Michigan Bar Journal - June 1997

WILL DESIGN-BUILD CONTRACTING REALLY SOLVE ALL OF THE PROBLEMS? 

By Mark L. McAlpine

The dramatically increased popularity of the design-build project delivery system has been the focus of a great deal of attention in all quarters of the construction industry.  In the last 10 years the use of this system, where both the design and construction are performed by a single entity, has grown from $18 billion to over $69 billion and now represents nearly 25 percent of the U. S. industry. While design-build is used extensively in the private sector, the most significant growth has been in the public sector where it is perceived as a solution to many of the frustrations of the public procurement process. 

Whether or not the perceived advantages of the design-build system are real, the current demand for the use of this system is changing the industry.  Because of the many unique subtleties involved with a design-build project, it is imperative to the successful use of this system that it be well understood by the parties and their attorneys. 

THE EMERGENCE OF THE DESIGN-BUILD SYSTEM

One measure of the popularity of a project delivery system is the existence and sophistication of the published standard contracts defining that system.  For instance, there are many standardized construction documents used to support the traditional design-bid-build delivery system, the most prominent of which are for architectural projects and are published by the American Institute of Architects (AIA), endorsed by the Associated General Contractors of America (AGC).  The Engineers Joint Contract Documents Committee (EJCDC) also publishes standard design-bid-build documents for engineered construction which are also endorsed by the AGC.  Each of these organizations also produces standard documents for projects utilizing a construction management system as well as for construction involving different pricing methods such as fixed price, guaranteed maximum price and cost plus contracts.  Similarly, the AGC produces specialized standard documents for the traditional systems. 

Until recently, only the AIA produced standard design-build contract documents (first published in 1985), although those documents were infrequently used.  Responding to the renewed interest in the design-build system, standardized design-build contract documents were published by the AGC in 1994, by the EJCDC in 1995, and, in a revised form, by the AIA in 1996.  The intense effort to produce standardized design-build contract documents and the ever increasing number of design-build seminars available for both the construction and legal communities, further establishes this system as a mainstay of the industry. 

HOW THE DESIGN-BUILD SYSTEM WORKS

The design-build process begins as does the traditional system, with the owner identifying its basic needs and requirements for the project.  The degree of specificity at the initial stage will range from simply identifying required square feet, site location, and minimal material specifications for architectural projects, at one end of the spectrum, to minimum performance criteria such as through-put or production requirements for engineered construction.  Generally, this process will take design development to a point of five percent completion and essentially replicates the program development phase of a traditional design-bid-build project. 

Various engineering associations such as the American Consulting Engineers Council have suggested that the owner should go further in the identification of its minimum requirements, such that the design development will proceed to a point of approximately 35 percent completion before design-build bids are solicited.  In order to accomplish this goal, those same organizations recommend that the owner retain its own design consultant to assist it in developing various schematic drawings and more detailed specifications.  Proponents of the five percent design development approach argue that taking the design to a point of 35 percent completion essentially undercuts a primary benefit of the design-build process by reducing the flexibility allowed in the design-build proposals. 

Regardless of the degree to which the owner's needs and requirements are identified, the next step in the process is the development of a request for a proposal which identifies the information that the bidders are required to take into consideration in the development of their proposals.  This information may include geotechnical reports, site restrictions, construction time frames, and proposed contract documents, as well as descriptions of owner-supplied equipment, materials or other requirements for the project.  In this respect, the AGC, AIA and other organizations generally recommend a two-step proposal process.  The first is a prequalification step which the owner uses to limit the number of ultimate proposers to between three and five.  The second phase allows the qualifying design-builders to submit fully developed proposals.

The evaluation of the design-build proposals can be complicated for even a sophisticated owner.  Unlike traditional delivery systems, there is no apples to apples comparison possible.  Instead, the owner must evaluate both the quality of the design, and the construction price.  This can be difficult where a number of owner representatives are involved in selecting the successful proposal, and particularly where more than one of the proposals are within the company's budget.  Owners typically proceed on the basis of a scoring matrix which ascribes a particular weight to the design portion of the proposal, a weight to the price proposal, and a methodology by which an overall score can be assigned to each proposal.  In most public procurement systems, the weight to be attributed to each element is described in the request for proposal (RFP).

Various construction industry groups have questioned the appropriateness of the design-build delivery system for the public environment given the vagueness of the contract award process.  Some argue that the inability to provide an apples to apples comparison essentially undermines the competitive nature of the public bidding process.  This is particularly true where significant weight is attached to the design portion of the proposal, thereby removing the traditional objectivity of hiring the lowest responsible bidder and replacing it with subjective criteria which opens the door to favoritism in the award.

After the successful proposal is chosen, the contract is awarded and the design phase is thereafter completed by the development of the construction drawings.  Since design-build is usually a turnkey system, the owner's involvement in the review of design submittals before the start of construction is much reduced, although not completely eliminated. In fact, the owner may wish to retain a consulting design professional to assist in the review of submittals, particularly with construction projects such as waste water treatment plants where the owner has a particular interest in the long-term usefulness of the equipment incorporated into the project.  Some owners have considered addressing this concern by incorporating a maintenance and operation requirement in the design-build scheme whereby the successful bidder will not only design and build the project, but will also maintain and operate the facility for a specified number of years.  In this way, the bidder accepts the performance risk for the project as well as the operation and maintenance costs which might be affected by questionable design and construction practices.

ADVANTAGES OF THE DESIGN-BUILD SYSTEM

No one factor fully explains the renewed interest in this system.  Certainly, the potential design liability for the owner in the traditional design-bid-build system explains the owner's interest in a system which limits that design liability.  That is, the case law in most jurisdictions holds that where the Owner procures the design from a design professional and then provides that design to the contractors, the owner attaches to the design its own warranty of sufficiency and completeness for the project.  In the design-build system, the design-build contractor is responsible for the design and therefore will be responsible for defects caused by design and/or construction errors.

Another anticipated advantage of the design-build system is the avoidance of problems encountered with the use of value engineering in the traditional process.  Value engineering is a process by which the initial design for the project is scrutinized by a third party to determine whether alternative design and/or material choices can lower the cost of the project or improve the performance of the final product.  Value engineering often occurs when the owner seeks the advice of a contractor, either by retaining a construction manager during the design process or by considering alternate proposals by contractors and prime subcontractors during the bid phase of the traditional process.  However, value engineering changes can result in project problems for which design professionals will deny responsibility. This is particularly true where the changes produce aesthetics which were not fully understood when the value engineering proposal was accepted and then later prove unsatisfactory to the owner.

Indeed, many lawsuits have focused on misunderstandings that can be traced back to the value engineering process and the parties' failure to properly identify the results of the value engineering proposal.  By having a single entity do both the construction and the design, the owner may reap the advantage of the value engineering process (options in design) while at the same time avoiding the gap or conflict in responsibility that value engineering frequently produces in the traditional systems.

Another advantage of the design-build system are the benefits realized by the owner where several design solutions are offered to meet its needs.  In the traditional system where the owner retains an individual design professional to propose a design addressing the owner's needs, the design options are restricted by the creativity of the design professional selected.  While this very often produces satisfactory results, the owner, nonetheless, does not typically have the advantage of seeing different design alternatives.  In the design-build process, the design-builders will each propose a design along with a construction price for that design.  This process presents the owner with three or more fully developed design solutions with detail costing proposals for its consideration.  In making the award of the design-build contract, the owner selects among the competing designs, with a much greater understanding of the cost implications of any given design option.

The design-build process in the public sector offers the advantages of greater flexibility and quicker awards depending upon the regulatory environment in which the project is undertaken.  With the traditional design-bid-build system in the public arena, the owner will complete the design effort and then release it for public bid under a regulatory scheme which will typically require that the contract for the construction be awarded to the lowest responsible bidder.

Construction lawyers operating in the public sector are well aware of the negative consequences of this process, both in terms of bid protests by disappointed bidders as well as by the sometimes narrow constraints placed upon governmental authorities in determining the lowest responsible bidder.  With the design-build system, the public owner is not necessarily required to award the design-build contract to the bidder proposing the lowest price project.  Rather, the quality of the design and the price are both considered in the award process.  Thus, if the owner determines that a more costly design is nonetheless superior, it may award the contract to a higher bidder, with a better design.  Similarly, the public entity can shift design costs into its construction budget by using a design-build system which may allow more dollars to be used for design than would otherwise be available if the design was separately contracted. 

In addition to various procedural and liability allocation advantages which are generally identified with the design-build system, there are a multitude of project specification advantages.  For instance, many owners believe that the time from concept design to the completion of construction can be reduced by starting construction before the design is complete (fast-track) and that this sequence works best using a design-build team.  Similarly, where the project employs new or complex technologies, owners can benefit from the close working relationship between designers and contractors that the design-build process engenders.

DISADVANTAGES WITH THE DESIGN-BUILD SYSTEM

While design-build is not new, the recent increase in the frequency of the use of this system translates into uncertainty about how courts and arbitrators will resolve newly arising issues associated with this system.  In many respects, the resolution of these issues must await the continued development of a body of case law as these projects produce issues for the courts to resolve.  Just as many commentators and construction lawyers were hard pressed to give clients good advice about how the courts would view various types of contractual relationships arising out of the burgeoning use of the construction management system in the past 20 years, so too must legal advisors be cautious in predicting how various issues will play out in the courts in the design-build era. 

One issue that must be resolved on a state-by-state basis is the professional licensing requirements associated with the design-build system where the contractor serves as the design-build entity and subcontracts the design.>  This occurs where the design-builder is a traditional contractor or construction manager, who is not and does not have licensed design professionals on staff.  In this situation, the construction manager/contractor delivers the design to the owner and it is that every point which is the focus of the state licensing requirements.  A number of states' licensing laws do not allow the delivery of the design in this manner. 

Similarly, an issue may arise where the Contractor has licensed design professionals on staff although the contractor itself is not a design professional firm.  A related issue is whether a contractor/designer joint venture must be separately licensed for both design and construction.  These and other licensing issues must be carefully considered very early in the process of selecting this delivery system by both the owner and design-build team in forming the business and contractor relationships.  Failing to obtain the proper licensing could prove disastrous since the consequence of failing to do so may be the unenforceability of the design-build contract. 

Another practical issue of more concern to the contracting community than to owners is the high cost associated with producing a design-build proposal which may limit the number of proposals.  In an ideal situation, from the owner's point of view, when the owner seeks design-build proposals it will identify only its basic needs and requirements for the project and take the design to a point of about five percent completion (conceptual design) before seeking design-build proposals. 

However, in order to give a reasonably accurate price for the construction of the design (and certainly before the design-builder will commit to a firm price), the design must be at least 35 percent complete so that quantities can be identified, in order to estimate the construction price.  Thus, the design-builder must engage in a fairly costly design effort which advances the design completion from five percent to 35 percent.

This is a very expensive process, which, when coupled with the inherent difficulty in providing a firm construction price with only a 35 percent design, creates a situation in which the bidder may spend from $50,000 to $200,000 to produce a design-build proposal on a substantial project.  This high cost threshold will deter many potential bidders.

The owner's concern should be with ensuring that a reasonable number of qualified design-builders are motivated to make proposals for the project.  If the chance of being awarded the project is low due to a large pool of potential bidders, the high cost of the proposal process may convince some desirable potential bidders to pass.  Many believe that the solution to this problem lies with the owner first using a prequalification effort to select between three and five bidders for the project.  The prequalification process examines the quality of the design-build team along with the team's prior experiences and financial resources.  Once the list of bidders is reduced to the desired number, many also suggest that an honorarium be paid to the unsuccessful bidders to help defray the development of the design-build proposal and encourage bidders to complete designs for the projects.

Another major concern in the industry is the limited design-build insurance and bonding available to the design-build entity for the full range of its efforts. In the traditional system, the design professional will often obtain errors and omissions insurance for the benefit of the owner, and the contractor will at times be required to obtain payment and performance bonding of its work for the benefit of the owner and subcontractors.  However, the design professional insurance community has expressed reluctance in issuing policies covering both design and construction activities.  The concern seems to focus on uncertainties associated with an environment in which the construction and design activities may be blurred into a single activity representing unfamiliar risks.  Some underwriters have even advised design professionals to participate in design-build projects only as a subcontractor to the design-build entity so that the errors and omissions insurance is issued for the benefit of the design-builder, with the ultimate owner as an additional insured on the policy. 

However, such a policy would not cover the contractor (design-builder) for its design liability to the owner even though the contractor will have total design liability to the owner which it does not have in the traditional design-bid-build system.  As of the writing of this article, the author is aware of only one underwriter offering coverage for the design-builder to the owner where the design is procured from a subcontractor and that policy has only been available since April of 1996.  The limited availability and scope of design-build insurance products represents a substantial risk both to the design-builder and to the owner, particularly in an environment in which the errors and omissions policy of the subcontractor designer may later give rise to arguments by its insurer that a given problem is caused by workmanship as opposed to design.  All parties are advised to carefully evaluate the insurance issues and scrutinize their policy to determine if the desired coverage is truly available.

A related problem is a similar concern by the surety community in connection with the issuance of performance bonds.  A performance bond is issued by a surety on behalf of the contractor/principal which essentially promises the owner as obligee on the bond that if the principal fails to perform its obligations under the contract, the surety will undertake to complete the principal's performance obligations.  However, these bonds are typically issued on behalf of contractors where the surety understands the risks associated with the construction side of the process.

Where the bond principal undertakes both the design and construction obligations, the surety community has expressed serious concerns about guaranteeing the performance of both the design and construction activities.  Understandably, the surety community is concerned about undertaking what amounts to errors and omissions risks which are as unfamiliar to them as the construction workmanship issues are to the errors and omissions insurers.  The owner must be prepared to consider accepting limited surety obligations where market conditions do not support the insuring of the traditional performance bond.  Indeed, sureties have issued bonds that exclude design liability, thus providing only the traditional construction related bonding.

While it is expected that the increased demand for the design-build delivery system will cause the insurance and surety communities to develop products that will meet the market demand for insurance and bonding under this system, all involved parties should proceed cautiously, both in the development of these products and in determining their suitability for any particular project.  Owners in particular are advised to read the insurance policies and bonds to determine the extent to which both the design and construction project are covered by the insurance and bonding products. 

Another practical issue to be considered, particularly during the administration phase of the project, is the manner in which design-related changes will be handled.  In the traditional design-bid-build system, where the contractor identifies a problem with the design (inconsistency, interferences or incomplete or unclear design details), the owner will turn to the design professional for clarification and will issue a change order to the contractor if the design must be changed to address the problem.  In the traditional system, the contractor will typically request an increase in the contract price as a consequence of the design change.  Where the design professional is at fault for overlooking the problem or by failing to produce a clear design, he or she will be required to pay the owner for the increased cost of the construction through some form of deduction from the professional fee.

However, in a design-build environment in which the design-builder has guaranteed a maximum price for both the design and construction of the project, the owner should consider whether its interest will be served in an environment in which the need for a design change may be compromised because the contractor will not be entitled to an increase in its construction price if the design must be changed.  This presents a problem on both performance based design-build projects (where the design-builder has greater flexibility in the development of the design) and those with approved plans and specifications (such as where the owner participates heavily in the design and there is no performance guarantee).  In both cases, the owner's interest in the long-term performance of the structure as well as in maintenance costs may be affected by poor design decisions.

A solution to this dilemma has been suggested in the form of a slight modification of the design-build system wherein the owner retains a consulting design professional to assist it in evaluating the performance of the design-build entity and in reviewing design submittals.   While this increases the cost of the project to the owner, this increased cost may be well spent depending on the type of project and the potential for changes during the construction base.  This type of concern is also lessened in a situation where the design is procured by a subcontractor to the design-built entity and the design professional/subcontractor can be made to absorb the construction cost consequence of a deficiency in the original design.

Also of concern to the owner is the financial consequence of placing the entire project in the hands of a single entity, particularly where that entity may either be a joint venture between a designer and a contractor (who may not have operated together before), or where the entity may have uncertain financial resources.  While the design-build system holds the promise of actually shortening the time from project conception to completion, the time can be dramatically lengthened and completion delayed if the design-builder encounters financial problems which may ultimately cause the replacement of the entire design-build team or where the designer and contractor as new business partners are unable to work together efficiently.  Owners are cautioned to carefully evaluate the financial wherewithal of the design-builder and the experience the design-builder has in blending the efforts of both the design and construction aspects of the project.

Although the foregoing concerns are only some of those that should be considered by an owner using a design-build method, they give certain ideas of the differences created by this relatively new construction process.

AN EVALUATION OF STANDARD DESIGN-BUILD CONTRACTS

There are currently three primary families of standard design-build contracts, all of which were published during the last three years.  While the AIA published its design-build documents in 1985, those documents were not particularly useful in the commercial market place, particularly as the design-build system has evolved of late.  Recognizing this, the AGC published its own set of design-build documents in 1994, followed by the publication of the EJCDC design-build family in 1995 and a revised series of AIA documents in late 1996.  Each of these families of documents has advantages and disadvantages and each is particularly well suited for specific types of projects.

As would be expected, each of these series of documents are particularly well suited for projects in which members of the sponsoring organizations are involved.  Thus the AGC documents are well suited for contractor lead projects; the AIA documents for architectural projects and the EJCDC documents for engineered construction projects.  Indeed, each series mirrors in many respects the format and detail characteristics of the sponsoring organization's traditional design-bid-build contractor agreements.  Thus, the EJCDC documents are the most detailed of the three series - the AGCs are the shortest and most flexible and the AlAs are the intermediate level documents.  Those familiar with the documents of each of these organizations will find their design-build documents fairly familiar. 

Space does not permit a detailed analysis or comparison of these documents. In general, the particular type of project and configuration of the design-build team will impact the selection of the series of documents to be used as the basis for the project.  Additionally, considerations affecting selection of the base documents should include: 

• Whether the owner will retain its own design consultant (see EJC Design No. 1910-43);
• Whether the owner wishes to have assistance in the development of its minimum requirements (AGC Document No. 400);
• The degree to which the owner's requirements will be specified (See EJCDC Doc.  No. 1910-42);
• The permitted uses of owner-supplied geotechnical information;
• The design standard of care which the owner seeks to impose as the design-builder;
• Scope of work considerations;
• How the owner will be involved in reviewing submittals and the liability consequences of its approval of submittals;
• Termination and dispute resolution procedures; and
• The particular needs of the project in the change order process.

Perhaps the more important contract documents will be those which allocate responsibility and liability between the design-build team members where that work will be performed by separate firms.  The joint venture agreement or subcontract must address the allocation of risks and establish a system that will allow for efficient and seamless interaction between the design and construction activities.  The owner may wish to examine portions of those agreements to ensure that the design and construction teams will be encouraged to work together efficiently. 

It will be somewhat difficult to work with the standard design-build agreements because they are so new and untested in the courts.  As such, all parties are advised to become very aware of the risks these projects represent and the options that they have for workable allocations of those risks.  The achievability of many of the advantages of the design-build system will hinge on whether the parties have carefully prepared the basic contract documents.  Until the courts begin to provide feedback on the standard documents and newly emerging issues raised by the design-build systems, the parties must rely on their experience and concentrate on anticipating potential problems so that they can be resolved in advance by the express terms of the contract documents.

CONCLUSION

Clearly, design-build is becoming a standard delivery system in the construction industry.  Its emergence as a preferred delivery system has broad implications for how the design profession and construction community will operate together in the system.  One immediate benefit for the industry, which comes from the many joint venture and merger discussions now occurring within the design and construction industry, is a greater awareness by both of the practical and legal concerns each have in the process.  This greater understanding is essential to the success of the design-build process and will produce benefits of greater cooperation where traditional systems are used.