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During a project's timeline changes can happen to affect the project's momentum. Some of the changes affect the contractual relationships between the parties involved within the project. The objective of this dissertation is to identify the feasible contractual solution to how a general contractor is able to act as both a main contractor and turnkey contractor within a single project.
In a construction project there are several parties involved in the completion of the project. These parties can be from the public sector, the private sector or the third sector. The key parties are the owner/client, the architect/engineer and the general contractor. Between these parties there are business agreements in the form of contracts to complete the work in the project, such as: design, engineering, construction, management and maintenance.
A construction project is ready for execution after the client/owner (hereafter called "client") acquires the necessary funds, the land and necessary approvals from the relevant authorities for the land use for the project's purpose. Upon meeting the above mentioned criteria for establishing a project, the client will approach an architect to complete the project.
In medium to large size projects the client can execute the work by employing the work force directly (trade contract), entrusting a select portion of the work to a general contractor and executing the remaining work directly (main contract) or entrusting the entire work to under a turnkey contract.
In a main contract, the client contracts an architect that is responsible for the design of the project and a general contractor who is responsible for the construction, which results in two separate contracts: the client-architect contract and the client-contractor contract. A client can decide to relinquish major decision making in the construction of the project by making the architect its representative.
In a turnkey contract there is a single contract between the two parties: the client-contractor contract wherein the general contractor is responsible for both the design and construction of the project and thereby becomes the turnkey contractor.
During the project many changes could happen to the client-contractor relationship, the client and/or the contractor could be bought out by a competitor or investor, merged with another entity or liquidated and become insolvent. For the purpose of this dissertation, let us consider that the change has happened to the client and this changes the contractual relationship that existed with the previous owner and the general contractor. For business reasons the new owner decides to change the relationship with the general contractor, and the general contractor is agreeable to that change to also act as a turnkey contractor for the project.
What kind of project will allow the general contractor to change its role?
How can a general contractor act as both a main contractor and a turnkey contractor within a single project?
This study is written from a practical perspective, not legal, perspective, and focuses on the relationship between the client and general contractor in a building construction project to identify the parameters within which the general contractor is able to be both a main contractor and a turnkey contractor within a single project. This study will not cover the legal issues pertaining to liability, insurance, and risk management.
The research for this study was conducted through qualitative and analytical methods from primary and secondary sources such as: interviews, published articles, reports, documents and books, internet websites, and public domain materials from internet websites (electronic books, archived documents etc.).
Prior to analysing which form of project will allow the general contractor to change their role in the project's organisational structure and how is the general contractor allowed to change roles, it is necessary to outline what each individual contractual role and responsibilities are within a project. By identifying roles and responsibilities, it allows for a more accurate analysis to answer the research questions presented in the problem statement section of this study.
1.1 What is a Turnkey Contract?
A turnkey contract is a business agreement between the client and a general contractor, where the general contractor (now turnkey contractor) is responsible for the design, engineering, construction and management of the project. The construction industry refers to the turnkey contractor as a 'single point of responsibility', a phrase that reflects the turnkey contractor's role and contractual obligations.
Note: The client can award the turnkey contract to either an architect or a general contractor, however this dissertation continues on the premise that a general contractor is awarded the turnkey contract.
The turnkey contract is a product of the Design-Build (DB) project delivery system i.e. it is a method by which the client controls the project from start to finish.
The turnkey contractor may subcontract an architect to perform the design work and trade contractors to perform specific works in the turnkey contract.
A turnkey contract can also be used in a Design-Build-Operate (DBO) project delivery strategy. While the turnkey contractor is responsible for providing design, engineering, construction and management services, it is also obligated to operate the facility once it is fully constructed and equipped for purpose.
The purpose of DBO is to provide the client with the opportunity to let a turnkey contractor "in a multidisciplinary contract: to design, build and operate as opposed to individual agreements to govern the different facets of a project" (Sunna, 2009).
In a DB project the client has a direct relationship with the general contractor, and the general contractor has a direct relationship with the architect, Figure 1.
Figure - An example of a DB project delivery system
1.2 What is a Main Contract?
The main contract is a contract awarded to a general contractor to execute the main construction works in the project. For a main contract to be awarded, the client first needs to acquire funds, land, land-use and other relevant approvals, and select a design from a chosen architect. The client initially awards the chosen architect to prepare drawings, specifications, and other design elements for the project. After the architect's submission is received the client then puts to tender the construction works for the project. This could be broken into several tenders, one of which is the main construction work. The general contractor who wins this bid is awarded the main contract.
The general contractor (now main contractor) may subcontract one or more trade contractors to carry out specific works in the main contract.
The main contract is a result of the Design-Bid-Build (DBB) project delivery system, a method through which the client controls the project. DBB consists of three parties: the client, the design party and the construction party.
The client is responsible for providing the location of a project (the site) and the contract documents to the main contractor, providing the architect with the budget, and funding the project (paying the main contractor and the architect). The budget is an important part of the project as it allows the architect to design a building that meets the client's requirements and it determines the scope of the project.
The design party includes the architect, specification writers (consultants), engineers (structural, services, mechanical), interior designers, quantity surveyors and other participants the architect considers necessary for completing the project. Depending on the client's involvement in the decision making, the architect is able to act as the client's representative and also for reviewing contract documents.
The construction party consists of the main contractor who is responsible for providing the labour, material, equipment, machinery and professional expertise to complete the project in accordance with the design and plan documents which are provided by the architects.
In a DBB project the client has a direct relationship with the architect and the main contractor (where the architect and contractor have an indirect relationship) shown in Figure 2.
Figure - An example of a DBB project delivery system
2.0 Private Finance Initiative
This section focuses on the Private Finance Initiative (PFI) in an effort to answer the research question: What kind of project will allow the general contractor to change its role? The research on project delivery systems and procurement methods show that the PFI involves both the public sector and the private sector working in collaboration to develop a project.
2.1 What is the Private Finance Initiative?
The private finance initiative (PFI) is a way by which public infrastructure projects are funded with private capital. Initiated by the Australian and United Kingdom governments, PFI has been adopted in many countries by corporations, national governments, and international bodies such as the World Bank and the World Trade Organization.
In general, under PFI, the government (public sector) is the client and invites the private sector to bid on a project, which includes construction work, services, operation and maintenance. Because these projects require a variety of inputs the government and a single private company or a consortium of companies in the private sector place a bid on the project, and work in collaboration to execute the project.
The concept of PFI is to involve the private sector in public sector services or projects, because it has multiple positives - it enables governments to provide national infrastructure such as bridges, motorways, power-supply, etc., at an earlier and quicker pace to the public; it provides business opportunities to the private sector; it increases employment; and, it offers better value for money.
When a project is awarded, the public and private parties (in this case the government and private companies) create a new private company to manage the project and deposit the required funds in this project's accounts. These funds are used to initiate and implement the project. For a construction project after the building is fully operational, if the private companies made an agreement for the maintenance of the building over a period of for example, 25 years; the government will reimburse the cost of the project (including interest) over time. Alternatively, the government does not pay the private companies their share of the costs but allows the private companies to maintain, operate and manage the facility (bridge, toll road etc.) and recoup their costs and some profit over an agreed number of years.
PFI is also known as Design-Build-Finance-Operate/Maintain (DBFO, DBFM or DBFO/M). The private sector designs, finances and constructs a new facility under a long-term lease, and/or operates and maintains the facility during the term of the lease. The private consortium transfers the new facility to the public sector at the end of the lease term.
2.1.1 Contract Process under PFI
A government authority signs a contract with a private party (a company or a group of companies) creating a public-private partnership (PPP). The PPP is created for the purpose of providing the PFI contract. A PPP is a legally-binding contract between a public authority and a private consortium for the provision of assets and the delivery of services that allocates responsibilities among the various partners.
Before the PPP is established a private company creates a new company in collaboration with other private companies, this is referred to as a 'Special Purpose Vehicle' (SPV). The SPV is made up of private investors, a construction company, a maintenance company and a bank lender/s. SPV contracts with the government creating a PPP, and also with general contractors responsible for constructing and maintaining the building or infrastructure facility.
The banks funding PFI projects are repaid by SPV, from payments received from the government over the duration of the PFI contract. The repayments are based on the SPV's ability to meet the requirements specified in the contract.
2.1.2 PFI Project Organisation Structure
See Figure 3, the SPV is divided into subgroups: A holding company, private investors/bank lenders and a services or operating company. The primary contract is between the government and the SPV, and the requirements in the specification transmit from the SPV to the holding company, the investors and operating company through secondary contracts, and then filter down to the trade contractors.
Figure - Example of a PFI project organisation structure
What kind of project will allow the general contractor to change its role?
A PFI project created through the partnership of the government and the SPV allows for a general contractor to change its role. As shown in Figure 2, the SPV is a part client (from the SPV's perspective) and a turnkey contractor (from the government's perspective).
2.2 How PFI allows a general contractor to change their role
Once a PPP contract is signed a new company is formed to finance the project. Referring to Figure 2, the SPV is considered as the client in this project because the government requires additional funding for the service or building project and is allowing the private party (the holding company, the investors and operating company) to partially privatise the project.
However, the government is still part owner; from the government's perspective the SPV is both a part owner and a general contractor.
Note: In a PFI project a client can also be a general contractor, depending on the project, this is known as owner-builder.
In Figure 2 the SPV is both financing and operating the project, depending on how the SPV wants deliver the project, Figure 2 assumes that the general contractor (in the project environment) is a main contractor, therefore the SPV will have a client-contractor relationship. But the government is still a part client to the project therefore the SPV is also considered as the turnkey contractor to the project.
This section focuses on Novation which is a situation in which a main contractor can be also turnkey contractor.
3.1 What is Novation?
The business dictionary defines novation as the "substitution of an original party to a contract with a new party, or substitution of an original contract with a new contract."
Once the original party is replaced, the original party's obligations are discharged, and the new party is responsible for the replaced party's obligations. Novation can only occur when all the parties involved agree to replacing a party or replacing a contract. For example: novation might occur when one company buys another company where both companies are providing project services to the client, in this case the single company formed by the merger of the two companies will receive the novated contract.
By replacing the obligations of the original party - the main contractor - all the parties involved (client, architect/engineer, and main contractor) in the original contract must agree for the replacing to take place. If the agreement to replace comes into effect, the new party will take over the responsibilities and obligations of the replaced party, i.e. the new general contractor will become a replacement to the original main contractor.
Novation is used "when the parties find that payments or performance are impossible under the terms of the original agreement, or the debtor will be forced to default or go into bankruptcy unless the debt is restructured." (Sahil, 2010)
According to Michael Rowlinson (2010), if the main contractor is being replaced with a new general contractor the client's role in the project remains unchanged (the client being the contracting party).
Figure 4 illustrates how novation affects the contractual relationship in a DBB project. The Client (A) contracts with an architect (B) and a construction contract with a general contractor (C). However, the client wants to create a single point of responsibility for both design and construction. For this to occur, the client (A) can novate their rights and obligations (under the client-architect contract) to the contractor.
Figure - Example of before and after effect of novation in a DBB project
4.0 The Case
A case study is used to illustrate the practice of PFI projects. This case will provide insight to the role of the public and private parties, and how this information is used to find how a general contractor is able to act as both a main and turnkey contractor.
4.1 Newcastle PFI Project - Medical Service Facilities Development
A contract was signed between the Newcastle-upon-Tyne Hospitals NHS Trust (public party) and a private consortium led by Equion plc, in May 2005. The contract was signed for a PFI project consisting of developing the Freeman Hospital and Royal Victoria Infirmary (RVI) in Newcastle, United Kingdom (UK). The purpose of this project is to improve the medical services in Newcastle, and transferring all of the hospital services from the Newcastle General Hospital site to the new facilities available in the Freeman Hospital and the RVI sites.
The Newcastle-upon-Tyne Hospitals NHS Trust promoted the project, which had a total capital of approximately GBP 300M. The PFI project involved constructing new facilities, renovating and refurbishing the existing facilities. The Freeman Hospital will receive a cancer and renal services centre, and a new multi-storey car park.
RVI received an operating theatre, a new accident & emergency department, with all the clinical support services required, such as neurosciences, infectious diseases, traumatic orthopaedics, dermatology and critical care. Additionally, children's services were integrated into a purpose-built facility adjoining the main development, (Newcastle-upon-Tyne Hospitals NHS Trust, 2005).
Figure - Newcastle PFI project organisation structure
See Figure 5, the PFI was established to make the Newcastle-upon-Tyne Hospitals NHS Trust responsible for the clinical care of patients, maintenance of equipment and existing facilities, technologically advancement medical equipment, and managing the multi-storey car park, after the new facilities were fully equipped for their purpose. Healthcare Support (Newcastle) Limited, controlled by Equion plc, (through subcontracts) provided the designing and construction work, non-clinical services and maintenance for a period of 38 years.
The research on PFI in section 2.0 of this dissertation explains that the public authority is the client in a PFI project; however the public authority is collaborating with a private consortium for ownership of the project. Through this ownership the public authority is allowing the private consortium to partially privatise the finished facility and/or service once the project is complete.
Because the public authority requires the facility and/or service to be available, the private consortium is responsible for providing it. Therefore the private consortium is responsible for the design and construction of the project.
The private consortium is made-up of separate entities: a holding company, a construction company, an operation and maintenance company, bank lender/s and private investors. The design and construction works are subcontracted to the construction company.
Theoretically, the public authority can novate their rights and responsibilities to the private consortium making them the client, however in PFI the private consortium is responsible for completing the project, and novation would not alter their responsibilities in the project's organisation structure. However, if the public authority novated their rights and responsibilities for the project to the private consortium, the private consortium is able to privatise the project in its entirety.
Using the data presented in the previous section, the Newcastle-upon-Tyne Hospitals NHS Trust is the client through PFI and Healthcare Support (Newcastle) Limited is the private consortium. See Figure 5, the relationship between the Trust and Healthcare Support is a PPP contract: they are legally bound to each other for the provision of the facilities and services within the project.
The relationship between Healthcare Support and Laing O'Rourke is a design and construct contract, whereby Laing O'Rourke is responsible for the design and construction through a subcontract of the PPP. From Laing O'Rourke's perspective, Healthcare Support is Laing O'Rourke's client.
It is important to consider that Healthcare Support, although collaborating with Trust, is still responsible for outcome of the project i.e. is responsible for the quality of the design, engineering, construction, management and maintenance for the project. These responsibilities are typical of a turnkey contractor.
Now Healthcare support is both a client and a turnkey contractor within the project. In further detail, Healthcare Support is a turnkey contractor to the Newcastle-upon-Tyne Hospitals NHS Trust, and a client to Laing O'Rourke. It is also important to note that Laing O'Rourke is responsible for the design and construction of the new facilities; however Interserve (Facilities Management) Ltd. is legally obligated to Healthcare Support for the maintenance of both the existing facilities and advanced medical equipment.
From a Healthcare Support's perspective Laing O'Rourke is a turnkey contractor (see Figure 5). If Healthcare Support contracted with an architect and a general contractor separately, the general contractor would be a main contractor. Theoretically, the Trust collaborates with Healthcare support, Healthcare support then contracts with an architect to design the project, after the design is approved general contractors place their bids. Now Healthcare awards the winning general contractor a main contract.
In the beginning of the PFI project, the public authority is the client and the holding company is a turnkey contractor. The holding company then subcontracts an architect for the design, once the design is approved; the holding company tenders the construction work.
The holding company then subcontracts a general contractor for the construction work, where the general contractor is now the main contractor within the project, shown in Figure 6.
Figure - Example PFI project
If the holding company is bought out by a competitor or investor, merges with another entity, the holding company can novate the architect's rights and responsibilities to the main contractor, if all the parties agree to this contractual change. The main contractor is now the turnkey contractor, shown in Figure 7.
Figure - Follow-up to Figure 6 including novation
Alternatively, if the holding company becomes bankrupt during the project, the holding company can novate its rights and responsibilities to the new holding company that substituted the original party. This new holding company can re-organise the contracts (through novation) to make the main contractor a turnkey contractor, responsible for the design, engineering, construction and management services for the rest of the project.
During the project many changes could happen to the client-contractor relationship, the client and/or the contractor could be bought out by a competitor or investor, merged with another entity or liquidated and become insolvent.
Based on the findings in this study, a general contractor can act as both a main contractor and a turnkey contractor within a single project through PFI procurement. However, this can only occur through novation: If the client decides to change the relationship with the general contractor, and the general contractor is agreeable to that change, the client is able to novate the contract.
A general contractor is able to initially act as a main contractor; however only through novation can a main contractor become a turnkey contractor, because novation occurs within a single project.
Therefore a general contractor is able to act as both a main and turnkey contractor in different phases during the project's duration.