11 July 2024
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Late payment and unfair contract conditions are major barriers to growth for many SMEs. Specialist contract lawyer Abiola Aderibigbe from the Building Engineering Services Association (BESA) offers some vital advice on what to do and, crucially, what not to do in any contract negotiation.
Being part of today’s construction supply chain calls for commercial, contractual, and legal awareness. That’s a lot to ask of any contractor, but particularly of small companies with limited resources who really want to focus as much of their effort on delivering the best possible engineering outcomes.
SMEs dominate the construction industry, but around 45% report late payment as a major obstacle to their success – compared with a national figure of 33% for all other business sectors, according to the Confederation of British Industry (CBI).
It means many of our SMEs spend a disproportionate amount of time chasing payment and sorting out complex legal agreements because of the widespread use of onerous/adversarial contracts. The level of risk forced down the construction supply chain to smaller businesses is little short of scandalous and undermines so much of the good work our industry can deliver.
The cash flow pressure on small businesses hamstrings their ability to invest in the recruitment, skills and technical developments that are essential if the country is to meet its targets for cutting carbon emissions and improving the built environment for the benefit of all society.
Too many larger firms expect sub-contractors to take on extensive obligations, onerous dispositions, and unlimited liability. Taking on such outlandish obligations is not a great place to be for the sake of your business. However, all is not lost. At BESA we spend a lot of time advising members about how to negotiate better terms and avoid the biggest contractual pitfalls.
Here are a few key pointers to take into consideration when negotiating your next contract agreement:
Base Date:
The base date serves as a critical reference point that defines the project’s initial conditions including costs, laws, regulations, and market conditions. It is a good idea to ensure that this date is as close as possible to the date of commencement for the project.
Collateral Warranties:
Collateral warranties (CWs) are contracts associated with your construction contract (the “underlying contract”). It allows for you to “warrant” to a third-party beneficiary that it has fulfilled its obligations under the underlying contract. It provides security and privity to the third-party beneficiary, while mirroring the responsibility in the underlying contract.
In industry, it has become standard to request for these, however it is essential there is a limit to the amount of these a contractor is required to give. Therefore ideally (subject to commercial circumstances), you should be looking to give no more than 2 CWs.
Fluctuations:
The aim of fluctuation provisions is to transfer some of the effect of increased cost during the execution of the contract to the counterparty. Therefore, it enables a contract to consider the impact of the cost of goods, materials, equipment, and labour, caused by circumstances such as rising inflation costs, economic and geopolitical factors.
Having these clauses in a contract, can help a contractor/sub-contractor mitigate some of their exposure to potentially uncertain market conditions.
Insurance (Employer’s Liability, Public Liability, Professional Indemnity & Contractor’s All Risk):
It is standard to expect that construction contracts would insist on a contractor/sub-contractor holding a level of insurance covering matters like Employer’s Liability, Public Liability, Professional Indemnity and Contractor’s All Risk.
However sometimes the levels of insurance demanded can be excessive when compared with the level or type of work being provided. So, you should try to ensure that the agreed figure is proportionate to the contract sum. Also, the basis on which insurance is procured is important.
Typically, in industry the basis of insurance would be either on a per occurrence/per event basis i.e. “each and every” OR on an aggregated (“in annual aggregate”) basis. Per occurrence (“each and every”) limits and (“annual”) aggregate limits both define maximum insurance payouts. However, they do so in different settings.
Per occurrence limits define how much a policy will pay for any one incident or claim, while an aggregate (annual) limit defines how much the policy will pay over the policy’s (annual) duration. For example, if you have £10m cover (for the duration of year) on a per-occurrence/incident basis, and five incidents occur, theoretically, your total exposure could be £50m (i.e. £10m x5 incidents).
However, if you have £10m cover (for the duration of year) on an aggregate basis, even if 10 incidents occur within the year, the total exposure would still be £10m. Hence why an “annual aggregate” basis is usually better to protect a contractor/sub-contractor’s exposure.
Liquidated & Ascertained Damages (LADs):
LADs are clauses in a contract which stipulate the amount of money that would be payable as damages for loss caused by a breach of contract (e.g. delays, disruption etc.) they are NOT penalties and are not intended to be punitive. Rather, LADs should be a genuine pre-estimate of loss, so as not to impose a punishment for a breach of contract, which is disproportionate to any legitimate interest of the innocent party.
Finally, LADs cannot be unconscionable or extravagant. Therefore, when negotiating these (either on a daily, weekly, or monthly basis), you should ensure that the sums agreed make commercially reasonable sense and be reasonably justified.
Parent Company Guarantees (PCGs):
PCGs are a form of security requested by an employer from the parent organisation of a contractor to help bolster the financial reliability of the contractor by providing the employer with some security if the contractor breaches its contractual terms or becomes insolvent.
Essentially the parent organisation guarantees the performance obligations of the contractor. A PCG is a contractual promise, so granting it comes with exposure and risk consequences to the parent organisation. Therefore, before agreeing to such a request, you must ensure that its use makes commercially reasonable sense.
Performance Bonds:
A performance bond is a financial guarantee used in the industry as a means of security against the risk of a contractor/sub-contractor defaulting on its obligations. The surety/guarantor providing the bond is usually a bank, insurance company or other independent financial institution. The amount of bond is typically a percentage of the value of the contract sum and they are in place for the duration of construction works expiring on practical completion or completion.
Some bonds expire after the defects rectification period and they can be “on demand” or “conditional” but in the UK, conditional bonds are more common. This means payment is usually conditioned on the beneficiary of the bond establishing the contractor/subcontractor’s default and amount of loss suffered.
Agreeing to this increases the contractor/sub-contractor’s level of risk because it can be a large financial undertaking and exposing you to further possible financial obligations. So, these should only be agreed if you determine that it is a commercially sound decision.
Unlimited Liability & Limitation of Liability (Cap):
Unlimited liability should not be accepted under any circumstance. Therefore, it is essential to ensure that you insist on inserting a cap on liability which limits your maximum exposure under the contract (save for personal injury, fraud and death which cannot be limited by law).
BESA’s legal & commercial team is dedicated to pointing out the above risks and many more within your contract agreements to improve negotiations and help the industry work to safer, fairer, and more business helpful terms and conditions.
