Choice of Contracts
34 Construction Contract Claims
2.6 Other Forms of Contract
Government forms of contract, such as are used extensively in the public sector. Amended versions exist for overseas projects. In the latest editions (Edition 3 and 1998) much of the administrative work falls on the project manager appointed by the authority (the employer). There are contractual provisions for acceleration. Variations and amendments to the standard publication enable alternative methods of contracting to be used, such as design and build.
Other standard forms of contract issued by professional bodies are avail- able and are worth considering as alternatives to some of the better known standard forms of contract.
In the civil engineering field, the ICE forms of contract (traditional, design and build and minor works contracts) are established in the UK. The sixth edition of the traditional contract is being phased out. The seventh edition the same as the sixth edition) is now in use and it remains to be seen if this form of contract can maintain its almost univer- sal recognition in the face of competition from new alternative forms of contract devised by leading experts in construction contracts.
The Model Form of Conditions of Contract for use in connection with Home or Overseas Contracts for the Supply of Electrical, Electronic or Mechanical Plant - with Erection 1988 Revision 3 1995 is com- monly used for major projects such as water or power plants.
FIDIC Contracts
The first contracts designed specifically for international contracts were probably initiated in the United States. These were largely defence project orientated and the most known is probably the Corps of Engineers contracts. The Associated General Contractors of America and the Feder- ation of Americana de la Industria de la Construction led the way for the US construction to move in the direction of the international
conditions of contract known as FIDIC des
which was based almost on the pre-Fifth Edition ICE conditions of contract. The First Edition of FIDIC was published in 1956 and has gone through several revisions, the latest edition which followed the ICE format being the Fourth Edition known as the Red Book) published in 1987. This form of contract was intended for use where the design was done by the and construction was done by the contractor.
Because of a growing international demand for a variety of contracts to suit different methods of procurement, other standard international forms of contract issued by FIDIC up to 1999 were (for Electrical and
Choice of Contracts 47 cal Works) the Yellow Book and (for Design-Build and Turnkey) the Orange Book. Apart from the changes giving emphasis to the nature of some of the specialist work in electrical and mechanical contracts, the main differ- ence between these two forms is the degree of design responsibility placed on the contractor. Both the Yellow and Orange Books contemplate design by the contractor.
In 1999, FIDIC published a new family of contracts:
The Red Book
Conditions of Contract for Construction for building or civil engineering works where the works are designed by the employer (or by his engineer) and where the contractor constructs the works in accordance with the design provided by the employer. However, the works may include some contractor-designed civil, mechanical, electrical and/or construction works.
The 1999 Red Book is intended to replace the 1987 fourth edition (also known as the Red Book).
The Yellow Book
Conditions of Contract for Plant and Design-Build for electrical and/or mechanical plant, and for the design and execution of building or civil engi- neering works. Under this form of contract, the contractor designs and provides plant and/or other works, in accordance with the employer's requirements.
The 1999 Yellow Book replaces the previous Yellow Book.
The Silver Book
Conditions of Contract for EPC Turnkey Projects for use in process or power plants, factories and the like, infrastructure or other types of devel- opment, where the employer requires a higher degree of certainty of final price and time, and where the contractor takes total responsibility for the engineering, design, procurement and execution of the project. Ideally there should be little involvement by the employer.
The 1999 Silver Book is intended to replace the 1995 Orange Book.
The Green Book
Short Form of Contract for building or civil engineering works of relatively small capital value and/or of a repetitive nature or short duration. Under this form of contract, the contractor may construct the works in accordance with details provided by the employer or it may be used for
48 Construction Contract Claims
designed civil, mechanical, electrical and/or construction works.
guidelines for the use of the Green Book suggest that 000.00 and twenty-six weeks should be regarded as reasonable limits on capital value and duration respectively, with the proviso that works of a repetitive nature may exceed these guidelines.
In spite of the criticism levied at the contracts (infra), the new stan- dard layout incorporating a great deal of common or 'core' conditions is welcome. Greater emphasis on definitions and a specific definition of 'force majeure' is new. There are numerous minor changes to some definitions and clauses between the three contracts for major construction projects (Red, Yellow and Silver Books) but the principal changes appear in the fol- lowing clauses:
Clause 3
In both the Red Book and the Yellow Book, these clauses are almost iden- tical and deal with the powers and obligations of the engineer (the Red Book provides for the contractor to confirm verbal instructions of the engi- neer whilst the Yellow Book requires all instructions to be in writing). The engineer does not feature in the Silver Book where clause 3 deals with employer's administration.
Clause 5
In the Red Book this clause deals with nominated subcontractors. (In the Yellow and Silver Books there are very brief provisions for nominated sub- contractors in sub-clause 4.5.) The same clause in the Yellow Book and Silver Book deals with design (by the employer). In the Yellow Book, the contractor may lose his rights to any claim in respect of incorrect infor- mation provided by the employer if he failed to properly scrutinise the employer's information in accordance with the contract and failed to give notice of the error within twenty-eight days. In the Silver Book, the con- tractor is deemed to have scrutinised the information provided by the employer before submitting the tender (before the base date) and shall be fully responsible for any error, inaccuracy or omission in the employer's information with the exception of:
(a) information stated in the contract as being immutable or the employer's responsibility;
definitions of the intended purpose of the works;
(c) criteria for testing and performance of the works; and
information which cannot be verified by the contractor except as oth- erwise stated in the contract.
Choice of Contracts 49
Clause 72
In the Red Book, this clause deals with measurement and valuation. In both the Yellow and Silver Books, clause deals with tests after completion of the works.
The Red, Yellow and Silver books all have provisions for 'value engineer- ing'. In the Red Book, the contractor and the employer share any saving that the contractor may be able to make or any benefit that the employer may receive as a result of:
(a) accelerated completion;
(b) reduction in cost to the employer of executing, maintaining or operat- ing the works;
improved efficiency or value to the employer of completed works; or other benefits to the employer.
Under the Yellow and Silver Books, any such proposal (for value engi- neering) shall be treated as a variation. It is unlikely that value engineering will feature in the Yellow and Silver Books as most contractors ought to have 'value engineered' his design at the tender stage.
The Red, Yellow and Silver Books have much improved procedures for better management, monitoring and control of the project (see Chapter 4).
The New Engineering Contract
The New Engineering Contract (NEC) has now been replaced by the Engineering and Construction Contract (NEC). The second edition was published in and reflects a substantial move to recognise, and cater for, the various forms of contract which have been discussed herein. It is based on a core contract with flexible alternatives allowing the employer to choose the appropriate version to suit his needs.
The tendocument package consists of a core contract containing pro- visions which are universal to all versions. The various versions are:
Document A - Conventional Contract with Activity Schedule;
Document B - Conventional Contract with Bills of Quantities;
Document C - Target Contract with Activity Schedule;
Document D - Target Contract with Bills of Quantities;
Document E - Cost Reimbursable Contract;
Document F - Management Contract.
An engineering subcontract, guidance notes, flowcharts and other optional provisions pave the way for a better understanding of contracting methods and their use should be encouraged.
Some of the important aspects of the NEC are as follows:
50 Construction Contract Claims
The first core clause sets out the philosophy behind the contract:
'The Employer, the Contractor, the Project Manager and the Supervisor shall act as stated in this contract and in the spirit of mutual trust and co-operation.
The Adjudicator shall act as stated in this contract and in the spirit of independence.'
In general terms, the project manager and the supervisor carry out the duties of 'the Engineer' in ICE and FIDIC contracts. The adjudicator settles disputes between the employer and the contractor.
As stated in Chapter there is provision for an 'early warning' to be given by the contractor or by the project manager. The response to an early warning contemplated by the contract is refreshing and should be taken on board in any form of contract if the employer is really going to have the best possible chance of getting his project on time and within budget. Clause
states:
'At an early warning meeting those who attend co-operate in:
making and considering proposals for how the effect of each matter which has been notified as an early warning can be avoided or reduced, seeking solutions that will bring advantage to all those affected, and deciding upon actions which they will take and who, in accordance with this contract, will take them.'
The various main options (A-F) use most of the core clauses and each option requires changes to particular clauses to suit the method of con- tracting. In addition, there are numerous secondary options. Some exam- ples are:
Option L: Sectional completion
This option is used should the employer require completion of various parts of the works at different times. If this option is not used, then there is only one completion date for the whole of the works.
Option M: Limitation on the contractor's liability for his design to reasonable skill and care
It is usually the case that where a contractor designs the works, his liability for design is 'fit for purpose'. This means that the design must work and the contractor will be liable for any failure in design. In contrast, where the design is done by the employer's designer and the contractor builds in accor- dance with the employer's design, then the employer's designer's liability for design is 'that of a professional man'. That is to say, provided that the
Choice of Contracts 51 employer's designer exercised reasonable skill and care (of the standard expected of a competent professional man), using all relevant and univer- sally known codes and standards, then he will not normally be liable if the design fails. This Option M limits the normal liability for design by the con- tractor to the same as 'that of a professional man'. This may be of signifi- cance, particularly if it is impossible to insure for design defects if the liability is 'fitness for purpose'.
Option Bonus for early completion
Bonuses for early completion are more often used in international contracts and most standard forms do not contain provisions for bonus. FIDIC con- tracts contemplate bonus for early completion in Part (Conditions of Par- ticular Application). NEC provides for bonus for early completion if this Option Q is used.
Option R: Delay damages
Delay damages is a term used for liquidated damages. Both NEC and the 1999 FIDIC contracts use this term in preference to liquidated damages.
Most standard forms have a provision for delay (liquidated) damages in the standard conditions. It is possible that the drafters of the NEC took the view that with an increasing number of clients wishing to opt for general or unliquidated damages, this option (which could therefore apply or other- wise) was preferable to having a standard provision which if deleted or had 'nil' inserted against it, resulted in the problems which could arise if the em- ployer sought to recover general damages (see Temloc Ltd v. Erril Prop- erties Ltd, infra).
Option S: Low performance damages
This option is particularly useful if the employer wishes to specify perfor- mance criteria which must be achieved. It is commonly used for design and construct or turnkey contracts for process or power plants (such as the FIDIC Yellow and Silver Books). If the specified criteria are not achieved, damages may be deducted until such time as the problem is rectified. Dam- ages are commonly measured as a fixed sum per percentage of shortfall in performance (or overrun in operating cost).
Build, Operate and Transfer Contracts
These forms of contract (sometimes known as Build, Own, Operate and Transfer - BOOT) are becoming more common, particularly in countries
52 Construction Contract Claims
where the government does not have sufficient public funds available to finance vital infrastructure, power or water projects and the like. Whilst this method has seen most growth in developing countries such as India, Thai- land, Malaysia, China and Vietnam, it is also popular in developed coun- tries. In the UK, BOT or BOOT is the basis of the Government's Private Finance Initiative
which attract revenue by way of tolls or levies -are candidates for this type of venture. A project is founded by the granting of a 'conces- sion' for a period of years (say twenty to thirty years) to the promoter or concession company. The promoter will seek equity funding from inter- ested investors and long-term finance from banks and financial institutions.
Normally banks and financial institutions need to be satisfied on the ratio and a minimum ratio may be set by the government. The promoter designs and constructs the or it enters into a turnkey con- tract with a contractor for the design and construction of the works. Unlike a traditional contract, the concession company does not receive payment in stages or on completion, but relies on the income generated from tolls or levies throughout the life of the concession. The remuneration (and profits) are generated over the period of the concession by tolls or levies, out of which the capital and interest charges are repaid to the lenders, and dividends are paid to the investors. If there is delay to the construction of the project, then the promoter suffers a loss of revenue. Depending on the discount rate, one-year delay to completion of construction may require more than five years' extension to the concession period in order to recover the loss.
Any project which has the potential to earn revenue over a number of years which is more than sufficient to pay back loans and interest and produce a reasonable return for investors is suitable for a BOT scheme.
The contractual structure of a typical BOT scheme is shown in Figure 2.5 and the flow of expenditure and income for most models of BOT schemes is shown in Figure 2.6.
The comparison of costs incurred and the income does not, by itself, indicate whether or not the bid is profitable. The costs and the income must be brought back to a similar basis by discounted cash flow techniques.
Lenders to a project want to be sure that the project has a potentially financial position. Lenders will measure the financial position of the concession company investors, for example, ROE (Return on Equity), and they expect to see a financially attractive scheme. Lenders fully realise that the project is more likely to succeed if the persons or bodies investing in the concession company have an excellent opportunity to earn a very good return.
In the early years of the operating period, all or most of the 'surplus' revenue will be used to repay loans
-
'debt service and repayment ofChoice of Contracts 53
CONCESSION AGREEMENT
INDEPENDENT CONSULTANT
Figure 2.5 Contractual structure
The ratio of debt to equity will diminish as years pass until, at a certain point, all the debt is repaid.
Diagrams showing how costs and revenue can be reconciled are given in Figures 2.7 and 2.8. Figure 2.7 shows expenditure and income and Figure 2.8 shows equity against dividends.
54 Construction Contract Claims