Strategic Drafting Considerations at the Pre-Tender Stage 

presentations 

September 2009

Managing Risk at the Pre-Tender Stages
Canadian Institute Conference

Introduction 

Lets face it, becoming involved in any construction project is a risky financial proposition. This is true for the owners, the financiers, the contractor, the subcontractors and suppliers, the architects, engineers and other consultants. Although one of the main purposes of a construction contract is to set out who is to do what, it can also be used to allocate the financial risks if the parties do not do what they are suppose to do pursuant to the contract. This includes the freedom to reallocate those financial risks in ways other than those one would normally expect pursuant to the common law or pursuant to standard construction provisions such as those set out in a CCDC 2.
 
While a construction contract is not finalized at the "Pre-Tender" stage, it may be a mistake to wait until the "Post-Tender" stage to start considering methods of contractually addressing financial risk (re)allocation. Quite frankly, that may be too late given the current law on tendering. For example, if an owner issues an invitation to tender which expressly contemplates entering into a CCDC form of contract, (as is often the case), and that tender is then awarded, the owner may then be hard pressed to seek contractual provisions at that point which (re)allocate risks in ways not contemplated by the CCDC. Indeed, the contractor may be within their (Contract "A"/Contract "B") rights to refuse to sign a proffered contract which contains unexpected or non-standard provisions that allocate material risks in ways which were not disclosed in the tender documents, particularly if such provisions would have materially affected the tender price or the desirability of tendering in the first place. The contractor may be within their rights to insist the contract be finalized without the risk reallocation provisions sought by the owner. 

Similarly, a contractor responding to a tender with the intention to disclaim various risks normally attributed to contractors may have a problem if same was not addressed in its tender. But that in itself may be problematic, as a tender response, with qualifications so as to reallocate risks contemplated by the invitation to tenders or to allocate a risk not considered therein, may be considered a non-compliant bid. It may be better to address the issue before responding to the tender, by, for example, discussing same with the owner and their consultant and having an addendum to the tender added so the risk (re)allocation is expressly addressed as part of the tender process, not afterwards. 

Accordingly, the time to start thinking about the allocation or reallocation of project risk is at the pre-tender stage. In that way, the strategy of addressing that risk can be incorporated, where necessary, into the pre-tender process and tender documents.
 
This paper builds on the foregoing thesis by setting out and considering three specific types of clauses intended to address risk allocation and doing so at the pre-tender stage.

1) Financial Disclosure 

The most obvious risk to contractors, and those working under them, is that they will not get paid by the owner. One way to reduce that risk is to ensure the owner has the financial wherewithal to pay before the project is even started. With the advent of the 1994 form of the CCDC 2 contract, it was expressly required that the owner provide the contractor with reasonable evidence that financial arrangements were in place to allow the owner to fulfill its (payment) obligations under the contract. Further, the owner had an ongoing obligation to advise the contractor if there were any changes to the said financial arrangements during the performance of the contract. These provisions continued, with some slight changes to wording, in the 2008 version of the CCDC 2. 

What may strike one as unusual is that the financial disclosure provision seems to have effect even before the Contract is signed.

5.1.1 The Owner shall, at the request of the Contractor, before signing the Contract, and promptly from time to time thereafter, furnish to the Contractor reasonable evidence that financial arrangements have been made to fulfill the Owner's obligations under the Contract.1(underlining added) 

One's initial impression of this provision is that it allows the successful tenderer to refuse to sign the contract if not satisfied with the owner's financial disclosure. But in doing so, would not the contractor in fact be relying upon provision 5.1.1 of the contract? How can a contractual provision have effect before the contract is even signed? There are at least two ways to analyze the issue (although they are not necessarily mutually exclusive). 

Firstly, if the tender documents contemplate a CCDC form of contract being signed, which of course includes the above cited financial disclosure clause, then arguably the "Contract A/Contract B" tender theory of the law could accommodate such an "out" for the contractor. In effect, the CCDC provision is part of the tender documents and as such, confers certain rights upon the successful bidder even before formally executing the formal contract. In effect, the right to refuse to enter into Contract B is expressly contemplated by Contract "A". 

Secondly, or alternatively, it may be that the remedy for the contractor is not necessarily to refuse to execute the CCDC (or Contract "B") document as initially suggested. Rather, the contractor may be required to execute the contract, but then be entitled to immediately rely upon GC 7.2.3 which allows the contractor to give written notice that the owner is in default. Such a default expressly includes GC 7.2.3.1 which is the failure to comply with the financial disclosure requirements. GC 7.2.4 allows the contractor to terminate the contract if the owner does not remedy the default within 5 working days. (It should be noted that while the mechanism of the remedy is set out, there is no guidance in the CCDC as to what constitutes "reasonable evidence" of the financial arrangements necessary to complete the project. Cases on this subject are rare2.
 
In their Annotation of the of the CCDC 2 - 1994, Harvey Kirsch and Lori Roth3 suggest that in such a circumstance, the contractor will not execute the contract, but would be wise to provide the 5 day written notice nonetheless so as to address the argument that the unexecuted contract may still have come into effect (presumably as "Contract B"). 

So why do we care about this at the Pre-Tender stage? 

It is clear that if a CCDC 1994 or 2008 form are referred to in the tender documents, the contractor has a right to pre-contractual financial disclosure from the owner (although the exact parameters of those rights have not been established under the caselaw). However, if a CCDC form of Contract is not referred to in the tender documents, the contractor may be in no position to demand such financial disclosure after its tender has been accepted. Thus, a contractor would be wise to consider and address this issue at the pre-tender stage if financial disclosure is desired.

2) "Pay When Paid" Clauses 

The use of "pay when paid" clauses in subcontracts is now a commonly used method of spreading some of the risk of non-payment (by the owner) from the contractor to its subcontractors. Properly worded "pay when paid" clauses have been found to be enforceable as a condition precedent to payment.4 Some have argued that such clauses are unfair as the contractors have the ability to obtain financial information concerning the owner (as noted in the preceding section) while subcontractors do not.5 It is submitted however that there appears to be nothing wrong, per se, with the parties having the freedom to contract as they see fit to allocate such risk. 

A review of the caselaw makes it clear that notwithstanding the increasing use of such "pay when paid" clauses, the ordinary presumption is that a contractor is obligated to pay its subcontractors in the ordinary course. A "pay when paid" term is not to be implied. Indeed, the wording of the clause must be reasonably clear and unambiguous to be enforceable.

In Tam-Kal Ltd. v. Stock Mechanical Inc.7, Tam-Kal submitted a bid for sheet metal work with respect to the Academic Science Building at York University through the Toronto Bid Depository. While its bid was not the lowest and therefore not initially accepted by the mechanical subcontractor, Stock Mechanical Inc., the low bidder dropped out following which Stock accepted Tam-Kal's bid. The rules of the bid depository provided that the parties would enter into the Canadian Construction Association short form of contract or the long form of contract or any other form of written contract. In fact, the parties did not enter into any form of formal contract with the result that the trial Judge, Ground J. , concluded that apart from what was contained in the bid form and the letter accepting same, he had to discern the remaining terms of the subcontract from the parties' course of conduct. 

With respect to Stock's assertion that it was not required to pay Tam-Kal until paid by the general contractor, Ground J. accepted that in the normal course, mechanical trades did not pay their subtrades until paid by the general contractor. Nonetheless, Ground J. was unable to accept that such a practice constituted evidence of a waiver by subcontractors of their ultimate right to be paid in circumstances where the mechanical subcontractor remained unpaid by the general contractor. Stock's counsel submitted that reliance could also be placed upon the terms of Stock's standard purchase order8, even though same had not been signed and returned by Tam-Kal. Ground J. found that the clause relied upon (if enforceable against Tam-Kal which he questioned) was ambiguous and, based on the contra preferentem rule, could at best be interpreted as addressing timing and process, but not waiving the right to payment. In Ground J's view, there was nothing as clear or specific as the "pay when paid" provision9 enforced by the Ontario Court of Appeal in Timbro applicable in the circumstances of Tam-Kal and Stock. 

Query whether Ground J. would have given effect to a properly worded pay when paid clause if same was contained in a subcontract document referenced in the tender documents. Arguably, the successfully bidding subcontractor would then be assumed to have taken into account the risk of non-payment by the owner in preparing its bid. Clearly, it would be wise for a subcontractor to know, before submitting its bid (ie at the pre-tender stage), whether they are expected to be bound by a pay when paid clause. 

Further, (and in answer to the criticism that subcontractors do not normally have access to the financial disclosure of the owner) it would be wise for a subcontractor to require that the contractor turn over any financial disclosure given to it by the owner. Further, the subcontractor may wish to have the same right to refuse to sign the subcontract (or to cancel same) if not satisfied by same. 

In the context of meeting a bid deadline, it may not be practical to provide for such disclosure, which is all the more reason for the subcontractor to consider, prior to bidding, whether or not its bid, if accepted, is likely to cause the subcontractor to be bound by a pay when paid clause.

3) Liquidated Damages Clauses 10 

Financial risk is associated with unknown future contingencies. Certainty reduces such risks. One way to control future financial risk is for the parties to pre-estimate the damages that will be caused by specified contingencies (typically, delays in the construction context) and then contractually provide that the pre-estimate will be paid in the event of the contingency rather than the actual damages. Thus, if a contract provides that in the event of delayed completion the contractor will pay a given sum for each day (week or month) of delay (assuming same is caused by the contractor), the risk of delay will be visited upon the contractor. The owner's risks of delay are thus extinguished, assuming the contractor can pay such damages and assuming that the actual damages incurred by the owner do not exceed the liquidated damages specified.11 

Consistent with the thesis of this article, it is unlikely that a liquidated damages clause could be forced upon a party at the contract execution stage of a tendered contract if such a provision had not been part of the tender process. If introduced afterwards, a contractor may very well be within its rights to complain that the shifting of risk (if viewed as such) will affect the bid price and is not something that was reasonably contemplated by the bid documents. There may also be issues with respect to whether or not a surety, supplying a bid bond, must thereafter issue a performance bond to cover a contract containing a subsequently introduced liquidated damages clause. Thus, parties wishing to provide for liquidated damages should at least consider same at the pre-tender stage and whether the same should be part of the tender. A further understanding of liquidated damages clauses is therefore in order. 

Basic Principles 

The courts will enforce a genuine pre-estimate of damages resulting from contractual breach. This is so even if the genuine pre-estimate turns out to exceed the actual damages suffered. But the courts will not enforce a draconian clause calculated to exact a penalty out of all proportion to the damages that could possibility be suffered.12 The following is a list of factors to consider in distinguishing a liquidated damages clause from a penalty. 

a) A clause is much more likely to be enforceable as a liquidated damages clause if there is some evidence that the parties gave genuine consideration to pre-estimating the damages that might be suffered prior to entering into the contract.13 In the construction context, this would be an ideal exercise to carry out at the pre-tender stage; 

b) The assessment of a clause as providing for either liquidated damages or a penalty depends predominately upon the circumstances prevailing at the time of contract rather than at the time of breach.14 In the construction context, the pre-tender stages leading to the contract would be relevant; 

c) In conjunction with the foregoing, specifying an amount which will exceed any actual damages that may possible be suffered upon breach will be viewed as a penalty;15 

d) Specifying a single amount payable with respect to several different breaches which vary in importance smacks of a penalty;16 

e) In the case of delay, specifying a per diem amount for delay rather than a lump sum, regardless of the amount of delay, is more likely to lead to the finding that the clause is for liquidated damages;17 

f) Again in the case of delay, the provision should be structured so that the party required to pay actually caused the delay and should not be applicable to excusable delay which would otherwise allow for an extension of time for completion; 18 and 

g) The actual label given to the clause (liquidated damages or penalty) is not conclusive. Certain clauses labeled as "penalties" have been upheld as liquidated damages and vice versa.19

An example of a liquidated damages clause upheld by the Ontario Court of Appeal is as follows:20

A. Should the Contractor fail to complete the Work in accordance with the contract and to the satisfaction of the Engineer, within the time specified in the Form of Tender, or as amended on the written authority of the owner, the Contractor shall pay to the owner the sum of $400 for each calendar day that the Work shall remain unfinished after such time. 

B. Such payments are agreed upon and fixed as liquidated damages that the owner will suffer by reason of delay and default, and not as a penalty. The owner may deduct and retain the amounts of such liquidated damages out of the monies which may be due or become due to the Contractor under the Contract. 

Of course, following this wording formula alone will not guarantee the enforceability of the clause. The other factors considered above must be applicable to assist in enforceability.
 
Liquidated Damages at the Pre-Tender Stage, an Example 

The failure or refusal of the low bidder to enter into a contract will inevitably lead to the owner turning to the next lowest bid and suffering damages in terms of paying the increased bid amount. This risk is usually addressed by way of a bid deposit or bid bond. Clauses providing for the forfeiture of the deposit upon refusal to contract have been expressly upheld. 

In City of Calgary v. Northern Construction Co. Division of Morrison-Knudsen Co. Inc.21, the contractor submitted a bid of $9,342,000 together with a 10% bid deposit of $934,200. Paragraph 10 of the tender documents provided that if the tenderer failed to fulfill its obligations, the City could retain the deposit as liquidated damages or require the tender to pay the difference between its bid and the next highest bid as well as any costs of the City associated with such breach.22 After submission of the tender, Northern discovered a $181,000 error in its bid and advised the City. The City wanted to accept the bid, but Northern refused to enter into a contract unless its bid was raised by the $181,000 error amount. This would still make the revised bid lower than the next lowest bid, which was $395,000 higher than Northern's initial bid. The City proceeded with the next lowest bid and sued Northern, claiming $395,000 of the bid deposit. 

Northern resisted the claim on the basis that the City was not entitled to accept its bid, having been advised of the error before acceptance. Northern also asserted that Paragraph 10 of the tender constituted an unenforceable penalty. The trial judge agreed that the tender was not capable of acceptance. However, the Alberta Court of Appeal reversed, holding that the City was entitled to the $395,000 bid difference. 

In doing so, the Court of Appeal rejected Northern's argument that the City had failed to mitigate its damages by accepting Northern's offer to enter into the contract for the $181,000 increased price, which was still lower than the next lowest bid. The Court of Appeal held that if same were allowed, the low bidder could always refuse to honour its bid, but then offer to enter into a contract for an amount just under the second lowest bid on the basis that owner must mitigate. Such a position would turn the tender system into an auction. 

With respect to paragraph 10 of the tender, the Court of Appeal upheld same on the basis that it was a fair estimate of the damages to be suffered by the City and was not oppressive. 

Northern Construction certainly supports the idea of the enforceability of a liquidated damages clause as part of the tender process; thus, such clauses should be considered at the pre-tender stage for inclusion in the tender package. Would the result have been the same had the City elected to keep the entire bid deposit of $934,200 as contemplated by the first part of paragraph 10 of the tender rather then the $395,000 bid difference, as contemplated by the second part of paragraph 10. If the clause was enforceable as a liquidated damages clause, there appears to be every reason to enforce the alternative remedy under the same clause. Indeed, faced with a choice of losing a $934,200 bid deposit or entering into a contract and dealing with a $181,000 underbid with respect to a $9 million contract, it appears rather obvious that Northern's best interest was served in signing the contract. Of course, that was the obvious intention of the clause was in the first place.

Limit on Damages 

As noted above, there is a risk that by the time the breach occurs, the actual damages suffered may exceed the sum specified in the liquidated damages clause. The party suffering the damages is not entitled to pick and chose between the liquidated damages and the actual damages. Having specified an amount, the parties are bound thereby.23 This doctrine creates certainty at the pre-tender and contract stage as the parties can then evaluate the risks of certain breaches and arrange their affairs accordingly. 

Effect on Subcontractors

We are all familiar with language within subcontracts to the effect that the subcontractor assumes the obligations of the contractor to the owner for the subcontractor's scope of work as if the subcontractor were the contractor and the contractor was the owner. The terms of the general contract are incorporated by reference into the subcontract. Presumably, this would include any liquidated damages clauses within the general contract or, based upon the thesis of this paper, contained with the terms of tender. 

It may not seem to be much of a stretch to suggest that a subcontractor cannot be held liable to indemnify a contractor with respect to the provisions of a liquidated damages clause unless they are aware of and have agreed to same. In K.&C. Electric Ltd. v. Gama Construction Ltd.24 the relationship between the owner and contractor involved more than merely a construction contract in that the plant was to be built upon land owned by the contractor (or its principal). The liquidated damages/penalty clause was contained within a lease. The party seeking the construction of the plant (the owner/operator/tenant) was to receive an abatement of 1 months' rent for every two weeks the project was delayed. The project completion was in fact delayed due to the late delivery of a vital component, which resulted in damages suffered by the owner/operator/tenant . The contractor/landlord sought indemnity from its subcontractor which was at the head of the supply chain further to which the delayed component was to be supplied. 

The court found that the project was delayed directly as a result of the delayed component. The court further held that the subcontractor could be held liable for the foreseeable consequences of its breach, but not the liquidated damages/penalty clause as it had no knowledge of same (as it was contained in the lease) and could not be reasonably expected to have known of those covenants. Thus to the extent that this clause provided for amounts payable beyond the actual foreseeable damages for breach of the contract, same were not recoverable from the subcontractor by the contractor/landlord. 

In concluding this section on liquidated damages clauses, it appears clear that if same are to be part of the project in question, they should be considered at the pre-tender stage. While it is not impossible to negotiate a liquidated damages clause at the contract stage (and indeed, this often happens, but undoubtedly for a price) one cannot expect to successfully impose a liquidated damages clause if same has not been raised at the pre-tender stage. If the idea is introduced at that stage and a contractor is still interested in tendering same, the contractor should consider what steps may be necessary in order to pass such costs/risks to subcontractors and what disclosure should be made, again, prior to tender. As a subcontractor, one should ensure one is aware, at the pre-tender stage, if a liquidated damages clause is in play and if so, is there an intention, implied or expressed, that same will be visited upon the subcontractor. 

Conclusion

There are obviously many other types of clauses and provisions that can be inserted into construction contracts to address the allocation of risk. Examples include provisions which address sub-soil conditions, specialized equipment supply, the bankruptcy of key suppliers, currency fluctuations, commodity price fluctuations (think of the recent pricing issues with respect to steel), unusual access issues, the effects of timing on weather conditions for construction etc. etc.. The point is that parties should be considering the methods of (re)allocation of risk before a tender is let as once the tender is responded to, it may simply be too late to impose or even seek a change of risk not contemplated by the tender documents because of the current state of the law of tender. Changes after tender to the risk allocation in the contract may not be possible without risking (no pun intended) having to pay a substantial premium for same. 

The exercise to be carried out at the pre-tender stage is not that difficult. Consider firstly the types of risk that one wants to address and the methods and clauses used typically to address or readjust that risk. Then consider the form of the contract that is to be referenced in the tender documents, (i.e. a CCDC or another industry standardized form or the standard form used by that institution). Is the desired allocation of risk contemplated by that form of document? Alternatively, is the desired allocation of risk contemplated by project specifications or other documents that will be part of the tender? If so, then the risk is covered, as desired. If not, serious consideration should be given to amending the tender documents to address the desired risk allocation before the tender is issued.

With the assistance of Josiah MacQuarrie.


1 CCDC 2 2008

2 See for example B. Mathews Developments Ltd. v. Humford Developments Ltd. (1985), 20 C.L.R. 134 (B.C. Co. Court) which dealt with a financial disclosure clause inserted into the 1982 version of the CCDC. In that case, the Court, inter alia, found that a letter from the owner's bank was sufficient.

3 Kirsch H.J. Kirsch and Roth: The Annotated Construction Contract (CCDC 2 – 1994), (Aurora, Canada Law Book Inc., 1997) at. p. 100.

4 Timbro Developments Ltd. v. Grimsby Diesel Motors Inc., (1988), 32 C.L.R. 32 (Ont. C.A.); Kor-Ban Inc. v. Pigott Construction Ltd. (1993), 11 C.L.R. (2d) 160 (Ont. Gen Div.)

 5 J. Wayne McLeish, Barbara F. Fisher and Tina Athananassiades, "Construction Contracts: Language to Avoid", The Project From Hell – 'The Sequel': Pitfalls in Construction Litigation: How to Avoid Them Held January 26, 1996.

6 See cases listed in Goldsmith and Heintzman, Goldsmith on Canadian Building Contracts, 4ed (Toronto, Carswell, 1988) at 4 § 2, notes 40.1 and 43.1.

7 (1988) 43 C.L.R. (2d) 94 (Ont. Gen. Div).

8 "…..draws and hold backs will be paid out from our draws from general contractors according to usual custom of the mechanical trade and compliance to the Mechanical (sic) Lien Act of Ontario."

9 The wording of the clause in Timbro was as follows:

  1. Payments will be made not more than thirty (30) days after the submission date or ten (10) days after certification or when we have been paid by the owner, whichever is the later. Holdback will be retained in accordance with the Mechanics Lien Act in effect at the time, and when released by owner all payments will be made in Canadian Funds and will be payable at par in Welland. (italics added)

10 With permission, this section relies extensively upon a paper by Warren H.O. Mueller Q.C. entitled "Liquidated Damages" presented at a conference hosted by Warren H.O. Mueller Q.C. and Glenn Grenier entitled, "The Traps and Pitfalls of Construction Delay Claims in Ontario", Hamilton, May 26, 2005. The paper was republished at 49 C.L.R. (3d) 10.

11 See for example Erskine Building Corp. v. First College Grenville Holdings Inc. (1993), 13 C.L.R. (2d) 51 (Ont. Div. Ct.) wherein a liquidated damages clause was upheld notwithstanding the owner's contention that its actual damages for delay exceeded the specified amount.

12 Eastern Elevator Services Ltd. v. Wolfe (1981), 119 D.L.R. (3d) 354 (N.S.T.D.)

13 Farmers Advocate v. Master Builders Co. (1917), 38 D.L.R. 409 (Man. C.A.)

14 St. Catharines Improvement Co. v. Rutherford (1914), 31 O.L.R. 574 (Ont. C.A.)

15 Graham v. Wagman (1976), 14 O.R. (2d) 349 (Ont. H.C.); varied (1978), 21 O.R. (2d) 1 (Ont. C.A.)

16 Pelee Island Navigation Co. v. Doty Engine Works Co. (1911) 23 O.L.R. 402 (Ont. C.A.)

17 Janse-Mitchell Construction Co. v. Calgary (City) (1919), 59 S.C.R. 101 (S.C.C.); W. Shepard & Associates (1965) Ltd. v. 400556 Ontario Ltd. (1983), 3 C.L.R. 267 (Ont. H.C.)

18 Supra, note 10, pp. 13-16. For a discussion of excusable and non-excusable delay, see Grenier G. Evaluating Concurrent Delay – Unscrambling the Egg (2006), 53 C.L.R. (3d) 46 at pp. 46-49.

19 McManus v. Rothschild (1911), 25 O.L.R. 138 (Ont. C.A.)

20 Bird Construction Company Ltd. v. Sault Ste. Marie Public Utilities Commission, 1997 CanLII 681 (ON C.A.).

21 (1985), 19 C.L.R. 287 (Alta. C.A.)

22 10 City's Rights on Failure or Default of Tenderer: If the Tenderer for any reason whatsoever fails or defaults in respect of any matter or thing which is an obligation of the Tenderer on the Terms of this Tender, the City at its option may either:

  1. Consider the Tenderer has abandoned the offer made or the Contract in the offer has been accepted, whereupon the acceptance, if any of the City shall be null and void and the City entitled to retain the deposit accompanying the Tender as liquidated damages, or
  2. Require the Tender to pay the City the difference between the offer made in this Tender and any other Tender which the City accepts if the same is for a larger amount and any cost which the City may incur by reason of recalling the Tender….. The Tenderer forwards herewith a certified cheque or Bid Bond in the amount of ten percent (10%) of the Contract Price payable to the City of Calgary, and the Tenderer agrees this amount may be forfeited as liquidated damages in the event that the Tenderer fails to comply with the provisions of this Tender…..

23 Lac La Rounge Indian Band v. Dallas Contracting Ltd. (2001), 9 C.L.R. (3d) 25 (Sask. Q.B.); appeal on another point (2004), 35 C.L.R. (3d) 236 (Sask. C.A.); Erskine Building Corp. v. First College Grenville, Supra, note 11; J.G. Collins Insurance Agencies v. Elsley [1978] 2 S.C.R. 916 (S.C.C.).

24 (1991) 48 C.L.R.74 (B.C. H.C.)