The risk of contract award for the Contractor
Correctly formulate clauses on the effective date of project contracts.
2016-02-12. It is certainly more than gratifying when the work that goes into an extensive offer regarding the design, production, delivery, installation and commissioning of plants and machinery leads to an order being placed by the Employer. However, a project can be overshadowed from the outset by obstacles arising long before the actual problems involved in the project implementation. This specialist article explains how the Contractor can avoid such obstacles.
A fictitious project example
Contractor`s sales department and technical departments have worked on the offer for the design, production, delivery, installation and commissioning of a process plant for a couple of months. Following lengthy negotiations, the contract has been signed by both parties. It came into full force as a result of being signed by both parties on 2016-01-02, as provided for in the contract. The contract also obliges the Employer to make a downpayment to the Contractor in the amount of 10% of the contract price. From the outset, it was the Employer’s wish to be able to provisionally accept the plant from the Contractor on 2018-06-30. The contract also contains a liquidated damages provision . If the deadline of 2018-06-30 is not met by the Contractor, it will be liable to 0.1% of the contract price in liquidated damages per calendar day of delay.
The above fictitious example highlights two weaknesses in the formulation of the contract. Whatever the reason was for including this arrangement in the contract, it harbours much potential for disputes between the parties, which may be difficult for the Contractor to win.
In this fictitious example, the contract becomes effective upon being signed by both parties (“unconditional coming-into-force”). The deadlines contained in the contract for providing the mutually contracted performances become legally effective. The Contractor is obliged to enable the successful completion of provisional acceptance of the process plant as at 2018-06-30. It is required to meet that deadline whether or not the Employer made the downpayment in the amount of 10% of the contract price to it. If it happens that the Employer fails to make the downpayment, for whatever reason, the Contractor will nevertheless be obliged to render its contracted performance to the Employer, thus putting it in a “cash-out” situation.
The specified fictitious deadline for provisional acceptance of the installations is fixed. It is a fixed date and not defined as a period in a number of calendar days from the effective date of the contract which links the moment of provisional acceptance of the plant to the effective date. Even if a conditional effective date of the contract were agreed in it, the Contractor would be obliged to ensure that the Employer can successfully complete provisional acceptance as at 2018-06-30. This means that, assuming an effective date of the contract of 2016-01-02, as originally intended between the parties but then not fulfilled, the Contractor would have had a total of 910 calendar days until 2018-06-30 to prepare the plant for successful provisional acceptance. With each day that the now conditional effective date of the contract is delayed, the construction period available to the Contractor is reduced and the risk therefore also increases of its having to pay liquidated damages to the Employer, in addition to the costs that the Contractor incurs to defend itself against Employer`s potential demand for liquidated damages.
Tips for remedial action:
1. Contractually agree a conditional effective date:
The effective date of the contract should be linked to the Contractor issuing a downpayment bond to the Employer in the amount of the contractually agreed downpayment and receiving from the Employer, against the submission of a downpayment invoice, the downpayment in the agreed amount. Only when both of these conditions have been completely fulfilled by the parties does the contract become effective. Both parties have thus obtained more security with regard to the future of the joint project. In addition, it should be agreed in the contract that the downpayment bond will be promptly returned to the Contractor by the Employer as soon it has provided appropriate proof to the Employer that it has rendered performances to it in the amount of the downpayment amount. If the Employer does not give the downpayment bond to the Contractor without a valid reason, it will be obliged to compensate the Contractor for the additionally incurred guarantee fees.
2. Agree relative performance deadlines:
Absolute performance deadlines should be avoided as much as possible in the formulation of the contract. With regard to the completion dates, delivery dates, engineering deadlines etc., periods in calendar days relating exclusively to the conditional effective date of the contract should always be defined. You thus ensure that your company is entitled to the period for performance that it calculated as being necessary at the planning stage during the preparation of the offer. For the fictitious example project presented above, the time of successful provisional acceptance of the installations would be defined as “910 calendar days after the effective date of the contract”.
3. Further practical tips
1.Unambiguous contractual definition of units of time: Alongside money, time is the most important asset in the project, so in the preamble of the contract define the units of time to be applied in the project. Agree on calendar days. Contractually establish the time when a calendar day starts and finishes, as well as the time zone which is to apply for the performances to be rendered by the Contractor on that calendar day. This will help to avoid disputes if things “get tight” in the project. Do not use “weeks” as the unit of time to avoid getting into a dispute as to when a week begins. Internationally, the unit of time “a week” starts and ends on a wide range of different days.
2.Definition of public holidays and special local circumstances: Contractually agree what calendar days are not business days at which place of performance, for example due to religious or national holidays. These days should, depending on the place of performance, be defined in the contract as “non-business days” and the construction period measured accordingly. This contractual measure also helps to avoid disputes and ensure clarity in the measurement of the contracted performances.
For the establishment and definition of contractually defined times and periods in the implementation of industrial projects, sufficient precision should be applied in order to avoid jeopardising the success of the project for both parties.