April 1, 2012

Risk Management and Project Structure – Part 2


In the March 2012 issue of Landscape Trades, we began our discussion of the choice of project structure in a construction project by reviewing the general contract (where the contractor builds to a design provided by the owner) and the design build contract (where the contractor is responsible for both construction and design). In this issue, we will discuss the project management and construction management structures. The key feature that distinguishes these project structures from the other two is that, when properly set up, the project or construction manager does not actually perform the physical work. Rather, under these models, the manager acts as the owner’s representative in negotiating and administering contracts for the work, which the trades and the owner enter into directly.

The project and construction management models are perhaps the most misunderstood and misused of the models available. Under these models, the owner hires the manager to manage the project on his or her behalf. All of the trade contracts are sourced and, once approved by the owner, administered by the manager. Usually, the owner is the named party to the trade contracts, although in some circumstances the manager expressly signs the trade contracts as the agent of the owner. In either case, the trades should know exactly with whom they are contracting.

The essential difference between the construction management and project management models, when they are used in their traditional way, is that under construction management the manager is only responsible to administer the installation of a design provided by the owner. Under the traditional project management model the manager is brought in earlier in the process and represents the owner, at least in part, in sourcing, developing and administering the design.

Under these models, the owner, not the manager, is responsible to pay the trades directly. Should the owner not pay, the trades’ recourse is to pursue the owner, not the manager. In this circumstance, then, there is no one general contract. Rather, there are several and sometimes many trade contracts, each between the owner and a trade contractor. For the purposes of construction lien legislation, there will be a separate holdback requirement for each trade contract, such that the expiry of lien rights, substantial performance or completion (depending on the province), and the release of holdback will arise on a trade-contract by trade-contract basis. There will also be labour and occupational health and safety issues for the owner, because the owner is contracting with the trades directly.

Know who assumes risk
Under these models, the manager is generally paid a fixed fee, often expressed as a percentage of the total construction cost. Beyond this, the terms of the management contracts can vary significantly. Generally, the owner is responsible to pay the total cost of the work, including all of the manager’s administrative costs. Under many management contracts, if a trade does not perform properly, or at all, the cost of rectifying or completing the trade’s work falls to the owner. Indeed, under many management contracts, the owner will have to pay all of the manager’s administrative costs in sourcing and administering the rectification and completion contracts. This highlights a general distinction to be made: Project and construction management contracts will generally be either at risk or not at risk contracts. The distinction is as follows: Where the manager is at risk, the manager is ultimately responsible to ensure the work is performed properly and on time, et cetera, in accordance with the trade contracts. Where there are delays, deficiencies or incomplete work, the owner can look to the manager to resolve the issues at his cost or to pay compensation in lieu of same. Where the manager is not at risk, his role is to simply administer on behalf of the owner. Should any issues arise, they are the owner’s responsibility and the owner will have to pay the manager for further assisting the owner in resolving them.

One might wonder why an owner would enter into an at risk contract. The answer lies in cost and flexibility. Many owners believe they can keep costs down if they have the opportunity to vet and approve quotes for each component of the work, thereby eliminating the middleman of a general or design build contractor. Also, the construction management model allows the owner to develop his design on the fly. The owner does not need to agree upon a fixed price for the total project at the outset when retaining a general or design-build contractor. Rather, the owner can move forward with the demolition and excavation trades before fully deciding where and how to spend his or her money on the rest of the project.

Read details of contract
Again, project management and construction management contracts are very often misunderstood and misapplied. Contractors will often draft contracts that suggest they are construction managers when they are not. It is also not at all uncommon for a project to unfold as a general contract model, for example, even though the contract provides for construction management. Often, although the contract calls for a separate trade contract for each component of the work, the manager nonetheless hires the trades, is paid by the owner for the trades’ work, pays the trades, and administers one contract with the owner for the entirety of the work, for construction lien holdback purposes. Where this occurs, confusion can become widespread, particularly where trades have not been paid and construction lien implications arise.

Who is obliged to pay the trades for the work will depend on the project model—on how the contracts between trades and owner or manager/contractor are set up. In addition, a trades contractor under a properly set up construction management contract model will have the rights of a contractor for the purposes of construction lien legislation. If, however, the trade is actually a subcontractor of the manager, the trade will have the lien rights and obligations of a subcontractor. This, of course, can be significant: The rights and obligations of contractors and subcontractors are different under Canadian lien legislation. Significantly in this regard, a subcontractor’s lien entitlement is generally limited to its pro-rata share of holdback, while a contractor faces no such limitation.

In the end, one telltale sign is the payment stream: If you are hired by a construction manager to perform work on a project, but enter into a contract with, and are paid by, the manager (and not the owner) you are most likely not working under the construction management model. Rather, you are most likely working in the general contractor model. Establishing at the outset which model you are working under is important because, as we have briefly outlined above, the model will determine whom you are working for, whom you pursue in the event you are not paid, and the extent to which you can recover under lien legislation.
Rob Kennaley practises construction law in Toronto. He speaks and writes regularly on construction law issues and can be reached for comment at 416-368-2522 or at kennaley@mclauchlin.ca. This material is for information purposes and is not intended to provide legal advice. Readers who have concerns about any particular circumstance are encouraged to seek independent legal advice in that regard.