Clause 14 outlines payment, certificates, and release from liability. While the methodology remains unchanged, procedural adjustments may delay payments but aim for prompt claim resolution. Some changes benefit contractors: e.g. claims are addressed during or shortly after the contract period.

This important clause sets out the method of payment, certificates, and release from liability.

The overall methodology has not changed, but there are several procedural adjustments and some inconsequential tidying. Some of the procedural changes will be welcomed by Contractors, but several will entail further delay in payment to the Contractor. There is a determined effort to ensure that all claims are dealt with during the contract period or very shortly thereafter.

Sub-Clause 14.2 – Advance Payment Guarantee

There is a new sub-clause specifically dealing with Advance Payment Guarantees. The most significant change (a very useful one for the Employer) is that where a guarantee has to be extended and the Contractor fails to do so, the Employer may call it in to the extent that any part of the advance payment has not been repaid.

The Advance Payment is to be made within 35 days of the Contractor’s providing their application together with the Performance Guarantee and Advance Payment Guarantee. This contrasts with 42 days under the 1999 Edition.

Sub-Clause 14.3 – Interim Payments

The 1999 Edition referred to applications for interim payment certificates (‘IPC’). This terminology is now gone. Now there is a Statement, which is then followed by the IPC (the term ‘IPC’ is used throughout).

The statement was formerly required in 6 paper copies. Only 1 hard “original” is now required, coupled with an electronic copy.

There then follows a list of the items which have to be included in the Statement. These have been expanded to include Provisional Sums, any release of Retention Money and the amount which the Employer is entitled to be paid for use of Temporary Utilities.

Presumably because Sub-Clause 21.4.3 requires that any money awarded by a DAAB shall be paid without the requirement for any certification or Notice, there is (in contrast to the 1999 Edition) no specific reference to such amounts in the list of items which are to be included in the Statement. Nonetheless, Contractors should include such amounts, as this will bring into effect the right to interest under Sub-Clause 14.8, running from the date of the decision. There is no provision for payment of interest unless a DAAB award is included in this way.

A new requirement has been added to the detail that the Contractor is required to provide. This is stated as “sufficient detail for the Engineer to investigate these amounts”. While this is obviously a useful and sensible requirement it has significant implications.

For the first time, an element of subjectivity is included in the requirements. It is quite possible that the Engineer and the Contractor will disagree about what is “sufficient” or what the Engineer needs to investigate any amounts claimed.

Should there be such a disagreement and the Engineer demands additional information, the time for payment under Sub-Clause 14.7 does not start to run until the relevant information has been received (there will arguably be a short-fall in the supporting documents). Not only may the Contractor be paid later than it would otherwise be entitled, it will also be limited in any claim for financing charges under Sub-Clause 14.8. Unfortunately, it is not uncommon for Engineers to be slow in issuing IPCs, especially when the Employer is having payment difficulties. The Contractor would be very unwise not to comply with any demands for additional information, even if it considers the demands unreasonable, but even then, there may be a consequent delay in payment.

It will be difficult for the Contractor to do anything to speed payment in these circumstances (a Notice under Sub-Clause 16.1 would be a drastic but possible remedy) but it will have the basis of a claim for Financing Charges. To gain these it will need to initiate a dispute under Sub-Clause 20.2 – a time-limited right, so notice needs to be given within 28 days of the Engineer wrongly refusing to accept additional information as sufficient for it to investigate.

However, it should be noted that Sub-Clause 14.6.2 requires the Engineer to issue an IPC even in the absence of such information, while making a suitable deduction to reflect his concerns (see also the discussion under 14.7).

Sub-Clause 14.4 – Schedule of Payments

Under the 1999 Edition, the Engineer was entitled to revise a payment schedule only if progress was less than expected. Now he may amend it if it “differs”. This opens the way to bringing payments forward if the Contractor is making better than expected progress. Unfortunately, there is no provision for the Contractor to trigger this correction process. However, the trigger date for the purposes of the Engineer’s Sub-Clause 3.7 process is when the difference is first “found by the Engineer”. Presumably the Contractor can tell the Engineer and thus makes sure he/she “finds” it.

Under Sub-Clause 3.7 however, the time allowed to the Engineer to make its decision is 42 days. The decision only starts the payment process, so it may be up to 70 days before a change takes effect.

Where the Engineer decides to invoke the process (most likely when progress is slower than that on which it considers the Schedule of Payments was based) the Contractor at least has the advantage that it is entitled to be consulted and that the Engineer must act neutrally and fairly.

There will be a question of how the Engineer can determine that progress differs from that on which the Schedule of Payments was based. If the Schedule simply provides for fixed payments on a monthly basis there will be the possibility of a dispute as to what progress was assumed in the Schedule of Payments. The Contractor’s principal obligation is to complete on time, not necessarily to conform to the programme. It is arguable that if the Contractor decides to change the way in which it will achieve timely completion, this does not mean that the agreed Schedule of Payments is inappropriate.

Where there is a Schedule of Payments, payments for Plant and Materials intended for the Works (see the next section on Sub-Clause 14.5) is disapplied. There is no equivalent provision in the 2017 Silver Book, and it is difficult to see how Sub-Clause 14.5 can work in this situation.

Sub-Clause 14.5 – Plant and Materials Intended for the Works

Like the 1999 Edition, the 2017 Edition allows the parties to agree that Plant and Materials may be paid for when shipped or delivered. The Contractor simply provides the evidence in his application for payment and the amount should then eventually be included in the IPC. Under the 1999 Edition, the term “determination” was used without cross reference to the (then) Clause 3.5. Once that determination was made the amount could be included. Presumably in the interests of clarification the clause now refers to Clause 3.7 [Determination].

This has the consequence that the Engineer has up to 84 days to make a decision, which previously would have been made immediately, and it will no longer be possible to include the amount in the next IPC. Even then there will be another 56 days delay before payment. In addition, the amount to be included in the IPC is only 80% of the value of the items.[1] It is thus probable that by the time the application is dealt with under Sub-Clause 3.7, the items will have been installed so this causes further cash-flow issues. The provision was intended to give the Contractor some early payment, but as amended, it achieves the opposite.

In a sensible and practical change, the requirement for a bank guarantee before the Engineer proceeds to determine a payment has been replaced with a promise of a guarantee, but with eventual payment being conditional on the guarantee being provided.

Note that (even if the parties have agreed to apply this provision) Sub-Clause 14.4 excludes its operation when payment is made against a Schedule of Payments rather than against measured interim payments.

Sub-Clause 14.6 – Issue of IPC

The Clause now provides, as a condition precedent, that the Contractor has appointed the Contractor’s Representative.

Sub-Clause 14.6.1 – Content of IPC

The Contractor is now entitled to a copy of each IPC and it is specified that the Engineer must explain any differences between the amount applied for and the amount Certified. Contractors will be very pleased to have an entitlement to this information.

It is interesting to note that the requirement for the Engineer remains to issue the Final Payment Certificate (‘FPC’) for such amount as he “fairly” considers due, so that while Sub- Clause 3.7 has moved from “fair” to “neutral”, the halfway house of fairness remains in place here. (Clause 14.13 includes the same requirement for issue of the FPC.

Sub-Clause 14.6.2 – Withholding (amounts in) an IPC

A further welcome addition from the point of view of Contractors is that the Engineer is now obliged to explain why amounts are withheld.

Where Engineers find significant errors or discrepancies in the Statement, they now have a right to adjust the amount certified to take account of the extent to which this has prejudiced or prevented a proper investigation. This does not amount to a licence simply not to include amounts in respect of items where there may have been such an error. All the Engineer is entitled to do is “take account” of the error. This must be something other than simply failing to consider material which contains errors. Presumably this is not intended to detract from the obligation to act fairly, but exactly what it will mean in practice remains to be seen.

The IPC also includes any amounts determined under Sub-Clause 3.7. Although there is no specific statement to this effect here, this provision in fact reflects another considerable improvement from the Contractor’s point of view. Virtually all employer claims now pass through the Sub-Clause 3.7 procedure, so the situation which prevails under the 1999 Edition (where a deduction is sometimes made for an Employer claim before the Contractor has the opportunity to argue the point) has now been remedied.

Sub-Clause 14.6.3 – Correction or modification of IPC

There is a welcome new provision setting out in detail what the Contractor is entitled to do if he does not agree with the IPC. Following the Contractor’s submissions, the Engineer has an opportunity to include corrections in the IPC. If he does not do so, or the Contractor still remains unhappy, he is entitled to entitled to ask the Engineer to deal with the matter under Sub-Clause 3.7. There is no time-limit on the Contractor making this request.

Although the 3.7 process is lengthy in the context of payment, the clear right for a Contractor to pursue this procedure in the face of a difficult Engineer will be welcomed by Contractors.

Sub-Clause 14.7 – Payment

As before the Employer’s time for payment runs from when the application is made by the Contractor. This is 56 days for all IPCs except the FPC. Confusingly the Sub-Clause includes two separate time limits for payment under IPCs – 56 days after Engineer receipt for normal ones and 28 days after Employer receipt where the IPC is issued as result of a Partially Agreed Final Statement under Clause 14.13. The FPC is payable 56 days after its receipt by the Employer.

Sub-Clause 14.8 – Delayed Payment

As before, interest is due on late payment. The rate is calculated at 3% above variously defined base rates which have been re-defined. Formerly the base was the discount rate of the central bank of the country of currency of payment. It is now based on the rates charged to borrowers at the place for payment or, if there is no such rate, the rate in country of the currency of payment (there may be some debate about what rate should be paid where the currency of payment is the Euro).

Payment is now to be made without any requirement for a notice from the Contractor of any sort. There is no time limit expressed and no provision for interest on late payment of such interest. Contractors who fear late payment of interest may be wise to include a claim in their next Statement for inclusion in an IPC.

Sub-Clause 14.9 – Release of Retention Money

This new provision marks a considerable negative change as far as Contractors are concerned. Under the 1999 Edition, payment was certified by the Engineer outside the normal IPC process and should have been made immediately. It is now to be included in a Statement for an IPC. This inevitably means at least a 56 day delay in refund.

Sub-Clause 14.10 – Statement at Completion

This has always been required to include any amounts the Contractor considers to be due. The particular categories are now spelled out in detail – including claims still being considered by the Engineer and the DAAB. These are only given as examples, but the list contains considerable gaps – for example, amounts where a NOD is likely to be issued, and amounts which are about to be challenged in arbitration.

Sub-Clause 14.11 – Draft Final Statement, Agreed Final Statement and Partially Agreed Final Statement

There are now three sub-clauses covering what was previously one, referring to the application for a Final Payment Certificate. As before the Sub-clause envisages a process under which the Engineer and the Contractor attempt to agree on the figures for the FPC.

The significant change is the introduction of the concept of a Partially Agreed Final Statement (PAFS). This is a Statement prepared by the Contractor identifying amounts which (after discussions with the Engineer) are agreed and those which are not agreed. This is a sensible additional provision to avoid the situation where there is disagreement over the content of the Final Statement and the Engineer is forced to make a decision as to what he includes in the FPC.

As with as Agreed Final Statement, the consequence of a PAFS is that the Engineer proceeds to issue an FPC (14.13). However, the payment consequences are different. In the case of an FPC, Clause 14.7 requires payment 56 days after receipt by the Employer. A PAFS does not lead to an FPC, but to an IPC which is to be paid 28 days after receipt by the Employer.

Sub-Clause 14.12 – Discharge

The 1999 Edition provided for a full and final discharge by the Contractor, which only took effect once all outstanding claims had been satisfied. This has now been limited in that the discharge covers all agreed amounts but can only exclude limited elements of the Contractor’s claims.

The excluded items may only be items in respect of which a DAAB or arbitration is “in progress”. Thus, claims still being dealt with by the Engineer under Clause 3.7 cannot be excluded, nor can those which, while still live, have not yet been made the subject of a DAAB or arbitration (notice not yet given, proceedings not yet commenced, etc). Contractors ought to be very reluctant to issue such a discharge, but it is a condition precedent to issue of the Final Payment Certificate. The discharge will be deemed to have been submitted and will be effective even if the Contractor fails to provide it so long as the amount certified in the Final Payment Certificate has been paid and the Performance Security returned.  Given that the FPC cannot be issued until the discharge is provided this provision is unworkable.

Sub-Clause 14.13 – Issue of FPC

The FPC is issued 28 days after the Final Statement or Partially Agreed Final Statement. This is as in the 1999 Edition, but the content of the statement now includes credit for any amounts paid under the Performance Security and any balance due from the Employer.

The Sub-Clause now contains additional wording to deal with the situation where there is a Partially Agreed Final Statement (or the Engineer considers that the draft final Statement submitted is in fact a Partially Agreed Final Statement).

Unfortunately (perhaps due to a drafting error) there are two alternative approaches included, with no indication as to which is to apply.

The opening words provide that following a Partially Agreed Final Statement, a Final Payment Certificate is to be issued.

However, the final paragraph provides that in the same case, no FPC is to be issued, but there is to be another IPC. As noted above, if this approach is followed, this IPC (unlike other IPCs) is to be paid 28 days after receipt by the Employer, rather than 56 days after its receipt by the Engineer.

Sub-Clause 14.14 – Cessation of Employer’s Liability

As in the 1999 Edition, the Employer’s liability is limited by reference to what is included in the Final Statement, unless something new arises after the work is completed.

The 2017 Edition contains an additional exemption for the Employer. Unless reference has been made in the Final Statement or Partially Agreed Final Statement, the Employer is absolved from any amounts which the Contractor might wish to claim, unless he makes a claim under 20.2 within 56 days of receiving the Final Payment Certificate. Under the 1999 Edition, no such cut-off was provided. Contractors will have to be sure to start all their claims immediately.

As with the 1999 Edition, the cessation of the Employer’s liability does not apply in the case of his indemnification obligations, or in case of fraud, deliberate default, or reckless misconduct. “[G]ross negligence” has now been added to this list (to the Contractor’s possible advantage) .

The addition of “gross negligence” may have substantially different results depending on which Law applies to the contract.

In a very interesting treatment of the subject recently presented to the Society for Construction Law in London,[2] the authors quoted a passage from a Court of Appeal case Armitage v Nurse[3] as follows:

“It would be very surprising if our law drew the line between liability for ordinary negligence and liability for gross negligence. In this respect English law differs from civil law systems, for it has always drawn a sharp distinction between negligence, however gross, on the one hand and fraud bad faith and wilful misconduct on the other

“… we regard the difference between negligence and gross negligence as merely one of degree … civil systems draw the line in a different place. The doctrine is culpa lata dolo aequiparatur [gross negligence is equal to fraud]; and although the maxim itself is not Roman the principle is classical. There is no room for the maxim in the common law.”[4]

On this basis it seems that, in common law jurisdictions, all significant negligence prevents parties from escaping from liability, and under civil systems, only fraud will enable them to escape.

Sub-Clause 14.15 – Currencies of Payment

This adds two provisions to those in the 1999 Edition. One provides for the way in which currencies are to be allocated in valuing variations (there is a comment on this in our treatment of Clause 13). The other deals with the currencies in which Performance Damages are to be paid.

Please get in touch at victoria.tyson@howardkennedy.com with your thoughts or to discuss any concerns.

[1] Note that under Sub-Clause 7.7 property in Materials and Plant does not pass until they are fully paid for, so this 80% provision means that the Contractor retains ownership far longer than one might expect.

[2] Exclusions from Immunity: Gross Negligence and Wilful Misconduct, James Pickavance and James Bowling SCL October 2017.

[3] [1997] EWCA Civ 1279, [1997] 2 All ER 705, [1997] 3 WLR 1046.

[4] Armitage v Nurse Note 14 [1997] 3 WLR 1046 para [254].

Employers avoid paying more under existing contracts, but forcing unprofitable work risks contractor insolvency. Contractors now seek protection from price fluctuations, preferring short projects or cost-plus letters of intent. Cost adjustment mechanisms, like FIDIC 1999 Sub-Clause 13.8, may help.

Construction costs are escalating

Under existing contracts, an employer will not want to pay more for the works. But forcing a contractor to perform works that are unprofitable or causing a massive loss is unlikely to be in the best interests of the project. It may result in the insolvency of the contractor forcing the employer to abandon the contract or re-let it, probably at a premium.

In new contracts, contractors are demanding protection from unpredictable price fluctuations. If a contractor feels exposed, it might only bid on projects with short construction programmes which give costs less time to increase. Or the contractor might seek to start work under a letter of intent on a cost-plus basis which then never crystalises into a full contract.

Is a mechanism for cost adjustment, such as FIDIC 1999 Sub-Clause 13.8[1] [Adjustments for Changes in Costs], an answer?

Type of contract

The type of contract usually informs as to which party takes the risk of price fluctuations.

• In reimbursable or cost-plus contracts, the employer takes the risk. The contractor is reimbursed the actual cost, plus allowances for overheads and profit. If the contractor’s actual costs increase, the contract price will increase also.
• In remeasurement contracts and fixed price/lump sum contracts the contractor usually takes the risk unless there is a mechanism for cost adjustment.
  • In remeasurement contracts (such as the FIDIC Red Book – For Building and Engineering Works Designed by the Employer) the contract price is based on approximate quantities and a schedule of rates and prices. But, if the rates and prices can be adjusted where price fluctuations occur, the contract price is recalculated using the new rates and prices and the final agreed quantities. The actual work done is remeasured when the works are completed.
  • In fixed price/lump sum contracts (such as the FIDIC Yellow Book – Plant and Design Build) the contractor provides an overall figure, ‘a lump sum’, for all the works that are agreed to be carried out under the contract. But, if the amounts due to the contractor can be adjusted where price fluctuations occur, the contract price is recalculated.

Legal principles

It is a basic principle of law that agreements must be kept. The Latin term for this is pacta sunt servanda. Therefore, unless there is a mechanism for cost adjustment, the contractor in a remeasurement contract or fixed price/lump sum contract may have a problem. In such circumstances, there are some legal arguments which might be deployed depending upon the governing law of the contract and local legal advice.

Fundamental change of circumstance

Some legal jurisdictions will allow a contract to be modified where it becomes inapplicable because of a fundamental or extraordinary change of circumstances. For example, under:

• the legal doctrine of rebus sic stantibus (meaning ‘things thus standing’[2]) which is sometimes described as an ‘escape clause’ to the principle of pacta sunt servanda; or
• the French doctrine of imprévision (meaning ‘lack of foresight’)[3].

Impossibility

A contractor might seek to argue that a contract has become impossible to perform; it is so different to the original bargain that it is frustrated so as to discharge the parties’ obligations.

Under the FIDIC 1999 editions, Sub-Clause 19.7 provides a remedy when any ‘event or circumstance outside the control of the Parties (including, but not limited to, Force Majeure) arises which makes it impossible or unlawful for either or both Parties to fulfil its or their contractual obligations…’.

There is similar wording at Sub-Clause 18.6 of the FIDIC 2017 editions.

However, economic unprofitability is unlikely to make it impossible or unlawful for the contractor to fulfil its contractual obligations. Just because something costs more to build does not make it impossible to build.

Force majeure

A contractor might seek to rely on force majeure, either under the governing law or in accordance with the contract conditions.

For an event to qualify as ‘Force Majeure’ under the FIDIC 1999 editions, five requirements must be met:

• it must be an exceptional event or circumstance;
• which must be beyond the parties’ control;
• which such a party could not have reasonably provided against before entering into the contract;
• which having arisen such party could not have reasonably avoided or overcome; and
• which was not attributable to the other party.

There is similar wording at Sub-Clause 18.1 of the FIDIC 2017 editions. However, the term Force Majeure is not used. The term Exceptional Events is used instead, although the definition does not actually require the event or circumstance to be exceptional.

Both Covid and the Russia-Ukraine war might fall within the FIDIC definition of Force Majeure. But to be entitled to an extension of time (or, in the case of the Russia-Ukraine war, Cost[4]), the contractor must be ‘prevented’ from performing any of its obligations under the contract by Force Majeure (and is subject to giving the prescribed notice). This means a physical or legal prevention. Economic unprofitability will not normally suffice. The mere fact that the cost of performance has increased is insufficient for prevention. So, whilst the Force Majeure clause may give the contractor extra time to procure materials that were prevented from being procured on time because of Covid or the Russia-Ukraine war, it is unlikely to assist a contractor who is merely obliged to pay higher prices than originally estimated.[5]

Good faith

A contractor might seek to rely on the principle of good faith which, under some legal jurisdictions, may be implied into the contract. Good faith arguments are usually raised as a matter of last resort.

Escalation clauses

A mechanism for cost adjustment is, potentially, a more reliable way to limit the contractor’s risk.

In the FIDIC 1999 editions the escalation clause is at Sub-Clause 13.8, and in the FIDIC 2017 editions it is at Sub-Clause 13.7. Sometimes the escalation clause is deleted or modified.

Sub-Clause 13.8 of the FIDIC 1999 editions (or Sub-Clause 13.7 in the FIDIC 2017 editions) is an ‘opt-in’ clause. It applies only if:

• Under the FIDIC Red and Yellow Books 1999 – a table of adjustment data is included in the Appendix to Tender.
• Under the FIDIC Silver Book 1999 – provided for in the Particular Conditions.
• Under the FIDIC 2017 forms – a Schedule(s) of cost indexation is included in the contract.

The table of adjustment data or Schedule(s) is a complete statement of the adjustments to be made to the cost of labour, Goods and other inputs to the Works (for example, fuel). Any other rises or falls in the Costs are deemed to be included within the Accepted Contract Amount. No adjustment is applied to work valued on the basis of Cost or current prices.

Where it applies:

• Under the FIDIC 1999 editions – the amounts payable to the contractor are adjusted for both rises and falls ‘in the cost of labour, Goods and other inputs to the Works’ by adding or deducting amounts calculated in accordance with a prescribed formula (in the FIDIC Red and Yellow Books) or as set out in the Particular Conditions (in the FIDIC Silver Book).
• Under the FIDIC 2017 editions – the amounts payable to the contractor are adjusted for both rises and falls ‘in the cost of labour, Goods and other inputs to the Works’ by adding or deducting amounts calculated in accordance with the Schedule(s).

In the FIDIC Red and Yellow Books 1999 a formula is set out, but this may be amended as the parties choose. The wording states: ‘The formulae shall be of the following general type’. The formula is as follows:

The FIDIC Yellow Book Guidance suggests that in a plant contract formulae which are more directly related to the timing of costs incurred by the manufacturers be adopted.

The FIDIC Silver Book 1999 and the FIDIC Gold Book 2008 do not set out a formula. The FIDIC Silver Book Guidance suggests that the wording for provisions based on the cost indices in the FIDIC Yellow Book be considered.

The FIDIC 2017 editions do not set out a formula either. The Guidance states: ‘It is recommended that the Employer be advised by a professional with experience in construction costs and the inflationary effect on construction costs when preparing the contents of the Schedule(s) of cost indexation’.

It is recognised that the formula set out above to calculate the adjustment multiplier (Pn), which is to be applied to the estimated contract value, is crude, but it is a fast and reasonably credible way of calculating and reimbursing fluctuations in costs.

The formula relies on:

• A fixed element (a), representing the non-adjustable portion in contractual payments, which is fixed at the time of Contract. FIDIC suggests 10% in the Appendix to Tender or Guidance.
• The weighting of the resources (b) (c) (d), which is determined at the time of contract. For example, a road project might be 20/40/40 for labour, equipment and materials.
• Cost indices for the current ‘now’ value (n) and the original value (o) for each of, for example, labour (L), equipment (E) and materials (M), which need to be updated frequently (preferably monthly rather than quarterly or annually, but that will depend upon the cost indices chosen).

Fixed element (10%)

Where there is contractor compensable delay which pushes the project into a period of inflation, it seems unfair that this portion is non-adjustable. Perhaps, it might be claimed as a prolongation cost as it falls squarely within the definition of ‘Cost’. The author is not aware of any precedent on this.

Weightings

In the FIDIC Red and Yellow Books 1999 (but not the FIDIC Silver Book 1999 or the FIDIC 2017 editions), the weightings may be adjusted if they have been rendered unreasonable by way of a Variation to the Works.

The last paragraph of Sub-Clause 13.8 of the FIDIC Red and Yellow Books 1999 states: ‘the weightings for each of the cost factors stated in the table(s) of adjustment data will only be adjusted if they have been rendered unreasonable, unbalanced or inapplicable, as a result of Variations’.

Therefore, the claiming party would need to demonstrate that the original contract weightings were correct at the time of contract and that a Variation had rendered them unreasonable, unbalanced or inapplicable. Inflation alone would be insufficient.

This provision does not apply simply where the original contract weightings fail to reflect the actual contract weightings. Sub-Clause 4.11 of the FIDIC 1999 editions states: ‘The Contractor shall be deemed to have satisfied himself as to the correctness and sufficiency of the Contract Price. … Unless otherwise stated in the Contract, the Contract Price covers all the Contractor’s obligations under the Contract (including those under Provisional Sums, if any) and all things necessary for the proper design, execution and completion of the Works and the remedying of any defects.’. The FIDIC 2017 editions have similar wording.

Cost indices

Cost indices provide a simple way to relate the original value to a corresponding cost now. Unfortunately, cost indices are not an accurate reflection of the actual costs, but they are easy and reasonably credible.

The choice of cost indices is important, and when choosing them it is necessary to understand, for example:

• Exactly what they measure. Many indices are intended to reflect only general building construction.
• In which location. The indices ought to align with the source of materials. Changes might be needed to the indices if there is a change in supplier or country of origin for the supply of materials, for example because of sanctions.
• In which currency. The currency of the cost indices and the currency for payment ought to align, otherwise there may be scope for further adjustment when the currency of the cost indices is converted into the currency of payment.

The categories of the cost indices are usually broad and not necessarily linked to specific items in the bill of quantities. Therefore, they do not work well with bespoke construction elements.

After the Time for Completion

Under the FIDIC Red and Yellow Books 1999 and the FIDIC 2017 editions, if the contractor fails to complete within the Time for Completion (meaning the time for completing the Works including any extension of time due to the contractor), further price rise risk is allocated to the contractor, and the benefit of any falling prices is allocated to the employer.

Adjustments to prices after the Time for Completion are made using the most favourable to the employer of:

• the index or price applicable from the date 49 days (i.e. 7 weeks) before the expiry of the Time for Completion; or
• the current index or price.

Procedure

Under both the FIDIC 1999 and 2017 editions, an application for an Interim Payment Certificate under Sub-Clause 14.3 must include any amounts to be added or deducted for changes in cost under Sub-Clause 13.8. The contractor is not obliged to give notice under Sub-Clause 20.1 of the FIDIC 1999 editions.

Other options

There are also practical things which the parties might consider in order to manage the risk of escalating construction costs in a smarter way.

During the tender process:

• The employer might give the contractor more flexibility when procuring materials by being less prescriptive in the specifications, for example in respect of the identity of the supplier and/or the type of material.
• The employer might encourage value engineering and permit alternative products where previously specified materials have dramatically increased in price.
• Provisional sums might be used for specific defined materials, to allow for greater price flexibility.
• The contractor might date limit its pricing for specific materials, therefore limiting its period of risk.
• The contractor might procure goods locally, where possible, in order to reduce transportation costs.
• The contractor might build closer and more collaborative relationships with suppliers.

During the works:

• The employer might agree to vary the contract to take into account some of the suggestions above.
• The contractor (or the employer) might identify capacity in the supply chains, buy price volatile goods, equipment and materials in advance and negotiate a delayed delivery or stockpile them[6]. The contractor might need to do this in any event because of excessive lead in times.
• The employer might agree to pay more in a supplemental agreement[7].

Conclusion

Contractors are demanding protection against escalating construction costs.

Although not without criticism, a mechanism for cost adjustment such as FIDIC 1999 Sub-Clause 13.8 is a reasonably credible way to limit the contractor’s risk if professional advice is sought on the correct cost indices to apply when preparing the contract documents.

I’d be interested to hear about your experiences and how you are addressing escalating construction costs in current and future projects.

Please call me, Victoria Tyson on +44 (0)20 3755 5733 or email Victoria.Tyson@howardkennedy.com to discuss your specific situation.

[1]   FIDIC 2017 Sub-Clause 13.7.

[2]   For example, under Polish law.

[3]   Article 1195 of Ordonnance No 2016-131 of 10 February 2016, enforceable in contracts concluded after 1 January 2016, states: “Where a change of circumstances that was unforeseeable at the time of the contract’s conclusion renders performance exceedingly onerous for a party that has not accepted to assume such risk, the party may ask the other party to renegotiate the contract”

[4]  War is payable under Sub-Clause 19.4(b) but Covid Is not. Natural catastrophes are excluded. For Cost, the event or circumstance must be of the kind listed in sub-paragraphs (i) to (iv) of Sub-Clause 19.1, and in the case of sub-paragraphs (ii) to (iv) occur In the Country.

[5]   Further, there is no entitlement to Cost in respect of natural catastrophes, and to be entitled to Cost in respect of the other specified categories, the force majeure must have occurred within the Country unless the force majeure arises out of “wars, hostilities (whether war be declared or not), invasion, act of foreign enemies”.

[6]   This will require up-front payment and security in relation to such payments.

[7]   For example, in the English case of Williams v Roffey Bros [1990] 2 WLR 1153 a contractor realised it had priced the works too low and would be unable to complete at the originally agreed price. It approached the employer who had recognised that the price was particularly low and was concerned about completing the contract on time. The employer agreed to pay the contractor more.

How important is it for an Employer to give a Sub-Clause 2.5 notice of a set-off or cross-claim under the FIDIC Red Book form of contract? Very, according to the Privy Council in NH International (Caribbean) Limited v National Insurance Property Development Company Limited . It found that: o Sub-Clause 2.5 applies to any claims the Employer wishes to make. o The Employer must make such claims promptly and in a particularised form. o Where the Employer fails to raise a claim as required, the back door of set-off or cross-claims is firmly shut. The case also serves as a warning to Employers who take a relaxed view towards their obligation under Sub-Clause 2.4 to provide reasonable evidence of the financial arrangements they have made and are maintaining to pay the Contract Price. It doesn’t matter how wealthy or important the Employer is (it may be a Government, company or individual with very substantial funds) detailed financial information must still be provided.

How important is it for an Employer to give a Sub-Clause 2.5 notice of a set-off or cross-claim under the FIDIC Red Book form of contract?  Very, according to the Privy Council in NH International (Caribbean) Limited v National Insurance Property Development Company Limited[1].  It found that:

• Sub-Clause 2.5 applies to any claims the Employer wishes to make.
• The Employer must make such claims promptly and in a particularised form.
• Where the Employer fails to raise a claim as required, the back door of set-off or cross-claims is firmly shut.

The case also serves as a warning to Employers who take a relaxed view towards their obligation under Sub-Clause 2.4 to provide reasonable evidence of the financial arrangements they have made and are maintaining to pay the Contract Price.  It doesn’t matter how wealthy or important the Employer is (it may be a Government, company or individual with very substantial funds) detailed financial information must still be provided.

The key facts

• The case concerned two appeals from the Court of Appeal of the Republic of Trinidad and Tobago.
• On 6 March 2003 a contract based on the FIDIC Red Book for the construction of a hospital in Tobago had been entered into by National Insurance Property Development Company Limited (the “Employer”) and NH International (Caribbean) Limited (the “Contractor”) for an original Contract Price of TT$118 million.
• The works commenced in March 2003 with an original completion date of March 2005.
• The Contractor first suspended work in September 2005 and then terminated the contract in November 2006.
• The disputes were referred to arbitration.
• Dr Robert Gaitskell QC was appointed as sole arbitrator in October 2005 and made five awards.
• Two issues were challenged (i) the Contractor’s entitlement to terminate (which was decided in his second award), and (ii) quantum (which was decided in his third award).

The Contractor’s entitlement to terminate

Sub-Clause 2.4 states:

“The Employer shall submit within 28 days after receiving any request from the Contractor, reasonable evidence that financial arrangements have been made and are being maintained which will enable the Employer to pay the Contract Price (as estimated at that time) in accordance with Clause 14 [Contract Price and Payment]….”.

As the works were executed the cost of the project was rising and so in September 2004 the Contractor quite sensibly requested that the Employer provide evidence of its financial arrangement under Sub-Clause 2.4 of the contract, and this further evidence was provided in December 2004.  A further request was made by the Contractor in April 2005 and this was provided in July 2005 but on a rather unusual “without prejudice” basis.  The Contractor understandably queried the “without prejudice” nature of the response and asked whether the Employer had obtained Cabinet approval for payment of the sums under the contract (as other contracts showed that Cabinet approval was needed, for public policy reasons, before money could be paid).  No response was received and so the Contractor suspended work in September 2005.

In October 2006 (over a year later) the Employer wrote stating that it would meet the contractual financial requirements for completion of the project. The Contractor patiently requested confirmation that the Cabinet had approved the funds but again no response was received.  So, in November 2006 the Contractor terminated the contract for a failure by the Employer to provide reasonable evidence that financial arrangements had been made and maintained. The Employer disputed the termination.

In April 2007, the arbitrator found that the Contractor had been entitled to terminate as there was no “reasonable evidence that financial arrangements had been made and maintained” to pay the sums referred to in the documentation provided.  Of Sub-Clause 2.4 the arbitrator wrote in his second award:

“The mere fact than an Employer is wealthy is inadequate for the purpose of Sub-Clause 2.4.  Similarly, the mere fact than an Employer has good reasons for wanting a project completed does not itself mean he has made and maintained the necessary financial arrangements.  Accordingly, the evidence given at the hearing to the effect that the [Employer] has very substantial funds is, prima facie, insufficient by itself for satisfying 2.4. Does the mere fact that the [Employer] has funds in general mean it has “made arrangements” enabling it to pay? The answer emerging from the evidence … as regards the significance of cabinet approval, is that (quite properly, and for very good public policy reasons) the [Employer] cannot pay large sums of public money in respect of cost overruns on construction contracts unless cabinet approval is given in advance or, perhaps, retrospectively. The issue of cabinet approval cannot simply be ignored. It is, at some point, an essential element of any “arrangement” to pay.

What was required was evidence of “positive steps” on the part of the Employer which show that financial arrangements had been made to pay sums due under the contract.

The High Court[2] agreed but the Court of Appeal[3] did not on the basis that the arbitrator had been demanding the “highest assurance” of evidence rather than mere “reasonable evidence” and accused the arbitrator of giving too little weight to certain evidence.

However, the Privy Council found that the arbitrator had made no error in law.  The arbitrator’s conclusion that insufficient evidence had been provided was one of fact not law, and therefore it was not open to a court to interfere with, or set aside, his conclusions on such an issue.  It stated:

“Where parties choose to resolve their disputes through the medium of arbitration, it has long been well established that the courts should respect their choice and properly recognise that the arbitrator’s findings of fact, assessments of evidence and formations of judgment should be respected, unless they can be shown to be unsupportable. In particular, the mere fact that a judge takes a different view, even one that is strongly held, from the arbitrator on such an issue is simply no basis for setting aside or varying the award. Of course, different considerations apply when it comes to issues of law, where courts are often more ready, in some jurisdictions much more ready, to step in.”

The Contractor’s termination for the Employer’s breach of Sub-Clause 2.4 was therefore upheld.

As an aside, the obligation under Sub-Clause 2.4 relates to the Contract Price which is defined as “the price defined in Sub-Clause 14.1 [the Contract Price], and includes adjustments in accordance with the Contract”.  Often the Employer and Contractor will have differing views on the amount of the Contract Price, as is apparent in this case where the Contractor requested evidence of the ability to pay TT$286 million, and the Employer wrote back with reference to its estimate of TT$224 million.  The Privy Council agreed with the Court of Appeal who ruled that TT$224 million was the correct sum as this had been certified by the Engineer and ultimately verified by an Independent Quantity Surveyor.

Financial claims

Whilst the matter of the termination was being appealed the arbitrator heard submissions on quantum and issued his third award.

The Contractor claimed its financial losses arising out of the termination; in response the Employer submitted various counterclaims.  The Contractor argued that the Employer’s counterclaims were barred for a lack of notice under Sub-Clause 2.5.  In fact, the first the Contractor had heard of the counterclaims was during the arbitration proceedings!

Sub-Clause 2.5 states:

“If the Employer considers itself to be entitled to any payment under any Clause of these Conditions or otherwise in connection with the Contract … the Employer or Engineer shall give notice and particulars to the Contractor… 

The notice shall be given as soon as practicable after the Employer became aware of the event or circumstances giving rise to the claim …

The particulars shall specify the Clause or other basis of the claim, and shall include substantiation of the amount … to which the Employer considers himself to be entitled.  The Engineer shall then proceed in accordance with Sub-Clause 3.5 [Determinations] to agree or determine (i) the amount (if any) which the Employer is entitled to be paid by the Contractor …

This amount may be included as a deduction in the Contract Price and Payment Certificates.  The Employer shall only be entitled to set off against or make any deduction from an amount certified in a Payment Certificate, or to otherwise claim against the Contractor, in accordance with this sub-clause”.”

In November 2008 the arbitrator found that notice was not required for the Employer’s counterclaims because “clear words are required to exclude common law rights of set-off and/or abatement of legitimate cross-claims and” and (by implication) the words of Sub-Clause 2.5 were not clear enough.  The High Court[4] and the Court of Appeal[5] agreed with the arbitrator.

The Privy Council took a different view.  It found the words of Sub-Clause 2.5 couldn’t be clearer.

• Sub-Clause 2.5 applies to any claims the Employer wishes to make (whether or not they are intended to be relied on as set-offs or cross-claims).
• The Employer must make such claims “as soon as practicable” and in a particularised form. If the Employer can rely on claims which were first notified well after that, there would be no point to the first two parts of Sub-Clause 2.5.  Further, if the Employer’s claim is allowed to be made late, there is no method by which it could be determined, as the Engineer’s function is linked to the particulars, which in turn must be contained in a notice, which in turn has to be served “as soon as practicable”.
• Where the Employer fails to raise a claim as required, the back door of set-off or cross-claims is firmly shut in accordance with the final words of the Sub-Clause which read “The Employer shall only be entitled to set off against or make any deduction from an amount certified in a Payment Certificate, or to otherwise claim against the Contractor, in accordance with this sub-clause”.

However, with reference to Hobhouse LJ in Mellowes Archital Ltd v Bell Products Ltd.[6] the Privy Council did concede that Sub-Clause 2.5 does not preclude the Employer from raising an abatement – e.g. that the work for which the contractor is seeking a payment was so poorly carried out that it does not justify any payment, or that it was defectively carried out so that it is worth significantly less than the contractor is claiming.

The third award was therefore remitted to the arbitrator with a recommendation that any sums which (i) were not the subject of appropriate notification complying with the first two parts of Sub-Clause 2.5 and (ii) cannot be characterised as abatement claims as opposed to set-offs or cross-claims, must be disallowed.

Conclusion

In summary, there is no excuse for poor contract administration.  Employers should ensure that notices are given on time and, when asked to do so, provide evidence that financial arrangements to pay the Contract Price have actually been made and are being maintained.  If there is in any doubt about the Contract Price ask the Engineer to certify the sum and if necessary seek an independent opinion.

[1] [2015] UKPC 37

[2] Claim No. CV2007-02224

[3] C.A. No. 281 of 2008

[4] Claim No. CV2008-04998

[5] Civil Appeal No. 246 of 2009

[6] [1997] 58 Con LR 22, 25-30