Thursday, 19 September 2019

Many of Australia’s mega projects have been living up to their name in the worst possible way, beset with mega delays, mega cost blow-outs and mega disputes.

As an experienced restructuring partner, my work involves stepping into the middle of mega project disputes to map a way forward for aggrieved parties.

By the time people speak to me they have exhausted a range of expensive, litigious and combative pathways. It’s only when people are in absolute dire straits and heavy financial distress that they come together and collaborate, after the intervention of an independent voice. Wouldn’t it be a better idea if we started from this place from the outset?

What I want to suggest is that we do things differently and change the way we think about the contractor-principal-subcontractor relationships, the tender process and applying a bespoke approach to contracts.

Things will go wrong!

Firstly, we need to accept that infrastructure is complex, challenging and highly technical. There are known unknowns, and unknown unknowns, if that makes sense. In short: things are going to be challenging.

A 2016 study by the Grattan Institute analysed more than 500 Australian transport infrastructure projects between 2001 and 2015 and found that for projects costing in excess of $600 million, more than 50 per cent experienced cost overruns and these overruns averaged more than 50 per cent of the original projected project cost. The bigger the project, the bigger the problem.

Construction can be difficult as we saw many years back when the cost to build the Sydney Opera House blew out by a whopping 1400 per cent. It was originally forecast to cost $7 million, but actually cost $100 million and took more than a decade to complete.

The problem is only getting worse in Australia. Based on publicly available information, the INPEX Ichthys LNG project is double the original budget of $20 billion. Similarly, the Chevron Gorgon LNG project was approved at USD 37 billion and is now hovering at USD 54 billion.

There is no shortage of reference points that confirm that in construction of infrastructure, things will go wrong. However, the way we contract our mega-infrastructure projects assumes it will be problem free. We’re starting the construction on the wrong footing. 

Short comings of EPC contracts

So let’s dig a little deeper into the problem with modern-day EPC infrastructure contracts. Contracts are drawn up assuming things will be fine and there will be no construction issues. The principal says to the contractor: ‘I want a fixed output, at a fixed time and for a fixed cost. Any derivation from that is your risk, your problem and your cost, contractor.’

That works fine for all parties if there are no construction issues, but evidence and history shows there are. So we are contracting for an outcome which is not a reality. We should be contracting as if we hope there will be no issues, but expect there will be. And therefore have a legal framework to rectify the unforeseen issues, rather than resorting to finger pointing and blaming.
EPC contracts are at the heart of the problem. These contracts ultimately pass on the most legal and financial risk to those who can least afford to carry it. The principal carries no risk and pushes the risk down onto contractors. The contractors then seek to push the risk down further, to subcontractors who have an even less ability to carry the risk.

So, when something goes wrong, and history says it does, the parties revert to their corners, call the lawyers and commence a fight. They have to do this because under the EPC contracts, the contractors and subcontractors are carrying a disproportionate amount of risk which they cannot carry, forcing them into a dispute-first approach.

The commonly accepted alternative is an 'alliance' style contract. These contracts are focused on a collaborative style of construction and are very popular around the world. This mode of contract shares the risk between the principal, contractors and subcontractors. And so, when problems arise, there is a greater focus on working together and driving the construction completion as the priority.

However, my view is that the best chance of success is not picking an alliance contract or an EPC contract. Rather, the principal and then the tendering contractors prepare a bespoke contract for the bespoke construction project.

So essentially, picking the best parts of the clear risk allocation in the EPC that work for the specific construction, and overlaying it with alliance style ‘cost plus’ type clauses. Importantly, spending time on constructing a contract that works for the principal, the contractor, and, as a result, motivates everyone to execute the physical construction on time and on budget.

'We’ve always done it this way' risk and iterative tendering

While this may sound incredibly optimistic and an unrealistic utopia, there are two concepts principals and contractors can embrace to maximise the chances of a successful construction. Or importantly, minimise the disruption in time and cost, when construction goes awry. And these two concepts are not commonplace. Even if the stakeholders say they are, they are not done with genuine conviction or throughout the organisation: 

1. Iterative tendering

While all principals will say there is consultation during the tender process, the contractor is very much on the outside. The principal spends many months and years, documenting their project and ultimately then gives the contractor a small set window to sign up and provide a construction cost number. This is not best practice. Principals go through many internal processes, approvals, committees, etc, and it is then provided to the contractor to asses with limited engagement.

An iterative tendering process will engage a set of tenderers at the very early stage. A brief is provided and discussed openly as a group. Side one-on-one meetings are also held between the principal and the contractors. The contractors consider the brief and subsequently report back.
The contractors give feedback on construction challenges, timeframes, risk allocation, authority interface, and compliance. 
The principals consider the feedback from the contractors and refines the project requirements. And this happens numerous times over the course of many months. 
This process does not hamper the competitive tension or the due diligence process. If anything, it maximises competitive tension as all contractors fully understand what they are tendering for, and therefore risk is appropriately priced in and with a clear knowledge of the scope of works.
What ultimately eventuates from this process is that all contractors will generally agree on what risks they are willing to take on and what risks they are not willing to take on. And while this will mean the principal will be taking on more risk, the contractors will be pricing the construction more accurately because project knowledge is so far greater and the risks can be understood and priced.
It also ensures the project starts in a collaborative fashion. The contractors feel like they are part of the principal’s team and are working together. We have seen this happen as a matter of course.
2.  Removing 'we’ve always done it this way' risk.
This approach is best described as ‘counterparties agreed to this clause previously, so you should’, or sometimes internally as ‘on the last project we did this, so we should do it again’.  Yet not enough thought goes into the fact that this build and the previous build are completely different. That previous clause may have been appropriate for the previous build, but not this one. My personal view for taking this approach is that employees are too hesitant to change. Employees take the view that if they are copying what has occurred previously, they cannot be criticised. This is not a proprietary approach to the project, rather a simple and unsophisticated mode of going about business. Employees who take this approach have a fear of criticism, rather than being focused on what is best for the project, and how it can be completed most efficiently and cost effectively.
We see this in many facets of the construction process, including contractual clauses, appointing of consultants, tendering processes, risk sharing and many other areas in the construction of mega projects.
Now you may still think this is unrealistic, however, I have seen this play out many times. Just not from the start of a project. It is only after we are called in and the project is at a crisis point, that parties focus on:
  • Sharing information on the construction to completion and how to allocate risk to get this build over the line as quickly and as cheaply as possible.
  • Accepting that where parties have come from will not get them to where they want to go. Parties are then willing to change contractual terms and take a bespoke approach.
If parties took this approach from the beginning, the success rate of completing on time and budget would be materially improved. It’s just a shame that it currently takes a moment of ultimate crisis to get everyone pulling in the same direction and collectively focused on completing the project.

Lack of leadership and an MO of fighting

Because we now have generations of employees who have only worked in the infrastructure construction industry with EPC contracts, which breeds litigation and dispute, we have a generation of employees who know nothing else. Their default setting is to fight rather than resolve. As a consultant to this industry, and a consultant in the most stressful situations, employees simply cannot see any other way of resolving issues other than litigating.

To change the modus operandi of the way we build in Australia, we need strong leadership from the c-suite. We need to have the CEOs, CFOs, General Counsels and COOs, who are always on message around partnering with our counterparts. Fostering an MO of collaboration should be a key pillar of every principal, contractor and subcontractor, with senior management setting the standard within the organisation.
Having strong leadership from the CEO and board of directors, that sends a message of collaboration in the infrastructure industry, that people want to work with us, and we care about what our counterparties say, can change the attitude of an organisation significantly. Further, with the senior management’s involvement in disputes and seeing these words in action, resonates deeply within an organisation’s employees and can have a stark impact on culture. Without this leadership, can you blame employees for their fear of criticism and adopting the 'we’ve always done it this way' approach?

In conclusion

Finally, we are in the middle of a national infrastructure boom, with both state and federal government splashing tens of billions of dollars on transport, infrastructure and other public works in a mega project spending blitz. This should be a boom time for contractors and those helping to build the nations new bridges, roads and infrastructure networks. Yet, many industry insiders view our infrastructure contracts as somewhat of a poisoned chalice.

This has led to industry participants leaving the industry citing an inability to make these projects viable in the Australian market. Plus, Prime Minister Scott Morrison recently conceded that fast tracking mega-infrastructure projects to simulate the economy will lead to cost blowouts due to the constraints.
However, by changing some fundamental ways we tender, contract risk, collaborate first rather than litigate first, and show strong leadership in the c-suite, we will see a step change improvement in completing our mega-infrastructure projects on time and on budget.
And this is not an unrealistic utopia. I have seen it happen many times when people have their backs against the wall. We just need the spirit of collaboration to emerge from the get-go, rather than as a consequence of crisis and project failure.