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Sample Essay 2: Risk apportionment in FIDIC Contracts

von Holger Langer, LL.M.

The apportionment of the risks to be borne by the Employer and the Contractor in the FIDIC Conditions of Contract (1999) for Construction (Red Book) and the FIDIC Conditions of Contract (1999) for EPC / Turnkey Projects (Silver Book)

FIDIC has recently updated its existing standard forms of Conditions of Contract, i.e. the Conditions of Contract for Works of Civil Engineering Construction (the so-called “Red Book”) and the Conditions of Contract for Electrical and Mechanical Works including Erection (“Yellow Book”), as well as the Conditions of Contract for Design-Build and Turnkey (“Orange Book”). The results are the new Conditions of Contract for Construction that replace the former Red Book and the Conditions of Contract for Plant and Design-Build that replace the former Yellow and Orange Books. As one of the main intentions of the FIDIC Task Group was to adapt the new forms to the significant changes that construction industry went through in the thirteen years since the last revision, the approach in drafting was somewhat different. The emphasis was shifted from the rather traditional distinction between civil engineering works on one hand and electrical and mechanical works on the other hand to a more modern approach, drawing the main distinction between works being designed by the Employer and works being designed by the Contractor[1]. In addition to these updates FIDIC introduced a further standard form of Conditions of Contract, namely the Conditions of Contract for EPC / Turnkey Projects (the so-called “Silver Book”).

To evaluate the apportionment of risks to be borne by the Employer and the Contractor in the FIDIC Conditions of Contract for Construction and the FIDIC Conditions for EPC / Turnkey Projects, one has to take a look at the range of application of either of these forms, since the risks of the Employer and the Contractor are usually allocated in relation to the true nature of the contract between them.

As mentioned earlier, the Red Book is drafted for the use in traditional projects of civil engineering, such as the construction of infrastructure facilities (roads, bridges, dams etc.). These projects are characterised by the inclusion of an Engineer on behalf of the Employer, who is typically taking over most (if not all) of the design, the administration of the contract and the certification of the Contractor’s payments according to the bills of quantities for approved work done[2]. The Employer is typically kept fully informed on the progress of the works and has the possibility to order variations.

On the contrary, the Silver Book is tailored to somewhat different types of projects. These “new” types of projects are based on some trends in the international construction industry that developed in recent years, such as the tendency towards larger and more complex projects at considerably higher costs and the corresponding rapid development of private financing for these undertakings[3]. These trends go hand in hand with a tendency for direct two-party construction contracts between Employers and Contractors, i.e. a renunciation or at least a less prominent role of the Engineer in the administration and adjudication of the contract. These projects typically include, on the other hand, private lenders who focus not only on the project process during the construction period, but also on the certainty of cash flow subsequent to the erection of the facility, since the construction contract usually forms just one part of a complex commercial venture, including also concession and finance agreements.[4] Consequently, lenders and concessionaires as well as the Employer demand contract terms that ensure an increased certainty that the agreed contract price and time for completion will not be exceeded. Thus, the characteristics of such an agreement would be that the Contractor – without the involvement of an engineer – is taking over the total responsibility for the design and construction of the facility, whereas the Employer is uninvolved in the actual construction as far as possible, but has the certainty of a fixed final price on lump sum basis, although on a higher price level.

The main differences in these two sets of standard forms therefore concern the parts which deal with the Engineer (and the respective provisions concerning the Employer’s administration in the EPC / Turnkey Conditions), the Contractor’s obligations and the general rules of risk allocation between the parties. The major difference – as was mentioned earlier – is the fact that in the EPC / Turnkey Conditions the design is carried out completely by the Contractor. In addition to the Contractor’s obligations, which are set out in clause 4 in both, the Silver and the Red Book, the Silver Book contains a specific clause that deals with the Contractor’s Design Responsibility, namely clause 5 of the Silver Book. Since under the Red Book the design is typically carried out in whole or to a major extent by the Engineer, the Contractor is according to sub-clause 4.1 only responsible for the design to the extent specified in the contract. In contrast, sub-clause 4.1 of the Silver Book provides that the Contractor shall design, execute and complete the (whole) works in accordance with the contract, so that after completion the works are fit for the purpose for which they are intended as defined in the contract. The works shall include any work which is necessary to satisfy the Employer’s Requirements, or is implied by the contract, and all works which are necessary for stability or for the completion, or safe and proper operation, of the works, even if they were not mentioned in the contract. This paragraph – together with the general design responsibilities set out below – shifts the design responsibility completely to the Contractor and might be problematic in two ways. First of all, the implication mentioned in this clause might prove difficult for a Contractor insofar as he might not be able to gain indemnification from his insurer and thus might have difficulties in properly calculating his risks.[5] Furthermore, it might cause problems in connection with clause 3.4 of the Silver Book. This clause allows the Employer to issue (written) instructions to the Contractor which may be necessary for the Contractor to perform his obligations under the contract (although it is somewhat restricted by the Employer’s obligation to state the contract term in which the concerning obligation of the Contractor is specified). This regulation might collide with the aforementioned obligation of the Contractor to carry out all necessary works, even if they are not mentioned in the contract, e.g. when necessary works in the sense of sub-clause 4.1 do not conform with the Employer’s requirements as mentioned in the contract. In this case the Employer might feel enabled to order an instruction to fulfill the obligations as what he considers to be “necessary” in the sense of sub-clause 3.4, so that the Contractor takes the risk of being in breach of his obligations, as long as he cannot convince the Employer of his differing view.

Another important point in this connection are the clauses regulating site data and unforeseeability. Sub-clause 4.10 states for both Conditions that the Employer shall make available to the Contractor all relevant site data and the Contractor shall be responsible for interpreting such data. The Silver Book goes further and provides that not only the interpretation but also the verification of the data is the Contractor’s responsibility. Clause 5.1 of the Silver Book states that the Designer shall be deemed to have scrutinised the Employer's requirements, shall be responsible for the design of the works and the accuracy of such requirements and shall not be relieved from his responsibility by data or information received from the Employer. The latter, on the other, hand shall not be responsible for any error, inaccuracy or omission of any kind in his requirements as included in the contract, except for some specific data mentioned in this clause. The problem of a Contractor at the time of tender submission might be to evaluate the likelihood of encountering difficulties. In addition to these regulations, sub-clause 4.12 deals with unforeseeable conditions. In the case of the Red Book, unforeseeability is expressly defined in sub-clause 1.1.6.8 and entitles the Contractor to an extension of time and payment of costs. In any case, the net effect of the adjustments shall not result in a net reduction in the agreed contract price, which might prevent an Employer from concealing relevant information from tenderers in order to achieve a reduced price this way.[6] The corresponding provision in the Silver Book does not protect tenderers in a comparable way, but sets out clearly in sub-paragraph (b) that the Contractor accepts total responsibility for having foreseen all difficulties and costs and in sub-paragraph (c) that the contract price shall not be adjusted to take account of any of these unforeseeabilities. This provision reaches very far and might increase the contract price considerably. An Employer might be well advised, if he previously assessed this risk apportionment accordingly.

One of the remaining key areas for the evaluation of risk apportionment in the two serts of Conditions is the allocation of risks for damage to the works and the corresponding insurance provisions. They are dealt with in clauses 17 and 18 of both Books. According to sub-clause 17.2, the Contractor is required to take full responsibility for the care of the works until the Taking-Over Certificate is issued. Any loss or damage to the works is to be rectified at the Contractor’s risk and cost, unless the loss occurred due to an Employer’s risk as defined in sub-clause 17.3. In general, these risks are either events that are not under the control of the parties, such as war, rebellion, terrorism etc., or events that are caused directly or indirectly by the Employer. According to the Red Book the Employer’s risks comprise also use or occupation of the works by the Employer (sub-clause 17.3 (f)) and design of the works by the Employer (sub-clause 17.3 (g)). Corresponding to the wider allocation of risks to the Contractor under the Silver Book, these two risks, i.e. use of the works and design of the works by the Employer, as well as the Employer’s risk for unforeseeable operations of the forces of nature, have been deleted in sub-clause 17.3 of the Silver Book.[7] If the works suffer loss or damage due to an Employer’s risk, the Contractor must according to sub-clause 17.4 rectify this loss to the extent required by the Employer or the Engineer, but may be entitled to an extension of time for delay and payment of the costs of rectification. In the case of sub-clauses 17.3 (f) and (g) of the Red Book, the Contractor is additionally entitled to a reasonable profit, cf. sub-clause 17.4 (b) Red Book. In the case of the Silver Book, this issue does not arise, since paragraphs (f) and (g) are not contained in these Conditions. Nevertheless, both of the new sets of Conditions now provide in sub-clause 17.6 for the possibility of limitation of liability, as long as liability does not arise out of fraud, deliberate default or reckless misconduct by the default party. Unless otherwise stated, the insurance for the works shall be effected and maintained by the Contractor as the insuring party (sub-clause 18.2 (a) and shall cover all loss and damage from any cause not listed in sub-clause 17.3 (sub-clause 18.2 (c). This means that in the case of the Red Book the Employer’s design risk in the sense of 17.3 (g) Red Book is not covered by the Contractor’s insurance, whereas in the case of the Silver Book the Contractor has to insure the complete design risk.

In summary it may be said that the Silver Book allocates the risk almost to a complete extent to the Contractor. The only exceptions are the Employer’s risks listed in sub-clause 17.3. Whether this apportionment of risk proves fair or unfair cannot be stated generally and might best be evaluated according to the nature of the specific project to be carried out. It must be kept in mind that the Silver Book shall provide for a higher degree of certainty that the agreed contract price and time will not be exceeded. To achieve this, the Contractor must be given freedom in carrying out the works as far as possible, i.e. interference by the Employer or by Employer’s personal has to be reduced to a minimum. Therefore, the design responsibility is shifted completely to the Contractor, who concurrently has to bear the majority of risks. Whether this one-sided allocation of risks can be met by a higher contract price is depending on the Contractor’s strength in negotiations and his ability to assess the risks as far as possible previous to the conclusion of an agreement with the Employer. Therefore FIDIC states that the Silver Book is not suitable in circumstances where there is insufficient time for tenderers to scrutinise and check the Employer’s requirements and where construction involves substantial work in areas which tenderers cannot inspect, such as underground work[8]. In addition, one has to keep in mind that in EPC / Turnkey projects a variety of exterior factors, such as the conditions of  lenders and concessionaires, have to be met, which can make further negotiations advisable or even necessary[9].

 

Essay evaluation: 70 % (distinction)

 

[1] See Wade, FIDIC’s Standard Forms of Contract – Principles and Scope of the Four New Books, [2000] ICLR 5, 8.

[2] See Wade, [2000] ICLR 5, 19 et seq.

[3] See FIDIC, Introductory Note to the First Edition of the Conditions of Contract for EPC / Turnkey Projects.

[4] See Wade, [2000] ICLR 5, 10 et seq.

[5] Booen, The Three Major 1999 New Books, [2000] ICLR 24, 32.

[6] Booen, [2000] ICLR 24, 35.

[7] This again makes clear that the Contractor is required to be entirely responsible for the design.

[8] See FIDIC, Introductory Note to the First Edition of the Conditions of Contract for EPC / Turnkey Projects.

[9] See for example Wade, [2000] ICLR 5, 15.