Construction and infrastructure projects involve highly technical aspects. The disputes related to them are equally complex. This makes robust contractual documentation a critical requirement. Uncertain and long-drawn litigation can be avoided by well-drafted contract documentation.
The principal construction contract is often a multi-party contract involving the owner (often referred to as employer), the contractor, the project consultant, engineers, etc. Further, the implementation often requires several back-to-back arrangements.
In this context, many parties often rely on standard templates like those of FIDIC, but it is advisable to undertake fact-specific customisation of clauses as standard templates may not always be suitable for specific scenarios. In this article, we aim to outline key contractual issues that frequently arise in India, but can be avoided through well-drafted documentation.
Key contractual issues in construction contracts
- Scope of work: One of the fundamental issues in construction and infrastructure contracts is defining the scope of work. Ambiguities or inconsistencies in the scope can lead to disputes and delays. To mitigate the issue, a contract should include the clear intention of the parties with detailed specifications, drawings and plans.
- Dealing with variations: Infrastructure contracts require a longer duration for completion and various factors influence the initially accepted scope and plans. The variation provisions must be carefully negotiated, including procedural aspects, so that the contractor is remunerated and granted additional time when variations are sought by the employer. The contract should include a well-defined procedure that outlines how changes are proposed, priced, approved and executed. Failure to manage change orders effectively can lead to increased costs and disputes.
- Price adjustments: Price adjustment provisions use formulas to arrive at price variations from time to time. An often-disputed aspect is simple compliance events, like the impact due to minimum wages, which may have been unintentionally omitted from the price adjustment formula. The aspects of the price adjustment formula must be carefully negotiated to ensure that the price revision impact can be passed on to the employer.
- Bank guarantees: Bank guarantees (BGs) from the contractor offer comfort to the employer regarding work performance. However, in many instances, employers invoke BGs for any breach of contract conditions, while contractors believe that every breach does not entitle invocation of BGs. Therefore, instances in which a BG can be invoked, including the conditional or unconditional nature of the BGs, must be specified in the contract documentation.
- Force majeure provisions: Under a force majeure event in a contract, a party to a contract can be excused from the performance of obligations, and the force majeure clause typically provides the description of events qualifying for this benefit. Often, force majeure claims are rejected by the non-impacted party citing non-compliance with procedural requirements like the issuance of notice. Therefore, the subsequent procedure upon a force majeure event must be documented in detail to avoid any interpretation disputes at the time of enforcement.
- Statutory dues: Common construction disputes in the past decade involved determining who should be discharging liability towards cess under the Building and Other Construction Workers Welfare Cess Act, 1998 (“Cess Act”). Considering that the frequency of enforcement of the Cess Act by the authorities is low, parties often fail to identify the party responsible for cess payments. This leads to disputes when the authorities issue a notice for the payment of cess. This also makes a case for involving people who are aware of laws specific to construction at the drafting and negotiation stages.
- MAGA: The Material Adverse Government Action (MAGA) relates to changes in government policies or changes in the political scenario that have an adverse impact on infrastructure projects. Contractors do not have control over MAGA events. In cases where the employer is a government entity, it is ideal to allocate certain instances of political risks to the employer to address such risks and implement remedial measures.
- Liability due to sub-contractors and other stakeholders: Contractors engage several sub-contractors in large-scale infrastructure projects. Performance delays or failure by one sub-contractor can have a cascading effect on the entire project and ultimately create liability for the contractor under the principal contract. Similarly, delays by the employer in fulfilling its obligations can impact sub-contractors’ performance. Therefore, appropriate back-to-back risk allocation must be undertaken through documentation to ensure that the non-defaulting party is not impacted in case of a breach by any stakeholder during the project implementation.
- Handback: In infrastructure projects implemented on the build-operate-transfer model, the assets must be transferred once the contract ends. The provisions concerning what needs to be handed over to the employer and what can be retained by the contractor must be carefully documented. Contractors must consider the value of handover assets in their pricing and the circumstances of the handover of assets must be captured to avoid disputes in the final stages. Typically, the contract is terminated upon the handover of assets.
- Termination payments: Contractors typically invest significant amounts in project implementation and their funders expect certainty regarding their investment. At the same time, employers may also have taken significant measures for the implementation of a project. However, there may be instances where the contract needs to be terminated due to a breach or any other reasons, with compensation provided to the non-breaching party. In this regard, it is ideal to provide calculation methods for determining compensation and the circumstances under which a party is eligible for termination payments. While the non-breaching party may be entitled to termination payments through judicial adjudication, specifying the conditions for termination payments will provide certainty.
- Compliance with regulations: Construction and infrastructure projects are subject to a myriad of regulations at the union, state and municipal levels. Contracts should outline the provisions that require compliance with all applicable laws, regulations and permits, and specify the party responsible for such compliance. Failure to comply with regulatory requirements can lead to financial liabilities and delays. Environmental-related compliance in recent times has often led to the stalling of projects, which require special attention in the initial stages.
- Choice of dispute resolution mechanism: In some instances, parties incorporate a multi-tier dispute resolution mechanism involving discussions in informal settings, followed by mediation, conciliation, negotiation, and finally, arbitration. Where multi-tier dispute resolution is employed, a common dispute is whether such a mechanism is mandatory or not, or if the parties can directly refer the matter to arbitration or approach the courts. To address this, clauses must be drafted with clarity on the mandatory nature, where parties intend to have a pre-litigation settlement mechanism. This can save time by preventing disputes within disputes and delays in the enforcement of the contract.
- Enforcement challenges: Large-scale projects involve parties from multiple jurisdictions. The dispute resolution mechanism is typically based on arbitration. Being a specialised subject, construction often requires experts to assist arbitrators. In cases where arbitrary methodologies were adopted by arbitrators to arrive at values, Indian courts have set aside the orders, leading to prolonged delays in adjudication and enforcement of contracts. Therefore, even at the stage of arbitration, it is essential to ensure that necessary expert assistance is provided to the arbitrators so that methodologies adopted can withstand legal scrutiny.
Construction and infrastructure contracts are essential tools for managing complex infrastructure projects. Addressing key issues such as variations, risk allocation, regulatory compliance, dispute resolution, termination procedures, and unforeseen events is crucial for ensuring the successful execution of construction and infrastructure projects. Global bodies like the World Bank and the Asian Development Bank often recommend best practices that can be customised and incorporated into project documentation.
Parties involved in these contracts should invest significant time and effort during the drafting and negotiation stages to anticipate and address possible issues to minimise disputes and project disruptions. Effective contract management and communication among all stakeholders are also essential for mitigating risks and achieving successful project outcomes.