The construction sector continues to be buffeted by insolvencies and disputes. ISG might be the most high-profile recent casualty here in the UK, but it is far from the only contractor to have seen its finances unravel and the problem extends far beyond the shores of Britain. But why do so many construction businesses find themselves in financial difficulty?

Complicated contracting

There are, perhaps unsurprisingly, numerous causes, that have contributed to making construction a risky business but arguably the most significant, at least for the contractors, is how contracts are structured. Take, for example, fixed-price EPC (engineering, procurement, and construction) contracts. These are particularly common for large international projects and the rationale behind them is relatively straightforward.

The contractor undertakes to deliver a complete facility to the developer, who expects to save money and time by concentrating responsibility for the entire project with a single entity. In theory, this should lead to faster and less expensive projects by allowing enabling works under a separate contract whilst the design is finalised and for decision-making to be streamlined by replacing a chorus of competing voices with one authority.

Unfortunately, in reality it rarely works that way. The process of seeing a major construction project all the way from the first shovels entering the ground to handing over the keys is rarely free of any challenges. Imagine, if you will, having spent five years building a power plant. When you began five years ago, the world was yet to experience either the pandemic, inflation crisis, or major international conflicts that have emerged. It should be no great surprise that these have all had a significant effect on the progress of a project and the associated costs.

Down to the dotted line

If the price of a fixed-price EPC contract truly is fixed, the contractor will be financially responsible for any delay or cost overruns, leaving the contractor in a far from enviable position. Indeed, given the scale and cost of many major international projects, it would likely leave the contractor in an untenable position. ISG鈥檚 collapse which its chief executive linked to legacy issues with 鈥榣arge, loss-making contracts鈥� won as long as six years ago reinforces that point.

But if contractors are left so badly exposed by these contracts, why sign them? Because contracts are rarely structured in so simple a manner as to place all risk on the contractor without the ability to seek additional payment and extra time in which to complete the works. Perhaps unsurprisingly, it is hard to imagine many businesses being willing to sign a contract requiring them to effectively take on all the risk. For developers, too, a contractor willing to sign on the dotted line in such conditions should ring alarm bells.

In practice, fixed-price contracts are rather more complicated than the name would suggest. The price is perhaps best understood as a downpayment rather than a final figure, and although it is likely to have been reviewed, challenged and tested throughout the tender process, contracts will certainly contain numerous clauses that provide for what will happen when risks emerge over the course of the project. These will enable the contractor to claim for more time and money, but will be subject to typically strict rules, procedures and information being provided and complied with, if the contractor is not to breach the agreement.

Establishing balance

For these clauses to be written in a way that fairly balances the interests of the contractor and the developer inevitably takes a considerable amount of time, planning and preparation, and will almost certainly require external expert advice. It will also not ipso facto extinguish the possibility of subsequent disputes 鈥� these will inevitably occur on some projects because construction will always be a business that is variously beholden to people, time, weather, and materials.

But the reality is that many of these disputes, and indeed loss-making contracts, occur not because of an inherent flaw with EPC contracts but because the parties signing the contracts do not invest the required time and effort at the outset to ensure that the final contract balances the interests of both. There is also the reality that parties to contracts often do not fully understand and appreciate their contents, the obligations upon them and the liabilities they have signed up to.

Of course, there are alternatives to fixed-price contracts, notably 鈥榗ost-plus鈥� contracts. But the risks associated with these contracts for developers may outweigh the rewards, save in instances where a very high-level of planning has gone into a project, the design is at a mature stage, and there is justifiable confidence that it will be delivered roughly on time and at cost.

The alternative, as the increasingly large costs of delivering half of the originally planned HS2 illustrates, is that the balance-of-power will swing too far in the direction of the contractor. Whilst the dangers of this may be overstated, particularly in the private sector where there will be greater limits on a developer鈥檚 ability to increase a project鈥檚 budget, cost-plus contracts can incentivise contractors to spend money they do not necessarily need to.

On fair terms that are understood

Ultimately, the decisive factor in ensuring that a contract fairly balances risk between parties will not be the form of the contract 鈥� whether that is fixed-price or cost-plus. Instead, it will be determined by whether the terms of the contract are fair. There is no hard-and-fast rule for what makes a fair contract term, nor are there any short-cuts to drafting them.

The only certain solution to tackling the issue of unfairness in construction contracts is to ensure that they are negotiated properly in the first place. The crucial importance of such negotiations is all-too often overlooked, with both parties preferring to speed through contract negotiations to save money and time, but it is badly drawn contracts that lead to faltering projects and costly disputes.

A fair contract is not necessarily a balanced contract. Risk can be placed with a party but should be identified and understood and the 鈥減rice鈥� of that risk - in terms of time, money, and other factors - fully understood.

Disputes may be unavoidable, but the number of them on any particular project can almost certainly be reduced by increased engagement and collaboration between the parties at the outset.

Bill Barton is a director at UK-based Barton Legal.