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CONSTRUCTION DISPUTE

AVOIDANCE NEWSLETTER
(number 47)

CLAIMS ARISING FROM DELAYS AND SCOPE


CHANGES
This month, we take a look at the losses that can sometimes
arise as a result of variations, scope changes and delays on a
project and the claims available to contractors to recover
losses arising as a result.

Introduction

Cost and Losses

Recovery of Costs and Losses

Entitlements under the Contract

Breach of Contract

Contacts

JANUARY 2013
Tokyo office
RECENT PUBLICATIONS

Introduction
Consider the following scenario. A Contractor has entered into an EPC contract for
the design and construction of a power plant with an Employer. Several months
into the project, with geotechnical surveys complete, and site preparation works
and design development work well under way, the Contractor is advised that major
changes are to be made to plant specifications that greatly affect the utility of much
of the work done to this point. The Contractor is advised that there may be a
number of delays while internal approvals are obtained for these plant changes but
a variation order will be sent through shortly.
What is the contractor to do?
A number of consequences will inevitably follow from a scenario of this kind. First,
the Employer will likely need to issue1 a variation order under the contract. 2
Inevitably, this will entitle the Contractor to some level of adjustment of the contract
price and the construction timetable. These adjustments, and in particular, any
adjustment to the contract price, however, may not fully compensate the Contractor
for all of the losses that it will suffer.

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Costs and Losses


As a result of the change the Contractor may incur additional costs in completing the work arising from the variation request
(assuming the scope of work increases).
1
2

Or under the FIDIC Red and Pink Book Contracts, the Employer will need to cause the Engineer to issue.
For current purposes, we have assumed that the contract permits the Employer to submit broad variation requests and that the variation
request is validly made. Both of these issues should be carefully considered.

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In addition to these costs, depending on the project involved, there may be a


number of other costs that either (a) have been incurred by the Contractor that will
now be wasted, or (b) will flow as a consequence of the variation request
typically, through delay or loss of productivity of the Contractor's workforce.
Typically, costs and losses of these kinds can be more difficult to recover (where
they are not attributable to the expanded scope of work) and as a result they
warrant some further consideration here. Before we consider the way in which
recovery occurs, it is worth considering the types of costs and expenses that can
arise.
Commonly, costs and losses will fall into one of the following general categories:
1.

2.

November 2012
FIDIC subcontract 2011: A
critique of the alternative
dispute resolution procedures
October 2012
Asia Quarterly Edition:
Contractual rates of interest in
construction contracts

Loss of profits.

July 2012
Asia Quarterly Edition:
Challenges in the enforcement
of dispute board decisions

Disruption costs.
Disruption costs are costs associated with the inefficient use of plant and
equipment, or anything else that makes it harder for the Contractor to
perform the contract works than would otherwise be the case. For
example, a variation request may require a contractor to use its equipment
in a way that requires double the maintenance or operating cost, or it may
make a particular method of construction previously relied on unfeasible.
Disruption costs seek to compensate for these differences, although they
are notoriously difficult to prove.

4.

December 2012
ADR in construction disputes:
arbitration and disputes boards
are not the only answer

Prolongation costs.
Prolongation costs are costs associated with an extension of the contract
period (irrespective of whether the extension relates to a scope of work
change) and they often relate to an increase in on-site and off-site
overheads. Prolongation costs can often include items such as hire or
depreciation on cranes, scaffolding, sheds and plant, telephones, utility
services, insurance, security, and head office overheads. Less commonly,
they can in some instances include interest on security bonds and
guarantees, increases in the cost of labour, materials and sub-contractor
claims.

Loss of profits are, typically, encroachments into the Contractor's


operating profit margin. Understandably, any commitment on the part of
the Contractor to allocate its resources and capital to a project will involve
a decision to forego the opportunity to make a profit by allocating these
resources to other projects. As a result, (simplistically) where the
Contractor can demonstrate that its profits have reduced as a result of a
delay or disruption or some other event, it may seek to recover any
resulting loss.
3.

INDEX OF PREVIOUS
NEWSLETTERS

Wasted (Abortive) costs.


These are costs that have been spent that are no longer needed to
achieve the contract's purpose. These costs can include, for example, the
cost of specialist equipment purchased in preparation for completing the
contract works that can no longer be used, idle time for the contractor's
employees and in some cases its sub-contractors, financing charges for
any project specific overdraft facility, forward contracts for materials that
will either no longer be required, and so on.

September 2012
FIDIC Sub-Contract: First
Edition
August 2012
A Significant New Decision:
Walter Lilly v Mackay July 2012

June 2012
EPCM contracts: a more
sophisticated procurement
methodology?
May 2012
Limiting liability
April 2012
Asia Quarterly Edition: Notice
Requirements in Construction
Contracts A Southeast Asia
perspective
March 2012
Force majeure clauses: FIDIC,
ENAA and drafting bespoke
clauses
February 2012
Recovering wasted
management costs
January 2012
Asia Quarterly Edition:
Constructor's liability for
defects

What should the contractor do when faced with costs or losses of these kinds as a result of a delays and scope changes? To
what extent can the Contractor recover any of these costs and losses from the Employer?

Recovery of Costs and Losses


The short answer is that Contractors are not automatically entitled to extra payments as a result of variations or scope changes,
delays or other disruptions to its work.

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In order to claim additional amounts from the Employer, the Contractor must show at least one of two things: a) that the contract
permits it to recover more money, and/or b) there has been a breach of contract by the Employer.
We begin with the position under the Contract.

Entitlements under the Contract


If a claim is made under a contract, while it may seem obvious, the amount that the Contractor can claim will depend on the
wording used in the agreement between the parties.
The contract will typically provide three categories of entitlements for the Contractor to pursue: variation entitlements; general
prevention loss/expense entitlements; and suspension entitlements.
Variations
The starting premise is that work done outside of the scope of the contract requested by the Employer will be compensated by a
reasonable sum. Most standard form contracts reflect this premise and permit the Contractor to recover additional amounts for
variations to the scope of works.
If a variation order requires enormous changes to the project, as a first step, the Contractor may need to consider whether the
variation request exceeds the limits of the Contract. 3
Assuming that the variations do not exceed the limits of the contract, however, the contract will prescribe a procedure for
responding to that variation request. In all widely used standard form contracts, the variation clause will identify what the
Contractor needs to show in order to establish its right to additional payments under the contract and how those payments are
to be calculated.
These must be considered in some detail. Sometimes, variation provisions in an agreement can state a procedure typically
involving the issue of notices that operate as conditions precedent to any entitlement to extra payment. That means that if the
contract steps are not followed, there is no right to further payment for completing the contract works, as varied. Because of the
effect of provisions of this kind, it is critical that care is taken to follow any process the contract states, particularly in relation to
the issue of any contractual notices.
In following that variation process under the Contract, the contractor may be able to claim particular items of costs and loss
(described above) in any variation amount. For example, in JCT SBC05 and SBC11, clause 4.23 permits the contractor to make
claims if it incurs direct loss and expense as a result of the 'progress of works' being 'materially affected' by a prescribed
'relevant matter', which includes variations.
Other contracts do not specifically contain loss and expense provisions, although they do permit claims to be made in other
ways. For example, the NEC 3 Engineering and Construction Contract provides (at clause 60) for a long list of "compensation
events" which, if the contract procedure is followed correctly, may increase the contract price or time for completion.
In other standard form contracts, the position is not so clear. For example, under the FIDIC Yellow and Silver books, the
Employer is entitled to instruct or approve a variation, the value of which, if not agreed is to be 'determined' under the contract. 4
The adjustments are to include 'reasonable profit', and are to take into account the parties' submissions regarding value
engineering (cl.13.3). While these adjustments are to include a 'reasonable profit', what that profit relates to is not made clear. Is
it the specific works comprising the variation only? Does it encompass all costs that are now wasted? Absent agreement with
the Employer, the only means of ventilating this issue is through the dispute resolution process in clause 20. 5 The Contractor is
not entitled to suspend the work in the meantime. This can be a difficult issue to navigate through and the contractor will not be
entitled to an extension of time while negotiations are in progress.
General prevention loss/expense entitlements
Sometimes variation provisions (described above) can be the sole source of entitlements under the contract, while at other
times, the contract can provide for other grounds of claim to be made. 6
For example, under each of the FIDIC Red, Silver and Yellow Book(s), clause 2.1 provides that the Employer is to give the
Contractor access to and possession of the Site (from the times stated in the contract), failing which the Contractor is entitled to

This is a topic for another day. In short, if the work is so peculiar and unexpected from what any person thought the contract was to involve,
the [contractor] must be paid on the basis of the reasonable value of the goods and services to be supplied, not under the simple contract
quantities: see Thorn v London Corporation (1875) 1 App Cas 120 at 127. This is not a simple claim to make out.
Sometimes, the contract between the parties contain price data that can be used for determinations of this kind: see for example, cl 14.1(d)
of the FIDIC Yellow book, which can sometimes be used as evidence for the purposes of any determination.
The Red Book (1999 edn) is different in this respect. It permits variations to be valued in accordance with clause 12 unless the Engineer
approves another method.
For example, the FIDIC Silver book permits the employer to suspend the all or part of the works where it chooses to (cl.8.8). Where that
occurs, the Contractor is entitled to its extra costs, among other things, of complying with the Employer's request.

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extra time, its 'Costs' and reasonable profit. How far provisions of this kind can be stretched to permit the costs and losses
referred to earlier is often a matter for discussion and negotiation (and sometimes dispute). The extent to which these costs and
losses are recoverable depends on the wording of the contract used.
Because the objective in contract interpretation is to determine the intention of the individual contracting parties, recoverable
costs can differ between cases, even when pro-forma contracting terms are used. For example, under the FIDIC Silver and
Yellow Book(s), sometimes the bespoke wording of the contract states that the 'Contract Price' includes a fixed sum for head
office overheads and profit which is not capable of adjustment, and that no claims on account of such costs will be made against
the employer. In the face of provisions of this kind, it may be difficult for the contractor to claim overheads and profit in any claim
for losses.
Suspensions
Finally, on occasion, the employer will suspend the performance of the contract works while scope changes are planned or
organised, typically to minimise the contractor incurring costs that will become abortive by the variation or scope change.
Suspensions can be a source of claims for the contractor for costs and losses attributable to a delay under many of the common
standard form contracts. 7 While these are less likely to permit claims for loss of profits, they can be a fruitful source of claims for
short disruptions.

Breach of Contract
Once the contractor has exhausted its entitlements under the contract, the only remaining basis on which further costs and
losses may be claimed is in the event that the employer has breached the contract in some way. These are not so simple to
make out. Naturally, the contractor must be able to:
(a) Identify an express or implied term of the contract that imposes a duty on the employer that has not been complied
with; and
(b) For the most part, they must be able to trace a specific cost or loss to the employer's failure to fulfil the duty or
obligation in question.
Resolving these questions is heavily fact specific, and once again, will depend on the proper interpretation of the contract
between the parties. As a general rule, unless the contract says otherwise, any act of the employer that hinders the contractor
from completing the contract works is likely to be a fertile ground for investigation.

For example FIDIC Silver book at cl. 8.8-8.9.

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Contacts
Peter Godwin (managing partner)

Emma Kratochvilova (partner)

Gaikokuho Jimu Bengoshi


T +81 3 5412 5444
peter.godwin@hsf.com

Gaikokuho Jimu Bengoshi


T +81 3 5412 5412
emma.kratochvilova@hsf.com

Dominic Roughton (partner)

Brad Strahorn (senior associate)

Gaikokuho Jimu Bengoshi


T +81 3 5412 5432
dominic.roughton@hsf.com

T +81 3 5412 5453


brad.strahorn@hsf.com

David Gilmore (partner)


Gaikokuho Jimu Bengoshi
T +81 3 5412 5415
david.gilmore@hsf.com

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Herbert Smith Freehills LLP 2013
The contents of this publication, current at the date of publication set out above, are for reference purposes only. They do not
constitute legal advice and should not be relied upon as such. Specific legal advice about your specific circumstances should
always be sought separately before taking any action based on the information provided herein.

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