Cashflow is the lifeblood of the industry, said Daniel Xu, Partner, King & Wood Mallesons MENA, while participating in the third edition of The Client, Consultant, Contractor Conference, organised by CPI Industry on September 30, in Dubai. Those consultants, contractors, manufacturers and suppliers that participated in the event agreed and added that the lifeline has long suffered under unmet payment terms leading to project delays, capital losses and very tight margins. Although payment terms have been an age-old problem, Rachel Ewin, Director, Contract Services, Turner & Townsend International Ltd, said that over the past 10-15 years, a number of initiatives have been rolled out in the United Kingdom and in the GCC region to help rectify the situation. Providing an example, she points to a 30-day payment process that has been implemented in Abu Dhabi. “We are moving forward,” she said. However, Ewin pointed out that there are a number of steps that stakeholders can take in order to protect themselves from common challenges related to payment terms and avoid costly legal disputes down the line.
TAKING A CLOSER LOOK
Ewin said that an important first step is for stakeholders to have a thorough understanding of the contract by looking at the terms and conditions, including the level of accountability among parties, the timing and amount of the payment as well as the protocols in place, in the event there is a disputed amount. “We have seen payment terms of up to 120 days, which is unsustainable in this industry,” she said. “It doesn’t help anybody’s cashflow incentives. This is affecting productivity, as well, and encouraging people to potentially swap out products. It becomes more about the price rather than suitability or value for money, and that is reducing the quality of the products used in the industry.”
Peter Anagnostou, Senior Associate, DLA Piper, said that while admittedly it takes time, effort and resources to analyse a contract, it is an absolute must. “The thing to remember is there is no construction law or act in the region,” he said. “The contract is the legal mechanism that governs the relationship between both parties, so it’s a very important document that should be taken seriously by both parties before they sign and also during the course of the project.” In agreement was Euan Lloyd, Senior Counsel, Al Tamimi & Company, who emphasised that ‘the devil is in the details’. “Once a contract has been signed, it’s a binding constitution between the parties,” he said. “You are held accountable based on the contract, even if you aren’t aware of the pressure points. It is worth to invest time and money to make sure there is clarity in this regard.”
Anagnostou said that in many instances, parties expect that the contract will be similar to those in previous projects. “However, in an evolving market, such as the Middle East, contracts are becoming much more sophisticated,” he said. “Each time, various changes may get more complex and more one-sided. You need to be aware of that before you go on working on a project, because a slight change to one clause can make a huge difference in your ability to claim or your liability. You need to be careful that you don’t take it for granted that the contract will remain the same every time and you take the time to look at it carefully and make sure you understand how it works for each particular project.”
Anagnostou also emphasised that the contract goes beyond the terms and conditions and includes the scope of work and specifications. “What we see in relation to design is that the specification will have a section that says, ‘The contractor is responsible for designing the following’. But it’s broad, very general and not clear,” he said. “It’s difficult to really identify where the scope of design begins and ends. You need to ensure that you carefully look at the specification before you agree to them and that there are no ambiguous descriptions in the contract when it comes to design responsibility. Once you clarify that, it should be pretty easy for the contractor to say ‘This is not my responsibility’.” Lloyd added that another issue to take into consideration is the incorporation of contractual terms by reference. “A contract may include entire clauses and may incorporate various other contracts,” he said. “Unless you review these additional revisions, which are incorporated by references, you could be signing up to various unknown risks.”
DRAFTING IDEAL CONTRACTS
Anagnostou said that stakeholders ought to take a more proactive role from the onset during the drafting of the contract to ensure all parties’ concerns are taken into consideration. “Historically, a lot of clients we see in the region have always just accepted the terms of the contract,” he said. “I know sometimes it’s not an option if you really want to work on a project, but there are ways to negotiate changes without losing that work. You have a position, you can negotiate particular terms, such as payment provisions or some kind of suspension clause that gives you the right to suspend if you don’t get paid certified sums within a reasonable time. These are some of the things to really consider before we sign a contract.” Ewin added: “Before you put pen to paper, you have the tender clarification period [there was a pre-defined period within the contract of the person asking the question] to make sure you have all the elements negotiated written down for clarification. We tend to see too many grey areas, making the contract quite broad. Specifications drawn up are done that way as a catch-all. We would suggest that within the tender clarification schedule of the contract you make sure that those inclusions are ratified and put down.”
The drafting period of the contract also allows the parties to prepare and protect their interests from variations. Ewin said that with a number of stakeholders contributing to the design of construction projects, it is inevitable that each party has a different want, need and requirement. The challenge is incorporating all of these into the contract, she said, otherwise the consequences are costly. “I had one instance where it took two years to get the full design of a project, including how and where we position the site,” she said. “The contract was signed and the value was up in the billions. One person, who was influential but not part of the project, decided they didn’t want that project on their doorstep, so the first variation is to move it six kilometres down the road, which had a massive impact on time and budget.” It is these things that the team and supporting legal counsel must look into before entering projects, she said. “One of the things we do is stakeholder mapping,” she said. “We figure out everyone involved, including how and what their level of influence would be. We analyse the different criteria and what the critical parts are for that project to work around the devised strategy to effectively be able to move forward.”
In some companies, Ewin said, there are regular meetings to solve the disputes that emerge in the course of the project. “What we have started doing when we are drafting or assisting in drafting the contract is to get the client and contractor in the same room and play a contract game playing out different scenarios,” she said. “‘For example: If we follow this clause to the letter, and you do not do what it stipulates, what will happen? Is it good or bad? What do we do to rectify it or to put something in place, so it doesn’t happen?’ When that happens, people understand what the contract says and how it can help and hinder you.”
Anagnostou added that it is also important to note that there are different types of variations within the contract. “You need to really understand the payment mechanism in your contract, whether you need payment upfront before you undertake the variation or whether you are expected to carry out the variation without payment and then receive some kind of valuation down the track,” he said. “You need to understand exactly what your exposure risk is, so you are not exposed to large variations, which you are liable for and which you might have to pay for in the future.”
Xu added that internal communication also plays a key role throughout the process. “What usually happens when the contract is being pushed through is that you have the site team not talking to your commercial or contracts team and going ahead, because they don’t want to cause delay,” he said. “Then, you have the contracts team finding out later there is a substantial change. It is important to maintain regular communication between commercial and contracts and the team on-site.”
However, despite the best efforts of all the parties, there are unavoidable instances where disagreements escalate. Lloyd said that one of the major problems in the perception among stakeholders is that if there is a dispute that can’t get resolved, they need to go to court or arbitration. “Both methods are fairly expensive and fairly time-consuming,” he said, adding that disputes often come down to opposing personalities. “Views between both sides become fairly entrenched,” he said. “I think sometimes it does help to have active involvement in the project.” Weighing in, Anagnostou said that in a lot of instances the contract states that if there is a dispute, parties may refer to arbitration, but, he emphasised, it doesn’t mean it’s the only option available to the parties. “The parties, at any time, can agree between themselves in writing to adopt a different mechanism that will suit them at the time,” he said. One way, Anagnostou pointed out, is through mediation. “While not as developed in the region, it is definitely becoming more popular,” he said. “More and more trained mediators are entering the market. They are actually qualified to mediate disputes here in the region, which makes a big difference.”
Anagnostou said that another benefit of mediation is that it provides both parties with a decision to take to their respective managements, which will ultimately make the final call. “It saves both parties a lot of time and money from actually going through arbitration or the court process,” he said. However, Anagnostou admitted that there are instances where arbitration is unavoidable. “If it’s a large and complex dispute, it needs to have that level of expertise and time offered by arbitration to analyse the evidence and review the complexities,” he said, “but if you’re looking for a short and quick solution for a very small dispute, then mediation is an option.”
Anagnostou also noted that, “Just because there is notice of arbitration it doesn’t mean that the parties are required to proceed all the way to arbitration,” he said. “You can stop at any time. We find that sometimes all it takes is for that notice to be filed and arbitration to be commenced to encourage parties to come to the table and negotiate sensibly some kind of settlement.” Xu agreed, adding, “It is about the message behind it.” Lloyd added that he believes there could be an opportunity for regulatory bodies in the Middle East to introduce a fast-track dispute mechanism, such as adjudication, which has worked so well in many jurisdictions around the world.
Anagnostou said that the most important thing from a legal perspective is to ensure claims are properly drafted, in accordance with the contract, and issued to the actual employer on time, and in the manner that it’s supposed to be issued. “I know sometimes contractors and suppliers are wary that if they issue claims it might cause problems, and cause aggression and antagonism between clients and parties,” he said. “But it’s really important to put your position down in writing at every stage of the project to protect yourself in the future.” He also emphasised that in the construction industry, having claims is not new or unusual. “You shouldn’t be scared to submit claims in accordance with the contract, to ensure you have protected yourself from variations and any kind of change during the course of the project,” he said.
Lloyd added that many stakeholders find it difficult to demand changes, owing to current market conditions and increased competition, in turn owing to the presence of a large number of players in the market. However, he emphasised that there is scope for negotiations, as long as the party can justify why they want these changes. “Sometimes, you don’t get completely what you want, but rather a compromise and get at least halfway there,” he said. “An example would be the ‘pay when paid’ [clause], which is a preference in this region and it can be a real killer to cash flow. There are certain ways to mitigate the harshness of the ‘pay when paid’ clause, like a transparency regime, whereby you get clarification or notification as to when payment has been made by the employer, which can then be flowed down to you. You just have to work out what’s important to you. Pick and choose your market. If you have the product at best price and that satisfies the consultant, you should be in a fairly decent position.”
Anagnostou added he has seen clients achieve positive results by negotiating amendments and not simply rushing to sign the contract. “You need to understand your commercial position,” he said, also emphasising that it is possible to present legal arguments on why certain provisions should be changed. “Sometimes, you can’t convince the other side to change clauses, because they don’t understand why,” he said. “All it takes is a simple letter from a lawyer, one page, saying ‘We have looked at this clause and the impact of this clause on the project would be as follows, therefore we suggest it gets changed to this’. If you can produce such a letter to the other side, saying, ‘My lawyers say the clause should be changed, because it could harm me down the line, it’s not my opinion, it’s their opinion’, that might be an added piece of leverage. Then, the other side can say to its management, ‘They can do the work but only if we change this clause, based on their lawyer’s advice’. Sometimes it takes some creative thinking to find a solution to the problem without an argument.”
Adding to this, Xu said that he has also seen subcontractors that are known for having a stomach for the fight when not paid. “In that sense, they have cultivated that market reputation that they don’t get pushed around and that they get their money back,” he said. “That’s one angle, if you are not that high up the value chain. You need to have a market reputation that you don’t get pushed around and that you will collect when you’re supposed to be paid.”
As such, Anagnostou encouraged stakeholders: “Sit down, think about the contract and ensure it works for all parties before you execute it. Hopefully, it will work throughout the project, as it should to ensure there is cashflow between parties.”