By Euan Massey, Director: MDA Construction & Technology Attorneys
Mining, construction and oil & gas (O&G) projects are usually technically challenging and often result in price and time overruns with resultant large and expensive disputes and claims. In this tough economic environment, we should be actively looking for possible alternatives.
While collaborative contracting is not the panacea to construction and mining industry woes, it can be valuable in reducing costs, creating efficiencies and providing more financial security. To have significant impact, several critical success factors need to be addressed: traditional procurement processes will need to change, incentives must be carefully crafted, and the right contracts must be in place. While there will undoubtedly be some challenges, if employers drive the process gradually, it is my view that collaborative contracting has much merit.
Collaborative contracting encompasses various initiatives aimed at building long-term relationships. Ultimately, it aims to achieve cost, efficiency and financial outcomes that benefit all contracting parties.
Partnering and alliancing contracts
Partnering involves a contractor and an employer and can be project-specific or long term. Alliancing contracts are only used long-term and involve all major participants.
Both models use initiatives to promote co-operation and include ‘softer’ issues like trust. They include a statement of goals to ensure alignment and the integration of management systems. Shared resources are attractive as single management teams remove duplication and inefficiency. Open book accounting requires parties to share their supply chain arrangements and how they can be used for benefit of all parties.
There are a number of benefits in partnering and alliancing contracts. There are fewer disputes and less litigation, time and quality outcomes are better and administration and legal costs are lower (at least on paper). However, a massive effort is required to manage the rigorous implementation measures. In addition, parties must make the distinction between conceptual partnering and contractual partnering.
One of the best examples of collaborative partnership is the Andrew Oil Field in the North Sea. The North Sea is notoriously difficult with prohibitively costly development costs. BP recognised that a fundamental shift in the traditional adversarial contracting model was essential to break through the cost barrier.
An alliance was set up with seven contracting parties and target cost models were used to incentivize the parties. Contractors were paid target cost and measured against cost incurred. There was an incentive to beat the target, and a cost if the target was not met. The model reduced life cycle costs of the project and significantly reduced the design interface.
Framework agreements
Typically, framework agreements involve separate long-term contracts and call off arrangements. This means that as work becomes available, it is awarded to a contractor on a pre-qualified selected panel of contractors. These agreements shorten procurement timeframes and offer contractors a degree of certainty in terms of possible future work. Having said that, many contractors report that in some cases, the time and effort to pre-qualify doesn’t match the anticipated reward.
In a collaborative environment, the framework is aimed at incentivising all parties. They can be binding or non-binding. Contractors may enter into such contracts on the knowledge that there is a strong possibility of work, but there is no consequence if they are not awarded work.
Motivation is the key
Parties must be motivated to work together, which hinges on putting appropriate payment options in place. Traditional payment options introduce competing interests, but target cost and cost-reimbursable payment options motivate parties to collaborate.
A second pivotal factor is ensuring that the most appropriate form of contract is used. Often in-house contracts are adversarial and provisions for issues and change management are inaccessible. In the event of unresolved issues, they tend to provide for archaic dispute resolution measures which are often in different countries and therefore extremely costly.
Finally, a support structure is required that enhances a collaborative culture between the various parties.
A South African perspective
At MDA, we have worked on a number of collaborative contracts in the coal sector using FIDIC contracts, as well as various shaft sinking projects with generally good results.
Collaborative contracts in South Africa include AngloGold’s TauTona project, which involved a technically challenging sub-vertical shaft. The contract utilised the employer’s in-house conditions and target cost based on the bill of quantities. Initial feedback from the employer was that the effort required to properly administer the contract had been underestimated.
Anglo Platinum conducted a mining partnering study which subjected several contractors to pre-qualification and concluded a non-binding framework agreement. Although this was shelved on the platinum price’s decline, the concept was adopted in other divisions.
Anglo Coal used agreed target cost contracts to execute various projects using the same contractors. Initially there were significant cost reductions, which ultimately led to cost certainty and improved market conditions as contractors secured more work.
Interest in collaborative contracting waned about 10 years ago, a time when there was increased market activity in the construction sector. The current climate is tense and worsening. Several large contractors are in business rescue and contractors are still dealing with the fallout of a Competition Commission findings of collusion from 2013-2016 that resulted in penalties of R3 billion. Share prices of listed contractors have crashed. The combined effect is constrained cash flow, low morale and ultimately, poor project delivery.
Employers are also in trouble. Not only are they facing economic headwinds, they are exposed to construction defects and delays. Construction guarantees are being called in at an unprecedented rate and disputes are rising.
Other territories
These problems are not unique to South Africa. UK’s Carrillion PLC, liquidated in 2018, was the largest ever trading liquidation in the UK and resulted in over 2000 of its suppliers and sub-contractors being liquidated. Other examples are CMC di Ravenna, an Italian company which was involved in Kenyan water projects, Natelco Corp (US) and Al Hassan Engineering Co (Oman).
Limitations of collaborative contracting
While there are many benefits, collaborative contracting is not suitable for all projects. It is not appropriate in public sector procurement because of regulations, for example. Certain relationships are working well and the JBCC building contract is well understood. In this context, significant technology or price benefits are unlikely.
Key players need to be incentivized. Mining, construction and O&G are technically challenging. Improving collaboration could streamline interfaces, with significant time and cost savings made possible just by sharing design and technology.
In addition to sharing efficiencies, transparency among parties and building long-term relationships will help employers to gain insight into cost models and how to cost future projects.
What contracts can be used?
Bespoke contracts are purpose-drafted by opposing legal teams and are often lengthy to conclude.
FIDIC’s standard form contract requires extensive amendment and is also lengthy to conclude. NEC3 has been marketed as a partnering contract as it provides payment options which support collaborative working. It includes secondary options for the payment of funds for early completion and payments relating to KPIs. NEC 4 has gone a step further and includes a standalone alliance contract.
The UK’s PPC 2000 is a project partnering contract that goes into great detail. It takes a multi-party approach and is managed by the core group. All parties commit to shared goals which could be related to innovation, efficiency, human capital, reduced waste or health & safety. There are team incentives and shared benefits, and an integrated and inclusive design, construction and supply process. The contractor and specialists provide input before any work commences and supply chain partnering is made possible by open book pricing and the ability to use volume supply agreements that benefit all. There are no time bars or liquidated damages.
Because incentives are central to successful collaborative contracting, they cannot simply be added to a standard contract.
Any good contract considers what each party wants, and this even more important in collaborative contracting. It needs to steer clear of ‘us and them’ thinking but be clear about each party’s priorities. Flexibility may be required to align these objectives on the understanding that if there is an opportunity, there must be access to incentives.
It is also important to understand that change takes time and commitment. Of course, that requires acceptance of change and well considered incentives. It won’t be an easy ride, but I have no doubt that collaborative contracting is worth the effort.