1
Overview

The construction industry accounts for nearly 8 percent of the gross national product of the United States and directly employs 6 percent of the U.S. workforce (12 percent if the production, hauling, and distribution of equipment and materials for construction are included). Capital projects valued at more than $1 trillion are constructed in the U.S. each year, and American companies build additional projects abroad. The Business Roundtable has called construction a “seminal” industry because the price of every factory, office building, hotel, or power plant that is built affects the prices that must be charged for the goods and services produced in or on it. These prices affect consumers and the ability of U.S. businesses to compete in a global market.

Construction is a high stakes endeavor that produces long-term, unique, and complex building projects and infrastructure. Taking a building project from planning through design, construction, and occupancy involves a diverse array of stakeholders: The project owners, which may be individuals, corporations, or government entities; architects; engineers; general contractors; subcontractors; suppliers; financing institutions; legal representatives; and others. These stakeholders bring varying and sometimes conflicting expectations to a project. They operate in an environment in which their control over a project shifts as the project progresses, and in which there are continual demands to deliver projects in less time and at lower cost.

Given the infinite complexities of delivering a building or infrastructure project, the multiplicity of organizations and individuals involved, and the magnitude of the dollars at risk, it is perhaps not surprising that the construction industry has been characterized by an adversarial operating environment that generates disputes and claims. Serious disputes are estimated to arise in 10 to 30 percent of all construction projects, and one in four construction projects has a claim.

Disputes can arise over schedule targets, performance guarantees, or deviations from the original contract terms. Claims typically fall into two categories: (1) contractor requests for compensation not anticipated in the terms of the original contract, and (2) owner requests for compensation for the contractor’s failure to meet contractual terms.

The transactional costs for resolving disputes and claims may total $4 billion to $12 billion or more each year. Direct costs include the fees and expenses paid to lawyers, paralegals, accountants, claims consultants and other experts, and salaries and associated overhead for in-house lawyers and employees who assemble facts, serve as witnesses, and process disputes. Indirect costs include the inefficiencies, delays, and loss of quality that disputes cause to the construction process itself; the lost-opportunity costs of diverting productive employees away from profit-making activities into litigation support; and the costs of fractured relationships between parties who would otherwise profit if they could continue to do business with each other.

Paradoxically, or perhaps because of its adversarial climate, the construction industry has also been a leader in developing innovative tools for preventing, controlling, and efficiently resolving disputes.



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Reducing Construction Costs: Uses of Best Dispute Resolution Practices by Project Owners: Proceedings Report 1 Overview The construction industry accounts for nearly 8 percent of the gross national product of the United States and directly employs 6 percent of the U.S. workforce (12 percent if the production, hauling, and distribution of equipment and materials for construction are included). Capital projects valued at more than $1 trillion are constructed in the U.S. each year, and American companies build additional projects abroad. The Business Roundtable has called construction a “seminal” industry because the price of every factory, office building, hotel, or power plant that is built affects the prices that must be charged for the goods and services produced in or on it. These prices affect consumers and the ability of U.S. businesses to compete in a global market. Construction is a high stakes endeavor that produces long-term, unique, and complex building projects and infrastructure. Taking a building project from planning through design, construction, and occupancy involves a diverse array of stakeholders: The project owners, which may be individuals, corporations, or government entities; architects; engineers; general contractors; subcontractors; suppliers; financing institutions; legal representatives; and others. These stakeholders bring varying and sometimes conflicting expectations to a project. They operate in an environment in which their control over a project shifts as the project progresses, and in which there are continual demands to deliver projects in less time and at lower cost. Given the infinite complexities of delivering a building or infrastructure project, the multiplicity of organizations and individuals involved, and the magnitude of the dollars at risk, it is perhaps not surprising that the construction industry has been characterized by an adversarial operating environment that generates disputes and claims. Serious disputes are estimated to arise in 10 to 30 percent of all construction projects, and one in four construction projects has a claim. Disputes can arise over schedule targets, performance guarantees, or deviations from the original contract terms. Claims typically fall into two categories: (1) contractor requests for compensation not anticipated in the terms of the original contract, and (2) owner requests for compensation for the contractor’s failure to meet contractual terms. The transactional costs for resolving disputes and claims may total $4 billion to $12 billion or more each year. Direct costs include the fees and expenses paid to lawyers, paralegals, accountants, claims consultants and other experts, and salaries and associated overhead for in-house lawyers and employees who assemble facts, serve as witnesses, and process disputes. Indirect costs include the inefficiencies, delays, and loss of quality that disputes cause to the construction process itself; the lost-opportunity costs of diverting productive employees away from profit-making activities into litigation support; and the costs of fractured relationships between parties who would otherwise profit if they could continue to do business with each other. Paradoxically, or perhaps because of its adversarial climate, the construction industry has also been a leader in developing innovative tools for preventing, controlling, and efficiently resolving disputes.

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Reducing Construction Costs: Uses of Best Dispute Resolution Practices by Project Owners: Proceedings Report PURPOSE OF THE FORUM The National Academy of Construction (NAC)1 has determined that disputes, and their accompanying inefficiencies and costs, constitute a significant problem for the industry. In 2002, the NAC assessed the industry’s progress in attacking this problem and determined that although the tools, techniques, and processes for preventing and efficiently resolving disputes are already in place, they are not being widely used. In 2003, the NAC helped to persuade the Center for Construction Industry Studies (CCIS) at the University of Texas and the Alfred P. Sloan Foundation to finance and conduct empirical research to develop accurate information about the relative transaction costs of various forms of dispute resolution. In 2004 the NAC teamed with the Federal Facilities Council (FFC)2 of the National Research Council to sponsor the “Government/Industry Forum on Reducing Construction Costs: Uses of Best Dispute Resolution Practices by Project Owners.” The forum was held on September 23, 2004, at the National Academy of Sciences in Washington, D.C. The forum brought together 16 leading experts (many of them members of the NAC) on the subject of preventing, controlling, and resolving construction disputes (see Appendix A for the forum agenda). The audience included approximately 150 government administrators and private owners of construction projects. Speakers and panelists at the forum addressed several topics: The root causes of disputes and the impact of disputes on project costs and the economics of the construction industry; Dispute resolution tools and techniques for preventing, managing, and resolving construction-related disputes; Examples of successful uses of dispute resolution tools and techniques on some high-profile projects; Ways to encourage greater use of dispute resolution tools throughout the industry; and Steps that owners of construction projects (who have the greatest ability to influence how their projects are conducted) should take in order to make their projects more successful. Neither the forum speakers nor the members of the audience were asked to arrive at a consensus on issues related to dispute resolution practices or to make recommendations. However, there was reasonable consistency among the speakers on virtually all of the topics addressed by the forum. The sections below summarize key points made by various speakers over the course of the forum. Chapters 2 through 10 include detailed summaries of each presentation. ROOT CAUSES OF DISPUTES Disputes typically start with a problem and develop into a difference of opinion, which can escalate to disagreements and conflicts that require attorneys and some form of legal action. Root causes of construction disputes identified by the forum speakers included the inequitable allocation of risk 1 The National Academy of Construction (NAC) is a group of senior construction industry leaders who make themselves available to the nation for advice and service in the interest of improving the construction process. Additional information about the NAC is available from the Secretariat, NAC, c/o Center for Construction Industry Studies, University of Texas, Austin, Tex., 78712-1076 and at http://www.naocon.org. 2 The Federal Facilities Council (FFC) is a cooperative association of federal agencies having interests and responsibilities related to all aspects of federal facility design, construction, operation, and management. Established in 1953, the FFC operates under the National Research Council, the principal operating agency of the National Academies, congressionally chartered, private, non-profit corporations. Additional information is available at http://www.nationalacademies.org/ffc.

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Reducing Construction Costs: Uses of Best Dispute Resolution Practices by Project Owners: Proceedings Report between owners, contractors, and subcontractors; inappropriate contracting strategies; the low bid process; lack of alignment of the owner’s, general contractor’s and subcontractors’ objectives; inadequate owner involvement; poorly developed and executed contracts; poor communication; lack of project management procedures; and fast-track scheduling (Chapters 2, 8, 10). Of these root causes, research has shown that projects that transfer more risk to the contractor, and projects that use a low-bid process, are significantly more likely to have a claim. One of the principal functions of a contract is to allocate risk among the owner and the contractors. It is not uncommon for owners to attempt to shift project risks to the contractor by adding contract clauses that impose no charges for delays on the part of the owner, or shift the risk of defects in specifications and drawings to the general contractor. In addition, some types of contract strategies, such as lump-sum contracts shift the greatest amount of risk to the contractor (Chapters 7 and 8). Market forces inherent in the low-bid process can drive the contract price to or below market; thus contractors enter the process driven to find ways to make a profit. Common ways to do this are to identify problems that result in change orders and claims for additional work over and above the original contract scope. These change orders and claims can create turmoil, confusion, problems, and time delays that lead to an adversarial environment. The claims process is not necessarily how contractors want to operate, but it is a function of the low-bid process (Chapter 7). Trust between the owners and contractors cannot be achieved if the allocation of cost and risk is fundamentally flawed (Chapter 7). Research also indicates that fast-track projects, defined as those with schedules 70 percent faster than the industry average, have significantly more claims than conservatively scheduled projects (Chapter 8). DISPUTE PREVENTION AND RESOLUTION TOOLS AND TECHNIQUES Dispute prevention and resolution is about identifying the root causes of conflict and preventing and/or managing conflict with the objective of resolving disputes during the construction process in order to avoid post-construction claims, litigation, and related costs. Traditional principles for managing conflict are intended to resolve disputes quickly and informally, get technical input if necessary, keep the job moving, and avoid the court system (Chapter 2). Because problems and potential disputes can occur in many different ways and at different times during a construction relationship, no one dispute resolution mechanism will fit all problems and disputes. The forum speakers identified numerous techniques and approaches for preventing, controlling, and resolving disputes that can be tailored to specific situations. Benefits from the effective use of dispute resolution tools include: early resolution of disputes; transparent procedures; an operating environment of understanding and cooperation; limited posturing by the various parties; fewer issues and claims; and reduced costs (Chapter 5). Several forum speakers emphasized that effective dispute prevention begins early, during project planning. It is incumbent on the project owner to acknowledge that problems and disputes will occur and to try to anticipate the kinds of problems and disputes that are most likely to occur. Owners can then design a system of techniques, controls, filters, and devices that will ensure the prompt and realistic resolution of disputes before they fester and grow into serious problems. During the planning phase, owners can select a contracting strategy for equitably allocating risk and identifying financial incentives so that owner and contractor objectives are aligned. At the same time, the owner can identify techniques to be used throughout the project delivery process to enhance communication, such as integrated project teams, partnering, dispute review boards, employing a project counsel, and others. The Construction Industry Institute has developed a set of best practices and tools that can be used in planning to help prevent disputes (Chapters 3, 4, and 9). A clear understanding of the scope of work, the labor environment, material availability, and other factors affecting the project prior to the bidding phase can also help avoid or minimize conflicts. It is important to understand site conditions early in the process or, if the conditions are uncertain, to put in place contract provisions that acknowledge and equitably allocate the risk associated with site

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Reducing Construction Costs: Uses of Best Dispute Resolution Practices by Project Owners: Proceedings Report uncertainties. Tools such as geotechnical baseline summary reports and escrowed bid documents can be used to address such circumstances (Chapter 3). Partnering, a team building effort in which the parties establish cooperative working relationships to achieve project goals and resolve potential problems, was highlighted as a particularly effective dispute prevention or resolution technique (Chapters 3, 4, 7, 9, and 10). It was also noted that effective partnering requires fairness from the beginning (Chapter 7). Arbitration has proven only marginally better than litigation in resolving disputes (Chapters 2 and 9). More effective procedures to manage and resolve disputes include “real time” processes such as negotiation, dispute review boards, or employing a project “neutral” (Chapters 2, 5, 6, and 10). BEST PRACTICES FOR OWNERS Several forum speakers stated that project owners need a multi-faceted approach to avoid or resolve disputes and claims. The following best practices for owners were identified: Establish a cooperative project environment, with leadership from the top; Set up controls that will minimize the frequency and severity of problems; Establish real time or jobsite techniques designed to get disputes resolved during construction; Use benchmarking and feedback to measure results, improve processes and performance, and build an atmosphere of trust with project participants; and Provide for a “backstop” combination of mediation and, as the final resort, arbitration before expert construction industry arbitrators (Chapters 2 and 3). During the planning phase, owners should: Assign project risk to the party that is best able to manage, control, and insure against the risk (Chapters 3, 6, 7, and 9); Choose the most appropriate project delivery and management method (Chapters 3, 4, 6, and 8); Use a best value approach in bid selection, as opposed to a low bid process (Chapter 7); Establish a collaborative team approach; Understand and deal realistically with site conditions (Chapters 2 and 3); Develop concise specifications and drawings based on national codes (Chapter 7); and Use commercial standards to the extent possible because unique requirements discourage firms from bidding on the project (Chapter 7). During construction, owners should: Encourage communication and open sharing of information (Chapters 3, 7, and 8); Use functionally integrated owner teams to oversee contractor work and take action when problems arise (Chapters 2, 3, and 4); Pay invoices in a timely manner to avoid friction among project participants (Chapter 7); Provide adequate authority at the job site so that decisions can be made quickly when something unexpected happens (Chapters 3 and 7); and Hold separate meetings to discuss solutions and “who pays” when resolving issues on the critical path (Chapters 3 and 7).

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Reducing Construction Costs: Uses of Best Dispute Resolution Practices by Project Owners: Proceedings Report INDIVIDUAL PRESENTATIONS Chapter 2. “Changing the Adversarial Culture of the Construction Industry and the Business World.” Keynote Address by Thomas J. Stipanowich, President and CEO, International Institute for Conflict Prevention and Resolution (CPR Institute). This presentation provides an overview of efforts to address the roots of conflict and strategies for transforming the adversarial cultures of the business world as well as the construction industry. Led by the construction industry, businesses in the United States have moved from litigation to arbitration, from arbitration to mediation, and, more recently, to methods for preventing, controlling, managing and achieving the earliest possible resolution of disputes. In doing so, they have moved the dispute resolution process “upstream” closer to the sources of disputes. Chapter 3. “Brief Review of Typical Dispute Prevention and Resolution Best Practices.” James P. Groton and Robert A. Rubin, Past Presidents of the American College of Construction Lawyers. A summary of innovative tools that the construction industry has developed to prevent, control, manage, and achieve the earliest possible resolution of disputes so that no dispute remains unresolved when a project is completed. Pre-Project Planning Tools prevent problems and lay the groundwork for a project climate that will control disputes. Problem Solving Tools institute processes for resolving disputes at the earliest and lowest project level. Dispute Control Tools level the playing field by encouraging transparency in project relationships. “Real Time” Dispute Resolution Tools establish processes for effectively disposing of disagreements and disputes. Overall Project Organization and Dispute Control and Management Techniques include the design of comprehensive systems and processes to ensure that disputes are managed and controlled and prevented from developing into conflicts that have to be resolved through litigation, arbitration, or mediation. Chapter 4. “Reducing Construction Costs: Uses of Best Dispute Resolution Practices by Business Owners.” Hans Van Winkle, Director, Construction Industry Institute. Through Construction Industry Institute (CII) research and implementation, owners have learned to use “best practices” to enhance project performance. Many of these CII Best Practices are also tools and strategies for conflict management. When used properly, they can help prevent, control, manage, and more quickly resolve disputes, as well as reduce costs and improve quality. Chapter 5. “Washington Metropolitan Area Transit Authority Successful Uses of Dispute Resolution Best Practices.” P. Takis Salpeas, Assistant General Manager, WMATA Capital Projects. The use of dispute resolution boards, partnering, and transparent consensual procedures has brought about earlier resolution of disputes, creation of a climate of understanding and cooperation, a reduced backlog of issues and claims, and cost effectiveness for projects of the Washington Metropolitan Area Transit Authority. Chapter 6. “Employing Standing Dispute Resolution Panels with the Bridging Method of Design and Construction Procurement.” George T. Heery, Architect and President, Brookwood Program Management. One of the best combinations of practices that protect the interests of owners and achieve cost-effective and successful construction projects is the use of the “bridging” method of project delivery together with the use of dispute resolution panels. This presentation describes the “bridging” process, an improvement on traditional design/build construction, whereby the owner employs an architect to complete schematic design and articulate the key design and performance requirements for the project, and then employs a design/build contractor to complete the design and perform construction within the owner’s requirements. This system obtains for the owner an early and realistic fixed price contract, net overall construction cost savings, “single point” responsibility for design and construction, and a significant reduction in exposure to disputes and claims. The presentation contains a number of supporting case studies.

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Reducing Construction Costs: Uses of Best Dispute Resolution Practices by Project Owners: Proceedings Report Chapter 7. “Risk Allocation: The Pentagon Renovation Project” Andrew Blumenfeld, Chief Counsel, Pentagon Renovation Project. The Pentagon has reorganized its construction renovation effort around the core principle that dispute minimization begins well before the contract is awarded, and that the single most important element of dispute minimization is the equitable distribution of risk. The presentation analyzes in detail the reasons why realistic assignments of risk that reflect the commercial reality of the project (not the relative bargaining power of the owner) are essential to the success of a project. The presentation outlines a series of “Best Practices for General Contractors” and “Best Practices for Project Owners” that are employed on the Pentagon Renovation Project. Chapter 8. “Current Extent of Use of Dispute Prevention and Early Resolution Practices Among Project Owners: Why Aren’t They More Widely Used?” Paul Barshop, Chief Operating Officer, Independent Project Analysis, Inc. This presentation, based on IPA’s studies of more than 10,000 projects, reveals that one in four projects has a claim, and addresses the nature of the project environments and risk factors that bear on the sources and size and results of claims. It explores the ways in which risks of claims can be mitigated, the current extent of uses of dispute resolution practices by owners of construction, and inquires why they are not more widely used. Chapter 9. “Exploring Ways to Encourage and Implement Greater Uses of Dispute Resolution Best Practices.” G. Edward Gibson, Director, Center for Construction Industry Studies, University of Texas. This presentation describes research by the Center for Construction Industry Studies into trends in construction claims on projects; investigations into the need for research that would benefit the industry in the areas of economics, finance, and dispute resolution; and the center’s ongoing research into the relative transactional costs of various forms of dispute resolution. It also explores ways to encourage and implement greater use of dispute resolution best practices. Chapter 10. “Getting Beyond Process to the Roots of Litigation: Changing the Litigious Culture in an Organization and Its Impact on the Construction Industry.” Lester Edelman, former Chief Counsel, U.S. Army Corps of Engineers. This presentation describes how the U.S. Army Corps of Engineers developed and implemented a dispute resolution strategy that can serve as a model for enabling change in governmental organizations and industry. It describes the implementation of training and development programs to encourage collaborative decision making and enhanced business relationships within an organization, and the type of environment needed to encourage cultural change.