May  7, 1999



Bulletin # 26: The Challenges of Design/Build Contracting Part I

For years, the owners of ZZZ Sheet Metal had been reading about design/build contracting as a major opportunity for HVAC subcontractors. However, the firm was comfortable with its role as the installer of systems designed by third-party mechanical engineers. In general, ZZZ management thought it best that the subcontracting firm stay away from design responsibility as much as possible.

On the other hand, the changes occurring in the contracting world were difficult to ignore. Increasingly, ZZZ was finding itself a first-tier subcontractor to the general contractor, rather than a sub-subcontractor to a mechanical contractor. It was asked to bid on a number of projects being constructed on a design/build basis by general contractors. The subcontractor perceived that its reluctance to assume some design responsibility would soon be tested by the requirements of the marketplace.

That test came sooner than expected. ZZZ management was approached by a general contractor to bid on a design/build HVAC system for a new hotel. It was a large, high-profile project to be built in several phases. If ZZZ secured the work on reasonable pricing terms, the firm's profitability for the next several years would be almost guaranteed. The subcontractor decided to take the plunge on design/build in a big way.

The firm had installed HVAC systems in a number of prior hotel projects and was generally familiar with the heating, cooling, and other air-handling requirements associated with a hotel. Using plans and shop drawings from the prior projects, the subcontractor firm laid out a basic system that appeared to have sufficient capacity to meet the required specifications. The system was reviewed by several ZZZ estimators for pricing. In addition, the firm retained (on a consulting basis) the brother-in-law of one of the firm's owners, who was trained as a mechanical engineer, but not licensed in the state in which the project was being constructed. With a few refinements from the brother-in-law/mechanical engineer, the proposed plans and specifications were submitted to the general contractor.

The ZZZ bid and proposed design were accepted with a few minor modifications. In fact, the general contractor called the president of ZZZ to compliment him on the cost efficiency of the design. ZZZ signed a subcontract form prepared by the general contractor that was very similar to the 1997 version of the AIA A401 (Standard Form of Agreement between Contractor and Subcontractor) and which incorporated by reference AIA A201-1997 General Conditions. The work was to be divided into two distinct phases, with substantial completion on each phase to trigger a full pay-out for the work on that phase. A ten percent retainage was to be maintained as to each phase.

An addendum was attached to the subcontract which contained provisions allocating design responsibility solely to the subcontractor. The addendum required ZZZ to represent that the subcontracting firm had been provided with all necessary information in order to design the system, that the system would meet or exceed the project's performance and design criteria, and that the system would comply with all applicable laws and building codes. The two-page addendum was something that ZZZ had not seen before, but it seemed consistent with the concept of a design/build project.

ZZZ management then developed a checklist of items that it would have to deal with on the large design/build project. Insurance coverage for design-related liability was not on the list. Management assumed that, since the work of any HVAC subcontractor involves some consultation on design issues and ZZZ had a fairly typical form of construction liability policy, it already had coverage for design-related liability. ZZZ management also failed to inform its insurance agent that the subcontractor would be responsible for significant design work on the hotel project. The subcontractor simply requested its standard form of insurance binder and forwarded it to the general contractor. The binder was forwarded to the general contractor. Hearing nothing more from the general contractor about insurance, ZZZ assumed that its insurance requirements had been properly addressed.

The hotel project required ZZZ to gear up immediately. There proved to be much more to the design/build process than the subcontractor had anticipated. It found that its plans were subject to constant modification as other components of the project changed. The enlarging of one banquet hall not only changed the chiller requirements, but also required a larger kitchen with upgraded venting systems. When the entry lobby ceiling design changed, the originally proposed standard duct work had to be replaced with ducts that would fit into the smaller space available. A redesign of the swimming pool caused the architect to move one of the primary mechanical rooms down a level, requiring ZZZ to redesign its fan and duct system. While dealing with all of the modifications was stressful for the ZZZ staff, the project had also become something of a contractor's dream, with change order following change order and the price for the subcontractor's work rising almost daily.

On the other hand, management at ZZZ had a growing concern as to whether the project design and installation processes were still completely under control. The design was now far from the “plain vanilla” systems it had installed in the other hotels. The plans were changing so rapidly that only sporadic review by the part-time engineer was occurring. Revised plans, shop drawings, and other materials were being submitted several times a week, some certified by the engineer and some not. The architect called on several occasions to complain about uncertified plans, but ZZZ simply indicated that it was doing the best it could under the circumstances. ZZZ had also gotten sloppy in maintaining written records as to architect approval of changes.

After almost a year, the first phase of the project neared completion. The same constant design changes that had made the project so stressful (and potentially lucrative) for ZZZ had also produced something akin to chaos in the overall project management. The general contractor, subcontractors, and architect were involved in wide-ranging skirmishes over change orders, project coordination, delay claims, and other payment issues. Some problems with the hotel design were already apparent (i.e. leaky skylights, condensation between panes of glass, water leakage in sub-surface areas, plumbing and electrical capacity issues, etc.). Hearing rumors that the lenders to the hotel developer were very disturbed about the costs and delays, ZZZ was interested in closing out its work on Phase I and getting paid the ten percent retainage held back under its contract.

When the subcontractor indicated that its Phase I work was substantially complete, a schedule was set for start-up and testing of the HVAC system. ZZZ Sheet Metal was about to learn a very harsh lesson about the realities of design/build contracting when a project is not properly managed.

The start-up of the HVAC system did not go well. Several components did not function as intended and the controls in one entire area of the building were not operating correctly. Once those items had been addressed, the system tests were conducted. It was then discovered that the venting system for the main kitchen did not work properly because the design did not produce the required negative air pressure in the restaurant and kitchen areas. Airflow to the ballrooms and other common areas was well below the project specifications. Some of the air intakes were picking up exhaust from one of the kitchens, creating a food smell in large parts of the hotel. Finally, the compressor units were causing so much noise that a number of nearby hotel rooms would probably not be usable.

The general contractor and architect rejected the ZZZ application for final payment, and forwarded a multi-page list of system deficiencies. Some of the deficiencies could be remedied and the subcontractor immediately set to work curing those problems (i.e. soundproofing around the compressors). However, addressing some of the other issues would have huge cost implications for the subcontractor. At the same time, a large portion of its project payment was in limbo and the subcontractor's work on the second phase was also in jeopardy. ZZZ management knew that it had problems. However, it had no notion of how big its problems really were.

In next month's contract bulletin, specific aspects of the hypothetical project and contractor liability issues will be addressed along with some preventative measures that the contractor can take to reduce its risk on a design/build project.

 

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