risk management in underground construction
TRANSCRIPT
RISK MANAGEMENT IN UNDERGROUND CONSTRUCTION
HOUSTON, TXMARCH 10-11, 2020
COST REIMBURSABLE CONTRACTS: MANAGING RISKS ON INFRASTRUCTURE PROJECTS
Ian H. Frank, Partner & Chair Construction Practice GroupFrantz Ward LLP
• Contract price based upon actual costs
• “Open Book” invoicing
• Overhead and profit – disclosed and negotiated
• Increased transparency
• Cost reimbursable or “cost-plus” ≠ “time and materials”
COST REIMBURSABLE BASICS
CONTINUUM OF RISK
Contractor Risk
Lump SumOwner Risk
Cost ReimbursableHybrid
CONTINUUM OF RISK: COST REIMBURSABLE CONTRACT ALTERNATIVES
Contractor Risk
Lump SumOwner Risk
Cost ReimbursableHybrid
Pure Cost ReimbursableCost Sharing ContractsCost-Plus-Incentive-Fee ContractsCost-Plus-Award-Fee ContractsCost-Plus-Fixed Fee ContractsTarget PriceGuaranteed Maximum PriceHybrids
DELIVERY METHODS THAT UTILIZE COST REIMBURSABLE COMPENSATION
Owner General Contractor
Subcontractors
Arch./Eng.
Arch./Eng.
Owner Construction Manager
Subcontractors
Arch./Eng.
Owner SubcontractorsContractor
Design-Bid-Build
Design-Build
Construction Manager at Risk
OWNER
Designer of Record General
Contractor
Design Subconsultants
TradeSubcontractors
Construction Manager
Preconstruction
ConstructionContractual Coordination
Requirements
DELIVERY METHODS - CM/GC
REASONS TO SELECT COST REIMBURSABLE CONTRACT
• Complex projects with significant risk that is difficult to forecast and price
• No clearly defined scope of work
• Possibility of a large number of scope changes
• Design incomplete
• Fast track project
• Unusual or uncertain site conditions
• Material costs volatile
• Sophisticated owner with sufficient resources for administrative obligations
• Transparency! Transparency! Transparency!
• Early involvement of major trade contractors and equipment vendors
• Consistent with collaborative delivery models and techniques
• Increased quality – less incentive to cut corners
• Lower overall final cost – eliminate undisclosed contingencies
POTENTIAL ADVANTAGES
• From the time the owner engages the contractor the owner does not know what the work will cost
• Exit ramps = delay and increased contractor leverage
• Less incentive for cost efficiency
• Additional administrative expenses for the owner
• Exhaustive accounting efforts, record keeping, and additional management to verify actual costs
POTENTIAL DISADVANTAGES
• Limited use historically on tunneling and other underground infrastructure projects
• Some notable success stories – Portland CSO Project
• Common features of underground projects make “cost-plus” a good fit:
o Complex
o High-risk
o Schedule
o Political scrutiny
COST REIMBURSABLE CONTRACTS: UNDERGROUND INFRASTRUCTURE PROJECTS
• “Cost of the Work” must be clearly defined
• One size does not fit all
• Basic components:
o Labor and material costs
o Equipment and subcontractor costs
o General conditions costs
• Allowed vs. Unallowed costs
DEFINING REIMBURSABLE COSTS
DEFINITION OF REIMBURSABLE COSTS
• Labor Costs
o Define personnel and positions
o Specify agreed billing rates, craft labor wage rates
o Burden: actual cost / agreed percentage or markup
o Travel and subsistence
REIMBURSABLE COSTS - LABOR
REIMBURSABLE COSTS – BILLING RATES
• Indirect Costs: Project-specific vs. non-project specific overhead
• Alternative strategies:
o Actual costs
o Lump sum fixed fee
o Percentage-based
• Closely tied to specifying billable project personnel
• Practice Tip: create detailed list of indirect costs that are non-reimbursable and included in contractor’s fee
REIMBURSABLE COSTS - GENERAL CONDITIONS
• Rental equipment
• Owned / purchased capital equipment
o Limited or non-existent standardized rates for specialized equipment
o Buyback issues
REIMBURSABLE COSTS - EQUIPMENT
• What are “reasonable” costs?
o Contract definition
o Implied agreement that costs will be reasonable?
• Some courts presume actual costs are reasonable
• Burden to prove costs are reasonable
• Best efforts standard – see McDonnell Douglas Corp. v U.S., 37 Fed. Cl. 295 (1997)
• Reasonable diligence standard – see Koppers Co., Inc. v. Inland Steel Co., 498 N.E.2d 1247 (Ind. Ct. App. 1986)
• Industry standards
• Productivity metrics
THE REASONABLE COST DEBATE
THE REASONABLE COST DEBATE
• Federal Regulations (48 C.F.R. 31.201-3):
o A cost is reasonable if, in its nature and amount, it does not exceed that which would be incurred by a prudent person in the conduct of competitive business
o Depends upon a variety of considerations and circumstances:
• Generally recognized as ordinary and necessary for the conduct of the contractor's business or the contract performance
• Generally accepted sound business practices and arm's length bargaining
• Contractor's responsibilities to the Government, other customers, the owners of the business, employees, and the public at large
• Any significant deviations from the contractor's established practices
THE REASONABLE COST DEBATE: PROPER PERFORMANCE OF THE WORK
• Proper workmanship required
o Majority rule that while the owner assumes certain risks under a cost-plus contract, the owner does not assume the risk of careless or improper workmanship on the part of the contractor
• Duty to minimize cost
o Contractor owes a duty to make every reasonable effort to minimize Frontier-Kemper Constructors, Inc. v. Elk Run Coal Co., Inc., 2008 WL 2937726 (S.D.W.V. July 23, 2008).
PROPER PERFORMANCE CLAUSE
• Good faith dispute vs. buyer’s remorse
• Cost submission and review process
• Course of conduct can be used to show parties intent. See Munn v. Thorton, 956 P.2d 1213 (Ak. 1998).
• Does acceptance of costs throughout project prevent objections to similar costs later?
o Waiver
o Cathedral Group Ltd. v. Gen. Constr. Mgmt. Co., 2013 WL 6451177 (Cal. Ct. App. 2013).
THE REASONABLE COST DEBATE: COURSE OF CONDUCT
• Does the contractor owe a fiduciary duty to the owner?
o AIA cost-plus contract includes language creating a relationship of “trust and confidence”
o Most courts conclude that does not create a fiduciary duty
• Eastover Ridge, LLC v. Metric Constructors, Inc., 533 S.E.2d 827 (N.C. Ct. App. 2000); Thomson v. Wheeler Constr. Co., 385 P.2d 111 (Ak. 1963); Munn v. Thorton, 956 P.2d 1213 (Ak. 1998)
• Exception – Jones v. J.H. Hiser Constr. Co., 484 A.2d 302 (Md. Ct. App. 1984)
• Implied duty of good faith and fair dealing
THE REASONABLE COST DEBATE: FIDUCIARY DUTY?
• Are these costs reimbursable?
• Alternative strategies:
o Permit reimbursement subject to a GMP
o Limited to costs not caused by the negligence of contractor or its lower-tiers
o Require contractor to first exhaust all remedies for recovery, including pursuing trade contractor
• Practice Tip: Require itemization and tracking of costs, even if not reimbursable
THE REASONABLE COST DEBATE:DEFECTS, REWORK AND REPAIR
DEFECTS CLAUSE
REWORK CLAUSE
• Percentage of the Cost of the Work
• Flat fee
• Incentive fee
• Award fee
• Interplay of costs and fee
CONTRACTOR FEE
• Pure Cost Reimbursable
o No Cap
o Control estimate/budget
o Periodic updates
• Target Price
o Formula-based
o Shared risk for overrun and savings
o Target adjustable
• GMP
o Functions as a lump sum price, but allows owner (and sometimes contractor) to recoup savings
MANAGING OVERALL COST RISK
• Process to establish GMP
• Timing: When is the right time to lock it in?
• Qualifications, Assumptions and Allowances
• Multiple GMPs
• Interim GMP
• Increasing the GMP:
o Scope changes
o Schedule impacts
o Completion of design
GUARANTEED MAXIMUM PRICE (GMP)
• Contractor Contingency
o Scope
o Control
o Deposits and withdrawals
• Owner Contingency
• Contingency Management Plan
o Process/formula for setting and adjusting GMP
o Buyout savings added
o Increases removed for alternates, owner contingency or GMP reduction
CONTINGENCY AND SHARED SAVINGS
• Design development contingency
• Division–level contingencies
• Special issue contingencies
o DSCs
o E&O
o Owner directed scope changes
• Cost tracking and progress billing practices
• Shared Savings
o Distinct from contingency
o Tracking and calculation
o When are savings determined?
CONTINGENCY AND SHARED SAVINGS
• “Cost Reimbursable Mindset”
• Extra Work / Scope Changes
o Change management process still necessary
o Notice
o Documentation
o Define entitlement – scope, systems, kind, quality, materials, finishes or equipment
• Change vs. cost overrun vs. design development
CHANGE MANAGEMENT
• How do delays affect contractor’s compensation?
o Bonus
o Liquidated damages
• Are delay costs reimbursable?
• Concurrent delay
• Impact to the GMP or target price
SCHEDULE IMPACTS
CONCURRENT DELAY CLAUSE
• Open book competitive solicitation
• Minimum of three (3) qualified trade contractors
• Self-performance issues
• Authority to select vs. object/approve
SUBCONTRACTOR BIDDING AND SELECTION
• Audit vs. obligation to maintain records and make available for inspection
• Audit Process:
o Scope
o Timing
o Frequency
o Cost allocation
• Audit standards to be applied
• Remedies for non-compliance
o Injunctive relief
o Liquidated damages
o Withholding payment
AUDIT RIGHTS AND ISSUES
Ian H. FrankPartner / Chair of Construction Practice GroupFRANTZ WARD LLP200 Public Square – Suite 3000Cleveland, Ohio 44114(216) [email protected]