Risk management

Managing risk in construction and development agreements

One of the huge challenges facing university estates teams is to replace or refurbish ageing, inefficient and inflexible buildings with modern spaces that deliver a competitive edge in attracting students, staff and research opportunities. According to the 2014 annual report of the Association of University Directors of Estates, the annual cost of meeting that challenge is £2bn (excluding residential accommodation), with institutions increasingly relying on surpluses and borrowing to fund their capital programmes. 

This article suggests some key ingredients that contribute to achieving a successful development or refurbishment project, whether or not the land is owned by the university. It then focuses on the key elements of a building contract or development agreement which drive quality, time and cost. 

First steps

A clear statement of the required outcomes for the project (and their respective priorities) is an essential first step. It facilitates the preparation of a business case identifying the need for change, reviewing a range of options and their respective costs, benefits and risks (legal, commercial and political), and recommending a solution. The prospects for success are enhanced by identifying a project champion within the university with personal responsibility for delivering the project. 

Identifying impediments and risk

The next step is to prepare a detailed assessment of the risks and impediments (internal and external) to implementation and to develop a strategy for addressing them. Risk should be assessed by reference to both the likelihood and consequence of occurrence of any event. The list will include issues of finance, funding and VAT, compliance with charity and procurement law, internal governance, HEFCE approval, legal title issues and the need for planning and other statutory consents. It should address the operational challenges during any on-campus development, and the importance of meeting teaching and research-led deadlines.

Appointing the contractor or development partner (‘developer’)

Aside from any procurement law requirements (beyond the scope of this article), the importance of engaging an external contractor or development partner with the appropriate technical competence, track record and financial soundness cannot be overstated.

The process includes an investigation of its financial strength, corporate and group structure, availability of funding (and pre-conditions to the availability of funding) and in appropriate cases the availability of a parent company guarantee and/or performance bond.

Quality

The risk is that the developer fails to deliver a good quality construction, including mechanical and electrical services and lifts, fittings and finish. An under-performing item may be repeated in many rooms.

The mitigation tools include:

✥use of a detailed specification (with specialist consultancy input as necessary) to reduce the risk of an under-performing product, and limiting the circumstances in which the developer may vary the specification

✥obliging the developer to construct to specified standards, including compliance with the specification, planning permission, building regulations and all relevant statutory consents and requirements

✥ensuring the university has the opportunity to approve the identity and terms of appointment of the key consultants and sub-contractors, including the terms of collateral warranties

✥ensuring the university has access to inspect the progress and quality of the works, with a mechanism for concerns
to be addressed

✥ensuring the university has meaningful influence over certification of practical completion of the works, including control over the extent of any permissible list of snagging items

✥ensuring the developer has ongoing obligations to rectify defects during an initial (minimum) 12-month rectification period, backed by a retention which the university can use if the developer defaults. 

Time

The risks are the operational, reputational, and financial consequences that flow if the works are completed late. In the context of residential accommodation it includes potential costs, claims and adverse PR if commitments to students cannot be met. The mitigation tools include:

✥a pre-agreed programme identifying key milestones. These can be linked to formal progress meetings where the university has an input in the outcome, possibly resulting in a requirement for the developer to deploy additional resource to ‘catch-up’ with the agreed programme

✥independent certification of any extension to the timescales (eg if delay arises beyond the developer’s control) with the certifier having power to decide whether any extended period should run concurrently or consecutively

✥a right to charge liquidated damages (‘LADs’) for each week’s delay. (LADs must be a genuine pre-estimate of loss, not a penalty)

✥as a last resort, failure to meet agreed milestones or insolvency should trigger termination or a right for the university to step-in after prior warning

✥where physical completion is time sensitive – as with student accommodation – it may be preferable to include a mechanism for the parties to agree a deferral (eg by a year). Whilst this may seem a drastic provision, it may be a useful risk-management tool for both parties, limiting a potentially large LADs bill that would otherwise be reflected in the contract price. The deferral decision needs to be taken sufficiently early to avoid the university incurring marketing and management costs and making commitments to students or academic colleagues that may not be met. 

Cost

The risk is that the total cost exceeds the university’s budget. The mitigation tools include:

✥using a detailed specification to enable the contractor to commit to a fixed price with minimal provisional sums
✥enabling the university to require variations to the specification without prohibitive additional cost
✥ensuring tight control over the build programme to minimise additional cost that the university might incur if the project is delivered late – eg the cost of temporary alternative accommodation, or the loss of rental income from a subletting
✥maximising the tax efficiency of any payments
✥structuring any funding deal to avoid excessive charges if there is a delay in drawing down funds
✥ensuring that the university is able to comply with any funding draw down pre-conditions at the point contract payments are due to the developer. 

From planning to implementation

As the project evolves from the business case and risk analysis to negotiation with the prospective developer, it is important to engage the wider project team – estates, faculty, project management, legal and finance – in the preparation of detailed heads of terms. Time invested at this stage in reaching an agreed position with the developer on the key commercial, operational and legal issues, will lead to a more efficient and cost-effective negotiation on the full legal documentation.

About the authors

Jason Prosser is a construction partner at leading education law firm Veale Wasbrough Vizards. Tim Smithers is a consultant solicitor in the real estate team. Jason can be contacted on 0117 314 5237 or at jprosser@vwv.co.uk. Tim can be contacted on 0117 314 5311 or at tsmithers@vwv.co.uk.

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