This article explains some of the common areas of risk in consultancy agreements relevant to the construction industry in Australia.
In the construction industry, consultants come in all shapes and sizes; from large engineering firms to small sole traders. Large consulting firms often have the benefit of large, sophisticated legal and commercial departments which are able to identify risks and negotiate consulting agreements for the benefit of their consulting firm.
On the other hand, smaller consulting firms may not have access to the same resources but are nevertheless expected by their (often much larger) clients to sign onerous terms in standard form consulting agreements.
Because of this, it’s important for consultancy firms (such as engineers, quantity surveyors and architects) to understand the terms of a consultancy agreement.
Author: Farrah Motley, Director of Prosper Law.
Fit For Purpose Obligations
Fitness for purpose requirements can be couched in many different ways, for example:
- Consultant warrants that their deliverables will be fit for the purpose(s) stated in the client’s project brief
- Consultants must ensure that their deliverables are adequate for the purpose(s) required by the client
- Consultant’s deliverables must be suitable for the purpose(s) that can be inferred from this consulting agreement
However the requirement is stated in the agreement, fitness for purpose obligations can be problematic for consultants. Whether and to what extent such clauses can be a problem depends on how the clause is worded.
Some of the reasons why a fitness for purpose clause might cause problems include:
- professional indemnity policies are designed to reimburse consultants for breaches of their professional duty. For example, an engineer’s professional duty will be the professional duty at law that is expected of a reasonably skilled, careful and diligent engineer;
- a requirement that something is “fit for purpose” may require something that goes beyond the professional duty owed by an engineer. For example, if the requirement is that the engineering drawings must be fit for the purpose of enabling the builder to quickly sell a block of apartments, this goes beyond what a “reasonably skilled, careful and diligent engineer” has control over, and it goes beyond their standard of professional duty;
- because a fitness for purpose requirement might impose a higher obligation on a consultant than their professional duty of care (which is what a professional indemnity policy responds to), a policy of professional indemnity insurance may not cover loss arising from a breach of a fitness for purpose obligation; and
- ultimately, fitness for purpose obligations contained in consulting agreements may, for the reasons set out above, lead to uninsured loss. This is problematic for both the consultant and the client.
We recently wrote about fitness for purpose clauses, why they can be a problem and tips to address those clauses.
Think of an indemnity like an open chequebook. Unlike a claim for breach of contract, or a claim for negligence, a client does not need to demonstrate the usual elements of a claim. All that needs to be proven (on the balance of probabilities) is that the event, which is the subject of the indemnity, has occurred.
Further, depending on the wording of the indemnity, it may not even be necessary to prove that there has been any wrongdoing on the part of the consultant. Taking it a step further, there are indemnities called “reversionary indemnities” which may actually require a consultant to indemnify a client for loss arising out of the client’s own wrongdoing!
There are many circumstances where a loss for which a consultant is required to indemnify a client may not be covered by the consultant’s policy of professional indemnity policy. You can read more on that topic here.
- An indemnity for infringement of intellectual property rights;
- An indemnity for liquidated damages (which are a pre-estimate of loss, typically a daily rate, which may be suffered by a client in the event of a delay or other breach);
- An indemnity for errors in deliverables caused by other consultants (although, in some cases, professional indemnity policies will extend to subconsultants that a consultant is legally liable for, for example, because there is a direct contractual relationship); and
- An indemnity for consequential or indirect loss (which is a type of loss not recoverable at law).
Aside from the insurability issues that these kinds of indemnities may create, it is unreasonable for a consultant to be held to account for loss caused by events not within the consultant’s control or realm of expertise.
Limits of Liability
A limit of liability is the gold standard of risk mitigation under consulting agreements. However, a limit of liability is only effective if it is worded appropriately.
Further, if a client seeks recovery of loss against a consultant and the consultant doesn’t have sufficient insurance to cover the loss, the consultant must itself pay for the loss out of its own pocket. In some circumstances, this may cause the consultant to become insolvent if it cannot pay its debts as and when they fall due.
So, what do limits of liability do? Well, (and again, depending on how they are written) they operate to put a limit on the amount and type of loss that a consultant would otherwise be liable to its client for.
An example of a limitation of liability clause is set out below:
The total liability of the Consultant to the Client for any loss or damage arising out of or in connection with the Contract and the Services, whether in contract, tort (including negligence), under an indemnity, under statute or any other basis in law or in equity, shall be limited to $1,000,000.
Whether the amount (highlighted in bold above) is reasonable will depend on the consulting fee and the nature of the project and consulting services being performed.
If you can negotiate a limit of liability like the one above, you’re doing well. Limits of liability typically include “carve-outs” (for instance, matters which are not covered by the limit of liability and themselves carry unlimited liability or a separate, independent limit of liability).
These carve-outs may include matters which are within the consultant’s reasonable control and which may be considered to be an absolute requirement. For example, the following matters might be excluded from a limit of liability:
- infringement of intellectual property rights by the Consultant;
- the fraud or wilful misconduct of the Consultant;
- breach of confidentiality by the Consultant; and
- loss which cannot be limited by law.
Scope creep occurs when a consultant is required to undertake a never-ending listing of work that the consultant had not initially contemplated or priced in developing the consultancy fee. Scope creep can come about because:
- a poorly worded contract and scope requires the consultant to carry out tasks that are not specifically set out in the contract; and
- a consultant becomes overly invested in the services and goes beyond what is required by the contract.
Set out below are examples of things that may be contained in a consulting agreement and which may lead to scope creep:
The definition of Services
“Services” are generally defined by reference to a schedule of the contract (which, if you’ve appropriately reviewed the schedule, is fine), but sometimes the definition goes further.
For example, it might define “Services” as “Services means the services set out in Schedule 1 and any incidental services or services which are necessary to complete the Services to the Client’s satisfaction”.
Vague, inclusive language
The words “including (but not limited to)” in the scope: scope items should be finite and not open-ended.
By stating services to be performed by the consultant as “including (but not limited to)”, there is uncertainty around what the specific services to be performed are, and the services become open-ended.
An obligation to comply with client directions
If the consulting agreement contains a blanket obligation to comply with the client’s directions, that could potentially lead to directions about the extent and nature of the services to be performed.
Value engineering or value management obligations
Value engineering is the method of carrying out service and substituting materials with less expensive alternatives so that a project can be completed at the lowest possible cost.
The problem with value engineering in a consulting context is – where does it end? If a client’s budget expectations are unreasonable or highly restrictive, the extent of services that may be required to achieve a particular value outcome may be significant.
How Can Prosper Law Help Your Business?
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If you need a contract reviewed or legal advice for your consultancy firm, contact us today for a no-obligation, free legal consultation and speak to our commercial contract lawyer.
Author: Farrah Motley | Director
PROSPER LAW – A Law Firm for Businesses
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