DIFFICULTIES IN DRAFTING OF CONSTRUCTION CONTRACTS

1. DIFFICULTIES IN DRAFTING OF CONSTRUCTION CONTRACTS Tejas Karia Partner, Head – Arbitration Shardul Amarchand Mangaldas & Co. 9 March 2019

2. Introduction - Construction Industry in India at present • India is projected to be the third largest construction market globally by 2030 • Government measures aimed at boosting the construction sector: • Relaxation of FDI norms (100% investment under the automatic route permitted in construction development (township, housing and built-up infrastructure)) add to growth of the sector • Input credit available under the Goods and Services Tax Act • However, projects beset with delays and cost overruns • Large sums tied up due to pending disputes • Disputes and resulting delays may slow the growth of the industry

3. Global Trends in Infrastructure Disputes *Global Construction Disputes Report, 2018: Average value and length of disputes.

4. Growth of Construction Industry in India *Ernst & Young, Making India Brick by Brick, Growth of India’s Construction Industry

5. Disputes in the Construction Industry • Disputes in the construction industry are of a recurring nature • Construction contracts are long-term contracts – increases possibility of disputes arising • Disputes typically arise due to: • Ambiguity in terms of the contract • Delay in completion of the project and request for extension of time • Variation in the scope of work of the contractor • Escalation in prices of materials and labour leading to demand for escalation in contractor's fee • Ambiguity in specifications issued by employer • Delay in issuance of specifications/drawings or handing over of site by employer • Employer’s refusal to certify bills raised by contractor

6. Contd…. • Disputes typically arise due to: • Delay in obtaining environmental clearance/ licenses/ permits for the project • Change in government policies (in case of contracts with the government) • Delayed payments to the contractor • Appointment of sub-contractor • Sub-contractor’s failure to complete the work as per specifications • Suspension of work by contractor due to unforeseen circumstances/ force majeure conditions • Termination by either party and invocation of bank guarantee by employer • Revision of specifications by employer • Loss of profit to the employer/ contractor due to delays in/ termination of the contract • Proper drafting of construction contracts integral to reduction of disputes

7. Contract Clauses to Look Out For Scope of Work Incorporation by reference Payment Time for Completion Liquidated Damages Procedure for making a claim Amendment/Variation Termination Dispute Resolution

8. Scope of Work • Scope of Work determines contractor’s obligations • Should identify stage-wise activities to be undertaken by the contractor • Scope would determine the range of activities included within the contract price • Any work done outside of the scope may give rise to claims for additional payment • The scope should be drafted in a manner that: • enables the parties to the contract to understand their respective obligations • Allows lawyers, judges/arbitrators to easily interpret the contract in case of a dispute

9. Incorporation by Reference • Construction contracts typically comprise several documents • Notice Inviting Tender • Letter of Acceptance • Contract Agreement • General Conditions of Contract • Special Conditions of Contract • Technical Specifications • Responses to Pre-bid queries • Drawings issued at the time of issuing the LOA • Important to identify the documents which will be considered “Contract Documents” • Typically, the Agreement will identify the documents which will be considered to be part of the contract • Inconsistency between documents should be avoided – Ensure consistent use of terms across all documents • The Agreement should specify an order of precedence among various contract documents (e.g. In case of inconsistency between LOA and responses to pre-bid queries, the latter will prevail)

10. Payment • Contract should specify type of payment • Fixed price (passes financial risk on to the contractor) • Item-rate - contractors are required to quote rates for individual items of work on the basis of schedule of quantities • Cost plus – Contractor is entitled to costs of labour and material plus a fixed amount designated as profit • Each type of contract has its own advantages and disadvantages • Fixed price contract reduces financial risks for the owner; however, it encourages contractor to use lower-cost materials • Item-rate contracts can be beneficial in cases where individual items of work can be clearly identified • Cost plus contracts may increase owner’s financial exposure; however, contractor has no incentive to cut on costs and therefore, may provide a higher quality product

11. Payment • Procedure for raising and verification of bills • Documents, if any, required to be provided in support of a bill • Time within which bill is to be either accepted or rejected • Consequence of rejection • Time within which bill required to be paid • Whether interim bills required to be raised • Authority which will be responsible for verification/approval of bills • Retention charges • Whether any retention charges will be applicable • Percentage of billed amount to be retained by owner • Payments for additional works • Escalation clauses – Contract may provide for escalation of contract price if works extend beyond specified time

12. Time for Completion • Contract may specify various timelines: • Date for handover of constructed asset to the owner • Date for completion of individual stages of the works • Period for curing defects • Whether time is of the essence of the contract • Failure to complete the works by the time specified would itself constitute a breach, entitling the other party to damages • Extension of Time - The contract should specify • the manner in which claims for extension of time are to be made • Time within which such claims are to be determined • Authority which will determine the claims (owner/engineer) • Situations in which claim for extension of time will be allowed • Whether claim for extension of time will entitle contractor to additional payment/prolongation costs

13. Time for Completion • Contract may also specify consequences of delay by the parties • Imposition of liquidated damages on the contractor (x per cent of the contract price for every week of delay, subject to a cap of a certain amount) • Termination of contract by the owner • Invocation of contractor’s bank guarantee • In case of delay by the owner in handing over the site or providing technical specifications • Contractor’s entitlement to prolongation costs • Typically, contracts do not give the contractor the right to impose liquidated damages for the owner’s delay • Contractors may wish to re-negotiate one-sided contract terms

14. Amendment/Variation • Contract should clearly specify the nature of changes that would constitute an amendment • Procedure for amendment should be specified • Mutual agreement of parties • Instruction issued by the owner • Impact of amendment/variation on the contract price ought to be provided • Variation must be in writing to be valid; contractor should seek written confirmation for any oral requests for variation

15. Drafting a Dispute Resolution Clause in a Construction Contract • Two Tier Clauses or simple arbitration? • Operational Level • Management / CEO Level • Engineer / Expert Adjudication • Whether any pre-arbitration steps are to be completed • Whether and which disputes shall be resolved through arbitration • Type of dispute • Value of dispute • The seat of the arbitration – should be clearly specified to avoid disputes regarding which courts have supervisory jurisdiction; parties may also include an exclusive jurisdiction clause • Merely specifying the seat of the arbitration may not suffice • Seat v. Venue

16. Contd…. • Law governing the arbitration • Determines the scope and validity of the arbitration agreement • Governing law of the contract • Determines the substantive disputes between the parties • Currency in which award is to be made • Bar on interest pendente lite • If the contract includes a provision barring award of interest pendent lite (that is, pre-award interest), arbitrator cannot award pre-award interest(Jaiprakash Associates v. Tehri Hydro Development Corporation, Civil Appeal No(s). 1539 of 2019, Supreme Court)

17. Contd…. • Clause should specify whether arbitration to be institutional or ad-hoc • Advantages of institutional arbitration • Parties can choose an institution which can provide specialist services or a panel of arbitrators with expertise in the construction sector • Parties and arbitrator are relieved of administrative burdens in case of an institutional arbitration • Rules of institution promote efficacy and speedy resolution • Rules provide for scrutiny of arbitral awards to ensure the awards are in compliance with the rules of the institute • Disadvantages of institutional arbitration • Institutional arbitration can be more expensive than ad-hoc arbitration • Parties cede control over the procedure to a third party intermediary

18. Contd…. • Procedure for appointment of arbitrators • Number of arbitrators • Manner of appointment • Appointment of former employees: Not invalid but may give rise to reasonable apprehensions (Afcons Infrastructure Limited v. Rail Vikas Nigam Limited Arb. P. 21 of 2017, Delhi High Court) • Time within which parties to agree on appointment (in case of appointment of sole arbitrator) or within which the parties’ respective nominee arbitrators to agree on appointment of third arbitrator • Qualifications, if any, of the arbitrator – parties may agree to appoint arbitrators with a requisite level of technical expertise • Compliance with 7th schedule (eligibility criteria) and 5th schedule (circumstances giving rise to justifiable doubts regarding the independence and impartiality of the arbitrator) – to avoid challenges to the appointment of the arbitrator or to the arbitral award at a later stage

19. Use of Standard Form Contracts • Parties should avoid using boilerplate clauses – dispute resolution clause should be tailored keeping in mind the nature/ value of the contract/ project • However, parties can adopt, for convenience, the dispute resolution clauses of certain institutions • Clause 21 of the 2017 Suite of the International Federation of Consulting Engineers (“FIDIC”) provides for dispute resolution • Clause 21 provides for reference of disputes to a standing Dispute Avoidance/ Adjudication Board (“DAAB”) • Clause 21.3 provides for ‘avoidance of disputes’ and allows parties to refer an issue to the DAAB, which may assist the parties or informally discuss and attempt to resolve the issue • Dispute avoidance/ resolution by the DAAB may be used as an interim measure until final determination by an arbitrator • The World Bank, in collaboration with the Indian Council for Arbitration has developed ‘standard operating procedures for dispute boards in India’ • Decisions of Dispute Boards are not binding in India

20. Contd…. • The Construction Industry Arbitration Council (set up by the Construction Industry Development Council and the Singapore International Arbitration Centre) recommends the adoption of the following model clause: “All and any dispute arising out of or in connection with this contract, including any question regarding its existence, validity or termination, shall be referred to and finally resolved by arbitration in [New Delhi/Singapore] in accordance with the Arbitration Rules of the Construction Industry Arbitration Council ("CIAC Arbitration Rules") for the time being in force at the commencement of the arbitration, which rules are deemed to be incorporated by reference in this clause.” • The CIAC Panel of Arbitrators includes judges, advocates, engineers, chartered accountants, director and other officers of PSU/Private Sector • Beneficial for parties to choose an arbitrator with expertise in the construction sector