Risk-Shifting Contracts Hurt
SURVEY. At Columbia University during my master’s program in civil engineering, I wrote a 30-question survey that I sent to contractors and facilities owners. I asked them about contract language that addresses subsurface soil conditions, delay damages, liquidated damages and contract changes. I based many of my questions on clauses taken directly from the "general conditions" contract of NYC Transit’s parent organization, the Metropolitan Transportation Authority, as well as on model contracts from groups such as the American Institute of Architects.
Of the 512 surveys that I sent last year, I received complete replies to about 20%, statistically a good response for a direct mail survey. Nearly all of the responses came from industry leaders–company presidents, principals and partners of general and subcontracting firms, construction managers, engineering firms, developers and public agencies nationwide.
According to the survey results, contractors generally pad their bids to handle commonplace contract clauses that exclude them from making claims "for damages for delay of any kind [instead] any such claim shall be compensated solely by an extension of time...in this regard the contractor alone hereby specifically assumes the risk of such delays." When presented with such language, 68% of general contractor and subcontractor respondents said they increase their bid prices, half of them by an amount greater than 5% of the ultimate contract value. And 25% of the contractor respondents said they refuse to bid a job with an unreasonable delay-damage clause.
As NYC Transit eventually came to realize, tough words about delay damages intimidate many contractors, despite considerable legal precedent for them to collect damages for delay under such circumstances. It may be that contractors are too familiar with the legal battles associated with delay damages and exculpatory contract language. Nearly half of my contractor respondents said they have been involved in more than one claim hearing or mediation due to delay damages in the past five years.
Although contract language may affect bid prices, some owners may perceive the bid premium as insurance they are willing to pay for. If a contractor believes that the risks are disproportionate and that the contract affords no protection in times of disagreement, the contractor may cover the risks with an additional contingency. With such padding, the owner ends up paying extra whether or not the risk materializes. Owners involved in several projects may be paying premiums that exceed the direct costs of any materializing risks.
The results of my survey also make clear that prudent contractors may not even bid on work for which a contract presents a large amount of unforeseeable or unbalanced risk. When potential bidders drop out, hidden costs may increase due to limited bid competition. Also, more claims and disputes may ensue with contractors who want to gamble or who fail to understand the risks. Consequently, the protection that an owner thought was furnished by a one-sided contract may prove detrimental.
An owner with a bad reputation, or without prior relationships with the bidders, may be particularly hurt by a one-sided contract. Contractors generally ignore harsh contract language only if, from prior experience, they can expect an owner to deal fairly with delays and changes.
In response to my survey, 75% of general contractors and subs said they increase their bid price, with 40% saying they do so by 5% to 10% of the contract value, when working with an unfamiliar owner. And 90% said they increase their bid price when working with an owner with a poor reputation for making prompt payments.
REFORM. More owners ought to follow the lead of NYC Transit. With a lot at stake, the agency became dedicated to contract reform in the early 1990s. This year, the agency expects to let $600 million in train-signaling contracts, not to mention other contracts to rebuild subway lines destroyed in the Sept. 11 attacks. In the past, scant bid competition forced the agency to delay some of its signalling projects because contractors were unwilling to absorb the high risks. But now, the agency compensates contractors for idle time beyond their control, and provides them with unlimited use of the agency’s flagmen.
In telling me about such reforms at NYC Transit, where a typical contract lasts three to five years, Nagaraja pointed out that contract reforms have reduced the average schedule delay from 20 months in the early 1990s to just four months last year. As he emphasized to me, there are clear benefits to taking on a little risk by avoiding the use of one-sided contracts.