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).

In the UK, the head of the National Audit Office (the body scrutinising public spending on behalf of Parliament) has called for a project-by-project review of future private finance initiative contracts, with stricter criteria being employed than in the last two years, to establish the most appropriate funding methods. The “Private Finance Initiative” is the UK’s own version of Public Private Partnerships or PPP and since its inception in the early 1990′s has resulted in over 500 operational projects in England alone with a capital value in excess of £28 billion (according to the National Audit Office Report published 3 November 2009).

Whilst obviously specific to the UK and PFI, the NAO’s report is revealing about the effects of the banking crisis on privately financed projects (PPP) and more interestingly, about the likely prospects for such projects in the future. Its recommendations for how such projects can be more efficient and offer better value for money make interesting reading in light of the UK government plans to put in place “an economic, efficient and effective strategy for financing public services”.

Approval of Treasury response to the credit crisis

The report commends the previous Labour government in its commitment to “reactivating” the financing market at a time when finance became increasingly unavailable, limiting the opportunity for the agreement of sizeable contracts. It also commends the Treasury’s approach at this time and suggests it was successful when establishing the Infrastructure Financing Unit in March 2009 to address the scarcity of debt finance. The Unit was tasked to ensure that 110 privately financed infrastructure projects (exceeding £13billion) would continue by funding any shortfalls in bank finance. For example, this Unit directly assisted the “Greater Manchester Waste Project” in April 2009 providing £120million to the project.

The UK Treasury’s willingness to lend improved market confidence and 35 government infrastructure projects were subsequently agreed without further public lending. However, although banks continued to lend, priority was given to closing deals at prevailing market rates, even if that meant that the public sector was paying more and the private sector was taking on less risk. The total interest cost of bank finance increased by one-fifth to one-third despite the fall in short-term borrowing rates and little change in the risk profile of the projects concerned.

Warning: Change to come

The NAO’s report reveals that higher financing costs added 6-7% to the annual charge of PFI projects. Between £500m and £1billion in higher costs has been built in over 30 years, although this has been partly offset by an increased public sector share in refinancing gains. In October 2008 the Treasury increased the public sector share of such gains from 50% to 70%.

The warning issued by the NAO is that, while the extra finance costs for projects in 2009 were able to provide value for money in the short term and achieve the government’s objective of stimulating the economy, “the Treasury should not presume that continuing the use of private finance at current rates will be value for money”.

Value for Money and Funding Options?

The Report states that the Treasury was justified in not reconsidering the individual business case of projects in 2009 but that in future, there should be “no presumption, based on previous business case analysis, that continuing the use of private finance at current rates will provide value for money”. In addition, the NAO recommends that more exacting and narrower criteria be applied to projects in development than at the height of the crisis. Key recommendations to the Treasury include:

• Analysing the lessons of the last two years with the view to preparing a contingency plan for how government departments should handle future market disruption affecting procurement plans.
• Where there are material changes, such as project costs increasing by 15%, require the department to re-evaluate the project. Such a re-evaluation would “assess all the benefits, and potential loss of benefits, of continuing the project in its current form, compared to other available options, including other forms of procurement”.
The report also highlights a number of alternative funding models for projects that are being developed and that greater emphasis should be placed on assessing the merits of other models when addressing funding issues. These funding models / options have the potential to be key factors in the future implementation and success of PFI projects. Recommendations to the Treasury include:
• During procurement, departments should assess a range of funding options to assess value for money including all public finance or part public and part private finance.
• Government departments should make greater use of sensitivity analysis to inform their decision-making when negotiating small changes in finance rates or considering requests to take on additional project risk.
• Continue to consider how a greater mix of finance sources, with less emphasis on the use of commercial bank loans, can be used to finance infrastructure projects. For example, other options highlighted include the approach of the French government in guaranteeing 80% of debt when a project is operating successfully and loans from the European Investment Bank which is generally able to make funding available on more favourable terms than commercial banks.
• The adoption by the Treasury of a portfolio approach to refinancing, so that individual authorities do not exercise any right to a refinancing on a piecemeal basis. Such an approach would enhance the public sector bargaining position, reduce transaction costs and increase potential gains.

The Future?

 There is a note of optimism in the Report. Infrastructure UK, the new coordinating body established within the Treasury “estimates that the Government needs to continue to encourage substantial investment in new infrastructure, possibly £40-50 billion per annum until 2030″.

Now comes the difficult bit – implementing the recommendations of the Report – and providing structures and funding for PFI projects that secure better value for money. If the private sector’s enthusiasm for PFI was cooling because of high bid costs and lengthy tendering periods, the tendering process will become an even more crucial part of the whole PFI deal, for both the public and private sector. The potential of increased unavailability of government funding will mean that the public sector has few choices outside PFI for the funding of capital projects and a focus and investigation of a variety of alternative funding options will be needed.

Do you have any experience of developments outside the UK for increasing the efficiency of similar projects – and particularly the tender process? If so, your input will be very welcome!

This judgment from the Inner House of the Scottish Court of Session is therefore very useful as an indication of the UK Courts’ current approach to causation of delay and extensions of time. Of course, this may not be the end of the story as City Inn still has the chance to lodge an appeal to the Supreme Court.

Key Elements

The dispute centred on a late-running project to build a hotel in the city of Bristol. Shepherd was employed by City Inn to carry out this project under an amended version of the 1980 edition JCT contract (a UK standard form of building contract with Quantities). The adjudications which followed the late finish resulted in Shepherd being awarded a 9 week extension of time (“EoT“) made up of 4 weeks awarded by the Architect and a further 5 weeks from the Adjudicator. City Inn was unhappy with this result and took the matter to the Outer House of the Scottish Court of Session. They applied for various orders including
a declaration that Shepherd were not entitled to an EoT; a reduction of the Architect’s award of 4 weeks EoT; and an order for payment of outstanding liquidated damages for delay.

Shepherd counterclaimed for a further 2 weeks EoT and for consequent loss and expense. The matter eventually proceeded to trial and was heard by Lord Drummond Young.

The main elements of the case were a bespoke clause covering entitlement to an EoT (clause 13.8), and the cause of the delay, taking into account the multiple delaying factors which occurred and the extent of their impact.

On the first issue, Lord Drummond Young found that clause 13.8 could not logically apply to instructions which caused delay just because they were in themselves late. Lord Drummond Young also noted that City Inn had not referred to their clause 13.8 rights until this juncture, and that neither of the parties appeared to take the clause into account when acting.

On the second – and more interesting – issue, causation and delay, Lord Drummond referred back to another contract clause (clause 25) to give his judgement. He said that under clause 25 the architect was to exercise his judgment and fix a “fair and reasonable” completion date. He held that an apportionment exercise may be necessary where there is concurrency or no dominant event.

The parties had been unable to locate an electronic, logic linked version of the original programme and so had to use a basic programme showing the activities and durations of the project. Lord Drummond rejected City Inn’s expert evidence which tried to establish, retrospectively, a critical path which led to the conclusion that Shepherd was not entitled to any EoT at all. Instead, he favoured Shepherd’s expert who said that he had attempted to establish a critical path, but that it was impossible to do so accurately. Lord Drummond preferred this common sense approach and found that, using this analysis, Shepherd was entitled to 9 weeks EoT.

City Inn appealed unsuccessfully with most of the judgment concurring with Lord Drummond’s reasoning. The majority opinion was set out by Lord Osborne, and contains five principles relating to the evaluation of a delay and loss plus expense claim. Of course, the Court was examining these issues under clause 25 of the JCT form. However, I think these general principles would have relevance to most construction contracts and illustrate the likely approach that would be adopted by the UK Courts:

1. For an EoT claim to succeed the relevant event must be shown to be likely to cause delay or have caused delay.

2. Whether or not a relevant event causes delay is a matter for common sense.

3. It is for the decision maker to decide what evidence to use in forming his conclusion. This may or may not include a critical path analysis. What matters is that the evidence used is sound, whatever form it takes.

4. If there is one dominant cause, all other causes will be disregarded. The dominant cause must be a relevant event for a claim to succeed.

5. It is for the decision-maker to apportion the delay to completion of works in a “fair and reasonable way” where there are two (or more) causes of delay, but only one of which is a relevant event and neither is dominant.

Although Lord Calloway dissented from the ‘apportionment’ reasoning, all three judges concurred in the result and on the critical path analysis being relevant but not necessary to decide the outcome of an EoT claim.

Implications for future cases

I should have of course stressed that this was a Scottish Judgment. What this means is that the decision is binding on the lower courts of Scotland but not so on the English courts – although given that it is an appeal court decision it will at least be persuasive in England.

What is most striking is that all the judges leaned heavily towards the arguments for being guided by principles of fairness, reasonableness and common sense. Many of the arguments put forward centred on the true meaning and consequences of events being concurrent. However, Lord Osborne stated that the important question was not whether events were truly concurrent, but rather the effects on the completion date of the events. In a similar spirit, Lord Carloway talks about the Architect applying “professional judgment” and “using his and not a lawyer’s common sense“.

In terms of implications for future cases in the UK, the judgment must not be considered an approval of the use only of common sense and fairness at the expense of a critical path analysis. In this case the critical path analysis presented was not considered sound and so was not used to form the judgement. However, that is not to say it may never be used to determine EoT claims, but rather it is up to the decision-maker as to whether he uses the critical path analysis in his “fair and reasonable” decision-making process.

And what of its implications further afield – in the international arena? I think the judgment and the arguments employed would be useful to anyone involved in disputes on causation and EoT’s where there are concurrent events and particularly where there is no critical path analysis or such evidence is flawed.

FIDIC talks about the Engineer making a “fair determination” whenever required to determine any matter under the Contract [Sub-Clause 3.5] and the provision dealing with extensions of time [Sub-Clause 8.4] refers to an extension of time “if and to the extent that completion……..is or will be delayed by any of the [specified] causes“. So the same arguments about causation, apportionment and concurrency could run under a FIDIC based contract.

Similarly, the NEC construction form NEC3, which treats delay events as “Compensation Events”, requires the Project Manager (who has to act “as stated in this contract and in a spirit of mutual trust and co-operation”) to assess “the length of time that, due to the compensation event, planned Completion is later than planned Completion” [Core Clause 63.3]. Interestingly, in NEC, assessment of the impact of the event includes “risk allowances for cost and time for matters which have a significant chance of occurring and are at the Contractor’s risk under this Contract” [Core Clause 63.6].

And, of course, I cannot sign off without mentioning that Pinsent Masons acted for Shepherd Construction on this case!

Shell’s position was that Centurion Petroleum Corporation was in repudiatory breach and that Shell had clearly “accepted” this repudiation. The problem they faced was that the arbitral tribunal had interpreted their letter notifying Centurion that their contract was at an end as an “affirmation” of the contract – an interpretation with a significant price tag attached. On appeal, Shell were asking the Court “what principle requires a clear election to terminate on the basis that a substantial sum is recoverable to be treated as a termination on the basis that nothing is recoverable?”

A fair question, you might agree. Yet the Court ruled that by sending a letter terminating the contract in accordance with its termination procedure, Shell had “affirmed” the contract – i.e. treated it as continuing. This cost Shell about $15m.

The background

A number of disputes had arisen between Shell and oil exploration company Centurion Petroleum Corporation (now Dana Gas Egypt) concerning their contract for an oil and gas exploration project in the Nile Delta. Shell argued that Centurion had committed a repudiatory breach of the contract by failing to issue notices about a change in control of its holding company and that Centurion had also breached one of its warranties, entitling Shell to rescind the contract in accordance with clause 5 of the contract.

By this time, Shell was also entitled to terminate the contract on giving 30 days’ notice to Centurion in accordance with clause 3.1.8 because the “Closing Date” had not been achieved by the specified deadline. This is the right that Shell in fact exercised. It wrote a letter to Centurion stating that the contract would be terminated 30 days after the date of the letter. In the letter Shell invoked Clause 3.1.9 of the contract which provided that if the Closing Date had not been achieved because certain consents from the Egyptian government had not been obtained, Centurion was obliged to refund all payments made by Shell, including its initial US $15m investment.

In fact, the authors of the termination letter were mistaken about the consents not being obtained; Centurion had provided them to Shell a month before. Centurion responded to the termination letter by accepting the termination, waiving the 30-day notice period and pointing out that Centurion was under no obligation to refund any payments.

The dispute went to arbitration and the arbitrators found that Centurion had indeed committed a repudiatory breach of the contract and a breach of warranty entitling Shell to rescind the contract. However, they found that Shell had neither accepted the repudiatory breach nor exercised their contractual right to rescind the contract. By terminating under the contract they had affirmed it. Shell appealed against this award.

The judgment

The High Court judge had to decide whether or not Shell’s termination letter could be regarded as accepting Centurion’s repudiatory breach as terminating the contract.

There is no set form for accepting repudiation; all that is required is a clear, unequivocal communication (whether orally, in writing, or by conduct) that the innocent party is treating the contract as discharged. Whether a clear and unequivocal communication has been made is examined objectively – what would the reasonable recipient of the communication have understood from it?

On the face of it, the letter clearly stated that Shell was terminating in accordance with clause 3 of the contract, and made no mention of the repudiatory breach. However, there is case-law that says that, if a party has both a right to terminate at common law for repudiatory breach and a right under the contract, as long as the innocent party makes it clear that he is treating the contract as discharged, he does not have to choose between the common law right and the contractual clause. He can effectively accept the repudiation by exercising the contractual right. This is the case even if he does not refer to the common law right, and even if he gives a “bad reason” for terminating the contract (such as wrongly asserting that consents have not been obtained).

He must choose which right to exercise though, if exercising the right under the contract is inconsistent with accepting the repudiatory breach. In this case, the rights Shell had at common law and under Clause 3 of the contract were inconsistent with each other. The termination clause was not triggered by breach, and provided that Centurion was not obliged to repay any money in the event that it was exercised.

So, would a reasonable recipient read the letter as unequivocally terminating under Clause 3.1.8, or as accepting the repudiation? Shell said repudiation, because, they argued, they had made a mistake about the government consents and no-one would think they were terminating under Clause 3.1.8 if they could not recover their $15m. The judge disagreed.

“The letter as written plainly communicates an unequivocal election to terminate under Clause 3.1.8. In my judgment the obvious mistake contained in it does not, in context, derogate from that message, because it was a perfectly feasible commercial stance for Shell to adopt (…)”

Faced with the choice of arguing about whether Centurion had committed a repudiatory breach or not, or exercising a contractual right which was indisputably available (which would have meant losing the initial $15m but not having to pay a further $20m), the judge thought it was plausible that Shell would have cut its losses and plumped for the termination clause.

Interestingly, the judge suggested that Shell could have “hedged its bets” and opted to accept the repudiation AND terminate under the contract in case they got it wrong:

“I can see no reason why Shell could not have served a notice which accepted the repudiatory breach as terminating the contract but, in the alternative, in case they were wrong in asserting that Centurion were in repudiatory breach, exercised the contractual right to terminate afforded by Clause 3.1.8.”

What can be learned from Shell’s expensive mistake?

Well, it shows how carefully you need to tread if you think the other side has committed a repudiatory breach. If you terminate the contract but end up being wrong about a repudiatory breach being committed, then you could be in repudiatory breach yourself.

On a positive note, the judge’s suggestion about how Shell could and should have worded its termination letter is helpful to others. Shell had their pick of reasons to terminate the contract but chose the wrong one – but maybe it is sometimes possible to have your cake and eat it?

By Sarah Thomas and Susannah Cassedanne

“Tests on Completion

The first 30 days shall be a monitoring period during which the Contractor sets up the operation of the plant and conducts his own water quality tests to confirm that the final effluent consent has been met. At the end of this period the Contractor shall notify the Engineer that the plant is complete and meeting the Process Guarantee which then shall be met by a further 30 consecutive days before Taking Over can take place.”

We have met the final 30 consecutive days successfully and want taking over. The Employer says we must complete the 90 days which takes us outside of the construction period and hence delay damages are being threatened.

I say we have satisfied the contract at the end of the 30 consecutive days and we should get Take Over even though it is not 90 days.

Have you any idea if we are right in our assessment?

Answer:
Firstly, a couple of brief provisos. I assume that you have made no amendments to the Yellow Book that affect this issue. I’m also assuming that, as you say, otherwise the works have indeed all been completed in accordance with the Contract.

Have the Tests on Completion been passed and are the Works ready for Taking Over?

Obviously your argument is that having satisfied the first 30 day monitoring period and then completed the further 30 consecutive day period and having notified the Engineer that the plant is complete and meeting the Process Guarantee, you have therefore satisfied the requirements for completion and Take Over.

Clause 10 – which deals with Taking Over – says that the Works must have been completed in accordance with the Contract and that a Taking-Over Certificate must have been issued. The Employer must issue such certificate within 28 days of an application if the Works are substantially complete in accordance with the Contract (i.e. apart from minor outstanding work and defects not substantially affecting the Works); otherwise the certificate is deemed to have been issued.

Crucially, “completion” for these purposes includes:

• achieving the passing of the Tests on Completion; and
• “completing all work which is stated in the Contract as being required for the Works to be considered completed for the purposes of taking over”.

So it all comes down to (1) what is required to achieve passing of the Tests on Completion and (2) what the Contract states needs to be completed to achieve take over.

Under the Yellow Book, “Tests on Completion” means “those tests which are specified in the Contract or agreed by both Parties…and which are carried out under Clause 9 [Tests on Completion] before the Works…are taken over by the Employer”.

Clause 9 goes on to spell out the process for carrying out these tests, which falls into 3 stages – pre-commissioning tests, commissioning tests and trail operation – the latter which is intended to show that the plant is operating reliably.

Ambiguous provisions

I think that the Engineer/Employer will forcefully argue that waiting for the 90th day to elapse is part of the “trial operation” and is required for you to pass the Tests on Completion. I agree that there is some ambiguity in the wording in Volume 3 of the Contract as it states: “At the end of this period the Contractor shall notify the Engineer that the plant is complete and meeting the Process Guarantee which then shall be met by a further 30 consecutive days before Taking Over can take place.” However, my own view is that the drafting of the full testing period is clear and explicit – “The test on completion duration shall be 90 days“. Bearing in mind that FIDIC explicitly states “The documents forming the Contract are to be taken as mutually explanatory of one another” I do not think that this wording is actually inconsistent with the words: “which then shall be met by a further 30 consecutive days before Taking Over can take place”. In my view, all the Contract is saying is that the actual commissioning tests period is 30 days but there is then a further 30 day trial operation period to ensure the plant is operating reliably. This is also consistent with the description of Tests on Completion (and the 3 stages) described in Clause 9.1.
Of course, it is open to you to request clarification on this point from the Engineer. Clause 1.5.2 of the General Conditions provides that: “If an ambiguity or discrepancy is found in the documents, the Engineer shall issue any necessary clarification or instruction.”

You do not mention if the Engineer in this case is an independent engineer or is part of the Employer organisation. Whichever is the case, he may well come to the same view as the Employer and, in my opinion, this would be consistent with:

• the express wording (“The test on completion duration shall be 90 days“);
• interpreting the documents as mutually explanatory of each other; and
• the 3 stage process of Tests on Completion which includes a “trial operation”.

Whether or not the Engineer is truly independent, Clause 3.5 applies when a party asks the Engineer for clarification and provides that he must consult with each party in an endeavour to reach agreement. If agreement is not reached, “the Engineer shall make a fair determination in accordance with the Contract, taking due regard of all relevant circumstances.”

The Engineer must give notice to both parties of the determination with supporting particulars. Each Party shall give effect to each agreement or determination unless and until revised under Clause 20 (Claims, Disputes and Arbitration).

What do you do now?

Whilst I think that the correct interpretation is that the testing period is the full 90 days, I am conscious that complying with this period will put you in delay and at risk of liquidated damages for delay. Therefore in practical terms, I think that you should at least make the argument that you have already substantially completed. I think that there is sufficient ambiguity in the Volume 3 wording to argue that the Tests on Completion have been completed and that you are entitled to issue of the Taking-Over Certificate. Therefore you should apply for issue of this certificate if you haven’t already done so (although if you haven’t already done so you will still have to wait at least 28 days before the Engineer is obliged to issue the certificate or you can argue that it is deemed to be issued).

Under Clause 10.1 [Taking Over of the Works and Sections], the Engineer is deemed to have issued a Taking Over Certificate if he fails either to issue a TO Certificate or rejects the Contractor’s application for a TO Certificate within a period of 28 days after receiving the Contractor’s application.

You have not said whether or not the Engineer has rejected the application. If he has not, and more than 28 days has elapsed since you issued it, then the TO Certificate will be deemed to have been issued on the last day of the 28-day period.

Of course, if you applied for the TO Certificate right before the end of the 30+30 days, then the Engineer has up to 28 days to issue or reject, and you are almost in the same position as if your completion test phase was 90 days. If you applied substantially earlier than that then it will make a bigger difference and might be the difference between completing on time or late.

If you are late, then there probably is no harm in making the application for a Taking-Over Certificate. Note that in accordance with Clause 10.1.3(b) of the General Conditions, if the Engineer wishes to reject the application, he has to give reasons and specify the work that is required to be done by the Contractor to enable the TO Certificate to be issued. Even if the Engineer has purported to reject your application, you might be able to argue that he has not done so in accordance with the contract, because he has not specified the work that is required to be done in order to enable the TO Certificate to be issued. Of course in my view, he is likely to simply point to the further 30 day trail operation period under the Contract.

Delay to Testing

Whilst I do not think you have a basis of claim (as my interpretation of the Contract is that you have not yet fully passed the Tests on Completion), if the Employer’s insistence on you waiting until the end of 90 days after the start of the testing period is not permitted under the Contract, there is potentially the right to claim for delay. Clause 7.4.5 provides that “If the Contractor suffers delay and/or incurs Cost … as a result of a delay for which the Employer is responsible, the Contractor shall give notice to the Engineer and shall be entitled to claim both an extension of time and “payment of any such Cost plus reasonable profit, which shall be included in the Contract Price” (Clause 7.4.5(b)). Equally there is the ground in Clause 8.4.1 (e), being “any delay, impediment or prevention caused by or attributable to the Employer, the Employer’s Personnel, or the Employer’s other contractors on the Site.” The Employer’s Personnel, as defined, includes the Engineer.

Any right to claim will be subject to strict compliance with FIDIC’s notice provisions in Sub-Clause 20.1 (Contractor’s Claims)). I have previously stressed the importance of getting your notice exactly right in the previous Q&A; click here to read more. After receiving this notice, the Engineer shall proceed in accordance with Sub-Clause 3.5 (Determinations) (see above) to agree or determine these matters.

One final note

Finally, do you have any minutes or notes of any discussions with the Employer about completion testing? If you do, have a look at them to see whether they clarify the position. Obviously it will be helpful if you have evidence that you and the Employer intended the tests to consist of the 30-day monitoring period plus the second consecutive 30-day period only. It is worth noting that FIDIC Yellow Book does not include an “entire agreement” clause precluding extra contractual documents/negotiations in interpreting the Contract. If you have clear evidence that the parties both intended the completion tests to last for 30 days plus 30 days (only) then you may be able to claim successfully that the figure 90 was inserted into the contract by mistake instead of 60, in the event that the dispute goes to arbitration.

]]> http://kluwerconstructionblog.com/2010/04/14/tests-on-completion-under-the-fidic-yellow-book/feed/ 0 http://kluwerconstructionblog.com/2010/02/26/new-decade-new-development-of-the-remoteness-rule/ http://kluwerconstructionblog.com/2010/02/26/new-decade-new-development-of-the-remoteness-rule/#comments Fri, 26 Feb 2010 09:44:38 +0000 Sarah Thomas http://kluwerconstructionblog.com/?p=409 Continue reading →]]> In this, the second of my New Year updates, I would like to discuss two interesting cases which have recently been decided by the UK courts. The first is the UK Court of Appeal upholding of a first instance judgment and the comments that the Court made on the recoverability of damages under English contract law.

The case is Supershield Limited v Siemens Building Technologies FE Ltd. As a reminder, the basic test under English law is that a party will recover losses flowing from the breach that (i) arise naturally, in the usual course of things, or (ii) are losses which the parties may reasonably be taken to have contemplated when entering into the contract (the “Hadley v. Baxendale” test, often known as the “remoteness” test). A previous recent development of this area resulted from the House of Lord’s decision in the Achilleas case which suggests that a defendant will not be liable for losses – even those which are not unusual and therefore potentially not too “remote” – which he cannot reasonably be regarded as having assumed responsibility for.

The facts of the Supershield case (whether Siemens could recover from its defaulting subcontractor the losses flowing from a series of failures in a water sprinkler system and in particular, the amount that Siemens had settled for a claim upstream with the main contractor) are not so important as what the Court said about the current interpretation of this remoteness rule. It held that Hadley v. Baxendale remains the standard rule and reflects “the expectation or intention reasonably to be imputed to the parties”. The Court went on to say that this can be interpreted so that “…if on the proper analysis of the Contract against its commercial background, the loss was within the scope of duty (i.e. what was within the contract breaker’s duty to prevent under the Contract) it cannot be regarded as too remote, even if it would not have occurred in ordinary circumstances”.

This means that under English law, a contract breaker can still be liable for damages even if those damages would have been considered unlikely by the parties when entering into the contract. Thus this judgment is important for its distinction between what “intention can be imputed between the parties” as to what damages should be covered and likelihood/foreseeability.

Another case, from a Scottish court, provides an interesting example of notice bars in a construction contract being strictly enforced in the UK. The case in question, Education 4 Ayrshire v South Ayrshire Council involved a contractor who had contracted to design and build six schools for the South Ayrshire Council under a PPP contract. During the works, asbestos that had not been revealed by a previous survey was discovered. This qualified as a “Works Compensation Event” under the contract, for which the Contractor might be entitled to an extension of time, payment of compensation and/or relief from its obligations but provided that the proper procedure was followed.
The Authority rejected the contractor’s claim for an extension of time and compensation on the basis that the contractor had failed to give the required notice in accordance with Clause 17 of the contract.
The judge agreed that the Contractor had not in fact complied with clause 17. He explained that once it is accepted that compliance with the notice clause is a condition precedent (and both parties agreed that it was), the question is simply, “what does the clause require?” In this case the clause required the Contractor to give notice of its claim. What the Contractor’s letter to the Authority about the delay actually said was “We will submit our full claim in accordance with clause 17.6 (…)”. This was held not to be valid notice under clause 17.6. A number of readers, particularly those from non-common law jurisdictions, will be surprised by this, as the Contractor had indeed flagged to the employer that a claim was being sought. But it just goes to show how strictly these notice provisions may be interpreted under English law and the need to follow ‘the letter of the contract’. You may recall that I answered a query on notices from a project manager recently (see Ask the Expert, February 2010) and warned of the need to check that the notice strictly complied with all formalities.
“But how is this equitable?” a number of you will cry. In the case, the judge said that the whole purpose of the clause is to give certainty – the Authority should not have to infer or assume from correspondence that a claim will be made. In this case, in accordance with the contractual notice provisions, the chief executive of the Authority was entitled to formal notification of a claim. The fact that those “on the ground” at the Authority may have been aware of the situation (the Authority was sent a copy of the survey report, attended a meeting to discuss its implications and had been provided with a copy of the Sub-Contractor’s claim against the Contractor in relation to the same event) was irrelevant.

Food for thought….

Please let me know if any of you have come across similar situations.

]]> http://kluwerconstructionblog.com/2010/02/26/new-decade-new-development-of-the-remoteness-rule/feed/ 0 http://kluwerconstructionblog.com/2010/02/16/a-new-year-brings-fresh-thinking-from-fidic-and-new-developments/ http://kluwerconstructionblog.com/2010/02/16/a-new-year-brings-fresh-thinking-from-fidic-and-new-developments/#comments Tue, 16 Feb 2010 15:33:03 +0000 Sarah Thomas http://kluwerconstructionblog.com/?p=380 Continue reading →]]> I thought that I would hail in the new year with an update on some interesting construction developments. Put it down to a period of reflection over the Christmas break! As I want to cover a number of areas, I have split this update into 2 postings.

In this first update, I am going to cover the latest FIDIC news and the new Bribery Bill currently going through the UK parliament. In my next posting I will look at two recent construction cases in English law, the first covering recoverability of damages and the English “remoteness” rule, the second covering treatment of contractual notice bars for claims.

Firstly, on FIDIC. I presented at the annual FIDIC conference in London in December of last year and can report some interesting developments:

FIDIC have just published a new Subcontract form (termed the Conditions of Sub-Contract for Construction). This is specifically designed as a construction only subcontract – to be used by main contractors operating under either the 1999 FIDIC Conditions of Contract for Construction for Building and Engineering Works designed by the Employer (known as the “Red Book”) or the Multilateral Development Bank’s Harmonised Edition of these FIDIC Conditions of Contract. The subcontract is drafted very much on the basis of a “total pass down of risk”, although there are some interesting features (particularly from an English law perspective).

For example, the payment provisions are effectively tied to payment under the “Main Contract” and include “pay when paid” clauses (Sub-Clause 14.6 (c)) in that the Contractor can withhold monies where “the Employer has failed to make payment in full to the Contractor in respect of those amounts…”. Of course, this protection will not apply where the reason for non-certification under the Main Contract is because of Contractor default or the Employer’s insolvency. Whilst common in subcontracts in Europe, any construction contract signed in England and Wales is subject to the UK Housing Grants, Construction and Regeneration Act and this prohibits pay when paid provisions. It will be interesting to see how this plays out in the market – readers will no doubt be conscious of the current harsher market conditions for contractors generally – so this may be more palatable to subcontractors in these straitened times. What it means in practice is that subcontractors will have to take a good deal more notice of what the main contract says about payment, and certification of payments, to ensure they are comfortable with these risks flowing down into their subcontracts.

As for other key features,

• Whilst the underlying principle is direct risk pass down, there is no general provision (as appears in many “pass-down” subcontracts) saying, for example, that the Sub-Contractor shall carry out the Sub-Contract Works such that he does not put the Contractor in breach of the Main Contract.

• The Sub-Contract assumes that the Main Contract will be the FIDIC Red Book and directly refers to Main Contract Clauses. Of course, the numbering will not necessarily work if the Main Contract is either not FIDIC or is an amended form of FIDIC.

• Not surprisingly, there are provisions allowing for immediate termination where the Main Contract terminates (Clause 15). Where the Main Contract is terminated for default the Sub-Contractor only gets the value of work and documents produced up to the date of termination (less amounts recovered by the Employer and any other losses and damages incurred by the Contractor and, notably in my view, its other sub-contractors). If not in breach, the Sub-Contractor gets paid the value of works/documents to date, demobilisation and reasonable repatriation costs, any other costs “reasonably incurred” in expectation of completing the Sub-Contract Works plus loss of profit. This is all fairly standard, although I suspect a number of main contractors may wish to curb the ‘loss of profit’ claim. However, the biggest potential issue is I think Sub-Clause 15.6. This allows the Sub-Contractor to terminate where there would be a right to do so under the Main Contract. The clause simply refers to the termination events in the Main Contract equally applying to the Sub-Contract. I query whether this actually works or makes the Contractor’s other termination rights sufficiently clear. It would be preferable to spell them out for such an important clause.

FIDIC is also proposing to issue a new user guide to accompany the Design Build and Operate form (Gold Book). Just to remind readers, the current form (first published in September 2008) covers design, build and long term operation of facilities on green field sites. The new guide will include provisions allowing this to be used for brown field sites. No doubt FIDIC hope that this will lead to a much greater use of the Book as most DBO projects involve some element of upgrade of existing facilities alongside new build. However, as this form is still in its infancy I am yet to hear from anyone who has actually used this form (- readers please get in touch if you have), it remains to be seen whether this will lead to wholesale take up of this new form. I think one reason for the lack of use so far may be that the form has no provision for funding by the Contractor and so is not suitable for PPP projects.

At the same time, FIDIC are proposing a review of all the contract forms in their current “1999 Rainbow Suite” (i.e. principally the Red, Yellow and Silver Books) and plan to amend these in line with current business practices and in response to request for amendments over the last decade. For example, one likely amendment is to include the amendment FIDIC has already made to Sub-Clause 20.1 in the DBO form dealing with the procedure for Contractor’s claims. Just to recap, Sub-Clause 20.1 has always been a sticking point for contractors as it essentially precludes any entitlement to claim for time/money if the conditions of this clause are not strictly complied with. What the Gold Book has introduced is a slight relaxation of this absolute notice bar, allowing the Contractor to apply to the Dispute Adjudication Board for a ruling if he considers there are circumstances which justify the late submission of a notice. If the DAB agrees that in all the circumstances “it is fair and reasonable that the late submission be accepted”, it can overrule the 28 day notice limit.

FIDIC canvassed views at our London conference as to what other clauses should be amended. There were a number of requests for a review of the variations clause (Sub-Clause 13) and in particular to the right of the Contractor to payment for value engineering changes. Currently under all the forms, the Contractor bears the cost of any proposal and only if it is accepted by the Employer, does he then get remunerated. This has always been something of a disincentive to propose value added changes.

Before signing off on this first update, I would like to touch upon the Bribery Bill 2009 which is currently going through the UK Parliament. The reason this has been introduced is because the UK has come under foreign criticism from the Organisation of Economic Co-Operation and Development (OECD – see website), amongst others, because of its perceived failure to carry out its obligations under the OECD Convention, which the UK ratified in 1998. The new Act, if it becomes law, will impact upon all commercial organisations seeking contracts with the public sector both in the UK and abroad.

Key features to watch out for if you are a UK contractor are the proposed new offences of bribing a foreign public official and the corporate offence of failure to prevent bribery by persons working on behalf of the business, including employees, agents and subsidiaries (whether domestic or foreign). The corporate offence applies to companies or partnerships which are either formed under UK law or which carry on business in any part of the UK – in other words, it could also impact on foreign companies doing business in the UK. The offence is punishable by an unlimited fine for the company whilst company individuals with responsibility for anti-corruption measures face personal criminal liability and up to 10 years’ imprisonment.

It will be a defence to the corporate charge for a company to show that “adequate procedures” to prevent corruption were in place at the time. The Bill does not detail what “adequate procedures” means but this month the Government agreed to add an amendment that will require the Secretary of State to provide guidance on this. All UK companies and overseas companies doing business in the UK should probably review their internal procedures carefully and update training, policies and contracts of employment to reflect the new law.

Some of you may ask whether there is sufficient parliamentary time to push this through before the UK election (which most commentators are forecasting in early May this year). The current view is that while the Bill is generally understood to have cross-party support, timing is very tight as there are a number of further stages that the Bill must complete in the House of Commons before it can be passed into law. If the Bill is not passed in time, it will need to be re-introduced in the next Parliament.

Any thoughts on the latest FIDIC development or indeed on the UK’s proposed anti corruption measures are of course always welcome!

]]> http://kluwerconstructionblog.com/2010/02/16/a-new-year-brings-fresh-thinking-from-fidic-and-new-developments/feed/ 1 http://kluwerconstructionblog.com/2010/02/02/ask-the-expert/ http://kluwerconstructionblog.com/2010/02/02/ask-the-expert/#comments Tue, 02 Feb 2010 10:44:58 +0000 Sarah Thomas http://kluwerconstructionblog.com/?p=346 Continue reading →]]> Question:
I am a project manager for the employer on a power plant project based in Europe. We have been on quite good terms with the contractor up until now. Last week the contractor sent us a claim for 12 weeks’ delay to the programme and for compensation costs (we are using the FIDIC Yellow Book (Plant and Design Build) 1999 form and English governing law). They are saying that dealing with contamination in the ground discovered in the last few weeks will cause a delay. We had a couple of site meetings with the contractor and sub-contractor about the programme and the potential delays, prior to the contractor sending the claim. I have two issues with the claim: firstly, we do not believe that the ground conditions will cause 12 weeks’ delay; our estimate would be closer to about 6 weeks. Secondly, the contractor’s written notice of claim is just a couple of lines in an email to me and I am not sure this counts as proper “notice”.
I do not want to jeopardise our relationship with the contractor, but obviously I am concerned to limit our exposure to any delay costs. I would appreciate any advice about how we can deal with this claim from our contractor.

Answer:
Let’s start by considering whether or not the contractor has given valid notice of the claim. In fact, even before we come onto that, I should just touch on whether or not the contractor has a claim in the first place. You do not say that you are disputing the existence of the pollution nor that it was “Unforeseeable” for the purposes of the contract (for the benefit of others reading this, “Unforeseeable” and “physical conditions” are defined in the FIDIC Yellow Book as not reasonably foreseeable by an experienced contractor by the date for submission of the tender and “physical conditions” means “natural physical conditions and man-made and other physical obstructions and pollutants which the contractor encounters at the Site when executing the Works”). Therefore as ground pollutants are expressly covered, I assume that you accept that the contractor has encountered unforeseeable physical conditions at the site which in principle give it the right to claim an extension of time and payment of costs under Sub-Clause 4.12.4 of the contract.
But Sub-Clause 4.12.4 makes that right to claim expressly subject to Sub-Clause 20.1. Sub-Clause 20.1 sets out strict time-limits for giving notice. Again, you do not say that the contractor’s notice was given late so I am assuming that you accept that it was given on time but I suggest that you check this carefully anyway. As a reminder, 20.1 requires the notice to be given as soon as practicable, and not later than 28 days after the contractor became aware, or should have become aware, of the event or circumstance giving rise to the delay. Note that this is days, not business days. You say that the pollution was discovered in the last few weeks so timing could be pretty tight. However, it is worth bearing in mind whether the Contractor has in fact given valid notice before the email. 20.1 talks about the notice needing to make a claim for extension of time and costs under Sub-Clause 20.1 and describe the event or circumstance giving rise to the claim. So the contractor can potentially fulfil this requirement in just a couple of lines and it is also not clear that he even has to issue this in a separate notice (i.e. separate from communications on other matters such as Programme, progress of Works, etc). Could any previous correspondence/documentation issued to the Engineer conceivably satisfy this requirement?
Also, significantly, I note that the email was sent to you. Was the Engineer copied in as well? Clause 20.1 actually requires the notice to be sent to the Engineer. You need to find out when, if at all, the Engineer received the notice and whether or not this was before the 28 day deadline. It is also worth checking whether your particular contract provides for notice formalities and whether this precludes email. FIDIC unamended simply says that notices shall be in writing and delivered by hand, mail or courier “or transmitted using any agreed system of electronic transmission as stated in the Appendix to Tender”. So you need to check this to see if email is allowed.
Sub-Clause 20.1.2 sets out quite clearly what is the effect of a failure to comply with this timescale: the contractor will not be entitled to any extension of time or costs and the employer will be discharged from all liability in connection with the claim.
In addition to the initial notice, the contractor must send to the Engineer a fully detailed claim which includes full supporting particulars of the basis of the claim and of the extension of time and/or additional payment claimed, in accordance with Sub-Clause 20.1.5. This must be sent within 42 days after the contractor became aware/should have been aware of the event or circumstances giving rise to the claim, unless any other period has been agreed between the contractor and the Engineer. The contractor is also obliged to keep such contemporary records as may be necessary to substantiate any claim (Sub-Clause 20.1.4). You will need to check whether or not these further obligations have been complied with in time.
Turning to your other issue with this claim – the length of the delay claimed by the contractor. As you know, the Engineer can respond with “disapproval” or with “detailed comments” if he considers that the delay claimed is too long. He can also request any necessary further information to help him assess the claim, but note that he must respond on the principles of the claim within the time limit set out in Sub-Clause 20.1.6, namely 42 days after receiving the claim or any other period he has agreed with the contractor. For that reason I am hoping that the Engineer’s assessment is well underway and even though there are queries about the validity of the claim, you need to make sure that this is the case.
Of course, he will also need to comply with Sub-Clause 3.5 (Determinations) which means he has to consult with both employer and contractor firstly to try and reach an agreement. This will be your opportunity to put forward your case for any notice non-compliances and regarding the length of delay impact. If the parties don’t agree he makes a “fair determination”. If at this point, you don’t agree with this determination it is always open to you to invoke the dispute resolution procedure and seek the decision of the Dispute Adjudication Board if there is one in your Contract.
To sum up, the contractor has to overcome several hurdles relating to the form, content and timing of the notice in order to benefit from its entitlements resulting from delays due to unforeseeable physical conditions. You will need to review the notice carefully against the contractual requirements referred to above and consider whether all the information has been provided in time, in the right format, to the right people. Given the clear language of Sub-Clause 20.1 it would be hard for the contractor to argue that compliance with clause 20.1.1 is not a condition precedent – i.e. if it does not comply, it cannot benefit from the relief. This strict approach was in fact adopted in a recent Scottish case. You may find that the contractor has not submitted a valid claim at all.  Concurrently, the Engineer will need to continue his assessment of the claim and preparation of his response in relation to the length of delay.

]]> http://kluwerconstructionblog.com/2010/02/02/ask-the-expert/feed/ 1 http://kluwerconstructionblog.com/2009/12/23/youre-creeping-me-out-design-creep-under-the-fidic-silver-book/ http://kluwerconstructionblog.com/2009/12/23/youre-creeping-me-out-design-creep-under-the-fidic-silver-book/#comments Wed, 23 Dec 2009 12:38:49 +0000 Sarah Thomas http://kluwerconstructionblog.com/?p=298 Continue reading →]]> In the wake of the current downturn, employers will increasingly look for greater budget certainty under EPC or Turnkey contracts. This is where the contractor undertakes all tasks – design, construction, management etc – so that, upon completion, the employer merely needs to ‘turn the key’ and operation of the plant or building can begin immediately. The whole point is that the contractor assumes price risk in return for relative autonomy over how he delivers the project – provided of course he meets the employer’s output requirements. But often employers want not just price certainty but also to retain control over design approval and how the project is actually delivered. This can lead to claims of ‘design creep’ by the contractor when he perceives that the employer is trying to introduce design improvements under the guise of reviewing the contractor’s documents.

But what is ‘design creep’? Why are contractors upset at its use and are their concerns justified?

I will be concentrating on the provisions of the FIDIC Silver Book, although design creep is not something particular to the Silver Book, or indeed any construction standard form.

Sub-clause 5.2 of the Silver Book allows the Employer to review the Contractor’s Documents. Nothing controversial about that. But what happens if the Employer undertakes a design review and makes ‘comments’ on those documents? Will those comments amount to a “Variation” (entitling the Contractor to time and money)? Or will they be taken as something less than a Variation, so that any additional work will have to be absorbed into the Contractor’s schedule and budget? This is the classic example of “design creep”.

What can the Contractor do when he considers that a comment constitutes a variation?

The first question to ask is: Does the “comment” amount to a “variation” under the terms of the contract? A Variation is defined in the Silver Book as “any change to the Employer’s Requirements or the Works which is instructed or approved as a variation under Clause 13″. Clause 13 [Variations] may be initiated at any time, “either by an instruction or by a request for the Contractor to submit a proposal”. The Contractor is often put in a difficult position because he must execute each variation unless he promptly gives notice that he cannot implement it (because of lack of goods, increased risk to safety or suitability of the Works or to his ability to meet Performance Guarantees). Obviously the broader the Employer’s Requirements and the Works are described in the contract, the less likely it is that the comment will be seen as a change to the Employer’s Requirements or to the Works.

However, if the comment does require a clear change, the Contractor’s first step should be to write to the Employer asking him to confirm whether the comment amounts to an instruction to change the Works under clause 13.1.

The second step is to follow the requirements of sub-clause 20.1 [Contractor's Claims] and request the Employer to agree or determine adjustments to the Contract Price and the Schedule of Payments, proceeding in accordance with sub-clause 3.5 [Determinations].

But what if the comment does not amount to a ‘change’ as such. Is the Contractor still bound to follow it? This is the more difficult area. The Contractor could argue that the provision of comments that do not specify “non conformity with the Contract” is not a proper use of the review procedure under sub-clause 5.2. That clause only allows the Employer to give notice to the Contractor if a Contractor’s Document fails to comply with the Contract. There is a difference here between the FIDIC Silver and Yellow Books. The key difference is that the documents are submitted “for review and/or for approval” (if so specified) under Yellow but under Silver, they are submitted for review only. Thus under Silver, the argument can be made far more strongly that the Employer can only issue a notice if the documents don’t comply with the Contract. Under Yellow on the other hand, where a document is specified “for approval”, the Engineer can give notice of approval with or without comments. This is an important difference and is the reason why “design creep” may well be a bigger problem under the Yellow Book than under Silver. But under both contracts, it is important to remember that the Employer’s scope to review the Contractor’s documents is confined to issuing a notice that the document does not comply with the Contract. A Contractor would also be well advised to check the formalities for issuing instructions and variations under his contract – to see whether he does in fact have to implement the change. For example under the FIDIC contracts, an instruction must (1) be given in writing and (2) state the obligations to which it relates as well as the sub-clause in which the obligations are specified [Sub-clause 3.4].

No matter what approach the Contractor adopts, to the extent that the Contractor is making a claim under a FIDIC contract, he will have to comply with the provisions of sub-clause 20.1.

So, what has been your experience of design creep? Is it occurring more or less often? What do you see as the threshold that needs to be reached in order for a comment to turn into a Variation? I would be interested to hear your war stories.

]]> http://kluwerconstructionblog.com/2009/12/23/youre-creeping-me-out-design-creep-under-the-fidic-silver-book/feed/ 2 http://kluwerconstructionblog.com/2009/11/25/how-fit-is-your-contract/ http://kluwerconstructionblog.com/2009/11/25/how-fit-is-your-contract/#comments Wed, 25 Nov 2009 16:00:46 +0000 Sarah Thomas http://construction.kluwerarbitrationblog.com/?p=110 Continue reading →]]> As lawyers, we want what is best for our client. We will fight for that additional clause or that tricksy wording that will give our client that added protection that may, someday, prove decisive in an argument with the contractor or the employer.

One issue that lawyers often fight quite savagely over (but in that overly courteous way beloved of lawyers) in construction contracts is the inclusion or exclusion of a fitness for purpose obligation on a contractor or architect. But do we know what we are fighting over? What will happen if fitness for purpose is not expressly included? And what is the real effect of including a fitness for purpose obligation? Will it be implied into your contract anyway? How does this affect insurance?

Reasonable skill and care

In English law, in the absence of an express or implied fitness for purpose obligation, designers are required to exercise reasonable skill and care in their design. This means that the design must meet the standard expected of a competent professional designer. So, why not rely on this standard of care? Why do employers spend many hours arguing with contractors, insisting that they accept a fitness for purpose obligation rather than a reasonable skill and care obligation?

The simple answer is that fitness for purpose is a stricter and tougher obligation for the designer to meet. A reasonable skill and care obligation essentially requires an employer to prove that the designer has been negligent. This requires the employer to show that the design fails to measure up to the standard of a competent professional designer.

But how does the court decide what the standard of a competent professional designer would have been? Well, as with a great deal of legal questions, the answer will, unhelpfully, depend on what a competent professional designer would have done in the circumstances. This question will need to be decided by a judge or arbitrator, taking into account evidence from expert witnesses. This subjective element of the standard of reasonable skill and care, and the need to prove that what has been designed is below that expected in the industry, is one of the principal reasons why many employers push for a express fitness for purpose obligation.

Fitness for purpose

The contractor’s acceptance of a fitness for purpose obligation effectively means that that it is guaranteeing that the design will meet the requirements (whatever they may be) of the employer. That being the case, the employer merely needs to prove that the completed building does not work as intended; there is no need to show that the design has been negligent. For example, if an architect were asked to design an office building, and within that building the suspended stair that was part of that design was found to shake when used, then the employer would only have to establish that the stair shakes when used. The onus would then be on the architect to demonstrate that its design was indeed fit for purpose but the stairs were not constructed as designed - e.g. the steel or glass used in the stair were not as specified. However any argument that a reasonable architect, exercising skill and care, could not have foreseen the failure of the stairs when used in this way would, where there is a fitness for purpose obligation, fall on deaf ears.

Similarly, where a fitness for purpose obligation is subsumed into a contract to design and build say, a desalination plant, then that contractor is normally guaranteeing that, once constructed, the plant will be able to produce, say, 10,000 litres of clean drinkable water per day. If it fails to do this, in that the plant can only produce 5,000 litres of clean water, or if it produces 10,000 litres of water that is not drinkable, then the contractor has failed to build a plant that is ‘fit for purpose’.

Of course I appreciate that in most design and build contracts of this nature the performance guarantees are spelt out anyway – so why the addition of express fitness for purpose? The employer is already effectively guaranteed that the end product will meet its needs by the inclusion of performance tests and guarantees.

What’s your purpose?

What both parties must be wary of is whether or not there is a clear indication in the contract as to what the employer’s purpose actually is. In the absence of a clear statement as to the employer’s purpose, the intended purpose will usually be assessed and determined by a court or arbitrator based on the facts. This places additional onus on the contractor to push for inclusion of a stated purpose or employer’s requirements and then to scrutinise them to ensure that the purposes are narrowly and specifically defined. For the employer such an “open-ended” clause gives him comfort that the contractor may still have to meet wider purposes of the building or plant that are not necessarily spelt out in the contract in the performance requirements. Thankfully for contractors, a number of those standard forms that still use express “fitness for purpose wording” nevertheless tie it to purposes expressly set out in the contract. For example, clause 4.1 of the FIDIC Silver, Yellow and Gold Books (Conditions of Contract for EPC/Turnkey Projects, Design and Build and Design Build Operate) contains the following provision:

“When completed, the Works shall be fit for the purposes for which the Works are intended as defined in the Contract.”

So, we have a clear and explicit fitness for purposes obligation placed on the contractor but tied to the purposes “as defined in the Contract”. The parties just need to be clear where these are in the Contract and (certainly for contractors) that they are narrowly and precisely defined.

Implied purpose

There is the potential (at least under English law) for a fitness for purpose obligation to be implied into a contract, absent an express fitness for purpose obligation. Where a contractor is tasked with carrying out all the design under a design and build contract, a fitness for purpose obligation will often be implied into the terms of the contract (George Hawkins v. Chrysler (U.K.) Ltd. (1986). Also see the Supply of Goods and Services Act 1982 (UK) which sets out that, when a customer indicates (expressly) that goods are wanted for a particular purpose, or where it is obvious (implied) that goods are suitable for a particular purpose, and a seller supplies them to meet that requirement, the goods should be fit for that specified purpose). Contractors unwilling or unable to take on a fitness for purpose obligation in their design and build contract should therefore look to include wording which expressly excludes fitness for purpose.

As to whether a particular Civil Law jurisdiction will imply a fitness for purpose or similar obligation on a contractor in a design and build contract will very much depend on the codified document setting out the law in that jurisdiction. For example, the German Civil Code includes a provision which implies that a contractor will provide a product that is fit for its intended purpose, while under UAE Civil Law there is no implied fitness for purpose requirement.

Fitness for purpose and insurance: The elephant in the room?

One of the main reasons why fitness for purpose obligations are often fought over so vehemently, is due to the impact that such an obligation has on the designer’s professional indemnity insurance. The vast majority of PI policies available to contractors and architects contain express exclusions such that any assumption of a fitness for purpose obligation will result in the designer not being covered under the PI policy.

So how do you deal with this issue of PI insurance dictating the risk allocation of your contract?

One technique that employers have used when faced with this scenario, is to remove any explicit reference to fitness for purpose from their contracts. For example an employer could amend clause 4.1 of FIDIC Yellow or Silver Books with something along the following lines:

“When completed, the Works shall comply in all respects with the requirements of the Employer as defined in the Contract.”

It is interesting that the more recent IChemE International Form of Contract (First Edition 2007) adopts this approach, recognising the problem with using explicit fitness for purpose wording – see for example clause 3.4 of “The International Red Book”.

The advantage of using the above wording from an employer’s point of view is that it has the same power and effect of a fitness for purpose clause, without the stark (and easily identifiable and word searched) term ‘fitness for purpose’. Contractors, on the other hand, should be wary of this type of ‘fit for purpose by stealth’ approach, particularly if their PI policy excludes cover for fitness for purpose. They may look at extending their PI policy in this instance, or alternatively they should look at counterbalancing the risk taken by seeking to limit their overall liability under the contract.

Your experience?

So, what has been your experience with fitness for purpose clauses? Do you push for their inclusion, or push for their exclusion? How have you balanced the competing forces of a fitness for purpose obligation with the strict terms of an insurance policy which excludes their use? All comments welcome.

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