Novation of construction contracts: some risks and issues
20-09-2008 - 12 MBA Executive Newsbrief - July - August 2008
It is not unusual in construction contracts for the principal to have engaged consultants to prepare designs or detailed project requirements prior to the engagement of a contractor to carry out the works. The principal may also have spoken to or engaged preferred suppliers or subcontractors. Such early planning or design may be required to obtain planning permission or financing for the project. One way of changing the risk allocation in the contract so that the responsibility for ensuring that certain work is carried out by these consultants or subcontractors is by novating them to the head contractor.
Most standard forms provide for novation. An example is clause 9.4 of the Australian Standard General Conditions of Contract for Design and Construct AS 4902-2000. When a novation takes place:
- any contract between the principal and the consultant or selected subcontractor will be discharged; and
- a new contract between the contractor and the consultant or selected subcontractor will come into existence, usually on the same terms as the original contract.
A novation clause in a contract generally requires the principal to give a direction under the relevant clause (which should be given promptly to avoid the risk of the contractor being able to claim extra time or costs as a result of the delay). It also requires the contractor to execute a deed of novation which is either attached to the contract or to be in a form acceptable to the principal.
Risks to the Principal
It is crucially important that the principal sets up appropriate procurement methods from the commencement of the project. Also, all consultants and selected subcontractors must be engaged using effective documentation that is drafted with the issues outlined below in mind.
All consultant or subcontract agreements should also contain an obligation to novate on the principal's request. For, as soon as a direction is issued for the novation of consultants or subcontractors under a construction contract, any issues with the engagement of those consultants or subcontractors will quickly be revealed.
One of the key risks to the principal of a novation is exposure to extra costs or delays due to problems caused by the contractor, consultant or subcontractor's reluctance to partake in the novation. In order to avoid a situation where issues or delays with consultants or subcontractors entitle the contractor to extra costs or an extension of time, the principal can:
- amend the definition of "qualifying case of delay" to specifically exclude "all acts, defaults or omission of selected subcontractors, consultants, agents or other contractors (not being engaged by the Contractor) in connection with or relating to any novation directed by the Principal";
- amend the contract so that the principal has power of attorney for the purposes of effecting any required novation.
Such amendments will help to minimise exposure in this regard. Any agreement entered into with consultants or subcontractors should also require them to novate immediately upon any such direction from the principal.
Potential issues
There are a number of issues that may cause difficulties for the principal when novating consultants or subcontractors to their contractors.
Some of they key issues include:
- Intellectual property - who owns what is an important question to resolve when novating any consultant or subcontractor, and the principal should remember to include any required moral rights waivers.
- The standard form deed in the Australian Standards (refer to Annexure Part D of AS 4902 for an example) only contains a very broad release in respect of all claims and demands in connection with the prior contract. The parties may wish to clarify the effect of the novation on accrued rights, claims and demands in connection with the prior contract and all future rights, claims and demands.
- Outstanding fees may be an area of contention - the standard form deed in the Australian Standards (again, refer to Annexure Part D of AS 4902) requires payment of all money "owing under the prior contract". The amount owing may be subject to disputed variations or other amounts in dispute and the principal may also have certain rights to offset monies. The principal should be aware that the point of novation may be used by consultants and subcontractors as the point of maximum leverage to extract money from the principal.
- Warranties and indemnities – these can cause significant issues for all parties and are likely to be the subject of intense negotiations. The key is to ensure that the warranties required under the consultancy agreement or subcontract agreement match up to those required under the deed of novation and the construction contract in order to ensure a smooth transition. By considering some of the key issues prior to engaging consultants, subcontractors or the contractor, principals can reduce their risk profile and help to ensure an easy and successful project outcome.
12 MBA Executive Newsbrief - July - August 2008