An IPD Primer

By Michael S. Zetlin, Partner, Zetlin & De Chiara LLP

As seen in Real Estate Weekly, October 12, 2011

Michael S. Zetlin, Esq.

Construction is a high-risk, high-reward industry. The traditional design-bid-build method often fosters conflicting interests and clashing incentives amongst the project participants, the owner, the design team and the construction team. The business independence of each participant can create an inherently adversarial environment, potentially impacting the productivity and efficiency of construction, which, in turn, can lead to project delays, cost overruns eroded profits, and costly claims. IPD breaks the traditional mold by financially incentivizing a collaborative approach to a construction project, an approach that paves a path to "we all win or we all lose." Project success becomes the mantra for all of the IPD participants.

Collaboration between the owner, the design team, and the contractors is not a novel idea. In the 1980s the concept of "partnering" was introduced to the industry. The partnering process was designed to allow the owner and contractor to reach a set of mutually agreed upon objectives and goals through a series of workshops. Partnering focused on developing inter-organizational trust and communication as the foundation of the cooperative relationship between owner and contractor. For various reasons, however, the partnering initiative never caught on in the United States.

Partnering floundered because of its inherent flaws: it was non-binding and lacked teeth. If a participant decided to reject the "we will all play nice together" notion or some project predicament harbingered some meaningful cost implications, the relationship defaulted back to the contractual rights of the parties dictated by the Owner–Contractor/CM agreement and Owner–Architect/Engineer agreement. The internal analysis of the parties then reverted to the inquiry: "Is my economic interest served best by asserting a claim, blaming others for the difficulty to avoid a painful financial hit?" IPD has the potential to erase this last question from the thought process, impelling the parties towards collaboration by having all parties share gains for success and losses for cost overruns.

IPD is intriguing because, through contractual arrangements of risk/reward incentives, often accomplished in a single agreement executed by the IPD participants – Owner, Contractor or CM, Architect/Engineer and, perhaps, significant subcontractors and subconsultants – risk/reward is shared among the participants. If an alleged design error causes some added costs to the project, the costs are shared as a defined percentage: no claim. If the GC/CM commits some construction snafu, the costs again are shared: no claim. If the project meets or beats project goals, which can go beyond budget and schedule and include things like safety record, design recognition, customer experience, etc., financial reward is shared.

Since with IPD everyone has skin in the game, the IPD contractual agreement typically modifies the conceptual approach to the phases of design and construction. On a design-bid-build project, a contractor may never have a hand in contributing value engineering concepts or constructability reviews during the design process. Likewise, an architect or engineer may never participate in a cost estimate meeting with a contractor. On a project utilizing IPD, however, both the design professional and contractor are strongly encouraged, and may be contractually obligated, to participate in the conceptualization of the project with the owner. All of the IPD participants can help develop design schemes, performance criteria and scopes of work, and even develop a collaborative budget for the construction costs. Then, during construction, all of the participants again collaborate in the decision-making process when issues arise relating to scope, budget, material purchases, schedule, conflicts, etc., issues that might impact the cost, timing or other goals of the project.

Although IPD is still in its infancy, we are seeing optimism that this new paradigm will work. Owners are signaling that they are ready for a shift, and contractors and design professionals seem willing to become real partners with owners to help ensure a successful project. We have already participated in successful IPD projects and see that it can work, with the right mindset of the participants and the proper structure in place. What makes IPD attractive is that it not only intends to create an environment where decisions, solutions to problems, and behaviors are driven by a shared set of goals and objectives, but when fully embraced, IPD drives a behavioral shift towards setting performance targets that can far exceed business-as-usual results.

Time Extensions Now Both Defensive and Offensive

Ever since the California Supreme Court handed down its decision in Peter Kiewit Sons' Co. v. Pasadena City Junior College Dist. (1963) 59 Cal.2d 241, California has maintained a strange dichotomy regarding time extension requests and liquidated damages that made some practical sense, and was a boon to contractors everywhere. The dichotomy provided: if a contractor wants a time extension, it must adhere to the contract's procedures and timely and properly submit one. However, an owner may not assess liquidated damages against a contractor for delays that are actually the owner's fault, REGARDLESS of whether or not the contractor ever submitted a timely and proper time extension request for these delays. The dichotomy made sense by depriving a careless contractor of affirmative claims for time when the contract's provisions are not followed, but not awarding the owner a windfall (LDs for delays that are actually the owner's fault) simply because the contractor neglected to timely file a time extension request.

That dichotomy came to an abrupt end this week, with the California Court of Appeal's decision in Greg Opinski Construction, Inc. v. City of Oakdale. The Opinski court acknowledged the rule established in Kiewit, but concluded that a 1965 amendment to California's Civil Code overturned the holding in that case. This conclusion came as a surprise to the many trial and appellate courts that have followed the Kiewit doctrine in the last forty-seven years---apparently, no one but this panel of the Court of Appeal realized that Kiewit had been superceded two generations ago.

Opinski makes more sense when viewed in the context of the overall approach of California courts to contractor's claims. In California, as in the Federal Court of Claims, contractors built a favorable body of caselaw from the 1960s through the early 1980s on topics ranging from weighing the propriety of termination to waiver of contractual change order procedures. Many of these cases are relied on to this day by contractors' attorneys. But starting in the mid-1990s, in both California and the Federal Court of Claims, the worm started to turn. Courts have insisted on more rigorous (occasionally, strict) adherence to contractual change provisions, and have shown greater willingness to strip a contractor of otherwise valid claims based solely on procedural defects. Contractors still win the occasional victory (Dillingham-Ray Wilson v. City of Los Angeles comes to mind), but the tide has clearly turned.

Residential Construction and Government Spending Lagging

This statistic shared courtesey of Brad DeLong (macroeconomist at Berkley).

Looking for Good News in Bitter Times

Here is the data for Total value of construction put in place, 2002-2010.   The latest figures available, for July 2011, show not much progress yet, with annually adjusted rate of $790 Billion; still below the low water mark set in 2010. 

It's not like there isn't work to do.  Construction could be leading the economy out of the doldrums if only Congress would get on board with tackling deferred maintenance and funding normal upgrades of our national infrastructure; if only Congress showed some leadership and vision in laying the foundation for the new infrastructure we'll need this century.   But instead of exhibiting some good old fashioned can do spirit, politicians are trying to outdo each other in how to further dismantle infrastructure spending.  It's enough to make a body depressed. 

In this sea of negativity, it's good to periodically take stock of the good things that are happening.   So here is a short list of accomplishments for the last decade. 

Can someone take a shot at expanding on the progress in construction?

It's Summertime: Another Contractor Stung by PWL in PPP

In Hensel Phelps Construction Co. v. San Diego Unified Port District (published July 26, 2011) the California Court of Appeal handed a prevailing wage bill to the general contractor of a $350 million hotel development project.  Odd, you might say, because the project seemed rather private.  The Port leased land on the San Diego waterfront to a developer (OPB) for construction of a hotel.  The lease term was for a long time, 60 years, and at the conclusion of the lease the land was to be delivered free and clear of the improvement.  In the meantime, the developer was to pay rent of $4.5 million per year ($2.25 during construction), plus 7% of room rental proceeds, 3% on food, and 5% on drink.  OPB hired a developer, who in turn hired Hensel Phelps Construction.  They apparently did not pay prevailing wages and the carpenters and laborer unions sued.

In making these wage and hour determinations, courts usually look to three things: 1) the nature of the ownership of the project, 2) whether the project is funded in part with public money, 3) and whether the project serves a public or private purpose.  See my recent article in The Procurement Lawyer.  In this case, none of these criteria jump out at you.  Although the Port owned the ground lease, the hotel project in this case was undoubtedly privately owned.  Similarly, although a hotel in the area would provide a shot in the arm for the neighborhood, operation of a private hotel does not seem particularly public in nature.  Finally, the Port District did not directly contribute any funds to the project. 

However, there wasa strong interest by the Port to have a hotel developed on the property.  Presumably they felt this was the highest and best use for the general development of the area.  In that sense, the project had a public purpose similar to the City of New London’s purpose in the Kelo case (U.S. Supreme Court takings case).  The Port District in this case attempted for many years to find a developer to build a hotel.  The Port provided specifications for the project.  In effect the Port lent the project a public air by taking such a keen interest in how they wanted the property developed. 

Ultimately, however, the case turned on statutory interpretation on the use of public funds.  The California Labor Code provides that prevailing wages must be paid on any project that is built in whole or in part with public funds, and the statute specifically provides that forbearance of rent counts as public funding.  In this case the developer advised the Port up front that the project did not pencil with the initially negotiated rents unless some of the rent was forgiven.  The Contractor and Developer argued that the lease agreement simply restructured the reasonable lease payments:  there was no lease obligation to be forgiven before the lease was signed and so this shouldn’t count as a “forgiving” of rent under the statute.  This argument was rejected. 

The moral of the story is, if a public entity has a strong interest in how a project is developed this may persuade a court that the project has a public character, even though it may be strictly private in ownership and use;  above all, however, pay very close attention to the applicable prevailing wage statutes in your jurisdiction whenever a public entity is involved, even if very periphorally.  One can’t tell from the opinion who will ultimately get stung here by this unexpected cost—suffice it to say it will not be pleasant. 

Brownfield Bloom and Nostalgia

My legal career started as a deputy prosecuting attorney in King County Seattle.  At the time I lived on a sailboat on the south side of Lake Union and conducted trial strategy meetings during Tuesday night beer can races.  The area between the south end of the lake and downtown, pictured here, has undergone many changes since then. 

Here is an article  in the WSJ about the 6.4 million of office space that Paul Allen's Vulcan has developed in this area since 2004.   If anyone has knowledge about this brownfield development, that would be an interesting discussion for a monthly call in meeting, hopefully for more than those of us who used to live on a boat on Lake Union.  

Alternative Energy Funding

Interesting article from May 2011  in the WSJ discussing financing of large alternative energy projects. 

To date the DOE has approved financing for 27 major projects, totaling 30 billion in loan gauarantees.  Of these, 16 projects have been funded, including Brightsource's  Ivanpah project near Las Vegas, currently being constructed by Bechtel.  The Brightsource Ivanpah project is the largest solar thermal project currently under construction worldwide and it will nearly double the amount of solar thermal energy being produced today.  The 845 MW Shepards Flat wind farm in Oregon's Columbia River Gorge is sponsored by GE Energy Financial Services and is funded with a mix of bonds, floating loans, and equity capital, with an 80% DOE loan guarantee.  In the meantime, developers of Cape Wind (the irritant of Kennedys) are looking for a 20 percent equity stake from Barclay's Investments and an 80 percent loan guarantee from the DOE's program for innovative technologies. 

As government support for these alternative projects is bound to wane in the current budget picture, the question will be whether enough of these projects currently underway can prove themselves so private capital will step in to finance future projects without, or with fewer, government loan guarantees.  Let's hope so.

These projects are dominated by technology and financing.  Nevertheless, there is a valuable role to be played by those of us versed in construction delivery models in allocating the risks and responsibilities between the parties.