Real Estate Weekly
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Construction & Design

Design/build agreements for P3s: Panacea or problem?

By Brian G. Lustbader, Esq., Schiff Hardin LLP

Our nation’s rapidly deteriorating infrastructure has spurred many states, municipalities and other public agencies to seek out new and innovative solutions to what has seemed like intractable procurement and production problems.

One such innovation that more and more jurisdictions are trying out are collaborations between public entities with private organizations, usually called public-private partnerships or P3s.

There are many advantages to P3s, including providing greater access to financing sources that might otherwise be unavailable, allowing the public sector to avoid adding to its already-high long-term debt, allowing the private sector expertise to “think outside the box” instead of bidding within a confined set of drawings and thereby to be as creative as necessary, and, ultimately, creating a better value for the public at large than a purely public – or a purely private – project might provide.

P3s typically involve use of Design/Build agreements, where a contractor/construction manager teams up with a design team to perform all the project work, from design to completion, on a turnkey basis.

Such Design/Build agreements are often viewed as a sure-fire mechanism for seeing that projects are built within budget and on time.

Often the opposite occurs, however. As a result, it is fair to say that without proper protections in place, the advantages offered by using the Design/Build agreement in P3s may prove that use to be more a problem than a panacea.

Before addressing the use of Design/Build agreements, it is useful to understand the P3 concept in greater detail.

There is no “one-size-fits-all” P3, as there are many variables and permutations to be considered before a public agency or a private consortium should embark on, or even participate in, a P3.

The overall concept behind P3s is that many of the risks and the rewards would be shared between the public and private participants.

The specific types of risks that must be addressed include (a) legislation, (b) government default, (c) project financing, (d) planning and design, (e) permits, approval, and actual construction, (f) operations and maintenance generating revenue from demand for use of the asset post-completion, e.g., highway tolls.

Mechanisms for performing the work run the gamut from Design/Bid/Build to Design/Build to Design/Build/Finance to Design/Build/Finance/Operate/Maintain.

And within those general categories, there are strategic roles that must be allocated between the public agency and the private participant(s), including (1) identifying the need, (2) proposing the solution, (3) financing the project, (4) designing the project, (5) constructing the project, (6) operating/maintaining the asset post-construction, and, finally, (7) ownership of the asset.

Presumably, the public agency will take on items (1), (2) and (7), but each of the others can be either public or private, or some combination thereof, and a Design/Build agreement can include some or all of items (3) through (6), depending on how the project is structured.

As noted above, typically a form of Design/Build agreement is entered into with the private entity, thereby extricating the public authority from nitty-gritty details of the design and construction process while still allowing the public agency to cap the project at a fixed price.

Indeed, public agencies often advertise that their Design/Build agreements are capped or fixed at a designated price, and that that fixed price assures that the project will come in at or under budget.  But unless the agreement has been artfully crafted and the project carefully monitored, change orders will likely permit the project to exceed the designated cap. And the numbers can be staggering.

As P3s are only used on massive projects, usually in the hundreds of millions, or in the billions, avoidance of even 10 percent in change orders can mean a savings of $100 million or more.

For that reason, sophisticated contract drafting and close monitoring with hands-on project controls should be implemented to assure that changes and disputes are kept to an absolute minimum.

Without such safeguards, costs may far exceed the amounts budgeted for the project, thereby dissipating the financial gains that were originally expected.

In short, the P3 mechanism as a concept is neither a panacea nor a problem, but can be a valuable tool so long care is taken in all aspects of planning, contract drafting, implementation and oversight.

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