mities es for dance suring otion. rate as to the notely vels of 2A are pleted aliance volved as little such as are not in their cpected ares for regard sible, key to -failure stantial vin the i “Fair and Reasonable”: the Determination of Prices for Variations in FIDIC Contracts Dr Wolfgang Breyer © Construction disputes; FIDIC conditions of contract; Price; Valuation; Variation 1. Introduction One of the strange findings when working with the FIDIC forms of contract is that it appears to have omitted rules on one of the key factors Which invariably lead to disputes between parties. The factor in question here is the valuation of a variation, which becomes a key issue. Ordinarily, the contractor who obtains the contract was the bidder who submitted the best price to the employer, such a price is routinely difficult for the contractor to sustain throughout the works, and many contractors hope to improve their earnings by means of variations. Indeed, there appear to be contractors whose entire business model is built around the objective of acquiring the contract first by means of an undercut price, and then arriving at profit later by means of payment for variations. Are these hopes justified, or do variations only make things worse for such contractors? 2. Guidance currently contained in the FIDIC forms A quick glance at the FIDIC forms shows that of all the FIDIC forms, only the Red Book contains, in its subcl.12.3, entitled “Measurement and Evaluation”, any guidance on how the value of the works is to be determined. Subclause 12.3, second paragraph states that, “for each item of work, the appropriate rate, or price for the item should be the rate, or price specified for such item in the contract or, if there is no such item, specified for similar work.” This already begs the question: what is “similar” work? Is it work of a similar technical nature, ic. “welding” and “welding”, or only work of a similar nature executed under similar conditions? If so, when are conditions similar enough to warrant adapting the unit rate? Incase of variations, or other changes to the works, things get more complicated, even though some form of guidance is supposed to be provided. Subclause 12.3 of the Red Book then goes on to state that a new price should be fixed if: “@) (@ the work is instructed under clause 13 [Variations and Adjustments}, (ii) no rate, or price is specified in the contract for this item, and "Breyer Rechtsanwalt, Stutgrt, Germany, (2013) 29 Cons. LJ, Issue © 2013 Thomson Reuters (Profesional) UK Limited and Contributors 3132 Construction Law Journal (iii) no specified rate, or price is appropriate because the item of work is not of similar character, or is not executed under similar conditions, as any item in the contract. Each new rate, or price shall be derived from any relevant rates or prices in the contract, with reasonable adjustments to take account of the matters described in sub-paragraph (a) and/or (b), as applicable. If no rates, or prices are relevant for the derivation of a new rate, or price, it shall be derived from the reasonable costs of executing the work, together with reasonable profit, taking account of any other relevant matters.” This, in tur, leads to further questions: + Whenis the “newly instructed” work similar (enough?) to any work already contained, or accounted for in the contract? + And, if'so, is the rate, or price contained in the contract applicable? How should this be evaluated? + What rate is applicable? There might be several different rates for “similar” works available. Which rate should apply? + And, what should apply if there is no relevant rate, or price in the contract, from which a new rate, or price might be derived? Both the Yellow and the Silver Books, in their subcl.13.3, in the end revert to a determination, by the engineer, or the employer in the case of the Silver Book, to arrive at an adjustment of the contract price. The question is: How exactly does the engineer (or, in the case of the Silver Book, the employer) determine these prices? Could it be argued that a principle is contained in the Red Book that, by referring to “relevant rates, or prices in the contract”, the agreed price shall prevail? If so, should this be in the way of “good price remains good, and bad price remains bad”, or should adjustments be allowed? And if adjustments are allowed, to what extent, and how should those be determined? 3. Disputes are about money, not technical matters Tt appears to be a fairly commonplace occurrence that the parties will fail to agree on aprice. Based on the authors’ experience, there rarely is a construction project executed without variations being ordered. Although, whilst the ordering of a variation, or the receiving of an instruction is in itself seldom cause for dispute, payment of such variations and/or instructions is a distressingly common cause for disputes. In other words, the parties rarely disagree about the work (and, if they do, the contract has in place mechanisms to handle that), but the parties regularly disagree on how that extra, or varied work should be paid, especially if there is no relevant tate, or price available in the contract for the rate or, price to be derived from. It appears to be quite obvious that the parties will argue the most about the money, and not about technical issues about how to solve a technical problem, The parties usually have a joint common interest in carrying out the works, and—contractors being contractors—every contractor usually desires to get a project finished, preferably on time, to the satisfaction of the employer. (2013) 29 Const. J, Issue 1 © 2013 Thomson Reuters Profesional) UK Limited end Contributorsvot, ilar sin ters ices ofit, ork ble? + for the toa k, to does hese ring, fso, vad”, tent, aject ofa oute, ause tthe orks, eta i Determination of Prices for Variations in FIDIC Contracts 33 Employers being employers, they usually desire to get their best money’s worth, and not to pay more than they must. As long as a technical problem is adequately solved, the employer will usually opt for the solution that, for them, promises the best value for money. How exactly a given solution works is usually (there are exceptions) not a concem of the employer. The contractor, too, is usually perfectly happy with the technical solution which they deem to be acceptable (also in terms of their defects liability). Disputes thus usually arise over claims for money, and not over any technical issues which might have arisen in the course of executing the works. Technical disputes are, in the authors’ experience, by and large, disputes about the cost of a solution, not disputes about the solution itself. 4, FIDIC on valuing works Surprisingly, the FIDIC contracts provide little (Red Book) to no (Silver Book, Yellow Book) guidance on how much exactly a contractor should be paid for additional, or varied work. The guidance contained in the Red Book, along with some of the problems it poses, is described above, Especially in the case of the Yellow, or Silver Books, where the contract does not specify an obligation of the contractor to provide a price breakdown, there is no guidance whatsoever. Even if some form of price breakdown is available, sub-clause 14.1 first paragraph (d) clearly states that, “any quantities or price data which may be set out in a schedule shall be used for the purposes stated in the Schedule and may be inapplicable for other purposes.” The result is that, when an adjustment is made in a Silver, or Yellow Book contract, the parties will, at least at the beginning, have virtually nothing to go along with; at a time when some type of guidance on the price is needed the most, the Silver and Yellow Books fail to provide. It appears somewhat strange that, especially in these lump-sum contract forms, where just one price is available and therefore itis particularly difficult to find the right price for variations, no guidance is provided by FIDIC, ‘The FIDIC contract forms place the responsibility to resolve this matter with the engineer, who is supposed to agree, or determine an appropriate rate, or price, “taking account of any other relevant matters”: subel.13.3. While this installs the engineer as the person in charge, it leaves the parties to the contract somewhat at a loss as to what the engineer, even if he should be bound by the principles of the Red Book, in the end, will determine to be an appropriate rate, or price, especially if the contract contains no relevant rate, or price which the engineer, or the parties may refer to for guidance. Furthermore, at the end of the day, if either party is not satisfied with the engineer’s determination, either the contractor, or the employer will, in the usual course of things, escalate the matter to a Dispute Adjudication Board (DAB) and, ultimately, fo an arbitral tribunal. This has the effect of replacing the engineer as the “price-determining person” with a DAB, and, ultimately, an arbitral tribunal, ‘This means that a price for additional, or varied works, especially if there is no relevant price, or rate contained in the contract which the parties can “snag” onto, will, in the end, be decided by what an arbitral tribunal thinks is reasonable at the (2013) 29 Const LJ, Isue 1 © 2013 Thomson Reuters (Profesional) UK Limited and Contributors34 Construction Law Journal time. This is a bit of a “black box” for the parties, and means that the result will depend very much on the person ultimately put in charge of determining the price. Things are supposedly casier where there is a unit rate, or price agreed which is applicable, then this will apply.’ There is no provision in FIDIC for “correcting” a wrong price in a bill of quantities (BoQ), or price breakdown.’ A word of waming, though: this might hold true for most jurisdictions, but need not hold true for al This does not in itself suggest a broken system, quite the contrary; the fact that @ matter is escalated means that it has not been agreed, and this indicates that the parties are unable to reach an agreement by themselves. Referring such a decision to an independent third person is an acceptable way of dealing with such a situation. 5. Faults in the current system However, transferring the power to determine a price does not necessarily increase the predictability, or reasonableness of a decision, and also makes it difficult for the parties to plan ahead. Given the fact that the contractor is bound by the contract, under subcl.13.3, to proceed with the works (“the contractor shall not delay any work while awaiting a response”), it may well be that the question of payment for a variation which was ordered and already executed will only be decided several years after the work has already been carried out. This is unsatisfactory to both parties, both for the employer, who is forced to commit funds, and for the contractor, who has to wait for his payment. In such a situation, neither party is afforded timely closure. Also, the goal of the escalation system in FIDIC, to provide for a quick and reasonable settlement, is not always obtained. How can such a situation be alleviated? The FIDIC contract itself does not really provide guidance on this matter, for the reasons indicated above; the contract fails to provide any guidance in precisely such cases when guidance is most sorely needed, i.e. when there is no comparable rate, or price. 6. Current price evaluation suggestions Utilising an applicable unit rate, or price breakdown item The question which often arises is, when are items of work similar enough to consider a BoQ rate applicable? On this matter, the literature is strangely quiet. The FIDIC Contracts Guide does provide some advice by arguing that: “The question as to the similarity of work may be resolved by referring to the description in sub-paragraph (b)(iii), which refers to similarity in terms of work being of similar character and executed under similar conditions.” Dr. Nael G. Bunni, in his often cited work The FIDIC Forms of Contract (3rd edn), states: | Henry Boot Construction Lid» Alstom Combined Cycles Lid (2002) B.R.247, CA. 2 PIDIC Contracts: Law and Praclce, by Baker, Mellors, Chalmers and Laver, pars 458 onward, pp.169 and 170, hereafter referred to as FIDIC Contracts: Law and Practice. FIDIC Contracts Guide, page 209. (2015) 29 Const LJ, Issve 1© 2013 Thomson Reuter (Professional) UK Limited and Contributorswill rice. hich ing” all. that tthe ision tion. vease It for act, any. at for 2d to wha ation ways snot orely hto uiet. gto ms Grd and sing, * — Determination of Prices for Variations in FIDIC Contracts 35 “Varied work is valued in one of four different ways. The first is where the variation is valued at the rates and prices set out in the contract if, in the opinion of the engineer, these rates and prices are applicable to the items of varied work. In considering the applicability of the rates and prices in the contract to the varied work, the engineer would have to take into account the nature and amount of the varied work in addition to, presumably, preliminary items which may be affected, the time when the variation is ordered, the method ofits construction and its physical location compared with other work under the contract. The second way in which a variation may be valued is where there are no applicable rates and prices in the contract, then the contract rates and prices are to be used as the basis for valuation so far as may be reasonable.”* So, if an applicable unit rate is contained in the contract, or a unit rate is deemed reasonably applicable by the engineer, the question of valuation of the works is answered by the contract itself, at least in the case of the Red Book. Ifnot, itreverts to the opinion of the engineer. The question of Valuation suddenly becomes viable again, in the case of a Yellow, or Silver Book contract, where no unit rate is supplied; for example, for lack of a BoQ. Cana price breakdown take the place of a BoQ in such a matter? This appears not to have been decided yet by any meaningful authority, but some authors appear to say that yes, a price breakdown can be utilised as a BoQ; even though the FIDIC forms seem to suggest otherwise. This would require that a price breakdown is available, however; it is the authors’ experience that such price breakdowns are not always available, or accurate, And even if they are available, what price breakdown item of a unit rate should be deemed applicable? Valuing works when no unit rate is available If no unit rate, or price is available, the original question returns: How should works be valued when no unit rate, or other “comparable item” is available? The answers provided by the literature appear to revert to “reasonable cost”, Dr. Bunni writes that: “The third way in which a variation may be valued applies if the contract, rates and prices cannot be used as a basis for valuation; then the engineer is required to agree new suitable rates and prices through the procedure of “due consultation’ with the employer and the contractor. Where no agreement is reached between the engineer and the contractor, then the engineer is required to fix such rates and prices as arc, in his opinion, appropriate.”* In similar vein, Baker, Mellors, Chalmers and Lavers argue that, ‘{As ten from Dr, Nael G, Bunni, The FIDIC Forms of Contract, 3rd edn (2005), p:301. SFIDIC Contracts: Law and Practice, para4.35 onwatds p.169. “As taken fom Dr. Neel G. Bunni, The FIDIC Forms of Contract (2008), pp 301-2. (2013) 29 Const. LJ, Issue ] © 2013 Thomson Reuters (Profesional) UK Limited and Contributors36 Construction Law Journal “where a rate, or price cannot be derived from the contract, it is then to be derived from the reasonable costs of executing the work, together with reasonable profit, taking account of any other relevant matters”,” Reasonable costs, according to this text, are meant to mean costs incurred, including, overheads and similar surcharges.* The FIDIC Contracts Guide contains only one sentence as to this matter: “Ifa new rate, or price is to be assessed, it may be derived from relevant rates and/or ptices in the Bill of Quantities, or other appropriate Schedules, and/or from reasonable Costs,” Again, while this is an indication of what should be utilised when arriving at the price, or rate, it can still be very much a matter of dispute whether, or not the costs incurred by the contractor were economical and/or reasonable. This is unsatisfactory; what, exactly, is a reasonable price? What, exactly, does “reasonable” mean? According to Black's Law Dictionary,” “reasonable” means “fair, proper, or moderate under the circumstances”. Clearly, this meaning is what the parties expect, when they turn over the determination ofa price to a third person, as the alternative meaning would not be helpful. As is concisely stated, “reasoning does not help much in fixing a fair, or reasonable price... .”"" While there exist various methods propagated by engineers on how to value disruption, delay, extensions, and so on, there is not much guidance, either for the parties, or the engineer, for that matter, on how to arrive at a new rate, or price which was not considered in the existing contract. This leads to uncertainty as to what will, ultimately, be found to be reasonable. The black box remains opaque. 7. Possible solution: agreeing procedures for valuation? It can be argued that the parties might be more inclined to settle and/or agree on a price for variations if they had a way of gauging what a DAB, or ultimately an arbitral tribunal, would find to be a reasonable price. ‘The uncertainty in such a decision need not be prevalent. There exist other forms of contract, which, while not having an ultimate solution, do provide some guidance to their respective users as to how variations are to be valued and prices for variations should be determined. Many standard forms of contract outside of FIDIC contain at least hints for such procedures, or such guidance, such as the Austrian ONorm, the French AFNOR, the Swiss SIA, and the German VOB/B. For example, the VOB/B grants the employer the right to instruct variations. In consequence, the VOB/B (in para.2, ss.5 and 6) grants the contractor a right to payment for such varied, or additional work. According to the interpretation of the VOB/B by the competent courts, entitlements to payment arising out of para.2 of the VOB/B are, however, affixed 2 RIDIC Contracts: Law and Proce, para 4.1, p.1 SFIDIC Conracts, Law and Proce, par), p.17 SFIDIC Contracts Gude, 210. ¥ Blacks Law Dictionary, 9 ed (West Group, 2008), “reasonable”. "Black Law Dictionary, (2008), “easonsble (2013) 29 Cons. LJ, lsue 1 © 2013 Thomson Reuters (Professional) UK Limited and Contibutorsto be with uding rates nd/or at the costs is is does er, or xpect rative help value orthe price as to que. eon tyan other ome tices 3 for 2nch ants ra, onal ixed Determination of Prices for Variations in FIDIC Contracts 37 to the “contractual price level”, and are not subject to the contractor’s cost." In a way, this is comparable with the provisions of the Red Book, although it also applies to lump-sum contracts and other types of contract. The goal of this interpretation is to preserve for the parties the respective good. deal which was achieved when the contract was first secured. The reasoning is that it would be unfair if the other party could be forced to pay a higher (or lower) price for such additional works if a much better price was originally secured, for example in a bidding situation. On the other hand, it can of course also be argued that it is unfair to ask the contractor to carry out additional works, which were assumedly not envisioned by the contractor when he submitted his bid for the contract, at a rate which may not be profitable, and which may lead to the contractor carrying out the works at a loss, which could lead to increasing losses in consequence of variations. In such a situation, the current ruling of the VOB/B is that “a bad price remains bad”, but again, this approach fails where a bad price becomes bad due to variations, as is often the case if a contractor decides to supplement a price for an item of work which he believes will not be of significance, but which then, to the surprise of all involved, becomes significant due to variations, Of course, this can also happen the other way around. Again, what is “fair”, or “reasonable” is very much a matter of opinion. An increase in losses in consequence of a variation seems to be unjustified, but so, too, would an increase in profits, when a “bad” price would suddenly become a “good” price, due to variations. Either way, the result may be deemed reasonable, or not, but does not really help in establishing a guiding principle for valuing variations. The purpose of this brief foray into the territory of the German VOB/B is not to say that itis superior to the FIDIC forms of contract, itis not. However, it does show that it is possible to provide some form of guidance by agreeing on a procedure on how works should be evaluated, which would enable the parties to gauge whether, or not an engineer’s decision would be upheld, or changed by a following DAB and/or arbitral tribunal. It should be up to the parties to agree on such an evaluation mechanism, several possible examples of which are sketched out below: Al variations could be valued “at actual cost”. This would mean that the contractor should prove all costs actually (and reasonably) incurred in carrying out the variation and the employer should pay those costs. ~ The parties could also agree to pay for the costs at their “current fair market value”. In such a case, the parties should agree on how to determine the market value of any additional work. Such agreement might include agrecing on a reference market (regional/ global, specialist/general, and so on) for the works to be executed, or the materials to be obtained, and agreeing, beforehand, on any overheads which the contractor would be entitled to add, such as site costs, HQ costs and similar, Possible systems for price-finding in such a manner might consist of “obtaining three sub-contractor offers”, or something similar, and then either utilising the cheapest sub-contractor, or the average of them, but in such cases, care must be taken to avoid the employer forcing a sub-contractor upon the contractor that the ” BGH Bauk 1996, 378, (2013) 29 Const. LJ, Issue 1 © 2013 Thomson Reuters (Profesional) UK Limited and Contibutors38 Construction Law Journal contractor does not have confidence in. In such cases, variations might be construed to be something of a “cost plus fee” arrangement, “Open book” price finding procedures could be built into both of the above mechanisms. - On the other hand, it is conceivable to have the parties agree upon some type of contractual price level. It does not seem unreasonable to have the contractor stand by his promise to execute the works for a certain price, for which reason the contractually agreed price level should be maintained. This might also prove to be a blessing for the contractor, especially if the contractor managed to secure a good price. In such a case, it might be unreasonable to deny the contractor his, profits for the additional services he is called upon to carry out, irrespective of any changes in market conditions. However, it is a bit hard to arrive at the contractual price level, because against what benchmark should the rates, or the contraet price be measured? Typically, the last market review for comparable services will have been the bid for the project in question, and also typically, the contractor with the successful bid will also have submitted the cheapest bid. If compared against the average of all bids, it is not so unusual to find that the winning bid was 10-15 per cent cheaper than the average ofall bids, maybe even more so. Should this imply that a winning bid will always contain a “contractual price level” of some 10-15 per cent below the average cost? ‘That would probably result in the contractor incurring losses and so that cannot be an appropriate price. Itis even harder when attempting to arrive at a proper benchmark against which to measure the price level. Should the entire contract be utilised to determine the contractual price level? Or only “relevant parts” of the price breakdown/BoQ, whatever they may be? Even if the end prices of various bidders will be grouped more or less closely together most of the time, there will be quite dramatic differences in the pricing of different sections and crafts that make up the same works, simply because costs that one contractor allocates to rebar and concrete, another contractor may choose to allocate to site overheads. Which price, then, should be utilised as a benchmark? ‘That of a single unit? That of a certain craft? And how should the market price level be determined? What would be fair? Whatever the outcome, it might be prudent to inform the bidders beforehand as to the extent to which their price breakdowns/BoQs may be utilised. If bidders know beforehand, such a price-finding mechanism might encourage bidders to submit reasonable price breakdowns and/or BoQs, if they knew for certain that they would be held to them later in case of variations. On the other hand, such knowledge might also spur bidders to speculate, with the risk/reward scenarios being different in every case. There are certainly various other price/value finding mechanisms available. The purpose of this article is not to explore the validity and economic sense of any ‘one such mechanism, or combination of mechanisms; rather, it is to make a case for the benefit that the parties would have by agreeirig upon such a mechanism in the contract, at the location which FIDIC Red Book subel.12.3 currently occupies. 8. The benefits of predictability By including such a price-finding mechanism, the parties would, in effect, be binding themselves, but also the engineer, and any DAB and/or arbitral tribunal (2013) 29 Const 1.1, Tssue 1 © 2013 Thomson Reuters (Professional) UK Limited and Contributors,trued iding type actor nthe ve to urea or his fany zainst cally, roject shave is not erage Iways cost? annot which re the BoQ, vuped matic same crete, then, sraft? sand ders 2rs to a that such ratios lable. fany case smin pies. 2t, be ounal Determination of Prices for Variations in FIDIC Contracts 39 at a later stage, as to how a reasonable price might be arrived at. Once such a mechanism is in place, the engineer will be able to utilise the mechanism when determining a price, should the parties fail to agree on that price. In such a case, the parties would be much better able to gauge if an engincer’s determination would be upheld, or overtumed by a DAB, or arbitral proceeding. The black box could be suddenly investigated and it could be ascertained if the price-finding mechanism was operated proper! This would serve to increase the predictability of a decision by the engineer, a DAB, or an arbitral tribunal, which in itself might be a factor to be considered when deciding to agree on a price before escalating matters. If you can reasonably infer how the engineer/DAB/tribunal will probably decide (within a certain margin of discretion), you might as well agree. In addition, it also becomes possible to evaluate if an engineer’s determination was within, or outside the bounds of the price-finding mechanism, and this could help to predict whether a decision will be upheld, or overturned when escalated. Finally, the parties, agreeing on a mechanism, will be limiting the possible bandwidth within which a price can be affixed, or agreed. This could mean that the “starting points” may not be as far apart as they otherwise would have been. Allof this can make a negotiated settlement more likely, or increase the chance ofthe parties accepting a determination, or DAB decision, and not further escalating things. If you know you will probably lose, you probably will not escalate. So, if the parties can pre-determine the likelihood of a price being upheld, they might be less willing to challenge a determination, And even if a party does not agree with a determination, it could add an entirely new layer to its arguments by showing how the engineer, or DAB failed to follow the price-finding mechanism agreed between the parties. This argument might either be persuasive in arriving at a settlement after all, or support the case in the next escalation step, but cither way, the argument is not available without an agreed price-finding mechanism. Instead of the unknown opinion of engineer, DAB, ot arbitral tribunal, a known mechanism, however imperfect it is, could be installed. The authors believe that these benefits have real value to the parties to FIDIC contracts, and would serve to reduce the number of claims which the parties would end up taking to arbitration. 9. Conclusion Thus, the authors conclude that: + the current FIDIC forms of contract do not provide sufficient guidance to the parties, the engineer, a DAB, or an arbitral tribunal as to how varied works should be valued, especially if there is no “reference rate” in the broadest sense available; + © there is a real benefit to the parties which might be obtained if the parties were to agree to a price-finding mechanism that can provide some guidance, mainly in terms of increasing predictability; + the presence of such a valuation mechanism in standard forms of contract would significantly reduce the number of claims which are disputed, as the parties would be much better able to gauge (2013) 29 Const. L., Issue 1 © 2013 Thomson Revters (Professional) UK Limited and Contributors40 Construction Law Journal beforehand if an engineer's determination would be upheld, or overtumed. Thus, the authors are of the opinion that a benefit could be added to the FIDIC forms of contract for the parties if the next revision of the FIDIC contract forms were to include some reference to a type of valuation mechanism, or provide some guidance about the benefits of including such a mechanism, in the guidance notes. Precisely what kind of price-finding mechanism should be offered is a topic in need of further discussion, research and, of course agreement between the parti (2013) 29 Const. 1.1, Issue 1 © 2013 Thomson Reuters (Professional) UK Limited and Contibutors