Two-stage procurement

26 September 2022. Published by Arash Rajai, Partner and Claire Wilmann, Senior Associate

This article  was first published on The Practical Law Construction blog on Wednesday, 21st September 2022.

In a recent survey undertaken as part of the RIBA Construction Contracts and Law Report 2022, it was reported that over a third (37%) of respondents had used two-stage procurement over the last 12 months. We are similarly seeing two-stage procurement being used more and more in the construction industry, particularly for major building projects. In fact, the majority of recent development projects we have advised on in the UK were procured on a two-stage basis. 

What is two-stage procurement?

Two-stage procurement (sometimes referred to as two-stage contracting or two-stage tendering) is when a main contractor is instructed on a construction project in two stages: firstly, for the pre-construction phase to carry out pre-construction services (often competitively tendered on a limited design basis) and, then, for the construction phase to carry out the main works for the project (often competitively tendered once the design has been sufficiently developed, for example to RIBA Stage 3 or 4).

Pre-construction services tend to include assisting the employer and the professional team with design development, advising on programme and buildability of the project, tendering key sub-contract packages (usually on an open book basis), signing off on the cost plan (whether provided by the employer or its professional team or the contractor) and developing and finalising the contract documents together with other commercial details for the contractor’s stage two tender. The pre-construction phase can sometimes include preliminary on-site works or procurement of long lead items.

Usually, the mutual initial intention will be for the contractor to be appointed for the main works in order for the construction phase to benefit from the contractor’s early project involvement. However, for the reasons discussed below, neither the employer nor the contractor will be committed at the outset of the pre-construction phase to progress with the second stage.

Why is two-stage procurement used?

Early contractor involvement promotes collaboration among the project team, with the project benefiting from the contractor’s expertise from an early stage.

The pre-construction phase can be used by the parties to develop and firm up the price for the main works on a transparent basis. Two-stage procurement should deliver greater cost certainty and reduce bid qualifications for the stage two tender as the contractor will have the opportunity, during the pre-construction phase, to assess the risks of the project (such as the condition of the site and any existing structures) and tender key sub-contract packages transparently. This can however lead to an overall higher (albeit more certain) quote from the contractor for the second stage and it does not avoid the risks of rapidly rising inflation impacting on subcontract prices in excess of the cost plan.

Early contractor involvement puts the stage one contractor in a more advantageous position compared to its competitors who will not have been involved in the project to date, thereby improving the stage one contractor’s bargaining position with the employer for the second stage. Occasional employers, as opposed to regular developer-employers who have established relationships with contractors, tend to be at greater risk of not being able to tender competitively.

However, there remain incentives for the stage one contractor to price the main works sensibly:

  • If not appointed for stage two, the contractor may find itself in a position where it has used staff and resources for the pre-construction services, possibly at discounted rates, which it could have deployed elsewhere on more lucrative projects with long term prospects.
  • Some pre-construction arrangements may include contractual incentives, for example, a portion of the pre-construction fee being contingent on award of the main works contract (see Almacantar (Centre Point) Ltd v Sir Robert McAlpine, a dispute highlighting the danger of ambiguous drafting in the PCSA) or an agreed uplift in the main contract allowance for overheads and profit where the second stage offer ends up being lower than the target contract price.
  • In the case of regular developers, there is a relationship consideration for contractors as contractors will want to ensure they continue to be appointed on future projects.

Documenting two-stage procurement

We have first-hand experience of documenting two-stage procurement in various ways but, generally, the differences are presentational or mechanical.
We have implemented the following options on our projects:

  • A pre-construction services agreement (PCSA) entered into for the pre-construction phase and a separate main works contract (often appended in agreed form or substantially agreed form to the PCSA) entered into for the construction phase once the second stage offer has been accepted by the employer.
  • A single contract entered into for the entire project with an in-built pre-construction phase (Combined PCSA/Main Contract).

A PCSA governs the pre-construction phase only whereas a Combined PCSA/Main Contract documents the entire relationship between the employer and contractor, from the start of the pre-construction phase and (assuming the contractor is appointed for the second stage) throughout the construction phase, but under a Combined PCSA/Main Contract the contractor is initially only authorised to undertake pre-construction services and sometimes preliminary on-site works and procurement of long lead items.

Both options include similar processes to authorise the next stage of works. With a PCSA, the parties will need to enter into a separate main works contract upon agreement of the second stage offer, whereas a Combined PCSA/Main Contract will include a “notice to proceed” (NTP), or similar, to be issued by the employer (typically at its sole discretion) to the contractor to instruct the commencement of the second stage once the commercial details (including the price and programme for the main works) have been agreed.

Please be aware that a PCSA is not the same as a letter of intent (LoI) or letter of limited authority (LoLA). A LoI or LoLA is usually used with the sole purpose of instructing the contractor to commence some early activities, which ideally should be done under a main works contract but the terms of the main works contract have not yet been agreed. Conversely, a PCSA documents a considered process to allow for early contractor involvement and deals with a separate scope of work to a main works contract.

While an agreed form of main contract can be appended to a PCSA, a Combined PCSA/Main Contract (where the parties have signed up to all its terms) can sometimes provide more comfort to the parties because, conceptually, the terms applicable to the whole project are agreed, even though a NTP needs to be issued and there are commercial elements to be agreed. Similarly, it can seem worse commercially if a party were to terminate a Combined PCSA/Main Contract prior to the construction phase, rather than terminate a standalone PCSA or, under a PCSA, simply refuse to enter into the main contract.

The parties can, using either option, leave specific clauses relating to the main works deliberately open to be resolved during the pre-construction phase. In our experience, this is more likely to be the case with the PCSA option because the main works contract is only appended but not entered into. In reality, because under either option there is no obligation on the parties to proceed to the construction phase, there is always scope (while often not ideal) to reopen negotiations on the terms and conditions applicable to the main works at the end of the pre-construction phase. In the case of a Combined PCSA/Main Contract, a variation agreement would likely need to be entered into or, depending on how the contract is drafted, variations could be included in the NTP. In the case of a PCSA, the related main works contract (which has not been entered into) would need to be amended before it is entered into.

We have focussed in this post on two-stage procurement generally: what it is, why it is used and the options for documenting it. In our next post in this series, we look forward to focusing on key topics to consider when drafting and negotiating PCSAs and Combined PCSA/Main Contracts.

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