Basics of Construction Contracts In Malaysia

Construction projects typically involve several different parties – owners, designers, prime contractors, subcontractors, architects, consultants, suppliers – with different interests.  Due to the many variables, construction projects have its associated risks.  Therefore, the purpose of the construction contract is to:

(1) allocate the duties between the parties; 
(2) recognize and allocate the risk to the different parties; and
(3) reduce the uncertainty surrounding the project and allow the parties to plan for the project and the future as best as possible.

In Malaysia, the introduction of Construction Industry Payment & Adjudication Act 2012 ("CIPAA 2012") is envisioned to regulate payment disputes which currently afflicts the construction industry. The scope of CIPAA 2012 is expected to include the oil & gas industry, petrochemical, telecommunication, utilities, infrastructure supply contracts, project and management, in addition to typical building construction projects.

Construction work must be carried out wholly or partly in Malaysia, and any payment dispute arising from a written contract may be referred to an adjudicator registered with the KL Regional Centre for Arbitration. The approach of such process is "PAY NOW, ARGUE LATER".

Is a verbal agreement enforceable?

Construction contracts may be verbal.  However, it is recommended that construction contracts be in writing in order to bring any payment dispute to be adjudicated within the ambit of CIPAA 2012.  A written contract presents a clear record of the parties’ agreement, whereas and oral agreement is subject to the parties’ recollection of the terms.  

When entering into a written contract, the parties should make certain that the writing accurately reflects the agreement between the parties.  The parole evidence rule may prohibit evidence of contract terms differing from those in the written agreement.  The integration clause of a contract also prohibits evidence of other terms or negotiations.

It must be emphasized that CIPAA 2012 only recognizes written contracts and not verbal or oral contracts, to be adjudicated by a Kuala Lumpur Regional Centre of Arbitration (KLRCA) certified adjudicator.

Stipulated value or lump sum contracts?

This is the typical contract with a negotiated lump sum price.  This type of contract is preferred by owners for the following reasons:

            •           owners can utilize a competitive bidding process

            •           all risks are placed on the general contractor 

            •           the general contractor must control costs and perform efficiently

Before entering into this type of contract, the owner must have detailed plans and specifications for the project, and the general contractor must have clear and specific instructions and scope of work.

What is a cost plus contracts with a management fee?

A cost plus contract is often used in the absence of detailed plans and specifications.  The general contractor is paid for all costs incurred.  The general contractor is also normally paid a fee for overhead and profit, plus a fee for general conditions.  The owner assumes all risks of excessive costs.  Frequently, an incentive provision is used to encourage cost savings by the general contractor.

What is a GMP?

Similar to a cost-plus contract, but with some protection for the owner, utilizing a GMP (guaranteed maximum price) as a cap for project.  The GMP is typically adjusted with each change order, just as a lump sum contract price is adjusted.  This type of contract is amenable to the design build situation, where the general contractor also serves as a designer.  The GMP is arrived at after the project has been completed to the design development stage.

What are the contract documents?

In most contracts, the contract documents are "incorporated by reference."  Contract documents usually include plans and specifications, the “prime contract” between the owner and all prime contractors, including the general contractor, addenda, building codes and regulations, and modifications to the plans and specifications after execution of the contract.

It is important for a contractor to review all contract documents incorporated by reference, as the terms of those documents may be binding on the contractor.  For instance, if a prime contract (between the owner and a general contractor) contains an arbitration provisions, courts will typically enforce the arbitration requirement against a subcontractor in contract with the general contractor. It is not necessary, however, that contracts provide for adjudication before payment disputes are brought for adjudication within CIPAA 2012.

On a smaller scale, a written contract may be referenced within documents used in the supply of goods and/or services, such as work order, purchase order, invoice, delivery order, etc. 

What is the scope of work?

Disputes regarding scope of work are often the basis of construction claims.  Scope of work is defined as the extent of a contractor's responsibility to perform certain contract work.  To determine the scope of work, the contractor may have to look to other contract documents –  plans and specifications, contracts with others – and to industry standards (building codes, etc.)

The scope of work issues between the owner and the general contractor differ from the scope of work issues between the general contractor and subcontractors.  The general contractor must be sure that all of the scope of work is contracted to subcontractors, and that there are no overlapping scope of work issues.   

Questions regarding scope of work should be resolved in the written contract.  Scope of work references should be detailed in the contract.  If detailed specifications are available, refer to the specifications in designating scope of work.

It must be pointed out that the scope of CIPAA 2012 is limited to payment disputes.

What is the contract sum?

The price in the contract will either be lump sum, unit price, or time and material.  The contract should include a definite price, or a definite method of determining price.  Absent price, an otherwise valid contract will be interpreted as requiring payment of a fair value (quantum meruit).

What are the methods for payment of the contract sum?

Progress payments are periodic payments constituting partial payment of the contract sum.  The contract should include a specific provision for time and method of payment and calculation of amount.

A schedule of values should be prepared by the contractor and approved by the owner and architect.  The schedule should accurately break down the scope of work into component parts, and assign a value to each component part.

Applications for payment should be measured against the schedule of values.  The application typically includes the amount of work in place, the cost of materials stored on site, the costs of labor to date, less an amount for retainage and previous payments.  The application is usually certified by the architect or owner and the payment is due thereafter.

It must be noted that CIPAA 2012 prohibits conditional payment terms such as "Pay When Paid", "Back to Back" or " Pay If Paid".

Pay when paid, or pay if paid provisions

One of the greatest concerns and risks on a construction project is payment by the owner, or main contractor or employer.  Once the contract work has been fully performed, everyone wants to be, and should be, fully paid.  One of the risks of nonpayment is the owner's or main contractor's or employer's potential inability to pay.  Throughout the work chain of contractors, sub contractors, sub-sub contractors and suppliers there is a need to agree on who bears the risk of nonpayment – the general contractor or the subcontractor, etc  

Contractors routinely try to shift the burden of nonpayment to subcontractors.  "Pay when paid" and "pay if paid" and "pay upon financial drawdown"  provisions are popular and widely used. Such conditional payment terms only serve to delay the time for payment to the subcontractor even in situations where the contracted work has been completed and complied with.

Typical pay when paid clauses provide something like:

"The total price paid to [subcontractor] shall be [contract price], no part of which shall be paid until 5 days after payment is received from owner."

or

". . . the Contractor shall pay the Subcontractor each progress payment and final payment . . . within three working days after he receives payment from the Owner . . . ."

In Thos. J. Dyer v. Bishop International Engineering Co., the Sixth Circuit U.S. Court of Appeals refused to enforce a pay when paid clause.  In Dyer, a general contractor was not paid on a project after the owner declared bankruptcy.  The general contractor, in turn, did not pay its subcontractor for the work it performed.

The introduction of CIPAA 2012 deems that such conditional payment are void and unenforceable. This, I believe, is where the impact of CIPAA 2012 will be keenly felt by players in the construction industry in Malaysia.

Typical schedule provisions

The schedule for completion of the contract work is an essential component of the contract, and a frequent focus of construction litigation.  In a perfect world, the contract will incorporate a detailed computer generated completion schedule, with milestone dates for the essential tasks, and the schedule will be updated periodically to reflect changes in the schedule to reflect changes and progress.

At a minimum, the prime contracts should include a date of commencement of the work, a project duration (the time that the prime contractor agrees to reach substantial completion of its scope of work), and a definition of substantial completion.  

The date of commencement is subject to change, based on several factors.  The most common factors affecting the date of commencement influenced by the owner are owner funding, the delivery of final plans and specifications, the availability of the building permit.  Changes in the date of commencement change the date of substantial completion.

The project duration is measure either in calendar days or working days, and is based on the number of days that the parties predict it will need to complete the project.  Project duration is subject to lengthen based on several factors: changes directed by the owner, unforseen conditions, force majeure, weather, contractor issues.