The design, novate and construct (DNC) contract (commonly the AS4902-2000) is the preferred method for the modern developer of large-scale commercial and residential projects.
Put simply, the DNC method of delivery can be summarised as follows:
- The principal employs design consultants to prepare a preliminary design based on a project brief.
- Once the design has reached a stage where the principal’s requirements have been identified and documented (ranges between 30% – 80% completion), the principal seeks tenders from contractors in order to adopt and complete the design and construction.
- During completion of the design, the selected contractor must accept novation of the contract entered between the principal and consultant, such that the consultant becomes employed by the contractor.
- The consultants continue to complete the developed design under the management and coordination of the contractor.
The benefit of the DNC procurement method for the client is threefold. Firstly, the client can appoint the design team and chooses their level of input during the planning phase. Secondly, there is greater design consistency, as the initial design team remains involved throughout the project. The third and most obvious benefit to the client is the contentious “risk dumping” nature of the method, in that all design risk is transferred from the principal to the contractor.
At first glance, the risks a contractor must accept under the DNC method seem to outweigh any benefits to the contractor. However, the DNC method is the modern form of procurement. In today’s competitive market, contractors need to take advantage of opportunities to demonstrate their competency in management of specialised consultants and creating cost savings on projects using innovative design techniques.
DNC Contracts
Most contractors don’t think twice before signing up to an Australian Standard series contract (AS 4902). This is problematic in the context of DNC contracts as the general conditions of the 20-year-old unamended AS4902 contains several ‘grey’ areas around the terms of the novation agreement.
In this article, we will explore practical risks facing contractors who sign up to DNC contracts as well as specific legal risks in a novation deed under an unamended AS4902.
What is a novation agreement?
A novation agreement discharges the initial design contract between the principal (outgoing party) and the consultant (continuing party) and forms a new contract between the contractor (incoming party) and the consultant.
Three key risks for contractors
The most significant legal risks for contractors undertaking a DNC project are:
- The consultant agreements not being ‘back to back’ with the terms of the building contract.
- An inability to claim against the consultant for design defects that occurred prior to
- Uncertainty surrounding the payment status of pre-and post-novation fees and the common problem of a lack of design fees for the post-novation phase.
Back to back agreements
Often the building contract will contain broad design warranties such as “fit for intended purpose”, which is intended to mean a subjective standard inferred from the entire contract. Conversely, the warranties in a consultancy agreement (particularly one provided by the consultant) will generally be more limited – for example, the consultant warrants only that the design will be “suitable and adequate for the stated purpose”. Suppose the principal sues the contractor for loss suffered as a result of a design defect. In this scenario, it will be easier for the consultant to defend a claim for contribution brought by the contractor due to the disparity between the contractual warranties.
The majority of AS4902 building contracts require the contractor to achieve practical completion by a specific date, or the contractor shall be exposed to liquidated damages. The contractor’s avoidance of liquidated damages under the head contract often relies on the consultant’s timely performance. Yet, it is rare to see specific completion dates or liquidated damages clauses in consultant agreements. This leaves the contractor in a tricky situation if it cannot compel the consultant to produce a design within the time required by the AS4902 program.
To avoid these situations, during the tender phase, contractors should insist that all copies of the consultant agreements are provided from the outset. Contractors should seek legal review of these agreements in detail and only accept warranties under the building contract which are consistent with those under the consultant agreement. Often, the principal will not yet have entered the consultant agreement with the consultant when it invites a contractor to tender.
We recommend that contractors have a template consultant agreement that is suitable to engage most consultants and consistent with terms it would generally accept under a building contract. If a novice principal does not yet have the consultants formally engaged, you could offer up your template agreement, which will provide you with better protection than most standard consultancy agreements.
Pre-novation defects – what contractors need to look out for when reviewing contracts
Clause 2 of the AS4902-2000 proforma deed of novation provides:
“The outgoing party and continuing party each warrant to the incoming party that preliminary design carried out to the date hereof, is in accordance with the provisions of the original contract.”
As a contractor, it is ideal for this wording to remain in the novation deed as it can be used to argue that all risk of pre-novation design is assumed by the principal. If you manage to negotiate the above wording into the contract you are halfway to significantly improving your company’s risk position!
There is a potential inconsistency between the above provision and clause 2.2(a)(ii) of AS4902. Under clause 2.2(a)(ii) the contractor warrants to the principal that it has “examined any preliminary design…and that such preliminary design is suitable, appropriate and adequate for the purpose stated in the Principal’s project requirements”. As such, the preliminary design is at the contractor’s risk.
If you are not confident in managing this design risk, we recommend the following amendment to clause 9.4 of the Contract (the novation clause):
“To the extent that:
(a) the preliminary design carried out prior to novation is not in accordance with the provisions of the prior contract between the Principal and the Consultant; and
(b) the non-compliance with the prior contract causes the Contractor to suffer delay and/or incur additional cost in carrying out WUC,
then there shall be a deemed variation.”
In the absence of this amendment, the contractor arguably inherits all risks associated with any weaknesses of the original design during the post-novation phase, with no relief for additional time or cost for unforeseen changes. Accordingly, contractors must make appropriate inquiries during the tendering phase to allow (in terms of both time and cost) for any re-design work that may be necessary to:
- bring the design to full compliance with any authority requirements, relevant legislation, standards and the principal’s design brief; and
- maximise the buildability of the design.
Based on our experience, the practical ways to minimise exposure to the risk of design errors are:
- to initiate an early contractor involvement phase (ECI) to allow sufficient time and opportunity for the contractor to thoroughly review the design documentation before tendering; and
- for the novation to take place as early as possible to enable the contractor to have the maximum effective input into the buildability of the project.
Novation Fees
Risks of a poorly drafted novation deed
The AS4902 unamended novation deed is unclear about the amounts owing to the consultant in connection with design work before novation. Clause 1 of the proforma deed simply states:
“Upon receipt by the continuing party of all moneys owing under the original contract”
The plain meaning of these words suggest that they apply to moneys which have become due to the consultant under the contract but may not apply to moneys for work carried out by the consultant under the original contract which have yet to fall due. It is also unclear whether “all moneys owing” is to be characterised as moneys owing in respect of fees only or for all claims under the contract (including disputed claims).
When the terms of the novation deed are unclear as to who is liable for which fees, the risk of a payment dispute increases. A contractor could find themselves subject to an unexpected claim by the consultant for outstanding fees owed in respect of pre-novation services. A properly drawn novation deed should contain a warranty from the principal that it has complied with the original contract and an indemnity for any claims by the consultant in connection with the original contract.
Poor quality design due to lack of fees
A common cause of dispute occurs when the principal exceeds the financial budget of the initial design process. This can result in insufficient funds under the novated consultancy agreement for design completion and modifications. A lack of design fees post-novation can result in the consultant implementing cost-cutting measures that may place the integrity of the design at risk. To avoid this situation, contractors should ascertain exactly what design work is complete, what is yet to be done, and the proportion of fees spent to date at the tendering phase.
Concluding remarks
The DNC model can be a devil in disguise for those without a strong sense of its inherent risks. Handling liabilities during pre-novation and post-novation is complex when a breach of contract arises.
Contractors must be attuned to the specific wording used in the proforma novation agreement that is attached to the draft building contract. At a minimum, all contractors should invest in a standard form consultant agreement that will provide them with the necessary protections in the event of a dispute concerning defective design. For larger complex projects, we recommend that you obtain a risk review of the proposed construction contract and deed of novation.
In the context of clauses like those described in this article, pre-emptive amendments to the wording of the contract could mean the difference of claim being made on the consultant’s professional indemnity insurance rather than your own!
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