help to avoid the parties falling into dispute and can kick-start an ailing contractual relationship, particularly when approached in good faith and in a cooperative and accommodating manner.
Getting paid...
One of the key issues contractors and employers face in the
current market is a lack of sufficient cash flow. This has meant
that many contractors are not being paid and projects are being
suspended or cancelled as a result. In these circumstances,
renegotiation may be the best option in order to bring a project
forward in what is proving to be a very difficult market.
Contractors may find that by offering to renegotiate their
contracts, particularly where payments have been delayed as a
result of cash flow issues, both parties are able to move forward
with the project in a productive way. Renegotiations in this
context can help to correct contract values so that they are
in-line with the current market and relieve employers from the
pressures of overinflated contract prices. The plus side for
contractors is that they can expect to start getting paid and can
also attempt to negotiate other contract provisions during the
renegotiation process such as greater security for payment or
retention of title clauses.
For example, a key issue that contractors can face is the delayed delivery of materials due to material shortages. Material delivery delays are often beyond the control of the contractor and can delay the entire project. Such delays put contractors at risk of liquidated damages and extended overhead and project costs due to missed project deadlines. Therefore, in order to deal with this issue contractors can consider lowering prices by renegotiating the contract in exchange for an extension to the contract programme for certain material delivery delays.
But is this fair?
Some take the view that renegotiation is unfair. From a contractor's perspective, one consideration is whether employers are likely to offer to renegotiate in circumstances where the market changes and prices increase? For the same reasons that renegotiation can be in the contractor's interest, where the market flips, renegotiation can also be in the employer's interests because the contractor is more likely to be able to complete the project on time, and with minimal claims. Therefore, where the contract reflects current market rates, both parties are more likely to administer the contract fairly and to work in a mutually beneficial way. Renegotiation therefore enables a fair allocation of risk.
A further consideration is whether renegotiation will ultimately
undervalue the legal strength of contracts in the region. By
renegotiating, are the parties effectively breaking the contract,
thereby removing the main purpose of signing a contract (i.e. legal
certainty)? This is an important consideration, however the
benefits of having legal certainty in the relationship between the
parties must be weighed against the benefits of increased
cash
flows and reduced risks of falling into dispute.
How do you approach renegotiation?
So you have decided to renegotiate. The first step therefore is to look at the contract. Standard form construction contracts will normally provide for renegotiation where the prices of materials rise or fall dramatically. However, in bespoke contracts, such provisions are the exception rather than the rule and most renegotiations will need to take place with the consent and cooperation of both parties.
The next step is to ensure, where possible, that existing claims are agreed and paid so that the parties can move forward from a defined point. This will help to ensure that the contractual position is clear for each stage of the contractual relationship.
Following this, the parties should look for issues that will be mutually beneficial. Onerous contract terms can be ameliorated or extensions to the programme can be made in exchange for a reduction in prices. In all circumstances, renegotiation should be approached in a fair manner that brings together the employer and the contractor as a team. The key is to be flexible, patient and for both parties to communicate their bottom line.
Savings on material prices are likely to be the most important issue and where the contractor accepts a reduction to the contract price, a fluctuation clause should also be included in the renegotiated terms to accommodate the possibility that material prices will rise again.
The impact of any amendments to the contact on subcontractors will also need to be considered and their consent to a reduction in prices or changes to their subcontract terms must be obtained before any agreement is reached between the contractor and the employer. Many contractors have found themselves in trouble by agreeing a variation to the contract with the employer and failing to amend their subcontracts accordingly. Such contractors often find themselves the subject of costly claims up the contractual line, without any recourse against the employer.
Going forward
There are certain realities the contractor must acknowledge in this difficult market, and renegotiation of the contract may be necessary and beneficial for both parties in order to bring an existing project to successful completion. In this regard, it may be possible for the contractor and the employer to renegotiate a contract to accommodate price fluctuations or industry shortages.
In the same way, if the duration of the project as well as the price of the project increases significantly, the contractor may be put at financial risk. In this situation, the employer must consider renegotiation rather than risk the failure of the entire project. In all circumstances, the key is cooperation and the identification of mutually beneficial outcomes so that both parties are able to obtain an advantage from the execution of the renegotiated contract.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
