Owner Windfalls in Design/Build Contracts
Unless a change is made to design/build contracts, the owner may have a windfall when there are errors in the design. Design/build contracts require the contractor, as the design/builder, to hire qualified design professionals to prepare the construction documents. The design/builder is to provide and pay for all design services, as well as the labor, material and equipment necessary for the proper execution and completion of the “work.” The design/builder is responsible to the owner for the acts and omissions of the design team and responsible for correcting and/or replacing defective work. If the project fails to meet the owner’s requirements, the cost of correction is the responsibility of the design/build team. In concept, a design/build project is essentially a performance contract, the design/build team guaranteeing an owner that the completed work will meet the owner’s requirements.
There are many positive aspects of design/build contracting, but the risk undertaken by the design/build team may result in unfair windfalls to the owner. The traditional project in which the owner provides the plans and specifications incorporates what is known as the “betterment rule.” The “betterment rule” needs to be incorporated into design/build contracts to fairly balance some of the extra risks taken by the design/build team.
Compare the outcome of an error in design in a design/build contract with the traditional contracting method. The project is to remodel an existing facility so the temperature in the building reaches a certain level within a set time. Assume an error in the HVAC calculations which results in the HVAC equipment being undersized. After analyzing the problems, it is determined that more equipment needs to be added to achieve the desired temperature. All of the newly installed insulation and HVAC equipment can be used. In the traditional method of contracting, the owner would pay the costs for the required additional equipment. To the extent that the owner has to pay more post-bid for the additional equipment than it would have paid if the equipment was in the original design, those additional costs, the “delta,” will be charged to the owner’s design team. However, the design team would not be responsible for the total cost of the additional equipment. If the original plans had been properly prepared, the required additional equipment would have been in the plans and specifications. Rather than the owner achieving a windfall, receiving the additional equipment at no additional cost, the owner pays the cost of the additional equipment the owner wanted. The design team then pays the cost of the delta, the additional costs which would not have been required. This is the “betterment rule.”
In the design/build contract, without changes to the typical contract, the design/build team will be responsible for all the costs for additional equipment, not just the delta. The contractor may file a malpractice claim with the design professional, who hopefully has insurance to cover the costs. However, the design/build contractor and its design team are responsible for all the costs required to meet the owner’s requirements. There may still be a claim on the designer’s malpractice policy, but the claim is larger, not just the delta of increased costs.
To avoid a windfall to the owner, change the contract by adding a clause to avoid unfair risk allocation. In some cases, rare but certainly possible, an owner can justifiably say that had it known that additional costs were going to be required to achieve the intended result, the owner would not have built the project. A more typical design error results in a cost that the owner would have rightfully paid as part of the original design. The design professional has responsibility for the design error, only the delta for additional costs.
One solution is to incorporate the “betterment rule” into the design/build contract with an owner. This would require the owner to pay the “net costs” of a change order if the project plans and specifications have a defect, error, or omission. To the extent that additional labor, material and equipment are needed to achieve an owner’s desired performance, an owner should pay the net costs, and the design/build team should pay all other costs. Those costs typically include removal and replacement costs, costs of delay, and the added costs of post-bid prices.
A change in the typical form contract is a fair resolution providing no party with a windfall, each party assuming a risk it most likely thought it was assuming when the plans were approved.