The construction industry is critical to the Australian economy, ranking as its fifth – largest sector. The sector faces mounting pressures which have led to an increasingly volatile operating environment including inflationary pressures and high interest rates. Supply chain disruptions, whilst easing, continue to impact project delivery at multiple levels. As a result, Australia’s infrastructure landscape has suffered from instability characterised by project delays, budget overruns, shortage of labour and growing numbers of contractor insolvencies.
Project owners and contractors have seen challenging insurance market conditions, with policy coverage narrowing and premiums increasing. Many insurers are either reducing their overall capacity or exiting the construction market altogether creating further difficulties when it comes to large project placements.
In response to these mounting obstacles, both public and private organisations are increasingly embracing collaborative contracting methods for large projects. This shift towards a more cooperative approach has seen a revival of “alliance contracts” and hybrid models, promoting a shared risk approach. This represents a significant departure from traditional risk allocation, acknowledging that conventional approaches may no longer suit complex project requirements or their associated risk profiles and a growing recognition across the construction industry that balanced, collaborative frameworks may be better suited to navigate current market uncertainties.
Alliance contracting is not a new concept, however its growing popularity seems to be closely linked to harder insurance market conditions. Its intention is to reduce project costs and improve desirability of projects for contractors in times of great uncertainty. In this article we will provide an overview of alliance contracting and the advantages and shortfalls associated with this collaborative project delivery method.
What is alliance contracting?
Alliance contracting is fundamentally different from traditional contracting methods. Conventional contracts typically see each party working with their own independent goals and risk allocations, whereas alliance contracting creates an environment where all participants have a unified approach working toward common objectives.
Alliance contracting divides parties into two groups, the entity procuring the project (who will likely hold the asset in the long term (the Owner)) and other parties only involved in the project delivery phase such as contractors, designers, consultants etc (non -owner participants or “NOP”s).
All participants share joint responsibility for delivering the project works and enter into a unique agreement where they commit, amongst other things, not to litigate against each other regarding project performance (with limited exceptions such as breaches of behavioural commitments or fraudulent misconduct).
The financial structure of an alliance contract also differs significantly from standard contracts. Rather than paying a fixed price or lump sum, the Owner reimburses the NOPs for their actual and reasonable costs, plus an allowance for costs such as corporate overhead and profit.
A crucial consideration for the Owner in alliance contracting is their own capability as the Owner will be taking on additional risks which are usually transferred to the NOPs under a conventional contracting regime. Therefore, it is critical that they have sufficient internal resources and expertise to participate as a fully informed member of the alliance process. This is essential for the success of the collaborative arrangement and proper oversight of the project.
Alliances can be expensive to establish, include nuanced interfaces and as such are generally most suited to projects where there is a high level of uncertainty and ambiguity of scope, such as high‐risk, tight timeframe, complex stakeholder issues and problematic external environments. The flexibility and collaborative decision-making inherent in alliance contracts enable the parties to navigate these uncertainties as and when they arise.
Alliancing is particularly valuable when certain aspects of the final construction remain undecided, for example, projects that demand innovation. This method of contracting allows parties to leverage the combined expertise of alliance members to address unresolved technical challenges and can lead to more innovative and cost effective outcomes.
Advantages of alliance contracting
Firstly, under a shared “risk and reward” approach, parties cooperate more readily and share responsibility for problem solving. This leads to enhanced collaboration and communication within the project team – open communication and teamwork among stakeholders should lead to a “best-for-project” mindset rather than individual business interests of the parties, creating less adversarial relationships which are common in traditional contracting.
Secondly, as mentioned above, there is more innovative problem-solving amongst members. This sees parties utilising their combined skills, knowledge and experience to promote creative solutions on value-engineering initiatives whilst working collaboratively to find efficient and cost-effective resolutions.
As all risks are shared there is a joint effort to manage the costs and lost time associated with project risk. There is a preference to work together to identify and manage risks early, and the coordinated approach encourages the early detection of issues, enabling proactive problem-solving and risk mitigation.
Overall cost savings will result if the alliance is successful. This contracting model supports the ability to avoid duplication of costs (including project resources and administration costs), reduced insurance premium costs, lower likelihood of claims or disputes, minimised project delays, transparent pricing and a leaner project team resulting in a total cost reduction to the benefit of the entire alliance group.
The openness and trust cultivated in this model also has significant cultural benefits on a project, as the relationships are non-adversarial in nature. This results in a more positive working environment with closer and longer term personal and working relationships between participants. This in turn enhances transparency in project operations, facilitating the tracking of progress, costs, and performance against benchmarks.
Why is alliancing not more commonly used?
Whilst in theory, alliancing seems to be the perfect contracting solution, the Australian construction industry remains hesitant in embracing alliance contracting methodologies. This may be due to several factors: insufficient familiarity or experience with alliance contracts, a preference (particularly by upstream parties) for traditional contracting and risk transfer methods, as well as uncertainties regarding the legal enforceability of specific alliance contract provisions.
The use of alliance contracting represents a fundamental shift in risk apportionment and relationships between parties to a project and requires substantial modifications not just to the overall project management but organisational mindsets as well. This approach is a move away from blame culture and unbalanced risk allocation practices and creates an opportunity for projects to commence that may otherwise be shelved, this being a key consideration for an industry facing growing challenges.
Insurance considerations for alliance contracting
For larger projects, the use of alliance contracting does not cause significant insurance concerns in relation to construction works and liability placements. Such project placements usually include all parties as an insured, irrespective of the contracting method used. The main difference with an alliance contract is that the contract will specifically state that the insurance will provide cover to all parties, whereas with a traditional contract, all parties will be required to carry the risk of damage to their portion works as well as third party liability for injury or damage.
From a PI insurance perspective, alliance contracting was historically very popular. Insurers would simply respond to the needs of the alliance contract which does not attribute liability or loss between the parties.
As the “trigger” for coverage under a traditional PI policy is a “claim” i.e. a written demand for compensation by a third party, claims in theory do not occur under an alliance arrangement so a traditional PI policy would not respond insofar as disputes amongst participants.
Alliance PI insurance has been developed to cover “losses” from the project due to the professional negligence of the parties, without the need for the usual trigger of a “claim” or litigation. Cover under alliance PI insurance is first party in nature meaning that for the policy to respond, there is only a need to show that the likelihood of a loss would flow from failing to remediate at the time an issue during the project is discovered.
PI insurance for alliances is readily available and whilst alliances have not been a popular choice for some time, insurers are keen to provide alliance insurance for the right project. Insurers who specialise in this kind of PI insurance work in a similar way to an alliance contract namely, shared risk and a no blame culture. Underwriters are very involved from the outset of the project to ensure they understand the project risk and to assist in mitigating any issues should they materialise.
The key to a successful insurance placement to complement this contracting method is to clearly articulate the participants’ experience and the work undertaken to form the alliance which demonstrates how this reduces risk to the insurers rather than increasing it. If insurers believe disputes could arise within the alliance (either due to the responsibilities of the parties or a history of disputes from one alliance member) they will be less likely to provide terms for the project.
Summary
Alliance contracting does provide an opportunity to reduce insurance costs and result in a more collaborative approach to projects from inception right through to operation. If you are considering an alliance contracting arrangement, it is important that you engage an insurance advisor who has had past experience with this mode of project delivery. Please do not hesitate to reach out to your Bellrock Advisor to discuss.
