Construction contractors sometimes need to retain engineers or other design professionals as consultants. They may require engineering support to design temporary works used as part of the means and methods of construction, or portions of the project delegated to the contractor by the design professional of record. In addition, contractors may benefit from professional advice to assist with bidding, to solve field problems or to resolve claims. While the need for contractors to engage consultants is common, the contractors’ personnel may not be experienced clients personally. This can lead to poor consultant selection, inadequate scopes, unmet expectations, sub-optimal risk allocation and a variety of other problems. These problems can be avoided by being better informed of how the services of engineers and other professional consultants differ from more familiar goods and services and how the relationship between professional and client differs from other business relationships.
Contractor personnel are often accustomed to their company’s policies for managing trade subcontractors and vendors providing materials, supplies and equipment. This leads to misguided attempts to shoe-horn consultants into one of these frameworks and attempting to adapt trade subcontracts and purchase order as professional service agreements. This is inappropriate. Professional services like engineering and architecture are fundamentally different as a matter of fact and of law from the work of construction contractors or products from vendors. So forget what you have learned about procuring construction labor, materials and equipment; professional services require a different approach.
Cost and Revenue
A good illustration of the differences between design professional firms and construction contractors is their greatly different cost and revenue structures. On a typical construction project, the design professionals’ fees total to about 10 percent of the construction cost. The remaining 90 percent comprises the contractors’ fees. For typical projects, most of the contractors’ money is paid out as trade labor costs. Indirect labor costs like benefits and taxes may be about as expensive as direct pay, especially for union contractors. Compensation of the management staff is often structured very differently, having more variability in pay between junior field engineers and senior management. Nevertheless, due to the sheer magnitude of labor costs, overhead is often on the order of ten percent of the contractor’s fee and profit is usually within single digits.
While design firms derive some of their revenue from paraprofessionals, exploratory work or equipment, most of the revenue is generated by the staff professionals. For all but large projects, the line between professional staff and management is somewhat blurred. Whereas for contractors, professional staff and management are overhead, for design professional firms they generate most of the firm’s revenue. While the starting pay for entry-level engineers and architects may be less than for trade labor, they may double or triple their income over the course of their careers. Design firms have to provide comparable benefits, but also professional development, staff licenses, decks, computers, software, telephone extensions and a variety of other resources. Because of these costs and the relatively small number of chargeable hours per project – at least compared to contractors’ hours – overhead can be exceptionally high for design professional firms.
Standard of Care
Contractors and design professionals are legally held to different standards. Construction contractors are obliged to perform according to the contract and are bound by the express and implied warranties of the contract and construction standards. The contractor is afforded control of their work within the limits of the contract and can transfer risk to insurance policies and other instruments.
Professional services like engineering and architecture are governed by the professional standard of care, defined as the degree of care and skill of an ordinary professional practicing under similar circumstances. This standard is not perfection, since professionals when providing their services must exercise judgment gained from experience and learning under circumstances that they cannot fully measure or control. As is the case with physicians and lawyers, there is no warranty associated with the services of design professionals. A warranty can be created by contract, but given the uncertainty professionals face, no professional can or should guarantee the outcome of their service.
Construction contractors are typically required to grant the owner a relatively broad indemnity and in turn, requires similar indemnities from their subcontractors. Similarly, some contractors, expect broad indemnities from their consultants for all claims arising out of the consultant’s services. This is inappropriate. First, many of the claims arising out of a consultant’s service may actually be caused by someone else. Consultants do not control the accuracy of the client provided information on which they must rely. They also cannot guarantee that the work they design is constructed competently or is properly integrated into the work as a whole.
Second, professional liability insurance policies do not generally cover contractual liabilities. Third, given that the liabilities created by broad-form indemnities can be orders of magnitude greater than the design professional’s fees, are substantially beyond their control and are not ordinarily insurable, accepting such a term is often an unconscionably poor business decision.
Contractors have several types of insurance instruments available to help them manage the risks they take on. By means of endorsements, the scope of these policies can be quite broad and include coverage for contractual liabilities like broad-form indemnities. Conversely, professional liability insurance will cover damages due to negligence as defined by the standard of care. It will not cover liabilities that are created solely through a contract. Therefore a contractual indemnity is uninsurable unless it is limited to actual damaged to a client resulting from professional negligence to the extent of professional’s negligence. It will not cover anything amounting to an express or implied warranty arising out of an elevated standard of care. Design professionals typically maintain general liability policies, but these policies exclude losses from providing professional services. Since design professionals are primarily engaged in providing professional services, the scope of their general liability policies can be quite small. Umbrella policies have similar exclusions and will not cover excess liability from professional services.
Good contractual relationships allocate risk and reward in a reasonable manner. Generally, each risk should be retained by the party originally exposed to it unless another party can better manage it. A contractual transfer of risk should be accompanied by a premium reflecting the increased risk exposure assumed by the other party. A client exposing their clients to greater risk should expect to pay more for services. However, for almost anyone but a mega-firm, trying to self-insure is a gambler’s ruin problem.
I am well aware that many engineers will agree to low fees, inadequate scopes and burdensome contractual liabilities. Some do not read their contracts or fail to understand the risk they are taking on. Some think that because they have insurance, any liability they face will be covered. Others knowingly take on the risk, but would declare bankruptcy in the event those risks manifest. Considering how fundamental risk management is to professional practice, especially the services commonly provided to construction contractors by engineers, one must ask: why would you want someone managing your risk, who do not understand how to manage their own?
Ultimately, it is not in any client’s best interest to believe that they are covered for risks when they are not. Most design professional firms rely almost entirely on professional liability insurance to cover liabilities from their services. Liabilities created by contract are not inherently the responsibility of design professionals, are not necessarily best managed by them, and cannot simply be transferred to an insurance carrier. These liabilities are also potentially orders of magnitude larger than a design professional’s fee, which makes accepting them a bad business decision. Sophisticated contractors understand the perils of poor risk allocation and financial losses suffered by their subcontractors, vendors and consultants. For the less experienced client, professional should be upfront about this and should not agree to take on liabilities that they have no means or intention of remunerating.
The information and statements in this document are for information purposes only and do not comprise the professional advice of the author or create a professional relationship between reader and author.