Whether you are a seasoned project owner or developer or just starting out on your construction journey, it is important to understand how to document your relationships with contractors. In this guide, our experienced construction lawyers will walk you through the features, benefits and risks of pre-construction service agreements and highlight how they differ from letters of intent.
- What is a pre-construction services agreement?
- What is the difference between a pre-construction services agreement and a letter of intent?
- When is a pre-construction agreement typically used?
- What are the benefits of using a pre-construction agreement?
- What should a pre-construction agreement include?
- Negotiating pre-Construction service agreements
- What risks do I need to be aware of when entering into a Pre-Construction Service Agreement?
What is a pre-construction services agreement?
A pre-construction service agreement (PCSA) is a contractual agreement between a project owner/developer and a contractor or consultant that outlines the services that will be provided before the construction phase of a project begins. It is typically used for larger construction projects to record the terms and conditions negotiated for preliminary services before the project is put out to tender.
A pre-construction service agreement is a distinct, stand-alone agreement separate from a construction contract (or the Main Building Contract). It covers specific pre-construction services that should not be incorporated into the Main Building Contract. The use of the pre-construction service agreement is generally restricted to projects which are going to be subject to what is known as a two-stage tendering process (first for the pre-construction service agreement, and then for the Main Building Contract).
The pre-construction service agreement makes it clear that there is no guarantee that the contractor undertaking the pre-construction service agreement work will be appointed as the main contractor for the final Building Contract. Although, many project owners/developers do employ the same contractor for both stages, having built up a working relationship with them during the pre-construction phase.
What is the difference between a pre-construction services agreement and a letter of intent?
A letter of intent (LOI) is used in a situation where the owner/developer has already identified the contractor it wishes to use for the works, but a number of important issues still remain to be agreed such as final design details, the contract sum, or the actual terms and conditions of the contract which will govern the parties’ agreement, before the formal contract itself can be entered into. The letter of intent (which is generally limited in both time and value) allows the contractor to commence work on site and progress the project, whilst the parties resolve the outstanding issues that will eventually enable them to enter into the final Building Contract.
It is important to note that pre-construction service agreements are not an alternative to a letter of intent. Their purpose and use in projects are wholly different from that of the letter of intent when considering matters from the project owner/developers' perspective.
The simple way to distinguish between the two is to consider pre-construction service agreements as complete ‘stand-alone’ agreements for a distinct and defined scope of work, without any obligation for the parties to proceed to enter into the Main Building Contract. A letter of intent in comparison, is only intended to be a temporary measure until the outstanding elements are agreed which will then allow the parties to enter into the Main Building Contract.
Although a well written letter of intent can cover core details, they by no means carry the same weight as a formal contract. A letter of intent is generally considered to be somewhat risky in nature given that the precise terms of the parties’ contract may not have been fully agreed up to that point and as such, the terms governing the works undertaken under the letter of intent can be open to debate. The commercial reality is that they are often used to give parties a small window to conclude negotiations and allow the works to commence on site whilst the final details of the Main Building Contract are ironed out.
When is a pre-construction agreement typically used?
A pre-construction agreement is typically used in large or complex construction projects by both private and public sector employers where there is a need for preliminary activities, services and preparation before the actual construction phase begins. In most cases, the purpose and use of pre-construction service agreement is in relation to projects where the contractor is undertaking either all of the design (eg JCT Design & Build Contract), or a substantial part of the design for specialist works that are key to the project, such as cladding etc; in order to allow those elements of the design to be determined and finalised, prior to letting the Main Building Contract.
Other reasons pre-construction service agreements are used by project owners/developers include obtaining expert advice and input on buildability, programme management, cost planning, tendering as well as planning permissions.
What are the benefits of using a pre-construction agreement?
- Building working relations: working with a contractor under a pre-construction service agreement gives time to build good working relations with the project owner/developer ready for the main phase of the project. At the same time, if there are any issues, it does not commit the owner/developer to using the pre-construction service agreement contractor for the actual main construction works.
- Cost and risk management: since the contractor will have been immersed in the project from the outset and provided essential design and management input into key areas such as design development, construction programming and costs planning, pre-construction service agreements might lead to greater costs certainty and lower risks of issues and delays in the long run.
- Efficient procurement and subcontractor selection: the pre-construction service agreement can provide valuable time for the contractor to evaluate potential subcontractors, solicit bids, and make recommendations based on their expertise and experience. Tendering of work packages often takes place on an ‘open-book’ basis, where contractors are expected to share their cost estimates, supplier quotes, and other relevant financial information with the project owner. This transparency provides the owner with insight into the contractor’s pricing and cost breakdowns, which ultimately facilitates a more accurate budgeting process.
- Leverage expertise: by involving contractors from the beginning, allow you to leverage their expertise and make informed decisions early on in the design and development stage. This in turn can maximise the overall project value. If, for example, the contractor has prior experience in constructing similar projects or sectors, their insights can be help reduce the overall construction time, maintain quality and identify cost-saving measures.
- Contractor preference: contractors may find pre-construction service agreements more attractive than the single stage tendering process. The knowledge and insight a contractor can develop from embedding itself in the pre-construction phase of a project, particularly the risks involved, can ultimately help them to formulate a more realistic pricing and programme for the job. For example, the contractor may be able to advise upon how to best to deal with risks that become apparent on assessment of the site condition at stage one.
What should a pre-construction agreement include?
The pre-construction service agreement sets out the terms and conditions under which the contractor or consultant will carry out the specified pre-construction services. It should cover in detail the responsibilities and obligations of both parties, so that there are clear expectations and well-defined roles. This in turn helps to avoid potential misunderstandings and any costly disputes later on.
Key elements that the pre-construction service agreement should address include:
- Scope of services and project schedule: the pre-construction service agreement should clearly define the specific pre-construction services to be provided and timeline for completion, including key milestones and deliverables.
- Payment terms: to include the anticipated fee, fee structure, invoicing schedule, and any additional costs or expenses that may be reimbursed.
- Confidentiality: a clause that ensures the protection of confidential information shared during the pre-construction phase, including plans, designs, and proprietary data.
- Termination: the grounds and conditions under which either party can terminate the agreement, specific procedures to follow including notice periods and the consequences of termination.
- Insurance and indemnification: the insurance requirements and indemnification obligations for each party involved.
- Ownership of documents: the ownership and use of intellectual property, such as drawings, reports, and other deliverables created during the pre-construction phase.
- Dispute resolution mechanisms: the procedure for resolving any disputes that may arise during the pre-construction phase, such as mediation or arbitration.
Importantly, as the pre-construction service agreement contractor is undertaking design work, the pre-construction service agreement should address whether they will have any design liability and how the liability will be impacted if they are not appointed on the second-stage construction. Under the standard form pre-construction service agreement contracts any liability on the contractor’s behalf for design is excluded..
Negotiating pre-Construction service agreements
When negotiating pre-construction service agreements, it is important to reach a mutually beneficial/acceptable position on salient points such as project timelines, costs, performance, etc. Certain aspects of the agreement that often lead to disputes if not thoroughly negotiated to ensure a shared understanding include:
- Defining Project Goals: It is crucial to clearly define the project goals. This includes specifying the objectives and desired outcomes and establishing a common ground regarding the project's purpose and key deliverables.
- Legal and Regulatory Compliance: It is essential to ensure that all parties involved adhere to applicable laws including safety regulations, environmental standards, and any other legal obligations. Negotiations should address how compliance will be monitored and enforced, as well responsibility / liability for non-compliance.
- Pricing and Payment Negotiations: This involves discussing the cost structure, payment schedule, and any potential variations or contingencies that may impact the pre-construction service agreements budget. Any conditions precedent to payment and capped values should be ironed out. It is also essential to carefully define the scope of works and what elements the contractor is to be paid for.
What risks do I need to be aware of when entering into a Pre-Construction Service Agreement?
As with any commercial agreement, there are risks as well as benefits. It is therefore crucial to obtain expert legal advice to minimise or mitigate any risks to you, including unusual or onerous obligations.
Some risks to be conscious of include:
- Contractor bargaining strength: when it comes to the second stage of the tendering process, the pre-construction service agreement or stage one contractor is in a more advantageous position to that of its competitors who will be new to the project. This may put the project developer/owner at risk of not being able to tender competitively. However, this can be addressed through the use of commercial / contractual incentives in the pre-construction service such as fixing various elements of the main contract price, or by providing that the contractor can only recover its full costs of providing pre-construction services if it is appointed to the Main Building Contract.
- Higher prices: the pre-construction service agreement can result in contractors pricing main build contracts much higher than the project owner/developer anticipates as a result of risks and challenges uncovered during the pre-construction phase. The very knowledge and expertise that helps mitigate risk and manage costs can also be used to justify higher main build prices.
- Ambiguous wording: If the pre-construction service agreement is not drafted carefully or there is ambiguous wording, the project owner/developer may find itself stuck with a contractor it no longer wants to work with or caught up in lengthy, costly disputes. Particular care and attention should be exercised when it comes to contractual incentives such as holding back or retaining a portion of pre-construction service agreement fees pending appointment of the same contractor to the main build.
Pre-construction service agreements form part of the two-stage tendering process and should not be confused with a letter of intent. Using a pre-construction service agreement has a specific purpose at the pre-construction phase and can help maximise project value and performance overall, but it is not without risk. It is therefore crucial when entering into a pre-construction service agreement to carefully review and negotiate the agreement with the help of expert legal guidance
Here at Harper James, our construction solicitors offer expert legal advice when it comes to drafting, reviewing, negotiating and/or signing pre-construction service agreement. We explain the technicalities in simple terms, so you fully understand your rights, obligations and liabilities under the agreement, avoid any pitfalls and ensure your commercial interests are protected. Talk to one of our construction lawyers today for more information.