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Technical Briefing Joint Ventures What are the Risks? CONSTRUCTION SERVICES AJGINTERNATIONAL.COM ARTHUR J. GALLAGHER 2 Arthur J. Gallagher Construction Services recently hosted a joint seminar designed
Technical Briefing Joint Ventures What are the Risks? CONSTRUCTION SERVICES AJGINTERNATIONAL.COM ARTHUR J. GALLAGHER 2 Arthur J. Gallagher Construction Services recently hosted a joint seminar designed to provide participants with an insight into the issues surrounding Joint Ventures. Chris Doran, Partner at DAC Beachcroft LLP, explored the issues surrounding liabilities and the allocation of risk, Edwin Lawrie, BAM Nuttall Limited, then examined the insurance considerations and Andrew Marsh, also a Partner at DAC Beachcroft LLP looked at the professional indemnity issues. Following on from the presentations a panel comprising the main speakers, together with Mike Roberts, Managing Director, Cunningham Lindsey Construction and Jason Stephens, Arthur J. Gallagher, took questions from the audience. 3 CONSTRUCTION SERVICES AJGINTERNATIONAL.COM ARTHUR J. GALLAGHER JOINT VENTURE CONTRACTING: LIABILITIES AND THE ALLOCATION OF RISK CHRIS DORAN, PARTNER, DAC BEACHCROFT LLP The Hon Mr Justice Akenhead recently reminded an audience that the roots of our modern system of construction law lie in the Code of Hammurabi, devised by the sixth King of Babylon in 1772BC. The code had a certain simplicity in its provisions. It provided that: where a contractor builds a house for a man and does not make its construction firm and the house which he has built collapses and causes the death of the owner, the builder shall be put to death; if it causes the death the son of the owner, the builder s son shall be put to death; if it be the case that the slave of the slave of the owner is killed, the builder shall give the owner of the house a slave of equal value; if a man makes a breach in a house, code required that the builder should be put to death in front of the breach and then thrust through it. The code therefore created a very simple regime. The builder didn t really need any insurance save perhaps for some good life assurance. However, today s construction contracts are considerably more complex and so are the insurance requirements needed to support them. What is a Joint Venture? Joint Ventures have become increasingly common here in the UK and internationally too. There are good reasons for this. The UK Government entered into its first Joint Venture arrangement a couple of years ago with Capita. Most recently when the Prime Minister of China visited the UK he entered into a Memorandum of Understanding with the government for the design, construction and operation of both new and existing rail infrastructure. In the past 18 months China has invested eight billion pounds into projects in the UK, many of which are taking place through the medium of JV arrangements, and the government expects that the use of JV contracting will continue to increase significantly in the future. It s therefore timely that we should be examining those risks today. A Joint Venture (JV) is a commercial arrangement between two or more participants (whether individuals, partnerships or companies) who agree (either for a specific project or for a limited period of time) to participate in a business enterprise, usually for profit. JV partners frequently share profit and risk equally but they are free to agree and allocate both as they wish. Joint Ventures have become increasingly common here in the UK and internationally... and the government expects that the use of JV contracting will continue to increase significantly in the future. CONSTRUCTION SERVICES AJGINTERNATIONAL.COM ARTHUR J. GALLAGHER 1 Types of JV arrangement Any kind of collaboration can be regarded as a JV. In the case of an integrated JV, the partners work together to share expertise and resources to deliver a project. Here the JV partners work so closely that it is often impossible or impractical to determine which partner has committed a breach of contract or other default and, as a consequence, they generally share liabilities and profits. In these circumstances, the partners will normally consider project or JV specific insurance arrangements. In a non-integrated JV the partners have distinct roles for example, one producing the design and the other carrying out the construction works. Here, despite their joint and several liability to the employer, the partners may retain rights of recovery against each other and reliance on their respective annual policies may be more appropriate. The benefits of JV contracting In 2011 the average construction dispute in the UK was around 6.5m. By 2012 it was 17.7m. Globally, the average dispute is about 20.4m and in the Middle East the figure is 40m. Part of that increase (as far as domestic disputes are concerned) can be explained by the fact that smaller disputes tend to be dealt with through adjudication with only the larger disputes going through the courts. Construction disputes are becoming larger and more complex so contractors need to look more carefully at how they can share and allocate risk. In addition to sharing risk, JV contracting offers participants additional benefits too. One is that the JV model allows them to combine talent and resources; helping them to avoid errors in bids and increase their bidding power and economies of scale particularly important in the case of very large projects. JVs can also assist expansion into new markets, for example where one partner joins up with a local partner to help compliance with local pre-qualification rules and thus enhance its chances of winning the contract, particularly in relation to government backed projects. Depending on the circumstances there may well also be tax advantages to adopting a JV structure. For employers JVs are attractive because, in addition to delivering economies of scale, greater competition and broader expertise, the ability of JVs to assume a greater level of risk in certain contract forms, for example in the case of the FIDIC Silver form, enables the employer to purchase a level of cover beyond that which is the norm for other forms. Structure of JV arrangements It s important to ensure that there is a JV agreement in place setting out the liabilities and obligations of each JV member to the other. A well structured JV agreement should set out: the purpose of the JV; how it will be managed; the contribution of resources that each JV partner will make and how profits (and losses) will be shared; the obligations of each partner effectively what each is bringing to the arrangement and what they will be doing; how risk and liability will be apportioned; how disputes will be resolved particularly important given that the number of disputes between JV partners is currently increasing; and, how the venture will be funded. There are a number of ways in which the arrangements can be structured, each of which has pro s and con s: Partnership Either in the form of a Limited Liability Partnership (LLP) or a less formal unincorporated partnership. The advantages are that such arrangements are inexpensive to set up (and to terminate) less formal (especially in the case of non-llps) and each partner is able to retain control over its own resources and maintain accounting privacy. The negatives are that unless an LLP is created, liability for each partner is unlimited. There may also be issues surrounding funding and access to performance bonds and/or parent 2 CONSTRUCTION SERVICES AJGINTERNATIONAL.COM ARTHUR J. GALLAGHER company guarantees with the parent less likely to provide these, especially where they may be liable for the activities of the other partner. Corporate Entity This is the most common form in more complex and longer term projects. The pro s are that a separate legal entity is created with clear management structures, limited liability and financial integrity assets are held in the name of the JV entity which may help with financing options. Against this is the fact that, depending on the jurisdiction, there might be significant compliance requirements. Further, there may be less flexibility in governance arrangements and, should the partners wish to terminate the arrangement, this is more complex to achieve. Finally, the obligations of each partner can be unclear meaning that it s extremely important to ensure that a comprehensive JV agreement is in place from the outset. Non-integrated JV These are generally utilised for very short term projects where it is easy to distinguish between the services of each partner. No formal partnership or other company structure is created and each partner is responsible for specified work and is responsible for providing the expertise and resources to carry out that work. Under such an arrangement there is no sharing of profit and losses how efficiently each JV partner carries out its share of the work determines the level of profit enjoyed by that partner. The advantages are that each partner is able to compliment the other s skills one may be responsible solely for design the other only for construction. Plus, such arrangements quick and inexpensive to set up and the insurance arrangements required are much less complicated. Against this, the absence of a unified management structure can lead to disputes and, as with unincorporated partnerships, there may be difficulty in obtaining access to finance, performance bonds and/or parent company guarantees, with the likelihood that partners will need to access bonds through the commercial rather than insurance market. Ultimately, the chosen structure will depend upon a number of factors including: the commercial objective of the JV. In the case of a single project there is likely to be a looser arrangement, where a multi-project association is involved then there may be a corporate entity; the tax position; liability and the importance placed on limiting liability will dictate whether adopting a corporate structure or a looser LLP type arrangement is appropriate, as will decisions taken as to how the partners wish the JV to be managed; the question of whether assets (including intellectual property) are to be owned individually or corporately; the ability to access funding, which may be enhanced by the adoption of a corporate structure; and, whether it is possible to distinguish between the work of each partner. Where it is then the option of adopting a non-integrated arrangement is available. CONSTRUCTION SERVICES AJGINTERNATIONAL.COM ARTHUR J. GALLAGHER 3 However, whatever structure is adopted it s vitally important to ensure that the roles of each partner are clearly set out and that a controlling participant is identified. The type of insurance that will be required will depend upon the nature and structure of the JV arrangement and therefore thought needs to be given to this before the JV is formalised. Obligations of JVs under the standard forms of contract A discussion of a contractor s obligations and the requirements of the insurance provisions under the main standard forms of contract could justify a separate seminar. Nevertheless, it is useful, before Ed and Andrew consider in detail the insurance issues arising out of JVs and JV projects, to briefly consider some of the key provisions. The Contractor general obligations and risks The key obligations for the contractor under each of the main forms of contract, JCT, NEC and FIDIC Red Book, are set out in Table One: Contractor obligations/risks. The first four which can broadly be summarised as being; (i) to carry out the Works in a proper and workmanlike manner; (ii) to complete the design, (iii) to use materials and goods of the right kinds and standards as set out in the Contract Bills and (iv) to complete the Works on or before the Completion Date set out in the contract. The contract goes on to provide that the contractor is to make good any defects particularly important to remember the need to consult insurers before decisions are taken which could affect insurance cover. NEC Section 2, of NEC3 sets out the main obligations. The first is to provide the Works in accordance with the Works Information which either specifies and describes the Works or sets out any constraint on how the contractor provides the Works. Where design is involved, the contractor is required to design the Works in-so-far as the works information provides. In keeping with its intention to promote collaborative working, NEC also requires contractors to work with others to provide the information they need in order to provide for the completion of the project successfully by all parties on time. JCT Where JCT is concerned, the relevant section is again section 2. Clause 2.1 requires the contractor to carry out and complete the Works in a proper and workmanlike manner. Clause 2.2 requires the use by the contractor of materials that comply with the contract documents. Clause 2.3 requires the contractor to proceed regularly and diligently with the Works. FIDIC FIDIC section 4 requires that the contractor shall complete the Works in accordance with the contract and the engineers instructions and goes on to deal with how the contractor is responsible for all of the temporary structures that are put on site and for the adequacy of all site operations, plant and materials. The Contractor insurance obligations The JCT, NEC and FIDIC forms of contract provide very complex provisions for the insurance of risk and the allocation of risk. However, a key point to note is that the insurance provisions of each contract are not intended to be an exclusive definition as to what insurance is actually required for any given project. They simply respond to the works that a contractor is instructed to carry out and the level of risk he has been asked to assume. Contracts that successfully allocate risk take into account a number of points. Risk should be allocated to the party that is best able to control that risk. Risk allocation should encourage good management by the party that carries the risk. Parties are motivated to manage risk by the potential financial consequences of assuming the risk. Risk should not be allocated to a party that is unable to sustain the level of the risk it is being asked to take on. 4 CONSTRUCTION SERVICES AJGINTERNATIONAL.COM ARTHUR J. GALLAGHER Table One: Contractor obligations/risks Obligation JCT NEC FIDIC (Red Book) To carry out and complete the works in a proper and workmanlike manner (in accordance with the Contract (FIDIC)) (includes Permanent, Temporary Works and Materials) To complete the design To use materials and good for the works of the kinds and standards described in the Contract Bills To complete the works on or before the completion date (Covered by clause 4.1 above) Notice by Contractor for delay to progress /16.1 (early warnings) Contractor to make good defects Consent needed to sub-contract works Comply with instructions issued Comply with Health and Safety requirements (i.e. CDM regs for JCT) Indemnities provided to Employer 6.1 & Consent for assignment Co-operates with others 25 To obtain Performance Security 4.2 To appoint a Contractor s Representative 4.3 Co-operate with Employer s Personnel, other Contractors and Public Authorities Set-out the work in relation to original points, lines and levels referred to in the contract Testing Preparation of programme Where the allocation of risk is split this should reflect each party s ability to influence the likelihood of a loss and its impact on the works being carried out. So, for example, if there s a joint party arrangement between contractor and employer, in so far as one or other is able to influence risk then this should have a bearing of what level of risk should be apportioned between the two. A common misconception in relation to insurance is that because a contract form indicates that a contractor is responsible for taking out insurance, the contractor will ultimately be responsible for that risk. That is not the case. The party ultimately responsible for the risk will depend upon the wording of the contract itself. So, for example, if a contractor takes out cover for damage to the Works, but damage occurs as a result of works carried out by, or activities of, the employer, then unless the employer s liability excludes this then the employer will be liable for the loss. CONSTRUCTION SERVICES AJGINTERNATIONAL.COM ARTHUR J. GALLAGHER 5 Table Two: Insurance Contractor Obligations summarises the sorts of risk that each of the three main contract forms requires to be insured and the provision under each contract that sets out that obligation. Under the NEC and JCT forms the indemnities are part-and-parcel of the insurance arrangements so, in order to understand the insurance component, it is necessary first to understand what indemnities the contractor provides to the employer. NEC Section 8 of the NEC form of Contract sets out the allocation of risk. Clause 80.1 sets out the areas of risk for which the employer is solely responsible (the Employer s Risks ), including: (i) claims, proceedings, compensation arising from the use of the site by the works and any negligence caused as a result of the actions of the employer; (ii) any loss or damage to plant or equipment supplied by the employer to the contractor (which is the employer s risk) (iii) loss or damage to the work, plant and materials due to specified risks such as wars, or radioactive contamination are also at the employer s risk. The contractor will not have liability should these risks occur. Where the Works have been taken over by the employer on completion of the Works then the employer carries the risk for the Works unless the loss occurred before the issue of the Defects Certificate due to a defect that existed at takeover or is an event occurring before takeover that was not an Employer s Risk. The areas of risk for which the employer is responsible having been set out in clause 80.1 from that point on the position under the NEC form is relatively simple; starting with the Start Date under the contract, and until the Defects Certificate for the Works (or any section of the Works) all other risks are carried by the contractor, unless that is altered in the Contract Data. Therefore, the contractor must provide those insurances set out in the Insurance Table in the NEC form. The insurance that the contractor must take out is a joint risks policy not envisaging subrogated claims against other JV members but rather in the form of a joint names policy. The policy will include loss and damage to the works plant and materials, loss and damage to equipment, liability for loss or damage to property or any liability for death or personal injury. The only contract in the JCT and the FIDIC suites that alters these positions is the Silver Form for Turnkey contracts pursuant to which the employer pays a premium to the contractor to take on a higher level of risk. FIDIC FIDIC deals with risk in a similar way, it sets out risks that the employer is responsible for with the other risks to be borne or dealt with by the contractor. It is not seeking to identify fault. It is simply the case that where there is loss or damage then the contractor must have taken out insurance against those risks. There are two types of insurance required: -- The first is insurance for the Works, plant, materials and contractor documents and employer s equipment for full reinstatement for damage to those items arising from any cause, whether or not the contractor is contractually liable for the damage. The insurance taken out by the contractor can exclude certain types of loss including those arising from defects in the design that is not its responsibility; and parts of the works which are lost or damaged in order to reinstate another part of the works which is the result of defective design. So, for example, if there were to be defective design in area one and in carrying out remedial work damage occurred in area two this latter damage would be something the employer would have to assume the risk for. -- The second is for loss, damage, d
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