A New Era in Design/Build Contracts

By Todd Taylor and Kermit Nash | January 01, 2008
As the ethanol industry adjusts to increased competition, a tighter credit market and escalating input costs, the fine details of the design/build contract are becoming more important than ever. Arguably, the most critical part of an ethanol construction project is the design/build contract. Owners must be aware that even the seemingly insignificant terms of the contract can have significant practical, financial and legal consequences. As the Greek philosopher Plato once said, "The beginning is the most important part of the work."

Carefully negotiating the terms, including what may be considered purely business or technical terms (the "boilerplate"), is an investment that may save an owner significant time and resources during and after construction.

The ethanol industry has transitioned from a once cautious use of design/build contracts to a saturation of contract forms from the American Institute of Architects, the Design/Build Institute of America, Associated General Contractors of America and other reputable sources. Each organization has forms that are excellent starting points, but according to their own sources, they should be used as guides and not blindly accepted. Also, the increasing number of developers in the biofuels construction industry has produced a new generation of "hybrid" construction documents which take elements from different design/build contracts. The forms are essentially a "cafeteria-style" approach to contract formation as they deviate, sometimes substantially, from standard industry documents. While this deviation is not an unpardonable sin, making certain that all the parties are in agreement with all of the terms of the design/build contract can be like learning to ride a bike—without the training wheels—for the first time.

Each ethanol project has unique requirements which must be considered at the design/build contract negotiation stage in order to address the owner's goals. The industry is accustomed to a "design/build bid contract" or "design/build lump sum contract" with fairly standard terms. Yet, one can skim no further than the definitions section of hybrid contracts and discover awkward shifts of duties and responsibilities from the contractor to the owner. While this departs from most independent owner's expectations, many owners are shocked to discover that their executed design/build contract reflects this "agreement."

The most common, yet avoidable, areas of dispute involve poorly defined, inconsistent or insufficiently defined terms in the contract. If the parties aren't careful, terms of a design/build contract can be ambiguous, used incorrectly or assume that each party understands a definition. For example, if you ask 10 people to define "best efforts," which is a common contract term, you will likely get 10 different answers—even from lawyers. Take into consideration instances when the terms are as technical as a performance guarantee where opinions vary between experts.

In addition to a reputable legal counsel negotiating these points, an experienced owner's representative can also spot issues for the owner. The owner's representative can also provide accountability to ensure that the negotiated criteria and other technical aspects are drafted and executed properly.

Other factors of consideration are a matter of common sense. Contracts should avoid dense industry jargon. Implement the "bus stop" approach to contract drafting. If the average person at the bus stop can't make sense of your agreement, then they won't be able to understand it when they're sitting in the jury box and in charge of resolving your contract dispute.

For specific industry terms relating to design criteria, change orders, payments, timing, "substantial completion," retainage, warranties and dispute avoidance, solid advice from a party who understands how these matters will be resolved if there is a dispute will help build a better contract. For example, change orders often cause difficulties if they aren't detailed and don't discuss timing, cost increases and responsibilities. Since change orders are often an exception to the lump-sum requirement of a design/build contract, owners must overlook the potential for additional costs, time and completion obligations in the balance of the contract. Court decisions throughout the United States demonstrate that changes not contemplated at the time of contract, even if not properly documented, can be properly awarded against an owner. Just think what would happen when "substantial completion" is not understood among parties, since it does not always mean the ability to produce fuel.

Handling Disputes
Even with the most careful planning and drafting, problems will occur once construction has commenced. An owner representing shareholders, investors and lenders, has a tendency to react quickly to keep a project on task. However, reacting too quickly can create ancillary problems that hinder resolving a business issue. The following offers a couple of practical considerations in light of a design/build contract.

First, carefully review the facts with the relevant contract provisions and construction binder to confirm the facts and factors of the situation. Second, confirm who bears responsibility for the problem pursuant to the contract. Third, convene with the owner's representative and an attorney to review the situation in detail, identifying all of the issues and potential outcomes in order to prepare a response. Be careful to consider all facts and possibilities, including potentially harmful information, since it is easier to deal with negative facts early in the process. Fourth, consider the costs of the alternatives, including the time and frustration that are a part of disputes and, for larger issues, litigation.

If a problem or dispute arises during the construction process, most modern design/build contracts follow a defined process that may include alternative dispute resolution, mediation and arbitration. Careful consideration of the contract requirements may prevent a problem from growing to an act of default that gives further remedy to either party. By following the proper notice provisions, including the timing requirements, you are adhering to the requirements of the design/build contract and creating a paper record of events required by insurance or used if litigation occurs. A problem doesn't have to stop the construction process. However, any indication that the problem is not going to be resolved in a reasonable manner may have broader implications for the project.

Failed negotiations usually lead to a form of alternative dispute resolution. Most modern design/build contracts contemplate non-binding mediation, followed by either binding arbitration or litigation. Mediation is non-binding and less formal than either arbitration or litigation. A well-drafted design/build contract will state that the goal of mediation is to get the parties to reach a mutually acceptable agreement to resolve a dispute. The mediator is usually an impartial industry expert, attorney or retired judge who has no formal power to force a settlement, but instead may help each party identify strengths and weaknesses with their case and offer creative methods to reach an agreement.

Arbitration is typically binding and the award can't be appealed in the courts. The arbitration process is less formal than litigation, but implements the use of many of the same evidentiary concepts and procedures. An advantage is that there is no jury and formal procedural calendar, which expedites the resolution process. In the event the design/build contract does not contain an arbitration clause, or the parties cannot resolve their issues amicably, litigation is a likely next step. The scope of this article neither allows the space or the need to articulate the costs of litigation nor the impact on a construction project. However, a well-negotiated contract, good legal counsel and proper documentation will be key factors in litigation preparation.

When problems and disputes arise during the construction process, the parties may carve out issues that are not material to the completion of the project, allowing the construction process to continue. It is possible for parties to resolve matters pertaining to costs and expenses relative to the design/build contract without impacting other aspects of the project. However, if the issue is material to the design, construction, operation or safety of a project, there will likely be no carve-out available. Since problems always arise, the contractor should have contemplated some degree of potential problems into their estimate of construction completion and cost.

For post-completion project issues, the design/build contract is still the source for resolving any issue. Once final completion is reached pursuant to the contract, post-completion issues shift from construction performance to warranties. The warranty provision is critical to resolving problems as the final payment subject to final completion has been met, bills have been paid and the contractor and subcontractors are working on their next project. Moreover, if the issue arises after the release of any retainage on the project, any commitment to address an issue will likely be an out-of-pocket cost for the party who has to make a correction. Warranty issues may be subject to alternative dispute resolution. Also, the critical element will be giving proper notice to the contractor upon discovery of the issue.

Do not rule out the importance of the bond and insurance policy for the project. Each policy contains language, often unread, that requires notice to be delivered to the carrier of any claim, defect, damage or otherwise. Failure to tender a claim in a timely manner may violate the terms of the policy or negate any proper claim made by the contractor or the owner.

Words fail to describe a project that has crumbled due to poor contract negotiation. The old adage that an ounce of prevention is worth a pound of cure is never more real than when considering how critical the design/build contract negotiation process can be. Since the goal of every project is to pump fuel, do not overlook the essential steps of properly preparing the contract, or if its already in place, getting the counsel you need in the event a problem arises.

Todd Taylor and Kermit Nash are officers with Fredrikson & Byron P.A. Reach Taylor at ttaylor@fredlaw.com or (612) 492-7355. Reach Nash at knash@fredlaw.com or (612) 492-7356.

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