Introduction

This guide briefly describes the following types of contracts that are commonly used to deliver construction projects:

• documented design (also known as construct only)
• design development and construct (DD&C)
• design, novate and construct (DN&C)
• design and construct (D&C)
• design, construct and maintain (DCM)
• guaranteed maximum price (GMP)
• managing contractor
• alliance
• privately financed project (PFP).

For each type of contract, guidance is provided on:

• when its use would be appropriate
• its benefits, and
• associated risks.

Table 1 below indicates in general terms which phases of a construction project can be incorporated into each type of contract.

Note that the procurement process is in effect a continuum, and that, provided the required scope of work is clearly defined, a contract can be drafted to incorporate whatever proportion of the design, documentation, construction or maintenance is desired.

Table 1. Relationship between contract types and project phases

Contract type	Concept design	Design development	Documentation	Construction	Maintenance / Operation
Developed design				Yes
DD&C		Yes	Yes	Yes
DN&C		Yes	Yes	Yes
DDC&M/O		Yes	Yes	Yes	Yes
D&C	Yes	Yes	Yes	Yes
DC&M/O	Yes	Yes	Yes	Yes	Yes
Managing contractor	Yes	Yes	Yes
Alliance	Yes	Yes	Yes	Yes
PFP	Yes	Yes	Yes	Yes	Yes

Different contractual arrangements allocate risks differently between the contracting parties.

For example, under a D&C contract the contractor accepts more design-related risk than for a developed design contract. As a result, the agency is exposed to less risk of cost increases due to documentation errors and related claims.

However, as the amount of detail provided in the tender documentation decreases, the agency relinquishes control of the design and accepts increasing risk that the completed work will not meet its expectations.

The agency may need to direct variations if its requirements are not clearly described in the tender documents, resulting in additional costs and delays.

Increasing the contractor’s design obligations is also likely to lead to:

• longer periods for tendering and tender evaluation, with associated higher costs for industry and the agency
• higher tender prices to allow for the associated risk transfer, and
• higher cost impacts if the agency requests a design change.

The major benefits of a D&C contract derive from the control the contractor can exercise over design details and the timing of the work. The contractor’s ability to introduce innovation can lead to cost savings for the agency, and design and construction activities can be overlapped in order to meet program requirements.

Figure 1 indicates how, in traditional construction contracts, the allocation of design control and design risk changes with the type of contract used.

With managing contractor and alliance contracts, the agency’s design risk can be reduced by involving the contractor in developing the project brief and scope and the detailed design.

The contractor’s design risk does not increase markedly under these contractual arrangements since payment for early development work is on a 'cost plus' basis and the target price is not agreed until the scope of work the contractor is to complete is fully understood.

Including maintenance in a contract that includes design and construction can reduce quality risks and improve value for money, as there is an extra incentive for the contractor to maintain standards in order to reduce maintenance costs.

It is important to take the relative benefits and risks into account when selecting a contract type. The information in this guide is intended to assist in the selection process.

Documented design (construct only)

With a documented design contract, most of the design, including drawings and other design documentation, is prepared by consultants engaged by or on behalf of the agency.

Tenders for the construction contract are not called until the whole of the work is designed.

While the tender documents include detailed drawings showing the proposed work, the contractor is nevertheless required to complete the design so that it is suitable for construction. This might include determining window framing details or the locations of handrail stanchions or preparing workshop drawings for structural steelwork or air conditioning ducting.

The contractor is paid on the basis of a lump sum price or tendered rates. Additional amounts are payable for changes to the agency’s requirements, errors and omissions in the agency’s tender documentation and, usually, circumstances such as unexpected adverse site conditions.

Figure 2 shows how the management approach can be represented:

Design development and construct (DD&C)

Under a design development and construct (DD&C) contract, the contractor is required to engage its own consultants to develop a preliminary design provided by the agency. The contractor prepares construction documentation and constructs the asset.

The preliminary design work, carried out by consultants under the agency’s direction, may include a concept design, a functional design or a performance specification.

The contractor is paid on the basis of a lump sum price or tendered rates. Additional amounts are paid for variations to the agency’s requirements, but because the tender documentation is not detailed, the agency is exposed to less risk on account of errors and omissions than for a developed design contract. The risk of latent conditions is generally allocated to the contractor.

Figure 3 shows how the management approach can be represented:

Design, novate and construct (DN&C)

A design, novate and construct (DN&C) contract is similar to a DD&C contract. Its distinguishing feature is that a single designer or design team is used from concept design through to design completion.

The agency engages a designer to carry out early design work, under a design agreement. The agency then enters a contract with a construction contractor.

When the construction contract is let, the agency novates the design agreement to the contractor. Novation involves signing over the contractual relationship between the designer and the agency to create a contractual relationship on the same terms between the designer and the contractor.

The contractor then assumes full and unambiguous responsibility for the whole of the design as well as the construction. The contractor takes over responsibility for paying the designer's fees for work done from the time of novation.

Figure 4 shows how the management approach can be represented:

Note that both the design agreement and the construction contract must include provisions foreshadowing the planned novation to the contractor. A form of novation agreement is generally provided in the design agreement and the construction contract.

Design and construct (D&C)

For a design and construct (D&C) contract, the agency provides a project brief, which may include some concept design and specifies performance and quality requirements.

The contractor engages consultants to prepare or complete the concept design, develop the design and prepare construction documentation. The contractor may also be given responsibility for obtaining approvals from authorities.

A 'supply and install' contract can be a form of a D&C contract.

The contractor is paid on the basis of a lump sum price or tendered rates. Additional amounts are paid for variations to the agency’s requirements, but the agency bears little of the risk of errors and omissions in tender documentation, since the contractor prepares the bulk of the design and documentation. The risk of latent conditions is generally allocated to the contractor.

Figure 5 shows how the management approach can be represented:

Design, construct and maintain (DC&M)

Under a design, construct and maintain (DC&M) contract, the contractor is provided with a project brief, generally including some concept design and the quality and performance requirements of the asset are specified.

The contractor is responsible for the preparation or completion of the concept design, development of the design, preparation of construction documentation, construction of the asset and maintenance for a specified period (say 10 years).

Asset condition monitoring indicators are specified, by which the performance of the completed asset will be measured during the maintenance period.

A DDC&M contract is similar, but a larger proportion of the design is completed before awarding a contract. Maintenance can be included in a developed design contract, but will not offer the same advantages as are gained if the contractor is responsible for design or design development.

Design construct and operate (DCO) contracts and DDC&O contracts are also similar, but include a requirement for operation instead of maintenance.

Figure 6 shows how the management approach can be represented:

Guaranteed maximum price (GMP)

Specifying a Guaranteed Maximum Price (GMP) can provide greater certainty of meeting the required project end cost and completion date. It is generally applied to a DD&C or a D&C contract.

The GMP contract is designed to limit changes to the contract price or completion date and to reduce contract management effort by incorporating terms such as:

• allocating to the contractor the risks associated with ambiguities or discrepancies in the tender documents, by allowing no claims for variations resulting from such ambiguities
• not requiring the contractor to use preferred or selected subcontractors
• including no provision for additional payment on account of latent conditions
• allowing no cost adjustment for inflation
• reducing the contractor’s entitlement to extensions of time, for example by disallowing claims on account of inclement weather or industrial disputes.

A GMP contract may include a provision requiring the contractor to provide offsets to maintain the original contract price by reducing the quality or scope of the work if the agency directs a variation. It may also allow a bonus for early completion.

Unless the agency directs a change to the scope of the project, the contractor must complete the work for the tendered lump sum price.

Managing contractor

A managing contractor contract is generally awarded early in the design phase, after a project brief or a concept design is developed. The tender document sets a target construction sum (or target price) based on the estimated cost of the construction work and a target date or dates for completion.

The contract is awarded on the basis of non-price criteria and tendered management fees.

There are many possible variants of a managing contractor contract. Some commonly used features are described below.

The contractor undertakes a significant part of the role a project manager carries out in a more traditional procurement approach. The contractor may be required to obtain development approvals, liaise with user groups and carry out site investigations.

The contractor engages consultants to complete the design and develops a program for preparing documentation, construction, commissioning and maintenance or operation.

For this development and management work, the contractor is paid the actual costs of consultants and service providers, often based on an open book approach, and the tendered management fee. The management fee can be a lump sum or a percentage of actual costs.

During this first stage, the contractor assesses the total cost to complete the contract work, including subcontractor costs, consultant fees and its management fee.

At a time when a firm estimate of the cost is possible, the contractor is required to submit a guaranteed construction sum (GCS) for agreement, or to confirm that the work can be completed for the target construction sum.

The GCS must not be greater than the target construction sum, and the contractor may be entitled to an incentive payment if the GCS is less than the target construction sum.

The contract may include an option to test the market, on the basis of completed designs, and elect not to accept the contractor’s GCS.

If the GCS is accepted, the contractor completes the construction documentation and manages the work covered by the GCS, including construction, commissioning and maintenance/operation if required. The contractor may choose to achieve the target completion dates by commencing early construction works before the design is completed.

The agency may direct variations to the work after the GCS is accepted, but if it does, it must adjust the GCS accordingly. The contractor warrants that the GCS (as adjusted for the principal’s variations) will not be exceeded.

The contractor is paid the actual costs incurred for materials, subcontracts and consultancy agreements plus its management fee, up to the GCS. If the GCS is exceeded, then the contractor is required to meet the additional costs.

To provide an incentive to manage the costs, the contractor is also entitled to share any cost savings upon completion and is commonly paid 50% of the difference between the actual costs plus its fees (the actual construction sum) and the GCS.

The potential for incentive fees to be earned is the most important aspect of the management contractor contract. It encourages the contractor to be efficient and make whatever savings are available. Other incentives linking aspects of performance to additional payments can also be incorporated into the contract.

Figure 7 shows how the management approach can be represented:

Alliance

An alliance contract (or project alliance) is an agreement between 2 or more entities that undertake to work cooperatively, reaching decisions jointly by consensus and using intensive relationship facilitation. The entities work together to achieve agreed outcomes and share project risks and rewards, relying on good faith and trust.

An alliance is a relationship contract that seeks to turn a project into a joint venture, where everyone involved is effectively treated as a member of the joint venture company.

The contract includes processes to manage relationships, remove barriers and maximise the contributions of all the participants. It requires the parties to commit to common objectives, act cooperatively, make decisions collectively, share information and knowledge and adopt a non-adversarial attitude to resolving differences.

Alliance participants vary to suit the project and are selected early in the project on the basis of non-price factors that will assist in delivering the required outcomes. Typically they include designers, consultants, management service providers, suppliers and construction contractors.

All the parties involved in a project could be alliance participants, or some parties could be engaged through more conventional contracting arrangements.

An alliance agreement includes conditions developed by the participants, generally under interim 'cost plus' consultancy agreements with the funding agency. Participants are represented on a management 'board' with an equal say in decisions made by consensus.

The people provided by the participants have defined roles and responsibilities in an integrated management team, and decisions are made on a best-for-project basis.

An alliance contract would usually require early identification of a target cost for the whole of the project, with actual project costs to be within the target cost and losses and gains, risks and rewards to be shared.

The alliance participants are normally paid their base costs, confirmed by open-book audit or negotiation, plus agreed corporate overhead and profit margins, as long as the target cost for the project is not exceeded and target performance is achieved.

If targets are not achieved, the margins are reduced according to agreed formulas. Other incentives may also be linked to performance targets, such as the payment of agreed shares of savings or the deduction from payments of agreed shares of cost overruns.

The liability of non-agency participants would generally be capped, with the agency accepting the remaining liability. The participants adopt a no-blame culture and litigation is only available for wilful default such as non-payment or failing to maintain insurance, honour an indemnity or provide audit access.

The agency has the right to change the project parameters, including project scope, budget and time, and the participants must change the Agreement to suit. The agency may also terminate the agreement, for example if consensus cannot be reached on a decision.

Figure 8 shows how the management approach can be represented:

Privately financed project (PFP)

Under a privately funded project (PFP), the private sector finances and constructs a capital asset, then owns and usually operates the asset for a specified period. NSW Government may contribute to the project by providing land or capital works, accepting some risk, diverting revenue or purchasing agreed services such as operation and maintenance of the asset.

The approach is used to provide new infrastructure assets and deliver associated services for a period that is typically around 25 years. Some examples or PFPs are:

• build, own, operate, transfer (BOOT) scheme
• build, own, transfer (BOT) scheme
• design, build, finance and maintain (DBFM) scheme.

PFP arrangements are complex because of the financial component of the contract and are not suited to all projects.

The NSW Treasury publication Working with Government: Guidelines for Privately Financed Projects, available on the NSW Treasury website, describes the mechanism used by NSW Government to involve the private sector in the procurement of infrastructure using PFP options.

The guidelines provide information and guidance on:

• identifying PFP options
• the PFP development and approval process
• the project management structure
• disclosure requirements and project reviews
• risk management
• assessing PFP offers
• probity and accountability
• terms the contract should include.

A PFP involves a 2-stage tendering process. Expressions of interest are called and assessed to establish a shortlist of suitable proponents. This is followed by a call for detailed proposals and further assessment of the benefits offered. The contracts are complex and may take considerable time and effort, including legal advice, to negotiate.

A PFP should offer a financial advantage to the State, in particular in relation to initial capital investment.

Figure 9 shows how the management approach can be represented:

Related resources

Find more resources on the construction category page.