Emhemmed Ghula

May 2021

ANY CONSTRUCTION PROJECT IS LADEN WITH RISKS, AND RISKS COST

Given the complex nature of the

construction project, involving a

large number of interacting

activities, each with its own

distinct possibility for something

to go wrong; construction projects

are sensitive to an extremely wide

matrix of hazards and risks.

CONSTRUCTION PROJECTS ARE PRONE TO RISK GENERATION BY MAIN PARTIES INVOLVED IN THE

CONTRACTS

RISK ALLOCATIONS IN FIDIC

When evaluating risks under the :

FIDIC Conditions of Contract for Construction,

FIDIC Conditions of Design & Build, and

FIDIC Conditions for EPC / Turnkey,

the parties first have to take a look at the scope of either of these forms, since the risks of the employer and the contractor are usually allocated in relation to the true nature of the contract between them.

FIDIC CONTRACTS

Due to their neutral standpoint, the FIDIC standard forms are adopted by many International organizations such as World Bank, the Islamic Bank for Development, European Commission etc and also many government and other leading organizations have standardized their contracts by making amendments to FIDIC forms.

The forms of contract in FIDIC suite deals with current and common types project procurement and delivery methodologies. FIDIC throughout the general conditions have provided a fine balance of risks and responsibilities allocated between parties to the contract. Change in quantities, design responsibility, variation, force majeure, unforeseen situations, price escalation etc are major risk faced in any contract.

FIDIC CONTRACTS

The Red Book is recommended for building or engineering works where:

Design is prepared by the employer or by his representative, the engineer.

The contractor is to construct the works in accordance with a design provided by the employer, although the works could include some elements of contractor-design.

The engineer is appointed to carry out traditional roles of administration and certification of the contract, acting as the employer’s agent.

The Employer is typically kept fully informed on the progress of the works and has the possibility to order variations.

Risks are allocated on a fair and equitable basis taking account of such matters as insurability, and each party's ability to foresee, and mitigate the effect of, the circumstances relevant to each risk.

As a result, the tender time can be relatively short.

FIDIC CONTRACTS

The Yellow Book .

The only difference between red and yellow books in relation to risk allocation is the design responsibility where:

Engineering work designed by or on behalf of the contractor.

The engineer is appointed to carry out traditional roles of administration and certification of the contract, acting as the employer’s agent.

The contractor obligation is to ‘design, ­execute and complete the works in accordance with the contract’ so that, when complete, the works will be ‘fit for the purposes for which they are intended as defined in the contract’.

The Silver Book is intended to provide conditions of contract for ‘EPC/­turnkey projects’. ‘EPC’ stands for ‘Engineer-Procure-Construct’, and indicates the range of services the EPC contractor is meant to perform.

The contractor in such a project is responsible for:

The engineering design work to meet certain performance requirements,

The full range of procurement for the project, and for the construction work.

renunciation or at least a less prominent role of the Engineer in the administration and adjudication of the contract

EPC contracts are ‘turnkey’ contracts in that the contractor provides a complete package, so that the employer or project promoter has a structure ‘at the turn of a key’.

The Employer is uninvolved in the actual construction as far as possible, but has the certainty of a fixed final price on lump sum basis, although on a higher price level.

FIDIC CONTRACTS

The Silver Book is tailored to somewhat different types of projects.

These “new” types of projects are based on some trends in the international construction industry that developed in recent years, such as the tendency towards larger and more complex projects at considerably higher costs and the corresponding rapid development of private financing for these undertakings.

These projects typically include, on the other hand, private lenders who focus not only on the project process during the construction period, but also on the certainty of cash flow subsequent to the erection of the facility, since the construction contract usually forms just one part of a complex commercial venture, including also concession and finance agreements.

Consequently, lenders and concessionaires as well as the Employer demand contract terms that ensure an increased certainty that the agreed contract price and time for completion will not be exceeded.

Such variety of exterior factors, as the conditions of lenders and concessionaires, have to be met, which can make further negotiations advisable or even necessary.

FIDIC CONTRACTS

To achieve higher degree of certainty that the agreed contract price and time will not be exceeded, the Contractor must be given freedom in carrying out the works as far as possible, i.e. interference by the Employer or by Employer’s personal has to be reduced to a minimum.

Whether this one-sided allocation of risks can be met by a higher contract price is depending on the Contractor’s strength in negotiations and his ability to assess the risks as far as possible previous to the conclusion of an agreement with the Employer.

Therefore FIDIC states that the Silver Book is not suitable in circumstances where there is insufficient time for tenderers to scrutinize and check the Employer’s requirements and where construction involves substantial work in areas which tenderers cannot inspect, such as underground work.

FIDIC CONTRACTS

FIDIC envisages two approaches in its model contracts:

Pro-contractor: the Red Book, Green Book

Pro-employer: the Silver Book

What about the Yellow Book? Is it Neutral !!

FIDIC CONTRACTS - SELECTION

A promoter of a project should consider, carefully analyse and determine four main aspects that govern the conditions and the success of the chosen contract:

Allocation of the essential functions found in a construction project and in particular the design function.

Allocation of the risks inherent in the Project.

Allocation of the management role.

Method and timing of valuing the work done and how the remuneration for the Contractor is paid.

He should also consider whether or not he is prepared to share these risks with the other parties and if so the extent of such sharing.

He has to take a look at the range of application of these forms, since the risks of the Employer and the Contractor are usually allocated in relation to the true nature of the contract between them.

FIDIC CONTRACTS - SELECTION

Essential functions which to be allocated to the various parties:

Promoter, Employer or Owner

Financier

Designer

Contractor

Sub-contractor, supplier and manufacturer

Project Manager

Safety Controller

Supervisor

Certifier

Adjudicator

Operator

FIDIC CONTRACTS - SELECTION

In broad terms, there are three types of contracts to be considered depending on the extent of risk accepted.

These may be sub-divided as follow:

Cost-reimbursable contracts

different types depending on the additions amount to be added to the actual costs.

Re-measurement contracts based on unit rates and prices

sub-divided into contracts with bills of quantities and others with a schedule of rates.

Lump-sum contracts

sub-divided into fixed-price contracts with no sharing of risks and others with limited sharing.

FIDIC CONTRACTS - SELECTION

AVOIDANCE OF MISINTERPRETATION RISK

A promoter in drafting a type of contract of a project should :

Incorporate provisions of local laws into particular conditions

Use FIDIC guidance notes which give general advice

Understand general conditions

Understand particular conditions

Set out responsibilities by :

Carefully analyse allocation of the essential functions found in a construction project and in particular the design function.

Carefully analyse allocation of the risks inherent in the project.

Carefully analyse allocation of the management role.

Carefully analyse method and timing of remuneration for the contractor.

AVOIDANCE OF MISINTERPRETATION RISK

Ensure that the engineer’s responsibilities as stated in his agreement with the employer are identical with those required under the contract for the works.

Discrepancies in respect of the engineer’s responsibilities and authorities under the various contracts cause disputes and expose the engineer to liability, such as Employer limiting, without prior written approval, the engineer’s authority to:

Vary the works,

Issue variation orders,

Determine unit payment rates for new work items,

Award extensions of time for completion,

Render determinations of contractor’s claims, etc..

But Clause 3.2 states that whenever the Engineer exercises a specified authority for which the Employer’s consent is required, then (for the purposes of the Contract) such consent shall be deemed to have been given.

AVOIDANCE OF MISINTERPRETATION RISK

This means that:

• The Employer is bound by the actions of the Engineer;

• The Contractor does not have to worry about whether or not the Engineer exceeded his authority;

• The Engineer may find himself sued by the Employer for the additional expense.

Therefore, if the service agreement and the works contract do contain contradictions, the engineer should inform the employer in writing with recommendations as to how the contradictions could be resolved, together with advice of the potential contractual repercussions of not doing so.

RISK ALLOCATIONS IN FIDIC

The great benefits of the present Red and Yellow Books are that the balance of risks and responsibilities as well as allocation of duties and authorities between the parties generally is accepted by both employers and contractors.

The FIDIC Conditions have therefore become the baseline conditions for a fair international construction contract

Many people regard the Red and Yellow Books as:

Seeking to strike a fair balance of risk between employer and contractor.

The contractor benefits because he need not price for risks which are hard to evaluate at the outset of the project;

The employer enjoys a lower contract price, and incurs extra cost only where certain defined risk-events actually occur.

The Red and Yellow Books are recommended where there is a basically conventional project structure of employer, contractor and engineer; the ­differences between the two Books arise mainly from the fact that, with the Yellow Book, the contractor undertakes most of the design. In such an arrangement, risk is allocated to strike a balance between employer and ­contractor, taking into account the extent to which each is responsible for design and other activities, and also each party’s ability to control or prevent particular risks.

In both the Red and Yellow books, risks are allocated between the parties on a fair and equitable basis, after considering matters about insurability, control of risk, and ability to foresee the risk.

It is therefore considered that Red Book and Yellow Book are fairer when it comes to allocation of risk; while Silver Book provides for allocation in a disproportionate manner.

RISK ALLOCATIONS IN FIDIC

FIDICs traditional approach has been allocating risk to the party who is in control of that factor; however, diverging from this policy the silver book can be considered as an effect of the market needs and it places majority of the risks on the contractor.

So far it is evident that the Silver Book imposes most of the risks, especially in respect to price and time for completion on the contractor.

Under silver book, the tenderers will require more information related to site conditions, hydrological and subsurface data to evaluate the risks involved.

Silver Book is meant for use by employers who do not want to assume more risk and prefer to have a stable contract sum.

RISK ALLOCATIONS IN FIDIC

Risks are not properly divided and identified in the 1999 Editions, but these are corrected in the 2008 DBO Contract as will as in the 2017 FIDIC contracts, where:

Employer Risks is now “Employer’s Risk of Loss or Damage” and not all the project risks (i.e., they are limited to risks which lead to some form of accidental loss or damage to physical property of personal injury, which in turn may lead to financial or time loss).

It may be inferred that all other risks are Employer’s risks, but this is not the case.

Therefore, Employer should, when allocating functions and risks to various Parties, consider the method of valuing the work done.

RISK ALLOCATIONS IN FIDIC – EMPLOYER RISKS

The main Force Majeure provisions in the 1999 FIDIC contracts are basically the same for the Red, Yellow and Silver Books.

‘Force Majeure’ is defined as ‘an exceptional event or circumstance’. Force Majeure does not have to be unforeseeable or even unforeseen.

However, it must be:

beyond a Party’s control;

beyond reasonable provision by a Party before entering into the Contract;

not reasonable capably of being avoided or overcome; and

not substantially attributable to either Party.

Although the obligation to give a Force Majeure notification is owed by both Parties, and the provision as to Optional Termination, Payment and Release can apply to either Party, the balance of risk allocation in the 1999 FIDIC contracts can generally be said to favour the Contractor, as it is more likely to be relieved of its obligations.

RISK ALLOCATIONS IN FIDIC – FORCE MAJEURE

The 2017 editions of the Red, Yellow and Silver Books have replaced the Force Majeure provisions in Clause 19 of the 1999 editions with a new Clause entitled Exceptional Events.

However, this is a less profound change than the replacement of a Force Majeure clause would suggest, because the 2017 definition of Exceptional Event is similar, though not identical, to the 1999 definition of Force Majeure.

Apart from some re-drafting, the most notable change to the non-exclusive scope of the provision is the addition of ‘tsunami’ to the ‘natural catastrophes’ item.

The effect of the occurrence of an Exceptional Event under the 2017 forms likewise resembles the effect of a Force Majeure event under the 1999 Forms; the procedures and consequences are similar, with some amendments to the drafting.

In terms of risk allocation, the Exceptional Event provisions are closely comparable to the former Force Majeure provisions

RISK ALLOCATIONS IN FIDIC – FORCE MAJEURE

In the 1999 FIDIC suite of contracts, Clause 17 uses indemnities as the medium for risk allocation on a range of issues.

The net effect is complex. Indemnities are given by both Employer and Contractor, and some of them are reciprocal.

Thus against all third party claims, the Contractor gives an indemnity to the Employer for personal harm and damage to property arising out of activities or personnel for which it is responsible and the Employer gives a similar, though not identical, indemnity to the Contractor.

More of Clause 17 is devoted to obligations of the Contractor, including responsibility for Care of the Works, which has no Employer equivalent.

The Contractor is liable for loss or damage during the period from the Commencement Date to the issue of the Taking Over Certificate, except where it has a cause classified as an Employer’s Risk.

But it would be an over-simplification to say that the indemnity provisions under the FIDIC contracts favour the Employer.

RISK ALLOCATIONS IN FIDIC - INDEMNITIES

Wherever loss or damage to the Works or other aspects of the project results from an Employer’s Risk, the Contractor may be able to claim an extension of time for delay, or additional Cost, or both, to be added to the Contract Price, or both.

While all books include as an Employer’s Risk foreign hostilities, civil conflict, riots/disorder, explosions/contaminations/ radiation and sonic damage by aircraft, the Silver Book significantly omits three categories of Employer Risk found in the Red and Yellow Books; these are:

Use or occupation by the employer,

Design of any part of the works by personnel for whom the employer is responsible, and

‘Unforeseeable operation of forces of nature’.

RISK ALLOCATIONS IN FIDIC - INDEMNITIES

The MDB version of the Red Book adds to the first paragraph of Sub-Clause 17.3 the words ‘insofar as they directly affect the execution of the Works in the Country’. When compared with the Red Book itself, ‘the effect of this is to narrow further the nature of the ‘Employer risks’’.

The indemnities for infringement of intellectual property rights are essentially reciprocal.

The exclusion of liability for ‘any indirect or consequential loss applies to both Parties.

There is provision for the Contractor’s total liability to be limited to a stated amount; the amount is the subject of express provision, usually included in the Particular Conditions following negotiation.

RISK ALLOCATIONS IN FIDIC - INDEMNITIES

In The 2017 FIDIC contracts there was a substantial re-working of the 1999 risk and responsibility clause in the form of a new care of the works and indemnities clause, which making the contractor fully responsible for the works, subject to exceptions expressly set out.

Employer’s risks are no longer listed as they were in the 1999 contracts, and the carve-outs from the contractor’s liability for care of the works are expressed as:

Interference with property rights as the unavoidable result of the execution of the works in accordance with the contract;

Use or occupation by the employer of any part of the permanent works;

Faults in design of the works undertaken by the employer;

Unforeseeable operation of ‘the forces of nature’;

Exceptional events; and

Acts or defaults by the employer’s personnel or other contractors of the employer.

RISK ALLOCATIONS IN FIDIC - INDEMNITIES

The exception to the contractor’s liability for care of the works based on faults in design of the works undertaken by the employer is expressed as:

Any element of the design of the works by the employer or which may be contained in the specifications and drawings (red book)/employer’s requirements (yellow book)' which an experienced contractor exercising due care would not have discovered before submitting the tender (red and yellow books); or

Any element of the design of the works by the employer' (silver book).

RISK ALLOCATIONS IN FIDIC - INDEMNITIES

The 2017 Yellow and Silver Books now feature a substantial strengthening of the Contractor’s design obligation using the Indemnity Provisions, so that the Contractor indemnifies the Employer against all ‘acts, errors or omissions’ in carrying out the Contractor’s design obligations resulting in the Works ‘not being fit for the purpose(s) for which they are intended’.

The 2017 Red Book equivalent applies ‘to the extent, if any, that the Contractor is responsible for the design of Part of the Permanent Works’ which is intended to refer to the situation where a Particular Condition allocates an element of the design to the Contractor.

Although the 1999 Yellow and Silver Books, and to a very limited extent the 1999 Red Book, contained fitness for purpose obligations in respect of design, none was underpinned by an indemnity on the part of the Contractor to the Employer in respect of any breaches of that obligation.

In this respect, the 2017 editions of the FIDIC contract can be said to represent a re-balancing of risk allocation in favour of the Employer.

RISK ALLOCATIONS IN FIDIC - INDEMNITIES

It is Foolish to allocate a risk to a party who cannot bear its consequences unless the party is able to shift or spread its allocated risk to others who can, usually through insurance.

FIDICs view in its older and conservative forms (red and yellow books) is that:

Insurable risks are covered by means of procuring adequate insurance policies, and

Non-insurable risks be borne by the party who was responsible for loss or additional cost.

RISK ALLOCATIONS IN FIDIC - INSURANCE

The insurances to be effected under the 1999 FIDIC forms of contract are basically against loss or damage to Works and Contractor’s Equipment, personal injury and damage to property of third parties and personal injury to the Contractor’s Personnel.

What cover is actually obtained will depend to some extent on what is available in the market and at what cost.

The insuring party, whether Contractor or Employer, must insure against loss or damage to Works and Goods ‘for not less than the full reinstatement cost including the costs of demolition, removal of debris and professional fees and profit’.

The required scope of this cover needs to be seen in conjunction with the Employer’s Risk provisions, which shall cover all loss and damage from any cause not listed in Sub-Clause 17.3’ subject to any Particular Conditions.

Insurance for Contractor’s Equipment has to be for ‘not less than the full replacement value, including delivery to Site’.

RISK ALLOCATIONS IN FIDIC - INSURANCE

The required scope of the insurance against personal injury and damage to property of third parties is also defined by reference to Sub-Clause 17.3, it being permissible to exclude liability to the extent that it arises from ‘a cause listed in Sub-Clause 17.3 [Employer’s Risks], except to the extent that cover is available at commercially reasonable terms’.

RISK ALLOCATIONS IN FIDIC - INSURANCE

In the 2017 editions, the General Conditions simply provide for Insurance to be provided by the Contractor, (although this could be varied by a Particular Condition).

There is still the obligation to cover the Works, Goods, against injury to persons and damage to property and injury to employees.

The scope of the cover contemplated has been expanded to include :

‘all other insurances required by the Laws of the countries where (any part of) the Works are being carried out’ and

‘other insurances required by local practice (if any) shall be detailed in the Contract Data’.

The most important addition, however, is in the requirement that the Contractor’s indemnity in respect of breach of its fitness for purpose obligation to the Employer in relation to design of the Works shall be covered by professional indemnity insurance if required by the Contract Data. However such cover will be difficult for many contractors to obtain in certain markets, which are used to insuring professional practitioners rather than building firms.

RISK ALLOCATIONS IN FIDIC - INSURANCE

EMPLOYER’S DESIGN CHANGES RISKS

Since under the Red Book the design is typically carried out in whole or to a major extent by the Engineer, the Contractor is only responsible for the design to the extent specified in the contract.

EMPLOYER’S RISKS

1.9 [Delayed Drawings or Instructions ]

2.1 [Right of Access to the Site ]

4.12 [Unforeseeable Physical Conditions ]

4.23 [Archaeological and Geological Findings ]

8.5 [Extension of Time for Completion]

8.6 [Delays Caused by Authorities]

8.10 [Consequences of Employer’s Suspension]

8.12 [Prolonged Suspension]

10.3 [Interference with Tests on Completion]

12.1 [Works to be measured] : Increase in Quantities

14.8 [Delayed Payments]

18.4 [Consequences of an Exceptional Event]

CONTRACTOR’S RISKS

The contractor must complete the work in compliance with the description of the works and within the time for completion.

The contractor is prohibited to cancel the contract, whatever may happen, other than the very limited situations like the employer’s non-payment for over a certain period of time, or prolonged suspension of the Works by the employer.

To get and start a project for the contractor, investments are needed beforehand. Such investments are valueless for other projects, thus, are called relation-specific investments.

The defects found in a certain period of time after the completion

CONTRACTOR’S RISKS

4.10 [Use of Site Data ]

8.8 [Delay damages]

8.9 [Employer’s Suspension]

9.4 [Failure to Pass Tests on Completion] Price reduction

11.2 [Cost of Remedying Defects]

11.3 [Extension of Defects Notification Period]

11.4 [Failure to Remedy Defects] price reduction

17.1 [Responsibility for Care of the Works]

8.10 [Consequences of Employer’s Suspension] TCP

8.12 [Prolonged Suspension] TCP, Omission, Termination

10.3 [Interference with Tests on Completion] TOC + TCP

12.1 [Works to be measured] : Increase in Quantities C

14.8 [Delayed Payments] - Financing Charges

18.4 [Consequences of an Exceptional Event] T &/or C

4.12 [Unforeseeable Physical Conditions ]

8.4 [Advance Warning ]

13.6 [Adjustments for Changes in Laws ]

13.7 [Adjustments for Changes in Cost ]

17.2 [Liability for Care of the Works ]

17.3 [Intellectual and Industrial Property Rights ]

17.6 [Shared Indemnities ]

18.1 [Exceptional Event ]

SHARED RISKS

4.1 [Design]

4.7 [Setting Out Data]

4.10 [Site data ]

4.12 [unforeseeable difficulties]

5.1 [General Design Obligations] ER accuracy

CONTRACTOR’S ADDITIONAL RISKS IN SILVER BOOK

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