Determining the Nature of a Turnkey Contract Agreement

The Nature of a Turnkey Contract Agreement

Turnkey contract agreements differ from other types of contracts for construction in that the owner is able to occupy (or at least use) a completed project, whereas with design-build construction the owner accepts a partially completed project. A turnkey contract agreement cannot be used on a project where the owner needs to occupy a partially completed project.
Turnkey arrangements allow the contractor to complete its work without the owner’s involvement. The owner simply hires the contractor, the contractor hires the subcontractors , and the contractors, anyway, have the risk of paying for their performance bonds (if required) and insurance. It is not necessary for the owner to be involved in the construction process, given that the owner can expect that the contractor will complete the work in accordance with the agreed upon plans, specifications, and contract. In fact, the owner’s lack of participation is what makes the turnkey arrangement appealing.
In a nutshell, a turnkey contract agreement minimizes the role of the owner in the design and construction of the project.

Characteristics of a Turnkey Contract

In any agreement, the salient features of the contract must be truly understood by the parties. The very fundamentals have to be comprehensively laid down in the contract so that all parties are well apprised. Considerations such as the scope of work, types of materials to be used, the time within which the project is to be completed, costs and expenses for each task, and the responsibilities of each party, must be explicitly spelt out to ensure that expectations of each party are met. The contract must define the relationship of the parties to the agreement and the terms of service.
The salient features of a turnkey contract include the fact that the contractor is responsible for all of the aspects of building the project, and that the contractor or an approved subcontractor is responsible for securing permits and licenses. With a few exceptions, the owner is required to own the land to build the project on. Once construction is commenced, the owner agrees to allow the contractor to make changes that are necessary, and those changes will not cost more than 50% of the initial project price. Because a turnkey contract differs from the traditional contract, there are some critical things that have to be specifically spelled out in a performance contract. Some of those critical components are:

Advantages of a Turnkey Contract

A benefit of the turnkey contract is that it is built upon a clear understanding of the project and its requirements. This mitigates the risk of misunderstandings and other risks that may arise in the more traditional methodology. The contract assumes responsibility for project completion and a detailed scope of services is used by the owner and contractor for the basis of the agreement from which the project estimate is generated. A fixed cost can be attached to the scope of services without fear of a contractor purposely underestimating costs to win a job.
This methodology also allows the contractor to complete and deliver the project in the most efficient manner because he or she does not have to wait for the owner to approve interim expenses and/or change orders. Since progress payments are tied to milestones that have been agreed upon and are defined in terms of time and results, the contractor has a stake in completing the agreed-upon milestones in a timely and cost efficient manner with no interruptions or delays waiting for the owner’s approval.
Similarly, since the contractor does not have to negotiate any changes with the owner, the owner is free to monitor the overall quality of deliverables throughout the process without significant disruption to the process and without incurring any additional costs as there are no change orders to negotiate.
Any design deficiencies are addressed and presented to the owner during an agreed upon review period so the contractor is not required to deliver a defined result and then wait for the owner to identify design deficiencies and interrupt the process for the owner to provide alternative designs that must be negotiated. As a result, the owner has the benefit of knowing the work will be done correctly without the contractor and subcontractors experiencing costly and time-consuming interruptions.
In addition, the lump-sum approach of the turnkey contract allows for project cost estimation with a high degree of accuracy because the scope of services is defined and established prior to project commencement. Because additional costs incurred through field changes and renegotiation do not affect a fixed price agreement, the project defined through the turnkey contract lends itself to accurate cost estimation resulting in a specified project cost that does not change.

Disadvantages of a Turnkey Contract Arrangement

The potential drawbacks of a turnkey contract agreement are relatively few, but they can nonetheless be significant. Likely the biggest problem is that your ability to alter the design and construction of the project could be severely limited. If the project is a home, then this could mean having to live with something you do not like, or paying more to change it. If the project is commercial – for example, a retail location, restaurant, or hotel – it could cost you business or otherwise hurt your bottom line. When taking on a large project, you should always consult an experienced attorney before entering any contract, to look for any hidden issues.
Another possible downside to a turnkey contract is that you have very little if any control over the contractors doing the work. This can be an issue if the contractor is unreliable. The quality of the work they do could be poor, or even dangerous. For example, if you are building a commercial property and the workers are careless, you could end up facing serious liability.

Turnkey vs Builder Agreement

The most obvious distinction between a turnkey contract and a traditional contractual agreement is the difference in process. In traditional construction, the builder and contractor work separately and take time to discuss and negotiate various aspects of the contract. Change orders may be needed, and the owner often finds it difficult to find a contractor who is willing to negotiate sections of an agreement or change previously agreed upon terms.
Turnkey contracts, on the other hand, allow these issues to be avoided entirely. The basic idea of a turnkey contract is that the client does not have to be involved in the construction process because he or she is "turning the key over" to the contractor, who will handle every element of the job from start to finish. This means that the client’s only involvement in the project is to approve the contract and budget used to finance it. For this reason, the traditional model of contract agreement can be much more stressful for the property owner.
This is why these agreements usually feature a fixed cost structure. Rather than agreeing to reimburse the contractor for all expenses related to the project, the owner will pay a flat rate for all the contractor’s services. The contractor takes great care to estimate his total expenses, which is why these buildings are usually of high quality , but if there are unforeseen issues during the construction process that drive expenses higher than the estimate, the contractor will likely have to absorb those costs, significantly reducing his profits. So while there may not be any "hidden" fees for the client, because the contractor is getting paid the agreed-upon amount only, he still has to price his time carefully to account for potential complications and make sure his investment in the project is worthwhile.
The most significant advantage of a turnkey contract is that the risk of the project not turning out as expected lies entirely with the contractor. The client must do little through the course of the project, and by the end simply steps into a turn-key property that is ready for immediate use or sale. While it may seem like a good deal for the contractor to take on this responsibility, experienced property owners who have successfully navigated the traditional contract path can understand why this would also be a good deal for the owner. The risk mitigation of a turnkey contract is a result of the contractor already shouldering all the responsibility for coming up with an accurate estimate. Because he’s on the line if the estimate was off, he will make every effort to ensure it is accurate and that the property is built to a high quality.

Key Clauses in Turnkey Contracts

Thorough construction contracts are essential to establishing protection and clarity for any construction project. When it comes to turnkey contract agreements, there are several clauses that every party should insist upon having in their contract to protect themselves. Here are the major clauses applicable to a turnkey contract: Third-party clauses – In a turnkey contract, third-party clauses confer the risk to the turnkey developer from a third party by allowing the turnkey developer to sue the subcontractor for damages if completed construction work is not suited to the purpose. The purpose here is to limit the liability of the turnkey developer for damages on the basis of indemnity. Termination – A termination clause is one of the most important aspects of a turnkey contract. It addresses the rights of the parties to terminate the agreement in the event of default. Many agreements include the grounds for termination and how the termination process will be completed. Payment – Payment provisions in a turnkey contract should be clearly defined. The payment terms are usually linked to specific milestones in order to establish accountability. Dispute resolution – Dispute resolution clauses tend to favour the developer or management firm as they either delegate the responsibility of resolving disputes to building owners or the management company or establish alternative dispute resolution channels.

Common Industries for Turnkey Contracts

While innovative, effective and efficient, turnkey solutions are typically advantageous in particular industries, they are particularly advantageous in the following industries:
Construction and Real Estate Development
Turnkey construction is sometimes called "build to suit" or "design and build." In recent years this type of contracting has become increasingly popular with the government. For example, the Department of Homeland Security, Veterans Affairs, General Services Administration, and Army Corps of Engineers, all use a design and build approach. Few building projects are better suited to the use of a turnkey contract than those undertaken by private entities as well as government agencies. Examples include commercial buildings, warehouses, manufacturing facilities and food processing plants. In these cases where one party bears all of the risk, the free market is expected to come up with solutions to site selection, design, cost, time, stamina, financing, management coordination and the like. While the details of a turnkey "build to suit" contract may vary, the result is a new building that fully meets the owner’s needs.
Transportation
Examples of transportation projects that have used turnkey contracts include highways, bridges, tunnels, mass transit systems and airports. These continue to be a growing source of business for contractors as state and local governments are more frequently looking for ways to sidestep the problems of the financing, construction and operation of transportation systems. In the United States during 1992-93, there were 26 bills proposing 92 public-private transportation projects, totaling $15.6 million. The projects ranged from $15 billion in expressway projects in California and Georgia to a $3 million pedestrian bridge in Washington State. Most likely due to financing disadvantages, there are fewer private toll roads in the United States compared to Europe. Examples of such projects include Route 66 in Illinois, I-395 in Virginia, Outerbeltway in Maryland, I-495 in Massachusetts, I-395 in Washington, Missouri 47 in Missouri and 1st Avenue in Washington.
Power Generation
Examples of power generation projects that have used turnkey contracts include nuclear plants, coal power plants, biomass power plants, natural gas fired plants with compressed air energy storage, small scale hydro power plants and landfill gas recovery. Examples of such projects include Wabash River in Indiana, Red Hills in Mississippi, MacBook in California and Kenetech Wind Power in Hawaii. Power generation plants use a variety of fuels in varying mixes or combinations. A good turnkey agreement anticipates the full range of flexibility needed at the front and the back-end of the project—in the middle there is no ambiguity: the project comes to completion.

Legal Issues in Turnkey Agreements

As with any contract, there are important legal considerations involved in the drafting and execution of a turnkey contract. Compliance with such requirements can be essential for the protection of the interests of parties to such agreements. For example, when drafting a turnkey agreement, a buyer must ensure that the developer is compliant with the statutory requirement for being appropriately registered at the Ministry of Housing, whether the investor’s funds to the development would be secured through a separate Trust Agreement or a subscription of securities to a Corporation .
Another important legal consideration is whether the developer has obtained construction-related licenses or permits as required by the local municipality or Redevelopment Authority or the Pennsylvania Gaming Board (e.g., such as a "gambling license" in the case of gaming facility developed under a turnkey contract).
Finally, the parties to a turnkey should also consider including in their corresponding agreement, dispute resolution and liability provisions that correspond to the specific turnkey arrangement. For example, while arbitration may be appropriate in some instances, in the case of a gaming facility, disputes may be required by the Pennsylvania Gaming Control Board to be referred to the necessary Court having jurisdiction in the playing of gaming.