December 09, 2019 In-House Counsel’s Desk

What is Wrong With Design-Build Contracting?

Jamie Peterson

Not all is well in the world of Alternative Project Delivery.  In the past year, several large design-build contractors elected to limit or end their pursuit of certain types of design-build or P3 projects.  When announcing these pullbacks, executives from the contractors explained that the risk allocation for these projects was out of whack, resulting in substantial losses to the companies.  No large engineering and design firms have announced similar dramatic withdrawals, but they too are being more selective about their pursuits for similar reasons.  From my perspective in the legal department of a large national engineering and design firm, these pullbacks are not a surprise.  For too long, owners have been flowing down inequitable and unsustainable risk to the design-build teams while reaping most of the benefits of these delivery systems.  A complete analysis of design-build contracting is beyond the scope of this article, but I will provide a few examples of unsustainable risk allocation that must be addressed for the long-term benefit of both design-build teams and owners.

Contractor Market Retreats

During the summer of 2019, SNC-Lavalin Group, Inc., Fluor Corporation, and Granite Construction Inc. all announced large quarterly losses resulting from mega-fixed-price alternative-delivery projects, and stated these losses were forcing them to alter their business strategies.  SNC-Lavalin Group will no longer bid on lump sum turnkey construction projects and will restructure the company.  The retreat was announced in a July 22, 2019 video posted on the company website, where interim CEO Ian Edwards stated that fixed-price contracts are the “root cause … of performance issues,” adding further:  “I think the current model within our industry is broken.”  

Granite Construction announced a large Q2 loss in August resulting from legacy fixed-price projects in its heavy-civil group, and CEO James Roberts stated “[i]t is now clear that, especially in the context of these megaprojects, the fixed-price design-build contract delivery model and public-private partnership … model resulted in an untenable imbalance in risk sharing.”  Other examples exist as well.  Fluor reported a large loss in Q2, and in September, announced the results of a strategic review that included plans to limit or end its pursuit of fixed-price projects across multiple market sectors.  In announcing its new project criteria, Fluor stated, “[f]or lump-sum projects, the terms and conditions must have an appropriate allocation of risk between client and contractor….”  Finally, Skanska quit the United States P3 market last year, electing not to pursue any work in which it would have an equity stake.

There has not been a similar exodus of large design firms from the design-build market, but they employ heightened risk-management procedures to evaluate these opportunities and are being selective in the projects they pursue.  These market retreats and additional scrutiny are the inevitable result of inappropriate contract terms being imposed on design-build teams by owners and their legal advisors.

Principles of Equitable Risk Allocation

A fair allocation of risks is essential to maximize the likelihood of a successful project: “a reasonable price, qualitative performance and the minimalization of disputes.”  Conversely, “[i]improper risk allocation may … result in prolongation of construction completion times, wastage of resources, and increased likelihood of disputes.”  Equitable risk allocation is by its nature subjective, but common factors cited for determining how to allocate risk include: (1) which party can best control the risk and its consequences, (2) which party can best foresee and bear the risk, and (3) which most benefits economically in controlling the specific risk.  In the world of design-build contracting, equitable risk allocation frequently does not occur due to uneven bargaining power and short-sighted decisions by owners to flow down risks that arguably should not be transferred.

Application to Design-Build

There are many benefits to owners utilizing the design-build delivery method, including projects that are generally completed faster and at a lower cost by allowing innovative approaches through early and continual contractor involvement during design.  The design-build contractor serves as a single point of contact responsible for both the design and construction of the project.  The benefits to the design-build team are less clear, but the risks are readily apparent.  The compressed process that design-build procurement entails results in price, schedule, quantities and other key decisions being made earlier and with more unknowns.  Rather than submitting a bid based on a complete set of design documents, the design-build contractor collaborates with a designer to submit a proposal – generally a firm fixed price – with the benefit of only thirty percent design drawings and frequently under a tight deadline.

The short time frame elevates the importance of the design, information, and reference documents that owners include with their solicitations.  Design-build teams do not have time to verify all of the details contained in these documents before submitting their bid.  Under the principles of equitable risk allocation, the resulting design-build contracts should be drafted to reflect that owners are in the best position to know the pre-existing condition of their site and the details of the conceptual design and specifications prepared prior to release of their solicitations.  The design-build contracts should thus provide price and/or schedule relief for any errors in these documents.  However, many design-build contracts provide the opposite and expressly prohibit reliance by the design-build team.

The same issue exists as to third-party risk, whether pertaining to utilities, regulatory agencies, or other stakeholders.  Design-builders are being asked to bear the risk of issues that are out of their control and extremely difficult to quantify prior to submitting a proposal.  It is inevitable that, as the design advances from thirty percent to one hundred percent, changes will be identified, and design-build risk allocation needs to be rebalanced accordingly.  Much of this risk would typically remain with owners when utilizing the design-bid-build delivery system, and there is no justification in transferring it to the design-build teams for design-build projects.

Inequitable risk allocation in design-build contracts negatively impacts designers as well.  First, design-builders seek to flow down these excessive risks to their design teams.  Second, once the inevitable change occurs during the post-award design phase, if the design-build contractor is unable to obtain price and schedule relief due to an onerous design-build contract, the design-build contractor frequently repackages its loss as a professional negligence claim against its designer.  Designers and their professional liability carriers are not a sustainable source of funding for changes on complex design-build projects that should be borne by owners.

Conclusion

While owners and their attorneys may be satisfied with the current risk allocation in their contracts, such short-term thinking has led us to the current situation where contractors are pulling back from the alternative-delivery project market.  What is needed instead is a long-term perspective on appropriate risk allocation for the sustainable health of all parties in this market.  Otherwise, owners may find a lack of qualified design-build teams responding to their solicitations in the future.

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Jamie Peterson

Senior Attorney & AVP, HNTB Corporation, Oakland, CA, Division 11 (In-House Counsel)