Onerous Construction Contracts – 10 Key Points to be Aware of
Onerous construction contracts are often entered into by contractors and subcontractors across the construction industry, leaving them out of pocket, at a high risk of cashflow problems, and even insolvency.
An onerous contract is one whereby the cost of meeting the obligations agreed under the contract exceeds the payment benefits. Standard forms of construction contract and bespoke forms differ immensely, and it is imperative to fully understand certain elements prior to committing to a contract.
Below is our top 10 key points to be aware of:
1. Payment Provisions
A construction contract must contain payment provisions that comply with the Construction Act, including:
- the provision of an adequate mechanism for determining what payments become due under the contract, and when.
- providing a final date for payment in relation to any sum which becomes due.
- providing for the giving of a payment notice not later than five days after the due date.
Non-compliant clauses can often be vague, as well as incorporating extended and lengthy payment provisions which can lead to confusion and dispute between parties. Such clauses or provisions should be negotiated to ensure clarity and compliance.
2. Defects and Retention
Bespoke or amended contracts may contain onerous retention mechanisms.
It is not uncommon to see clauses in subcontracts that are drafted to only release retention to the subcontractor on completion of the main contract works, or the issuing of the certificate of making good defects under the main contract. Such clauses are non-compliant to the Construction Act, which prohibits clauses that make payment conditional on performance under another contract, and payment of the retention can be forced.
3. Set-Off Clause
Although set-off clauses are permissible in principle and allow the employer to make deductions for payments to the contractor for any money which the contractor owes to the employer, there are some to be cautious with.
Set-off clauses that not only allow deduction from sums due, but also require reimbursement to the employer as such clauses could cause cashflow problems for the contractor.
Clauses which allow the employer to set-off sums due under one contract against sums reimbursable under a different contract may also be problematic. Not only due to the risk to the contract, but also as such clauses run the risk of falling foul of the prohibitions on conditional payment as contained within the Construction Act.
Care should be taken to understand the extent of the rights and remedies that they afford to the employer, and likewise the risk placed on the contractor.
4. Design Responsibility
Design responsibility can be a common point of contention and dispute, and if not fully understood, can lead to vulnerability to unexpected cost, time, and being contractually required to undertake design over and above what was intended.
If you are entering a contract where you do not intend to design the works, then ensure that the contract does not place design responsibility upon you. Likewise, if you are contracting to undertake design, ensure that the contract is clear as to the full extent of your design scope and responsibility. Common issues include:
- A lack of clarity and dispute over the responsibility of interfacing between the contractor’s design portion and any design undertaken by others.
- The contract seeking to make the contractor responsible for accuracy and suitability of the design produced by or on behalf of the employer.
- “Fitness for purpose” obligations, requiring the contractor to guarantee the performance of the design as opposed to a requirement to use reasonable skill and care.
Consideration should also be given to your PI insurance cover, and in particular whether you are insured for the full extent of the design responsibility required under the contract.
If you identify design responsibilities that you are unwilling to accept then care should be taken to negotiate the responsibilities and ensure the contract is amended to accurately reflect the intentions of the parties.
5. The Right to Extension of Time and/or Loss and Expense
All standard forms of construction contract allow for an extension of time in the event of certain delaying events, and for loss and expense against certain matters. The JCT form contains a comprehensive list of events that allow an extension of time, whereas a bespoke form may contain significantly less.
When considering amended or bespoke contracts, understand the extent of the events and matters which give rise to extended time or loss, the associated risks for delays, and the resulting costs and exposure to delays damages. Similar consideration should be given to loss and expense provisions in bespoke or amended contracts which may be much more restrictive than those in standard forms.
6. Condition Precedent
A condition precedent is a clause that makes the rights under a contract clause pre-requisite on the fulfilment of a prior obligation. The most common examples are:
- A requirement to notify a variation within a specified timescale as a condition precedent to payment.
- A requirement to notify a delay within a specified timescale as a condition precedent to any extension of time.
It is important to identify conditions precedent within a contract, and to also understand the obligations that arise as a failure to comply that could lead to your contractual rights being diminished or lost altogether. The failure to notify in time, could result in complete loss of entitlement to claim the associated time and money.
If you identify condition precedents in contracts, consider whether you can comply with the requirement and the consequence of failing to comply. If you are unable to comply or unwilling to accept the commercial risk of failing to comply, then it would be prudent to negotiate amendments to the clause to either (a) make the clause less onerous in respect of timescales or consequence, or (b) have the condition precedent removed altogether.
7. Acceleration Omission and Supplementation
It is commonplace to see bespoke contracts or bespoke clauses that allow the employer to alter the scope of the works and programme to suit their own requirements. Such examples include clauses that permit the employer to:
- instruct the contractor to accelerate the works without compensation.
- omit any part of the works and have these works completed by others without compensation.
- supplement the contractors’ labour if they consider the contractor is in delay and contra charge the contractor for doing so.
The above clauses are very unfavourable and if identified in a contract then care should be taken to consider the acceptance of such commercial risk. Generally, if unacceptable to you, it would be prudent to negotiate amendments to the clauses to either (a) allow the employer to take such actions, but to allow the contractor to be compensated as a result, or (b) have the clauses removed.
8. Termination Provisions
Termination provisions are common in construction contracts, and it is important to review them and understand what rights and remedies they provide the parties. In many bespoke forms it is not uncommon to see clauses that permit the employer to terminate for any reason they like and restrict the contractors’ rights to claim any damages in the event they are terminated.
It is also not uncommon for bespoke forms to contain provisions that provide the employer with the contractual right to terminate, but do not contain any provisions affording the same contractual rights to the contractor.
Identify and understand the rights, and risks associated with such clauses. For example, a clause that allows the employer to terminate for convenience coupled with a clause that prevents the contractor claiming loss of profit following termination, would allow the employer to terminate the contractor on a whim and with no financial consequences. The contractor could be left with no workflow, idle resources, and with no financial right to claim for the loss that they incur as a result.
9. Conclusivity Provisions
Many forms of contract will include clauses that provide that a certificate or decision will become final and binding on the parties if it is not challenged within a certain period. Examples include the final certificate becoming binding under a JCT if dispute resolution proceedings are not commenced within 28 days.
A conclusively clause is designed to provide finality and certainty, and to prevent disputes from being prolonged for an extended period.
Care should be taken to identify such conditions within a contract, and to understand the timescales that apply and the risk for failure to comply. In particular, consideration should be given to any conclusivity provision that provides a very short period of time to challenge the certificate or decision. There can be a substantial risk if for example, you dispute a final certificate, but the contract provides insufficient time for you to properly compile your claim and commence dispute proceedings.
If you identify such clauses and are concerned as to the ability to comply, then it would be prudent to negotiate amendments to the clause to either (a) provide a longer timescale prior to the matter becoming final and binding, or (b) have the conclusivity provision removed.
10. The Particulars
In addition to onerous clauses, it is important to check that the particulars of the contract are accurate as basic errors, vagueness, or ambiguity can often creep into the contract and lead to significant issues.
Details that should be checked and verified for accuracy before entering the construction contract include:
- Who are the parties – are the names, addresses and company numbers correct?
- What is the scope of works – does the contract accurately reflect what the parties intend the contract to do?
- What are the contract documents – for example does the contract refer to the correct drawing revisions? Are all the design documents included?
- What is the programme – is it agreed and achievable?
- What is the cost - for example is the contract cost correct?
How to deal with Onerous Contracts
It is always best to examine a construction contract closely before it is entered into, onerous contracts may be apparent from the start of the works or when unavoidable circumstances occur such as material shortages, delays or unpredictable costs. By understanding the contract terms and provisions from the outset, disputes can often be avoided. Our full advice guide on onerous construction contracts
If you have a query on onerous construction contracts, require any clauses to be checked or would like a contract written, please contact Arbicon on email@example.com or call 01733 233737.