Negotiation and settlement

Most construction claims are resolved by negotiation, not by a decision. Even claims that go to adjudication, arbitration or court usually settle at some point before the final award. Negotiation is therefore the most important dispute resolution skill a construction manager can have, and it is the one most often left to chance. This lesson applies negotiation principles to construction claims. It builds on the general negotiation material in PMP-121 lesson 9 and the business negotiation concepts in BUS-210, and focuses on what is specific to claims: valuing the alternatives, protecting what is said, structuring offers and writing a settlement that ends the dispute.

The aim of a claim negotiation is a settlement that both parties prefer to their alternatives. That sounds obvious, but many claim negotiations fail because one or both sides have not worked out what their alternative actually is, or because they negotiate positions rather than interests, or because the people at the table do not have authority to settle.

Interests, positions and alternatives

A position is what a party says it wants: 'We claim $860,700.' An interest is why it wants it: Kestrel Ridge needs cash to cover subcontractor payments, wants to protect its margin and its reputation with its surety, and would like to bid the city's next recreation centre. The City of Ashford wants to stay within its council-approved budget, avoid an embarrassing public dispute, recover what it can from its consultant and get the pool open. Negotiating interests opens options that negotiating positions does not: a payment schedule that helps Kestrel Ridge's cash flow, a joint approach to Halloway Partners for the design error, or a release that lets the city close the project file.

Each party's best alternative to a negotiated agreement (BATNA) is what it will do if negotiation fails. For a claim, that is usually adjudication, arbitration or litigation, with all their costs, delays and risks. A party should not accept a settlement worse than its BATNA, and should not reject one that is better. The zone of possible agreement lies between the two parties' walk-away points. The skill is in valuing the BATNA honestly.

Valuing the alternative with a decision tree

A decision tree sets out the possible outcomes of the alternative, their probabilities and their values, and calculates an expected value. The probabilities are judgments, ideally informed by legal advice and an honest view of the evidence; the value of the exercise is that it forces those judgments into the open and shows which of them matter.

# Kestrel Ridge's view of arbitrating its Ashford claim versus settling (illustrative, in $000)
outcomes = [            # (probability, award including interest)
    ("Full success",    0.35, 820),
    ("Partial success", 0.45, 480),
    ("Claim fails",     0.20,   0),
]
own_costs = 260         # legal, expert and staff costs through a hearing
months = 20             # time to an award
discount = 0.06         # annual cost of money

ev_award = sum(p * a for _, p, a in outcomes)
pv_award = ev_award / (1 + discount) ** (months / 12)
kr_value = pv_award - own_costs
print(f"Expected award {ev_award:,.0f}; present value {pv_award:,.0f}; net of costs {kr_value:,.0f}")

city_costs = 240
city_exposure = pv_award + city_costs
print(f"City's expected cost of arbitrating: {city_exposure:,.0f}")
print(f"Settlement range: {kr_value:,.0f} to {city_exposure:,.0f}")

print("Sensitivity to the chance of full success (partial fixed at 0.45):")
for p_full in (0.20, 0.35, 0.50):
    ev = p_full * 820 + 0.45 * 480
    print(f"  p(full) = {p_full:.2f}: Kestrel Ridge net {ev / (1 + discount) ** (months / 12) - own_costs:,.0f}")

Expected award 503; present value 456; net of costs 196
City's expected cost of arbitrating: 696
Settlement range: 196 to 696
Sensitivity to the chance of full success (partial fixed at 0.45):
  p(full) = 0.20: Kestrel Ridge net 85
  p(full) = 0.35: Kestrel Ridge net 196
  p(full) = 0.50: Kestrel Ridge net 308

Kestrel Ridge's expected award is $503,000, worth about $456,000 today if it arrives in 20 months, and about $196,000 after its own costs of arbitration. The city's expected cost of arbitrating is about $696,000 including its own costs. Any settlement between roughly $196,000 and $696,000 leaves both parties better off, on these estimates, than arbitrating. The sensitivity shows that Kestrel Ridge's walk-away value moves by about $110,000 for each 15-point change in the chance of full success, so that judgment deserves the most attention.

Two points are often missed. First, costs are frequently the largest single factor: on claims of a few hundred thousand dollars, the cost of a full arbitration or trial can consume much of what is at stake. Second, the parties are rarely risk-neutral. A small contractor that cannot afford to lose may rationally accept less than the expected value; a public owner may pay more than expected value to avoid a precedent or public criticism. Expected value is a starting point, not the answer.

Costs rules affect the tree. In Canadian courts and in many arbitrations the successful party usually recovers part of its legal costs from the other side, so a strong claim is worth more and a weak one is riskier; the tree can add branches for costs recovered or paid.

Preparing for a claim negotiation

Preparation decides most negotiations. A checklist for a claim negotiation includes the following.

Authority matters especially for public owners. A city project manager may not be able to approve a settlement above a certain amount without council or senior management approval. A contractor that negotiates for hours with someone who cannot agree will be frustrated; one that asks at the outset what approval is needed can plan the process. Many contracts' dispute clauses require negotiation between senior representatives before escalating, precisely to bring fresh people with authority to the table.

Protecting what is said

Parties negotiate more openly when they know that offers and admissions will not be used against them if the negotiation fails.

In Canada, settlement privilege protects communications made in a genuine attempt to settle a dispute, whether or not they are marked 'without prejudice'; the Supreme Court of Canada confirmed its scope in Sable Offshore Energy Inc. v. Ameron International Corp., 2013 SCC 37. Marking letters 'without prejudice' is still good practice because it shows the intention. Privilege does not protect facts that exist independently of the negotiation, and there are exceptions, such as proving that a settlement was reached.

Mediation adds a further layer: mediation agreements and the rules of mediation bodies usually make the process confidential, and the mediator can hear each side privately. Lesson 10 discusses mediation in detail.

Making and responding to offers

A claim negotiation usually proceeds by exchanges of offers. Some practical rules help.

• Anchor with justification. An opening position that can be explained, item by item, carries more weight than a round number. Kestrel Ridge's opening at its full claim is credible only because each event is supported.
• Trade, don't give. Each concession should be exchanged for something: a concession on the concrete modified total cost claim for the city's withdrawal of a back-charge, or a lower figure for faster payment.
• Negotiate by event where possible. Agreeing the fill change and the tiling disruption first builds momentum and narrows the gap on the harder items.
• Watch the counterclaims. The city's potential claim for liquidated damages on the contractor-caused days, and its back-charges for cleanup, are part of the negotiation and should be resolved in the same settlement.
• Keep the relationship. On a project still under way, the parties must keep working together. Separating the people from the problem, as negotiation texts put it, is not just good manners; it protects the rest of the project.

Writing the settlement

A settlement that leaves room for argument is not a settlement. The written agreement should be drafted carefully, usually with legal advice, and should cover at least the following.

The third-party term deserves emphasis on Ashford. The city will want to recover part of the settlement from Halloway Partners. A release of Kestrel Ridge must not accidentally release or prejudice the city's claim against its consultant, and the city should notify Halloway Partners and its insurer before settling, as many professional liability policies require.

After the settlement

Signing the settlement is not the end of the work. The contract administrator should issue the change order or amending agreement that records the agreed sum and extension, update the schedule and the cost report, release or adjust any holdback or retainage as agreed, and close out the claim in the change log with a reference to the settlement. Subcontractors whose claims were included should receive their share promptly and sign their own releases, or the contractor may find itself paying twice. Finally, both parties should hold a short lessons-learned review: which events produced the dispute, which records helped, and what each would do differently on the next project. On Ashford, the city recorded that its tile approval turnaround had caused two of the disputed events and changed its procedure for the next recreation centre.