Phases of a Construction Project
By Larry Watkins, Esq. (AR)
All projects follow – or should follow – a structured approach that moves from phase to phase. Each phase of the project acts as a financial gate, and the owner as well as the other project participants must determine whether to go through the gate to the next phase. As the construction project progresses through the phases, the financial expenditures follow an “S” curve, which, more often than not, means an exponential increase in costs until substantial completion.
This article briefly discusses each construction project phase to assist architects, engineers, owner’s representatives, owners, contractors, subcontractors, attorneys, and lenders in better understanding what to expect in each phase, how each phase acts as a financial gate, and why these phases are important to follow.
This phase refers to the owner’s initial market, cost, and schedule analysis. This phase is usually funded with capital from the project sponsor or owner, and most of the costs are for internal labor or external consultants. In short, in this phase the owner determines whether it makes financial sense to progress to the next phase.
During this phase of any construction project, the owner begins investing in the project beyond internal labor and limited consulting. It is critical that the owner immediately determine which project delivery method it will use for the project because all subsequent steps will flow from the chosen delivery. For a design-bid-build project delivery method, the owner may contract with an architecture firm or engineering firm to provide a conceptual design, plus/minus 30% construction cost estimate, and high level schedule. If the owner uses a construction manager (“CM”) or design-build delivery, then it is likely the contractor needs to begin its involvement at this stage via a limited-scope consulting agreement or a memorandum of understanding. Although the CM or design-builder may recoup its development phase costs in the future contract, at minimum the contractor will likely require an exclusivity agreement prior to beginning work.
For energy, process plant, and industrial projects in particular, the development phase is even more important to project success. Besides the issues in the preceding paragraph for all construction projects, the development phase for energy, industrial, and refining projects is a period when preliminary agreements, such as letters of intent and memorandums of understanding, are negotiated and signed for input supply, off-take, EPC, EPCM, and financing. This phase is normally funded by the project sponsor, investors, and a lender providing a bridge loan based on the project pro forma (projected statement of cash flows).
During the contract phase for all construction projects, the owner’s prior choice of a project delivery method governs the contracting structure. The diagram below illustrates the project delivery method options:
For a CM delivery, the owner must contract with a construction manager who will provide management of the project. The owner must also contract individually with all prime contractors directly. Although CM allows fast-tracking a project – overlapping design and construction – CM truly works best for an owner that has a robust internal team to manage the project procurement. Lastly, for a design-build delivery, the owner contracts with a single contractor that will provide all design, material & equipment purchases, and construction. Design-build also allows fast-tracking the project.
Energy, industrial, and refining projects have additional contract phase activities. In the contract phase, all final contracts are negotiated and signed, especially the input contract, off-take agreement, financing agreement, EPC or EPCM contract, and operation and maintenance (“O&M”) agreement.
In terms of the critical path method (“CPM”) schedule, the construction phase for a conventional project is the duration from notice to proceed (“NTP”) from the owner to substantial completion. In terms of activity on the project, the contractor builds 99% of the facility and the owner spends 95% of the project funds during this phase. Finally, in terms of project dispute statistics, 99% of all project dispute issues are discovered in or occur during the construction phase.
Here, energy, industrial, and refinery projects differ from conventional projects in two important ways. First, the construction phase begins at NTP and ends at mechanical completion – which means the facility and all equipment have been constructed and installed, but the equipment is not necessarily functioning at the specified levels. Second, substantial completion may not occur for weeks or months after mechanical completion. The commissioning phase section below further discusses substantial completion for energy, industrial, and refinery projects.
The commissioning phase occurs when the project’s performance is ready for demonstration and measurement. For conventional projects, such as an office building or education facility, the majority of the commissioning work involves adjusting building systems (ex. testing and balancing the HVAC system).
Energy, industrial, and refinery commissioning on the other hand is quite involved, and the potential liabilities are large. For example, if a design-build (EPC) contractor provides a performance guarantee that a gas turbine power plant will produce 500MW of electricity, then the plant’s meeting that output is measured during commissioning. In many cases, the contractor must adjust the engineering or construction of the power generation equipment to produce 500MW during the commissioning phase. Once the power plant produces the guaranteed amount for a testing period, then the project has achieved substantial completion.
Unlike conventional projects, substantial completion for such a power plant may not occur for months after construction is complete (mechanical completion). Because there are typically large performance and delay liquidated damages associated with not achieving substantial completion or achieving it beyond the CPM schedule date, an energy plant contractor’s greatest financial risk occurs during the commissioning phase.
Operations for a conventional construction project means that the facility is ready to be used for its intended purpose. An office, for example, is ready for workers. However, for such a conventional project, the owner likely accepted care, custody, and control of the project well before this time. For an energy, industrial, or refinery project, the operations phase begins after substantial completion and when the owner’s staff takes over the operations of the plant – this is the care custody and control moment for these complex projects.
In conclusion, remember that following these phases provides a structured approach and a financial gate for the project. Further, especially for large or complex projects, it is essential that the project participants understand and follow these phases.*
*The information in this article does not constitute legal advice and is for general educational purposes only.