What Is Going On?
Recent Trends in the World of Construction
By Arthur Cox Construction Team
The Irish construction sector has experienced a few busy years now, with no immediate sign of let up. New projects and developments are visible all around Dublin, and in other areas of Ireland. The high level of construction activity, however, is now leading to disputes, as projects commenced in 2015 and later are now being completed. Notably, adjudication, which has applied to construction contracts and appointments entered into after 25 July 2016, is on the rise!
Activity continues to be focussed in the private sector, including commercial and residential development, healthcare, retail and leisure, as well as wind and other renewable energy projects. International companies operating in the pharmaceutical, IT and data centres also remain active, with new and extended facilities being developed around Ireland. There is also increased activity in the semi-state sectors reflecting the growing economy, with sod now turned on the new runway at the airport. Public sector contracting continues but is less dominant than it was a number of years ago. Again, this is likely to change over the next year or two and public private partnerships are also likely to have a renaissance later this year and into 2020, to deliver both accommodation and other key social and transport infrastructure.
The sustained levels of activity across a range of sectors combined with the increasingly international players involved means there is diversity in the procurement models and forms of contract being adopted. Timing and quality of delivery are often taking precedence over price, which has allowed more successful use of early contractor involvement, particularly in design & build arrangements, as well as more diverse pricing structures such as management contracting, GMP and target pricing.
Positively, development financing is on an upward trend with various alternate lenders and international traditional lenders becoming increasingly more visible on the Irish development landscape. The current “hot” development financing structures are forward fund or forward sale agreements and are most common in the following sectors: accommodation projects for the Private Rented Sector (PRS), student accommodation, commercial office space and hotels.
Project financing has continued to be very active as the need to plug the Irish infrastructure gap and to prioritise decarbonisation has come into sharp focus following the publication of the National Development Plan 2018 – 2027. Competitions for financing mandates for shovel-ready projects are invariably over-subscribed, as the window for constructing projects which can benefit from the REFIT 2 and REFIT 3 support regimes is closing. Meanwhile the detail on the design for the forthcoming Renewable Electricity Support Scheme (“RESS”), a firm date for the first RESS auction and confirmation of whether an extension to the REFIT timeline will be granted (to extend out the closing date for energisation to December 2020) are all still eagerly anticipated. In renewable energy project financings, various domestic and international banks are willing and able to take construction risk and are offering increasingly attractive terms with tighter pricing and innovative opportunities for developers to release equity post commercial operation. Refinancings of operational projects are becoming more common as developers seek to secure better terms and extract value from their now de-risked projects, which can be achieved either by agreeing new terms with a new lender group and agreeing a new suite of documentation, or increasingly more commonly by documenting through an ‘amend and restate’ with the existing lender group, securing more attractive pricing terms and by replacing Debt Service Reserve Accounts with Debt Service Reserve Facilities. Refinancing operational windfarms on a portfolio basis has the potential to deliver even more competitive terms and could see a continued influx of non-bank lenders or institutional investors, whose presence in the Irish market has been noticeably on the rise.
The growth also of more complex funding and purchase arrangements to facilitate development, with the preponderance of parties requiring collateral warranties from the various parties involved in both design and construction has focussed minds on seeking to limit liability which a contractor or designer may potentially have on any one development. Caps on liability are becoming the norm, accompanied by a variety of other limitations which parties will look for (but not always achieve!). Alongside this, comprehensive insurance coverage is a must. Latent defects insurance (although a relatively newcomer to the Irish market) is frequently required by lenders particularly those domiciled in the UK.
Adjudication is now taking off as a further means of resolving ‘disputes relating to payment’: the number of adjudications increased exponentially in 2018, with at least 25 appointments made by the Chair of the panel (and likely a similar number of adjudicators appointed by agreement). In addition, the ‘threat’ of adjudication, particularly by disgruntled sub-contractors struggling with delayed payment has, anecdotally, made a discernible difference to payment practices.
As Brexit looms, there are increasing concerns about Brexit, its impact on the construction industry and associated risks, including the potential costs and delays arising from imports, exchange rates and regulation. There are a lot of unknowns as to how Brexit may impact the industry generally, or a specific project in particular and incorporating a “Brexit clause” into your contract may help. The key question to consider is how you wish to deal with the risks associated with Brexit (and the answer to this question may not be the same every time). Should there be a risk sharing or should one or other of the parties shoulder additional costs and delays which may arise?
While, from an Employer’s perspective, it might look attractive to push this risk onto the Contractor, this approach may not give the best outcome or be either reasonable or practical, requiring the Contractor to build a significant contingency into the contract price. Some form of risk share may provide a more reasonable solution, and leaves it open to the parties to develop a dialogue in circumstances where Brexit does have an impact on the particular scope of works, whether through additional costs, delays or shortages of labour and materials. In addition to these considerations, sharing the burden of Brexit could also include agreed trigger events, notification procedures, consequences and remedies.
For parties who currently have construction contracts in place, it may be worth reviewing contracts to assess how Brexit would impact on specific projects; for example, what are the implications of delays to the project and how are damages for delay set out. If you are entering into a new contract now, it would be prudent to consider the specific implications which Brexit may have on the project. This can be done by including a provision expressly dealing with the Brexit-related risks, which will ensure that the parties have a clear mechanism which they can revert to when assessing the impact it may have on cost and time, while also providing certainty.
Achieving price certainty (whether by way of a ‘guaranteed maximum price’ mechanism or otherwise) in construction projects is a consideration that is becoming increasingly important for developers and employers, particularly in larger contracts both in the private and public sector. Price certainty is also important where a project is being privately funded by a bank or financial institution, as the cost of construction is often linked to the level of debt funding available. Strategic planning at an early stage of the project is critical in determining the preferred contractual approach to maximise price certainty. Often, key factors to consider at this stage include an assessment of (1) how time sensitive the delivery of the project is (2) the quality of the works required and (3) the budget or cost available for the project.
Where price certainty is a key consideration for the developer, there are a number of ways that this can be achieved contractually. A cost-reimbursable contract with an upper limit for the cost of the works beyond which the contractor takes the risk (known as a ‘guaranteed maximum price’ or GMP contract), can be attractive to employers in many ways, as it can enable a contractor to start works at an early stage in the project, before the design has been fully developed. This approach can be problematic, however, where it seeks to impose an unduly high level of risk on the contractor, particularly where there are unknown factors in play at the time the project is tendered (e.g. the scope of works or the design). This can ultimately result in a higher likelihood of disputes and costs escalating under the contract.
Fixed price (or lump sum) contracts are often used in the delivery of traditional build only and design/build construction projects. This type of arrangement provides the most cost certainty and will usually come at a premium. The downside of this structure is that the project will have to be as close to fully designed as possible (by either the employer’s or contractor’s design team) to enable the contractor to accurately submit a fixed price. Where the design is not fully developed at the time the project is tendered, contractors can end up pricing unknown contingencies into their bid to account for cost overruns (increasing the cost to the employer of the overall project), or compromising on quality to ensure that the works are delivered within the set price.
These considerations are just some of the decisions employers and developers face at the outset of a project, in determining the best contractual approach to adopt. In our experience, project planning is critical at these early stages to ensure that the contractual structure appropriately reflects the key risks associated with the project and the parties’ objectives. One size rarely, if ever, fits all. In the current Irish market, where developers, employers and state bodies are under increasing pressure to deliver projects quickly and on-budget and where design may not be finalised at the outset of the project, the design/build fixed price model is falling out of favour for the reasons outlined above. It will be interesting to see whether this trend continues in 2019 and beyond.
Niav O’Higgins, Partner and Head of The Construction and Engineering Group, Arthur Cox.
Karen Killoran Partner, Construction
Niamh McGovern, Senior Associate, Infrastructure, Construction and Utilities
Ciara Dooley, Associate, Infrastructure, Construction and Utilities
Charlotte Upton, Senior Associate, Project Finance