Engineering, Procurement and Construction (EPC) and Engineering, Procurement and Construction Management (EPCM) contracts are two project delivery methods commonly used in the mining, mineral processing and power industries. Despite the widespread use of these contract models, there remains a general level of mystification associated with EPCM contracts, and the distinction between EPC and EPCM contracts is not particularly well documented or understood.

In acronym alone, the two contract models appear to be similar. So what’s in an ‘M’?

EPC contracting

Under an EPC contract, the EPC contractor develops the project from its inception to final completion. The principal provides the EPC contractor with technical and functional specifications for the project, and the EPC contractor subsequently designs, builds and delivers the project in an operational state so that it can be operated at the ‘turn of a key’ (resulting in the common reference to EPC contracts as ‘turnkey’ contracts).

EPC contracts are almost always ‘lump-sum’, where the EPC contractor is limited to receiving a fixed price irrespective of the actual cost of performing the work. The EPC contractor generally takes the benefit of any savings (and the risk of any cost over-runs). In addition, in an EPC contract, the EPC contractor usually provides a performance guarantee (subject to agreed liability caps).

An EPC contract provides a suitable framework for projects where significant engineering expertise is required, and the principal does not need to retain design control or flexibility in execution. EPC contracts are commonly used for large scale resource developments, such as oil and gas plant projects.

EPCM contracting – How is it different?

In contrast to an EPC contract, an EPCM contract is a sophisticated project management or agency arrangement where the EPCM contractor:

-  is responsible for the detailed engineering and design for the project; 

-  administers and manages the project as the principal’s agent or representative, including by providing programming and strategic management services; and 

-  is typically responsible for breaking down the procurement and construction work into packages, managing their tender, overseeing the principal’s entry into the trade/supply  contracts and managing those trade/supply contracts on the principal’s behalf to achieve completion of the project.

Unlike EPC contracts, EPCM contracts are almost always ‘cost plus’ (or ‘cost-reimbursable’). The principal pays the subcontractors directly for materials, equipment and on-site works, and only pays the EPCM contractor its actual direct costs (mostly labour) for performing engineering and supervisory services, plus an agreed margin. The margin charged by EPCM contractors varies depending on the risk assumed (which is usually low), the size of the project (small projects usually have higher margins) and supply/demand position in the economy.

An EPCM contract provides a suitable framework where the nature of the project requires continual design development either due to the complex nature of the project (or its interface with other assets or projects) or because the outputs of the project have not yet been finally determined. So long as the principal has the expertise, experience and resources to manage the progress of the project and can afford to retain the cost and time risk of the project, the principal can avoid payment of a hefty premium to put the risk on a head contractor under an EPC contract.

An EPCM contract may be appropriate where the inherent advantages of other procurement models (largely time and cost certainty) are not able in a practical sense to be delivered, perhaps due to lack of market appetite or capability to accept the risk transfer of traditional models. This is particularly relevant where the principal is unable or unlikely to obtain a suitable contractor and price using an EPC contract model.

EPCM contracts are commonly used for the construction or expansion of large scale heavy engineering facilities or manufacturing plants in the petrochemical oil and gas, mining and power sectors, where engineering and project management skills are more likely to be separate to construction and supply capability. EPCM contracts are not generally used for civil projects, except where the project can be delivered by relatively small, self-contained packages awarded to multiple contractors.

So what’s in an ‘M’?

There are, of course, many other differences between EPC and EPCM contracts. The fundamental difference, however, lies in the ‘M’. The ‘Construction Management‘ component of the project delivery method means that the EPCM contractor does not perform construction work and does not usually take full responsibility for delivering the completed project. The principal is able to take a more ‘hands on’ approach, with greater flexibility to modify project specifications and effect changes to the scope of the works throughout the project. However, as with any project delivery method, if you elect to use an EPCM contract model for your project, it should be moulded to fit the needs of the project and the principal to give your project the best chance for success.

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!

So while the past ten years have provided an interesting economic backdrop for players in the construction industry – with the world economy moving from boom to near bust to (hopefully) better times ahead – for most of those years Australia’s construction industry simply surged ahead, even during the global economic downturn of 2008/2009.

Nonetheless, changes in the economy did lead to changes in how projects are delivered in Australia. Which begs the question – how has project delivery evolved in Australia over the past decade and how will the abundance of upcoming construction work across the country be delivered going forward?

The short answer to the first part of that question is that owners and contractors have worked together to develop contracting models that are more sustainable for both parties, by considering movements in the economic climate and the best management of risk allocation.

Ten years ago, the contracting models used for projects were the ‘traditional’ form of contracts – an allocation of risk for an agreed fixed lump sum. Popular contract models included EPC, design and construct, and construct only contracts, with contractors being appointed following a competitive tender process.

This process was costly for all involved. In difficult times, contractors would accept a high level risk with only small contingencies, which led to a claims-focussed culture. In less difficult times, contractors would either accept a high level of risk (with a price tag to match) or a low level of risk and again revert to focusing on claims if any of the owner’s risks came to pass.

By 2003/2004 contractors had become more selective about the projects they bid for, and they began to avoid high risk delivery models. Owners were therefore forced to critically assess traditional procurement processes and to become innovative in order to attract the best contractors and engineering resources.

The most dramatic change to project delivery models came with the development in Australia of “alliancing”.

Alliances involve an owner and one or more service providers (designer, builder, supplier) coming together to work as an integrated team to deliver a specific project under a contractual framework where the commercial interests align with the actual project outcome.

One of the significant drivers for the parties to ensure the project is successful is that most risks and rewards are shared jointly. Put simply, in the first phase of an alliance, the parties work together to finalise a scope of work and prepare a target cost estimate (TCE) of the cost to complete the project. That TCE is locked in, and phase 2 (the actual construction) commences.

During phase 2 the parties endeavour to complete the project for less than the TCE. If they do so, they share in the savings. If they exceed the TCE, then they share in the cost overruns (although, typically, the service providers’ share of risk is capped at their profit, so they always receive their actual costs).

The use of alliances peaked in Australia in about 2006. They are particularly suited for project delivery where the risks are not known at the time the service providers are introduced to the project. In a heated market, however, they were used across a very wide range of projects.

One criticism of alliances, not necessarily well founded, is that TCEs have become ‘too high’ – that is, the parties have ensured that the TCE will never be exceeded. There was also concern that service providers are paid all of their direct costs, regardless of how well (or poorly) the project performs.

With the onset of the GFC in late 2008 the focus of owners shifted. What they looked for was cost certainty that did not involve significant contingencies but equally recognised that, in order to attract the best contractors and engineers, contractors needed to have sufficient involvement with the project to identify risks and price the works accurately.

This balancing act resulted in what is now described as the Early Contractor Involvement model (ECI).

ECI extended the first stage of alliancing from identifying risks and establishing a TCE for the project works to identifying the risks, allocating responsibility for those risks and determining an overall hard dollar figure for the project works based on that risk allocation.

ECI is seen as an appropriate middle ground. The ‘best of both worlds’, it uses a soft dollar approach to the first stage (avoiding some of the difficulties associated with a traditional D&C) and then a hard dollar approach with a traditional lump sum contract at the point where all risks can be accurately identified and priced, creating greater cost certainty through the fixing of the price (potentially with incentives).

In the last year of the decade, and as the market steadies from the effects of the GFC, we see increased use of the ECI model for all kinds of projects – small, medium and large. Like alliancing, it works well where a project needs to be fast tracked, or where the design is complex or where there is significant risk that cannot be quantified at the time of tender.

Although alliancing will remain important in project delivery in Australia, ECI is the way of the future.

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.

Most of these standards are privately owned and promoted, but on December 11, 2009 at the Climate Change Summit in Copenhagen, the United Nations Environmental Programme (UNEP) unveiled the “Common Carbon Metric” for measuring energy use and reporting greenhouse gas emissions from building operations. UNEP proposes establishment of the Common Carbon Metric to measure the weight of carbon dioxide equivalent (kgCO2e) emitted per square meter per year by different building types and climate regions. While the Common Carbon Metric has yet to be adopted by any governing body, entities such as BRE and the USGBC may well incorporate the metric in their rating systems.

The diversity in rating systems means that parties wishing to build green projects in diverse locations need to be familiar with different standards for use in different countries, or even regions within a country. The different rating system requirements also need to be compared to local building codes and regulations, to ensure that there are no conflicts between them.

This diversity also undermines one of the principal business reasons for green building. A recent study sponsored by the World Green Building Council determined that the top business reason for green building is because it is the “right thing to do.” Positive publicity is the most obvious commercial benefit from “doing the right thing,” and a common standard for assessing a project’s “greenness” makes garnering that positive publicity much easier. The Sustainable Building Alliance (SBA) is working to solve this problem by developing common minimum standards for adoption by the different rating systems. SBA’s goal is to ensure consistency among the systems and to promote “dual certification.” But because each rating organizations has its own commercial interest in promoting its system, SBA has a difficult task ahead of it. Uniformity is certainly in the interest of engineers, architects, builders, and owner/developers, and there are early signs of progress, as SBA has reportedly fostered an agreement between BRE and HQE to create together a common standard for the European Union.

William Devan
Andrew Ness

The leading set of green building standards and certification process used in the U.S. to date is the LEED certification process, developed by the U.S. Green Building Council. Achieving a given LEED rating (Silver, Gold or Platinum) depends not only on the structure’s design but on its construction process and how it actually performs once in operation. Many commentators have noted that this creates the potential for significant disputes as to whom, if anyone, may be found liable if the project fails to achieve the targeted LEED rating. There is a consequent perceived need to control contractually the associated liability risks of project participants on green projects.

The new “ConsensusDOCS 310 Green Building Addendum,” released November 11, 2009, is intended to address this concern via a single Addendum for incorporation into each of the major contracts for the project. The basic scheme of the Addendum calls for the Owner to designate a Green Building Facilitator (GBF) to take the lead in identifying the measures needed to achieve a particular green status (such as a particular LEED certification level targeted by the Owner), coordinate their implementation by the project participants, and gather and submit the documentation needed to actually achieve the desired certification. The GBF can be the existing Architect/Engineer, the prime Contractor, or an entirely separate consultant. The project Architect remains responsible for incorporating the chosen “green measures” into the project design, with assistance from the GBF.

Most interesting are the provisions assigning potential liability. First, all project participants other than the GBF are expressly relieved of liability for failure of the selected green measures to achieve the targeted green status. The GBF’s own potential liability is left for determination under the GBF’s separate contract with the Owner. Second, damages from failure to achieve the targeted green status such as expected operating cost savings, tax benefits, and enhanced marketing opportunities, are all deemed “consequential damages,” and made subject to any waiver of consequential damages in the underlying contracts. Third, all project participants (including the GBF) preserve any specific limitations or assumptions of liability in their respective underlying contracts with the Owner.

Doubtless other forms will be unveiled in the coming months and years to deal with the growing popularity of green building, and their provisions will likely evolve over time to account for changes in green building methodologies and certification processes. The ConsensusDocs Green Building Addendum merely starts the conversation, offering one considered approach to dealing with the new legal issues associated with sustainable building projects.

Eric Casher
Andrew Ness

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.

Particularly in the face of current economic conditions, project owners are well-advised to include appropriate provisions in their project contracts giving them the right to terminate without cause. Although “termination for convenience” clauses are not uncommon in construction contracts, they are, somewhat surprisingly, absent from some standard forms, such as the CCDC 2 – 2008 (the flagship standard form fixed price contract in the Canadian construction industry). Even in robust economic times, termination for convenience rights can provide owners with a measure of flexibility (for similar reasons, the inclusion of an express right to suspend the work for the owner’s convenience should also be considered).

Without a termination for convenience clause, a party who terminates without having appropriate grounds to do so may be exposed to liability for breach of contract. That liability could include not only the terminated party’s out-of-pocket damages, but also its lost expected profits on the unperformed work.

Accordingly, while termination for convenience provisions should address operational and commercial issues unique to the circumstances of the project (including, for example, the timetable and procedures for winding down the work and demobilizing), the key component of a termination for convenience clause is almost always the method for calculating the amount to be paid as compensation to the terminated contractor. Will the contractor be entitled only to payment for the work performed to the time of termination? To what extent should it be reimbursed for its cancellation and demobilization costs? What amounts, if any, should the contractor be paid as compensation for its bid costs, unabsorbed overheads and lost profits? These are some of the questions to which the terms of the contract should ideally provide answers if termination for convenience is contemplated.

To avoid disputes and unpleasant surprises, owners should give thought to including the right to terminate for convenience, and both parties have an interest in ensuring that the compensation to which the party terminated for convenience will be entitled is clearly articulated in the contract.

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.