Understanding and negotiating turnkey and EPC contracts

UNDERSTANDING AND NEGOTIATING TURNKEY CONTRACTS

•

UNDERSTANDING AND NEGOTIATING TURNKEY CONTRACTS

By

JOSEPH A. HUSE Freshfields, Paris

SWEEr" MAXWELL

Published in 1997 by Thomson Reuters (Legal) Limited (Registered in England & Wales, Company No 1679046. Registered Office and address for service: 100 Avenue Road, London, NW3 3PF) trading as Sweet & Maxwell Digitally reprinted in 2009 by TJI Digital, Padstow, Cornwall

ACKNOWLEDGMENTS

The author would like to thank all the partners, managers and staff at the various offices of Freshfields for their assistance. In particular, he would like to thank Matthew Turner and Claire Skrinda for their invaluable efforts with respect to the preparation of the second edition of this book.

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© Joseph A. Huse 1997

v

FOREWORD When the first edition of "Understanding and Negotiating Turnkey Contracts" was written by Mr. Huse, the Orange Book ("Conditions of Contract for Design-Build and Turnkey"), issued in 1995, was the only FIOIC form of contract intended for use in a design and build context. FIDIC being well known for the quality of its prior documents, it was certainly only natural for him to use the Orange Book as a basis for discussing turnkey contracts and proposing negotiation points for the parties. In 1999, three new Books were issued by FIDIC, with their basic structure and wording harmonised around the previous Orange Book format. These Books were the Conditions of Contract for Construction, for Plant and Design-Build, and for EPCffurnkey Projects. The first one is intended for construction works where the employer is responsible for the design, similar to the old Red Book, and with an important role for the Engineer. The two latter ones are intended for cases when the contractor supplies the design. The Plant and Design-Build Book has the traditional Engineer while the EPCffurnkey Projects Book has a two-party only arrangement. With further development, the new (1999) "Conditions of Contract for Plant and Design/Build" retain the essential elements of the earlier Orange Book. It had been noted, however, that new trends in project financing and management, especially related to PFI and BOT, required a different set of conditions, and the "Conditions of Contract for EPCffurnkey Projects" were drafted to cater for this. They complement but do not replace the "Conditions of Contract for Plant and Design/Build", in that they are intended to be used in a rather specific context, e.g.: • • • •

when greater certainty is sought that price and time will not be exceeded; when the Contractor is required to take total responsibility for the design and construction of the infrastructure or other facility; when the Employer is willing to pay more in return for the Contractor bearing the extra risks associated with this; and when uncertain or difficult ground conditions or other largely unforeseeable risks are unlikely to be encountered.

They should rather not be used for design-build work in other circumstances. The decision which Book to use should, therefore, always be taken in full consideration of the particular characteristics of the project at hand. In a similar way, depending on the project context, the first edition of "Understanding and Negotiating Turnkey Contracts" very much retains its merits for a better understanding and appreciation of FIDIC's new "Conditions of Contract for Plant and Design/Build", while the new, second edition is equally valuable with respect to the "Conditions of Contract for EPCffurnkey Projects". vii

FOREWORD

In the very detailed discussion of the context and of the operation of the various clauses, the author pays special attention to the operation of the contract in a BOT project. This will certainly be much appreciated by the many employers and contractors who do not yet have much first-hand experience of such projects but are eager to make the best possible use of this approach to project financing and execution. Other interesting features are the tables summarising the employer's and the contractor's obligations under the various clauses of the contract, and comparisons with other standard forms of turnkey contracts. For FIDIC, its own "FIDIC Contracts Guide", with detailed guidance to the new contracts, remains the main reference work, especially since it was written by the principal drafter of the three 1999 Books. However, Mr. Huse's work is still the major commentary coming from an independent construction lawyer and will therefore certainly receive much positive attention from employers, contractors, lenders and other interested parties. Daniel Ivarsson Managing Director FIDIC

INTRODUCTION

When drafting international construction contracts, practitioners often use standard form contracts as a basis for their documents. The form contract provides a familiar starting point to ease the drafting burden and facilitate negotiation. The Federation Internationale des Ingenieurs-Conseils (FIOIC) has recently published a new form contract for use with the design and construction of works using the engineer, procure, construct or turnkey contracting method. This contract, the FIOlC Conditions of EPCffurnkey Projects (the Silver Book), is aimed at situations where bids are invited on an international basis; with some modification the contract could be used, in certain countries, for domestic contracts as well. The purpose of this book is twofold: (i) to provide a comparison of the terms of the principle design-buildlEPClturnkey contracts; and (ii) to assist contract drafters in their analysis of the Silver Book and in the modification of its provisions to meet the specific needs of the project in question. The final chapter gives drafting suggestions for selected contract provisions of the Silver Book from the perspective of both the contractor and the employer.

Turnkey contracts In a design-bid build contract, the employer supplies the design, which often includes the designation of materials and other key construction parameters. Under an EPC agreement, the contractor provides all of the engineering, procurement and construction. Under a turnkey contract, the contractor supplies the final design of the project. From the perspective of the author, these three terms are largely interchangeable and the drafting of this book reflects this position. These contracts place the design and construction duties in the same hands, providing in theory a more easily co-ordinated project with potential for increased speed of completion and decreased cost, due to tighter project organisation. They also place primary liability on the contractor for any defect in the design, construction or performance of the works. Therefore, as a general proposition, where a defect arises in the works, the employer need not prove to what extent resultant damage was caused by faulty design or by faulty construction, as may be the case under a design-bid-build contract. As the contractor is allocated design, co-ordination and construction responsibilities for the whole of the work, the employer need not provide the same level of technical expertise required under the traditional contract, e.g. he need not provide detailed design preparation capabilities. In complex EPC and turnkey contracts parties often use the lump-sum viii

IX

INTRODUCTION

pricing method. This method provides greater price certainty. Fixed pricing can also facilitate financing, as many banks and other financing institutions prefer or require increased certainty as to the final price for a project. EPC and turnkey contracts often provide for contractor training of the employer's staff, as well as provision of know-how updates, patent licences and other technological aspects of the project. Among the disadvantages of EPC and turnkey are the employer's decreased role in co-ordination of the construction and the cost of tender. The contractor, receiving a lump-sum price, will be under a certain pressure to provide less sophisticated designs in order to save on costs and increase profit. Since the employer is removed from the dominant position in the design and co-ordination of the project he will need to monitor the contractor's performance carefully. An EPC or turnkey contract can also result in an increase in the cost of tendering. The employer will need to develop a complete and clear set of requirements and criteria for the project in order to define the design and construction to be executed by the contractor. The bidders may need to provide an advanced level of design for the project at tender. Such a complete tender will often require extensive studies of the site and the needs of the employer. The following are form contracts cited throughout this book: Silver Book (Federation Internationale des Ingenieurs-Conseils, Conditions of Contract for EPCffurnkey Projects, 1999), a turnkey/engineer-procureconstruct style contract. Orange Book (Federation Internationale des Ingenieurs-Conseils, Condition of Contract for Design-Build and Turnkey, 1995), a turnkey/ design-build style contract. Red Book (Federation Internationale des Ingenieurs-Conseils, Conditions of Contract for Construction, 1999), a standard form contract using an engineer and largely employer-designed works. Yellow Book (Federation lnternationale des Ingenieurs-Conseils, Conditions of Contract for Plant and Design-build, 1999), a contract using an engineer and largely contractor-designed works. ENAA Contract (Engineering Advancement Association of Japan, Model Form International Contract for Process Plant Construction, General Conditions, 1992), a turnkey-style contract designed specifically for process plant construction. ICE Contract (Institution of Civil Engineers, Conditions of Contract Design and Construct, 2001), a design-build style contract. x

INTRODUCTION

EIC Contract (European International Contractors, Conditions of Contract for Design and Construct Projects, 1994), a turnkey-style contract. AlA Contract (American Institute of Architects, Standard Form of Agreements Between Owner and DesignlBuilder, Document A191, 1996), a two-part design-build-style contract. The first part provides for design and budgeting, while the second provides for construction. DBIA Contract (Design-Build Institute of America, Standard Form of Agreement Between Owner and Design-Builder - Lump Sum, 1998), a design-build style contract. AGC Contract (Associated General Contractors of America, Standard Form of Design-Build Agreement and General Conditions between Owner and Design-Builder, 1999), a design-build style contract. Employer-Owner Certain contracts such as the ICE Contract and FIbIC Silver Book use the term "Employer" for the person who has contracted with the contractor for the completion of the works. Others, such as the ENAA Contract, use the term "Owner". Where the discussion is general in nature, the term "employer" will be used. Where the discussion relates to a particular contract, the terms specific to that contract will be used. Notes for reading this book Starting with Chapter 5 the chapters of this book follow the Silver Book clause by clause, in an effort to folIow the logic of its construction. In each section, a comparison is made with provisions from other form contracts. These comparisons are meant, inter alia, to highlight alternatives available to drafters and other approaches to issues considered by the Silver Book. The author does do not claim to provide an intensive study of each and every form contract used. The first chapter describes the different types and elements of construction contracts, including price, payment and co-ordination. It is meant to provide a general overview of construction contracting. The second chapter defines in some detail the turnkey concept, its advantages and disadvantages. The third chapter contains a brief discussion of certain of the other model form contracts and an introduction to the Silver Book. The fourth chapter presents a discussion of BOT contracts and how the Silver Book may need to be modified for use in such projects. Chapters 5 to 24 discuss each clause of the Silver Book. The first section of each of these chapters prevents a general discussion of the topic of the relevant clause of the Silver Book. The second section considers the contract clause section by section, comparing it to other FIDIC contracts, the Orange Book, Yellow Book and Red Book, and to other form contracts. It also gives xi

INTRODUCTION

guidance as to how the clauses should be adapted to the drafter's individual needs. The last chapter provides an examination of the employer's and contractor's interests as they relate to each sub-clause of the Silver Book. This chapter is intended to assist drafters in identifying the needs and interests of the party, and gives some suggestions as to how to modify the Silver Book in relation to the drafter's interests. However, the list of items discussed is by no means exhaustive. This work is also confined to the contractual relationship between the employer and contractor. The author will not venture into the internal organisation of the contractor, by studying the relationship between the contractor and designer, nor the relationship between the contractor and other contractors. Nor will the author discuss contractual groupings of contractors (e.g. consortia or joint ventures) for the purposes of submitting a single tender. The drafting of a construction contract involves important legal consequences. Each project is unique and will require consideration of issues specific to that project and its participants. Changes to model form contracts will have legal implications, which will vary in accordance with the applicable legal system. Reference to this book should not replace reference to competent and experienced legal counsel.

Comment/request for Information The first edition of the FIDIC Conditions of Contract for EPClTurnkey Projects, otherwise known as the Silver Book, was published in December 1999 (although draft editions were available earlier). This means that the construction industry's experience of negotiating and litigating the provisions of the Silver Book has been, until now, necessarily limited. Consequently, in some respects this book is somewhat premature. However, my colleagues urged me to bring out this book as quickly as possible and given the need for a commentary of this type this seem an appropriate thing to do. With this in mind, I would welcome any material or comments that would improve any subsequent editions. In particular, I would greatly appreciate any comments from construction industry professionals regarding their experience in using the Silver Book. Such material or comments should be sent to me at the following address: Joseph A. Huse Freshfields 69, Boulevard Haussmann 75008 Paris France Fax: (33) 1.44.56.44.00 [email protected]

Xli

CONTENTS

Page Acknowledgments Foreword Introduction 1. Types of Contract

Contracting Methods Design-bid-build Single versus multiple construction contracts Management contracting Design-build, turnkey and EPC BOT (Build Operate Transfer) Pricing Methods Lump-sum method Cost-reimbursable or cost-plus Unit price or bill of quantities Bonus schemes and currency of the price Payment Methods Payment after completion Milestone payments Progress or scheduled payment 2. Turnkey and EPC Contracts Advantages and Disadvantages of Turnkey and EPC Contracts Advantages Disadvantages Issues in Connection with Lump-Sum Turnkey or EPC Contracts Standard Form Design-Build and Turnkey Contracts 3. FIDIC Design-Build, Turnkey and EPC Contracts Introduction From the Orange Book to the New Yellow Book Major drafting changes Is the new Yellow Book a good idea? From the New Yellow Book to the Silver Book Major drafting changes Is the Silver Book a good idea? FIOIC Policy on Design-build, Turnkey and EPC Conclusions

v

vii ix 1 1 2 3 4 5 7 9 10 11 12 13 14 14 15 15 17 17 17 20 23 24 29 29 30 30 34 35 35 37 38 39

CONTENTS

CONTENTS

4. The Use of the FIDIC Silver Book in the Context of a BOT Project

8. The Contractor 41

41 Introduction 41 Description of a BOT Project 46 Allocation of Risk Specific Issues raised in connection with the use of the Silver Book 48 in the context of BOT projects 48 Design 50 Construction 53 Tests on completion 54 Taking over 55 Tests after completion 56 Time for completion 59 Price 63 Liquidated damages 64 Guarantees 65 Co-ordination of construction (employer's control) 67 Payments 68 Additional lender requirements 70 Conclusion 5. The Contract General Comments Contract language Conflicts clause Confidentiality clause Definition of design Rights in the construction documents Discussion of Specific Sub-Clauses General provisions

6. The Employer General Comments Access and possession Employer assistance with permits and licences Discussion of Specific Sub-Clauses Employer Obligations in the Silver Book

7. The Employer's Administration General Comments The role of the engineer in the construction contract Turnkey contracts with an employer's representative Comparison of the role of the employer and his representative in the Silver Book with the role of engineer in the Yellow and Red Books Discussion of Specific Sub-Clauses XIV

71 71 71 72 72

73 74 74 74 107 107 107 108 108 117 123 123 124 125 128 130

General Comments The tender phase The performance phase Discussion of Specific Sub-Clauses Key Obligations of the Contractor in the Silver Book

9. Design General Comments Design standard / contractor's liability Design timing issues Discussion of Specific Sub-Clauses

10. Staff and Labour General Comments Provision of staff and labour Superintendence Discussion of Specific Sub-Clauses

1t. Plant, Materials and Workmanship General Comments Discussion of Specific Sub-Clauses

12. Commencement, Delays and Suspension General Comments Commencement and time for completion Completion delays Suspension by the employer Suspension by the contractor Discussion of Specific Sub-Clauses

13. Tests on Completion General Comments Discussion of Specific Sub-Clauses

14. Employer's Taking Over General Comments Discussion of Specific Sub-Clauses

15. Defects Liability General Comments Duration of the defects period Duties placed on the contractor Employer's right to use an outside contractor Expiration of the defects liability period and its effect Discussion of Specific Sub-Clauses

141 141 142 148 152 197 205 205 205 208 209 233 233 233 234 235 251 251 251 273 273 273 274 276 277 277 311 311 312 323 323 324 335 335 336 336 337 337 339 xv

CONTENTS

CONTENTS

16. Tests After Completion General Comments Minimum levels of performance Failure of impossibility of attaining the expected performance Discussion of Specific Sub-Clauses

17. Variations and Adjustments General Comments Variations The variation procedure Value engineering Valuation of variations Provisional sums Discussion of Specific Sub-Clauses

18. Contract Price and Payment General Comments Lump-sum price Adjustment of price for unforeseen circumstances Payment methods The interim payment procedure Retention money Advance payments Final payment and discharge Discussion of Specific Sub-Clauses

19. Termination by Employer General Comments The validity and effect of a termination clause Drafting of the termination clause Default of Contractor Procedure for termination Grounds for termination Effects of termination for default of the contractor Termination for convenience Discussion of Specific Sub-Clauses

20. Suspension and Termination by Contractor General Comments Suspension by the contractor Termination by the contractor Bases for termination Procedure for termination Valuation and payment at termination Discussion of Specific Sub-Clauses

I

xvi

357 357 359 359 360 369 369 370 371 372 372 373 373 393 393 393 394 395 395 396 397 397 397 443 443 443 444 444 445 445 446 447 447 465 465 465 466 466 468 468 469

21. Risk and Responsibility General Comments Employer's risks Contractor's responsibility for the care of the works Indemnification Environmental risks Intellectual and industrial property rights infringement indemnification Limitation of contractor liability Discussion of Specific Sub-Clauses

22. Insurance General Comments Property insurance Liability insurance Terms of insurance and the insurer Proof of insurance Failure to provide insurance Discussion of Specific Sub-Clauses

23. Force Majeure General Comments Force majeure Discussion of Specific Sub-Clauses Comparison of Force Majeure Provisions

24. Claims, Disputes and Arbitration General Comments Procedure for claims Final dispute resolution Discussion of Specific Sub-Clauses Initial claim Supporting documentation Fully detailed claim Interim and final claim measures Employer's response Payment of contractor Formation of DAB Composition of DAB Remuneration of DAB Replacement of DAB member Expiration of DAB Composition and Appointment of DAB Terms of appointment of DAB Remuneration of DAB and DAB activities Failure to pay remuneration

483 483 485 485 485 486 487 487 488 509 509 511 513 514 515 515 515 531 531 531 532 550 555 555 555 561 564 566 567 567 567 568 568 572 574 574 574 574 575 575 575 576 xvii

CONTENTS

Submission of dispute to DAB Decision rendered by DAB Effect of decision rendered by DAB Where one party protests decision rendered by DAB Effect of notice of dissatisfaction Eligibility for arbitration Proceedings before the arbitrators 25. Negotiation of the Silver Book Formulating a Negotiating Strategy: The Key Characteristics of the Silver Book Specific Negotiating Issues

584 585 585 586 586 591 591

599 601

655

2. Engineering Advancement Association of Japan Model Form International Contract for Process Plant Construction (Turnkey Lumpsum Basis) with Process Licence

757

3. European International Contractors: Conditions of Contract for Design and Construct Projects

1

TYPES OF CONTRACT

599

APPENDICES 1. Federation lnternationale des Ingenieurs-Conseils: Conditions of Contract for EPClrurnkey Projects

CHAPTER

819

4. AlA Document A191: Standard Form of Agreements Between Owner and Design/Builder 1996 Edition

843

5. Design-Build Institute of America: Standard Form of Agreement Between Owner and Design-Builder-Lump Sum

869

6. AGC Document No. 415 Standard Form of Design-Build Agreement Between Owner and Design-Builder

903

Index

935

In considering which contracting method to use the employer will need to assess his own particular institutional and technical strengths and weaknesses (including access to financing).1 Each method of contracting affects in its own way the allocation of responsibility and the demands on the employer for coordination of the project. Through the proper allocation of responsibility for the project to reflect these strengths and weaknesses, the employer can rationalise the price of the contract against his exposure to project risks. The employer's first consideration will be to identify the design source, i.e. the person who will develop the employer's requirements for the project into a practicable design. This design source can come from the employer's inhouse staff, an independent consultant or the contractor. The person providing the design will often have some oversight function in the execution of the project to ensure proper implementation of the design and provide for efficient and effective interfaces in the construction of the works. Next, the employer must consider how best to allocate co-ordination responsibility. The individual elements of the design and construction process will need to be properly co-ordinated to ensure balanced and efficient progress. This includes management of incoming and stored supplies, construction by the contractor's employees and subcontractors, and inspection and testing crews belonging to the employer, the contractor or local regulatory bodies. Co-ordination can be provided by the contractor, the employer or a third party such as a management contractor. These two aspects will be discussed under the section on contracting methods (below). Finally, the employer must also consider the pricing method to be used (considered below) and the payment conditions to be incorporated into the contract (also considered below).

1-01

1-02

Contracting Methods Although the construction contract can be broken up into the various elements necessary for construction (such as civil engineering, electrical/mechanical engineering, finishing, and so on) the two main aspects of the construction that the employer needs to consider when choosing the 1

xviii

See generally I.N.D. Wallace, "Contracts for Industrial Plant Projects" (1984) 2 I.c.L.R. 322 at 328 (hereinafter "Contracts").

1

1-03

TYPES OF CONTRACT

1-04

CONTRACTING METHODS

appropriate contracting method are the design function and co-ordination of the works. The employer can himself provide one or both of these functions, or he can allocate them to one or more third parties. Methods of contracting available to the employer can be split into two broad categories: design-bid-build, which separates the design and construction functions, and design-build, or turnkey, which places the entire project, including design and construction, in the hands of the contractor. The turnkey method is often referred to as "engineering, procurement and construction" (or "EPC"), especially in the context of project financing. With respect to the first category, a distinction should be made between a designbid-build project using a single construction contract and a design-bid-build project using several construction contracts.

Design-bid-build

1-05

1-06

The design-bid-build method is the traditional approach to construction contracts (see Figure 1.1). First the employer provides for the design of the project in accordance with his requirements. The designer chosen by the employer then provides a set of drawings sufficient for construction. How far advanced these designs are when used for the tendering process may vary Figure 1.1

The design-bid-build method

I

EMPLOYER

I I l

I 2

DESIGNER

I

ENGINEER

I

ICONSTRUCTION I ICONSTRUCTION I CONTRACT CONTRACT

in relation to the origin and experience of the employer. In France, for example, the contractor will usually be responsible for detailed design. In a design-bid-build project the employer provides the design and co-ordination of the project; thus he will be responsible for the interface between the design and construction aspects of the project. The designer often acts on behalf of the employer as the supervisor or engineer for the project, guiding the contractor in the progress of the works and supervising the interface between the design and construction. Where the project requires extensive financing, this may not be acceptable to lenders (as discussed below). There are a number of potential disadvantages associated with the designbid-build form of contracting. It tends to delay the overall completion date due to the use of distinct design and construction phases (as opposed to the turnkey method). The employer-provided designs will not necessarily correspond with the technical capacities of the contractor. There may be added delay while the contractor familiarises himself with the designs provided and the technology used in the designs.

Single versus multiple construction contracts When choosing the design-bid-build method of contracting, the employer will need to decide whether he wants a number of contractors to fulfil the various construction tasks of the project, or whether to place all of these tasks into the hands of one contractor. When using a number of contractors, the employer may also need to decide which tasks to contract out and which tasks can be provided by his own in-house staff. The employer may choose the multiple-contract approach when he wishes to establish individual construction packages in order to achieve the lowest price. If multiple construction contracts are used, the employer will need to provide co-ordination of the various contractors and, under certain circumstances, subcontractors. 2 Therefore, the employer will be responsible not only for the interfaces between the designs used and the work methods of the various contractors and suppliers, but also the co-ordination of each of the construction packages assigned to such contractors and suppliers. This necessitates either that the employer has the skills and experience to undertake such co-ordination (and understands the construction methods and technology to be used by the various contractors and suppliers), or that he contracts with a competent third party to undertake such co-ordination. The employer's first step in implementing the construction component of such an approach to design-bid-build is to define the individual construction work packages. Construction packages are sometimes defined on the basis of electrical/mechanical works and works of civil engineering. Subject to relevant procurement requirements, the employer will then be able to allocate the individual work packages to the contractor or supplier of his choosing. 2

I.N.D. Wallace, Construction Contracts: Principles and Policies in Tort and Contract (Sweet & Maxwell, London, 1986), p. 401 (hereinafter Construction Contracts).

3

1-07

1-08

CONTRACTING METHODS

TYPES OF CONTRACT

1-09

1-10

Since the employer chooses the individual contractors and suppliers for each construction package, the employer has greater control over the quality of contractors used and materials chosen. By using this contracting method, the employer may also achieve a lower price for the works. The use of several contractors may enable the employer to use local contractors, possibly under the supervision of experienced foreign contractors, particularly where it is in the employer's interest to effect a transfer of technical and managerial skills to the site country. This same goal can, however, be achieved in a single construction contract by mandating the use of local subcontractors for a certain percentage of the works. When using the multiple contract method, properly defining the interfaces among each of the work packages may be problematic. Any ambiguity, or the failure of any such definition, is the responsibility of the employer and may result in contractor claims. For the employer this constitutes one of the major risks of the multiple contractor method. Under the single or prime construction contract method, the employer places the responsibility for all of the construction of the works with one contractor. This relieves the employer of the need to co-ordinate the interfaces among the construction packages. It also reduces the risk of contractor claims in respect of such interfaces. However, it removes from the employer a certain amount of his control over the construction of the works. The use of this method may also result in a higher cost for the construction of the works (as mentioned above). In a design-bid-build project with a single construction contract, the employer will still be required to manage the design/construction interface. However, the employer will be able to pass on to the contractor the responsibility for the interfaces between the various construction packages. Design-bid-build with multiple contractors provides the employer with extensive control over the design and construction process. Not surprisingly, this method also requires the greatest degree of intervention on the part of the employer. He will be responsible for interfaces between the multiple contractors and co-ordination of their work. The design-bid-build model can prove to be disappointing. The designer employed by the employer is often removed from the actual field experience of contracting; thus his designs may be distanced from the realities of construction. This distance could result in inaccurate cost and scheduling estimates, impractical or outdated designs and failure to implement new construction methods. 3

Management contracting 1-11

Management contracting is a less traditional approach which involves hiring a contractor whose role is the co-ordination and management of the project. J

4

Brown, "Opportunities and Risks of Design Build Superconference, San Francisco, U.S., December 7-8, 1995.

Projects~,

The Construction

This management contractor organises time, cost and quality control. He engages a number of other contractors to do the actual construction work. The management contract provides the employer with the control of the project typical of a traditional design-bid-build contract, while reducing the requirements on the employer (a feature similar to the turnkey contract). The primary difference between the management contract and the turnkey model is that the management contractor generally assumes no responsibility for the work of the other contractors or for the performance of the design. 4 He acts purely as a management intermediary. The management contractor can be given any number of different mandates, with greater or lesser powers of intervention in the construction process. He can be involved from the very outset of the project, inviting tenders, negotiating for the employer and selecting contractors, through to the completion of the works. The management contractor's fee can be tied to the completion time or the overall price of the contract, or both, using a target price. The management contractor's fees will decrease where the actual price surpasses the target price, and increase where costs are less than those targeted. Under this system by using target pricing the management contractor has an incentive to control the price of the contract in the employer's favour. Similarly, the management contractor can be required to assume some of the liability for the performance of the works or the quality of construction to provide an incentive to supervise closely the quality of the workmanship and materials that go into the works.

Design-build, turnkey and EPC The "turnkey" arrangement, (also known as the "package deal", "design and build", "cle-en-main " , "design and construct" or "EPC") places the duty to design and construct solely on the contractor. There is no accepted definition for each of these terms in the construction field. The term "turnkey" tends to mean the most extreme form of placing design and construction responsibility on the contractor, such that after completion the employer need only turn the key to commence operation of the constructed facility. Notwithstanding this, the term "turnkey" will be used here to describe the more general global arrangement of placing all design, procurement and construction responsibilities on one contractor. In recent years, design-build projects have seen rapid growth in some parts of the world. For example, use of the design-build method increased from an $18 billion (in the mid-1980s) to a $69 billion (in the mid-1990s) industry and now represents roughly 25 per cent of the United States construction industry.s 4

5

For a detailed analysis of the management contracting method, see generally Freshfields' Construction & Engineering Group, Freshfields Guide to Management Contracting: Law and Practice (1994). . M.L. McAlpine, "Construction Law: Will Design·Build Contracting Really Solve All of the Problems?" (1997) 76 MI Bar Jnl. 522, online: LEXIS at 533.

5

1-12

CONTRACTING METHODS

TYPES OF CONTRACT

1-13

1-14

Where the contractor takes responsibility for the design of the works, the employer's advisers find their involvement limited primarily to the tender process and supervision of the contractor's work. The definition of supervision is likely to be the subject of extensive negotiation between the parties, as the employer will want to maintain control over the construction process. The turnkey system generally uses the lump-sum pricing method. Certain practitioners believe that it is ill-suited to interim payment based on the cost of work done, due to the difficulty of verification by outside experts of the figures submitted by the contractor. 6 The turnkey contract places the responsibility for the entire project in the hands of the contractor. Thus, there is no need to identify whether a defect has been caused by defective design or defective construction of the works. As a general rule, any defect falling within the scope of works will be the responsibility of the contractor. Contractor liability makes design-build contracts particularly attractive for employers.7 The potential liability of the employer under other construction contracts (where, for example, he provides any design specification) has led to a dramatic growth of design-build contracting. 8 The use of the turnkey method of construction results in a considerable reduction of intervention by the employer in the design and construction process, as compared with other contracting methods. The role of the employer will consist primarily of contract administration. His role may also include, depending upon the terms of the turnkey contract, review and/or approval of designs. Further, the design used ought to be consistent with the technical capacities of the contractor, resulting in a more efficient and costeffective application of the design to the construction of the works. The combination of the design and construction responsibilities should also decrease the overall time for completion. This phenomenon is known as "fast track" construction. Efficiencies in the design and construction process may potentially reduce the price of the project. However, certain construction professionals maintain that the claims of earlier completion with designbuild construction are exaggerated and that design-bid-build projects achieve similar completion times. As the responsibility for co-ordination of the project passes from the employer to the contractor, so does some of the control. The employer will experience a decrease in his day-to-day control of the construction of the works. As the contractor's control of the construction increases, so does his need to be experienced in the management of large-scale projects. This may include handling interfaces between multiple methods of construction, interfaces between different industries, and the various designs used by subcontractors and suppliers. Under the turnkey method of contracting, the tender stage takes on greater importance. Given the short time period available, it may be difficult for the

employer to analyse properly each design at tender. 9 Therefore, he will need to be extremely precise in his "request for tender" as to the performance and capacities desired from the works, (known, in the Silver Book, as the Employer's Requirements). The employer will need to spend a greater amount of resources on the tender stage to ensure the contractor and his proposed design are of the requisite quality. Similarly, the contractor may need to expend heavily on bid preparation to ensure the buildability of the project and the profitability of his bid price. to The employer may choose to use a turnkey model for only part of the project (called "part-turnkey" or "semi-turnkey"). The co-ordination responsibility for the entire project will then either fall on the employer's consultants or the turnkey contractor. The contractor will, therefore, bear design responsibility for only a part of the works. ll Thus, for example, the turnkey contractor can provide certain aspects of the works such as heavy civil facilities which require specialised design and attention, while the employer can contract on a designbid-build basis for the finishing of the works and equipment systems. This method decreases necessary interfaces, thus simplifying the co-ordination of the project. It may also separate the responsibility for differing types of work, for example equipment systems work and heavy civil work, thus reducing contact between various industries not necessarily familiar with each other's working methods. The advantages and disadvantages of the part-turnkey model are generally the same as those for the turnkey and design-bid-build models, including considerations related to the combination of the two contract models. Reference should also be made to a variant of the EPC construction methodology referred to as "EPCM" or "engineering, procurement and construction management". The essential difference between EPC and EPCM methodology is that the contractor under an EPCM contract assumes responsiblity for supervision/management of construction but does not assume responsibility for the construction itself. BOT (Build Operate Transfer)12 The typical BOT (along with its variants such as BOO (Build Own Operate), BLT (Build Lease Transfer) and others) contract encapsulates the process whereby a government grants a concession or similar right to a project development company to develop and operate what would normally be a public sector project, for a given period of time known as the concession period. The project development company obtains financing for the project, and then designs and constructs the facility; it then operates the facility during the agreed period and thereafter turns the plant over to the government. The 9

6 ?

8

6

Construction Contracts, op. cit. n. 2 above, p. 365. M.L. McAlpine, op. cit. n. 5 above, 522, online: LEXIS at 555. C.G. Hammond, "Dealing with Defects: Defective Owner· Provided Preliminary Design in Design-Build Contracting" (1998) 15 1.C.L.R. 193 at 196.

1-15

10 11

12

M.L. McAlpine, op. cit. n. 5 above, 522, online: LEX IS at 554; I.N.D. Wallace, "Designand-Build: a No-No for Owners" (1999) 4 Const. & Eng. L. 7 at 8 (hereinafter "No-No"). For an outline of how this process might look under the Silver Book, see the applicable sections of the FIDIC Guide. Construction Contracts, op. cit. n. 2 above. . For further analysis of this concept, in relation to the Silver Book, see Chap. 4.

7

1-16

TYPES OF CONTRACT

l-17

parties generally intend that the income received by the project development company during the concession period (including, in certain circumstances, subsidies) will pay for the cost of financing and running the plant with an adequate return for the investors. These investors often include the contractor. 13 Any BOT project involves a potentially complex contractual structure. However, in most cases, the BOT project will use a turnkey or EPC contract for the actual design and construction. Thus the BOT is not really a separate method of construction contracting, but rather a method of financing the project. Indeed, the lenders of the BOT projects have significant influence on the terms of the underlying construction contract, including the requirement that such a contract be turnkey and, often, in the form of an EPC contract. 14 In a BOT project, the operation period between completion and transfer also gives the transferee an opportunity to verify the quality and quantity of output of the works. The contractor can be required to provide the transferee's personnel with training prior to the transfer, thereby easing transition. The transferee will need to take care to maintain the operator's incentive to maintain properly the works, in order to avoid deterioration in the final period before transfer to the transferee (the operator, in an attempt to save on costs, may towards the end of the operating period decrease maintenance and operating expenditures resulting in accelerated deterioration of the works). In certain BOT projects, the operator is required to assume defects liability for a limited period of time subsequent to the transfer. A BOT project, in practice, is often not as simple as its definition implies. There may be a large number of parties. For example, in a recent hydroelectric project, the project development company (granted a concession by the government), entered into various contracts for the building of the facility, its operation and maintenance during the concession period and a power purchase agreement with an electrical utility. The construction of the facility was provided through a turnkey contract with a consortium of contractors. Each of the turnkey contractors was also an investor in the project development company. A subsidiary of one of these turnkey contractors also acted as the operator of the facility after completion. This complex structure is typical of power plant BOT projects in developing nations, as developing economies struggle to meet the dramatic increase in demand for energy (see Chapter 4 BOT)Y The increasing popularity of the BOT project is largely due to a shortage of public funding and the opinion that the facility will be more efficiently managed by a private entity.16 In theory, the BOT scheme provides developing countries with much-needed infrastructure at a reduced direct cost to the government. I? However, BOT projects are high-cost and high-risk ventures for private entities operating in a traditionally public domain. j. Scriven, "A Banking Perspective on Construction Risks in BOT Schemes" (1994) 11 I.C.L.R. 313 at 314. 14 C. Wade, "History and Scope of the Three Major Books" (1998) online: FIDIC http://www.fidic.comldocumentsllaunchlwade1.html(date accessed: November 19, 1999). IS D. Blumental, "Sources of Funds and Risk Management for International Energy Projects" (1998) 16 Berk. J. Int'J Law 267, online: LEXIS at 270. 16 j. Scriven, op. cit. n. 13 above, 313. 17 S.W. Stein, "Build-Own-Transfer (BOT) ARe-Evaluation" (1994) 2I.C.L.R. 101.

CONTRACTING METHODS

The cost of tender being high, the project company members should take great care to examine the risks associated with the project prior to tendering. The project company will prefer an exclusive and specific mandate from a host country interested in the project and supportive of it. 18 Project company members should have experience not only in constructing large projects but also in investing in and operating such projects. 19 Where the grantor of a concession for a project is a political entity, it takes on a further political risk in that the project is placed in the hands of an entity not necessarily affected by the political repercussions of its actions. The public may not understand that the grantor is removed from the day-to-day operations of the public service subject of a BOT project (e.g., an underground railway) and thus any mismanagement or politically unpopular decision may be imputed to the grantor. Although the contract may provide for grantor influence in the selection of personnel in order to ensure proper operation, the effectiveness of such influence may be practically minimal. The grantor will, thus, want to consider the independent status of the project development company and the potential effect the company's actions may have on the grantor's political position and the public welfare. Banks and other financing institutions will make it a condition of their financing of a project that there is implementation of a contractual scheme that provides them with some certainty as to their financial risk. By using a lump-sum price and placing much of the completion risk on the contractor, the turnkey contract can provide the lenders with a significant amount of certainty and thereby confidence in the project. (A more detailed discussion of the issues can be found in Chapter 4 BOT.) Some authors assert that the "contractor and employer are very likely to rely on the Silver Book as a good compromise approach». 20

Pricing Methods 1-19

Some of the most common methods of pricing a construction project are: (a) (b) (c)

lump-sum; cost-reimbursable; and unit price.

T.hey can be used alone or in combination. The selection of a pricing method directly affects the distribution of certain risks, such as changes in the cost of labour and materials.

IJ

8

1-18

18 19

20

Gurun, ." Build-Own-Tran.sfer Projects: The Contractor's Role in Risk Management", InternatIOnal Ba~ ASSOCIation Conference in Tokyo, japan, February 1993, at 11. S.W. Stem, op. CIt. n. 17 above, 101. C. Pedamon, "~ow is Convergence Best Achieved in International Project Finance?" (2001) 24 Fordham Int J L.}. 1272, online: LEXIS at 1300.

9

PRICING METHODS

TYPES OF CONTRACT

Lump-sum method L-20

The lump-sum method gives a price for the whole of the contract, irrespective of the contractor's as-built cost. The difference between the price and the actual cost of the works to the contractor will constitute the contractor's profit or loss. The contractor assumes substantial risk, including the risk of most changes of circumstances (for example, a change in the price of materials or labour). Although most lump-sum contracts provide for modification of the price in certain limited circumstances, such contracts usually provide that the contractor may not claim additional payment for work indispensably necessary to completion, even where omitted from the specifications of the contract. The employer is therefore given a figure representing his global exposure, although this figure may be subject to adjustment as provided by the contract. The contractor will usually be paid the lump-sum price in instalments. The instalments will be based on a schedule of payments or payable at specified stages of completion. In certain cases the lump-sum price may only be payable by the employer to the contractor upon completion, i.e. where completion is a condition precedent to payment. 21 1-21 The lump-sum is generally easier and less expensive to administer than the other pricing methods, as the price is clearly specified (although variations and other alterations to the contract and its price are still possible). Rather than having to calculate the pricing of completion based on the amount of construction units required or the extent of materials, equipment and services used (e.g. a calculation of the cost of construction), the parties need only refer to the lump-sum price. The employer will need to provide for compilation and transfer of information concerning the site in order to enable the contractor to formulate a realistic lump-sum price. Construction contracts often provide that the contractor will not be required to go through the expense of verifying employer-supplied information. However, the contractor will almost invariably be required to investigate, or be deemed to have investigated, the site and the conditions present at the site. The time and cost associated with lump-sum tendering required of both parties may exceed the cost of tendering in contracts priced in accordance with actual cost. 22 The employer may require the contractor to provide him with a breakdown of the lump-sum price into specific amounts payable for different activities or portions of the works. In a tender process, this information will enable the employer to obtain a better understanding of the basis of the contractor's price. This breakdown will facilitate adjustment or revision of the contract price where provided for in the contract. It may also be used for the pricing of variations.

The lump-sum price regime does not allow for adjustment or revision of the contract price, unless specifically provided for in the contract. There may be adjustment for incorrect data provided by the employer, unforeseeable adverse sub-surface conditions, or changes in the works required by the employer. The employer may also decide to assume the risk of inflation and exchange rate risk. The parties should specify with clarity the situations in which adjustment is available.

Cost-reimbursable or cost-plus Under cost-reimbursable conditions the employer pays the contractor for costs incurred plus a predetermined margin of profit. The margin or fee can be fixed, fluctuating or determined as a percentage of actual costs. For example, the margin for building a tunnel may be a flat fee on completion, a percentage of the actual costs incurred in building the tunnel, or a fee that will fluctuate in accordance with some external measure such as the rate of inflation or the base rate of the central bank of the country in which the tunnel is built. This form of payment may create no incentive to work economically or rapidly, since, for example, the greater the cost, the greater the profit, irrespective of progress. In order to compensate for this lack of incentive the parties can include, as part of the pricing provisions of the contract, an incentive mechanism. One example of an incentive mechanism is target cost. This mechanism may be implemented in a number of ways. One possibility is that any cost above a maximum "upset" or "target" cost will not receive any profit or "fee", and may incur a decrease in "fees" already earned. 23 To increase the incentive to finish within a given time period, the contract could also increase or decrease the fee in relation to the completion date of the project. 24 The cost-plus system is generally only used as a last resort, where it is impossible to calculate construction costs, such as tunnelling works. For example, the Eurotunnel project used a target cost mechanism for the tunnelling works. The construction contract awarded the contractor 50 per cent of the savings should the actual price be les:; than the target price. Where the actual price exceeded the target price then the contractor was liable for 30 per cent of the difference. The contractor's liability was limited to half of the fee, or 12.36 per cent of the contract price for such works. 25 Another method of reducing the employer's risk in respect of the cost reimbursement price is to apply a reasonableness standard. The contractor is then only compensated for costs reasonably expended. However, it may 23

Z4 2\ 22

A. Burns ed., Construction Disputes: Liability and the Expert Witness (Butterworths, London, 1989) p. 26 (hereinafter Construction Disputes). , P.O. Marsh, Contracting for Engineering and Construction Proiects (Institute of Purchasmg & Supply, 1988), p. 164.

10

IS

"Contracts", op. cit. n. 1 above at 345. P.O. Marsh, Contracting for Engineering and Construction Projects (Institute of Purchasing & Supply, 1988), p. 167. Huse, Kirkland and Shumway, "The Use of the Target Concept for Tunnelling Projects in Light of the Eurotunnel Experience", Options for Tunnelling Conference of the International Tunnelling Association, Amsterdam, the Netherlands, April 19-22, 1993, at 6.

11

1-22

1-23

PRICING METHODS

TYPES OF CONTRACT

be difficult to determine the reasonableness of a given cost. 26 This difficulty arises in the pricing mechanism of any cost-reimbursable contract, requiring detailed provisions regarding verification and administration of the contractor's costs, detailed schedules and care in eliminating the possibility that the contractor could make a profit at the costs level before the fee element has been calculatedP An employer becomes dependent on the reliability and efficiency of the contractor, despite protection placed in the body of the contract. 28 The contract may also provide that the employer pay to the contractor only the amount paid for materials and services actually used by the contractor (to take into account any over-ordering by the contractor and subcontractors). The definition of costs may also take into consideration any discounts offered by suppliers. The obligation of the contractor to keep extensive records will provide some measure of protection for the employer in calculating costs.

Unit price or bill of quantities

1-24

According to the unit pricing method, the price of the project is calculated in accordance with the amount of work done. The price is established per unit of quantity with reference to a bill of quantities or a schedule included in the contract which specifies the amount of materials and labour needed for a particular task. This method places the risk of the number of units used on the employer but transfers risk of change in the cost or rate of each unit to the contractor. 29 Thus, if the cost of a unit of excavation in a tunnelling contract is provided at 100, the employer will pay where more units are excavated than expected. However, in the absence of unforeseeable adverse sub-surface conditions (assuming the contract provides a changed conditions clause), the contractor is responsible for added cost where the unit of excavation costs more than 100. The unit pricing method is common in construction contracts. Employers have traditionally used this method where the quantity of construction inputs is not ascertained at the time of contracting. Thus, for example, where the amount of concrete to be used for the construction of a building is not yet ascertained, the employer can price the contract in accordance with the cost of a unit of concrete. The contractor will then be compensated for the actual amount of concrete required, while the employer will be assured a fixed price per unit of concrete. This method continues to be used extensively today, even in projects where the quantity of materials is certain. Certain publications, such as the

26

21

28 29

ibid. at 3. "Contracts", op. cit. n. 1 above at 345-346. Construction Disputes, op. cit. n. 21 above, p. 26. Huse, Kirkland and Shumway, op. cit. n. 25 above, at 3.

12

Standard Methods of Measurement in England, provide forms of schedules as a pricing method. As with the lump-sum pricing mechanism, the parties may provide for a system of adjusting the unit price. The pricing mechanism may provide for changes beyond the parties' control, such as unforeseeable sub-surface conditions, or changes in law or regulations that affect some aspect of the contract. The contract may even provide for adjustment on the basis of changes in the cost of materials or labour. The ability of the contractor to obtain an adjustment to the contract price in respect of certain defined circumstances shifts the risk in respect of such circumstances from the contractor to the employer. The parties should, of course, define carefully any such circumstances and their potential impact on the unit price. The parties will need to agree on a precise method of calculating the quantities used. Although the costs of valuation and measurement associated with a project carried out under a unit-priced contract are not as high as those of a similar project under a cost-reimbursable contract, they are still higher than those necessary under a lump-sum contract. While a good idea in theory, and often in practice, parties should be wary of the potential for the bills of quantities system to be abused. After the Second World War, widespread usage of contracts of this type "rapidly produced a whole science of upward price manipulation bearing no relation to the site realities which lasted for decades due to the apathy of clients' legal advisors and ~he collusion of architects, engineers, etc".30 Eventual disillusionment with the bill of quantities method is perhaps one of the reasons for the growing interest in, and popularity of, the turnkey (and therefore lumpsum) contracting method.

1-25

Bonus schemes and currency of the price In addition to the pricing mechanism, the parties may want to add a bonus scheme to create an incentive for early completion. Such a bonus can be calculated in a manner similar to the calculation of liquidated damages, providing for a fixed amount or percentage of the contract price for each day of early completion. The employer may wish to defer payment of the bonus to the contractor until after the works have been operational for a period of time, such as after the defects liability period, to ensure proper performance of the works. Further, it is not normally advisable to use the bonus system in a cost-reimbursable contract without including a mechanism designed to eliminate any incentive that the contractor might have to construct using more costly methods in order to achieve early completion. The parties will also need to consider the currency in which the price is paid. If the price is to be paid in the currency of the costs incurred by the contractor and such currency is different from the currency of the employer's

30

"No-No" op. cit. n. 9 above at 7.

13

1-26

1-27

PAYMENT METHODS

TYPES OF CONTRACT

country, then the employer carries the risk of a change in the exchange rate between the currency of the employer's country and the currency of the price. Where the currency of the price is the currency of the employer's country then the contractor bears the risk of a change in the exchange rates. If the currency of the contract is a third currency, not that of the employer's country and not that of the costs incurred, then both parties will bear a portion of the risk of a change in exchange rates. In certain countries, the parties may also have to consider exchange control regulations, including restrictions on the currency of payment of a contract and restrictions on indexation tied to a currency other than the currency of the locale of the project. Currency ledging may also be available to layoff part or all of the currency risk onto one or more financial institutions.

Payment Methods 1-28

1-29

When considering the payment provisions of the contract, the parties must agree upon the methods of payment. The contract may provide for a certain portion of the price to be payable upon commencement of the works, through advance payments, in order to provide the contractor with sufficient cash flow to cover the substantial expenditures which may be required at the early stages of construction. For example, in a power plant project, advance payments may be provided for the purchase of certain equipment and machinery such as the generator and the turbines. This advance payment would then be repaid through reduction of future payments. The employer may also want a security to be provided for the amount of the advance payment. An advance payment guarantee for the amount can be provided by a third party much in the same way as a performance security, with the employer giving his consent to the guarantor chosen or a guarantor being indicated in the contract itself. The cost of the guarantee will lessen the benefit of the advance payment to the contractor, but may allow the employer to provide a larger sum than he would otherwise have supplied without the protection of the guarantee. Where funds must be transferred to different locations the parties must consider risks relating to exchange rate fluctuation during transfer, and the tax regulations concerning such transfers. The form of payment may also incorporate some guarantee of payment, such as the use of a letter of credit. There exist a number of methods of payment, three of which are discussed below. The second and third methods are the most commonly used.

it is not unknown on larger projects. When used on such large projects the payment after completion provides a form of contractor financing of the project, requiring the contractor to obtain outside financing himself or to auto-finance the construction. Sometimes this method will be used to finance a portion of the construction with payments extending well beyond completion of the construction.

Milestone payments Under milestone payments the parties set up a schedule of tasks for the contractor to perform. For each milestone achieved, the contractor is paid a portion of the lump-sum price or an amount in accordance with rate schedules, bills of quantities or cost-plus pricing. Payment occurs only after completion of the tasks required. Milestone payments at specified stages of completion provide an incentive for rapid progress. 31 Milestone payments can occur either at the completion of each given milestone, or periodically, resulting in payment for all milestones completed within the period involved. Thus the greater the progress during a payment period the greater the value of the payment received. Contractors may be tempted to carry out the more expensive tasks at the early stages of construction, resulting in less of an; incentive to progress at later stages of completion. Where combined with lump-sum pricing, milestone payments can avoid such "front-loading" by the contractor. 32 This approach may be combined with the progress payment method for certain portions of the works. For example, the parties may decide that the contract will be paid in accordance with milestones except for the price of the plant or certain materials for which the contractor will be compensated once they are in the employer's possession (such as upon delivery to the site).

Progress or scheduled payments

Payment after completion

The contract can provide for payment for work completed during a given period of time, calculating the value of the work done during the period, or simply setting a percentage of the contract price to be paid at the end of each period. The former method of payment is frequently used in connection with the unit-price method of pricing. The latter method of payment is not frequently used. There is little incentive for efficient completion under this latter type of periodic payment since the contractor receives remuneration irrespective of the progress achieved by the work completed. In order to balance the need for progress and timely completion with the use of progress payments, parties may institute different pricing or incentive

The first is rare in large construction contracts, involving the payment of the contract price only after completion of the works involved. This method is more common for smaller subcontracts or simple task-oriented contracts but

J2

14

1-30

)1

Construction Contracts op. cit. n. 2 above, p. 380. "Contracts" op. cit. n. 1 above at 345-349.

15

1-31

TYPES OF CONTRACT

programmes. The use of target costs, as described under cost-reimbursable pricing, will provide the contractor with an incentive to decrease the real cost of the project, while the use of unit pricing will define the value of work completed in order to avoid the effects of increases in costs of materials and labour.

CHAPTER

2

TURNKEY AND EPC CONTRACTS Advantages and Disadvantages of Turnkey and EPC Contracts In recent years the use of turnkey and EPC contracts for construction projects, and in particular infrastructure projects, ha~ become popular with employers and financing institutions. However, · although the turnkey approach is in fashion and it provides many benefits to these entities, it also has certain disadvantages.

2-01

Advantages In traditional design-bid-build projects, responsibility for design and construction is often spread between a number of parties. Design and construction tasks are often performed by separate entities or pursuant to separate contracts. Such projects are often split into different elements, or works packages. These packages will interact with one another (their "interface"). Interfaces exist between the design and all the construction packages but also between the individual construction packages themselves. Generally, in design-bid-build projects the employer takes the responsibility for co-ordinating these various project elements and their respective interfacing. For example, in the construction of a hydroelectric project the employer will have to ensure that the design element and the civil and electrical works interface correctly as well as between the civil and electrical works elements themselves- by seeing, for example, that the foundations can sustain vibration from turbines. Each contractor or participant will only have liability for the discrete project package for which he is responsible. This may lead to a number of problems. Contractors may make claims as a result of poor co-ordination between packages. One contractor may delay the work of others. Furthermore, it may be very difficult to allocate responsibility for defects between a designer and a contractor. By contrast, the turnkey or EPC contract makes the contractor entirely responsible for both the design and construction of the works. The employer receives a completed project in accordance with his performance specifications. When he looks for accountability as to the performance and quality of the works, he need look no further than the contractor. 16

17

2-02

2-03

TURNKEY AND EPC CONTRACTS

2-04

2-05

This means that the employer does not need to worry about co-ordinating contractors effectively (and avoids claims resulting from lack of interface definition). If he wishes to make a claim concerning a defect he can look to the contractor without the need to address whether it is a design or workmanship problem. In addition, single-point responsibility can also reduce the opportunity for claims by the contractor. Under more traditional contracting arrangements, these claims are often based on directions given by the engineer. Since the engineer is no longer a central co-ordinating figure in the turnkey contract and the contractor has taken on the responsibility for the design and construction the turnkey contract may provide decreased opportunity for claims. The contractor must deliver works that are fully operational to the specifications of the employer; any defect or fault is necessarily his responsibility except where the contract provides otherwise. Everything relating to the works can, thus, be concentrated in a single point of responsibility-the contractor. This single point responsibility has two notable consequences: first, the role of performance criteria; secondly, the standard of performance expected from the contractor. The contractor must design and build the works in a manner such that the performance of the finished works satisfies the criteria set out in the contract (otherwise known as performance criteria). The employer will define these performance criteria in such a way as to ensure that the works provide at least the level of performance required for profitable production. The performance criteria may specify output, input, waste, and any other performances the employer may desire. For example, in the construction of a coal-fired power plant the employer will want to ensure that the plant produces sufficient power to satisfy his commercial needs, in particular where he has entered separately into an agreement for a third party to purchase a certain amount of the electricity produced. Thus, these criteria set out levels of performance the employer expects; it is then the responsibility of the contractor to produce works that are in conformity with them. Under a traditional design-bid-build contract the construction contractor and the designer are held to different standards of performance for the completion of the works. Designers in many jurisdictions traditionally have not been required to guarantee results, but rather method. They are held to have a superior base of knowledge, sufficient in competency and ability to complete the design with a reasonable degree of technical skill. For example, courts in the United States have held that the designer, in the preparation of designs and drawings, must exercise his skill and ability, judgment and taste reasonably and without neglect.! This standard represents a professional duty of care. The contractor, on the other hand, often may be required to construct the works

ADVANTAGES AND DISADVANTAGES OF TURNKEY AND EPC CONTRACTS

with due care and diligence. The standards are often defined by the relevant legal system and in accordance with industry practice. The standard of performance can 'vary from contract to contract, and construction contractors are required to complete the works in accordance with the contract. Therefore, the contractor will not generally be held responsible for design deficiencies. Under a turnkey or EPe contract both the designer and contractor responsibilities are placed on the contractor along with a :stricter standard of performance. The standard of performance applied will be provided by the contract, or in the absence of a specific provision, by the applicable law. Under the Silver Book the standard is "fitness for purpose".2 According to English case law, a turnkey contractor is under strict liability to deliver a structure "fit for the purpose" for which it was made. 3 The "fitness for purpose" standard goes beyond a "professional" duty of care, placing on the contractor liability for any failure of the design to perform to the standards required. This provides the employer with works constructed and operational in accordance with the intended purpose or use of the works as provided in the contract. For example, in the construction of a thermal power plant the employer can set out in the employer's requirements the size and nature of the plant desired, as well as its operational output and the consumption necessary to reach such output. Therefore, if the employer's original conception of the works lacked some element necessary for it to be fit for the purpose intended, the contractor would be responsible for ensuring that the finished works contained the missing element. 4 Lump-sum price. The lump-sum pricing method is often used for turnkey and EPe contracts and enables the use of fixed payments by stages of completion. Lump-sum pricing and fixed insta lment payments provide the employer with greater certainty in overall cost as well as in the timing of payments. s This system reduces front-loading by the contractor and encourages rapid completion. It also facilitates financing, as lenders will have greater certainty of financial exposure and the timing of draw-downs. However, even where the contract is priced on a lump-sum basis, the contractor will normally have the right, under certain limited circumstances, to claim an increase in the contract price (as discussed above).

2-07

The role and influence of project financing. Lending institutions, such as the European Bank for Reconstruction and Development, often insist on lumpsum turnkey contracts for construction projects which they finance. Project lenders believe that lump-sum pricing and single-point completion responsibility reduce the completion risk to project lenders and provide greater

2-08

2 J

I

Stated in the U.S. case of Surf Realt)' Corp. v. Standing 78 S.E.2d 901 at 907 (1953) cited in Gravel), v. Providence Partnerships 549 F2d 958 (4th Cir. 1977).

18

2-06

4

5

Silver Book sub-clause 4.1. IBA v. EMI and BICC (1980), 14 B.L.R. 1. For a more detailed discussion of the "fitness for purpose" obligation, see Chap. 8. I.N.D. Wallace, Construction Contracts: Principles and Policies in Tort and Contract (Sweet & Maxwell, London, 1986), p. 408 (hereinafter Constmction Contracts).

19

ADVANTAGES AND DISADVANTAGES OF TURNKEY AND EPC CONTRACTS

TURNKEY AND EPC CONTRACTS

certainty of overall financial exposure. This method of contracting is becoming increasingly prevalent for international infrastructure projects. This is particularly true in BOT and similar projects, where limited recourse financing makes lenders wary of taking further risks when it comes to the pricing of the construction project. 6

2-09

Speed of procurement. The traditional design-bid-build method of contracting contemplates separate and distinct design and construction phases. The turnkey or EPC method combines these two phases and allows construction to proceed along a "fast-track"; in certain cases the contractor can even commence construction prior to the completion of the design phase. Consequently, the turnkey method of contracting may result in earlier project completion.

2-10

Efficiency. Since the contractor both builds and designs the works, the contractor no longer needs to take the time to understand the employer's designs. 7 The design should also take into consideration the contractor's methods of construction, providing more efficient and timely completion. 8 The control given to the contractor should facilitate implementation of new and better approaches to design, developed through his experience and expertise. The contractor will have an incentive to implement such timesaving changes under the turnkey structure, which may not be true under more traditional contracting methods. Since the designer and the constructor work as a team, they are more likely to identify critical flaws in the design at an earlier stage, ensuring avoidance or mitigation of the flaw when such action is more effective. This team approach will help avoid many design and construction risks which a separate designer and constructor would not be able to identify.9 The joining of the design and construction task under one contractor may also reduce the number of disputes which arise between the contractor and employer.

Disadvantages

2-11

Loss of control. The overall design and construction supervision role of the engineer is absent from the turnkey contract. Under the Silver Book, the engineer's supervisory role has been replaced, but in part only, by that of the employer's representative. This new role is relatively flexible, allowing D. Blumental, "Sources of Funds and Risk Management for International Energy Projects" (1998) 16 Berk. J. /nt'/ Law 267, online: LEXIS at 271, 288-289. 7 However, contractors operating under the terms of the Silver Book would be wise to take time to understand employer designs, as the contractor is strictly liable for any designs proVIded by the employer under the Silver Book. See discussion in Chap. 9 (design) • Construction Contracts, op. cit. n. 5 above, p. 407. 9 Brown, "Opportunities and Risks of Design Build Projects", The Construction Superconference, San Francisco, U.S., December 7-8, 1995, p. 5.

input in and control of the design and construction of the works. However, the turnkey model generally contemplates less day-to-day intervention than is present under a traditional design-bid-build contract. Under the turnkey contract, it may be more difficult for the employer to exercise his variation power properly. He may be distanced from the design, reducing his understanding of the processes used and his ability to verify the need for a variation and whether the variation proposed will affect the performance of the finished works. Where the engineer designs and co-ordinates the construction, the employer knows at each stage how the works may need to be altered. In the absence of the engineer, the employer's understanding of the process of the design and construction of the works may be diminished. The contractor will want to execute the works within the parameters of the employer's requirements for the least cost possible. The contractor in a turnkey or EPC contract may be tempted to under-design the project in order to cut his costs and save on time. Therefore, under the turnkey or EPC model the employer will still need to provide supervision of the construction, to ensure that the contractor's performance satisfies the contract requirements. Indeed, where the nature of the project is such that design changes are likely to be necessary (and yet where the contractor will not be entitled to an increase in the contract price) the employer should be aware that the ultimate maintenance costs and long-term performance of the project's structure may be negatively affected. 1o Some employers try to offset this risk by requiring the successful bidder to operate and maintain the facility for a period of time after construction, thereby providing the contractor with incentive to produce an efficient, low-maintenance product. 11 Cost of tender.12 When tendering for a turnkey contract, the contractor often must have a design in the advanced stages of completion, having made sufficient tests and studies to know the costs and the level of risk involved in the project. Under such circumstances, the cost of tendering a turnkey contract can be quite high. In order to counteract the expense of bidding, the World Bank has suggested limiting the number of bids to a maximum of six, based first on technical merit and secondly on price competition. 13 The employer can also offer to make a payment to those contractors giving serious bids, but who are not chosen. This will decrease the cost of bidding to the contractor and increase the quality of the bidding pool. However, in practice, employers do not often provide for such payment.

6

20

M.L. McAlpine, "Construction Law: Will Design-Build Contracting Really Solve All of the Problems?" (1997) 76 M/ Bar Jnl. 522, online: LEXIS at 557; I.N.D. Wallace, "Design-andBuild: a No-No for Owners" (1999) 4 Canst. & Eng. L. 7 at 8. " M.L. McAlpine, op. cit. n. 10 above, online: LEXIS at 555. 12 For further discussion of issues relating to the tendering process, see Chap. 5. 13 G. Westring, "Turnkey Heavy Plant Contracts from the Owner's Point of View" (1990) 7 I.C.L.R. 234 at 235. 10

21

2-12

TURNKEY AND EPC CONTRACTS

The cost to the employer of verifying the design-if such verification is possible considering the time frame of the tender process-may prove to be quite high. As one construction expert has noted: " ... if a really detailed check of the design and specification is attempted, using consultants engaged for that purpose by the owner, the basic saving in costs by way of reduced fees of professionals is likely to prove illusory" .14 The temptation to underdesign, combined with the difficulty of verifying the quality and efficiency of the design tendered, could result in increased contract cost. Further, carrying out an effective comparison between the various tenders (due to their individual design characteristics) will likely prove costly in both time and money to the employer. IS In order to avoid the temptation to accept bids based on price rather than quality of design, the World Bank suggests a two-stage bidding process. During the first stage contractors submit unpriced technical proposals. It is only during the second stage that prices are considered. A legal counsel for the World Bank suggests five main steps: pre-feasibility, feasibility, bidding, evaluation of bids and award of contract, and negotiation. 16 Such staged bidding will allow the employer to look first to the quality of the design, then only secondly at the bid price.

2-13

ISSUES IN CONNECTION WITH LUMP-SUM TURNKEY OR EPC CONTRACTS

Issues in Connection with Lump-Sum Turnkey or EPC Contracts There are a number of key issues relating to the drafting and negotiation of lump-sum turnkey or EPe contracts which drafters will need to consider carefully, to ensure complete and effective allocation of risk. The key issues include the following: (a)

(b)

(c)

Cost of risks,l7 Under the turnkey or EPC contract the employer benefits from an increased amount of the risk of the project being placed on the contractor. However, depending upon market forces, a contractor will attempt to increase the contract price in accordance with the increase in risk. IS Where there is little competition, the employer may have to assume the cost of the increased risk placed on the contractor. Thus the employer may end up paying a higher overall price for the project due to the degree of risk that is placed on the contractor and the need for the contractor to price such risk. Indeed, this is the idea behind the risk transfer and the justification for such transfer. Whether the advantages of the turnkey contracting method will outweigh the disadvantages will depend primarily on the nature of the project in question and the identity of the parties involved. Naturally, the answer will also be influenced by the balance of power in the contracting relationship. The current employer-dominated market often results in greater risk being allocated to the contractor, without a commensurate increase in the contract price to the contractor.

(d)

(e)

(f)

(g)

(h)

(i) I~ IS 16

11 18

Construction Contracts, op. cit. n. 5 above, p. 409. I.N.D. Wallace, "Design-and-Build: a No-No for Owners" (1999) 4 Const. & Eng. L. 7 at 8. G. Westring, "Turnkey Heavy Plant Contracts from the Owner's Point of View", op. cit. n. 13 above at 236-238. For further discussion of risk allocation issues, see Chap. 21. P.O. Marsh, Contracting for Engineering and Construction Projects (Institute of Purchasing & Supply, 1988) at 252.

22

19 20 21

The definition of the scope of the works l9 : the parties will need to specify carefully the scope of the works and the employer's requirements. in order to define the contractor's liability for design, construction and performance. 20 Use of an engineer or employer's representative: the parties will need to decide how to make use of an engineer and his role (or the role of the employer's representative) in the execution of the project. Increases in the contract price: the lump-sum price is fixed, except to the extent that the contract provides for price increases for certain events or modifications. Due to the contractor control over the works, the employer may want to limit the. ability of the contractor to obtain such increases. Extensions of time for completion: the time for completion of the works, otherwise fixed, can be extended under certain circumstances. The employer may want to limit the scope of the contractor's right to obtain such extensions. Resp~nsibilit.y for employer-supplied designs: the risk of employersupplied desIgns should be specifically allocated as between the parties. 21 Employer's ris.ks: the contract will need to list the employer's risks, so as to proVIde a comprehensive allocation of such risk for the project. Performance guarantees: the parties will need to discuss the form and amount of the security provided by the contractor to the employer for performance of the contract. This security can take the form of ~ bank guarantee or other security and/or retention money. Completion: the contract should provide a definition of the extent and nature of completion required before the employer takes over the works. It should identify whether any performance tests are to be passed before or after such completion. Defects liability: the parties will need to decide the period of time

The definition of the scope of the works is found in the employer's requirements in the Silver Book. Under the Silver Book, the contractor is responsible for almost the totality of the risk assocIated WIth these phases of the process. Under the Silver Bo~k, the contractor is deemed to have scrutinised the employer's requirements and therefore IS generally responsIble for the accuracy of any designs provided in such requIrements (SIlver Book sub-clause 5.1).

23

2-14

TURNKEY AND EPC CONTRACTS

during which the contractor will be responsible for remedying any defect that may arise in the works. (j) Training of staff: to the extent training of staff is required, the parties will want to provide for a period of time during the contract period and before the employer takes possession of the works for the contractor to train the employer's staff. (k) Use of a consortium or a joint venture by the contractor: a consortium or joint venture of contractors may prove beneficial to the employer as they can provide more expertise as well as a broader base of liability for the completion of the works. However, the employer will need to ensure that the contractors agree to joint and several liability and elect a representative of the joint venture with sufficient decision-making power to facilitate interaction with the employer. (I) Regulation of labour to be used on site: including origin of staff, facilities to be supplied and the skill and experience to be required of such employees. (m) The organisation of the site: including the contractor's responsibilities for safety and protection, as well as sanitation and services such as water and electricity. (n) Effect of local law and regulations including allocation of the responsibility for obtaining permits and licences. (0) Patent and know-how rights and licences of the technology necessary for the completion of the works. The drafter of a turnkey contract will need to consider each of these points, among others. Allocation of risk for these issues should follow a reasonable assessment of the ability of the parties to bear the risk in question.

Standard Form Design-Build, Turnkey and EPC Contracts 2-15

Sectors that require a high degree of expertise and technicality, such as the construction sector, often engender the development of standard form contracts. 22 Such forms can be an important factor in reducing costs for the participants, as they represent a predictable and stable basis upon which parties can begin negotiating. 23 Indeed, some attribute the sophistication and existence of standard form contracts for design-build projects to be a measure of the popularity of this project delivery system. 24 When using standard form contracts, however, parties should always keep in mind the specificities of the project (which may make a particular contract less suitable) as well as the particularities of the governing law (which may denature, if not override, sometimes key provisions of the standard form contract). 22

C. Pedamon, "How is Convergence Best Achieved in International Project Finance?" (2001) 24 Fordham Int'/ L.}. 1272, online: LEXIS at 1294.

23

ibid. at 1298. M.L. McAlpine, op. cit. n. 10 above, online: LEXIS at 553.

2~

24

STANDARD FORM DESIGN- BUILD AND TURNKEY CONTRACTS

Over the past few years a number of standard form design, build, turnkey and EPC contracts have been published. These include: (a) (b) (c) (d) (e) (f) (g) (h) (i) (j)

the ENAA Model Form International Contract (1992); the ICE Design and Construct Conditions of Contract 2nd Ed. (2001); , the DBIA (1998); the AlA Contract Form A191 (1996); the AGC 415 (1994); the EIC Contract (1994); the FIDIC Orange Book (1995); the FIDIC Silver Book (1999); the FIDIC Yellow Book (1999); the FIDIC Red Book (1999).25

The above list is by no means exhaustive. A brief introduction to each of the listed contracts is set forth below. The ~~AA Contract Model Form, The Engineering Advancement Assocl~tlon of Japan (ENAA) is a non-profit organisation that was established 10 August 1978 and supported by the Ministry of Economy, Trade and I~dustry.of J~~an and by various other national and local government agenCies, UniverSIties and research organisations. The Association has the support of numerous specialists from member companies as well as various experts in their respective fields. 26 ' . This book. refers .to the second edition of the ENAA model form published 10 1992, which reVised the first edition issued in October 1986. Volume 1 of the EN~A Model ~orm for Process Plant Construction is reproduced in the appendl~es of thiS book. The remaining four volumes, Samples of Appendices (Volume 2), Guide Notes (Volume 3), Work Procedures (Volume 4) and Alternative Form ~ithout Process Licence (Volume 5) are not reproduced. T~e form contract IS meant for use in connection with the design and construction .of process plants using the turnkey approach.27 In 1996 the ENAA published a standard form relating to Power Plant Turnkey Cont~a~ts. That edition consisted of three volumes: Agreement and General Condlt1ons (Volume 1), Samples of Appendices (Volume 2) and Guide Notes (Volume 3). It has not been reviewed for the purposes of this book.28 The ICE Design and Construct Conditions of Contract. This model contract :-vas drafted by the Conditions of Contract Standing Joint Committee which IS the permanent joint committee of the Institute of Civil Engineers (ICE), the l':I0te that, although not a turnkey contract, for comparison purposes this book will also con. SIder the terms of the Red Book. ~; jay~es, ".Turnkey Contracts: japan's Model Forms" (1993) 10 I.C.L.R. 251 at 253. Engmeermg Advancem~nt Association of japan, Model Form International Contract for 28 Process Plant ConstructIOn, Volume 3 Guide Notes (1992), p. 1. T~es~ fo~ms m~y ~ obtained by contacting the ENAA at GECIENAA, CYD Bldg. 1-4-6, NIshI Shmbashl,. Mmato-ku, Tokyo 105-0003, japan; telephone +81 35024441; fax +81 3502 5500; emaIl [email protected]. 25

25

2-16

2-17

STANDARD FORM DESIGN-BUILD AND TURNKEY CONTRACTS

TURNKEY AND EPC CONTRACTS

design-build method of contracting, the AGC first published a set of standardised design-build contracts in the early 1990s. 36 In 1999 the AGC published the standard form contract AGC 415 to be used as a follow-on document to the 1999 edition of AGC 400. Unlike its predecessor, AGC 415 is not intended as a stand-alone agreement, but rather assumes that schematic design documents plus a preliminary estimate and schedule (i.e. the work product of AGC 400) is part of the owner's program provided in AGC 415. The revision of AGC 415 was developed with the advice and cooperation of the AGC Private Industry Advisory Council which council is comprised of a number of Fortune 500 owners' design and construction managers who meet with AGC contractors to discuss issues of mutual concern. 37

Association of Consulting Engineers and the Federation of Civil Engineering Contractors. This drafting body has a long history in and experience of traditional forms of contract, including, most recently, the ICE Minor Works 3rd edition (2001) and the ICE Conditions of Contract, 7th edition (2001). The ICE Design and Construct Contract 2nd edition, referred to here as the ICE Contract, is based on the traditional form contracts of the ICE and adapted for use in connection with the design and construction of civil engineering works. The second edition of the ICE contract reflects certain changes made in light of "legislative change and [... 1evolution of working practice".29 2-18

2-19

2-20

The DBIA Agreement Between Owner and Design-Builder-Lump Sum. The Design-Build Institute of America (DBIA) was founded in 1993 in order to promote the design-build project delivery process throughout industry and government in the United States. 30 In 1998 the DBIA published Document No. 525, Standard Form Agreement Between Owner and Design-Builder-Lump Sum. This form is examined in this book, along with Document No. 535, a Standard Form of General Conditions of Contract Between Owner and Design-Builder, which complements this document.

The European International Contractors Turnkey Contract. The European International Contractors (EIC) is associated with the FIEC (Federation de l'Industrie Europeenne de la Construction) and the CICA (Confederation of International Contractors' Associations). Its membership includes 15 construction industry federations in 15 different European countries. 38

2-21

The FII~IC Design-Build and Turnkey (Orange Book). Created in 1913, the Federation Internationale des Ingenieurs-Conseils (FIDIC) represents national associations of consulting engineers. It maintains its seat and secretariat in Lausanne, Switzerland. The first FIDIC conditions of contract were published in 1957 with the aid of the Federation lnternationale du Batiment et des Travaux Publics (FIBTP). The (1995) Orange Book represents the fifth FIDIC form of contract. It is intended for use with international design and construct contracts.

2-22

The FIDIC Plant and Design-Build (Yellow Book). The (1999) Yellow Book (first edition) is based both on its predecessor (the (old) Yellow Book) and on the Orange Book. 39 The Yellow Book is intended "for plant and for building and engineering works designed by (or on behalf of) the Contractor where, nonetheless, the Employer may have executed some design".4o

2-23

The AGC Document 415 Standard Form of Design-Build AgreementLump Sum. The Associated General Contractors of America was formed in 1918 with the intention, amongst others, to adopt standard form construction contracts "which would equitably divide responsibilities and risks and assure fair competition for works". 35 In response to a renewed interest in the

The FIDIC Construction (Red Book). The (1999) Red Book (first edition) is based on its predecessor (the (old) Red Book) and is intended to be "suitable for building and civil or other engineering works designed by the Employer or by his representative, the Engineer" .4!

2-24

Online: The ICE http://www.ice.org.uklnavigationlindex_news.asp?page=/newsI pressarchive.asp Online: The DBIA http://www.dbia.org/aulindex.html(date accessed: August 16, 2001); online: The DBIA hrrp:/lwww.dbia.org/aulmission.html(date accessed: August 16,2001). R.J. Smith, "Risk Identification and Allocation: Saving Money by Improving Conrracts and Contracting Practices" (1995) 12 I.C.L.R. 40 at 58. M.L. McAlpine, op. cit. n. 10 above, online: LEXIS at 558. American Institute of Architects, Form A 191 Instruction Sheer at 1. J.E Butler, "Protecting Owner with Conrract Clauses" in R.E Cushman & K.S. Taub (eds), Design-Build Contracting Handbook (Wiley Law Publications, New York, 1992),253 at 255. T.J. Stipanowich, "Reconstructing Construction Law: Reality and Reform in a Transactional

System" (1998) Wis. L. Rev. 463, online: LEXIS at 485 n. 74 citing in turn Booth Mooney Builders (or Progress 6 (1965). ' , ~; M.L. McAlpine, op. cit. n. 10 above, online: LEXIS at 553. AGC Document 415 Instruction sheet. 38 Dr J.J. Goudsmit, . "The EIC (European International Contractors) Turnkey Contract 39 (Co?dltlons for DeSIgn and Construct Projects)" (1995) 12 I.C.L.R. 23. Online: FIDIC http://www.fidlc.org/resources/contracts/courses.asp (date accessed, April 4 2001. . ,

The AlA Form A191. The American Institute of Architects (AlA) is a national association of architects whose form contracts for design-build projects are a standard in the construction industry of the United States. 3! AlA contracts are particularly well suited for architectural projects. 32 The AlA A191 Standard Form of Agreement Between Owner and Design/Builder is for use where the employer contracts directly with one entity for both design and construction services. 33 The AlA A191 is a two-part agreement, developing the project and the design through two separate agreements, one for preliminary design and budgeting and one for final design and construction. 34 This structure and the guiding concepts of this form are markedly different from the approaches of the other standard forms examined in this book.

29

30 31

I

32 33 34 35

26

40

41

C. Wade, "~istory and Scope of the Three Major Books" (1998) online: FIDIC http://www.fidlc.comldocumentsllaunchlwade1.html(date accessed: November 19 1999) at 2 ibid. at 2. ' .

27

TURNKEY AND EPC CONTRACTS

2-25

Due to significant changes between the two versions of the Yellow and Red Book contracts, FIDIC issued the new contracts as first editions. CHAPTER

The FIDIC EPC and Turnkey Projects (Silver Book), The Silver Book (1999 first edition) was issued for EPC Turnkey Projects and is suitable for BOT projects as well as process plant projects (such as E&M, or electrical and mechanical, projects).42 The Silver Book provisions arguably reflect industry practice at the expense of FIDIC's traditional even-handed approach. 43 Under the Silver Book, the contractor takes a higher degree of risk and, therefore, the construction time and cost are more certain. 44

31

FIDIC DESIGN-BUILD, TURNKEY AND EPC CONTRACTS Introduction Over the past 40 years, the Federation Internationale des IngenieursConseils (FIDIC) has developed an unparalleled reputation as the leading body for the development of model standard form contracts for use in the international construction industry. In September 1998, FIDIC published four new or revised standard form contracts comprising new editions of two existing forms-the Red Book 2 and the Yellow Book 3-and two completely new forms-the Silver Book4 and the Green Book. s Definitive editions of these contracts were published in 1999. Previously, FIDIC had in place two contracts that were based on the nature of the works: broadly speaking, the Red Book (fourth edition)6 dealt with civil engineering works and the Yellow Book (third editionj7 with electrical and mechanical works (in both instances, the employer and/or the engineer either supplied the design or played a central role in producing it). FIDIC prepared the Orange Book (first edition)8 to provide a contract where the contractor supplied the design and took single-point completion responsibility. The Orange Book, unlike the old Red and Yellow Books, contemplates the use of an employer's representative and does not use the term "Engineer". The new Red and Yellow Books have shifted this perspective to contracts based on the relationship between the parties, particularly with reference to which party takes responsibility for the design. 9 The revised Red Book is now primarily focused on those situations where the employer will supply A previous version of this chapter (in anticipation of the publication of this edition) first appeared in (1999) I.C.L.R. 27 and was co-authored by Joseph A. Huse and Jonathan Kay Hoyle. 2 Conditions of Contract for Construction (for Building and Engineering Works Designed by the Employer) (1998). J Conditions of Contract for Plant and Design-Build (for Electrical and Mechanical Plant and for Building and Engineering Works Designed by the Contractor) (1998). • Conditions of Contract for EPC Turnkey Projects (1998). S The New Short Form of Contract (1998). 6 Conditions of Contract For Works of Civil Engineering Construction (1992). 7 Conditions of Contract for Electrical and Mechanical Works (1998). S Conditions of Contract for Design-Build and Turnkey (1995). • See also the comments of Christopher Wade in his paper "History and Scope of The Three Major New Books" in FIDIC's New Standard Forms of Contract, IBC U.K. Conferences Limited. 1

42

43 44

ibid. at 5. ibid. at 4; see generally C. Wade, "The Silver Book: The Reality" (2001) 18 (3) I.C.L.R. 497. Online: FIDIC www.fidic.orglresources/contracts/courses.asp (date accessed: April 4, 2001).

28

29

3-01

3-02

FROM THE ORANGE BOOK TO THE NEW YELLOW BOOK

FIDIC DESIGN-BUILD, TURNKEY AND EPC CONTRACTS

3-03

the design (and an engineer will be used) and the new Yellow Book on those situations where the contractor supplies the design (and an engineer will be used). By contrast, the Silver Book is intended to deal with something entirely new in FIOIC's scheme: an EPCIO turnkey contract where the contractor takes responsibility for design and the contract is on a strictly two-party basis (that is to say, there is no intermediary such as the engineer). The new FIOIC contracts are harmonised around the same basic format: that of the Orange Book. Therefore, the new Red, Yellow and Silver Books are now all structured in the same way: the 20 clauses of the Orange Book taking account of the particulars of each contract. This harmonisation has extended to the language of the contracts. Much of the basic Orange Book language has been retained in the three contracts. The author welcomes, for the most part, the specific drafting changes to, for example, the new Yellow Book (as compared to the Orange Book) that FlOIC has undertaken. However, he questions the rationale used in developing the new Yellow Book and Silver Book, particularly in light of their relationship to the existing Orange Book and the role they will playas design-build contracts.!! This chapter will first provide some preliminary comments on the new Yellow Book and the Silver Book. The chapter will then consider FIDIC's overall approach to design-builditurnkey/EPC contracts and attempt to reach certain tentative conclusions regarding the policy underlying the new Yellow Book and the Silver Book. This chapter is not meant to constitute a detailed analysis of the language of the new Yellow Book and the Silver Book, which may be found in subsequent chapters.

From the Orange Book to the New Yellow Book 3-04

The following analysis will first describe certain (but not all) of the major changes made to the drafting of the Orange Book in the development of the new Yellow Book. It questions whether, instead of drafting the new Yellow Book, FIDIC should simply have prepared a second edition of the Orange Book. All parenthetical clause references are references to clauses in the Yellow Book.

Major drafting changes

3-05

"Defects Notification Period" (Sub-clause 1.1.3.7). This definition is not in the Orange Book. The concept of the contract period in the Orange Book

10 II

Engineering, Procurement and Construction. For further discussion of this term see para. 3-32 below. FIDIC now has three design·build contracts: the Orange Book, the New Yellow Book and the Silver Book.

30

has been removed (something the author welcomes). The period is defined as one within which defects are notified and runs from the date on which the works are certified as being complete. Assignment (Sub-clause 1.7). Surprisingly, the Orange Book did not contain any general language concerning assignment. This omission has been corrected in the new Yellow Book. Neither party can assign any "benefit or interest" without the prior agreement of the other party. However, they can assign, as security, the right to money due under the contract to a "bank or financial institution". This is clearly a sensible addition.

3-06

Compliance with Laws (Sub-clause 1.13). Under the new Yellow Book scheme the employer has been given responsibility for obtaining "the planning, zoning or similar permission for the Permanent Works, and any other permissions described in the Employer's Requirements".

3-07

Employer's Financial Arrangements (Sub-clause 2.4). This sub-clause is not in the Orange Book. The employer must furnish "re~sonable evidence" after a request from the contractor that the financial arrangements for the project have been made and are being maintained. This seems a fair measure-the contractor should have a means of satisfying himself, if the need arises, that the employer is capable of paying. However, the sub-clause leaves open the issue of what constitutes reasonable evidence. This ambiguity is particularly important given the remedy that the contractor has if he is not satisfied by the employer's evidence.!2

3-08

Employer's Claims (Sub-clause 2.5). This sub-clause is not found in the Orange Book. It mirrors the formal requirements placed on the contractor by making the employer follow a claims procedure for certain payments he wishes to obtain from the contractor or any extension of the defects notification period. The employer must present a notice to the contractor after which the engineer determines the claim on the basis of the particulars supplied.

3-09

The Engineer (Clause 3). The employer's representative in the Orange Book is replaced, in the new Yellow Book, by an engineer; however, his powers and duties under the contract are broadly similar to those of the employer's representative (for example, the first determination of extensions of time and extra cost, certification of payments, issue of the taking-over and performance certificates). As under the Orange Book, he does not have the authority to amend the contract, he must be suitably qualified and he may delegate his duties to an assistant. There are limited differences between the role of the engineer and that of the employer's representative (for example, sub-clause 3.4); however, most

3-10

12

See Clause 16 (Default of Employer) of the Yellow Book. The contractor is entitled to termi. nate the contract if he does not receive reasonable evidence within 42 days after giving notice.

31

FROM THE ORANGE BOOK TO THE NEW YELLOW BOOK

FIDIC DESIGN-BUILD, TURNKEY AND EPC CONTRACTS

of these differences are due to the drafting and best practice changes, many of which are described in this section (paragraph 3-05 et seq.). The author also notes that under sub-clause 3.2 of the Orange Book the employer's representative shall be a suitably qualified engineer or other appropriate professional and that under sub-clause 3.1 of the new Yellow Book the engineer is deemed to act on behalf of the employer.

3-11

Training (Sub-clause 5.5). This sub-clause is not found in the Orange Book and is a welcome addition. It sets up a regime for the contractor to train the personnel for operation and maintenance of the plant. The contractor is often best placed to carry out such training.

3-12

Testing (Sub-clause 7.4). The testing regime has been modified under the new Yellow Book. The employer now has the express right to vary the location or details of the tests by means of a variation. If the varied or additional tests show that the plant, materials or workmanship are not in accordance with the contract then the contractor pays the costs of carrying out the variation. This clause also contains a provision allowing the contractor to claim extra cost and time when "complying with the Employer's instructions (to refrain from proceeding with the tests) or as a result of a delay for which the Employer is responsible".

3-13

3-14

3-15

Remedial Work (Sub-clause 7.6). This is an entirely new sub-clause in the new Yellow Book. It provides that the contractor may now be asked to carry out remedial work on any plant and materials by removal, substitution or re-execution of the work. The contractor must comply with any such instruction irrespective of whether he intends to challenge its validity. Programme (Sub-clause 8.3). The programme provisions have been restructured and modified in order, presumably to take account of what FIDIC considers to be current best practice. Broadly, the contractor now has a duty to submit revised programmes when the operative programme is inconsistent with current progress or with the contractor's obligations. The contractor must now warn the engineer of "probable future events or circumstances which may adversely affect the work".13 Extension of Time for Completion (Sub-clause 8.4). In the new Yellow Book, two grounds for claiming an extension of time have been added to the Orange Book scheme. First, the contractor is able to claim for "unforeseeable climatic conditions"; secondly, he can claim for "unforeseeable shortages in the availability of personnel or Goods caused by epidemic, changes in Law or other governmental actions".

IJ

However, the language in the Orange Book relating to precedence networking techniques has been removed.

32

Tests on Completion (Clause 9). The new Yellow Book wording now takes account of three phases:

3-16

(i)

pre-commissioning tests including appropriate inspections and functional tests; (ii) commissioning tests including specified operational tests; and (iii) trial operation (it is made clear that trial operation does not constitute taking-over).

If any of the tests on completion have been unduly delayed by the employer then the contractor may claim an extension of time for completion and extra cost. In the event that the plant fails to pass the tests on completion then the employer has the same remedies as under the Orange Book.14 However, rejection of the works is no longer an unfettered right; it has been qualified by whether such failure deprives the employer of "substantially the whole benefit of the Works". Adjustments for Changes in Cost (Sub-clause 13.8). This sub-clause provides for the possibility of price adjustment in the new Yellow Book for "cost of labour, Goods and other inputs to the Works". This provision is optional ("if this Sub-Clause applies"); see, however, the similar clause in Part II of the Orange Book.

3-17

Insurance (Clause 18). There have been a number of changes to the insurance scheme under the new Yellow Book but perhaps the most noteworthy is that the contractor is no longer required to take out insurance for his design.

3-18

Force Majeure (Clause 19). The framework for force majeure under the Orange Book contains a number of unsatisfactory features. IS Under the new Yellow Book, there has been a wholesale reworking. Important changes have been made to what constitutes force ma;eure. 16 The insistence in the Orange Book of a force majeure event having to be beyond the control of both parties has been removed. The test has now become one based on an event which:

3-19

(i) (ii)

is beyond a party's control; could not reasonably be provided against before entering into the contract; (iii) could not be reasonably avoided or overcome; and (iv) was not "substantially" attributable to the other party. I. See sub-clause 9.4 Orange Book. The remedies are: (i) further repetition of tests, (ii) rejectIon of the works or section, and (iii) issuance of a taking-over certificate plus an agreed reduction in the contract price. IS See sub-clause 19.1 of the Orange Book. Note, for example, the concept of impossibility. 16 Changes that appear to be based on model wording set out by the International Chamber of Commerce (ICC) in Paris. Brochure No 421. See also the comments of Christopher Seppala in his paper "Risks, Force Majeure, Claims, Disputes and their Resolution" FIDIC's Four New Standard Forms of Contract, !BC U.K. Conferences Limited.

33

FROM THE NEW YELLOW BOOK TO THE SILVER BOOK

FIDIC DESIGN-BUILD, TURNKEY AND Erc CONTRACTS

Two examples of force majeure have been added-the operation of forces of nature and change in law.

Is the new Yellow Book a good idea?

3-20

3-21

FIDIC states that the Orange Book is suitable for works "which may include any combination of engineering (including civil, mechanical and electrical) and building works" (emphasis added)Y By comparison, the new Yellow Book is recommended "for the provision of electrical and/or mechanical plant, and for the design and execution of building or engineering works". The basis of the contract is stated to be that the contractor "designs and provides, in accordance with the employer's requirements, plant or other works which may include any combination of civil, mechanical, electrical and/or construction works" (emphasis added).18 From this standpoint, with the exception of the use of the term "Engineer", there would seem to be little to differentiate the aims of the new Yellow Book from the Orange Book. As discussed above, the role of the "Engineer" under the new Yellow Book is broadly similar to the role of the "Employer's Representative" under the Orange Book. Aside from the confusion that may be caused by use of the term "Engineer" in this context, it is also surprising from an historical perspective. In early drafts of the Orange Book, FIDIC had included the term "Engineer" but the term was deleted before the issue of the test edition. From a design and build perspective, the changes described in paragraph 3-05 et seq. above cannot be considered as radical. In this regard, the allocation of risk has remained broadly the same as the Orange Book. In certain limited instances, additional risk has been placed on the contractor-for example, it is now the contractor's responsibility to ensure that personnel are properly trained to operate the plant and he now has an express obligation with respect to remedial work. In certain limited instances, the employer has been allocated additional risk-for example, the employer takes the risk of obtaining planning and zoning permission for the works. In some cases, changes have modified procedures but not significantly shifted risk from one party to the other-for example, the tests on completion now comprise three phases including trial operation. On the basis of this comparison of aims and the actual drafting changes in the new Yellow Book, it is arguable that there is little essential difference between the Orange Book and the new Yellow Book-both are design-build contractS-that place substantial risk on the contractor. Consequently, it would seem legitimate to pose two questions: (i) (ii)

why did FIDIC go back to the use of the term "Engineer" in the design-build context; and why did FIDIC simply not issue a second edition of the Orange Book?

I 17 18

See the introduction to the Orange Book (1st edition). See the introduction to the new Yellow Book.

34

From the New Yellow Book to the Silver Book The following analysis will first describe certain (but not all) of the major differences between the new Yellow Book and the Silver Book and then query whether similar changes should also have been made to the new Yellow Book and the Orange Book. All parenthetical clause references are references to clauses in the Silver Book. The reader should note that virtually all of the changes described in paragraph 3-05 et seq. above, with the exception of those in respect of the "Engineer", "Adjustments for Changes in Costs" and "Extension of Time for Completion", have been included in the Silver Book.

3-22

Major drafting changes Employer's Administration (Clause 3). Consistent with FIDIC's stated aim of making a strict two-party contract, the role of the engineer or employer's representative has been removed. The employer deals directly with the contractor; for example, the employer determines in the first instance claims for extra cost and/or extension of time. However, the employer has the option of having a representative if he so wishes and he may delegate any authority to such a representative.

3-23

Setting Out (Sub-clause 4.7). The contractor now takes responsibility for "the correct positioning of all parts of the Works, and shall rectify any error in the positions, levels and dimensions or alignment of the Works". The corresponding provision of the new Yellow Book-according to which the employer is responsible for any errors "in these specified or notified items of reference" and the contractor may, under certain circumstances, seek an extension of time or extra cost if extra work is necessary as a result of such errors-has been deleted.

3-24

Site Data (Sub-clause 4.10). The contractor is responsible for verifying as well as interpreting all relevant data in the employer's possession, made available to the contractor, on hydrological and sub-surface conditions at the site. The corresponding provision of the new Yellow Book does not contain any such obligation on the contractor in respect of the verification of the data.

3-25

Unforeseeable Difficulties (Sub-clause 4.12). Under the new Yellow Book, the contractor may obtain extra time or cost in the event that he encounters unforeseeable sub-surface conditions. Under the Silver Book, the contractor is deemed to have taken account of all necessary information; furthermore, the contract price is not adjusted "to take account of any unforeseen difficulties or costs" (emphasis added) except as otherwise

3-26

35

FROM THE NEW YELLOW BOOK TO THE SILVER BOOK

FlOIC DESIGN-BUILD, TURNKEY AND EPC CONTRACTS

stated in the contract. Contractors will argue that this is an unreasonable allocation of risk.

3-27

Design Obligations (Sub-clause 5.1). Under the Silver Book, the contractor has been allocated almost all of the design risk. The contractor is deemed to have taken account of the employer's requirements and he is "responsible for the design of the Works and for the accuracy and completeness of the Employer's Requirements (including design and calculations)". Thus, as under the ICE19 design-build contract, the contractor's risk with respect to design includes not only his design for the works but also the employer's requirements generally. The employer also disclaims any responsibility for information given to the contractor. The above responsibility is, however, tempered by the addition of wording identifying three parts of the employer's requirements for which the employer remains responsible: (i) the definitions of intended purposes of the works; (ii) criteria for testing and performance of the works; and (iii) any other portions of the works for which the employer is responsible under the contract.

3-28

Taking Over of Parts of the Works (Sub-clause 10.2). Under the Silver Book, there is a simple bar on early taking-over or use of parts of the works by the employer subject to the agreement of the parties.

3-29

Tests after Completion (Clause 12). The Silver Book provides that the contractor is responsible for carrying out the tests after completion.

3-30

The Contract Price (Clause 14). The payment structure of the Silver Book is different from the new Yellow Book. The concept of certification has been dropped; it has been replaced by interim payments (although both the new Yellow Book and the Silver Book have the same system of statements for showing the amounts due). This is consistent with the direct relationship between the employer and the contractor contemplated by the Silver Book.

3-31

I

Employer's Risks (Sub-clause 17.3). There are three areas of risk which the Silver Book has not retained as employer's risks from the new Yellow Book scheme. First, use or occupation by the employer of any part of the works, presumably on the basis that the employer is barred from using the works except as agreed between the parties. Second, design of any part of the works by the employer's staff and personnel, on the basis that the contractor takes all the design risk. Third, any operation of the forces of nature which is not reasonably foreseeable.

Is the Silver Book a good idea? The Silver Book, according to FIDIC, would appear to be designed for a specific role. It is described as being a contract for "EPC Turnkey Projects". It would be inappropriate to place any exaggerated emphasis on the nomenclature "EPC!Turnkey". FIDIC has, until now, placed no special emphasis on the use of the word "turnkey". As far back as 1995, in the introduction to the Orange Book, it was stated that "there are no universallyaccepted definitions of the terms 'design-build' and 'turnkey', except that both involve the Contractor's total liability for design" (emphasis added). In as much as a distinction was made it rested on turnkey contracts being the provision of a "fully-equipped facility, ready for operation and ... typically includ[ingJ design, construction, fixtures, fittings and equipment the scope of which would be defined in the contract documents" .20 Likewise with the term "EPC"; it is simply an acronym for "Engineering, Procurement and Construction" . FIDIC has set out in the introduction to the Silver Book what it believes to be the key concept of an "EPC" contract for use in a project finance context. It states that such projects require greater certainty about cost and, therefore, final price than is ordinarily the case (generally driven by the concern of lenders). Consequently, it is necessary for the contractor "to assume responsibility for a wider range of risks than under the traditional Red and Yellow Books" -all in the name of greater cost certainty. Thus, FIDIC seems to be putting forward the Silver Book as a design-build/turnkey with greater price certainty that will be acceptable to the employer (and lenders) for such a project. However, it goes on to state that the Silver Book is suitable for projects "where the government departments or private developers wish to implement their project on a fixed-price turnkey basis and with a strictly two party approach" (emphasis added). As can be seen from the previous section, the Silver Book places greater risk on the contractor than the Orange Book or the new Yellow Book. In the areas of site data, unforeseeable conditions and design, the contractor is allocated substantially all of the risk (apart from the intended purpose of the employer's requirements and the testing criteria). However, the number of such changes remains relatively small. With the exception of the role of the engineer/employer's representative and the related issue of certification of payment, the rest of the Silver Book does not appear to be fundamentally different from the Orange Book and the new Yellow Book. Furthermore, it is arguable that the scope of the changes that FIDIe has included in the Silver Book as compared to the Yellow Book are not sufficient to make the contract a "project finance" construction contract. In this regard, FIDIC states in the introduction to the test edition, that the contract "may need to be adapted to take account of the special, if not unique, 20

19

The Institution of Civil Engineers Design and Construct Conditions of Contract (1999), sub. clause 8(2)(b)_

36

See Hudson, Building and Engineering Contracts (11th ed., 1995), section 3.026 pp. 426-428, where the editor suggests that the expressions "turnkey" and "design-and-build" can now be said to be synonymous.

37

3-32

3-33

FIDIC DESIGN-BUILD, TURNKEY AND EPC CONTRACTS

characteristics of each project, as well as the requirements of lenders and others providing financing". 21

FIDIC Policy on Design-build, Turnkey and EPC 3-34

3-35

From the wider perspective of strategy and policy there appears to be some confusion over how the FIDIC "design and build" contracts (i.e. the Orange Book, the new Yellow Book and the Silver Book) will operate in practicethat is to say, how these contracts conceptually fit together and in which circumstances it would be appropriate to use each of them. FIDIC has chosen not to update the Orange Book. While the contract has been used as the basis of the drafting of the new Yellow Book and the Silver Book, the Orange Book itself has not been the subject of the new modifications. On this basis, the Orange Book would seem no longer to represent best practice and therefore should not be used unmodified. This policy of benign neglect towards the Orange Book is somewhat puzzling. The Orange Book had started to gain market acceptance and FIDIC is simply not in the habit of launching and then discarding form contracts. 22 The new Yellow Book has made a number of changes to the present Orange Book; these changes could be described as (i) minor drafting changes and (ii) incorporation of best practice. One of the few major conceptual changes is that the new Yellow Book now makes use of the term "Engineer". Yet, in fact, when the engineer's role under the new Yellow Book is examined it turns out to be quite similar to that of the employer's representative under the Orange Book. However, the use of the term "Engineer" may cause potential users to avoid adopting the contract. The Silver Book itself is largely based on the new Yellow Book. One major difference is that the engineer has been removed in order to make the contract a "two-party" contract-although in the event that the employer chooses to use a representative he presumably could have powers similar to those of the representative under the Orange Book. Another major difference is that additional risk has been placed on the contractor. However, FIDIC is also apparently keen to promote the Silver Book as a fixed-price turnkey contract on a two-party basis not limited to project financing. From this it would appear that FIDIC has not decided whether these changes regarding additional risk constitute "best practice" or constitute necessary modifications purely in a project financing context. 23 If FIDIC believes that such changes constitute best practice, it should also have made corresponding changes to the new Yellow Book and the Orange Book. However, it is 21 22

23

FIDIC POLICY ON DESIGN-BUILD, TURNKEY AND EPC

unlikely that contractors will agree that such changes should in fact be characterised as best practice, particularly when they are imposed outside of a project finance context. With these considerations in mind, the author has to wonder whether it would not have been more appropriate to update the Orange Book as FIDIC's flagship "design and build" contract and take account of its project finance applications in an expanded set of particular conditions.

Conclusions FIDIC is to be applauded for its decision to harmonise the basic structure and wording of the new Red, Yellow and Silver Books around one model. FIDIC is also to be congratulated on making a comprehensive attempt to make the new design-build contracts consonant with best practice. The author broadly welcomes the quality of the changes made to the drafting of the Orange Book in the development of the new Yellow Book and the Silver Book-although it is to be expected that employers and contractors will have differing views as to the appropriateness of certain of these modifications. However, the author queries why FIDIC went back to the use of the term "Engineer" in the design-build context and why it did not issue a revised version of the Orange Book instead of issuing the new Yellow Book. The Silver Book retains the changes made to the new Yellow Book but with a strict two-party approach. The Silver Book places completion risk on the contractor additional to that contemplated by the new Yellow Book and the Orange Book. FIDIC states that the Silver Book is suitable for all fixedprice turnkey projects (with a two-party approach). FIDIC apparently believes that the provisions regarding allocation of additional risk to the contractor constitute best practice for all such projects, and not just projects financed on a '"project finance" basis. If this is the case the author does not share FIDIC's view. Further, if indeed this is FIDIC's view then corresponding changes in the new Yellow Book and the Orange Book should have been made as well. If, however, FIDIC believes that the Silver Book is suitable for all such projects except that the allocation of additional risk provisions should be implemented only in the project finance context, then FIDIC could have prepared special conditions to the appropriare standard form design. build contract reflecting this approach.

For further discussion on this point, see Chap. 4. Wade comments that although the Orange Book has been superseded, in practice superseded FIDIC contracts continue to be used by certain parties years after a new edition has been published. C. Wade, "The Silver Book: The Reality" (2001) 18 (3) I.C.L.R. 497. For discussion and defence of the rationale behind FIDIC's introduction to the Silver Book, see ibid.

38

39

3-36

3-37

CHAPTER

4

THE USE OF THE FIDIC SILVER BOOK IN THE CONTEXT OF A BOT PROJECT1 Introduction In August of 1.999, the Federation Internationale des Ingenieurs-Conseils ("FIDIC") published the first edition of its Conditions of Contract for EPCffurnkey Projects, commonly referred to as the "Silver Book". In the Introductory Note to the Silver Book, FIDIC states that the Silver Book is intended to be suitable, in particular, for BOT and similar type projects. This chapter will identify important issues and generally discuss the suitability of the Silver Book in BOT-type projects. It will begin by providing a description of a typical BOT power project, then discuss issues of risk allocation in such projects and conclude with an examination of the relevant provisions of the Silver Book as they relate to the BOT method.

t

Description of a BOT Project

The term "build-operate-transfer" or "BOT" is used to identify a particular type of project, generally falling within the broa'der category of project financing. In project finance, as the term is now commonly used, a project is developed and financed on a non-recourse or limited recourse basis. Project lenders look primarily to the revenues generated by the completed facility for repayment of the loan and to all the project assets as security for the loan. Project finance differs from traditional loan structures in that lenders generally have recourse only to project assets or limited recourse to sponsor assets. Under the BOT model a particular country's government ("host government") identifies an infrastructure need, for example, a power generation facility. Potential sponsors organise in an effort to obtain a concession from the government through a bidding process. Under such a concession, the sponsors agree to build and own the project for a specified number of years and to then transfer ownership of the facility to the host government. The sponsors will organise into some type of special purpose vehicle ("project I

4-01

A version of this chapter (in ancticipation of the publication of this edition) first appeared in Huse, "The Use of the FIDIC Silver Book in the Context of a BOT Project" (2000) 17 I.C.L.R. 384.

J.

41

4-02

DESCRIPTION OF A BOT PROJECT

THE USE OF THE FIDIC SILVER BOOK IN THE CONTEXT OF A BOT PROJECT

4-03

company"), which will normally be a limited liability company. However, the choice of form will depend on the specific needs of the sponsors regarding taxation, risk and management requirements. It is interesting to note that the roots of project finance for government projects may be traced at least as far back as the period between the middle ages until the seventeenth century.2 The historical roots of this process indicate that it may remain a useful method of finance for times to come. The project company will be obligated under the concession agreement signed with the host country to design and construct the works, and possibly operate the works during the concession period. Once the facility is built, the project company will use the income generated by the facility'S operations to make repayments of the loans incurred for the construction process and operate the facility. Any extra revenue will be distributed to the shareholders as a return on their equity. At the end of the concession period, the project company transfers the facility back to the host country that granted the concession. Funds for the facility's construction are provided by loans from any mixture of commercial banks, export-credit agencies or multilateral agencies. Generally, one or several commercial banks will organise the loan facility as the arrangers. The loan will often then be syndicated in order to allow a number of lenders to participate in the credit facility and to distribute the risk among a greater number of lenders. The credit agreement signed between the project company and the lenders will be a key document in a BOT project because it may impose detailed requirements to be incorporated in the concession, construction and other agreements. Pledges of project assets as well as sponsor and other guarantees will be put in place as security for the loan. As indicated above, revenue from the project's operation will fund loan repayments. The reason for using project financing for the construction of large infrastructure projects is evident. The sources of direct financing available from the public sector are not presently sufficient to fund the infrastructure needs of many developing economies in regions such as Africa, Asia and Eastern Europe. In particular, certain infrastructure projects, such as electrical power generation, require a scale of investment beyond the capabilities of the governments of most emerging economies. 3 Even in developed countries, many governments are unwilling to use their scarce resources to fund projects. 4 2

C. Pedamon, "How is Convergence Best Achieved in International Project Finance?" (2001) 24 Fordham Int'J L.J. 1272, online: LEXIS at n. 3.

D. Blumental, "Sources of Funds and Risk Management for International Energy Projects" (1998) 16 Berk. J. Int'l Law 267, online: LEXIS at 296. • Perhaps an indication of the widespread or growing use of BOT financing structures, UNIDO published UNIDO, Guidelines for Infrastructure Development Through Build-OperateTransfer (BOT) Projects (UNIDO, Vienna, 1996) (IDISER.0/22); and UNCITRAL published UNCITRAL, Legislative Guide on Privately Financed Infrastructure Projects (UN, New York, 2001) (UNDOC. NCN.9/SER.B/4) online: UNCITRAL Homepage (pdf format) http://www.uncitral.org!englishltexts/procurem/pfip-index-e.htm (date accessed: July 16, 2001). For further discussion see Pedamon, op. cit., n. 2, ahove. J

I

42

Figure 4.1

4-04

The structure of a BOT project Shareholders

Shareholders' agreement

Credit agreement

Power purchase agreement

Concession agreement

O&M agreement

~--------~OPERATOR

Construction contract

Fuel supply agreement

CONTRACTOR

This shortage of such public funding and a belief that the construction and operation of the facility would be more efficiently managed by a private entity has led to the development of the BOT project finance mode!.s The BOT method of project finance is rapidly becoming the vehicle of choice for large-scale infrastructure projects. 6 The BOT concept theoretically allows .1

6

Other variants include the BOO (build-own-operate) and the BLT (build-lease-transfer). D.A. Levy, "BOT and Public Procurement: A Conceptual Framework" (1996) 7 Ind. Int'l & Camp. L. Rev. 9.1 at 96.

43

4-05

THE USE OF THE FIDIC SILVER BOOK IN THE CONTEXT OF A BOT PROJECT

governments to obtain needed infrastructure without using public funds. In addition, the government will assume much less risk as compared to the project company and the various lenders. Although critics in a number of countries have questioned whether the BOT format truly gives significant advantages in comparison with more traditional formats, it is being used on an increasing number of major infrastructure projects worldwide. This increased use of the BOT financing techniques has led to a greater awareness among infrastructure project participants of the need for careful risk analysis and allocation in structuring a successful BOT project. Figure 4.1 shows the structure of a typical BOT power project. Such projects generally require a complex contractual structure, including a construction element that reflects the numerous interlocking elements. 4-06 The shareholders' agreement (top of chart): this governs the relationship of the shareholders in the project company. The agreement will cover items such as the business of the project company, conditions precedent to its creation, the issue of shares and the management of the project company. 4-07 The credit agreement (upper left): this contains the terms and conditions pursuant to which the lenders agree to loan funds to the project company. The lenders to the project may include commercial banks, export credit agencies and multilateral lending institutions such as the World Bank. The credit agreement is of particular importance in the BOT context as the lenders will generally be responsible for financing a substantial portion of the project. A typical equity to financing ratio might be 30 per cent to 70 per cent, respectively. As a result of this funding, the lenders will usually have a substantial influence in the drafting of the other agreements involved in the BOT project with a view to limiting the risk they bear (in particular the concession agreement, the power purchase agreement and the turnkey construction contract). 4-08 The concession agreement (upper right): the government grants a concession to the project company for a fixed period, the concession period, for the operation of a project which would often otherwise belong to the public sector. The concession agreement may also provide the legal and tax regime applicable to the project and any environmental obligations of the project company. The terms of the concession will need to satisfy the requirements of all of the project participants, including the lenders. 4-09 The power purchase agreement (left): this is of primary importance in a BOT power generation project. It creates a contractual relationship between the power purchaser and the project company obligating the power purchaser to purchase a certain amount of electricity over a given time period. This obligation may be based on a take-or-pay regime, whereby the power purchaser must purchase a minimum amount of power at a certain price. If it does not purchase (or take) the minimum amount, it must nevertheless pay the price. The project company is obligated to provide a certain quantity of electricity over the given period, and the power purchaser's obligation is subject to the condition that the project company is capable of delivering the amount in question for the relevant period. 44

DESCRIPTION OF A BOT PROJECT

The power purchase agreement will provide sanctions, including liquidated damages, where the project company fails to deliver electricity as promised (in particular as a consequence of the power plant not being finished within the time for completion or not performing as required). Failure to deliver where the works are not maintained in a manner sufficient to ensure continued operation at the intended output levels may also result in liquidated damages being imposed on the project company. The duty to purchase output may also involve requirements that the power purchaser maintain transmission lines and a power grid sufficient to receive the power transmitted. One of the more significant risks in the power purchase agreement is the devaluation of the local currency. Lenders will often require loan repayments in a hard currency, such as U.S. dollars, and may require the project company to fix power purchase obligations in the currency of repayment, rather than in the local currency. This causes the power purchaser to assume the risk of changes in the exchange rate, namely devaluation of the local currency due to inflation or other events. Consequently, if the local currency is subject to significant value fluctuation it may require more local. currency for the power purchaser to purchase the fixed amount of power from the project company. Since consumer electricity rates are generally inflexible, the price charged to the consumer may be insufficient for the power purchaser to meet its power purchase obligations to the project company. This risk of default is very real, and the power purchaser's default may cause a default by the project company with regard to its loan repayments. However, it is possible for the project company and the power purchaser to share this risk. Nonetheless, default of the power purchaser is a primary risk to the success of a BOT power project. The fuel supply agreement (lower right): this obliges a fuel supplier to deliver periodically a given amount of fuel at a certain level of quality to the operator. This agreement allocates market risk involved in the price and availability of fuel to the fuel supplier. The terms of this agreement will be closely linked to those of the power purchase agreement and operation and maintenance agreement. The operation and maintenance agreement (right): the project company and other project participants will want to ensure proper operation of the works during the concession period. Thus the project company will enter into an operation and maintenance agreement with some entity (possibly one of the sponsors) to operate the facility. The maintenance obligations of the project company under the power purchase agreement will in large part be passed to the operator. The government will also want to ensure that the operator is bound to a strict maintenance programme to avoid degradation during the final phases of the concession. In some cases warranties will be given as to the state of the works at the time of transfer to the government. The construction contract (bottom): in a BOT project this is generally a turnkey construction contract, sometimes referred to as an EPC (engineering, procurement and construction) contract. The lenders, in search of security and certainty of exposure, generally require the use of turnkey contracts with a fixed lump-sum price placing the majority (and in some cases substantially all) of the completion risk on the contractor. Lenders may also require

45

4-10

4-11

4-12

ALLOCATION OF RISK

THE USE OF THE FIDIC SILVER BOOK IN THE CONTEXT OF A BOT PROJECT

4-13

that the contractor acknowledge and consent to the assignment of the employer's right under the contract to the lenders.7 Other contracts: Although not represented on the chart, the project company may also enter into certain external credit support arrangements, as required by the lenders. Some examples are direct agreements (consent agreements), collateral warranties, equity contribution agreements, subordinated loan agreements and sponsor guarantees. The project company will also need to have in place a stand-by credit facility because the costs of the project normally exceed the original contract price. This may involve primary loan facilities in an amount greater than the original contract price or some form of stand-by credit facility.

Allocation of Risk 4-14

4-15

As the focus of this work is the FlDIC Silver Book, the following discussion of risk allocation does not attempt to cover all the risks to all the parties in a BOT project. Much of the risk allocation will occur in contracts other than the construction contract, such as the concession and the power purchase agreement. However, some aspects of risk allocation can be discussed generally before moving on to a more specific discussion of the FIOIC Silver Book provisions. The assessment of which parties will be affected by a particular element of risk, and in what way, will be quite complicated and difficult to clarify since many project participants typically assume several project roles (for example, the turnkey contractor may also be one of the shareholders of the project company and/or the operator). In most projects, the following risk allocation operates: market risk will be assumed by the project company (and the power purchaser to a limited degree-for example, in a power project); design, construction and commissioning risk will be assumed by the contractor; and operation and maintenance-related risk will be assumed by the operator. The majority of political risk, such as events of war, rebellion and delays by authorities, will generally be allocated to the government through the concession agreement. It is appropriate that the government accepts such risk as they are the sole party who could control it (by direct influence) and mitigate its effects. Any residual risk will be borne, in the first instance, by the project company, which will frequently attempt to transfer this risk to the host government. The project lenders, positioned as they are behind the project company, will want to limit their assumption of any risk, but will generally be unable to displace all of it.

I 7

B. De Cazalet & R. Reece, "The New FIDIC EPC BOT Contract" (1999) Project Finance Inf/, online: FIDIC http://www.fidic.orglresourceslcontractslbot_ pfi_ nov99.asp (date accessed: July 4, 2001) at 6.

46

Provisions that deal with risk allocation may be drafted so as to mirror the language of the concession, and other agreements, (e.g. power purchase). This will generally have to take account of considerations such as identical language for force majeure and extensions of time (e.g. for the project company under the concession agreement and the turnkey contractor). Such back-to-back language reduces the scope for ambiguity and gaps between the various agreements. However, in order for it to function effectively the governing law and dispute resolution clauses need to be identical. For example, to save time and money and to avoid the risk of conflicting decisions, the employer "may wish to try to find a way of involving the contractor in dispute resolution proceedings with the grantor or otherwise to oblige the contractor to accept findings made in:such proceedings". 8 A practical solution to such difficulties is to include "if and when" language in the turnkey contract-for example, the turnkey contract may state that the contractor is entitled to extensions of time, under certain circumstances, if and when such extensions are granted to the project company under the concession agreement. Few projects appear to implement such arrangements. The project company may also wish to see an overriding provision in the turnkey contract such that the contractor is under an obligation to perform so that the project company is not in breach of its obligations in the concession and other project agreements. Completion risk, containing elements of design, construction and commissioning risk as well as other residual risk, will be a factor for all of the principal project participants. A certain number of them will typically bear the greatest level of such risk (in particular, the Contractor), but even the power purchaser may end up bearing some of the completion risk. The allocation of risk for lenders is further affected by the recourse that is open to them with regard to the financing of the project. The financing may be recourse, non-recourse or limited recourse. Recourse financing provides the lenders with full recourse to the assets of the shareholders (or other project participants) in the event of default on repayment of the loan by the project company. Non-recourse financing limits the lenders' recourse to the assets of the project at hand. Limited recourse financing provides the lenders with recourse to the assets of the shareholders up to a limited maximum amount and over a limited period of time (although such financing may be structured in a variety of ways). In a limited recourse financing, the period of recourse may be limited to the period until completion of the works (which will generally be defined in the contract and marked by the issue of a certificate or the passing of specified tests). It may be limited to the period in which certain financial ratios are achieved or to the period until the works are "up and running" (e.g. subsequent to a period of performance at a certain level and over a certain period of time). In the event of certain breaches of a covenant or representation by the project company or its shareholders (often limited to intentional breaches) such limitations may no longer operate. 8

Ibid. at 6.

47

4-16

4-17

THE USE OF THE FIDIC SILVER BOOK IN THE CONTEXT OF A BOT PROJECT

SPECIFIC ISSUES RAISED IN CONNECTION WITH THE USE OF THE SILVER BOOK

BOT projects are typically financed primarily on a limited or nonrecourse basis with the cash flow generated by the project and the project assets constituting the principal project security. Therefore, project lenders (and consequently the other participants) in such projects have become particularly sensitive to the need to identify and allocate project risks at a very early stage of the development of the project. Although the contractor assumes much of the risk, vis-a-vis the owner, during the construction phase (see discussion below) the construction phase is the "most critical stage for the lenders" as in non-recourse financing they only have recourse to the project assets and "as such, the lenders take on proportionally greater risk".9

Understanding and Negotiating Turnkey Contracts lO in 1997, has been incorporated into the FIDIC Silver Book (e.g. sub-clauses 5.1 and 5.8). 5.1

The Contractor shall be deemed to have scrutinised, prior to the Base Date, the Employer's Requirements (including design criteria and calculations, if any). The Contractor shall be responsible for the design of the Works and for the accuracy of such Employer's Requirements (including design criteria and calculations), except as stated below. The Employer shall not be responsible for any error, inaccuracy or omission of any kind in the Employer's Requirements as originally included in the Contract and shall not be deemed to have given any representation of accuracy or completeness of any data or information, except as stated below. Any data or information received by the Contractor, from the Employer or otherwise, shall not relieve the Contractor from his responsibility for the design and execution of the Works.

Specific issues raised in connection with the use of the Silver Book in the context of BOT projects 4-18

As mentioned above, the Silver Book was specifically drafted for use in BOT projects. However, it is important to note that most large contractors, sponsor groups and law firms working in the area of project finance will have their own in-house standard EPC contract. For these entities, the Silver Book may serve as a solid reference to review and update their in-house standard forms. For those who do not have an in-house standard, the Silver Book can serve as a good basis for the EPC contract in a BOT project. EPC contracts are also heavily negotiated, and in practice it is more likely to find a single set of general conditions, rather than separate general and particular conditions as contemplated by the FIDIC Silver Book. When the Silver Book is being used for the turnkey construction portion of a BOT project the financing institutions involved as lenders in the project will wish to carefully review the construction-related risks and responsibilities of the contractor and his liability to the project company. For the purposes of the turnkey contract, the project company is usually the employer or owner. Therefore, in the discussion set forth below reference will be made either to the project company or to the" Employer", both terms having the same meaning.

Design

4-19

I

Financial institutions acting as the lenders in a BOT project generally require a single point of responsibility for the design and construction of the works. They therefore require the contractor to assume the risk of any defect or error in the design, including any defect or error in the employer's requirements. This idea, expressed by the author in the first edition of this book

9

48

D. Blumental, op. cit. n. 3 above at 288.

4-20

General Design Obligatio,:,s

However, the Employer shall be responsible for the correctness of the following portions of the Employer's Requirements and of the following data and information provided by (or on behalf of) the Employer: (a) portions, data and information which are stated in the Contract as being immutable or the responsibility of the Employer, (b) definitions of intended purposes of the Works or any parts thereof, (c) criteria for the testing and performance of the completed Works, and (d) portions, data and information which cannot be verified by the Contractor, except as otherwise stated in the Contract. In summary, sub-clause 5.1 makes the contractor responsible for the design of the works and the employer's requirements, which the contractor is deemed to have examined carefully. This clause further operates as a disclaimer of the employer's liability for any "error, inaccuracy or omission of any kind" in the employer's requirements and expressly denies any representations concerning the accuracy or completeness of the data and information therein. In its final paragraph sub-clause 5.1 does provide a list of some exceptions for which the contractor does not assume responsibility, such as definitions of intended purposes of the works, testing and performance criteria and data which cannot be verified by the contractor. These exceptions reflect the idea that the contractor cannot in fairness be held responsible for errors in the employer's definition of the intended purpose of the works because those parameters are solely within the control of the employer. However, it is important to consider this exception in light of sub-clause 4.1 which req uires

10

j.A. Huse, Understanding and Negotiating Turnkey Contracts (Sweet & Maxwell, London, 1997), p. 452. In addition, the author's suggestion that the language in Clause 4.1 of the

Orange Book allowing the contractor to notify and obtain a variation from the employer for any faults in the employer's requirements discovered prior to the commencement of the design process has also been incorporated into the FIDIC Silver Book.

49

4-21

THE USE OF THE FIDIC SILVER BOOK IN THE CONTEXT OF A BOT PROJECT

SPECIFIC ISSUES RAISED IN CONNECTION WITH THE USE OF THE SILVER BOOK

~he contractor to pr?vide works "fit for the purposes for which [they] are

struction risks, must be borne jointly and severally among all members of any joint venture, consortium or group of any type that constitutes the contractor (sub-clause 1.14). The contractor will also be responsible for any acts of defaults of any of its subcontractors (sub-clause 4.4). Silver Book sub-clause 4.1 "Contractor's General Obligations" states that "[t)he Contractor shall design, execute and complete the Works in accordance with the Contract, and shall remedy any defects in the Works .... The Contractor shall be responsible for the adequacy, stability and safety of all Site operations, of all methods of construction and of all Works." Sub-clause 4.1 also sets the standard that will be applied to the completed construction: the works must be "fit for the purposes" intended by the employer. In addition to the general obligation to execute and complete the works, the contractor has a related obligation of completeness. The completeness obligation means that the contractor must supply all materials and services necessary for the execution of the contract. The result of non-compliance with these obligations is the loss of payment for work not completed, deductions for the cost of rectification and replacement (sub-clause 14.6) and possibly liquidated damages (sub-clause 8.7) or contract termination (sub-clause 15.2). This author suggested in 1997 that the FIDIC Orange Book could be adapted for use in a BOT project by adding, among other things, a clause requiring the contractor to acknowledge that it has examined all aspects of the project prior to commencement. 11 This clause would serve to avoid claims in respect of time and cost changes once the works commence. The FIDIC Silver Book incorporates such a clause. In 'addition to the general attribution of construction risks in sub-clause 4.1, sub-clause 4.12 provides for "unforseeable difficulties".

Intended as defined In the Contract". The testing and performance criteria are also solely within the control of the employer and therefore not the responsibility of the contractor. The Employer in a BOT project will wish carefully to consider the appropriateness of each of these exceptions. The last exception in sub-clause 5.1(d) is perhaps the most subject to interpretation. It states generally that "the Employer shall be responsible for the correctness of ... portions, data and information which cannot be verified by the ~ontractor, except as otherwise stated in the Contract". This exception permIts the contractor to rely on information in the employer's requirements without taking responsibility for the correctness of the information when the contractor is unable to verify that information. This language may create some ambiguity and uncertainty as to what information in the employer's requirements cannot be verified by the contractor. A modification to this sub-clause 5.1(d) may be appropriate to reference and incorporate a schedule or exhibit which specifically lists the information from the employer's requirements that cannot be verified by the contractor and on which the contractor shall be able to rely without risk of liability. Without a specification of this information the contractor could simply claim in the event of a dispute that the incorrect information that perhaps led to a defect or delay of the works could not have been verified by the contractor and is therefore not his responsibility. Sub-cl~use 5.8, entitled "Design Error", allocates some additional design~elated. rtsk .to ~he contra~tor, stating: "If errors, omissions, ambiguities, inCOnsIstencIes, inadequaCIes or other defects are found in the Contractor's Documents, they and the Works shall be corrected at the Contractor's cost ' notwithstanding any consent or approval under this Clause." Construction 4-22

I

In addition to requiring a single point of responsibility for the design of the works, financial institutions acting as the lenders in a BOT project will require such responsibility for the actual construction of the works as well. As stated earlier, the primary means for lenders to allocate constructionrelated. risks will be to require the project company to pass substantially all these nsks on to the contractor in a fixed price, lump-sum turnkey contract. Lenders may also require performance and completion guarantees from the contractor, often supported by bonds or letters of credit. ~here are numerous. identifiable construction-related risks in any major proJect. Some of the prtmary risks are unanticipated construction costs and d~lays, the risk o.f unforeseeable physical conditions, the risk that the project wtll not be ~hY~lcally completed and the risk the project will not meet perf?rmance cntena. The FIDIC Silver Book provides a relatively comprehensIve treatment of these and other risks. A basic requirement in attributing risks is ensuring that all construction parti~ipants are jointly and severally liable to the project company. Under the Stiver Book, responsibility for contract performance, including all con50

4-23

4.12 Unforeseeable Difficulties Except as otherwise stated in the Contract: (a) the Contractor shall be deemed to have obtained all necessary information as to risks, contingencies and other circumstances which may influence or affect the Works; (b) by signing the Contract, the Contractor accepts total responsibility for having foreseen all difficulties and costs of successfully completing the Works; and (c) the Contract Price shall not be adjusted to take account of any unforeseen difficulties or costs.

In a related provision, sub-clause 4.10 "Site Data" requires the employer to provide the contractor with any information in the employer's possession on subsurface and hydrological conditions at the site. It states that" [t)he Contractor shall be responsible for verifying and interpreting all such data. The Employer shall have no responsibility for the accuracy, sufficiency or II

Ibid. p. 452.

51

4-24

THE USE OF THE FIDIC SILVER BOOK IN THE CONTEXT OF A BOT PROJECT

4-25

completeness of such data, except as stated in sub-clause 5.1 [General Design Responsibilities]." This may cause the employer to assume responsibility for site data it provides to the extent that it is not verifiable by the contractor. The employer is responsible under sub-clause 5.1 for data and information it provides that cannot be verified by the contractor. To avoid this responsibility, the employer may choose (or be required by the lenders) to either provide no site data or to give the contractor a complete opportunity to verify any site data. Even in the latter case, it would still be prudent to obtain from the contractor a representation that he had full opportunity and was able to verify any and all data provided by the employer. Nonetheless, this attribution of risk to the contractor regarding site data essentially requires every bidder (assuming, for example, a project which includes works of underground construction) to conduct its own subsurface and hydrological study of the site conditions before being able to develop an appropriate tender offer. The inefficiency lies in the requirement that each bidder conduct such a survey rather than allowing them all to rely on a single site survey prepared by the employer or project company. FIDIC itself recognises this inefficiency and states in the "Introductory Note to First Edition" of the Silver Book that: These Conditions of Contract for EPCffurnkey Projects are not suitable for use in the following circumstances: • If there is insufficient time or information for tenderers to scrutinise and check the Employer's Requirements or for them to carry out their designs, risk assessment studies and estimating (taking particular account of Sub-Clauses 4.12 and 5.1). • If construction will involve substantial work underground or work in other areas which tenderers cannot inspect. ( ... )

FIDIC recommends that the Conditions of Contract for Plant and Design-Build [the "Yellow Book"] be used in the above circumstances for Works designed by (or on behalf of) the Contractor. 12

4-26

I

Yellow Book sub-clause 4.12 "Unforeseeable Physical Conditions" does not require the contractor to assume the risk of unforeseeable subsurface conditions. It provides for a potential extension of time and increase in cost in the event unforeseeable physical conditions are encountered on the site. The alternative under the Silver Book may simply be for the employer to conduct a thorough site survey, provide the information to potential bidders and assume responsibility for the accuracy of the data. Lenders might object to this. However, the assumption of risk for site data may reduce the overall contract price and allow more competitive and prudent bidding. If no site data is provided or if the employer refuses to assume responsibility for the site data it does provide, each bidder is essentially required to conduct its own 12

FIDIC, Conditions of Contract for EPCrrurnkey Projects, Introductory Note to First Edition, 1999.

52

SPECIFIC ISSUES RAISED IN CONNECTION WITH THE USE OF THE SILVER BOOK

site survey, which may be cost prohibitive and discourage bidders. However, some bidders may simply assume the risk without a proper survey and either increase the contract price to reflect the increased risk or make an imprudent bid in the hope that unfavorable site conditions will not be encountered. In either case, the employer and the project lenders may be at risk. Under the Silver Book, the contractor also must assume the risk of suitability and availability of access routes to the site (sub-clause 4.20) and is liable for any damage to the employer's equipment while being used by the contractor or its personnel (sub-clause 4.20). In the event of the contractor's faulty design, workmanship or materials the contractor risks a suspension of the works by the employer. In relation to a suspension by the employer due to these faults, the contractor will be responsible to the employer for any delays and additional costs (sub-clause 8_9) as well as any deterioration, defect or loss to the works occurring during the suspension period (subclause 8.12). \3 Despite the attribution of substantially all co~struction risks to the contractor, the Silver Book does set a limit on total liability in sub-clause 17.6. Sub-clause 17.6 "Limitation on Liability" states that: [t)he total liability of the Contractor to the Employer, under or in connection with the Contract other than under Sub-Clause 4.19 [Electricity, Water and Gas], Sub-Clause 4.20 [Employer's Equipment and Free-Issue Material], SubClause 17.1 [Indemnities] and Sub-Clause 17.5 [Intellectual and Industrial Property Rights), shall not exceed the sum stated in the Particular Conditions or (if a sum is not so stated) the Contract Price stated in the Contract Agreement.

Limitation of liability in an amount equal to the contract price should be acceptable to the project lenders, provided that the contract price is generally a good estimate of the cost of completion. However, if the contract price is deemed too low, the project lenders may require a higher limit on liability.

Tests on completion Tests on completion are those tests to be performed on the works in order to demonstrate their substantial completion. The works must pass the tests on completion before issue of a taking-over certificate. In order to review the testing procedure and its execution, the lenders may wish to have their own technical adviser present and involved in the tests, or possibly on site during the construction in general. The operator under the operation and maintenance agreement may also need to be involved in the testing in order to familiarise himself with the works and their operation. 13

Note that Clause 8.12 states generally that contractor is responsible for deterioration, defects or losses during a suspension instructed by the employer but does not indicate, as it does in Clause 8.9, that rhe contractor must be at fault for it to be responsible for these rhings.

53

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THE USE OF THE FIOIC SILVER BOOK IN THE CONTEXT OF A BOT PROJECT

SPECIFIC ISSUES RAISED IN CONNECTION WITH THE USE OF THE SILVER BOOK

The Silver Book provides that if the works, or a section, fail to pass the tests on completion when they have been repeated, the project company may choose to reduce the contract price by an amount agreed between the project company and the contractor (sub-clause 9.4). The lenders may prefer to remove this power from the project company or qualify it, since they will not want to be left with works which underperform. The lenders may require that more detailed provisions be included as to the method of calculation of any contract price reduction. Any acceptance of substandard performance for a price reduction may need to be reviewed by the lenders' technical adviser to determine the ultimate effect on the project's operation. The lenders may also want the right to approve or disapprove any performance shortcoming or insist upon rectification at the contractor's cost. They will want to consider the effect of the contractor delivering a facility which underperforms on the other agreements involved in the project, such as the concession agreement, the power purchase agreement and the fuel supply agreement (to the extent that this provides for a minimum fuel purchase).

responsibility of the contractor. The parties may also wish to implement a dispute resolution mechanism specific to the relationship of the operator and the contractor during this interim period.

Taking over

4-28

!

Under Silver Book sub-clause 10.1, the contractor finishes the works, or sections of the works, which are then transferred to the care of the employer. This transfer is called taking over and occurs after substantial completion of the works and passing of any tests required by the contract. The works may then be subject to tests after completion, performed either by the contractor or the employer under the contractor's guidance. In most BOT projects, however, the project company does not take over care of the works after substantial completion. Rather, the works pass into the care of the operator after completion. Thus the question arises as to the responsibility of the contractor and the operator for the works during this period of taking over. The lenders are interested in the organisation of the responsibility for the works during the period of transfer between the contractor and the operator. This transfer may cover an extended period of time, where taking over of sections of the works is allowed. The lenders may want the contractor to remain responsible for ensuring completion and performance of the works, notwithstanding the completion of individual sections. In the alternative, taking over in sections may be precluded by the lenders so that the operator may take over fully completed works at one point in time. However, if commercial operation of a unit is necessary (for example, to begin some power generation before final completion), the lenders will want to ensure that there is no gap in responsibility for the works and that overlapping responsibilities do not inhibit use of the portion of the works taken over. One way to fill this gap is to require the contractor to remain liable to the project company for the entire works until taking over of all the sections and to require the operator to operate the facility under the supervision and

54

Tests after completion The Silver Book also provides for tests after completion if these are specified in the contract. The tests after completion take place after the employer has taken over the works or a section thereof. Sub-clause 12.2 "Procedure for Tests after Completion" indicates that "the Contractor shall carry out the Tests after Completion ... as soon as is reasonably practicable after the Works or Section have been taken over by the Employer". If defects or damage to the works are identified by the tests or a remedy is otherwise required that may affect the performance of the works, "the Employer may require the repetition of any of the tests described in the Contract, including Tests on Completion and/or Tests after Completion" (subclause 11.6). However, the Silver Book contemplates the possibility that the particular conditions may state amounts of non-performance damages for certain defects. In that case, if the works do not pass the tests after completion the contractor may pay these non-performance (liquidated) damages to the employer to satisfy his performance obligation or propose and execute any adjustments or modifications to cause the works to pass these tests (sub-clause 12.4). Again, the lenders should carefully consider the propriety of giving the contractor the option of paying non-performance damages in lieu of remedying defects. Accepting a liquidated sum rather than specific performance generally means the project is not complete to the expected performance level. The turnkey construction contractor will assume a large share of the risk that the works will not perform to the standards and criteria specified in the contract. This allocation is generally effected by placing performance criteria in the construction contract and requiring the works to meet a fitness for purpose standard evidenced by successful completion of the tests after completion, among other things. Failure of the works to pass such tests will expose the turnkey contractor to either rejection or, assuming minimum performance levels are met, liquidated damages, in an amount and to a maximum relative to the value of proper performance which must be specified in the particular conditions. The project company will ensure that these liquidated damages cover "back-to-back" any damages that would be incurred through other agreements, such as the power purchase agreement. The project company will also seek to allocate certain performance risks to the power purchaser, the fuel supplier (where relevant) and the government (for risks such as the failure of water supply in hydroelectric projects). The Silver Book contemplates that, subsequent to taking over, the tests after completion will be carried out to ensure that the works perform to the levels required by the employer's requirements. The lenders may decide to require the contractor to carry out any such tests before taking over, to

55

4-29

4-30

THE USE OF THE FIDIC SILVER BOOK IN THE CONTEXT OF A BOT PROJECT

ensure that the works satisfy the performance criteria before transfer of the care of the works and the contractor is relieved of the sanction of liquidated damages for delay. The minimum levels of performance, if any, will need to be reviewed by the lenders. The lenders will want to maintain maximum liability on the contractor where the failure is due to reasons attributable to the contractor. The project company's remedies and damages, for breach by the contractor of its obligations under the contract, will need to be reviewed by the lenders. In this regard, the lenders will need to consider carefully any proposed cap or limitation on the contractor's liability. Sub-clause 12.4 of the Silver Book provides that if the performance criteria are not attained then the contractor shall have the option either of making changes to the works in order to attain the performance criteria or paying liquidated damages. The lenders may prefer that the project company elect whether to require the contractor to make the changes or accept liquidated damages, thus maintaining the duty to achieve the performance criteria on the contractor.

SPECIFIC ISSUES RAISED IN CONNECTION WITH THE USE OF THE SILVER BOOK

Despite the general rule that the contractor is responsible for achieving completion on a certain date, it is commonly acc~pted that the contrac~or will not be responsible for delays caused by certalO types of events outSide his control. Silver Book sub-clause 8.4 is the primary provision dealing with time extensions.

The Contractor shall be entitled subject to Sub-Clause 20.1 [Contractor's Claims) to an extension of the Time for Completion if and to the extent that completion for the purposes of Sub-Clause 10.1 [Taking Over of the Works and Sections] is or will be delayed by any of the following causes: (a) a Variation (unless an adjustment to the Time for Completion has been agreed under Sub-Clause 13.3 [Variation Procedure]), (b) a cause of delay giving an entitlement to extension of time under a SubClause of these Conditions, or (c) any delay, impediment or prevention caused by or attributable to the Employer, the Employer's Personnel, or the Employer's other contractors on the Site.

Time for completion

4-31

Under the FIDIC Silver Book and in the BOT project scheme the construction contractor bears the risk of delays in completion. This allocation of risk is based on the principle that the contractor will best be able to regulate the timing of the construction work to satisfy his work programme and meet the contractual date of completion described in Silver Book sub-clause 8.2.

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8.2 Time for Completion The Contractor shall complete the whole of the Works, and each Section (if any), within the Time for Completion for the Works or Section (as the case may be), including: (a) achieving the passing of the Tests on Completion, and (b) completing all work which is stated in the Contract as being required for the Works or Section to be considered to be completed for the purposes of taking-over under Sub-Clause 10.1 [Taking Over of the Works and Sections].

4-33

The particular conditions will set completion dates either for the works as a whole or for discrete sections or milestones, if appropriate. Respect from the contractor for the time for completion of the works will be essential to the lenders. Late completion can cause loss of production, loss of market share, damages in relation to other related agreements, such as the power purchase agreement, and can result in additional finance charges. For this reason, the Silver Book generally satisfies the lenders' requirement that each event resulting in the contractor's right to request an extension of time be specifically identified and defined in the contract.

56

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8.4 Extension of Time for Completion

H the Contractor considers himself to be entitled to an extension of the Time for Completion, the Contractor shall give notice to the Employer in accordance with Sub-Clause 20.1 [Contractor's Claims]. When determining each extension of time under Sub-Clause 20_1, the Employer shall review previous determinations and may increase, but shall not decrease, the total extension of time.

Other than the extensions granted for variations or delays attributable to the employer, subpart (b) of sub-clause 8.4 incorporates the numerous other grounds for time extensions found in the Silver Book. These other potential grounds for an extension of time are the following:

• • •

• • •

•

delays caused by the employer's failure to give the contractor access to or possession of the site within the time stated in the particular conditions (sub-clause 2.1); delays caused by the employer's instructions to the contractor regarding archaeological remains discovered on the site (sub-clause 4.24); changes in the host country's technical standards and regulations for which the contractor's compliance causes delay (sub-clause 5.4); delays caused by the employer's instructions to vary the location or details of any tests or to perform additional tests (sub-clause 7.4); unforeseeable delays or disruptions by the public authorities of the host country (sub-clause 8.5); delays caused by the contractor's compliance with the employer's instruction to suspend work to the extent the suspension was not due to the contractor's fault (sub-clause 8.9); delays caused by the employer's interference with the tests on completion (sub-clause 10.3);

57

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THE USE OF THE FlDIC SILVER BOOK IN THE CONTEXT OF A BOT PROJECT

•

delays caused by a change in the laws of the host country (sub-clause 13.7); delays resulting from the contractor's suspension of work for the employer's failure to provide evidence of its ability to payor for non-payment (sub-clause 16.1); delays caused by the occurrence of an employer's risk (sub-clause 10.3); delays caused by the occurrence of a force majeure event (sub-clause 19.4).

ordination of the various constituent contracts so that the allocation of risks in one contract corresponds to the allocation of risks in other dependent or related contracts. For example, if the contractor is entitled to an extension of time under the construction contract for a particular force majeure event, the project company should ensure that the same events of force majeure are contained in the other contracts within the overall BOT project.

Sub-clause 8.4 effectively requires any extension of time to which the contractor believes himself to be entitled to be subject to the procedure for "Contractor's Claims" under sub-clause 20.1. Under sub-clause 20.1 the contractor must give notice to the employer and later provide a fully detailed claim describing the event for which the contractor requests an extension of the time for completion. The employer will then either approve or disapprove the request with detailed comments in the event of disapproval. If an extension of time is approved, the employer then proceeds in accordance with sub-clause 3.5 "Determinations" to agree or determine the extension of time. Under this sub-clause the employer must consult with the contractor and try to reach an agreement on the extension. If no agreement is reached, the employer may make a fair determination in accordance with the contract. Note also that this procedure generally applies with regard to price increases as well, discussed below. If the contractor receives a variation order under the construction contract, responsibility for any resulting delay will frequently remain with the project company. However, where the variation order is a result of the changed requirements of the host government or the power purchaser (as, for example, in respect of connection to the power purchaser'S grid), this risk will commonly be transferred to such parties. The risk of delay caused by the failure of government authorities to issue construction, import and other permits is also frequently assumed by the host government in the concession agreement on the theory that the host government will be best able to control and minimise this risk. The project company will also attempt to transfer to the host government liability for various force majeure events that may be deemed to be within the government's control, such as political strikes, acts of war, sabotage, terrorism or changes in local law. The project company (and its insurers) will then bear any additional force majeure risk it is unable to transfer to the other parties, as well as gaps in its "back-to-back" protection, such as where the definition of force majeure in the construction contract is broader than that in the power purchase agreement. Where the- contractor may receive an extension of time under these circumstances, the project company should try to transfer as much risk as possible to the host government, the power purchaser or even the project lenders and insurers to avoid being in default. The importance of completion time and extensions in a BOT structured project lies therefore in the co-

Under the FIDIC Silver Book and in the BOT project scheme the contractor also bears the risk of contract price sufficiency. The contract price is defined in sub-clause 1.1.4.1 as "the agreed amount stated in the Contract Agreement for the design, execution and completion of the Works and the remedying of any defects, and includes adjustments (if any) in accordance with the Contract". Sub-clause 4.11 attributes the risk of contract price sufficiency to the contractor.

4-37

4.11 Sufficiency of the Contract Price

4-38

• • • 4-36

I

SPECIFIC ISSUES RAISED IN CONNECTION WITH THE USE OF THE SILVER BOOK

58

Price

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. In short, the contractor must agree to complete the works for a fixed, lumpsum contract price (sub-clause 14.1). The contractor therefore assumes the risk that the contract price is not sufficient to cover his contract obligations and provide a reasonable profit. Price/cost exceptions in favour of the contractor. As indicated below, the Silver Book attempts to specify each situation where a price increase or decrease may occur. Lenders may wish to review and shorten this list and limit the circumstances in which a variation may be sought by the employer, and impose a cap on any resulting adjustments to the contract price. The Silver Book contains numerous exceptions allowing the contractor to request an increase in the contract price in certain circumstances, as follows:

• •

costs to the contractor caused by the employer's failure to give the contractor access to or possession of the site within the time stated in the particular conditions (sub-clause 2.1); unforeseeable work accommodations to the employer's personnel or public authorities causing the contractor to incur additional cost (sub-clause 4.6);

59

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THE USE OF THE FIOIC SILVER BOOK IN THE CONTEXT OF A BOT PROJECT

• • •

• •

• •

• •

• •

• • • •

•

• • 60

costs caused by the employer's instructions to the contractor regarding archaeological remains discovered on the site (sub-clause 4.24); changes in the host country's technical standards and regulations for which the contractor's compliance causes additional costs (subclause 5.4); additional costs caused by the employer's instructions to vary the location or details of any tests or to perform additional tests (subclause 7.4); additional costs caused by the contractor's compliance with the employer's instruction to suspend work to the extent the suspension was not due to the contractor's fault (sub-clause 8.9); additional costs caused by the employer's interference with the tests on completion (sub-clause 10.3); additional costs of tests required after the correction of any defect or damage to the works to the extent the defect or damage was not attributable to the contractor (sub-clause 11.6); additional costs incurred by the contractor when instructed by the employer to search for a defect in the works not attributable to the contractor (sub-clause 11.8); additional costs to the contractor caused by any unreasonable delay by the employer to the tests after completion (sub-clause 12.2); additional costs as a result of any unreasonable delay by the employer in permitting access to the works or plant by the contractor, either to investigate the causes of a failure to pass a test after completion or to carry out any adjustments or modifications (subclause 12.4); variations (sub-clause 13.3); additional costs caused by a change in the laws of the host country (sub-clause 13.7); price adjustments for increases or decreases in the cost of labour, goods and other inputs to the works (if so provided in the particular conditions) (sub-clause 13.8); financing charges for delayed payments (sub-clause 14.8); additional costs resulting from the contractor's suspension of work because of the employer's failure to provide evidence of its ability to pay, or for non-payment (sub-clause 16.1); cost to the contractor of rectifying any loss or damage due to an employer's risk event (sub-clause 17.4); payment by the contractor of insurance premiums for which the employer is responsible and the amount of any insurance payment that would have been received upon the occurrence of an insurable event absent employer failure to maintain insurance (sub-clause 18.1); costs resulting from the occurrence of a force majeure event (subclause 19.4); costs incurred in connection with termination of the contract after a force majeure event (sub-clause 19.6);

SPECIFIC ISSUES RAISED IN CONNECTION WITH THE USE OF THE SILVER BOOK

•

costs incurred in connection with termination of the contract due to the occurrence of an event making it impossible or unlawful for either party to fulfil its contractual obligation and which under the law of the contract entitles either party to be released from further performance (sub-clause 19.7).

As for extensions of time, contractor requests for increases in the contract price or payments are generally subject to the "Contractor's Claims" procedure under sub-clause 20.1 and the "Determinations" process under subclause 3.5. The host government can reasonably be expected to bear the increased construction costs associated with newly enacted or newly amended laws in the host country which enter into force and affect the contractor in the performance of his construction work. If construction costs increase as a result of a change in the requirements of the power purchaser (for example, where the power purchaser changes the requirements for interface with its distribution grid and the contractor receives a corresponding variation order) these costs will usually be passed on to the power purchaser. In general, the risk of an increase in construction costs will be borne by the turnkey contractor on the theory that the contractor is the best placed to control this risk by virtue of having considered all available information that would affect his tender and having provided an appropriate contract price in consideration of all labour and materials necessary for the design and execution of the works. Consequently, the contractor will generally be unable to seek a price increase in the event of changes in the cost of labour or materials. Price/cost exceptions in favour of the employer. In addition to circumstances that might allow an increase in the contract price or additional payments to the contractor, the Silver Book also provides for situations where the contractor may be required to make additional payments to the employer, effectively decreasing the contract price. The contractor may incur additional financial liability beyond the contract price in the following circumstances: •

• • •

•

changes in applicable country standards which might reduce cost to the contractor and be subject to a claim for price reduction by the employer (sub-clause 5.4); additional costs to the employer from the rejection and retesting of part of the works (sub-clause 7.5); additional costs to the employer for performing remedial work for which the contractor is responsible (sub-clause 7.6); additional costs to the employer relating to any revised programme necessary to ensure an appropriate rate of progress in the completion of the works (sub-clause 8.6); liquidated damages payable by the contractor to the employer for each day after the time for completion until the issuance of the taking-over certificate (sub-clause 8.7); 61

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THE USE OF THE FIDIC SILVER BOOK IN THE CONTEXT OF A BOT PROJECT

•

• • • • • •

• •

• • • • •

•

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additional costs to the employer for carrying out the tests on completion upon the contractor's failure to do so within the time allotted (sub-clause 9.2); reduction in contract price due to failure of works to pass the tests on completion (sub-clause 9.4); cost to the employer of remedying any defects; cost to the employer of the contractor's failure to remedy any defects (sub-clause 11.2); increase in performance security for the contractor's removal from site of defective work for repair (sub-clause 11.5); additional costs of retesting after defects are remedied for which the employer is not responsible (sub-clause 11.6); any cost to the employer of clearing the site after completion (subclause 11.11); cost of retesting upon failure of the works to pass the tests after completion where the fault is attributable to the contractor (sub-clause 12.3); non-performance damages (if provided) for failure of the works to pass the tests after completion (sub-clause 12.4); decrease in cost resulting from a change in the laws of the host country (sub-clause 13.7); adjustment of contract price for fall in the cost of labour, goods and other inputs to the works (if so provided in the particular conditions) (sub-clause 13.8); retention money for work not in accordance with the contract or other failure of the contractor to perform (sub-clause 14.6); cost to the employer of any termination for the contractor's fault (sub-clause 15.4); cost of any loss or damage to the works for which the contractor is responsible (sub-clause 17.2); payment by the employer of insurance premiums for which the contractor is responsible and the amount of any insurance payment that would have been received upon the occurrence of an insurable event absent the contractor's failure to maintain insurance (subclause 18.1).

The employer must comply with the "Employer's Claims" procedure under sub-clause 2.5 with regard to any additional payment from the contractor under the contract to which the employer believes itself to be entitled. Under sub-clause 3.5 the employer must give notice and particulars of the claim to the contractor. The employer will then proceed in accordance with sub-clause 3.5 "Determinations" to either agree or determine its own claim. This process applies to additional payments from the contractor and any payment withholding or reduction of the contract price to be undertaken by the employer, except as provided under sub-clause 14.6 "Interim Payments". Sub-clause 14.6 allows direct deduction of amounts from interim payments for work not completed by the contractor, the cost of rec62

SPECIFIC ISSUES RAISED IN CONNECTION WITH THE USE OF THE SILVER BOOK

tification or replacement of work and the value of any failure of the contractor to fulfil a contract obligation. Liquidated damages As discussed briefly above, the Silver Book contains provisions regarding liquidated damages in the case of non-performance of the contractor's obligations. Liquidated damages allow the injured party to receive the relevant amounts without having to refer to an arbitrator or a national court (although this may not be true in every jurisdiction). If properly drafted, the liquidated damages provision of a construction contract will provide the contractor with a powerful incentive to complete the project on time and will apportion clearly the financial responsibility for late completion. The Silver Book also contemplates under sub-clause 12.4 that the particular conditions may be drafted to contain liquidated damages for certain performance shortcomings in addition to the provisions for delay contained in the general conditions. Specifically, sub-clause 8.7 "Delay Damages" of the Silver Book provides for per diem liquidated damages in an amount stated in the particular conditions for every day of delay from the fixed time for completion date until the issuance of the taking-over certificate. These damages are subject to a ceiling representing the maximum amount of permissible liquidated damages for delay. These damages are generally the only damages for delay that may be extracted from the contractor. Potential liability for the liquidated damages for delay terminates on the date of issuance of the taking-over certificate. Nonetheless, the contractor will still have remaining obligations under the contract, such as performing the tests after completion and remedying any defects. Sub-clause 12.4 "Failure to Pass Tests after Completion" therefore refers to the possibility of including liquidated damages for non-performance relating to the failure of the works to pass the tests after completion. From the perspective of the project company, in the event of late completion due to contractor default, the contractor should be obligated to pay liquidated damages in an amount equal to or greater than the amount of the delay payments (including interest) the project company will be required to make. However, depending on the governing law, attention may need to be given to avoiding a potential recharacterisation of the liquidated damages as an illegal penalty. The lenders will want to review any cap on the contractor's overall liability in the context of liquidated damages. The liquidated damages and any such cap provided for in the construction contract must also take into consideration loss of debt service during the period of delay. The lenders should therefore closely scrutinise Silver Book sub-clauses 8.7 and 12.4. The limit for delay damages should be set in an appropriate amount, and language in the particular. conditions should be included to enable the liquidated damages for performance in sub-clause 12.4. 63

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I

THE USE OF THE FIDIC SILVER BOOK IN THE CONTEXT OF A BOT PROJECT

SPECIFIC ISSUES RAISED IN CONNECTION WITH THE USE OF THE SILVER BOOK

Guarantees

Parent company guarantees. The contractor will traditionally be required to provide a parent company guarantee, if applicable. In the parent company guarantee, the contractor's parent company guarantees the p~rforma.nce of the contractor's obligations under the contract and agrees to mdemmfy the .. employer in the case of the contractor's non-perfo.rmance. As mentioned earlier, the lenders may also reqUIre some additional external credit support arrangements affecting the Contractor, such as a consent agreements and collateral warranties. However, these are generally not part of the construction contract.

In order to protect against additional costs or delays, the Silver Book requires that several guarantees be put in place for different aspects of the contract. Generally, the contract will require the following guarantees from the contractor: (1) a performance security, (2) an advance payment guarantee, (3) a security in the amount of any retention (where actual retention money is not used), and (4) a parent company guarantee where a subsidiary acts as the contracting party. As discussed above, any contractors acting through a joint venture must be jointly and severally liable to the employer (as is provided under the Silver Book sub-clause 1.14). The lenders will review the form and the amount of guarantees provided by the contractor to ensure adequate protection in the case of default. The lenders will wish all guarantees to be in the form of, and/or to have the characteristics of, an on-demand guarantee. Performance security. The project company will attempt to ensure timely completion by obliging the contractor to provide a performance security. Sub-clause 4.2 "Performance Security" indicates that the contractor shall provide a performance security in the amount stated in the particular conditions which must remain valid and enforceable "until the Contractor has executed and completed the Works and remedied any defects". The amount of the performance security will vary widely from project to project anywhere from five per cent to 50 per cent of the overall contract price depending upon the type of project and the financial standing of the contractor. Ten per cent of the contract price is average for a performance security. Advance payment guarantee. Under sub-clause 14.4 "Advance Payment" the contractor must submit a guarantee to the employer before the employer is required to make its advance payment for mobilisation and design. The advance payment guarantee must cover the entire amount of the employer's advance payment and remain valid and enforceable until the advance payment has been repaid to the employer by proportional reductions in the interim payments. A similar guarantee is required under sub-clause 14.5 "Plant and Materials intended for the Works" for interim payment for plant and materials which are not yet on the site. Retention money. As an additional guarantee Silver Book sub-clause 14.3(c) "Application for Interim Payments" contemplates that a percentage of the payments from the employer to the contractor may be retained as retention money, if specified in the particular conditions. There may also be a fixed maximum amount of retention. The employer may thus retain a certain portion of each interim payment. These funds will then be returned to the contractor by virtue of sub-clause 14.9 "Payment of Retention Money": one half upon the issuance of the taking-over certificate and the other half at the end of the defects notification period.

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Co-ordination of construction (employer's control) Some commentators conclude that in design-build contracts in general, "the Contractor should be given the freedom to carry out the work in his chosen manner provided the end result meets the performance criteria specified by the Em'ployer. Consequently, the employer should only exercise limited control over and should in general not interfere with the Contractor's work."14 Although the thoughts expressed above may be the general rule for turnkey contracts, increased control of the construction by the employer may be required by lenders and may be more characteristic of the construction contract in a BOT project. FIDIC designed the Silver Book for BOT projects yet indicates that it is not appropriate for contracts where "the Employer intends to supervise closely or control the Contractor's work, or to review most of the construction drawings" .IS However, relaxing the employer's control over the project may be somewhat contrary to the requirements of a BOT project. In any event, despite FIDIC's intention and statement in its "Introductory Note" to the Silver Book that "the employer should only exercise limited control over and should in general not interfere with the contractor's work", the Silver Book is replete with opportunities for the employer to control many aspects of the project's completion. This level of employer intervention should ~e satisfactory to lenders. Examples of the employer's control can be found 10 the following sub-clauses: • •

•

1.8 "Care and Supply of Documents": right of access of the employer's personnel to all the contractor's documents at all reasonable times. 1.14 "Joint and Several Liability": prohibiting alteration of the contractor's joint venture or other association without the employer's consent. 3.4 "Instructions": ability to instruct the contractor concerning contract execution.

,< C. Wade, "History and Scope of the Three Major Bo'oks" (1998) online: FIDIC http://www.fidic.comldocumentsllaunchlwade1.html(date accessed: November 19,1999) at 9. '5 FIOIC, op. cit. n. 12. above.

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THE USE OF THE FIDIC SILVER BOOK IN THE CONTEXT OF A BOT PROJECT

• • •

• •

• • •

• • • •

• • •

• • • •

•

• • • • •

• 66

3.5 "Determinations": power to unilaterally determine disputed matters, such as price increases, decreases and time extensions. 4.1 "Contractor's General Obligations": ability to require the contractor to submit details of contractor's construction methods and arrangements. 4.3 "Contractor's Representative": power to approve or reject the contractor's representative. 4.9 "Quality Assurance": ability to audit quality assurance system put in place by the contractor. 4.21 "Progress Reports": requirement of monthly progress reports to the employer. 5.2 "Contractor's Documents": power to review and reject the contractor's documents. 6.9 "Contractor's Personnel": power to order removal of the contractor's personnel and representative. 7.2 "Samples": ability to review samples of materials. 7.3 "Inspection": power to inspect all parts of the works and progress of construction at all times. 7.4 "Testing": power to vary the details of any testing. 7.5 "Rejection": power to reject plant, materials, design or workmanship. 7.6 "Remedial Work": power to instruct remedial work. 8.3 "Programme": power to reject the contractor's programme. 8.6 "Rate of Progress": power to order acceleration of work's progress. 8.8 "Suspension of Work": power to suspend work. 9.2 "Delayed Tests": power to execute testing upon the contractor's failure. 11.4 "Failure to Remedy Defects": power to reduce contract price or terminate contract for the contractor's failure to remedy defects. 11.5 "Removal of Defective Work": power to approve removal of defect works for repair. 13.1 "Right to Vary": power to order a variation. 13.3 "Variation Procedure": power to order a variation proposal from the contractor. 13.5 "Provisional Sums": power to control expenditure of provisional sums. 14.6 "Interim Payments": power to withhold payments for nonperformance. 14.11 "Application for Final Payment": power to approve or reject the contractor's application for final payment. 15.1 "Notice to Correct": power to order the contractor to carry out any obligation under the contract. 15.2 "Termination by Employer": power to terminate contract. 15.5 "Employer's Entitlement to Termination": power to terminate for convenience.

SPECIFIC ISSUES RAISED IN CONNECTION WITH THE USE OF THE SILVER BOOK

Notwithstanding the employer's specific powers and abilities under the contract, the lenders may also wish to exercise some degree of control over the progress of the works, contract administration and the project company's decisions (where they relate to the completion and performance of the works). This control may be accomplished by the appointment of a lenders' engineer or technical adviser. The lenders' engineer or adviser will also provide technical expertise as requested by the lenders. The degree of control that he exercises varies but might include some control over extensions of time, variations, payments to the contractor, and issuance of certificates, particularly in relation to testing. The lenders will want to ensure that the engineer has wide powers relating to access and inspection in order to protect their interests in the project. However, the presence of a lenders' engineer may also result in an unacceptable level of intervention by the lenders in the execution of the works by the contractor. The contract will need to clearly specify the roles of the lenders' engineer and the employer's representative in order to avoid any friction and resultant delay (particularly as concerns the testing regime).

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Payments Starting from the point where all guarantees required from the contractor have been put into place, payment of the contractor generally occurs as follows. Under sub-clause 14.2 "Advance Payment" the employer will make an "advance payment, as an interest-free loan for mobilization and design" which is then repaid through proportional deductions from the interim payments. At the end of a period of payment stated in the contract (or monthly if not otherwise stated), the contractor makes an application for interim payment to the employer in the form of a statement under subclause 14.3, together with all supporting documents, including the progress report. The statement indicates the estimated contract value of the works executed and the contractor's documents produced (including variations) and must also specify any amounts to be added or deducted pursuant to the contract, the amount of retention (if any) and any amounts to be added or deducted for advance payment and repayments. If the contract includes a schedule of payments specifying instalments, the instalment amount will be the estimate contract value for the period (subclause 14.4). The employer shall then make the int~rim payment pursuant to and subject to any modifications under sub-clause 14.6. As indicated above, the money retained as retention money (if any) is returned in halves at the time of taking over and at the expiry of the defects notification period. Within 84 days of receiving the taking-over certificate, the contractor must prepare pursuant to sub-clause 14.10 "Statement at Completion" a statement indicating the value of the work done to date, any further sums due and any further sums the contractor believes will become due. Within 56

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THE USE OF THE FIDIC SILVER BOOK IN THE CONTEXT OF A BOT PROJECT

SPECIFIC ISSUES RAISED IN CONNECTION WITH THE USE OF THE SILVER BOOK

days after receiving the performance certificate, the contractor must submit under sub-clause 14.11 "Application for Final Payment" a draft final statement showing the value of all work done under the contract and any further sums the contractor considers it is due. With the application for final payment the contractor submits a written discharge under sub-clause 14.12 "Discharge" indicating that the final statement represents the full and final settlement of all moneys due to the contractor under the contract. Under subclause 14.13 "Final Payment", "the Employer shall pay to the Contractor the amount which is finally due, less all amounts previously paid by the Employer and any deductions in accordance with sub-clause 2.5 [Employer's Claims)". The lenders will want to control the payment regime implemented by the contract. By controlling the payment regime, the lenders can ensure timely and proper performance and regulate outflow of capital from the project company. The payment regime review will begin with the amount, timing and repayment of the advance payment. Lender control of the payment regime may include the lenders' engineer being given the right to certify interim payments. The lenders will seek to impose a contract payment method that will provide the greatest incentive for timely completion. Therefore, the lenders will often require payments of the contract price to be linked to milestone events. The language of the Silver Book is appropriate for payments linked to milestones (sub-clauses 14.3 and 14.6). The present Silver Book language, in sub-clause 15.4 "Payment after Termination" provides that in the event of termination for cause by the employer the project company will receive the difference between the cost of completion and the contract price, taking into account any limitation of the contractor's liability as provided for in the contract and the valuation of the works to date. For lenders this compensation scheme may be considered insufficient, as it does not explicitly protect their interests in the project company's loan service costs. In the event of such termination, the lenders may want to be paid all amounts that they have advanced for construction costs. Consequently, they may wish to modify the present Silver Book language to provide for payment by the contractor of all other direct or indirect damages suffered by the project company as a result of the termination. The contractor will be reluctant to accept any such provision.

to act where the contractor intends to terminate for a project company default.

Additional lender requirements 4-55

The preceding portions of this chapter discuss ways in which the specific provisions of the Silver Book address, with or without modification, the risks and requirements of the construction contract in a BOT project. However, the project company does continue to bear some risks under the Silver Book which may not satisfy the lenders. The lenders may wish to see additional financing for cost overruns. Furthermore, the lenders may want the ability

68

Financing of cost overruns. As discussed above, the financing of the project company must take into consideration potential cost overruns. This can be done either through increasing the amount of financing by an amount to account for a reasonable contingency (e.g. five to ten per cent), or by providing for a stand-by line of credit, with or without a cap, generally from the sponsors of the project. This stand-by credit can also be provided by the contractor (in the form of an additional completion guarantee), although this will generally not occur unless the contractor is also one of the sponsors.

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Step-in / step-out rights. The lenders may also want to implement step-in / step-out rights which allow the lenders to step into the turnkey contract and take the place of the project company under certain circumstances. In common-law countries, it is generally possible to establish fixed and floating charges and to permit lenders to appoint a receiver or manager over the project assets. However, in many civil-law countries it is not permitted for lenders to establish such a global package for protection; the lenders must provide a contractual security regime. Such contractual provisions give the lenders the right to step into the contractor's obligations under the contract but do not require them to do so. The lenders will also be allowed to step out of the contract, where they have stepped in but no longer want to maintain the obligations they have assumed. This regime can be included in the conditions of contract or as a separate agreement between the lenders and the contractor. The step-in / step-out rights include a regime for the contractor's co-operation with the lenders, including communication to the lenders of the contractor's intention to act in accordance with its right to terminate. Where the contractor intends to terminate, the lenders will have certain rights to intervene, including cure rights, step-in rights, substitution rights and novation. Cure rights allow the lenders to maintain the project company in its position in the contract by curing whatever defect has given the contractor the right to terminate. The regime for cure rights will vary where the termination is for non-payment or for some other default. The lenders will first give a notice of intention to cure, which will suspend the contractor's right to terminate for a certain period. This suspension will be lifted if the lenders do not act within that period. If the lenders decide to cure, they will enter into an undertaking with the contractor to remedy the breach by the project company. As mentioned above, step-in rights provide the lenders with the right to step in for the project company in the contract. The lenders will give a notice, after which the contractor's termination rights are suspended. The lenders will then appoint an additional obligor who will be bound to satisfy the project company's obligations under the contract until completion or step-out has

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THE USE OF THE FIDIC SILVER BOOK IN THE CONTEXT OF A BOT PROJECT

occurred. The contractor will then be bound to the additional obligor for the period of its presence as the step-in entity. The additional obligor or the lenders may give a step-out notice, indicating that they are removing themselves from the step-in position. During the time of step-in, the project company remains liable under the contract. Substitution leading to novation allows the lenders to provide an alternative party who will take the place of the project company and take over the obligations under the contract. This requires a complete novation of the contract, involving a transfer of the rights and obligations of the project company under the contract to a third party. The contractor must generally consent in writing to any such novation, although the contract can specify that he may not withhold such consent unreasonably. The effect of the novation is to remove the project company entirely from the contract. The substitute entity then becomes the project company for the purposes of the contract.

Conclusion

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The review of the Silver Book in this chapter evokes two general conclusions. First, the FIDIC Silver Book is clearly a document that is very well developed and drafted. Second, it can be used as a good starting point for the drafting and negotiation of the EPC contract in a BOT project. However, as discussed above, it does contain numerous areas requiring review and careful consideration to ensure its successful use in such a project.

CHAPTER

5

THE CONTRACT General Comments As with any complex construction contract, the Silver Book is a compilation of separate documents that together constitute the contract .. These documents are subject to certain rules of interpretation and definltlon. Part II of the Silve~ Book states that the employer will want to be especially careful when drafting the central documents of the contract, which include the conditions of contract, the employer's requirements, and the schedules. These documents will set forth the rights and obligations of the parties and the scope of the contract. . In order to simplify and better organise the contract, the Silver Book provides a definition section organised according to general topics that is similar to the other FIDIC contracts examined, namely the Orange, (new) Yellow and Red Books. Those working with the contract may find it easier to organise the definitions by alphabetical order, as opposed to grouping the definitions by category, in order to simplify term searches. The Silver Book is divided into two parts. P~rt I, entitled "General Conditions" sets out the general conditions of contract. Part II, "Particular Conditions", discusses certain sub-clauses and suggests modifications to the conditions of contract found in Part I. Memoranda annexed to the contract agreement complete the conditions of contract and further define certain terms.

5-01

Contract language The parties should be aware of the language used for the documents prepared in connection with the project. Where the contract documents, designs or the arbitral procedure are to be carried out in differing languages there may need to be translation of documents and proceedings, which may prove both burdensome and confusing to the parties.! The parties may want to provide for a single language for all of the project documents and contractual procedures. The employer's representative and the contractor 1

Wiwen-Nilsson «A Brief View of the 1992 Edition of the ENAA Model Form-International Contract for Pr~cess Plant Construction (Turnkey Lump sum Basis)" (1994) 111.C.L.R. 526 at 532.

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GENERAL COMMENTS

THE CONTRACT

would then need to be fluent in such language, or to provide for competent translators, in order to avoid misunderstandings during the progress of the works. The Silver Book (sub-clause 1.4) provides for a ruling language for the contract. Thus where documents are drafted in several languages, those drafted in the ruling language prevail. This will give some certainty where the parties have failed to provide for one language.

Conflicts clause

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The conflicts clause, which governs the order of priority of the contract documents, should not be used as a replacement for careful cross-comparison of the documents to ensure technical and legal consistency. Although such "c.ross-commenting" may prove time-consuming, it is invaluable as a preventative measure in avoiding disputes. The conflicts clause may not be able to remedy every inconsistency, since it could be disputed whether a given term was inconsistent with the other contract documents or merely a specific exception to a general rule. Further, the conflicts clause will not remedy gaps between the conditions and the specifications. 2 Sub-clause 1.6 of the Silver Book wisely places the expressed intention of the parties above the form of the conditions of contract. This follows the warning, given by a noted expert in the field, against placing the standard form contract in a position of priority over the less formal documents that express the true intention of the parties. 3 However, the Silver Book also places the contractor's tender at the bottom of the list. The contractor will need to be aware that his tender document will have a lower priority than the employer's requirements.

Confidentiality clause

5-04

The Silver Book provides for confidentiality concerning certain details, as specified in the tender. The parties may want to add provisions such as the following: exclusion from the site of parties not bound to similar confidentiality provisions; exemptions where the information is in the public domain or where confidentiality agreements are made with third parties (this allows confidential details to be given to third parties if such parties are in turn, bound by a confidentiality agreement).4 The ENAA and EIC use such an exception in specifying that documents or data in the public domain, to R.H. Turner, uAvoidance and Resolution of Construction Disputes-Prior to and During the Construction Process" (1994) 11 I.C.L.R. 284 at 285. J I.N.D. Wallace, Construction Contracts: Principles and Policies in Tort and Contract (Sweet & Maxwell, London, 1986), p. 376. • J.S. Roehl & J.B. Grove, uP~rformance Guarantees and Testing; Intellectual Property and Technology Transfer Issues" In R.E Cushman & K.S. Taub, eds, Design-Build Contracting Handbook (Wiley Law Publications, New York, 1992),341 at 341. 2

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which the party had lawful access at the time of disclosure or to which the party acquires lawful access through a third party, do not fall under the confidentiality clause (ENAA 16.3; EIC 21.2). There should also be exceptions to the confidentiality clause where financing and licensing is involved. Financing institutions may require that certain information be revealed either to reassure them as to concerns regarding the risks involved, or to verify the validity of the project. In some instances licensing by a local authority, particularly in the area of environmental regulation, will require disclosure of the methods and processes used. In such situations the parties will want to specify in detail the information to be disclosed in the contract. Further, the party owning the process or method to be disclosed for licensing may want to take the responsibility for such licensing in order to protect their intellectual property rights and facilitate the licensing process. The Silver Book sub-clause 1.9 provides an additional sub-clause requiring information concerning the project to be kept confidential in order to avoid publication or disclosure of such information without employer consent. This.obligation will restrict unwanted publicity for commercial or political reasons. Highly sensitive or cutting-edge projects may require such additional language.

Definition of design The Silver Book does not provide a separate definition for design: it simply places the responsibility for the entire design on the contractor (sub-clause 5.1). The contractor is limited in the form of the design by the specifications provided in the employer's requirements and elsewhere in the contract. However, the employer may want to specify more thoroughly the design obligations. The EIC does this by dividing the definition and treatment of the design into several stages. Sub-clause 1.1 (i) of the EIC gives a general definition of design. Section (ii) defines "conceptual design", which is the employer's submission to the contractor upon which the design is based. Under the Silver Book this concept would fall under the employer's requirements. Under the EIC, the "design elements" (section iii) are the contractor's response to the conceptual design and is accepted by the parties as the design to be developed for the works. The "preliminary design" (section iv) is the next step of a completed design provided by the contractor. The "final design" (section v) is the last stage of design; it consists of a fully detailed design. The "approved design" is the final design as it is approved by the employer. This detailed definition of design may be useful where substantial design development will be required during the period of the contract. If the employer has an approval power over each such stage of design development, the time necessary for the exercise of such approval rights will need to be reflected in the project programme. 73

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DISCUSSION OF SPECIFIC SUB-CLAUSES

THE CONTRACT

Rights in the construction documents 5-06

The parties will need to allocate specifically the right to use the construction documents. The allocation of these rights will depend generally on the origin of the technology reflected in the construction documents and the balance of power as between the parties. As a general proposition, where one party brings a specific skill or technology to a project, that party should maintain their proprietorship of that technology. For example, where the employer wishes to build a facility to process a given raw material, he may hire a contractor who specialises in such a process. In such a case the contractor would maintain his rights to the process, restricting the employer's use of the process to the facility constructed. On the other hand, the employer may come to the contractor with an idea, a basic design. He then hires a contractor to develop that idea into a buildable final design. In such a one-off situation, arguably the employer should obtain the rights to the design and documents developed on his behalf. Construction documents may also be relevant to the production of spare parts. The employer may want the right to use the documents to produce spare parts, decreasing his costs of operation. The contractor, particularly if he is a supplier of such spare parts, may not want to give the employer rights to such technology.

persons; dates, tests, periods and completion; money and payments; works and goods; and other definitions. As mentioned above, parties working with the Silver Book may wish to put the list in alphabetical order in order to facilitate term searches.

1.1.1.1 "Contract" means the Contract Agreement, these Conditions, the Employer's Requirements, the Tender, and the further documents (if any) which are listed in the Contract Agreement. 1.1.1.2 "Contract Agreement" means the contract agreement referred to in Sub-Clause 1.6 [Contract Agreement], including any annexed memoranda. 1.1.1.3 "Employer's Requirements" means the document entitled employer's requirements, as included in the Contract, and any additions and modifications to such document in accordance with the Contract. Such document specifies the purpose, scope, andlor design andlor other technical criteria, for the Works. 1.1.1.4 "Tender" means the Contractor's signed oHer for the Works and all other documents which the Contractor submitted therewith (other than these Conditions and the Employer's Requirements, if so submitted), as included in the Contract. 1.1.1.5 "Performance Guarantees" and "Schedule of Payments" mean the documents so named (if any), as included in the Contract.

Discussion of Specific Sub-Clauses General provisions 5-07

Clause 1 of the FIDIC Silver Book provides definitions that apply to both the general and particular conditions. In addition, clause 1 sets forth general provisions that relate to these conditions. A well-drafted general provisions section is essential for both defining terms to be used in the contract as well as providing coherence to the contract documents as a whole.

5-08

1.1 Definitions In the Conditions of Contract ("these Conditions"), which include Particular Conditions and these General Conditions, the following words and expressions shall have the meanings stated. Words indicating persons or parties include corporations and other legal entities, except where the context requires otherwise. The Silver Book sub-clause 1.1 provides lists of definitions for words or phrases used in the particular and general conditions documents. These definitions are grouped under the following categories: the contract; parties and

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1.1.1 The Contract

1.1.1.1 "Contract". The "contract" defines the legal agreement including the conditions of contract. The list of documents that make up the "contract" should be extensive enough to provide the parties with flexibility, yet restricted enough to avoid the inclusion of inappropriate documentation that might misrepresent the intent of the parties. Parties should be careful to appropriately entitle each contractual document, as many contractual documents are referred to by their title. s Due to the particularities of the negotiation of a contract under the Silver Book, the list of documents constituting the contract is more restrictive than under the other FIDIC contracts examined herein. All of the FIDIC contracts, however, provide for the addition of further contractual documents as the parties may list in the contract agreement. For example, the Red Book specifically includes drawings listed in the contract agreement. This is because, under the Red Book, the employer supplies the design and not, as under the Silver and Yellow Books, the contractor. Further, the other FIDIC contracts define such terms as "schedules", "contractor's proposal", "letter of tender" and "letter of acceptance" as such documents are included in the list of contract documents. Finally, due to the importance of defining the documents comprising the contractual .I

FIDIC, The Fidic Contracts Guide (Federation Internationale des Ingenieurs·Conseils, Lausanne, 2000), p. 44 (hereinafter HDle Guide) .

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DISCUSSION OF SPECIFIC SUB-CLAUSES

THE CONTRACT

agreement, all of the standard form contracts examined herein define the contract. 6

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1.1.1.2 "Contract Agreement". In the Silver Book, the signature of a contract agreement is specifically contemplated. In the Red and Yellow Books, the contract agreement is optional (as it is in the Orange Book). The ENAA, EIC, ICE and OBIA all provide contract agreement definitions within the sense of that of the Silver Book, although a contract agreement is optional under the ICE.

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1.1.1.3 "Employer's Requirements". This document outlines and defines the works in accordance with the employer's concept of the project. The FIDIC Guide recommends the employer's requirements include details such as "the definition and purpose of the works; quality and performance criteria; definition and location of the site; special obligations; etc. "7 The Silver Book and the Yellow Book indicate the employer is to specify "the purpose, scope, and/or design and/or other technical criteria, for the works". FIOIC suggests the employer's requirements "should describe the principle and basic design of the plant on a functional basis". 8 The Orange Book provision is slightly less detailed. Finally, the Red Book calls for "specification", instead of employer's requirements, where such document merely "specifies the works". The specifications, coupled with the drawings, are to specify "all matters not covered in the conditions of contract".9 The ICE, OBIA, AGC contain definitions of employer's requirements.

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1.1.1.4 "Tender". The tender in a turnkey contract often involves the submission by the contractor of a more complete set of documents than does the tender for a traditional design-bid-build contract. The contractor must invest greater time and resources in order to provide sufficient design for the project. The risk the contractor incurs in providing a tender for large-scale construction projects, such as BOT projects under the Silver Book, is partly offset by the tendering practices under such projects. For example, bidders may be subject to pre-qualification in order to ensure they are fully capable of performing the contract satisfactorily. to This partially eliminates the risk of bidding against unrealistically low bidders. 6

7 8

9 10

For the purposes of the definitions discussion in this chapter, the provisions of the various contracts will only be sited where such definitions are not found in the general definitions section of the relevant contract. Further, where a standard form contract, usually examined in this book, is not referenced in this discussion, there exist no equivalent provisions in the relevant contract. Fidic Guide, op. cit., n. 5 above, p. 45. C. Wade, "History and Scope of the Three Major Books" online: FIOIC http://www.fidic.com/documents/launch/wade1.html (date accessed: November 19, 1999) (hereinafter "History"). Fidic Guide, op. cit., n. 5 above, p. 45. O.A. Levy, "BOT and Public Procurement: A Conceptual Framework" (1996) 7 Ind. Int'/ & Compo L. Rev. 95 at 102 for a fuller discussion of tendering/bidding procedure under BOT projects, see same; for an outline of how FlOIC envisages the tendering process under the Silver Book, see "History" op. cit. n. 8 above; see also FIDIC Guide, op. cit. n. 5 above, for outline of tendering procedure and sample forms and instructions.

76

The Silver Book definition of tender is the same as those of the (new) Red and Yellow Books, once the definitions of "letter of tender" are included in the later. The Orange Book definition of tender does not seem to require the signature of the contractor on the priced offer of the contractor for the works. The ICE also works under a tender system and provides a form of tender as an appendix. "Appendix'to Tender". Unlike under the Silver Book, the Orange Book and (new) Red and Yellow Books include definitions for an "appendix to tender". Although an appendix to tender is not excluded from the definition of tender under the Silver Book, there may be a functional purpose to the separate definition provided under the other FIOIC contracts. In the other FlOlC contracts, the appendix to tender is referred to where the Silver Book refers to particular conditions. The appendix to tender originates from the contractor whereas the particular conditions are negotiated between the parties. Further, under the priority ranking of the contractual documents, the Silver Book places the particular conditions just below the contract agreement, where the Red and Yellow Books place the letter of tender in this position. A separate definition for an appendix to tender is indicative, therefore, of the relative importance of the tender under the Red and Yellow Books. 1I The FlOIC Guide explains the omission of the use of an appendix to tender in the Silver Book as a means to provide greater flexibility in the use of this contract. 12 Contractual references to the particular conditions, in lieu of the appendix to tender, allow parties to include the relevant information, refer to the location of the relevant information, or delete the sub-clause in the particular conditions.

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"Contractor's Proposal". Both the Orange and (new) Yellow Book define a contractor's proposal, which is to be submitted with the letter of tender regarding the preliminary design. Although this preliminary design is an important part of the contract it is subject to the specifications provided in the other contract documents such as the employer's requirements (in accordance with the priority of documents provided in 1.6 Orange Book; 1.5 (new) Yellow Book).

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1.1.1.5 "Performance Guarantees" and "Schedule ~f Payments". The Silver Book allows the employer to adjust the schedule of payments in all those cases where the contractor does not achieve the progress required by the contract (sub-clause 14.4). Thus, even when the parties choose not to base the schedule of payments on the progress of the works, the employer has the ability to amend it in respect of any delay in progress. This may be inconsistent with the needs of the contractor.

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II

12

For a comparison of FIDIC's view of the tender process under the Silver Book and the Yellow Book, see C. Wade, "The Silver Book: The Reality" (2001) 18 (3) I.C.L.R. 497. FIDIC Guide, op. cit. n. 5 above, p. 47.

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THE CONTRACT

DISCUSSION OF SPECIFIC SUB-CLAUSES

The Silver Book also contains reference to performance guarantees. Such guarantees are found under all of the FIDIC contracts examined herein (Silver, Orange and (new) Red and Yellow Books sub-clauses 4.2), although only the Silver and Yellow Book define such guarantees. Performance guarantees are important to the employer as they provide security for the contractor's financial ability to perform his obligations under the contract.

terms (such as under the insurance provisions, see Chapter 22). As a result, parties may latter assign responsibility, under a given clause, to either the contractor or employer by substituting the appropriate designation. Second, the Silver Book is the only contract where a "third party" is not intimately involved in the carrying out of the contractual pro~isions. The "employer's representative" under the Orange Book and the "engineer" under the Yellow and Red Books, however, play significant roles in the respective contracts.

1.1.2 Parties and Persons

1.1.2.2 "Employer". Whereas the "employer" is named in the contract agreement in the Silver Book, he is named in the appendix to tender under the other FIDIC contracts examined herein. The Orange Book excludes any unapproved assignees of the employer or his legal successors from the definition of "employer". The other FIDIC contracts do not specifically exclude unapproved assignees under the definition of employer, but rather in a separate sub-clause 1.7 (see discussion below). The ENAA, EIC and ICE also provide definitions for employer or, the equivalent, "owner".

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1.1.2.3 "Contractor". Where the "contractor" is named in the contract

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1.1.2.1 "Party" means the Employer or the Contractor, as the context requires. 1.1.2.2 "Employer" means the person named as employer in the Contract Agreement and the legal successors in title to this person. 1.1.2.3 "Contractor" means the person(s) named as contractor in the Contract Agreement and the legal successors in title to this person(s). 1.1.2.4 "Employer's Representative" means the person named by the Employer in the Contract or appointed from time to time by the Employer under SubClause 3.1 [The Employer's Representative], who acts on behalf of the Employer. 1.1.2.5 "Contractor's Representative" means the person named by the Contractor in the Contract or appointed from time to time by the Contractor under Sub-Clause 4.3 [Contractor's Representative], who acts on behalf of the Contractor. 1.1.2.6 "Employer's Personnel" means the Employer's Representative, the assistants referred to in Sub-Clause 3.2 [Other Employer's Personnel] and all other staff, labour and other employees of the Employer and of the Employer's Representative; and any other personnel notified to the Contractor, by the Employer or the Employer's Representative, as Employer's Personnel.

•

1.1.2.7 "Contractor's Personnel" means the Contractor's Representative and all personnel whom the Contractor utilises on Site, who may include the staff, labour and other employees of the Contractor and of each Subcontractor; and any other personnel assisting the Contractor in the execution of the Works. 1.1.2.8 "Subcontractor" means any person named in the Contract as a subcontractor, or any person appointed as a subcontractor, for a part of the Works; and the legal successors in title to each of these persons. 1.1.2.9 "DAB" means the person or three persons so named in the Contract, or other person(s) appointed under Sub-Clause 20.2 [Appointment of the Dispute Adjudication Board] or Sub-Clause 20.3 [Failure to Agree Dispute Adjudication Board]. 1.1.2.10 "FIDIC" means the Federation Internationale des IngenieursConseils, the international federation of consulting engineers.

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1.1.2.1 "Party". The Silver Book definition of party is unique to the FIDIC contracts examined herein. "Party" is defined in the Silver Book for two reasons. First, it allows provisions of the contract to be drafted in neutral 78

agreement in the Silver Book, he is named in the appendix to tender under the other FIDIC contracts examined herein. The Orange Book excludes any unapproved assignees of the employer or his legal successors from the definition of "contractor". The other FIDIC contracts do not specifically exclude unapproved assignees under the definition of employer, but rather in a separate sub-clause 1.7 (see discussion below). The ENAA, EIC and ICE all provide definitions for contractor.

1.1.2.4 "Employer's Representative". Like the Orange Book, the Silver Book has an "employer's representative" and no "engineer". The employer's representative plays a less prominent role in the Silver Book than in the Orange Book. A reflection of this fact, Silver Book sub-clause 3.1 allows that the employer "may" appoint a representative whereas Orange Book sub-clauses pertaining to the employer's representative presume his appointment. Under the Orange Book, the employer's representative "shall be a suitably qualified engineer or other appropriate professional" whereas the Silver Book makes no such specification (Silver Book sub-clause 3.1). The Yellow and Red Books still use the offices of an "engineer" rather than an employer's representative (sub-clauses 1.1.2.4). Whereas the employer's representative is to "act on behalf of the employer", the role of the employerappointed engineer in the Yellow and Red Books is less clear. For example, the engineer is to be "deemed to act for the employer" (sub-clauses 3.1(a)) but the contractor may raise reasonable objections to the appointment of a replacement engineer (sub-clauses 3.4). In addition, the engineer exercises a dispute resolution function under these contracts (sub-clauses 3.5). The removal of the engineer, in the Silver and Orange Books, is consistent with the nature of the turnkey contract in which the contractor designs the project and coordinates construction thereby reducing the need for a central figure. A detailed discussion of the role of the employer's representative is contained in (Chapter 7). 79

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THE CONTRACT

The ENAA, EIC and ICE also provide definitions for the employer's representative.

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1.1.2.5 "Contractor's Representative". Under the FIDIC contracts, a "contractor's representative" may be appointed and fills a, largely, facilitative role. Unlike the other FIDIC contracts, the Orange Book does not specify that the contractor's representative "acts on behalf of the contractor". He provides a connection between the contractor, on the one hand, and the employer's representative, on the other hand, as regards communication and notices. Despite the differences in the definitions, the contractor's representative fulfils a similar role under the FIDIC contracts examined herein. The ENAA, EIC and ICE all provide definitions for the contractor's representative.

DISCUSSION OF SPECIFIC SUB-CLAUSES

may arise in a less contentious atmosphere than would be found in arbitration or litigation. All of the FIDIC contracts examined herein contain equivalent definitions of this board. Further discussion of this dispute resolution regime may be found in Chapter 24. None of the other standard form contracts examined herein define their dispute resolution bodies, where such exist.

1.1.2.10 "FIDIC". This is a seemingly unnecessary definition that is, nonetheless, provided in all FIDIC contracts other than the Orange Book. The FIDIC Guide states this definition is provided for greater certainty, as (under sub-clause 20.3) the president of FIDIC or his appointee may act as appointing entity for the purpose of sub-clause 20.3.13

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1.1.3 Dates, Tests, Periods and Completion

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1.1.2.6 "Employer's Personnel". The Silver Book definition of "employer's personnel" is the same as that of the Yellow and Red Books, except that the latter two include the engineer and his delegates in this category. This inclusion has implications at other points in the contract and calls into question the independence of the engineer. As discussed above, however, the engineer is not truly independent. Rather, a better characterisation of the engineer is that he is relied on to be professional. The Orange Book does not designate employer's personnel, nor do the other standard form contracts examined herein.

1.1.3.1 "Base Date" means the date 28 days prior to the latest date for submission of the Tender. 1.1.3.2 "Commencement Date" means the date notified under Sub-Clause 8.1 [Commencement of Works], unless otherwise defined in the Contract Agreement. 1.1.3.3 "Time for Completion" means the time for completing the Works or a Section (as the case may be) under Sub-Clause 8.2 [Time for Completion], as stated in the Particular Conditions (with any extension under Sub-Clause 8.4 [Extension of Time for Completion]), calculated from the Commencement Date.

1.1.2.7 "Contractor's Personnel". All FIDIC contracts examined herein, with the exception of the Orange Book, define "contractor's personnel". This definition has consequences under the contracts, especially with regard to the allocation of responsibility for actions attributable to the contractor or the contractor's personnel. The other standard form contracts, however, do not provide definitions for contractor's personnel.

1.1.3.4 "Tests on Completion" means the tests which are specified in the Contract or agreed by both Parties or instructed as a Variation, and which are carried out under Clause 9 [Tests on Completion) before the Works or a Section (as the case may be) are taken over by the Employer. 1.1.3.5 "Taking-Over Certificate" means a certificate issued under Clause 10 [Employer's Taking Over).

1.1.2.8 "Subcontractor". The contractor, when performing the works contemplated by a turnkey contract, will generally use a number of subcontractors to provide various services and supply materials for construction. These subcontractors are referred to in the conditions of contract. This allows some regulation of them by the employer in the interests of ensuring, inter alia, the quality of the construction and the materials used. The Silver Book provision is identical to those of the Red and Yellow Books. The Orange Book provision differs in that it specifically includes a manufacturer or supplier for a part of the works. The Orange Book specifically excludes subcontractor status to the assignees of any subcontractor. The ENAA, AGe and DBIA all provide definitions for subcontractors. 1.1.2.9 "DAB". The dispute adjudication board provides the dispute resolution function that was traditionally part of the role of the engineer. The goal of such dispute resolution is the rapid resolution of any dispute that 80

1.1.3.6 "Tests after Completion" means the tests (if any) which are specified in the Contract and which are carried out under Clause 12 [Tests after Completion] after the Works or a Section (as the case may be) are taken over by the Employer. 1.1.3.7 "Defects Notification Period" means the period for notifying defects in the Works or a Section (as the case may be) under Sub-Clause 11.1 [Completion of Outstanding Work and Remedying Defects), as stated in the Particular Conditions (with any extension under Sub-Clause 11.3 [Extension of Defects Notification Period]), calculated from the date on which the Works or Section is completed as certified under Sub-Clause 10.1 [Taking Over of the Works and Sections). If no such period is stated in the Particular Conditions, the period shall be one year.

Il

ibid., p. 310.

81

DI SCUSSION OF SPECIFIC SUB-CLAUSES

THE CONTRACT

1.1.3.8 "Performance Certificate" means the certificate issued under SubClause 11.9 [Performance Certificate]. 1.1.3.9 "day" means a calendar day and "year" means 365 days.

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1.1.3.1 "Base Date". All of the FIDIC contracts reviewed in this book provide the same definition of the "base date". The base date allows the contractor to utilise, for pricing and programming purposes, the laws and certain circumstances that existed at the appropriate time when he finalised his tender. Thus he will not bear the risk of a change in law or circumstances occurring after the formulation of the tender. The base date could be defined as a particular calendar date. The base date is referred to in Silver Book sub-clauses 4.10 (site data); 5.1 (general design obligations); 5.4 (technical standards and regulations); 13.7 (adjustments for changes in legislation); 14.15 (e) (currencies of payment); 17.5 (b)(ii) (intellectual and industrial property rights); 18.2 (insurance for works and contractor's equipment). None of the other standard form contracts contain a definition for a mechanism similar to the base date. 1.1.3.2 "Commencement Date". The commencement date can be indicated either by the employer or his representative, by reference to events external to the parties, or can be predetermined in the contract. The definitions of the other FlDIC contracts examined herein are essentially equivalent to that of the Silver Book, although the provisions vary, regarding the commencement date, as between the contracts (sub-clauses 8.1). The FlDIC contracts do not specify what occurs if the contractor is not notified of commencement within the time specified under the various contracts. Presumably, the contractor would be allowed to terminate under sub-clauses 16.2. The parties may wish to specify the effect of such a failure. The ICE defines a commencement date. The ENAA provides a definition for an "effective date" within seven days after which commencement is to occur (ENAA Agreement 5.1). 1.1.3.3 "Time for Completion". Generally speaking, the contractor must achieve substantial completion of the works within a given time period, defined as the time for completion. Under the Silver Book, the contractor must complete the works, including passing the tests on completion, within the time for completion. This leaves the tests after completion to be performed subsequent to the time for completion. The FIDIC contracts examined herein contain similar provisions to that of the Silver Book, although the time for completion under these contracts is stated in the appendix to tender. Both the ENAA and EIC also define a time for completion. 1.1.3.4 "Tests on Completion". Tests on completion are designed to verify that the contractor has completed construction of the works to the extent 82

required within the time for completion. The works must pass these t.ests before they can be considered complete; they can then be pa~sed. back I~to the possession and care of the employer. Care should be .t aken In dlffere.n tlating between tests on completion and tests after completion, as the passmg of the former test will precede the employer's taking over of the works (or a section thereof).14 This section is identical to those definitions found in the (new) Red and Yellow Books and similar to that of the Orange Book. Rough equivalents to this definition may be found in the ENAA and EIe.

1.1.3.5 "Taking-Over Certificate". Taking over indicates the successf~1 completion of the works to the extent required by the contract .. At thiS point the works are taken over by the employer who proceeds With tests after completion to verify the functioning of the works as contracted. Although the contractor no longer has possession of the site and care of the works, he maintains the right to enter the site and have access to the works in order to fulfil his obligation to remedy defects.·The Orange Book and (new) Yellow and Red Books' definitions follow the wording of that of the Silver Book. Of the other standard form contracts examined herein, only the EIC contains a similar definition. Along a similar vein to the purpose of a taking-over certificate, the ICE, AGC and DBIA all provide definitions for "substantial completion" and for the issue of corresponding certificates.

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1.1.3.6 "Tests after Completion". Under a turnkey or EPC contract the contractor must deliver completed works satisfying certain specifications provided by the employer. These specifications may include performance standards that the finished works must meet. In such case the parties may include tests after completion to verify that the works perform to the specifications required. The FIDIC contracts examined herein contain similar definitions for tests after completion, although the Orange Book definition does not refer to Orange Book clause concerning tests after completion (clause 11) and the Red Book includes the specifications for these tests in the particular conditions. In order to provide sample wording for both instances, FlDIC requires the contractor to carry out the tests after completion in the Silver Book, whereas the employer is to do so under the Yellow BookY

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1.1.3.7 "Defects Notification Period". The defects notification period is important, as this period is effectively a warranty period on the works of the contractor. The contractor is bound to remedy any defects where the owner notifies the contractor of these defects within this time period. Both the (new) Yellow and Red Books contain equivalent provisions to that of

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14 IS

ibid., p. 51. ibid., p. 51.

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THE CONTRACT

DISCUSSION OF SPECIFIC SUB-CLAUSES

the Silver Book, although neither contract provides for a one-year period where no period is stated in the particular conditions. The Orange Book does not provide any such definition. The ENAA, EIC and ICE contain ~oughly equivalent definitions to that of the Silver Book, and the EIC Includes a 12-month fall-back where there is failure to stipulate a period otherwise.

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1.1.3.8 "Performance Certificate". The performance certificate indicates both successful passage by the works of the tests after completion and the approval of the works by the employer. The issue of the performance certificate also signals the end of the defects liability period. The other FIDIC contract provisions are virtually identical but, under these contracts, the certificate is to be issued by the engineer ((new) Yellow and Red Books) or the employer's representative (Orange Book) where such are used. Finally, while the other standard form contracts examined herein may use a similar mechanism (i.e. the final certificate) only the ENAA contains an equivalent definition of this mechanism (i.e. acceptance).

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1.1.3.9 "Day". Such a provision can be important in international contracts where projects may be constructed in countries running under other calendar systems. A year could mean a year under the Islamic calendar, for example. Another example of potential for confusion: in Israel each day begins at sunset. All of the FIDIC contracts examined herein contain equivalent provisions. In addition, and an indication of the importance of such a definition, the ENAA, EIe, AGC and DBIA all define day.

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1.1.4 Money and Payments 1.1.4.1 "Contract Price" means the agreed amount stated in the Contract Agreement for the design, execution and completion of the Works and the remedying of any defects, and includes adjustments (if any) in accordance with the Contract. 1.1.4.2 "Cost" means all expenditures reasonably incurred (or to be incurred) by the Contractor, whether on or off the Site, including overhead and similar charges, but does not include profit. 1.1.4.3 "Final Statement" means the statement defined in Sub-Clause 14.11 [Application for Final Payment]. 1.1.4.4 "Foreign Currency" means a currency in which parr (or all) of the Contract Price is payable, but not the Local Currency. 1.1.4.5 "Local Currency" means the currency of the Country.

I

1.1.4.6 "Provisional Sum" means a sum (if any) which is specified in the Contract as a provisional sum, for the execution of any part of the Works or for the supply of Plant, Materials or services under Sub-Clause 13.5 [Provisional Sums].

84

1.1.4.7 "Retention Money" means the accumulated retention moneys which the Employer retains under Sub-Clause 14.3 [Application for Interim Payments] and pays under Sub-Clause 14.9 [Payment of Retention Money]. 1.1.4.8 "Statement" means a statement submitted by the Contractor as part of an application for payment under Clause 14 [Contract Price and Payment].

1.1.4.1 "Contract Price". The Silver Book assumes that the price, for construction will be a fixed amount, rather than one based on the actual cost of the work completed or the amount of work done, i.e, a fixed, lump-sum contract. This fixed price is called a lump sum. Turnkey and EPC projects are more amenable to lump-sum pricing given the control that the contractor has over the design and construction of the project. The Silver and Orange Books speak of the "contract price" which includes adjustments of this price made in accordance with the contract. The (new) Yellow and Red Books splice their definitions such that the "accepted contract amount", found in the letter of acceptance, does not include adjustments whereas the "contract price" includes any adjustments made in accordance with the contract. The ENAA, EIC and ICE all define the contract price.

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1.1.4.2 "Cost". The definition of cost may have a significant impact on the performance of the contract when it comes to valuation of damages and reimbursement of the contractor for such events as changes in legislation. The definition specifically excludes profit. However, it does not specify the treatment of supplier discounts and other such benefits that contractors, especially on large purchase orders, might receive. It also includes overhead and similar charges that arguably render the definition favourable to the contractor. The definitions of the FIDIC contracts are almost identical. The ICE also provides a definition for cost but, unlike the FIDIC contracts, does not require the expenditures in question to be incurred by a particular party (ICE 1(5)).

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1.1.4.3 "Final Statement". Issued subsequent to the performance certificate, which is issued within 28 days of the end of the contract period, this statement indicates the work completed, its value and the amount still due to the contractor by the employer. The final payment is based on this amount. The FIDIC contracts contain similar provisions to each other as regards the final statement mechanisms.

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1.1.4.4 "Foreign Currency". This sub-clause contemplates that the contract price will be paid, at least partly in local currency. This may not be the case, however, particularly where project financing is obtained or where another currency is preferable for reasons of exchange or stability. The Silver Book definition is identical to that of the (new) Red and Yellow

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85

THE CONTRACT

Books. The Orange Book differs, however, as the definition specifies that foreign currency means a freely convertible currency. It is unclear what the result under the Orange Book will be, if a currency referred to in the appendix is not freely convertible or loses its convertibility after the contract comes into force. Although parties are unlikely to choose an unstable foreign currency, parties may, nonetheless, want to include the specifications of the Orange Book. The ENAA does not define foreign currency but does provide that the contract price may be paid in both local and foreign currency (ENAA Agreement 3.1). 5-42

1.1.4.5 "Local Currency". This definition is identical amongst the FlDIC contracts.

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1.1.4.6 "Provisional Sum". Provisional sums are used by the employer to maintain control over certain aspects of the construction-for example, the purchase of know-how, the hiring of subcontractors or the choice of the materials to be used in the works. The contract specifies the amount that is then allocated in accordance with the directions of the employer's representative. The FIDIC contracts examined herein contain virtually identical definitions.

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1.1.4.7 "Retention Money". A portion (usually a percentage) of each payment made to the contractor is retained by the employer to be paid back at specified stages of completion. This provides the contractor with a greater incentive for timely completion at later stages of construction and also gives to the employer an added guarantee against failure of performance by the contractor. The amount held back is the retention money. The parties may prefer to replace retention money with a bond or third-party guarantee in order to provide the employer with an additional performance security while maintaining the contractor's capital flow. The issue of a bond or guarantee may also prove less costly to the contractor than the use of retention money. The FlDIC contracts examined herein contain virtually identical definitions. 1.1.4.8 "Statement". The FIDIC contracts examined herein, other than that of the Orange Book, provide a general definition of "statement" under the contracts. The Orange Book contains an almost identical list of requirements for a contractor's statement (under 13.3 Orange Book), although no definition of "statement" is provided in the definitions section. The Orange Book excludes liquidated damages deduction by the employer from such a statement (sub-clause 8.6).

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"Payment certificate"; "interim payment certificate"; "final payment certificate". The Red and Yellow Book's definitions include mention of a 86

DISCUSSION OF SPECIFIC SUB-CLAUSES

"payment certificate", as an engineer is used under these contracts. For the same reason, these two contracts, as well as the Orange Book, each define a "final payment certificate" and an "interim payment certificate". Under the Silver Book, interim and final payments are made on the basis of the statements issued by the contractor and su~mitted directly to the employer. 5-47

1.1.5 Works and Goods 1.1.5.1 "Contractor's Equipment" means all apparatus, machinery, vehicles and other things required for the execution and completion of the Works and the remedying of any defects. However, Contractor's Equipment excludes Temporary Works, Employer's Equipment (if any), Plant, Materials and any other things intended to form or forming part of the Permanent Works. 1.1.5.2 "Goods" means Contractor's Equipment, Materials, Plant and Temporary Works, or any of them as appropriate. 1.1.5.3 "Materials" means things of all kinds (other than Plant) intended to form or forming part of the Permanent Works, including the supply-only materials (if any) to be supplied by the Contractor under the Contract. 1.1.5.4 "Permanent Works" means the permanent works to be designed and executed by the Contractor under the Contract. 1.1.5.5 "Plant" means the apparatus, machinery and vehicles intended to form or forming part of the Permanent Works. 1.1.5.6 "Section" means a part of the Works specified in the Particular Conditions as a Section (if any). 1.1.5.7 "Temporary Works" means all temporary works of every kind (other than Contractor's Equipment) required on Site for the execution and completion of the Permanent Works and the remedying of any defects. 1.1.5.8 "Works" mean the Permanent Works and the Temporary Works, or either of them as appropriate.

1.1.5.1 "Contractor's Equipment". The FIDIC contracts examined herein provide similar definitions of contractor's equipment. The Orange Book, however, does not specifically exclude employer's equipment from this definition, nor does it specifically include vehicles. It may be difficult to differentiate contractor's equipment from temporary works unless they are specifically defined in the contract. The ENAA and ICE also provide definitions for contractor's equipment.

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1.1.5.1 "Goods". The Silver, Red and Yellow Books provide identical definitions of "goods", while the Orange Book provides none. "Goods" are used in the FIDIC contracts to allocate responsibility to the contractor for the care of such items while in transit to the site (under 4.16 Silver, Red and Yellow Books). "Goods" include both the contractor's equipment

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87

DISCUSSION OF SPECIFIC SUB-CLAUSES

THE CONTRACT

and temporary works (which will revert back to the contractor) as well as the materials and plants (which will be incorporated into the permanent works).16 The Orange Book provisions, however, do not hold the contractor exclusively liable for such items. For example, Orange Book sub-clause 4.20 stipulates that where the employer is to provide machinery and materials, such items are, at his risk and cost, transported to the site. 5-50

5-51

5-52

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1.1.5.3 "Materials". The FlDIC contracts examined herein provide similar definitions of "materials". The Orange Book definition differs from the other FIDIC contracts as it is only prospective: the materials are "to be provided" whereas the other contracts speak of items "intended to form or forming" part of the permanent works. The ENAA also defines materials. 1.1.5.4 "Permanent Works". Permanent works are those works which are to be erected on the site and which will remain on the site for use by the employer. Under both the Silver and Orange Book such works are "designed and executed" by the contractor whereas the (new) Red and Yellow Books only mention those works "executed" by the contractor. This is in keeping with the allocation of design responsibility under the contracts. Under the Yellow and Red Book, the contractor is to design the works in accordance with the engineer's instructions or subject to his approval (5.1 Yellow Book; 4.1 Red Book). Under the Silver and Orange Book, the contractor alone is to design the works, although the employer's representative plays a role under the Orange Book (5.1 Orange Book; 5.1 Silver Book). The ICE also defines permanent works.

less valuable) taking-over certificate for the works at the end of the project. IS ., .. The FIDIC contracts examined herein provide Identical definitIOns, although the Silver Book provides such sections may be delineat~d in. the particular conditions whereas, in the other contracts, such speCificatIOns are to be found in the appendix to tender. Due to the use of the contract period, division into sections will not affect the defects liability of the contractor. The ICE also contains a definition for section. 1.1.5.7 "Temporary Works". Temporary works are those works to be erected on the site for the sole purpose of constructing the permanent works that will then be removed by the contractor by the end of the project. The FIDIC contracts examined herein contain identical provisions, although the Orange Book omits the qualification of permanent works in its definition. The ICE also contains a definition for temporary works.

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1.1.5.8 "Works". The FlDIC contracts examined herein contain identical provisions. In addition, the ENAA, EIC and ICE all contain similar definitions of works. The AlA, AGC and DBIA, on the other hand, define works differently. Due to the design-oriented nature of the contracts, "work" includes the design/construction services provided by the contractor (AlA 1.1.2-Part 2; AGe 2.4.2; DBIA 1.2.12).

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1.1.6 Other Definitions

5-56

1.1.6.1 "Contractor's Documents" means the calculations, computer pro· grams and other software, drawings, manuals, models and other documen~s of a technical nature supplied by the Contractor under the Contract; as descClbed in Sub-Clause 5.2 [Contractor's Documents]. 1.1.6.2 "Country" means the country in which the Site (or most of it) is located, where the Permanent Works are to be executed.

1.1.5.5 "Plant". Plant indicates elements to be incorporated into the construction of the permanent works that have an independent function. An example would be a generator in a power project. The FIDIC contracts contain virtually identical definitions, although the Orange Book definition adds supply-only items. The ENAA and EIC also contain definitions for plant.

1.1.6.3 "Employer's Equipment" means the apparatus, machinery and vehicles (if any) made available by the Employer for the use of the Contractor in the execution of the Works, as stated in the Employer's Requirements; but does not include Plant which has not been taken over by the Employer.

1.1.5.6 "Section". The parties may divide the completion of the works into sections that can be completed as separate units (for example, the separate generating units of a power plant). Each section can then be allocated a separate time for completion, if such sections are truly susceptible to independent completion. In addition, these sections should be given precise geographical definitions in order to clarify the extent of parties' responsibilities upon taking over.17 FIDIC also advises that the whole of the works not be divided into sections, as this would eliminate the need for the (nonethe16 17

ibid., p. 55. ibid., p. 5.5.

88

1.1.6.4 "Force Majeure" is defined in Clause 19 [Force Majeure]. 1.1.6.5 "Laws" means all national (or state) legislation, statutes, ordinances and other laws, and regulations and by-laws of any legally constituted public authority. 1.1.6.6 "Performance Security" means the security (or securities, if any) under Sub-Clause 4.2 [Performance Security].

18

ibid., p. 55.

89

DISCUSSION OF SPECIFIC SUB-CLAUSES

THE CONTRACT

1.1.6.7 "Site" means the places where the Permanent Works are to be executed and to which Plant and Materials are to be delivered, and any other places as may be specified in the Contract as forming part of the Site. 1.1.6.8 "Variation" means any change to the Employer's Requirements or the Works, which is instructed or approved as a variation under Clause 13 (Variations and Adjustments).

•

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1.1.6.1 "Contractor's Documents". The contractor's documents definitions are roughly equivalent between the FlDIC contacts examined herein. The Orange Book, however, caIls such documents "construction documents". In addition, each FIDIC contract provides further specifications for such documents (5.2 Silver Book; 5.2 Yellow Book; 5.2 Orange Book), except for the Red Book. This discrepancy may be explained by the fact that under the Red Book the employer is to provide for the design for the works. The employer's use of these documents is subject to constraint (see subclauses 1.10).

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1.1.6.2 "Country". Although defined under the FlOlC contracts, this definition does not appear in the other form contracts.

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1.1.6.3 "Employer's Equipment". Silver, YeIlow and Red Books define employer's equipment. The Orange Book does not define employer's equipment, although the possibility of employer-supplied machinery and materials is addressed under Orange Book sub-clause 4.20. The (new) Yellow Book contains an error in referring to "specification", instead of "employer's requirements", for a list of items making up the employer's equipment. Specification is relevant only under the Red Book.

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1.1.6.4 "Force Majeure". The FIDIC contracts examined herein, other than the Orange Book, contain definitions of force majeure. The Orange Book, however, provides a definition of force majeure under the clause relating to the occurrence of such an event (see 19.1 Orange Book),

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1.1.6.5 "Laws". The FIDIC contracts, other than the Orange Book, provide definitions for laws referred to under the contracts. Where such reference is made, parties should take care to specify the jurisdiction in question, as provisions such as those relating to the law governing the contract would not be sufficient. The DBIA also provides a definition for "legal requirements".

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1.1.6.6 "Performance Security". The contractor's provision of performance security to the employer is an important feature of the FIDIC contracts. Under the provisions of the FIDIC contracts, performance security is to remain valid and enforceable until the contractor has executed and completed the works and remedied any defects (see sub-clauses 4.2). Such security helps ensure the contractor wiIl have the financial means to complete the various 90

stages of the contract. The FlDIC contracts, other than the Orange Book, provide definitions for performance security referred to under the contracts. Performance security is, nonetheless, discussed under Orange Book subclause 4.2. 1.1.6.7 "Site". The site includes the locations to which the contractor will have access and over which he will have control to permit construction of the works. The site must, therefore, be carefuIly delineated in the contract, particularly in consideration of the contractor's duty to keep the site clean and secure and to avoid poIlution issuing from it. Although the contractor may, upon agreement by the employer, obtain additional working areas (under sub-clause 4.23), these areas are not included in the site definition as "such provision would be inconsistent with the employer's obligations in respect of the site" {i.e. under sub-clause 2.1 ).19 The FIOIC contracts examined herein provide virtuaIly identical provisions although the Orange Book omits the qualification of permanent works in its'definition. The ENAA, ElC, ICE and DBlA 1.2.8 also contain definitions of site.

5-62A

1.1.6.8 "Variation". Although the contractor is generaIly responsible for design and construction of the works, the employer may implement changes during the period of the contract. Such variations are performed at the cost of the employer. The FIDlC contracts examined herein contain essentially identical definitions in this regard. The Red Book, however, does not mention a change to the "employer's requirements" as such requirements do not exist under this contract. The ElC and AlA also contain definitions for variation.

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1.2 Interpretation

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In the Contract, except where the context requires otherwise: (a) words indicating one gender include all genders; (b) words indicating the singular also include the plural and words indicating the plural also include the singular; (c) provisions including the word "agree", "agreed" or "agreement" require the agreement to be recorded in writing, and (d) "written" or "in writing" means hand-written, type-written, printed or electronically made, and resulting in a permanent record. The marginal words and other headings shall not be taken into consideration in the interpretation of these Conditions. The Silver Book sub-clause 1.2 indicates general principles of interpretation for the contract documents. This clause is standard in construction con19

ibid., p. 57.

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DISCUSSION OF SPECIFIC SUB-CLAUSES

THE CONTRACT

tracts to allow sufficient flexibility in the contract language and to avoid misinterpretation. The relevant Yellow and Red Book provisions are identical to that of the Silver Book. The Orange Book provisions differ from the Silver Book, however, specifying, "words importing persons or parties shall include firms and corporations and any organisation having legal capacity" (Orange Book 1.3). The Orange Book also diverges from the other FIDIC contracts in not including clarification of terms relating to "agreement". Finally, the Orange Book, unlike the other FIDIC contracts, does not begin with the proviso that the context may require an interpretation other than as provided under the interpretation provision. Various other of the standard form contracts examined herein contain 'similar provisions to that of the Silver Book regarding headings (ENAA 3.3; ICE 1(3); EIC 1.3; AGC 13.5; DBIA 12.6.1) and the significance of words appearing in the plural or singular (ENAA 3.2; ICE 1(2); EIC 1.10). The ICE also includes a definition for "in writing" (ICE 1(6)). Similar to the Orange Book, both the ENAA and the EIC indicate that reference to persons or parties, under the contract, may include firms, organisations, and any organisation having legal capacity (ENAA 3.4; EIC 1.4).

5-65

cautions that the importance of the requirement that certain communications not be unreasonably withheld or delayed should not be under-estimated, nor should the serious consequences of non-compliance with this requirement. 2o The ENAA covers notices but with more specificity with respect to time periods, presumption of reception in a certain time and time period for confirmation. The presumption of reception under the ENAA has been criticised, suggesting that parties should instead be required to provide evidence of actual receipt. 21 The ICE, EIC and DBIA provisions relating to notices are less detailed (ICE 68; EIC 1.11; DBiA 12.7). Similar to the ENAA, the DBIA also contains a presumption of receipt clause (DBIA 12.7.1).

The Contract shall be governed by the law of the country (or other jurisdiction) stated in the Particular Conditions. If there are versions of any part of the Contract which are written in more than

one language, the version which is in the ruling language stated in the Particular Conditions shall prevail.

1.3 Communications Wherever these Conditions provide for the giving or issuing of approvals, certificates, consents, determinations, notices and requests, these communications shall be: (a) in writing and delivered by hand (against receipt), sent by mail or courier, or transmitted using any of the agreed systems of electronic transmission as stated in the Particular Conditions; and (b) delivered, sent or transmitted to the address for the recipient's communications as stated in the Contract. However: (i) if the recipient gives notice of another address, communications shall thereafter be delivered accordingly; and (ii) if the recipient has not stated otherwise when requesting an approval or consent, it may be sent to the address from which the request was issued. Approvals, certificates, consents and determinations shall not be unreasonably withheld or delayed. The Silver Book sub-clause 1.3 provides details on how communications under the contract should occur. Communication between the parties is extremely important in a construction project, not only for the proper performance of the contract but also for the resolution of any claims made by the contractor. The provisions of the various FIDIC contracts examined herein are substantially the same, although some additional language is added to ensure the employer and employer's representative/engineer each both get and give notice. The FIDIC Guide

92

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1.4 Law and Language

The language for communications shall be that stated in the Particular Conditions. If no language is stated there, the language for communications shall be the language in which the Contract (or most of it) is written. The Silver Book sub-clause 1.4 indicates the relevant law and language for both the governing of the contract and communication between the parties. The other FIDIC contracts examined herein contain equivalent provisions. Differences do appear under the Orange Book, which fails to provide a default language for communications, should none be stipulated in the appendix to tender. The Orange Book also only refers to "day-to-day" communications whereas the other FIDIC contracts address communications in general. The choice of language can be extremely important. A single day-to-day language will prevent confusion on the site caused by linguistic differences and translations. The language of the contract is similarly important. For example, a construction contract may provide for the contract language to be both French and English. Such a stipulation may be politically convenient but could result in confusion and miscommunication, particularly in the more technical aspects of the contract documents. The choice of law is equally important. It will define and regulate the terms and execution of the contract. The parties should indicate a legal system 20

2.

ibid., p. 59.

Wiwen-Nilsson," A Brief View of the 1992 Edition of the ENAA Model Form-International Contract for Process Plant Construction (Turnkey Lump sum Basis)", op. cit. n. 1 above at 532.

93

DISCUSSION OF SPECIFIC SUB-CLAUSES

THE CONTRACT

consistent with their needs and protective of their interests. The EIC Guide warns, for example, that "under certain Civil Law jurisdictions, some Silver Book conditions may be considered unfair trade terms and therefore inapplicable" .22 Furthermore, parties should inform themselves as to the rules of public order of the jurisdiction in question, as such rules may not be contracted out of. Other standard form contracts examined herein contain provisions relating to language (ENAA 3.1; EIC 25.4) and law (ENAA 5; EIC 24; AlA 7.1Part. 1; AlA 11.1-Part.2; AGC 13.2; DBIA 12.3).

5-'{)7

1.5 Priority of Documents The documents forming the Contract are to be taken as mutually explanatory of one another. For the purposes of interpretation, the priority of the documents shall be in accordance with the following sequence: (a) the Contract Agreement, (b) the Particular Conditions, (c) these General Conditions, (d) the Employer's Requirements, (e) the Tender and any other documents forming part of the Contract. The Silver Book sub-clause 1.5 sets out the priority of the various documents comprising the contract for the purposes of interpretation. This section is similar to those of the Yellow and Red Book sub-clauses 1.5, although these sub-clauses include the letter of acceptance (which is not specifically referenced or defined under the Silver Book) after the contract agreement. Further, the "schedules" referred to in the Yellow and Red Books take the place of, and are roughly equivalent to, the "tender" of the Silver Book. Finally, the Yellow Book, as does the Orange Book, places the "contractor's proposal" at the bottom of the priority list. The FIDlC Guide justifies placing the employer's requirements before the tender as this signals to the contractor the obligatory nature of the employer's requirements. Where the tender does not, or to the extent that it does not, conform to the employer's requirements; these differences may be incorporated into (and thus sanctioned) the letter of acceptance or contract agreement. 23 Further, although the general conditions are ranked above the employer's requirements and the tender, where the general conditions state they are to apply "unless otherwise stated in the contract" the provisions of these lower-ranked documents may apply in case of conflict. 24 The Orange Book does not include a catch all of the other documents forming part of the contract. The Orange Book also provides a different 22 2J 24

EIC~ The EIC Contractor's Guide to the F1DIC Conditions of Contract for EPC Turnkey ProJects (European International Contractors, Berlin, 2000), p. 8 (hereinafter EIC Guide). FIDIC Guide, op. cit. n. 5 above, p. 62. ibid., p. 62.

94

ordering from that of the Silver Book, placing both the employer's requirements and the tender before the particular and general conditions (although called by a different name). The Red and Yellow Books allow the employer to issue a clarification or instruction (under sub-clause 3.3) where an ambiguity or discrepancy is found in the contract documents. The Silver Book contains no such provision and, therefore, the FIDIC Guide suggests, "parties should endeavour to reach agreement on how [such discrepancy] should be resolved, which may result in an adjustment to the contract price".2s Other standard form contracts examined herein also contain provisions both ranking the various contract documents and specifying that these documents mutually complement each other (ENAA Agreement 1.2; EIC 1.5; AGC 2.4.1; DBIA Agreement 3.1). The EIC provision, however, only specifies that the parties may agree to a ranking but does not indicate the ranking itself. 1.6 Contract Agreement

S-'{)8

The Contract shall come into force and effect on the date stated in the Contract Agreement. The costs of stamp duties and similar charges (if any) imposed by law in connection with entry into the Contract Agreement shall be borne by the Employer. Silver Book sub-clause 1.6, unlike the other FIDIC contracts examined herein, requires a contract agreement in which the date of the entry into force and effect of the contract is stated. Under the Red and Yellow Books, the parties are to enter into a contract agreement "within 28 days after the contractor receives the letter of acceptance" unless agreed otherwise. Where no letter of acceptance exists under these contracts, however, in order to establish a binding contract parties must sign a contract agreement. 26 Under the Orange Book, a contract agreement may be entered into at the request of either party. Unlike the other FIDIC contracts examined herein, the Orange Book contains a further provision regarding the "effective date", meaning "the date on which the contract entered into legal force and effect" (sub-clause 1.1.3.2). In general, the provision for drafting of a contract agreement stems from concerns regarding legality, as in some jurisdictions a contract agreement is advisable or required. The parties should make sure their contract includes an appended form of contract agreement, as do the Orange, (new) Red and Yellow Books. Where parties do enter into a contract agreement, all of the FIDIC contracts examined herein place the cost of stamp duties and execution costs as well as the cost of drafting on the employer. 25 26

ibid., p. 62. ibid., p. 63.

95

THE CONTRACT

DISCUSSION OF SPECIFIC SUB-CLAUSES

1.7 Assignment

5-69

Neither Party shall assign the whole or any part of the Contract or any benefit or interest in or under the Contract. However, either Party: (a) may assign the whole or any part with the prior agreement of the other Party, at the sole discretion of such other Parry, and (b) may, as security in favour of a bank or financial institution, assign its right to any moneys due, or to become due, under the Contract. The Silver Book sub-clause 1.7 prohibits either party from assigning his interest or benefit under the contract unless approval is obtained from the other party or assignment is made as a security in favour of a bank or financial institution. The (new) Red and Yel10w Book sub-clauses 1.7 contain identical provisions to that of the Silver Book. The Orange Book, however, does not contain a clause relating to the assignment of benefits or interests under the contract. The other standard form contracts herein contain provisions relating to assignment of contract interests. As a general rule parties must obtain permission from each other before any assignment (ENAA43, EIC 25.1; EIC 25.2; ICE 3; AlA 7.2-Part 2; AlA 11.6.1-Part 2; AGC 13.1; DBIA 12.1.1). The contracts provide several derogations from this principle, however. For example, the ENAA al10ws the contractor to assign monies that are, or will be, due and payable to it under the contract (ENAA 43). Further, the EIC allows the contractor to both assign, to his insurers, his right to obtain relief against any other party liable (EIC 25.2(b)) and assign monies due as a charge in favour of the contractor's banker (EIC 25.2(a)). Finally, under the AlA, the owner may assign the agreement to an institutional lender providing construction financing (AlA 11.6.1Part 2).

The Silver Book sub-clause 1.8 indicates the arrangements for the allocation of the care and supply of the documents as between the parties. Taking over of the contractor's documents does not correspond with the taking over of the works, or part thereof, but rather is generally occasioned by the contractor's issuance of these documents to the employer.27 The Red and Yellow Book sub-clauses 1.8 are identical to that of the Silver Book with regard to the contractor's documents. There will, however, be fewer (if any) contractor's documents in a Red Book contract depending on the amount of the contractor's design responsibility of the contract. The Red Book differs from the other two contracts in that the specifications (the Red Book equivalent to the employer's requirements) and drawings are to be in the custody and care of the employer. The Silver and Yellow Book clauses do not address the employer's requirements. Orange Book sub-clauses 1.7 and 1.9 roughly correspond to that of the Silver Book. The Orange Book provisions, however, do not require that one party notify the other party where there is an error or defect of a technical nature in a document relating to the execution of the works. Several of the other standard form contracts examined herein contain provisions similar to those of Silver Book sub-clause 1.8. For example, the EIC requires the contractor to provide the employer with copies of both t~e drawings and, following the issue of the taking-over certificate, the as-bUilt drawings (EIC 6.14). In addition, the ICE provides for certain documents and drawings to be kept by the contractor on the site, with access for inspection and use by the employer's representatives (ICE 6(2)). Final1y, the AGC requires the owner give prompt written notice to the contractor where the owner "becomes aware of any error, omission or failure to meet the requirements of the contract documents or any fault in the work" (AGC 4.3.2).

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1.9 Confidentiality

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1.8 Care and Supply of Documents

Both Parties shall treat the details of the Contract as private and confidential, except to the extent necessary to carry out obligations under it or to comply with applicable Laws. The Contractor shall not publish, permit to be published, or disclose any particulars of the Works in any trade or technical paper or elsewhere without the previous agreement of the Employer.

Each of the Contractor's Documents shall be in the custody and care of the Contractor, unless and until taken over by the Employer. Unless otherwise stated in the Contract, the Contractor shall supply to the Employer six copies of each of the Contractor's Documents. The Contractor shall keep, on the Site, a copy of the Contract, publications named in the Employer's Requirements, the Contractor's Documents, and Variations and other communications given under the Contract. The Employer's Personnel shall have the right of access to all these documents at all reasonable times.

If a Party becomes aware of an error or defect of a technical nature in a document which was prepared for use in executing the Works, the Parry shall promptly give notice to the other Party of such error or defect.

Silver Book sub-clause 1.9 states that the parties are to treat the details of the contract as private and confidential. This confidentiality provision is unique to the STiver Book amongst the other FIDIC contracts examined herein. Such a provision may be important, particularly to the employer, where the project is of a sensitive nature, commercial1y or otherwise. Where

27

96

ibid., p. 65.

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DISCUSSION OF SPECIFIC SUB-CLAUSES

THE CONTRACT

the contractor's design includes commercially sensitive data which he does not want disclosed, the second sentence of this sub-clause might be adjusted to include reference to the employer. 28 A few of the other standard form contracts examined herein also provide confidentiality clauses. Both the ENAA and EIC impose a general obligation of confidentiality with respect to data or other information received in connection with the contract whose dissemination is not necessary for the fulfilment of contractor's obligations under the contract (ENAA 16.1; EIC 7.2; EIC 21.1). Indeed, parties may wish to provide that such particulars should no lo~ger be subject to confidentiality once they fall within the public d.omam. The EIC also provides that confidentiality obligations will not apply eIther where the information falls within the public domain or where it is obtained from outside of the confidential relationship between the parties (EIC 21.2). This provision may be superfluous, as the law of the jurisdiction of the contract may provide similar qualifications where a confidential relationship exists between parties.

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1.10 Employer's Use of Contractor's Documents As between the Parties, the Contractor shall retain the copyright and other intellectual property rights in the Contractor's Documents and other design documents made by (or on behalf of) the Contractor. The Contractor shall be deemed (by signing the Contract) to give to the Employer a non-terminable transferable non-exclusive royalty-free licence to coPy, use a~d c~mmunicate the Contractor's Documents, including making and uSing modificatIOns of them. This licence shall: (a) apply throughout the actual or intended working life (whichever is longer) of the relevant parts of the Works, (b) entitle any person in proper possession of the relevant part of the Works to copy, use and communicate the Contractor's Documents for the ~u~poses of completing, operating, maintaining, altering, adjusting, repamng and demolishing the Works, and (c) in the case of Contractor's Documents which are in the form of computer programs and other software, permit their use on any computer on the Site and other places as envisaged by the Contract including replacements of any computers supplied by th~ Contractor. The Contractor's Documents and other design documents made by (or on behalf of) the Contractor shall not, without the Contractor's consent be used copied or communicated to a third party by (or on behalf of) the Em;loyer Eo; purposes other than those permitted under this Sub-Clause.

The Silver Book sub-clause 1.10 indicates how the ownership and use of the contractor's documents are to be allocated between the parties. 29 Indeed, due to the sensitivity and value of the documents used in construction, including know-how and construction procedures that may not be licensed, the contractor will want to be protected against improper use of such documents by the employer. Thus, all of the FlDIC contracts examined herein stipulate that the contractor retains the copyright of the contractor's documents. Unlike the Orange Book, however, the other FIDIC contracts examined deem the contractor to have given the employer a "non-terminable transferable non-exclusive royalty-free licence to copy use and communicate" the contractor's documents. Such a clause gives the employer both certain rights in the use of the contractor's documents and a way of conceptualising these rights. The Orange Book provision is less comprehensive that those of the other FIDIC contracts examined, and does not provide a time period during which the employer may make certain uses of the contractor's documents, nor is the case of computer software mentioned. The employer may want to clarify the language of this clause to ensure that he has the right to use the construction documents for future additions or modifications to the site or the works. He may also wish to ensure that he has the right to make or have made any necessary spare parts. The employer's rights in the designs and construction documents will depend on his negotiating power in the transaction as well as his economic investment in the designs. Where the contractor is developing an idea provided by the employer, the employer may want to own the rights to the designs and construction documents. This is particularly appropriate where the contract involves a one-off project. The majority of the other standard form contracts examined herein contain similar provisions. For example, under the ENAA, a number of provisions create similar rights between the parties to those of the Silver Book (ENAA .15; ENAA 16). The ICE, on the other hand, claims the copyright remains with the contractor, but only provides for the grant to the employer of the use of, and not the licence to use, these documents (ICE 7(1)(b)). Under the EIC, the contractor retains the copyright in any drawings, documents, data and other information he provides to the employer (EIC 20.2). No mention is made of a licence to use the documents but rather the employer is granted a non-exclusive fight to utilise patents, know-how and other industrial property incorporated in the works (EIC 20.1). Under the AlA, the contractor retains intellectual property rights regarding drawings, specifications and other documents provided by the contractor (AlA 3.1-Part 1; AlA 1.3.1-Part 2). The employer is allowed to make copies of these documents (AlA 3.1-Part 1; AlA 1.3.1-Part 2) and may 29

28

The EIG C:uide makes this suggestion, although sub-clause 1.12 may address some of the contractor s concerns 10 thiS regard. EIC Guide, op. cit. n. 22 above, p. 8.

98

The FIDICGuide notes the e.xpression "as between the parties" was utilised in the drafting In order to mclude other parties (such as subcontractors) in the intellectual property protection prOVided under thiS sub-clause. FIDIC Guide, op. cit. no. 5 above, p. 69.

99

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THE CONTRACT

DISCUSSION OF SPECIFIC SUB-CLAUSES

request permission to use these documents (AlA 3.2-Part 1; AlA 1.3.2Part 2) but a licence to use these documents is not granted to the employer save upon the contractor's default in his obligations to the owner (AlA 3.3Part 1; AlA 1.3.3-Part 2). The DBIA allocates a limited licence to the employer, but only upon payment in full (DBIA Agreement 4.1; DBIA Agreement 4.2).

5-74

through the special expertise of the contractor, then ar~uably the contractor should own the rights to the design and constructIon doc~ments. FO.r example, where the contractor is experie~ced in t~e co~structIon of fOSSIl fuel power plants, the contractor may decide that hIS deSIgns and construction documents prepared for the construction of such a plan~ should not become the property of the employer. Further, a contractor who IS also a supplier may not want to provide the employer with the technology needed to produce needed spare parts.

1.11 Contractor's Use of Employer's Documents

The Silver Book sub-clause 1.11 allows for the contractor to copy and use employer's documents. The employer retains the intellectual property rights in these documents, however, and the contractor may not, without the employer's consent, transmit them to a third party except as necessary for purposes of the contract. 30 The FIDIC contracts examined herein contain equivalent clauses to that of the Silver Book. Only a few of the other standard form contracts examined contain similar provisions regarding the employer's documents. This is perhaps because, under turnkey contracts, the contractor will produce the majority of the drawings and documents used in the construction. The employer, however, may provide designs in the employer's requirements or he may provide know-how or techniques that need protection against improper use by the contractor. The contractor should, therefore, retain sufficient flexibility to be able to use the documents and information for the purposes of the contract. The ENAA and ICE provisions roughly mirror those of the Silver Book (ENAA 16.1; ENAA 16.2; ICE 7(1)(a)). The same caveat regarding the lack of confidentiality of information in the public domain, or accessed through third parties, applies here as in the case of contractor's documents (ENAA 16.3). As discussed above, ownership of the construction documents and designs developed under the contract may result largely from the economic investment of the parties. Where the contractor is largely responsible for the designs of the project, developed with minimal preliminary design or )0

The Contractor shall not be required to disclose, to the Employer, any information which the Contractor described in the Tender as being confidential. The Contractor shall disclose any other information which the Employer may reasonably require in order to verify the Contractor's compliance with the Contract. Silver Book sub-clause 1.12 provides the contractor with an additional protection of confidentiality, allowing the contractor not to disclose information specified as confidential in the ten?er. The employer ~ay require the contractor to disclose any other information reasonably reqUIred f?r the empl.oy~r to verify the contractor's compliance with the contract. The SIlver Book IS Silent as to what would occur where the contractor classifies as confidential any information that is needed by the employer to verify the contractor's performance of the contract. Under the o'range Book, as under the Silver Book, the contractor may stipulate, in the tender, confidential details he will not be required to disclose although, unlike the Silver Book, the Orange Book does not provi?e a~y specific disclosure requirements. Indeed, it is often important to maJOtaln confidentiality in order to protect the interests of t~e parties involved. As discussed above in relation to Silver Book sub-clause 1.9, the contract can also include a provision protecting the parties from any publication of the . details of the agreement. The Yellow and Red Book sub-clauses 1.12 differ from that of the Silver Book. First, the contractor is required to disclose all such confidential, and other information as the engineer may reasonably require to verify the contract~r's compliance with the contract. Second, there is no mention of the contractor's ability to place information off limits through classifying such information as confidential. Indeed, the wording of these provisions suggests even confidential information may be released to the employer for the purposes of certain ends. The FIDIC Guide, however, states that the contractor may not be required to make certain disclosures where such are precluded in contractual documents having priority over the general conditions. 31

The FIDIC Guide notes the expression Mas between the parties" is utilised in the drafting in order to include other parties (such as the employer's personnel) in the intellectual properry protection provided under this sub·clause. FIDIC Guide, op. cit. n. 5 above, p. 70. )1

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1.12 Confidential Details

As between the Parties, the Employer shall retain the copyright and other intellectual property rights · in the Employer's Requirements and other documents made by (or on behalf of) the Employer. The Contractor may, at his cost, copy, use, and obtain communication of these documents for the purposes of the Contract. They shall not, without the Employer's consent, be copied, used or communicated to a third party by the Contractor, except as necessary for the purposes of the Contract.

ibid., p. 71.

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THE CONTRACT

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DISCUSSION OF SPECIFIC SUB-CLAUSES

1.13 Compliance with Laws i ,

j

The Contractor shall, in performing the Contract, comply with applicable Laws. Unless otherwise stated in the Particular Conditions: (a) the Employer shall have obtained (or shall obtain) the planning, zoning or similar permission for the Permanent Works, and any other permissions described in the Employer's Requirements as having been (or being) obtained by the Employer; and the Employer shall indemnify and hold the Contractor harmless against and from the consequences of any failure to do so; and (b) the Contractor shall give all notices, pay all taxes, duties and fees, and obtain all permits, licences and approvals, as required by the Laws in relation to the design, execution and completion of the Works and the remedying of any defects; and the Contractor shall indemnify and hold the Employer harmless against and from the consequences of any failure to do so.

It is important for both parties to ensure that the other abides by the legal system of the site country and any other country that may have jurisdiction over performance of the contract. This is especially true for the employer, who may be liable for the contractor's failure to comply with certain regulations, obtain permits or pay fees required for the construction of the works and any of its ancillary activities. Indeed, the majority of the other standard form contracts examined herein contain provisions relating to the compliance of laws. The Silver Book sub-clause 1.13 both affirms that the contractor is to comply with applicable laws in performance of the contract and apportions the responsibility for the compliance of various laws between the parties. More speCifically, the employer is responsible for obtaining the relevant permission relating to the permanent works, in addition to any other employer responsibilities for permissions as described in the employer's requirements, and shall indemnify the contractor against any consequences of his failure to do so. The contractor's responsibilities, on the other hand, are to obtain permissions relating to the design, execution and completion of the works and the remedying of any defects. The contractor shall indemnify the employer against any consequences of his failure to do so. The exact responsibilities of the parties under this sub-clause are potentially ambiguous. For greater clarity, parties may wish to append to the contract a detailed schedule of the permits required and indicate which party is to procure these permits. 32 Parties may also include such information in the particular conditions. 33 The Red and Yellow Book sub-clauses 1.13 are essentially identical to that of the Silve.r Book. The Orange Book, on the other hand, diverges significantly from the Silver Book. Orange Book sub-clause 13.1 provides a general provision requiring both parties to comply with the laws of each country where the 32 33

EIC Guide, op. cit. n. 22, p. 8.

For ~~re guidance as to issues to consider in the preparation of this aspect of the particular conditions, reference may be had to FIDIC Guide, op. cit. n. 5, p. 72.

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activities are performed. Further, the contractor is responsible for both assuring the compliance with the bureaucratic requirements of the jurisdiction of the works and for obtaining the relevant permissions relating to the works or their completion. The parties may, however, wish to allocate the burden of obtaining licences and permits on the basis of the identity of the parties, as under the Silver Book provision. Indeed, as the employer's requirements exist under the Orange Book, it might make sense to allocate responsibility to the employer for permissions required in relation to these requirements. Under the ENAA, the contractor has a general responsibility to comply with all laws in force in the country where the works are carried out (ENAA 9.4). The contractor is to obtain permissions required from government authorities in the country where the site is located that either relate to the performance of the contract or that the employer is not otherwise required to obtain (ENAA 9.3). The employer, on the other hand, must obtain permissions required from such authorities necessary for the execution of the works (ENAA 10.3) and shall assist the contractor in obtaining such permissions where they are not the responsibility of the employer under the contract (ENAA lOA). The ICE provides that the contractor is to act in accordance with applicable laws (ICE 26(3)). The contract also allocates to the contractor the general responsibility for obtaining permissions relating to both the design construction and completion of the permanent and temporary works (ICE 26(1)). The contractor is not responsible, however, for obtaining permissions in respect of the permanent works or any temporary works where such works were designed other than by or on behalf of the contractor (ICE 26(3)(c)). Under the AlA, the contractor is not obliged to violate any applicable law and shall notify the owner, in writing, where' implementation of any instruction received from the owner may result in such violation (AlA 1.2.5-Part 1; AlA 1.2.2-Part 2). This provision is complemented by a general stipulation that the contractor comply with the applicable laws, including the procurement of permissions, relating to the project (AlA 3.2.11-Part 2). Under the AGC, the contractor is responsible to "give all notices and comply with all laws and ordinances legally enacted at the date of the execution of the agreement which govern the performance of the work" (AGC 3.2.3). Similarly, the DBIA provides the contractor shall both perform the work and provide the legal notices necessary in connection with the work as required by the legal requirements (DBIA 2.5.1). The owner, on the other hand, is to obtain the permissions required "for the construction, use, occupancy or renovation of permanent structures" (AGC 4.1.2). Other provisions specify the contractor's responsibility to comply with applicable safety laws for the safety of its employees on the project (AGC 3.2.6; DBIA 2.8.2) and to ensure the drawings and specifications conform to the codes or laws enacted at the time of their preparation (AGC 3.1.1). Finally, under the DBIA the contractor is to ensure any design consultants used in the formulation of the design be qualified and licensed professionals, in conformity with applicable state licensing laws (DBIA 2.2.1). ln~

5-77

DISCUSSION OF SPECIFIC SUB-CLAUSES THE CONTRACT

5-78

1.14 Joint and Several Liability

If the Contractor constitutes (under applicable Laws) a joint venture, consortium or other unincorporated grouping of two or more persons: (a) these persons shall be deemed to be jointly and severally liable to the Employer for the performance of the Contract; (b) these persons shall notify the Employer of their leader who shall have authority to bind the Contractor and each of these persons; and (c) the Contractor shall not alter its composition or legal status without the prior consent of the Employer.

of these two entities varies in accordance with differences in legal culture and experience. The author identifies them as discussed below. The integrated joint venture involves the parties investing certain skills or materials in the project. The parties then receive a percentage of the profit made in the joint venture. In the example given below, the parties each place certain inputs or contributions into the joint venture. At the completion of the project they receive a set percentage of the projects made from the performance of the entire contract. A 20/% of profit or loss

A 20% of inputs -

5-79

The Silver Book sub-clause 1.14 speaks to the situation where the contractor, under the contract, is neither a single corporation nor a single physical person. Where such is the case, the entities comprising the contractor are to be held jointly and severally liable to the employer for performance of the contract, and are to indicate to the employer a designated spokesperson with the authority to bind the contractor. Finally, any change in either the legal status or composition of the contractor is subject to the prior consent of the employer. The contractor may wish the provisions of this sub-clause also to apply to the employer. 34 All of the FIDIC contracts examined herein contain similar provisions with regard to the potential nature of the contractor as a joint venture or consortium, although the Orange Book omits or other unincorporated grouping from its description of the contractor. The majority of the other standard form contracts examined herein do not contain provisions similar to that of the Silver Book. The ENAA is an exception, specifying that the contractor be "an independent contractor performing the contract" (ENAA 3.8). The ENAA places more emphasis on the contractor's position in relation to the owner, however, as the same provision also confirms that "the contract does not create an agency, partnership, joint venture or other joint relationship between the parties thereto" (ENAA 3.8). Often under construction contracts, the contractor may be a single entity or a group of entities acting collectively through a given project vehicle. The project vehicle may either be established in the form of a contractual grouping or a project company. Given the variety of legal regimes under which turnkey construction contracts are found, parties may want to include a clause, such as those found in the FIDIC contracts, specifying the responsibility of a party where that party is not a single entity. For example, although the legal construction of partnerships may be found in many jurisdictions, significant differences can occur between jurisdictions with respect to the asset base for any liability of the partnership and who may legally bind the partnership. However, although the contractor may form a company (e.g. partnership or limited liability company) for the purposes of the contract, contractual groups are more common. The two forms of contractual groupings most frequently employed by contractors are the joint venture and the consortium. The conceptualisation H

ibid., p. 9.

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B 30% of inputs -

Joint Venture

_

C 50/% of profit or loss

C 50% of inputs Figure 5.1

B 30/% of profit or loss

5-80

An integrated joint venture

The second method involves the creation of a consortium, or a non-integrated joint venture. In this model, the parties come together to tender a bid for a project. Once the bid has been accepted, each party is responsible for a discrete portion of the works. The contract price will be allocated according to each such portion. For example, one consortium member could be responsible for the civil works and the other could be responsible for the electro-mechanical works. As among the members of the consortium, each member will be responsible for the profits or losses realised with respect to the portion of the works for which he is responsible.

100% of input-

100% of input-

Figure 5.2

A

(civil)

B

(electro-mechanical)

5-81

100% of profit - or loss

100% of profit - or loss

5-82

A non-integrated joint venture 105

THE CONTRACT

5-83

As mentioned in particular conditions of the Silver Book, the employer may want to impose other requirements on joint ventures in large turnkey contracts, such as the provision of parent company guarantees (sub-clause 1.14). There may also need to be some scrutiny of the joint venture, its make-up and operation, by the financiers of the project. Provision for the intervention of financiers involves a separate topic which will not be studied in detail in this work, but which should be considered carefully by the employer when first tendering the project (e.g. compliance with the procurement rules of the European Bank for Reconstruction and Development).

CHAPTER

6

THE EMPLOYER General Comments The first edition of the present book was based on the FIDIC Orange Book (1995), which contained a clause 2 "The Employer" similar to the current clause under discussion in this chapter. Some of the provisions contained in the Orange Book clause 2 have been moved to different sections of the Silver Book. In addition, the Silver Book clause 2 contains three new provisions concerning the obligations of the employer regarding his personnel, proof of the employer's financial capability and a separate clause setting forth a procedure for claims against the contractor by the employer. Silver Book Clause 2 contains five sub-clauses setting forth a number of the employer's express obligations: sub-clauses 2.1 "Right of Access to the Site", 2.2 "Permits, Licences or Approvals", 2.3 "Employer's Personnel", 2.4 "Employer's Financial Arrangements" and 2.5 "Employer's Claims". This chapter will begin with a brief discussion of two of the major topics contained in clause 2 and then move to an analysis of the specific clauses with comparisons to similar provisions from other industry standard form design-build/turnkey contracts.

6-01

Access and possession The employer's duty to give access to and provide the site constitutes one of the fundamental aspects of the parties' relationship under the construction contract. Whether or not it is specifical\y included as an obligation in the construction contract, the employer wil1 nonetheless have to provide the contractor access to and possession of the site. Preferably, this will be an express obligation in the contract and wil1 occur in accordance with specific provisions. The contract should careful1y define the site to be provided and the timing of giving access or possession to allow performance of the work in accordance with the programme and completion dates. In any event, the contractor should be adequately protected from the consequences of the employer's failure to provide site access and possession and to provide certain elements of the site at the appropriate time or times during the construction process. The approaches used by the various form construction contracts discussed herein differ widely. The Silver Book seems to be at one extreme containing

106

107

6-02

DISCUSSION OF SPECIFIC SUB-CLAUSES THE EMPLOYER

very specific obligations for the employer both to provide access to the site and regarding other elements of the site for which the employer is responsible. It also contains specific provisions for contractor extensions of time and payment of costs for the employer's failure in these obligations. At the other extreme would be the AlA and AGC contracts that do not contain any express obligation for the employer to provide site access and possession, and only provide general time extension and cost-payment provisions covering delays attributable to the employer. An approach similar to the provisions of Silver Book sub-clause 2.1 seems to be preferable, as discussed more fully below.

Employer assistance with permits and licences

6-03

The contract should clearly allocate the duty to obtain the permits and licences necessary for the design and construction of the works. Under traditional contracts the duty to obtain, for example, any necessary import licences, the construction permit and other licences and permits would often be allocated to the employer. However, where the contractor undertakes both the design and construction functions, the employer may prefer to place a greater burden in this regard on the contractor. Consequently, it is appropriate to impose specific obligations on the employer to assist the contractor in obtaining permits or other authorisations. These authorisations may require procedures under local law with which the contractor may not be familiar. In addition, turnkey contracts are often entered into by large private or public entities from the site country acting as the employer. In such cases, the employer may be better placed to obtain the necessary permits and licences at a lower cost, thereby potentially decreasing the contract price. The title of sub-clause 2.2, "Permits, Licences or Approvals" is somewhat misleading in that the substance of this clause concerns primarily the employer's obligation to assist the contractor in obtaining certain permits. The actual designation of responsibility for permits between the employer a?d co?tractor is contained in sub-clause 1.13 discussed in Chapter 5. The discussIOn of sub-clause 2.2 below will deal mainly with the employer's obligation to assist the contractor.

Discussion of Specific Sub-Clauses 6-04

2.1 Right of Access to the Site The Employer shall give the Contractor right of access to, and possession of, all parts of the Site within the time (or times) stated in the Particular Conditions. The right and possession may not be exclusive to the Contractor. If, under the Contrac.t, the Employer is required to give (to the Contractor) possession of any foundation, structure, plant or means of access, the Employer shall do so in the time and manner stated in the Employer's Requirements. However, the

108

Employer may withhold any such right or possession until the Performance Security has been received. If no such time is stated in the Particular Conditions, the Employer shall give the Contractor right of access to, and possession of, the Site with effect from the Commencement Date. If the Contractor suffers delay and/or incurs COSt as a result of a failure by the Employer to give any such right or possession within such time, the Contractor shall give qotice to the Employer and shall be entitled subject to Sub-Clause 20.1 [Contractor's Claims] to: (a) an extension of time for any such delay, if completion is or will be delayed, under Sub-Clause 8.4 [Extension of Time for Completion], and (b) payment of any such Cost plus reasonable profit, which shall be added to the Contract Price.

After receiving this notice, the Employer shall proceed in accordance with SubClause 3.5 [Determinations] to agree or determine these matters. However, if and to the extent that the Employer's failure was caused by any error or delay by the Contractor, including an error in, or delay in the submission of, any of the Contractor's Documents, the Contractor shall not be entitled to such extension of time, Cost or profit. Silver Book sub-clause 2.1 states that the employer must give the contractor access to and possession of all parts of the site within the time stated in the particular conditions, or as of the commencement date if no other time is specified. Sub-clause 2.1 indicates that this right and possession may not be exclusive to the contractor. This language may need to be clarified to indicate that the contractor's rights regarding possession of the site definitely "are not exclusive", rather than "may not be exclusive", given that certain legal systems might imply exclusive possession as a result of the contract unless otherwise stated. Silver Book sub-clause 2.1 also contains language indicating that the employer must give the contractor possession of "any foundation, structure, plan~ or means of access" in the time and manner stated in the employer's reqUirements. These terms suggest that if the employer must provide an element necessary to the overall works which must be provided prior to the cont~actor'~ co~mencement or continuation of its work, the employer has a speCific obhga.tlOn to do so in accordance with the employer's requirements. For. example, If the employer agreed to provide the cement foundation upon which the contractor would subsequently build a'nd install an electrical plant, the employer must ensure that the foundation is completed and available to the contractor at the appropriate time so as not to delay the contractor's work or affect the critical path of the overall completion timing. No~etheless, if the parties intend for this clause to clearly apply in such a situatlO~, the particular conditions and the employer's requirements should contam.a v~ry pr~c!se description of what element the employer has agreed to proVide m addition to the exact time at which it must be available and finally, a stipulation that such element is intended to be covered by the term~ of this sub-clause. .

109

THE EMPLOYER

6-05

Sub-clause 2.1 further provides that the contractor may claim an extension of the time for completion as well as cost plus profits in the event these claims result from the employer's failure to provide timely access to the site or to a particular structure or item of plant. This possibility of claims by the contractor makes it important to be precise in the contract with regard to the exact date that site possession must be given to the contractor in order better to calculate the amount of delay or cost. However, the last sentence of sub-clause 2.1 indicates that the contractor is not entitled to any extension of time or payment of costs if the employer's failure to provide access to the site or to a site element is due to any error or delay by the contractor. Silver Book sub-clause 2.1 differs in many respects from the corresponding sub-clause 2.1 contained in the Orange Book. The Orange Book provision includes the obligation to provide access or possession of the site but not a specific obligation to provide timely access to other potential site elements for which the employer may be responsible, such as plant or foundations. However, unlike the Silver Book, the Orange Book does not give the employer the right to withhold site access until the contractor's performance security is in place. Another slight difference is that under the Orange Book it is the employer's representative who would agree or determine any time extension or price increase whereas it is the employer who makes these determinations in the Silver Book. Both the Silver and Orange Books, however, are similar in that the greater part of the risks and costs associated with access are imposed on the contractor, which appreciably limits the obligations of the employer as regards access rights (OB sub-clauses 4.9, 4.12, 4.13; SB sub-clauses 4.15, 4.13, 4.10).1 The provisions in sub-clause 2.1 of the current (new) Red Book and Yellow Books (1999) are nearly identical to the provisions of Silver Book sub-clause 2.1 except that the default time for possession of the site in the absence of a specific time or times stated in the appendix to tender 2 is not the commencement date, as it is in the Silver Book. The Red and Yellow Books simply indicate that absent specification in the appendix to tender the site must be provided "within such times as may be required to enable the Contractor to proceed in accordance with the programme ... ". This language may be more effective than the default time used in the Silver Book ("access ... with effect from the Commencement Date") in the event that certain portions or elements of the site will be provided by the employer at some time after the commencement date, such as a foundation on which an electric plant would be installed. The provisions of the old Red Book (sub-clause 42.1) and old Yellow Book (sub-clause 17.1) similarly require the employer to give access to the site. In the old Red Book this must occur upon the engineer's notice and in the old

DISCUSSION OF SPECIFIC SUB-CLAUSES

"

Yellow Book within a reasonable time. Unlike the new FIDIC contracts, neither the old Red nor the old Yellow Book mentions the provision of access to or possessi