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First impressions are important. For this reason, substantial amounts of time, money and effort are spent on the fit-out of shops, restaurants and offices so their appearance aligns with the image the owners wish to portray, creating an environment conducive to making sales and conducting business. In a construction contract the employer is at risk of being exposed (and potentially out of pocket) if a fit-out is not completed on time, on budget and at the required quality.
Fit-out contracts are not always given the attention they merit. Indeed, we have experience of high-value and high-profile fit-out projects being procured on the basis of flimsy letters of intent and on the contractor’s standard terms of engagement, which are invariably biased in the contractor’s favour. This can result in contracts being executed under which the employer’s contractual entitlements could be ambiguous, limited or which fail to correspond with the rights that an employer might assume that it would have, especially given the significant sums of money concerned.
Against this background, there are a number of key issues employers should ensure are properly addressed in any fit-out contract.
Selecting the contractor is the first step and it is usually prudent for employers to run a tender process to determine the most competitive offer, taking into account quality, price and the experience of the contractor. The tender process should be completed in good time so the contractor has sufficient opportunity to place orders for materials, while careful consideration should be given to identifying the party responsible for obtaining the necessary consents and approvals (such as the building permit) for the project.
Design and construction
Another important issue is the extent the contractor is required to undertake design. As a general rule, specialist designers are likely to be engaged for complicated designs, while design responsibility will probably reside with the contractor (whomay have its own design team) if the design is relatively functional, and straightforward. The contract period is usually quicker if the fit-out is both designed and constructed by the contractor.
Regardless of the identity of the designer, it is important for the terms of engagement to include a design review process (to ensure that the design is satisfactory to the employer, including in terms of aesthetics and against any design requirements for franchise stores) as well as a fitness for purpose warranty. All design obligations should be backstopped by the designer’s professional indemnity insurance.
Once the design is sufficiently advanced, construction works can begin. The contractor should be subject to appropriately robust construction obligations. In particular, it is important the contractor is required to construct the works in accordance with best industry practice and with good-quality materials. The employer should engage a project manager to supervise the works, to report back on progress and to certify payments.
The scope and nature of fit-out works are usually relatively certain and this lends itself to lump sum pricing structures, which in turn increase certainty of price for the employer. That said, no contract price can ever be totally fixed as, for example, it will increase if the employer instructs the contractor to perform additional work or changes to the plans.
As with any other construction contract, it is important for the employer to have the express right to instruct variations (including decreasing or omitting part of the works) and the variation process must be subject to a clear pricing mechanism. For example, variations could be priced in accordance with analogous prices under the contract or in accordance with prevailing market rates, which can be determined through obtaining quotes from the market.
Fit-outs often take place within close proximately to operating neighbouring businesses, such as in malls. This means that contractors must perform the fit-out works in such a way that they do not cause nuisance or inconvenience to third parties and in accordance with the requirements of the landlord/building owner. On account of the interface with third parties, it is vital the contractor carries robust public liability insurance, which names the employer as a co-insured party.
As the employer will almost certainly be prevented from trading (and, therefore, generating revenue) while the fit-out works are being undertaken, fit-out contracts must be subject to definitive commencement and completion dates. If the works are not completed on time, consideration should be given as to whether delay damages should be levied against the contractor for each specified period of delay (such as a day or week). It is important that the rate of delay damages is sufficient to incentivise the contractor to complete the works as quickly as possible, while a further incentive can be added by providing that the employer can terminate the contract if any cap on delay damages (which is customarily 10 per cent of the contract price) is exhausted.
In addition to imposing penalties for late completion, employers sometimes agree to pay bonuses if the works are completed before the contractual completion date, especially if it is commercially important for the works to be completed by a particular date, such as during a shopping festival. In order to avoid any ambiguity, the contract should clearly set out the standards that the works are required to attain. Aesthetic appearance is important so, at the very least, the employer must be satisfied that the works have been performed in accordance with agreed designs and with the specified materials. Additionally, the contractor must have obtained all necessary consents and approvals, i.e. from the Civil Defence and the relevant municipality, for the works to be occupied and used for their intended purpose, while the contractor must have a good reason for not remedying any outstanding defects or completing any outstanding works.
Notwithstanding the taking over of the works, it is almost inevitable that defects will subsequently emerge. Defects must be promptly remedied by the contractor when directed by the employer, bearing in mind the need to minimise disruption to the employer’s business.
Dispute resolution is invariably expensive, and the cost can be disproportionate to the actual value of the fit-out project, so it is prudent to include mechanisms in the contract to enable the employer to recover money from the contractor in the event of breach. This approach also serves to incentivise the contractor not to breach its obligations and to quickly make good any breaches that do occur.
In this regard, employers usually require the contractor to provide a performance security. The best option for the employer is to obtain an on-demand performance bond from a bank operating in the same jurisdiction in which the employer is located, which remains in force until the expiry of the defects liability period (provided the employer is satisfied all defects have been remedied).
However, contractors sometimes resist providing performance bonds because of the cost, which could also lead to an increase in the contract price.
A pragmatic solution to this is for the contractor to furnish the employer with a signed but undated security cheque. To comfort the contractor, in can be clarified in the contract that the employer will account to the contractor if the amount received by the employer from cashing the security cheque exceeds the cost of the loss.
A further mechanism is for employers to seek to retain 10 per cent from each payment and press for this amount to only be paid to the contractor with the final account (after all defects have been remedied). If this is unacceptable to the contractor, a typical compromise is for half the retention to be paid upon takeover, with the balance to be given following the remedy of all defects.
A fit-out contract should be subject to clear rights of termination, including in respect of breaches that remain outstanding following the expiry of a cure period, insolvency, as well as if a cap on delay damages is exhausted. Any applicable local laws regarding termination should be properly addressed in the drafting. Fit-out projects are subject to the same issues and risks that apply to any construction project and failure to properly address these concerns can seriously backfire on an employer.
We recommend to invest time in engaging fit-out contractors upon clearly drafted and robust short form construction contracts that adequately protect the interests of the employer.
Source: Property Weekly