Drafting Construction Contracts to Avoid Disputes
Authors: Vickery Howard 
Published: October 2008

"Good fences make good neighbors." Robert Frost

In an ideal world run by engineers, offshore construction projects could be run on a handshake, and there would be no need for well-drafted contracts or lawyers. Parties to a contract would work together to solve problems and differences would be ironed out through discussion and compromise. In the real world, however, it is a different story. Litigation has surpassed baseball as the national pastime in the United States, and the contentious spirt seems to be spreading worldwide.

Offshore construction projects lend themselves to disputes. The projects are technically complex, and cost overruns and delays seem par for the course. This paper explains the key considerations in drafting construction contracts to close the loopholes that give rise to contractor claims, the use of performance bonds to shift the risk of cost overruns and delays, dispute resolution procedures to avoid litigation, and management techniques to prepare for litigation if the worst should come to pass. The prudent owner should hope for the best and prepare for the worst.

This paper grows out of the author's experience as lead counsel for Petroleo Brasileiro S.A. - Petrobras ("Petrobras") and its subsidiary Braspetro Oil Services Co. ("Brasoil") in litigation over the allocation of cost-overruns and delay costs in connection with the conversion of the P-19 and P-31 platforms in Brazil. The contracts were 100% bonded by world class surety companies. When the contractors were financially unable to complete the projects and the costs of the projects soared above the fixed price, Petrobras terminated the contractors and called upon the sureties to complete the projects. The sureties refused claiming that the performance bonds had been discharged on the grounds, inter alia, that Petrobras had made extensive changes to the design of the projects, had usurped the role of the contractors, had improperly terminated the contractor, and had made extra-contractual advances and loans which were not recoverable under the bonds. Litigation followed in both New York and Brazil. After extensive discovery involving millions of pages of documents and over two hundred days of depositions, the case was tried for two months before a federal district court judge in New York City. Petrobras ultimately won a $370 million judgment, but the struggle highlighted weaknesses in its Engineering Procurement & Construction ("EPC") contracts. The Petrobras contracts withstood the acid-test of litigation, but the struggle would have been less arduous if the contracts had been better drafted. This article reflects the lessons learned in the Petrobras case about the drafting of construction contracts, the pitfalls of performance bonds, and the essentials of good contract management.

I. Performance Bonds and Payment Bonds As Safeguards Against Non-Performance and Cost Overruns

The best drafted contract in the world will not protect the owner if the contractor goes broke or its assets are beyond reach. Moreover, a contract is just a piece of paper if the local courts will not enforce the contract fairly or in a timely manner. This is a real risk because many of the worlds foremost yards are located in developing countries where the legal systems may be suspect or inefficient.