Time to engage – consultation draft released on NZS 3910 construction contract

Time to engage – consultation draft released on NZS 3910 construction contract

The committee tasked with reviewing NZS 3910:2013 –Conditions of contract for building and civil engineering construction (NZS 3910) has released a consultation draft of a revised version of NZS 3910, entitled DZ 3910:202X (DZ 3910).

The review, led by Standards New Zealand and commissioned by the Construction Sector Accord and the New Zealand Infrastructure Commission – Te Waihanga, identified that a comprehensive review was needed to update NZS 3910 which (with the exception of an interim update of recommended special conditions published in October 2022) had not been reviewed since 2013.

This article examines certain key areas of change to NZS 3910 as set out in DZ 3910, namely:

 the addition of a target outturn cost (TOC) contract pricing option;

 the replacement of the role of Engineer to the Contract with the roles of Contract Administrator and Independent Certifier;

 the dispute resolution regime; and

 contractor indemnity and limit of liability. We also identify some features which we consider would be useful additions to DZ 3910.

TARGET OUTTURN COST

DZ 3910 includes a TOC pricing option, which may be utilised either on a standalone basis or together with other (existing) pricing options. The TOC pricing model under DZ 3910 provides for the reimbursement of the Contractor’s Net Costs, plus Preliminary & General and Margin, subject to a “pain/gain” concept. This concept essentially provides that if the final Contract Price (i.e., the aggregate of all Net Costs plus Preliminary & General and Margin) is:

 more than the TOC, then the Contractor bears a pre-agreed share of the overrun (or “pain”) potentially up to a maximum amount equal to, say, its total Margin (i.e., the Contractor cannot lose more than its Margin on account of an overrun); or

 less than the TOC, then the Contractor is paid a preagreed share of the underrun (or “gain”).

A TOC contract is based on the idea that each party will primarily act in its own self-interest, and so seeks to align those interests by prioritising a “best for project” outcome whereby a positive outcome is jointly positive, and a negative outcome is jointly negative. In this sense, it is not that different from an alliancing agreement, but without the inclusion of the “no fault, no blame” edict that characterises an alliance.

We have advised on a number of major projects which utilise a TOC pricing model under NZS 3910 through special conditions. The mechanical drafting included in DZ 3910 generally reflects the equivalent drafting which was adopted on those projects, and (for the most part) does what it needs to do establish a workable TOC pricing regime.

That said, the mechanical “pain/gain” provisions are but one key feature of a TOC contract. For a TOC contract to work effectively, a number of additional features, both contractual and non-contractual, are required. We discuss some of these features below.

 Consistent with the fundamental premise that the parties are jointly banking on the actual final Contract Price being less than the TOC:

o all Net Costs should be incurred, documented and shared on a fully transparent and open book basis (so that both parties are able to establish what Net Costs are being incurred and counted towards the TOC (and on what basis)), and

all recoverable Net Costs must be allowed for in the schedule of Net Costs;

o a defined schedule of Net Costs is agreed between the parties which essentially documents those Net Costs which are recoverable by the Contractor (and so count towards the TOC) and those which are not. As a starting point, this schedule should reflect the categories of costs which are allowed for in the TOC. Items which are not listed in the schedule are deemed covered by the Margin; and

o there is typically no separate fixed allowance or percentage for Preliminary & General (or on-site overheads), instead these costs are to be incurred and reimbursed on a Net Cost basis in line with the schedule of Net Costs.

The above reflects the position that has been adopted on major TOC contracts in New Zealand, reflects the approach taken under other standard form TOC contracts (including NEC4 – engineering and construction contract – C: target contract with activity schedule) and, more generally, on alliances. This is not, however, reflected under DZ 3910 which approaches the build-up of the Contract Price under the TOC pricing model in the same way as a costreimbursement pricing model, notwithstanding the fundamentally different commercial premise and relational aspects of a TOC contract.

 The Margin under a TOC contract should be set on a lump sum basis relative to the Net Cost component of the TOC (again, as is the case in other TOC contracts, the NEC4 target contract, and alliances), and subject to adjustment for Variations or other compensation events. This is consistent with the commercial intent of the parties to deliver the Contract Works for less than the TOC: if the Contractor continues to receive Margin on Net Costs incurred once the TOC is exceeded, as is contemplated under DZ 3910, the incentive to deliver for less than the TOC will be eroded as its liability for a share of the overrun will be partly offset by its continued recovery of Margin.

 A TOC contract typically includes a pre-contract price exchange process (sometimes as part of an ECI phase) pursuant to which the Contractor and the Principal each prepare a build-up of the total cost expected to achieve completion of the Contract Works using the same base case parameters and assumptions, exchange their expected total cost, and then commercially agree a final expected total cost which (together with Margin) comprise the TOC. While this is not something we would expect

to see in DZ 3910 itself, we would hope that guidance notes will be included in the final version which touch on the pre-contract processes to be followed in order to develop a robust TOC.

 A TOC contract requires a streamlined approach to the valuation of Variations to facilitate upfront valuation and any adjustment to the TOC. The alternative, of valuing Variations during or after the fact by reference to the actual quantum of costs incurred or work completed, means that the delta between Net Costs incurred towards the TOC and the actual TOC will generally be maintained, so reducing the efficacy of the TOC and the pain/gain mechanism. This is a significant issue which has the potential to undermine any TOC contract, and we would like to see the position under DZ 3910 clarified (either through changes to the General Conditions or the inclusion of appropriate guidance notes).

 A TOC contract often includes a non-costs financial performance regime based on key result areas (KRA) which prioritise non-financial and qualitative outcomes through project specific key performance indicators (KPI). From a Principal’s perspective, a KRA regime offers some protection against the risk that qualitative outcomes may be compromised due to the Contractor seeking to complete the Contract Works for less than the TOC. From the Contractor’s perspective, a KRA regime represents an opportunity to further share in the positive outcomes of the project by way of additional financial reward. There is no mention of a non-cost performance regime in DZ 3910 (c.f. other TOC contracts, the NEC4 target contract, and alliances) and we suggest the Committee consider including such a regime.

 Perhaps most importantly, a TOC contract is reliant on a shared culture and way of working being established and fostered between the Principal and the Contractor, reflective of the underlying win together / lose together premise. This is akin to the cultural emphasis commonly prioritised (often at great effort) in alliance contracts. It requires considerable time and cost investment by both parties, and whole-of-organisation acceptance of a “best for project” philosophy. We would like to see guidance on the different approach to working under a TOC contract (versus other pricing models) included in the guidance notes to DZ 3910, or perhaps more appropriately published separately by the Construction Sector Accord or the New Zealand Infrastructure Commission – Te Waihanga.

CONSTRUCTION CONTRACT

We admire the intent of the Committee in including a TOC pricing model, not least because it builds on the positive changes in contracting practices and behaviour that have been fostered by the Construction Sector Accord and the New Zealand Infrastructure Commission – Te Waihanga (among others) in recent times. As noted above, however, we have some reservations about the manner in which a TOC pricing model has been allowed for in DZ 3910, especially given that DZ 3910 is intended to be the primary industry standard form construction contract going forward and the market, generally, has limited familiarity with the model. Noting the additional complexity associated with a TOC contract, and the fundamental differences between a TOC pricing model and the other pricing models under DZ 3910, it may be more appropriate to publish a separate New Zealand Standards TOC contract. This could also include the guidance necessary to successfully establish and administer a TOC contract.

ENGINEER TO THE CONTRACT IS NOW THE CONTRACT ADMINISTRATOR AND INDEPENDENT CERTIFIER

The role of the Engineer under NZS 3910 has been split into two new roles under DZ 3910:

 The Contract Administrator acts for and on behalf of the Principal in giving “Instructions” to the Contractor and administering the Contract.

 The Independent Certifier acts fairly, impartially and independently of either contracting party and makes “Decisions” on all matters that are entrusted to it under the Contract.

The dual role of the Engineer under NZS 3910, i.e., as a decision maker and as the Principal’s representative, was specifically identified by the Committee as a key area of consideration early in the rewrite process. Subject to our further comments below, the move to separate the role is not a particularly surprising change and we anticipate that it will be welcomed by those who have been critical of the potential conflict of interest in the role under NZS 3910.

The process of appointment, and the identity of the person(s) who may be the Contract Administrator and the Independent Certifier, do, however, raise questions.

Under DZ 3910, the Principal is responsible for ensuring that at all times there is a Contract Administrator and Independent Certifier, and that the relevant person(s) fulfil all aspects of the relevant roles and functions reasonably and in good faith. We expect that both the Contract Administrator and Independent Certifier will be engaged directly by the Principal (under a usual professional services type arrangement) or employed by the Principal. Like the Engineer under NZS 3910, there is no prohibition on either the Contract

Administrator and/or the Independent Certifier being a person from the Principal’s organisation or part of the Principal’s wider consultant team (such as the architect or project manager). The only limitation is that both the Contract Administrator and the Independent Certifier must be a natural person.

There is no indication that the Independent Certifier has any direct contractual link to the Contractor – it is the Principal who is required to ensure that the Independent Certifier fulfils all aspects of its role (including acting impartially and independently) and functions reasonably and in good faith. So, much like the position under NZS 3910 in respect of the Engineer, if the Contractor is not satisfied that the Independent Certifier has properly performed its role, it would presumably need to raise this directly with the Principal. While it could be argued that the Independent Certifier may owe a duty of care to the Contractor in particular cases, the courts have historically been reluctant to impose such duties on a person performing such functions.

DZ 3910 also allows for the same person to be appointed as both the Contract Administrator and the Independent Certifier, which could effectively return the position back to the status quo under NZS 3910. We expect that certain Principals will avail themselves of this option to avoid the prospect of incurring additional consultancy fees which may arise as a result of engaging a separate Contract Administrator and a separate Independent Certifier. We will be interested to see whether there are any changes to these aspects of DZ 3910 following the current consultation process.

DISPUTE RESOLUTION

The Committee has landed on significant changes to the dispute resolution regime in General Condition 13 of DZ 3910. Changes to the regime were allocated to the full Committee for “all-in” consideration given the significance of the provisions. The Chair of the Committee reported that these changes were the subject of considerable debate. The Committee has, however, ultimately agreed on what it describes as “a process for the management of disputes which sets out mandatory and optional steps to simplify and clarify the dispute process”.

We make the following observations in respect of the regime proposed:

 There is now a more familiar hierarchy of escalation. It commences with a mandatory party-party attempt at resolution between a “senior member” of each party’s organisation. Non-compulsory mediation follows as an option but ultimately, disputes will be resolved via arbitration before a sole arbitrator. For the senior member engagement to be of utility, those involved in

that aspect will need to be well briefed on the dispute and issues arising.

 There is no timeframe attached to the negotiation between senior members of each organisation -either at the front or back end. For example, you might typically see that such engagement must occur within 10 working days of an event (e.g., a notice of dispute) and a set period of time for that engagement to occur. We can foresee possible disputes between parties about whether the requisite senior member engagement has occurred and, therefore, whether the parties can proceed to further steps in the disputes process.

 There are some other potential timing issues within the regime:

o There is no time limit to exercise arbitration rights after a Final Decision (General Condition 13.3.2). This could result in very extended periods between a Final Decision and an arbitral process subject only, possibly, to limitation issues.

o The parties have 20 working days to agree an arbitrator, which is a reasonably lengthy period of time.

 It is not clear how it is intended that this regime will interact with the role of the Independent Certifier and the “Decision” / “Final Decision” regime provided for in General Conditions 6.2 and 6.4, which extends to “the determination of claims submitted by the Principal or the Contractor” (as explained in the definition of “Decision”):

 The regime now provided for in General Conditions 6.2 and 6.4 allows for: (1) Decisions by the Independent Certifier; (2) a “first” review of that Decision (giving rise to a “further Decision”); and, (3) a “second” review, ultimately giving rise to a “Final Decision”. All of these decisions and their review are under the remit of the Independent Certifier.

 The parties are allowed to call on the assistance of an agreed expert once the matter is in review territory. That expert is entitled to make a “recommendation”.

It is not absolutely clear whether parties are required to go through the Independent Certifier Decision / Final Decision process before engaging in the General Condition 13 disputes process. This process engages where there is a “dispute or difference between [the parties]”, and goes on to provide that “the parties agree to refer any dispute or difference between them to arbitration, including any dispute of a Final Decision…”. It then distinguishes between disputes relating to final decisions and disputes referred to arbitration. All of this suggests that the parties can go straight to arbitration (following attempts by senior members of each organisation to resolve the dispute) but clarity here would be preferable.

Other points to note include:

 General Condition 13.3.4 provides that “the award in the arbitration shall be final and binding on the parties”. This raises the question of an appeal against the arbitral award if a party is dissatisfied with it. The clause intersects most significantly with appeals on questions of law (to the High Court) pursuant to clause 5 of Schedule 2 of the Arbitration Act (where this schedule applies to the arbitration). There is judicial authority to the effect that, where parties provide in their agreement that the award will be “final and binding”, this does not amount to implied contracting out, but is a factor against granting leave to appeal under clause 5(1)(c) of the Arbitration Act. This is an important point that parties should be aware of.

 It seems likely that the deletion of the (former) General Condition 13.2.1 changes the position resulting from the Court of Appeal’s decision in SRG Global Remediation Services (NZ) Ltd v Body Corporate 197281 ([2022] NZCA 518), which interpreted that clause to disapply arbitration rights after the period for seeking an Engineer’s review of the final payment schedule has expired (which means that disputes must then be litigated in court).

 Outside of DZ 3910, parties are still going to have to manage the potential for disputes to be referred to adjudication under the Construction Contracts Act. However, this is not a new risk and simply something that remains to be managed by all parties to construction contracts.

 General Condition 13.4, which deals with “actions during dispute”, has been amended to remove the ability of the Engineer to instruct the Contractor to suspend the execution of the Contract Works. It is not clear whether the Committee’s deletion of this power was because the Committee determined that it was covered elsewhere (e.g., under General Condition 6.8 which provides generally for the suspension of the Contract Works, including on the instruction of the Contract Administrator) or it thought the power should be removed. Given disputes sit within the remit of the Independent Certifier, it might seem odd that a separate, formerly express, power resides in the Contract Administrator. Again, clarity here would be useful.

INDEMNITY AND LIMITATION OF LIABILITY

The Principal’s non-fault based indemnity under NZS 3910 in favour of the Contractor under General Condition 7.1.3 in respect of the matters covered by 7.1.2(c) has been removed under DZ 3910. Similarly, there is a proposed narrowing of the Contractor’s indemnity under DZ 3910 in favour of the

Principal, which limits the Contractor’s indemnity to loss attributable to Contractor negligence or from breach of the Contract. General Condition 7.2.1 of DZ 3910 of introduces a cap on the Contractor’s liability (to the extent the parties specify a cap in the Specific Conditions). Any such cap is subject to exclusions, for example, the cap will not apply to:

 liability arising from the Contractor’s obligations to indemnify the Principal;

 any fraud, illegal acts/omissions, wilful or reckless misconduct or wilful default by the Contractor in the performance of its obligations under the Contract;

 the Contractor’s abandonment of the Contract; and

 penalties applicable at law.

There is potential for disputes to arise in relation to the application of the cap. In particular, as to the interpretation of the Contractor’s uncapped liability for loss arising from Principal liability to third parties or from illegal acts/omissions or wilful or reckless misconduct, which could potentially be read quite broadly. In addition, the uncapped indemnity for penalties applicable at law will be of no practical effect where insurance against fines is unlawful under statute, for instance under the Health and Safety at Work Act 2015.

The Contractor’s liability will exceed any agreed liability cap in the Specific Conditions insofar as the Contract requires the Contractor to hold insurance over and above that amount and where the policy responds to a loss, or would have responded to the loss but for the Contractor’s failure to claim and/or breach of the relevant insurance policy, or due to the Contractor’s failure to maintain the insurance.

OTHER POTENTIAL FEATURES FOR INCLUSION IN DZ 3910

Particularly relevant for larger projects of a significant contract value, DZ 3910 does not contain or allow for various matters which are a common feature for large projects, including:

 an on-demand, unconditional form of performance bond (either Principal or Contractor) or retentions bond;

 a form of off-site materials agreement that can be used for cash deposits and/or as-yetunmanufactured goods;

 a weathertightness warranty, separate from a warranty for the contract works in respect of materials and workmanship;

 a schedule of warranties, indexed by trade and warranty periods for materials and/or workmanship (although this is often included in the specifications); and

 continuity guarantees from key subcontractors.

CONCLUSION

Overall, the Committee has taken a step towards addressing some of the known issues with NZS 3910, legislative changes, and changes in the construction industry since 2013. Many of these issues were often already addressed through a number of special conditions used across many projects. The Committee has also ventured to include a new TOC pricing model but we caution that a substantial amount of work is still required to make this useful and effective.

While the update aims to reduce the scope and number of special conditions, the reality is that the specific requirements of the Principal and/or Contractor, certain third parties (e.g., funders, insurers, landlords, etc.) or the project itself will still need to be addressed on a project-by-project basis through special conditions.

The public consultation period on DZ 3910 is currently open until 30 June 2023, with the Committee aiming to publish a revised standard in December of this year. It is hoped that wider industry input will clarify some of the current ambiguities identified and ensure that the revised standard, once published, will be fit for purpose and widely accepted in the industry.

This article was contributed to by the following authors: David Chisnall, Jesse Wilson, Ian Becke, Kirsty Dobbs, Brad Ward, Mathew Brown, Scott Lochhead, Julian Brown, Charles Wong, and Maiya Christini.

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Disclaimer: This publication is necessarily brief and general in nature. You should seek professional advice before taking any further action in relation to the matters dealt with in this publication.