The commercial reality model

A balanced contract is generally what the market price is to complete a job properly. Interestingly, the best quality product comes at market price too.

Forming construction contracts can be a daunting task. The biggest problem is the language, which in itself isn't hard; it’s just hard to understand what it means to the contracting parties. A lot of 'trust' is placed in others to get it right and to get the best possible outcome and that is where the problems start, the best possible outcome for whom?  I've found that clients generally want to make money from a project when finished, not through the process of delivering the project.

So they form a contract to achieve their outcomes and engage legal teams to look after their interests. The legal teams then manage these interests through various contract clauses and the output can be a very one sided affair. But at what premium and is the outcome really a good deal? How can you get the contract to get you what you wanted? The answer is balance. The more balanced a contract is, the more likely a better overall result will be achieved.

Early in my career I learned an extremely valuable contracting lesson about the 'cause and effect' of modifications to standard contract terms. I was working with a guru in contracts, Brent, when negotiating a heavily modified construction contract. I sat for 4 hours in awe as he helped four Partners from two different law firms and two in-house legal counsels come to the realisation that the contract they'd prepared might not get their client the best deal. It wasn't balanced enough. There wasn't enough left for innovation. And the client had noticed too.

The lawyers had done nothing wrong. They were protecting their clients’ interests, and transferred as much risk as possible to the contractor. What they didn't fully comprehend was what that might do to the price of the project or the programme. They did when we'd finished and the contract was far more balanced at the end of the session. As Brent and I talked afterwards, he explained all he was doing was balancing their arguments with a dose of commercial reality. The words on paper didn't convey the intent or how the other party may react to them. Experience did.

So I turned Brent's approach into a diagram. The contract is the pivot point. Contracts are a formal record of risk allocation, an insurance policy that IF something happens, they're used to apportion risk transfer. The balancing act comes when you price out the risk in time and money. Equal and opposite as Newton used to say and nothing is for free. More risk on Contractor, higher price. More risk on Client, lower price. Similarly with the time taken to complete projects.

A balanced contract is generally what the market price is to complete a job properly. Interestingly, the best quality product comes at market price too. Transfer risk too much either way or quality suffers. Innovation comes when the price is high, it allows room for contractor to provide delivery innovation and return the balance. The counter to this is that the client needs to innovate too to allow that to happen.

Balance, pivot, action and consequence.  I have drawn the above diagram on the board in my own legal sessions since and helped everyone understand what we're trying to do.  A really useful concept that's easy to grasp when you're in a room full of lawyers trying to get a good deal. For you and your client.

Ignite Your Thinking

What Do You Think?

Charles · 10/12/2015 10:02:43 AM
Thanks for sharing this insight- I'm posting the blog post to NZ Contractor magazine's <a href="https://www.linkedin.com/company/nz-contractor-magazine" target="_blank" rel="nofollow">LinkedIn page</a>.

Barry · 18/11/2015 4:56:36 PM
Great article and a very insightful approach to contracting. I often have contractors asking what contract they should use when clients want to engage them. More often than not I would have recommended a contract that tended to be balanced in their favour.

Your explanation above is brilliant in its simplicity. A great read and I will be sharing.

Thank you