Thinking about Alliance Contracting?
By Serge Mendis, Lovegrove Solicitors, Construction and Commercial Lawyers
In today’s crowded resources, infrastructure and development marketplace, alliance contracts are often posed as the new standard operating procedure for both private enterprise and also for government bodies. However it is still wise to think twice before entering into unstructured agreements like alliances.
A key issue to bear in mind with alliance contracting for many is that it is not really a contract in the traditional sense of the word. Although there is a central contractual document involving at least two parties, the focus of the alliance is more geared towards the end result, thus often leaving the process to achieve it less than certain. Traditional contracts, although often adversarial in nature, have a clear central document where obligations and responsibilities are set out, and the system for handling an unknown quantity, or more appropriately, who will handle the risk, is known by all parties to the contract at the outset.
In an alliance, self-interest will have to take a back seat, as the primary responsibility of all parties will be the delivery of the final outcome. All other considerations become secondary. This is not to say that alliancing is not a relevant form of project delivery, in fact it is all well and good for parties to enter into an alliance, as long as they are aware of the inherent differences in comparison to traditional contracting.
Where an alliance becomes a unique delivery vehicle is when parties converge their interests. Traditionally, a principal would want the best ratio of time, cost and quality possible, resulting in a speedy delivery. A contractor however, would benefit from a longer term or open ended contract. An alliance attempts to combine the interests of both, often providing the contractor with a bonus for early delivery.
Where such an arrangement can become problematic however is that it will require complete transparency from all involved parties prior to commencement. Significant front end work will be required by all parties to ensure that the risk to profit ratio is suitable. Establishment of the alliance will therefore require as substantial amount of trust, a commodity often in short supply in modern contractual relationships. In fact trust will be the catalyst for commencing an alliance, and it will also be the glue holding it together. The parties to an alliance really must have absolute faith in each other. A contractor will typically have to tender to be a part of the alliance, but will have to be entirely transparent about its processes and its margins, and a principal will have to appreciate that the contractor needs to make such a margin. In many circumstances a company’s main competitive advantage will be exposed for other members of the alliance to see, thus requiring the circle of trust to be absolute.
Without trust, an alliance will not work. Thus prospective parties to an alliance will need to carry out significant due diligence prior to entering into the relationship. This in itself generates a very large start up cost for the alliance vehicle. The high cost of commencement often leaves alliancing as the exclusive preserve of only top-tier organisations in their respective fields.
A further complication associated with the alliance is that instead of relying on a central document, decisions will be made by an integrated project team, or an alliance board. With a traditional contract, the construction program will be fixed from the start, and neither party will be keen on re-negotiating it. Where an alliance board is present, it will make key decisions in relation to the project on an ad-hoc basis as they arise. This results in the potential for major changes to the original scope being made during the execution phase of the project itself. This can be a disadvantage for both contractors and principals alike.
As the alliance instrument itself is nothing like a traditional contract, the alliance board is left to make many of the key decisions that arise during the project. This will include resolution of disputes. Alliance contracts will invariably have no formal dispute resolution clauses. Often, there is also no inherent right to sue another party in the alliance, unless the circumstances involve fraud or misleading/deceptive conduct. As it is the responsibility of the alliance board to make a decision regarding any dispute, or any unexpected changes to the program as they arise, this can lead to time and cost overruns beyond original projections.
If a project requires several changes, principals can risk getting bogged down and being exposed to higher costs. If delivery is not timely, the contractor also risks losing any potential bonus. As time and cost obligations are often less important in an alliance, parties who enter into the alliance must have complete focus on the end outcome. For this reason, many entities which might otherwise consider alliance arrangements may prefer other forms of project vehicle. Government bodies for example are often bound by both budgetary considerations and time constraints, thus making an ‘open ended’ alliance risky.
The cost and time paradigm can also affect security of finance. Once again, enhanced due diligence will come into play in this instance. Notwithstanding the fact that banks are slowly coming to terms with alliance contracting, the level of due diligence required will often keep such alliances outside the scope of smaller organisations, as only the larger entities or government bodies will be able to secure finance for such projects. When engaging in lengthy and large scale projects, alliances can often be a method of achieving good results for both principals and contractors. For the time being, smaller entities can rely on traditional contracting arrangements to ensure project delivery, whilst minimising time and cost excesses.