Perspectives on Real Estate Newsletter - Spring 2012 (PDF-3245kb)
Avoiding Construction Project Failures: 8,000 Romans, 3,000 Greeks, One Lesson
Perspectives on Real Estate Newsletter - Spring 2012
Over two days in 279 BC, Rome fought a bloody battle at Asculum against the Grecian-allied armies of Tarantine, Oscan, Samnite and Epirote. As with all important battles (ancient and modern), the Battle of Asculum was part of a war for control over an enormous parcel of prime real estate on the southern Italian coast known at the time as Magna Graecia. Those miles of waterfront property with no zoning restrictions and deepwater access were coveted by every developer from Macedonia to Gaul.
Jeffrey R. Gans, John A. Fedun
When the joint venture talks broke down, the battle was joined and heavy casualties were suffered on both sides. In the end, the Romans were routed from the field when their line was broken by a charge from the Greeks' armored elephants. But the Romans turned a defeat at Asculum into a victory in the war by inflicting heavy casualties on a Greek army that was far from reinforcements. We remember this event for the wisdom shown by the Greek King Pyrrhus, who famously stated, "If we are victorious in one more battle with the Romans, we shall be utterly ruined."
Attorneys see nearly all of their clients' Pyrrhic victories. Clients, through excellent contract negotiation and drafting, obtain rights to build office buildings, convention centers, stadiums, schools and mixed-use projects worth hundreds of millions of dollars, only to lose the benefit of their early success when red flags are not recognized early and monitored assiduously. Often, the problems come when clients rely on contract negotiation and drafting as a substitute for diligence. Everyone loses something when a good project fails—whether it be money, opportunity cost, time or reputation—regardless of how those failures may be ameliorated by fault, risk-shifting, insurance or indemnity.
Projects fail for myriad reasons that can be avoided when issues are identified early and managed through completion. Here, we discuss three red flag situations that can be identified and addressed in a construction project's early days: (1) unusual contracting arrangements, (2) undue risks revealed during the bid process, and (3) changes in key leadership at the design, engineering, general contracting or construction management firm.
Unusual Contracting Arrangements
Unusual contracting arrangements, whether related to design services or construction management, are red flags. Project owners and their counsel must scrutinize project frameworks that either establish an irregular division of responsibility or place responsibility for dependent tasks on independent entities.
Unusual allocation of design responsibility
When design responsibility falls to two or more architects and/or engineers that each have privity with the owner but not each other, managing the relationships among the design professionals falls to the owner. But the greater involvement an owner has in the "means and methods" of the professionals' services, the greater the chance that the owner may make, or cause the design professionals to make, a mistake because of miscommunication, lack of understanding or other reasons. In the best case, an owner will engage an experienced design project manager, insured against failures and motivated by reputation or liability, for the ultimate responsibility of delivering the final design product.
Unusual allocation of construction management responsibility
When a project is divided by geography or phase among multiple general contractors, the owner becomes the de facto construction manager. Proper management of complex construction is time-consuming and expensive, and the consequences of mistakes can be dire. The management of every complex construction project requires strong leadership to make difficult choices for the good of the project that often advantage one entity at the expense of another. When the entities involved have no contractual relationship with one another, the dispute can quickly become a claim for compensation for the consequent disadvantage. Without proper management, even resources like available staging space or the use of the project crane may not be expended for the good of the overall project. Very few owners employ a sufficient number of experienced people to successfully manage construction projects in-house. (It can be done successfully, but the contractors must be managed carefully and consistently.) As with design management, construction management is best done by an experienced construction manager with experienced staff.
Other red flags may be vigorously waived during the bid process, which is often the proverbial canary in the coal mine. However, if an RFP draws too few bidders, bids that are ultra-lean, or bids far in excess of the expected range, an owner should scrutinize the RFP, the bids and the bidders before selecting a winner.
Too Few Bidders
If the top firms in the field are not seriously competing for an owner's business, there is a problem. Good firms have enough experience and expertise to overcome many design/planning flaws, so if a proposal is too flawed to entice their participation, beware.
Similarly, a construction budget that has too little fee for the actual construction management (as opposed to the money going to the subcontractors to perform the work) means lean staffing and relentless effort by the construction professionals to find a way to profit from the project during construction. While an ultra-lean bid may be attractive for the lower cost and potentially greater profit to the owner, an owner should think critically about whether or not the bidders' incentives will be aligned with the owner's goals.
Bids Far in Excess of the Expected Range
Sometimes, a well-respected firm will submit a bid that is wildly out of proportion to the other bids. This type of response may reflect the bidder's decision not to seriously chase the work by asking for a price driven high by large markups. While it is easy to discard such a proposal as out of bounds, some effort should be made to identify the bidder's motive. That bid may reflect the bidding firm's error, reveal an error in the winning firm's low bid or highlight aspects of the work (such as timing, legal requirements, etc.) that the owner may not have previously considered.
Changes In Key Leadership
A third red flag is recent changes in key leadership at the firms that are critical to a project, including architects, engineers, construction managers and general contractors. Even in the post-modern age, project development from design to final construction is a human endeavor, and little matters more than the talents of the people who are responsible for the work.
Of course, a wise owner will investigate the reputation and skills of the staff proposed to lead its project's efforts. Checking references and interviewing prior to executing a contract, rather than waiting to meet the staff at the first project meeting, can be worthwhile. After all, calling off a wedding after the invitations are mailed is hard, but it's a cakewalk compared to a divorce.
Furthermore, when previously touted talent leaves a firm that is being considered for a project, the owner should ask about, and independently verify, the circumstances of the departure. An owner should do this even if the departed employees were not supposed to be staffed on the project, in case the employees' departure is a sign of other trouble in the firm.
The risk areas discussed above can be addressed by good legal agreements, written and negotiated by experienced counsel. But no matter how well written, contracts merely shift risks; they do not eliminate them. Your chances for a successful project increase significantly if risks are recognized and avoided, instead of merely being shifted to another party. Conversely, if the project fails, everyone loses something, no matter the reason or how the risk was allocated. And despite his fame, no one wants to emulate King Pyrrhus. If a project owner recognizes and proactively addresses the red flags described in this article, he or she will go a long way toward a true, rather than a Pyrrhic, victory.
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