Construction
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This article is written by Venkat Ramaiah, pursuing a Diploma in Business Laws For In-House Counsels from Lawsikho.

Introduction and scope

Construction contracts in a strict sense are those contracts that are to do with building of structures, laying of roads, constructing dams, digging canals, making bunds, etc., which are predominantly civil engineering activity. In usage though it has become a norm to call any large contract that involves aspects of civil engineering as a construction contract. There are many articles on ‘Types of Construction Contracts’ listing and explaining them. It is not the intention of this article to add one more to the galore, rather it is to seek the reason for so much variety and show how and why these construction contracts have become a fertile ground for unusual and weird legal disputes, not to mention regular ones. 

Note: The size of construction contracts focused on in this article are large ones, and in that sense sometimes the word Project(s) is used to refer to the contract(s) as well as the work they represent. 

Types of construction contracts

There is no definitive answer to the question, ‘How many types of construction contracts are there?’ Some types of construction contracts are listed below:

  1. Cost (Plus) Contracts
  2. Lump Sum Contracts (Also known as Fixed Price Contracts)
  3. Piecework Contracts
  4. Unit Pricing Contracts
  5. GMP Contracts (Guaranteed Minimum Price Contract)
  6. Rate Contracts
  7. Target Contracts
  8. Materials and Labor supply Contracts
  9. Time and Materials Contracts

Again, in Cost Contracts there are:

  1. Cost Plus Contracts
  2. Cost Plus Percentage Contracts
  3. Cost Plus Fixed Fee Contracts
  4. Cost Plus fluctuating Fee Contracts

Similarly, under the Rate Contracts there are:

  1. Item Rate Contracts
  2. Percentage Rate Contracts

The list goes on. In the last couple of decades three other types of contracts have become popular,

Operate, Maintain and Transfer (OMT) Contracts (popular in roadworks); 

Build Operate Transfer (BOT) Contracts; and

Build Own Operate Transfer (BOOT) Contracts.

Contract types explained

As stated under the scope the intention of this article is not to dwell into the details of construction contracts. One can easily access sufficient information from Google by searching by name each of the named contracts listed under heading-2 above. Those interested in a quick overall view of some of these contracts may refer to types of Construction Contracts.

Why so many types

Civil engineering deals with natural elements of earth like water, sun, rain, etc., to protect living beings by keeping them out if not containing, by regulating if not controlling and by shielding from if not conquering these elements. Added civil engineering together with other technologies is employed to satisfy the ever-changing needs and wants of humanity for its comfort and pleasure. The complex and imponderable nature of these elements makes it difficult to standardize engineering designs and firm-up cost estimates. 

A glance at the names of these contracts shows the emphasis is on method of payment to or recovery by the contractor. A construction contract is normally a huge commercial activity with a profit motive. These contracts run into months and years, and one inadequately worded or missed clause, one unforeseen, misjudged, or miscalculated factor can mire contracting parties in seemingly interminable litigation and loss. 

Faced with such huge risks and given a contract is a legally binding agreement enforceable under law, the parties to both sides of the contract choose to safeguard their interests by legally harnessing by all possible means and methods, adding to the variety of contracts. One remedial safeguard introduced leaves in its wake the potential for another kind of vulnerability. The net outcome seems to be web complexities and complications leading to litigation.

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Reasons for the complexities and complications

Let us take the example of earth work to understand the complexities in such contracts. Any construction contract by default involves some earthwork such as digging, leveling, filling etc. The interest of the owner awarding the contract may be either in the space dug as in foundations or canals or in the material removed to bundle roads or embank rivers, canals and tanks, or the combination of both dug and material removed. 

The variables, constraints, limitations, and conflicts of interest involved in construction contracts are presented under headings 2.3.1 through 2.3.4 by taking for illustration the example of earth work. In fact, earthwork is the basic and simplest in the context of overall contract. 

Types of soils and difficulty involved in excavation and estimation

The types of soils is a subject in itself. Just to give a flavor:

Based on particle and particle size soils are classified as Sand, Loamy and Clay.

There are other types of soil which are a mix of the above like sandy clay, loamy sand etc.

Based on their color soils are known as Red soil, Black soil, Brown soil.

In India there are eight major groups of soil[1] namely:

  1. Alluvial Soils 2. Black Soils 3. Red Soils 4. Laterite and Lateritic Soils 5. Forest and Mountain Soils 6. Arid and Desert Soils 7. Saline and Alkaline Soils 8. Peaty and Marshy Soils.

Add to the above the rocks, semi-disintegrated and disintegrated rocky soils encountered in excavation or drilling. 

Each type of soil presents its own hardships and costs in excavating or blasting and removing them. The mix of rocky and other types of soils in the worksite is both a nightmare and money bags to contractors, depending on which way one looks at them. It costs maximum to excavate/remove a cubic meter of rock than a cubic meter of Alluvial soil. The others falling somewhere in between. Sandy and clay soils present problems of a different type.

Monopsony nature of construction (project) owner

All high value or public interest construction contracts are owned and contracted out by the Government, State or Central as the case may be. The fact that Governments spend public money means the process has not only to be transparent but also appear to be transparent. This is a constraint in construction contracts. Accordingly, there are norms, rules, regulations, precedents set to be followed by Government authorities in finalizing and awarding a contract. All aspects considered the determining factor in awarding a contract is to L1, the one who bids the lowest for the work. 

Rates and costs

The rates paid for excavation and removal of different types of soils is different. Government departments have over the years come up with certain guideline rates. However, the contractor can quote his own rates, the awarding party only looks at the total amount not individual rates per se. The L1 principle. 

Minimization of risk and cost – maximization of savings/profit 

Each side to the contract, the owners and contractors wish to minimize their risk and cost and maximize their savings or profit. This leads to conflicts of interest. The contractor prefers chunks of work on piece work piece rate basis. The owner prefers to deal with a single or minimum number of entities – depending on size of the contract – with provision for the main contractor(s) to give out sub-contracts. 

In construction contracts while the volume of soil to be excavated can be more precisely determined the ratios of soil mix is difficult to predict. An estimate is made by sample drilling by the owner and accordingly the ballpark cost of the contract is fixed. The estimated figures cannot be held to strict proof by the bidder, but he is free to survey, drill and make his own assessment before quoting for the contract. Hypothetically let us say that the owner says 20% is rock and 50% is semi disintegrated-rock and the contractor’s survey shows that it is different say 40% rock and 20% semi-disintegrated rock, then he quotes a much higher rate for rock than normal and a lower rate for semi- disintegrated rock to ensure that his overall cost of excavation quoted is less than owner’s estimate to compete to be L1. When actual work is done the scales may swing way out of what is estimated or lie somewhere in between. The difficulty arises when the scale swings way out, for one’s loss is another’s bonanza, leading to distress and lookout for opportunities to litigate to mitigate loss. 

Laws – legalese – litigation 

Before diving into the subject let us see how construction contracts are different from other contracts.

What makes construction contracts different from others

  1. To begin with the construction industry itself is a specialized one with its own tailored designs and methods.
  2. Often there is more than one party to each side of the contract and co-ordination and collaboration between the parties is a sine qua non for completion of the contract. If one party fails or lags the entire project fails or drags, affecting every other party.
  3. As one could fathom by now there are way too many variables involved and a good number of them unknown or partially known and unpredictable. Even when some are predictable their extent and enormity cannot be predicted or estimated.
  4.  In most other types of contracts, it is possible to engineer and specify to a great extent, no matter how big in size or money outlay. This makes it possible to workout the project amounts more accurately. 
  5. Unlike other contracts the requirement of labor – semi-skilled and unskilled – is high in construction contracts.
  6. Construction contracts/projects are continuous in terms of time, money, and physical layout. They run into months, often years. 
  7. The involvement of land brings litigation related to ownership, acquiring the land for the project etc. Sometimes the responsibility is clearly defined. Many times, the onus is put on the contractor. Sometimes the contract document is silent, and each party lobs the ball into the other’s court. 
  8. Land clearing inter-alia involves removal or cutting of trees, forest clearance etc. Obtaining the forest clearances from concerned is not only difficult but like in acquiring land, the tussle as to who should do it turns contentious after signing of documents. 
  9. If the construction area is close to seacoast, river bed, waterbody or habitation then getting the necessary environmental clearances is another hassle.
  10. Particularly in construction contracts if disagreements lead to dispute litigation then they complicate and give rise to more problems rather than to an acceptable resolution. Result: sunk and unproductive costs compounded by cost escalations due to delays. 

Laws

In the west like in the United Kingdom and some of the states of the United States of America there are specific Construction Acts. In India there is no separate Construction Act. The law that governs a construction contract is the same law that governs other contracts viz – The Indian Contract Act, 1872. 

The contract made under the Indian Contract Act, 1872 to be valid, should be in consonance and not in conflict with any other laws or rules or regulations for the time being in force. So, depending on the scope of work and provisions of the contract the following are to be complied with.

  • Labor laws (Minimum Wages Act, Child Labor Act, welfare Acts of women & children)
  • Environmental laws (Related to pollution, forestry, coastal corridor etc.)
  • Land laws
  • Property Laws
  • Sale of Goods Act, 1930
  • Related State laws
  • Local Municipality/Corporation Rules and Regulations
  • Arbitration and Conciliation Act
  • Limitation Act, 1963
  • Tax Laws 

Legalese

The construction contract documentation runs from a few hundreds to thousands of pages. ‘The documents required’[2][3] in a construction contract are: 

  1. The Main agreement 2. General conditions 3. Specifications 4. Drawings 5. Special conditions* 6. B.O.Q (Bill of Quantity)  7. Contractor Bid 8. The Letter of Acceptance 9. Schedule of Rates 10. The Bond

Below are some of the ‘common conditions’ [2] in majority of projects:

  1. Definition of the project 2. Contract components 3. Project schedule 4. Rights and responsibilities for the owner and contractor 5. Payment method 6. Warranty and delay penalty

*Special conditions to a contract are the conditions required to suit the uniqueness of the project, or to make the contract flexible for the nature of the project to achieve the project objectives. 

[3] Ordinarily, reference in the work order or agreement to a particular document suffices to incorporate that document in the contract *Royston U.D.C Vs Royston Builders Ltd., (1961), 177 Estates, Gazette 589, Halsbury 4th Edition, Vol. 1 para 1107

*It is a practice in Arbitration and sometimes in judicial courts to refer to foreign judgements.

While the huge volume of work, high investment involving large resources including time are an overt reason for such voluminous documentation, the covert reason is the fear of losing in case of a disputed contest and therefore to legally secure oneself. 

What is important in a construction contract? To answer it is like answering the question ‘Which is the most important wheel in a car?’ Do you know the answer? It is the missing wheel! And everything important is reduced to writing in a contract, otherwise the party to the contract is in the danger of losing a legal battle when there is one. The express as well as subtle undercurrent beneath everything is that in the event of something going wrong or unexpected happening, who is going to pay for it? – to appreciate this point refer to ‘seigniorage’ under heading Litigation.

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Litigation

Construction contracts by nature of their size, complexity and imponderables are prone to some degree of disagreements and conflicts as they progress. Being human no two persons will view an issue from the same perspective. As if this is not sufficient, because construction projects affect the public, there will be interventions by the local bodies and authorities; public interest litigations by affected communities and spirited individuals are common, all in all making these a fertile ground for litigation. 

A sample collection[4] of regular cases and some cases peculiar to construction contracts are mentioned below. 

Force majeure: While the term is well known to parties to a contract it is not used in the Indian Contract Act, 1872 (Act, 1872). But, the impossibility of performance and the doctrine of frustration is embodied in Section 56 of the Act, 1872. In the case of, 

  • Satyabrata Ghose Vs Mugneeram Bangur & Co., AIR 1954, SC 44

It was held that an untoward event or change of circumstance which totally upsets the very foundation upon which the parties have entered into their agreement, will amount to force majeure

  • In Energy Watchdog vs CERC, (2017) 14 SCC 80 it was held that force majeure clauses are to be narrowly construed. Further, where the parties have a specific force majeure clause in the agreement, the provisions of the Indian Contract Act, 1872 would not apply. 

Seigniorage*: *Seigniorage is the difference between the ‘actual value’ and ‘cost of production’, claimed by the government – as a prerogative – particularly for soil taken from river beds, lakes and tanks. It is a factor probably not anticipated and therefore not considered at the time of bidding. We can see this in the case of NCC, … Vs Govt. of A.P & Ors. where the contractor Nagarjuna Construction Co. Limited (NCC) had to appeal all the way to the Supreme Court to get relief. 

  • In NCC, … vs Govt. of A.P & Ors. (October 20, 2008) where seigniorage fee was claimed from NCC, the Supreme Court pointed out that what was supplied was gravel from the quarry and the ordinary earth from patta land and therefore the argument that the total material received by BHEL was partly gravel from sources of foothills and partly ordinary clay from the tank beds and, therefore the material is subject to seigniorage fee was vitiated for the reason that there was no material supplied by one of the appellants namely NCC from the foothills and the tank bed lands. 

For the want of a power of attorney: Here is a case that reminds us of the quote by Benjamin Franklin “For the want of a nail… the kingdom is lost, and all for the want of a horseshoe-nail.” Only, in this case the contractor petitioner got relief from the High Court of Delhi. 

  • In IVRCL Infrastructures & Projects … vs National Highways Authority of India (NHAI) on 10th March 2011, Delhi High Court.

Briefly, IVRCL fulfilled the requirements in Request for Qualification (RFQ) and was short-listed as eligible for Request for Proposal (RFP) by NHAI. It is a bid for road work on OMC basis. The RFP submitted by the petitioner was accompanied by a bank guarantee of Rs. 15.00 crore as Bid Security Amount as per requirement. IVRCL (Petitioner), however, came to know that NHAI (Respondent) was treating the petitioner’s bid as non-responsive on account of an alleged defect in the Power of Attorney submitted along with the RFP document, the purpose of which was to authorize a person to submit the bid on behalf of the bidder. The Respondent penalized the Petitioner. Cut to chase the court in its judgment said, “We are, thus, of the view that the RFP submitted by the petitioner being responsive, the forfeiture is illegal and invalid and the petitioner is entitled to refund of the said amount from the respondent. This is apart from the reason, set out hereinabove, that the provision permitting forfeiture of 5 percent of the Bid Security Amount, even for a non-responsive bid, being penal in nature, was illegal. Accordingly, we direct refund of the Bid Security Amount within a period of 15 days from today, failing which, it will carry simple interest at the rate of 15% p.a.”

Here is a funny case, to lighten the mind from the legal cases above. The Newby–McMahon Building, commonly referred to as the World’s Littlest Skyscraper, which made its way to ‘Ripley’s Believe It or Not’ is reportedly the result of a fraudulent investment scheme. It is said that a man called J.D. McMahon was able to raise £200,000 so he would be able to build a 40 feet tall building. It is located at 701 La Salle (on the corner of Seventh and LaSalle streets) in downtown Wichita FallsTexas. The builder did not tell a lie – technically speaking. On the blueprints, he wrote 480 ” – meaning 480 inches – while everyone took it for 480’ (480 feet), much to the embarrassment of the city and its residents. [5] 

Dispute resolution

In India there are many recognized ways of contract dispute resolution – like, through court litigation, arbitration, mediation, conciliation, and dispute resolution boards. Each with their merits and limitations. After UNCITRAL agreement and the 2019 amendment to Arbitration and Conciliation Act, arbitration is often resorted to by the disputing parties. As to how satisfactory it is, is a moot point. 

Can something be done to reduce litigation

Trust and empathy are two requisites for a relationship that is to survive for a period, as in construction contract, to complete a contract gainfully. Trust and empathy are the first casualties whenever a dispute arises in a construction contract. So, next time a new and different type of contract is conceived to sidestep the situation. Thus, the variety grows by accretion rather than organically. Such additions are ad hoc or band aid solutions, with different methods of payment and clauses with each side covering its risk or feathering its nest. The wording of contract clauses effectively sweeping the risk into others fields has become a breeding ground for conflict and litigation. As arbitration evolved as an alternative solution worldwide over judicial court litigation there is need to think of an alternative way to draft construction contracts, then coming up with more varieties.

Summary and conclusion

  • There are many types of Construction Contracts. It is the result of many variables and uncertainties on one hand and driven by a fear to minimize the risk and an urge to maximize own benefits by the parties to contract on the other hand. 
  • The variety and clauses that are intended to ensure a win-win between the contracting parties are ending up as lose-lose solutions.
  • No doubt there are dispute resolution clauses and multifarious recognized systems of contract conflict resolution mechanisms, but how effective they are is debatable. 

To conclude, as a person with knowledge of construction contracts, engineering, and law, I see the approaches adapted are based on self-defense rather than safeguard all. The solutions are the end of the pipe solutions, moving the problems, not removing them. Like arbitration for dispute resolution, there is a need to come up with out of box solutions for construction contract documentation. To begin with engineering and legal heads from both sides are to sit together and proactively device contract documents based on equity and good conscience to deal with unforeseen factors. The clauses should focus on prevention and risk reduction, and apportionment of unforeseen costs rather than determining who should shoulder all such costs. Sounds utopian but it is more likely to produce results if time is spent proactively and collaboratively by the engineers and lawyers on both sides to the contract at the formation stage rather than wasting time and resources resolving the disputes.

References

[1] 8 Major Soil Groups Available in India an article shared by Negi Mohita on ‘Your Article
Library’

[2] theconstructor.org 

[3] Construction Contracts: Some Legal Aspects – P.M. Bakshi

[4] Sources of case laws: Construction & Engineering Laws and Regulation (iclg.com), India
Kanoon, Legit Quest and Lexology

[5] Wikipedia, builderstorm.com 


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