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Is an Alliance suited to your IT Project?
Alliance contracting is a tool with very specific uses, and needs the right project.
Aligning the objectives of all parties to a contract is not always easy, with divergent interests having the potential to slow – if not derail – cost-effective and timely project delivery. The search for alternative methods of structuring contractual relationships to improve outcomes led to the development of alliance contracts.
Alliance contracts have been used successfully in both complex engineering and building projects, for instance the Acton Peninsula Alliance for the National Museum of Australia). Between 2004 and 2009, the "total value of alliance projects" accounted for $32 billion of the "road, rail and water sectors in New South Wales, Victoria, Queensland and Western Australia", which was equal to 29% of total infrastructure spend Australia-wide for this period. The issue is, could they benefit other industries?
Pure alliance contracting appears to have fallen out of favour in Australia following the release of a report by the Victorian Department of Treasury and Finance that found that while the model has potential, it had not necessarily led to the cost savings envisioned where previously applied. However, this may have more to do with alliance contracts being used on inappropriate projects than problems with the model of contracting itself. In high-risk and uncertain projects, alliance contracting in the form of a hybrid alliance/collaborative contract have continued in infrastructure projects as a way of getting all feet moving in the same direction, to achieve project outcomes. However, this contract structure has the potential to be applied beyond just infrastructure projects, potentially being able to be used across a range of industries where projects are high risk: for example, complex IT or other equipment and services acquisition agreements is an area where a hybrid alliance/collaborative contract could offer several advantages over more "traditional" contract arrangements.
What is alliance contracting – a refresher
Alliance contracting is a form of relationship-based contracting where the parties to a project form a team, and take a collaborative, risk-sharing approach to delivery of the project. During the early 1990s, alliance contracts became popular as a means of mitigating the adversarial elements in contracts by actively fostering cooperation and aligning otherwise divergent commercial interests between owners and contractors in complex resources and infrastructure projects.
Alliance contracts generally involve:
- the parties (generally the owner and 'non-owner participants' (NOPs)) assuming collective responsibility for project delivery and collective ownership of project risks;
- the owner paying contractors for services and supplies on a 100%, open book compensation basis (covering project costs, overheads, normal profit) and also an additional "pain/gain" share; and
- high-value contracts.
Alliance contracts typically exhibit three key characteristics that differ from more traditional contractual arrangements:
- "No blame, no dispute" clauses where parties waive their rights to bring legal action against each other except in limited circumstances.
- "Unanimous decision-making" where all parties are involved in decision-making; and
- "Performance-based remuneration" where profit is linked to the satisfaction of "key result areas" (KRAs).
In practice however, "hybrid" alliance agreements incorporate some/all of these features to varying degrees, depending on the nature of the project, its objectives and the parties' appetite for risk.
Alliance contracts may also exhibit other characteristics. The will often be supported by an "Alliance Charter" governing the parties" relationship and administered by an "Alliance Leadership Team", made up of representatives from all parties who together make decisions. Alliance contracts will also clearly identify the shared objectives and measurable rewards and risks associated with the project, will often limit variations in cost to substantial changes in scope (ie. each party absorbs its own costs in this regard), and generally require transparency around the parties' finances and transactions.
Revamped remuneration – the painshare/gainshare regime in action
A key characteristic of alliance contracting is its approach to remuneration. In a traditional:
- lump sum contract, the contractor(s) would be paid a lump sum that would encompass their "direct costs" to complete the project; an amount for "contingencies"; and an amount representing profit/overhead costs; or
- time and materials contract, the contractor will be paid for time spent.
By contrast, in an alliance contract, payments to contractors or NOPs are structured so that contractors are reimbursed for services and supplies on a 100%, open book compensation basis covering the project's direct costs, whatever these may be and regardless of whether they exceed the project's estimated completion cost according to its minimum requirements. The contractor will also receive a project fee, calculated on a fixed or variable basis.
A key issue in traditional contracts arises where a contractor has been paid to provide personnel, who may or may not be skilled, on a time and materials basis, which has not always resulted in the desired outcome being met.
In the alliance, the "gainshare/painshare" regime sets up a system where NOPs share in the entitlements and liabilities for excellent or poor performance against specified and measurable KRAs, such as time, cost, quality and operational efficiency. Under this arrangement, the contractor(s) and NOPs receive greater profits where they exhibit excellent performance against the KRAs, but incur an increased proportion of "painshare" or liability in the form of reduced profits where they perform poorly. This "painshare" payment is usually capped, for example at the NOP's fee entitlement. This way, each NOP effectively puts "'at risk' its profit and contribution to overheads, but not its direct costs".[1] This is not unusual in any performance-based service rebate arrangement.
This allows for risks to be shared between all parties, who are incentivised to meet the project's KRAs or risk losing their profits. In theory, costs are also reduced as there is no incentive for them to be increased; contingency payments are made only when risks actually incurred, rather than when anticipated; and there are fewer internal expenses for administering the contract/monitoring liability in circumstances where the parties are committed to a system of shared risk and mutual collaboration. However, the model is not without risks, as direct costs are essentially uncapped, insurance may be difficult to obtain, and project delivery times may be unclear.
What's next for alliance contracting in Australia?
Alliance contracts and hybrid alliances (collaborative agreements) are not for the faint-hearted. They are resource-intensive and require effective governance, but by sharing risks they can achieve results when other models fail. If you have a large value complex project where risks are such that a traditional contract may not work, an alliance or hybrid alliance is worth considering.
The major challenge to their use, however, is understanding when they are properly used. There is now a sufficient body of projects (both successful and failed) to give us some good ground rules for their use. Alliance contracting has been most successful in large-value projects where the owner has been unable to identify, and contractors have been unable to price, risk. This may occur where:
- there are a broad range of unpredictable or complex risks which can only be managed by the parties working together;
- there are a range of stakeholders;
- the external environment contains threats to project delivery or will result in there being a high likelihood of changes to the scope of the project as a result of technological or political changes; and/or
- there is a need for the owner to be actively involved in project delivery.
Some would say that alliance contracting is suited for projects at least over $80 million, but in our experience the bar might be even higher. The pay-off is not only the management of risk and scope, but the flexibility. Similarly, an alliance contract is not constrained solely to infrastructure projects.
Rather, traditional alliance contracting can be tailored to individual projects/party needs, in the creation of a hybrid alliance. For example, a hybrid alliance contracting arrangement was well-suited to Defence's Air Warfare Destroyer agreement, enabling the necessary degree of mutual decision making and collaboration while aligning the interests of all parties "through joint responsibility for program outcomes".
There's also some evidence that the model is evolving, with the emergence of a similar, if different "Delivery Partner Model" (DPM), which incorporates elements of alliance contracting including the gainshare/painshare component. The DPM model is currently being employed in the Woolgoolga to Ballina Pacific Highway Upgrade, worth approximately $4.36 billion.
Alternatively, even if an alliance contract or hybrid alliance is not warranted for a particular transaction, a performance-based (incentive-based) approach can still be used.
Ultimately, alliance contracting presents a more collaborative and integrated method for project delivery than a traditional lump sum or time and materials contract. However, alliance contracts must be resourced and supported by effective governance structure. Alliance contracts should be considered amongst the options available when determining how to deliver a complicated project and achieve the best value for money in the circumstances.
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Disclaimer
Clayton Utz communications are intended to provide commentary and general information. They should not be relied upon as legal advice. Formal legal advice should be sought in particular transactions or on matters of interest arising from this communication. Persons listed may not be admitted in all States and Territories.