Turkish Law Blog
Risk Allocation in Construction Contracts; a Limited Comparison of FIDIC’s Conditions of Contract for Construction, 1999 and the New Engineering Contract 3rd Edition
A good construction contract means less disputes leading to successful project completion and must have following basic characteristics;
- suitability for intended use,
- clear risk allocation
- clarity of its language,
- proper mechanism for contract administration
One of the most powerful ways to prevent and control disputes between contracting parties is to rationally allocate risks by assigning each potential risk to the party who is best able to manage, control or insure against the particular risk. It is impossible to remove the risks totally, however the contract must provide the mechanisms to mitigate them.
“Prof. Ian Macneil and Paul Gudel divide contract planning into two main dimensions, performance planning and risk planning. The first dimension is about the substance of relationship, seeking to secure smooth and efficient performance and accomplishment of parties’ goals. The second dimension is about risk and contingencies: contract terms dealing with remedies, limitations on liability, indemnities, dispute resolution, and the like.”
What do we exactly mean by “risk”? Risk is defined as an effect of uncertainty on objectives in ISO Risk Management Standard (ISO 31000:2009). The PMI Guide to the Project Management Body of Knowledge defines risk as an uncertain event or condition that, if it occurs, as a positive or negative effect on project’s objectives. Thus, two main conclusions can be extracted as uncertainty and the likely positive or negative impact of the uncertainty.
In the recent article of the author, contract is defined as an agreement entered between two or more parties (individuals, or entities) that creates obligations and rights and these obligations and rights are legally binding for parties. Parties assume these obligations and rights with an objective of obtaining benefit. In this sense contracts become business benefit realization tools and the contract risk is the possibility that leads to negative deviation from the expected business outcomes.
Construction contracts shall be designed to define and allocate the risks correctly and to provide the necessary mechanisms to the Parties to mitigate their risks. Standard forms of contracts widely used are quite developed. The New Engineering Contract 3rd Edition goes farther and aims at mitigating the risks collaboratively. The risk register procedure has been developed for this purpose as stated in Guidance Notes:
“The Parties are then required to meet, to seek mutually beneficial solutions to overcome these problems, and to operate a formal Risk Register of notified events.”
In this sense, the philosophy of NEC is that, by working together to anticipate and plan for the eventualities that can arise on any construction project, the impact of risks is likely to be reduced, leading to better outcome for all parties. Risk reduction meetings are the embodiment of the NEC’s problem-solving culture and provide the forum for joint discussions of risks and actions to be taken to mitigate them.
In construction contracts, the main contract risk assumed by Employer that would lead to negative deviation from the expected outcome are Contractor’s defected performance and the delay by the Contractor.
Construction contract shall provide reasonable protection to Employer in case of Contractor’s defected performance. FIDIC’s Conditions of Contract for Construction, 1999 provides the following protection to the Employer; Clause 4.2 - Performance Security (clause 4.2), rejection of defective plant, materials and workmanship (clause 7.5), and employer’s remedial actions including employing other persons in the failure of the Contractor to remove or re-execute the defective plant or material (clause 7.6). In addition, Section 11 contains detailed Defect Liability of the Contractor and the Employer’s respective rights.
Delay of the project is the most important risk the Employer bears. It may have serious consequences on the Employer’s business. Most of the standard contract forms impose strict responsibilities on parties to ensure the timely completion of the project. Also, they detail procedures to control the progress, to avoid delays, to investigate the root of delays etc. and allows both parties to mitigate their risks.
In the New Engineering Contract 3rd Edition, Contractor is obliged to comply with the Key Dates (clause 30.3). The main objective of New Engineering Contract 3rd Edition is the timely completion of the project and section 3 defines the parties’ responsibilities by giving the highest priority to have a current update work program. This does not mean that the delay by the Contractor is a removed risk and therefore secondary option X7 provides the respective delay damages.
Special focus shall be given to a time of the essence clause. This clause may simply state time is of the essence of the contract. It is understood that the timely performance of the contractual obligations by the Contractor is so essential and its breach is considered as the fundamental breach of the contract that may even lead to termination by the Employer. In supply contracts it is widely used to ensure the timely delivery of the goods. In majority of the construction contracts, timely performance is given the utmost importance, but delays are also common due to many reasons attributable to both parties of the contract. Therefore, it is advised to think twice before including such clause in construction contracts.
The Contractor is a party to the construction contract only with a unique purpose; to make benefit from the construction contract, it will not benefit from the completed structure in the future. Therefore, the Contractor’s main objective is to avoid any monetary loss in the performance of construction contract.
Monetary loss in the performance of construction contract, can be caused by following events:
- delay by the Employer,
- error in drawings and documents
- unforeseeable physical conditions,
- delay by authorities
- Employer’s failure to pay
- Suspension and termination
In construction contracts, proper protection for Contractor must be provided for above events, such a protection can be extension of time so that Contractor is not subject to liquidated damages due to failure to catch the time for completion and/or compensation of extra cost that Contractor faces with. However, it must be underlined herein Contractor’s entitlement to additional time does not mean additional cost in some cases.
In the New Engineering Contract 3rd Edition, the Contractor’s entitlement to additional time and money is dealt under section 6: Compensation events. This section provides very detailed procedure basically requiring the parties to agree on the time and cost effect of the compensation event on timely basis to avoid future disputes. By this, the Employer gains price and time certainty. The Contractor gains as it is his own forecast of the time and cost impact which forms the basis of reimbursement.
FIDIC’s Conditions of Contract for Construction, 1999 the procedure is more complicated. In some circumstances the Contractor is entitled to cost plus reasonable profit; delayed drawings (clause 1.9), delayed access to the site (clause 2.1), error in reference items for setting-out (clause 4.7), Employer’s instruction for additional testing (clause 7.4), variations (section 13) and in some only cost; unforeseeable physical conditions (clause 4.12), fossils (4.24) etc. The reasoning seems to be the distinction between the Employer’s act and other circumstances causing the delay. In some other case, the Contractor is entitled only to cost; suspension by the Employer (clause 8.9). As per clause 8.11, the suspension can be extended up to 112 days. However, in suspension by the Contractor (clause 16.1) due to the Employer’s failure, the Contractor is entitled to cost plus reasonable profit.
FIDIC’s Conditions of Contract for Construction, 1999 includes an interesting clause requesting the Employer to provide reasonable evidence that financial arrangement have been made to pay the Contractor (clause 2.4). The aim is to ensure the Contractor that the Employer has money to pay the Contractor. Lack of response from the Employer within 28 days entitles the Contractor to suspend (clause 16.1) and later even to terminate the contract (clause 16.2). There have been many debates especially around what constitutes ‘reasonable evidence’ since this may become important in case of a dispute relating to its precise meaning due to the serious sanction that follows such failure.
Termination clauses are also the risky clauses that deserve special attention of Contractor. Some construction contracts even include a termination for Employer’s convenience clauses such as “The Employer may at any time and for any reason can terminate the contract at his convenience”. In case such clauses cannot be avoided, a cost compensation clause for Contractor shall be allocated.
 Haapio, H. and Siedel, G.J., (2013) A short Guide to Contract Risk, 1st edn. Gower Publishing, p.84
 Macneil, I.R. and Gudel, P.J. (2001) Contract – Exchange Transactions and Relations. Cases and Materials, 3rd edn. New York, NY: Foundation Press
 Unal, Ulas Devrim, “Conclusion of Contract and Sources of Contract Terms”, https://turkishlawblog.com/read/article/175/conclusion-of-contract-and-sources-of-contract-terms
 Haapio, H. and Siedel, G.J., (2013)A short Guide to Contract Risk, 1st edn. Gower Publishing, p.20
 John Hughes-D'Aeth, Berwin Leighton Paisner LLP, ‘NEC3: role of the Project Manager’, <http://uk.practicallaw.com/4-383-6298?source=relatedcontent>
 FIDIC’s Conditions of Contract for Construction, 1999 and The New Engineering Contract 3rd Edition do not contain time of the essence clause.
 Lavin M.A & Potts K.F. University of Wolverhampton, ‘Response to the new engineering contract – a review of experts’ observations on this radical new contract’, Construction and Building Research Conference 1998.
 Seppala, C. R., Contractor's claims under the FIDIC civil engineering contract, Fourth (1987) Edition, International Business Journal, 1997