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Provisional sums and reasonable profit in FIDIC Yellow Book

Question:
I am a consultant and the appointed “Engineer” working on a harbour construction project in Eastern Asia, using the FIDIC Yellow (Design & Build) Book. Some confusion has arisen over the interpretation of the following clauses:

1. Clause 13.5 Provisional sum: this Clause contains two sub-clauses 13.5(a) and 13.5(b). We (Consultant) think that 13.5(a) applies to works which are undertaken by the main Contractor and that 13.5(b) applies to works which are undertaken by third party sub-contractors or suppliers.

The Contractor disputes our interpretation and says that 13.5(a) applies to work (any kind of works executed by anybody (main contractor or sub contractor)) and 13.5(b) applies to supplies (supply by suppliers (plant, material, services)).

2. Clause 13.3.4 states that “reasonable profit” shall be paid to the Contractor. We are unsure how to determine “reasonable profit”?

• What does “reasonable profit” mean?

• How is it determined and what does it include (overheads, profit etc)?

• If it means pure profit only, how does the Contractor recover his overheads?

• The Appendix to the form of Tender includes 12.5% for OHP for Provisional Sums. Is this applicable to both Clauses (13.5(a) and 13.5(b)) or to (b)? If (b) only, do we establish a new % or use the tendered OHP?

Could you please give us your interpretation of the above?

Suggested Answer:

 

Clauses 13.5.1(a) and (b): Your first query is about the meaning of Clauses 13.5.1(a) and (b) and what is covered by the Provisional Sum. I tend to favour your view. I think the correct interpretation is that (a) covers direct costs – i.e. work being provided directly by the Contractor and (b) refers to subcontractor or supplier costs i.e. for plant materials or services that the Contractor has to procure (“purchase”) from third parties. Essentially, 13.5.1(a) covers works (with a small “w”, including any Plant, Materials or supplies involved in those works) to be executed by the Contractor. 13.5.1(b) covers anything required for the Works (“Plant, Materials or services“) that is to be “purchased by” the Contractor.

Reasonable profit: Your second query is about the reference to “reasonable profit” in Clause 13.3.4. You will notice that this term used in the Yellow Book (or indeed in any of the FIDIC contracts) is not a defined term and is therefore to be given its natural, ordinary meaning. However, what I think is clear is that it relates to pure profit (and not overhead and profit or “OHP” as it is often termed). This is because “overhead” is separately expressly accounted for within the definition of “Cost” in the Yellow Book (and FIDIC contracts generally) (“Cost” means all expenditure reasonably incurred……..whether on or off the Site, including overhead and similar charges but does not include profit”). Equally, clauses that entitle the Contractor to profit separately use the words “Cost plus reasonable profit”.

What is “reasonable” will depend upon the particular context and circumstances of your contract. A starting-point for setting a reasonable profit might be to look at what rates of profit are charged in comparable contracts in your market. You may need to take into account factors such as availability of materials, supplies and manpower, and the level of any skill and risk involved in the works which are being costed. Sums which are wildly above or below the market norm might not be regarded as “reasonable”.

The Yellow Book standard form contract does not fix what a rate of reasonable profit is, but the FIDIC Contracts Guide provides guidance. The Guide suggests that if parties wish to specify in their contract the rate of what is a reasonable profit they could add an amendment stating that where the expression “Cost plus reasonable profit” is used, “reasonable profit” is a set percentage of that Cost. The Guide suggests this percentage as 5% of the Cost, which gives you an idea of the sort of rate of profit that FIDIC considers may be deemed reasonable. However, I still think that the reasonableness will depend on the particular market, type of contract, risks involved etc with which you are dealing. To avoid these kinds of arguments and uncertainty, I always advise both contractors and clients alike to agree the profit percentage up front before entering into FIDIC contracts.

Bear in mind that any abnormally high rate of profit claimed by the Contractor in its proposal for an adjustment to the Contract Price (discussed below) is likely to be questioned by the Engineer when he/she considers that proposal.

As the term “reasonable profit” only covers “pure” profit and not the Contractor’s overheads and other costs, the Contractor claims for its overheads and other costs by including them in its proposal for the adjustment to the Contract Price which he submits to the Engineer in accordance with Clause 13.3.1.

Your final question is about the sum for overhead charges and profit referred to in Clause 13.5.1(b)(ii) and how it applies to 13.5.1(a) and (b). You will remember from the answer to the first question above that (a) is work executed or supplied direct by the Contractor and (b) is Plants, Materials or services purchased by the Contractor. The price for these two items is calculated differently and is summarised below; the 12.5% applies to (b).

The price for (b) is calculated by adding together the actual amounts paid or payable by the Contractor for the Plants, Materials or services plus a sum for overhead charges and profit. The amount of overhead charges and profit is calculated as a “relevant percentage” of the actual amounts paid or payable by the Contractor. The relevant percentage is stated in the appropriate schedule; if there is no rate specified, the percentage to be applied is the rate stated in the Appendix to Tender which in your contract is 12.5%.

The price for (a) is calculated in accordance with Sub-Clause 13.3. Under the procedure in Sub- Clause 13.3 the Contractor submits a proposal for the adjustment to the Contract Price to cover the relevant work to be performed. The adjustment includes a reasonable profit (discussed above). The Engineer responds with approval, disapproval or comments. If the Engineer proceeds to authorise the relevant works he will agree the cost proposal made by the Contractor or, if he does not agree with the Contractor’s price proposal, determine the adjustment to the Contract Price in accordance with Sub-Clause 3.5. This clause requires the Engineer to consult with each party to the Contract in an endeavour to reach agreement. If agreement is not achieved, the Engineer makes a “fair determination” in accordance with the Contract, “taking due regard of all relevant circumstances”. Any disputes are settled in accordance with Clause 20 (Claims, Disputes and Arbitration).

Therefore, the short answer to your final question is that the 12.5% applies to (b) but in relation to (a) it is the Contractor who makes a proposal about the amount (which could be 12.5%, or a greater or lesser rate).

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One Response to this post

  1. I this is very true the contractors at the end of the day do choose their rate of above or below 12.5% simply to either get the job in times of economical hardships or oter reasons