Advising Chinese Bank on Construction of Hotel and Office Block

Introduction:

The construction of a hotel and office block to the value of £130million is a considerably large project to undertake in a city centre. Apart from logistical and planning issues, there are contractual issues to resolve such as choice of contract, payment terms and resolving disputes. This report outlines advice that should be given to the Chinese Bank around these issues. This shall compare the JCT 2016 with Bills of quantities with NEC4 Engineering and Construction contract Option B to analyse the contractual differences.

1.

Suicide bidding is where a contractor submits a tender bid which is less than the cost to complete the Works. This allows the contractor to win the bid, maintaining their labour levels, with the aim to break even or achieve profit by submitting variations. According to Construction Magazine (27th May 2011) there are ‘reports of some bids being made 20% below the average (tender bid)’. This shows how suicide bidding could be identified.

Variations under JCT 2016 are defined under clause 5.1, valuations of which are outlined in clause 5.2. The methodology of valuing these instructions is outlined in clauses 5.6 to 5.10. These can cause costly and lengthy disputes between clients and contractors.

The NEC4 does not have variations, however does contain compensation events in section 60 of the core clauses. Compensation events are instructions issued by the Project Manager changing the scope of works, except where changes are to accept a defect or the change is provided by the contractor, where it’s at the contractors request or ‘in order to comply with the scope provided by the client’. As with the JCT, these can cause costly disputes.

Suicide bidding can negatively impact the Chinese Bank. Firstly, the contractor could go bankrupt due to losses on the project. This would cause delays as the client would have to find a replacement contractor through the re-tendering process, increasing the likelihood that the project will not be completed when desired. Finally, unless the requirement of accepting the lowest tender bid is changed, the client could be subjected to yet another suicide bid.

If the client wants protection against suicide bidding, one option available is including tender clauses, giving the client rights to ask contractors for evidence they can complete the Works to the specified standard if the bid is a certain percentage below the bid average. This allows the client to scrutinise the bid in further detail, disregarding it if deemed a suicide bid.

Another option is to focus more on whole life cost rather than the tender price. A tender bid focussing on whole life cost would be higher than the lowest tender price, however by using better quality construction greater value and lower maintenance costs are achieved throughout the life cycle of the project. By accepting a marginally higher bid, the likelihood of accepting a suicide bid is reduced, reducing the likelihood of the contractor going bankrupt and quality construction is achieved, reflecting well on the company brand in the long term.

2.

Under the JCT 2016 liquidated damages (LDs) are covered under clause 2.32. This outlines the process of applying LDs, which are primarily due to late completion of Works, where the value is an estimate of damages only. Actual damages not during the project and not predetermined would be addressed in court under unliquidated damages.

Under the NEC4, delay damages are covered in the secondary option clause X7. There is less information provided here compared to the JCT, however it is evident it works in a similar fashion where the value is based on a genuine estimate.

There are clear rules when applying LDs. LDs must be reasonably estimated and agreed in advance when the contract is signed. Secondly LDs are to function as damages and not as penalties, which are illegal under English law. If the amount is deemed unreasonable then it’s likely a court of law will identify the clause as a penalty and the Employer will pay damages to the Contractor.

This is clarified in the case of Dunlop Pneumatic Tyre Company v New Garage & Motor co [1915] AC 79 House of Lords. The House of Lords ruled this was not a penalty clause, with Lord Dunedin stating ‘(LDs) will be held to be a penalty if the sum stipulated is extravagant and unconscionable in amount in comparison with the greatest loss that could conceivably be proved to have followed from the breach’.

Therefore, the Chinese Bank can use LDs of £2million per week if this value is based on a reasonable estimate. If it’s found to be extravagant then it’s a penalty clause and will be voided. LDs can be used to compensate for damages which are difficult to quantify, but cannot be used to penalise the contractor for failing to perform in any way.

JCT 2016 covers retention bonds under clause 4.18. Again, this outlines the process of applying retention bonds, encouraging the contractor to complete works to a high standard so they are not required to rectify defects in future.

Retention bonds are only briefly mentioned in NEC4 under secondary option clause X16.3, stating the contractor may use a retention bond however the client has the right to refuse this if the commercial position is not strong enough.

Retention bonds are used to protect the client against defective works as normal retention does, however it also increases contractor’s cash flow, reducing the likelihood they have financial difficulties throughout the project. Clearly retention bonds benefit both parties. However, with retention usually 5% of the contract value (or reverting to 3% if left blank under Contract Particulars) the £11million retention bond appears high in value, being 8.46% of the contract value. This could cause difficulties in attracting contractors to the project if the cost of the surety is greater than the retention monies received. It’s also possible that the contractor could pass on the cost of the surety to the client through their tender price, increasing the cost of construction for the Chinese Bank.

Retention bonds can be used in the same contract as LDs due to their differing functions. However, this means the Chinese Bank cannot claim on both LDs and the retention bond for the same delay. Furthermore, these values are a huge financial burden for a contractor, potentially causing them to have financial difficulties, leading to liquidation. This means the Chinese Bank would have to find another contractor to complete construction, losing more time and money in the process.

3.

The fit out company is a nominated subcontractor in this case, which is selected by the client and forced upon the main contractor. This can bring advantages to the client as it allows them to engage specialists in the design process earlier and should improve quality of construction instead of leaving it to a generalist. This process should also ensure the client will get the end product they desire.

However it’s difficult to hold the main contractor responsible for a nominated subcontractor. Both contract types lack clauses dealing with nominated subcontractors as they are now rarely used in the UK construction industry due to the complex contractual issues that can arise, such as deciding who is liable for the nominated subcontractors design or construction. 

Unlike the NEC4, JCT 2016 clause 3.8 does allow the client to list a minimum of three named subcontractors in the tender documents along with provisional sums to cover their costs. This allows the client to influence the choice of subcontractor, whilst keeping the liability and risk with the main contractor. The successful main contractor will then select the subcontractor from the list.

Provisional sums are included in with the list of selected subcontractors. These sums are allowances for undefined sections of work or sections without substantial detail. It’s the main contractor’s responsibility to negotiate an actual price with the subcontractor, removing provisional sums in the process.

However, it’s vital the client follows the rules stated under the JCT subcontractor clauses (3.7 to 3.9), nominate a minimum of three subcontractors and listen to any main contractor objections. Failing to do this and interfering with procurement processes too much could mean that the named contractor becomes a nominated contractor, as found in the case of St Modwen Developments Limited v Bowmer & Kirkland [1996]. Here the Engineer procured subcontractors on behalf of the client, ignoring the procurement rules set up for the main contractor that allowed them to select the subcontractor. This meant the main contractor was given extra payment and an extension of time to allow for the now nominated contractor.

4. 

There has been a push in the construction industry to agree 30-day payment terms, predominantly by the Construction Supply Chain Payment Charter (2014). JCT 2016 covers interim payments and due dates under clause 4.8 and does automatically set interim valuation dates (IVD) at one month if another period of time is not agreed. The agreed payment frequency with the contractor is then passed down to subcontractors.

NEC4 outlines timing of payments in clause 51.2 of the core clauses. If the Chinese Bank want to set a period for payments of three months then this is stated in the contract data. This is similar to the JCT.

To deviate away from the industry standard 30-day terms could have adverse implications to contractors working on this project. Firstly, if payment terms are set on a three-monthly basis then subcontractor payment terms agreed with the main contractor are also on a three-monthly basis. Cash flow problems can arise as the majority of construction companies will pay their workers and supply chain on a weekly or monthly basis; if they do not have a monthly cash flow, it is more likely they will struggle to make these payments on time. Furthermore, this could increase the likelihood of bankruptcy for any member of the supply chain. This can be seen in the case of Carillion’s collapse in early 2018, where it was widely reported their 120-day payment terms caused bankruptcies in the supply chain.

If bankruptcy occurs it means additional time will be required to find replacement contractors, especially ones that will sign up to uncommon payment terms like three months. This could cause delays on the project, making it unlikely the client will have a finished hotel or office block by the Completion Date.

Furthermore, using three-month payment terms could also impact quality of construction. If subcontractors are struggling with cash flow they might ‘cut corners’ in order to save money on materials and reduce labour time on site. This means that the client may not get good value for their money, impacting quality throughout the hotel and office block, adversely impacting their brand identity.

5.

The Housing Grants, Construction and Regeneration Act (1996) states that a party to a construction contract has the right to Adjudication before arbitration and litigation. Adjudication can be called upon throughout the project, meaning that the process allows construction to continue even after a dispute has arisen.

Disputes can be settled more quickly than arbitration and litigation, with the whole process taking 28 days, making it the more attractive process.

This act also states the adjudicator must settle any dispute in a neutral manner, declaring any interests they have such as personal relationships with either side. The client’s requirement to employ their golf partner as the adjudicator due to her expertise is one valid point, expertise which is required under clause 9.2.2.1 of JCT 2016. However selecting this particular adjudicator would need to be agreed by the client and the contractor when the dispute arises and not prior.

The NEC4 addresses the use of adjudication more extensively than JCT in the ‘Resolving and Avoiding Disputes’ section, outlining three scenarios and the procedures that must be followed. This also states under clause W1.2, W2.2 and W3.1 that the adjudicator must act impartially.

Unfortunately for the client they will not be able to name their golfing partner as the adjudicator or arbitrator as the contractor would argue the adjudicator was bias if they lost a dispute. This scenario is illustrated in the case of Discain Project Services Ltd v Opecprime Development Ltd [2001] EWHC 435 (TCC). Whilst it was accepted there was no actual bias, apparent bias was identified, meaning it was a matter of perception there was bias from an objective observer. This was despite the adjudicator acting professionally and not having any association to either party.

Therefore, both the JCT 2016 and NEC4 does not allow the client to name an adjudicator before the dispute occurs and certainly won’t allow the naming of the clients golfing partner due to the proximity of relationship. 

Arbitration is outlined in JCT 2016 under clauses 9.3 to 9.8. This states under clause 9.4.1 that the arbitrator shall be an individual agreed by the parties, or failing this they’re appointed on the application of either party in accordance with rule 2.3. Again, unless both the client and the contractor agree to a particular arbitrator then the arbitrator will be chosen by a third party specified in the contract particulars. Arbitration is only briefly mentioned as a process in NEC4 under W1.4.5, W2.4.4 and W3.3.4.

Arbitration is a popular method of dispute resolution internationally, where disputes are settled after construction, thereby satisfying the client’s requirement. It is attractive due to the private nature of the process and outcome, like adjudication; however the result is binding and can be enforced by the courts unlike adjudication. Even so, the arbitrator’s decision can also be overturned in court if the arbitrator has acted in a biased manner. As seen in the case discussed above, bias is likely to be found in this scenario if the golfing partner was selected as the arbitrator and so both contracts will not allow the golfing partner to be selected.

6.

The JCT 2016 addresses sectional completion under clause 2.30.2, where the sections and dates of possessions are stated in contract particulars 2.4. NEC4 refers to sectional completion under secondary clause option X5, where the sections and dates for completion are stated in the contract data.

The contractor may have several reasons for wanting a sectional completion clause. One reason is that the contractor would be relieved of some of their contractual obligations after completing each floor. For example, after the sectional completion of a floor in the hotel was agreed, the rectification period for that floor starts. The risk of loss and responsibilities transfer back to the Chinese Bank. Assuming that LDs have been agreed, the value of these would reduce as stated in JCT contract particulars 2.32.2. If retention is to be paid then half of this is released for that section upon certification. Overall, contractor’s risk reduces as each floor of the hotel is completed. 

However the contract has already been signed. For a legally binding contract, three elements are required: offer, consideration of the contract and acceptance. There must also be intent to create a legal relationship and the terms of contract to be certain. In this scenario, given the fact that the contract has been signed and we assume signed by an employee of the contractor who is authorised to sign it, the contractor cannot make changes to the contract without prior authorisation and agreement by the Chinese Bank. The signature is evidence that consideration has been made of the contract particulars, which have been understood and then agreed to.

This can be seen in the case of L’Estrange v Graucob [1934] 2 KB 394. As the claimant had signed the order form, she was bound to all terms and conditions. This means that the contractor in our case would have to comply with all terms and conditions stated under the already signed contract.

Conclusively, changes to the contract cannot be made as consideration has already been made of the terms. If the contractor wanted a sectional completion clause, this should have been considered when negotiating the contract before signatures were applied.

Recommendations:

1. The Chinese Bank should prioritise whole life costs rather than lowest tender bid. This would increase the quality of construction and decrease the likelihood of accepting a suicide bid.
2. The Chinese Bank should include tender clauses giving them rights to ask contractors for evidence they can complete the Works to the specified standard if the bid is a certain percentage below the bid average.
3. It is recommended the value of the retention bond should be changed. The value of LDs needs to be based on a reasonable estimate. As penalty clauses are illegal under UK law, the Chinese Bank cannot penalise the contractor for failing to perform in any way, they can only insure and protect themselves from different risks. They also cannot call upon LDs and the retention bond for the same event.
4. The client should not use nominated contractors due to the contractual issues that can arise, but should include named subcontractors in the tender documents along with provisional sums.
5. The client should use 30-day payment terms instead of 3-month payment terms. This should reduce the risk of the contractor going into liquidation and the likelihood of delays. 
6. The clients golfing partner cannot be named in either the JCT 2016 or NEC4. It is recommended an adjudicator and arbitrator should be selected by a nominated body when a dispute arises and not prior.
7. Adjudication can be called upon to solve disputes throughout the project and is a right to any party of a construction contract. Therefore the client may not have a choice but to settle a dispute during the project. This fact should be considered and prepared for.
8. The contractor does not have the right to change clauses in either the NEC4 or JCT 2016 without the client agreeing to the changes as well. This means the client does not have to respond to the email, or can reply explaining sectional completion has not been agreed.
9. To achieve the client objectives, it is recommended the Chinese Bank use the JCT 2016

References:

1. Submitted by Darley PCM, 30 January 2012. Why lowest price isn’t always best – suicide bidding [online]. Available at: https://www.darleypcm.com/blog/whylowestpriceisntalwaysbest-suicidebidding [Accessed 2nd November 2019]
2. Article in Construction Manager Magazine, 27 May 2011. Crack down on suicide bidding [online]. Available at: http://www.constructionmanagermagazine.com/news/crack-down-suicide-bidding/; [Accessed 3rd November 2019]
3. Dunlop Pneumatic Tyre Co Ltd v New Garage & Motor Co Ltd [1914] UKHL 1 [online]. Available at: https://www.bailii.org/uk/cases/UKHL/1914/1.html; [Accessed 3rd November 2019]
4. Dickens, G., 2019. Liquidated Damages, partial possession and sectional completion [Lecture to CONM40013 Professional Practice & Procedure for QS, Nottingham Trent University]. Presented 31st October 2019
5. Dickens, G., 2019. Risk, bonds, parent company guarentees [Lecture to CONM40013 Professional Practice & Procedure for QS, Nottingham Trent University]. Presented 14th November 2019
6. Mohammed, I., 5 June 2018. Retention Bond v Performance Bond (Construction Surety Bonds) [online]. Available at: https://www.linkedin.com/pulse/retention-bond-vs-performance-construction-surety-mohammed-fciarb-/; [Accessed 6th November 2019]
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17. Evans, R., 17 November 2016. What happens if an adjudicator is perceived to be biased? [online]. Available at: https://www.ice.org.uk/news-and-insight/the-civil-engineer/november-2016/what-happens-if-an-adjudicator-is-perceived-bias [Accessed 10th November 2019]
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