Randa Adra, Joshua Lindsay, Edmund Northcott and Evelien Van Espen | Global Arbitration Review
Introduction
Construction contracts not only define project scope, price and timeline, but crucially allocate risks between parties. Effective risk allocation – covering issues like cost overruns, design errors, unforeseen conditions and delays – is essential for project success and dispute avoidance. Standard forms such as those of the International Federation of Consulting Engineers (FIDIC), the Institution of Chemical Engineers (IChemE), the New Engineering Contract (NEC) and Leading Offshore Energy Industry Competitiveness (LOGIC), aim to align risks with the party best able to manage them, promoting fairness, reducing disputes and supporting efficient delivery. Poorly balanced risk allocation can drive up costs, deter bidders and increase conflicts.
Achieving fair risk allocation requires cooperation between employer and contractor, informed by the chosen procurement method and tailored contract terms. FIDIC contracts are international benchmarks, with the Conditions of Contract for Construction for Building and Engineering Works Designed by the Employer (the Red Book) and the Conditions of Contract for Plant and Design-Build for Electrical and Mechanical Plant and for Building and Engineering Works Designed by the Contractor (the Yellow Book) offering more balanced allocations, and the Conditions of Contract for EPC/Turnkey Projects (the Silver Book) assigning greater risk to contractors. The 2017 FIDIC editions maintain these distinctions but introduce important updates. Other forms like IChemE and LOGIC are industry-specific, while NEC4 is increasingly adopted internationally.
Ultimately, careful risk identification, negotiation and clear contract language are key to predictable and equitable project outcomes.
Risk in construction contracts
A construction contract, in its simplest form, can be described as an agreement between a contractor and an employer whereby one person agrees to construct an asset for another person for an agreed remuneration at an agreed time.[1] Construction contracts can be much more complex than this formulation, particularly when they involve multiple parties serving different functions, such as subcontractors, designers or operators.
Regardless of their complexity, well-crafted construction contracts will clearly stipulate the rights and obligations of the parties and allocate responsibilities between them for specific risks in various hypothetical situations that may transpire during the contract’s execution.[2] The distribution of responsibility for such risks in a construction contract represents its risk allocation.
In a project delivery context, risk can be defined as ‘an uncertain event or set of circumstances that, should it occur, will influence the achievement of one or more of the project’s objectives.[3] Risk exists because of uncertainty, and exposure to risk produced by uncertainty must be managed within the contract and beyond.[4] Dr Nael Bunni describes risk as a mathematical equation: ‘RISK = Probability, or frequency, of a defined event x Consequences of that event’.[5]
Common risks prevalent in construction projects include errors in cost estimating, scheduling issues, delays, financial difficulties, labour disputes, faulty materials or workmanship, operational problems, inadequate design plans, ambiguous scope or specifications, and unanticipated site or environmental conditions.[6] Projects will also have additional specific risks, depending on their nature, the relevant industry and surrounding circumstances. Risks can lead to disputes, especially when the allocation of risks is unbalanced or poorly defined.
The pursuit of a fair and equitable allocation of risk
Oftentimes the employer or project owner prepares the contract document bid package such that they are in a position to define the allocation of risk.[7] As holders of the pen, owners may be tempted to assign most of the risks to contractors;[8] however, this must be tempered by an understanding of the potentially adverse consequences of allocating risk to a party that may have less authority to manage that risk.[9] Tender packages that allocate too much risk to bidding contractors may preclude the submission of bids or lead to an increase in cost such that the project is no longer financially viable.[10] Likewise, risk allocation without thoughtful planning may result in prolongation of construction completion times, waste of resources or increased likelihood of disputes. Careful risk identification and distribution are the essential ingredients to increasing the effective, timely and efficient delivery of construction projects.[11]
While parties may negotiate any and all terms of a construction contract, the construction industry increasingly relies on a number of standard form contracts as the bases for construction contracts. One feature of standard form contracts is the intent to produce a ‘fair and balanced’ allocation of risk, which some believe will provide the best chance of successful project delivery.[12] Compared to heavily skewed risk assignment, a balanced and transparent allocation – aligned with trust – often drives lower costs, better collaboration and fewer disputes.[13]
Max Abrahamson suggests that to achieve a fair and equitable allocation of the risks inherent in construction projects, a risk should be allocated to a party if:
- the risk is within the party’s control;
- the party can transfer the risk (e.g., through insurance), and it is most economically beneficial to deal with the risk in this fashion;
- the preponderant economic benefit of controlling the risk lies with the party in question;
- to place the risk on the party in question is in the interests of efficiency, including planning, incentive and innovation; or
- should the risk eventuate, the loss falls on that party in the first instance, and it is not practicable, or there is no reason under the above principles, to cause expense and uncertainty by attempting to transfer the loss to another.[14]
Although consideration of which party controls a risk is a powerful factor in the determination of risk allocation, it is not comprehensive and other principles should be used to address adequately the allocation of risk in a construction contract.[15] For example, events of force majeure by their nature cannot be controlled by either party, but the consequences of such risks must be assessed and allocated.
Recognising that not all risks can be controlled by either party, Dr Bunni proposes that the following four considerations should be used when allocating risks in construction contracts:
- Which party can best control the risk or its associated consequences?
- Which party can best foresee the risk?
- Which party can best bear that risk?
- Which party ultimately most benefits or suffers when the risk eventuates?[16]
The question of what is a fair and equitable risk allocation is ultimately a subjective one, although using objective tests such as those mentioned above may be of assistance. In deciding how to procure a project and allocate risks, an employer will need to weigh up the theoretical efficiency of the risk allocation with political and market dynamics and the needs of the particular project, stakeholders and any financiers.
Allocating risk in construction contract procurement
Before individual contracts are tendered and let, most construction projects proceed through a planning process that includes selecting a delivery structure and procurement method. How a project is procured – which includes consideration of which entities will perform which roles, how the work scope will be packaged, and which entities will be in contract with each other – will affect the allocation of risk between the various parties.
Design–bid–build
Perhaps the most traditional project delivery method in construction, in a design–bid–build procurement, the employer will engage a design consultant or team to prepare the design for a project and then bid and award a construction contract to a contractor to construct the project in accordance with that design. A design–bid–build procurement is linear, straightforward and relatively easy to implement, especially for less experienced owners.
In a design–bid–build structure, the owner often has a higher degree of control over the design and the construction, the employer typically takes responsibility for the design provided by the design consultant or team, and the contractor will generally be entitled to relief (which may be in the form of an extension of the time for completion or an increase in the agreed remuneration, or both) if there are defects or deficiencies in the design;[17] therefore, even if the owner has recourse against the designer, it accepts greater risk for potential errors or omissions in the design.
Design-build
In a design–build structure, the owner awards the entire project to a single company, making the design–build contractor responsible for both the design and construction to meet the contractual specifications. The owner defines the project objectives and requirements, and the design–build contractor develops a design to meet the project requirements and then proceeds with construction, managing all aspects of the project.
A design–build procurement can shift some of the design and construction risks from the owner to the design–builder because this delivery structure provides the owner with a single point of contact and responsibility for the entire project, from initial design through construction. The precise cause of defects is sometimes difficult to trace to either design or construction, which under a more traditional design–bid–build procurement can lead to disputes as to whether the owner or designer, or the builder are responsible.[18] A design–build delivery structure alleviates this owner risk by allocating responsibility for design and construction to the design–build contractor, but often requires the owner to relinquish some control of the design process.[19]
EPC
A furtherance of the design–build delivery structure, in engineering, procurement and construction (EPC) contracts, a single contractor takes responsibility for all elements of design (engineering), construction and procurement of a project on a turnkey basis. While similar to design–build contracts, EPC contracts are a more comprehensive approach, often used for larger, complex projects, where the contractor generally takes on significantly more risk and responsibility for the entire project life cycle, from initial design to procurement of subcontractors, through to construction and ultimately final commissioning.[20]
EPCM
An engineering, procurement and construction management (EPCM) delivery structure is a project execution approach where a contractor provides engineering design, procurement of materials and construction management services. Unlike an EPC contract, where the contractor handles the entire construction, in EPCM, the owner typically hires the construction contractors directly, although typically with the EPCM’s management of the procurement process, including selecting contractors, negotiating contracts and purchasing materials and equipment on the owner’s behalf. The EPCM contractor acts as the owner’s representative throughout the project, managing the project from design through procurement and construction management.
By retaining contracts with construction contractors directly, the owner retains greater control over the construction process. Likewise, the owner may bear more project risks arising from contractor performance, while the contractor retains risks arising from its engineering, procurement and management performance.
CMAR
Construction manager at risk (CMAR) procurement is a project delivery method where a construction manager is hired early in the design phase to provide pre-construction services and to manage the project through construction, all within a guaranteed maximum price (GMP), which typically includes materials, labour and the overhead and fees of the construction manager (CM).[21] This approach involves the owner contracting with a CM who provides pre-construction services as a consultant and then takes on the role of general contractor during construction. The CM collaborates with designers, architects and engineers to provide input on the project design, costs and constructability.[22]
The CM typically assumes the risk of cost overruns exceeding the GMP, and the early involvement of the CM can help to mitigate such risks because it provides opportunity for the CM to identify potential cost implications during the design phase and can encourage greater collaboration and communication between the owner, designer and CM. The owner, however, is highly reliant on the CM to properly perform in managing its contractual risks and in maintaining proficient communication between collaborating parties.
DBOM
A design–build–operate–maintain (DBOM) delivery structure involves a single entity responsible for design, construction, operation and maintenance of a facility or infrastructure project over a defined period. Sometimes also referred to as a build–operate–transfer, this structure can shift even greater responsibility and risk to the contractor. DBOM contracts are often used by government entities to structure the construction of public infrastructure projects, and these long-term contracts can last for many years, often spanning the operational life of the facility.
Public–private partnerships (PPPs) are an increasingly popular form of DBOM procurement of major public infrastructure projects because they often reduce the financial and administrative burden on the public sector owner. Likewise, the contractor’s long-term investment in the project is intended to incentivise innovation and efficiency, which can improve project performance for all parties involved. As with other procurement structures that shift risk away from the owner, the owner likewise may have less control during the design and construction period.
Section summary
Each of the above approaches offers a distinct balance of control, responsibility and exposure to risk. Even in a delivery structure that shifts more risk to a particular party, that party remains reliant on the proper performance of others to adequately manage and mitigate those risks. Ultimately, employers and contractors should carefully assess their risk appetite, the project complexity and the desired level of control when choosing a procurement strategy, as the chosen structure will have lasting implications for project delivery, cost certainty and dispute mitigation.
Allocating specific risks in construction contracts
Beyond the general principles of risk allocation inherent in a project’s delivery structures, parties may further define the allocation of risk within the various contracts that form the relationships between parties on a construction project. Certain legal systems may set default rules allocating risks in the absence of a contractual provision, but parties can often achieve greater certainty by crafting their own express terms and ensuring that all risks are clearly assumed and allocated at the contract phase. This certainty, in turn, helps parties prepare for, finance and insure their projects. Below are some of the more significant categories of risk that parties may wish to account for in construction contracts.
Quantities
At the outset of any construction project, parties will endeavour to accurately estimate the amount of material, equipment, and personnel resources required. The quantity of resources required can be impacted by changes in design, delays or disruption to schedule, or myriad other factors.
The allocation of quantity risk is affected most directly by the payment structure selected. Two of the more fundamental renumeration structures are lump sum and remeasurement:
- Under a lump sum contract, the contractor is paid a fixed amount, regardless of the quantity of resources used; therefore, the contractor carries the risk if more resources are required, which must be accounted for in the formulation of the contractor’s bid.
- Under a remeasurement contract – sometimes called a unit-rate or time-and-material contract – the parties agree on unit rates for the required resources, and remuneration is calculated based on the actual quantities used, rather than projected or estimated quantities. The employer bears the risk that the required resources may exceed the quantities initially assumed.
Where there is significant uncertainty as to the quantity of materials required in a construction project, parties may wish to share the risk by using an alternative contractual payment structure that aims to avoid either party assuming an unacceptable amount of risk. One alternative is a cost-plus contract, in which an employer pays a contractor for the actual costs of a project, plus an additional fee or percentage for profit. This structure can offer employers greater certainty regarding the contractor’s potential profits while assuring the contractor reimbursement of its costs plus a predictable profit margin.
Many variations of the cost-plus model exist – including cost-plus fixed fee, cost-plus percentage of cost, cost-plus incentive fee, cost-plus award fee and cost-plus with GMP – each of which allocates the risk differently between the employer and the contractor and which can vary according to the project or contract’s particular characteristics.
Parties may also mitigate risk related to unexpected quantities by including a ‘changes in the work’ clause, where parties agree on rates and fees for additional work in advance. When unforeseen changes arise on a project that result in increased quantities of material, equipment or resources, parties can also use pre-agreed provisions to facilitate negotiation of a change order that accounts for any cost and schedule impacts.
Errors or changes in employer-provided information
In construction projects, it is common for the employer to provide the contractor with a range of information at the outset, including location and condition of the site and other specifications, including details related to permits, weather contingencies and site access. Such information may be provided to the contractor on a non-reliance basis or for ‘information only’. In such cases, the risk of errors or inaccuracies in the information will generally run with the contractor.
Alternatively, the employer may agree to assume some of or all the risk by allowing the contractor time or cost relief where the employer-provided information proves to be incomplete or incorrect.
Unforeseen ground conditions
The risk of unforeseen ground conditions is well-known to the construction industry. While certain projects may be more susceptible to differing ground conditions than others, most structures have subsoil foundations of some kind, making this issue and related risk calculations widely applicable to the construction landscape. Unexpected difficulties encountered during construction may require the contractor to pivot away from existing plans or methodologies. Unforeseen conditions may sometimes even render it impossible for contractors to execute their projects as originally conceived. Accordingly, the potential time and cost consequences should be considered and provided for in any construction contract.
In the FIDIC suite of contracts, the Red and Yellow Books traditionally have sought a balanced allocation of risk, favouring contractual provisions where both the employer and contractor bear some risk related to unforeseeable ground conditions in terms of both time and cost. Meanwhile, unforeseen ground conditions are dealt with quite differently by the ‘unforeseeable difficulties’ provisions of the Silver Book.
In 2019, FIDIC published a Tunnelling and Underground Works Contract, which uses the Yellow Book as a base and further incorporates a risk allocation theory specifically tailored to the nature of underground projects.
Force majeure
Over the course of a construction project, performance of the parties’ obligations may be delayed, impaired or altogether prevented by extraordinary circumstances – also called force majeure events – outside the parties’ control. Many legal systems have codes or precedent governing the impossibility or inhibition of performance of contractual obligations because of some extraordinary event, so the underlying law of the parties’ contract may determine the allocation of risk when such events arise. To mitigate uncertainty, however, parties may choose to incorporate clauses into their contracts that more expressly define what constitute force majeure events and how risk is allocated when they occur.
A typical force majeure clause is designed to excuse one or both parties from performance of an obligation rendered impossible, whether by natural disaster, war or other category of extraordinary event as understood by the parties. These clauses may also provide for the complete termination of the contract, depending on the type and extent of the event.
Depending on its drafting, a force majeure clause may allocate the risk entirely to the employer, who will ultimately enjoy the benefit of performance and may consent to pay a premium to ensure a project’s completion, emergency event notwithstanding. Alternatively, a force majeure clause might allocate risk to the contractor, who may be incentivised to mitigate losses and prioritize performance to the extent possible.
Force majeure provisions can also balance the risk between the parties; for example, the contractor may be required to bear the additional costs, delays and hurdles of completing the project after an extraordinary event, but the employer agreed in the contract that if prices exceed a certain threshold, so too would the contract price.
Change in law
Construction contracts, like other commercial agreements, typically presume that, as each party performs its contractual obligations, each will do so in compliance with applicable law. In the absence of a specific provision concerning any change in law following execution of the contract, contracted-for obligations will generally continue by default. In a construction contract, this may mean that the contractor remains responsible for executing the project, even if performance has been made more difficult because of the new laws. Certain legal systems, particularly in civil law jurisdictions, may offer relief to contractors when a change in law significantly alters the commercial expectations of a contract, but such provisions are more the exception than the rule. Because the risk typically runs with contractors for a change in law, parties may specifically consider whether they wish to reallocate in their contracts some portion of this risk to employers, who may be incentivised to accept such risk to ensure completion of their projects.
Delay and disruption
Delay to project completion is one of the most commonly occurring risks in the construction industry, and identifying which party is responsible for the causes – and therefore the consequences – of that delay is a major driver of construction disputes.
Construction contracts typically include a projected timeline for completion, by which the contractor is required to execute the project and the employer is required to pay. If the project is not completed by the target date, the contract may provide that the contractor must pay liquidated damages for the delay (i.e., a predetermined formula for calculating the amount that a contractor must pay if the contractor fails to complete the project on time). Construction contracts may also include some provision for the contractor to receive an extension of time allowance where the contactor’s performance is delayed because of some reason attributable to the employer. Various causes for delay may also be specifically accounted for in the parties’ contract in the form of an agreed extension of time.
Performance guarantees
In construction, a performance guarantee, often in the form of a performance bond, ensures that a contractor fulfils its contractual obligations, protecting the project owner from financial loss due to non-performance. Essentially, it is a financial commitment that the contractor will complete the work as agreed, or the surety (usually an insurance company or bank) will cover the costs to complete it or compensate for damages. The guarantee protects owners from risk of contractor default and also provides a safety net to contractors should they become incapable of completing performance.
A construction contract may also include a guarantee that the constructed facility will achieve certain performance metrics, such as plant output or efficiency in the case of plants. In these types of guarantees, the contract will set out a testing and commissioning regime whereby the plant will be evaluated for its ability to perform as anticipated.
To the extent that the plant does not meet the relevant performance guarantees, the parties’ contract will determine how the shortfall is resolved. Most contracts allow the contractor the opportunity to make good any faults to ensure that the relevant performance guarantees are met; however, if the contractor fails to meet the relevant performance guarantees even after attempting to remedy the identified shortcomings, the contract may also require the contractor to compensate the employer, which may be calculated according to an agreed formula based on the relevant performance metric. Some contracts will also specify certain minimum performance levels which, if not met, will allow the employer to reject the plant entirely.
Warranties
In construction contracts, the contractor may make a warranty to the employer in which the contractor carries the risk related to any defects or failures of the completed works within a set time, such as within the first 12 to 24 months of the employer’s use of the project. Warranties, much like performance guarantees, often allow the contractor an opportunity to first remedy the defect. Then, if the contractor refuses or fails to do so, the contractor may owe the employer compensation commensurate to their breach of warranty.
Indemnification
Indemnity provisions allow parties to completely allocate risk. The typical indemnity clause requires one party to commit to carrying all risk in a specified circumstance or in the occasion of a particular adverse event. Upon occurrence of such event, the responsible party generally must indemnify or hold harmless the other party.
Indemnity clauses are typically designed to insulate one party when disputes are brought by third parties against the employer or contractor. In construction contracts, indemnity clauses may, for example, indemnify the employer and divert all liability to the contractor for harm sustained during construction, with carve-outs where the harm was caused by the employer’s sole negligence.
Insurance
Because of the many risks associated with construction projects, each party is often required to carry some form of commercial liability insurance, and, depending on the party’s role, additional insurance coverage, such as professional liability insurance, may also be required. As is typical of insurance generally, a contractor or employer obtains coverage by paying pre-calculated insurance premiums. Then, upon the occurrence of a qualifying event, which may involve any of the risks enumerated in this section, the insured party may seek reimbursement.
Often, a complex construction undertaking involves multiple active insurance policies. Parties may decide which elements of the project must be covered by whom, or a default rule may apply. FIDIC, for example, pre-allocates responsibility and assigns certain parties the obligation to insure against certain kinds of risks.
Termination
A construction contract may include terms that allow the parties to end the agreement entirely where the risks associated with completion are determined to be non-viable, whether due to commercial constraints, performance problems or otherwise. A termination clause outlines qualifying conditions for the contract to completely terminate and for both parties to be released from their respective contractual obligations.
Termination clauses typically fall under two main categories: termination for cause (or default) and termination for convenience. Termination for cause occurs when a party fails to fulfil its contractual obligations, which generally results in the defaulting party bearing the risk and costs of ending the contract. Conversely, termination for convenience allows either party to end the contract without a specific reason, often requiring advance notice and compensation for work completed, with the terminating party bearing the costs of termination.
Allocating specific risks: FIDIC approach and other standard contract forms
Different versions of the FIDIC forms of contract remain in use. Officially, the current versions are the second editions of the Red, Yellow and Silver Books, whichwere published on 5 December 2017; however, a significant number of companies continue to use the 1999 FIDIC suite, perhaps out of habit or by virtue of preference. This section therefore contains commentary on both the 1999 contracts and 2017 editions.
In commenting on and comparing the FIDIC provisions with other standard form contracts, this section also considers certain provisions from the IChemE,[23] NEC4[24] and LOGIC[25] standard forms of contract.
Quantities
1999 FIDIC contracts
In the FIDIC Red Book, the quantities, which may be set out in the bill of quantities or other schedule, are remeasured upon completion. The estimated quantities are not to be taken as the actual and correct quantities for the purposes of Clause 12.[26] The principle is that the works are to be valued by measuring the quantity of each item of work under Clause 12.2 and then applying the appropriate rate per unit quantity or the appropriate lump-sum price under Clause 12.3. This system follows from the fact that Red Book is based on the employer’s design.
In both the Yellow and Silver Books, the quantity is a risk to the contractor as the contract is based on a lump sum amount.[27] This follows from the fact that the Yellow and Silver Books are based on the contractor’s design (tailored to the employer’s requirements).
2017 FIDIC contracts
The 2017 version of the FIDIC Red Book is still a remeasurement contract, but introduces changes and clarifications to the risk allocation related to quantities. The engineer’s notice to the contractor shall be given within seven days of the works to be measured. In addition, such notice must express (1) the parts of the works to be measured, (2) the date on which the works will be measured and (3) the place at which the measurement will be made.[28] The 2017 version also requires the engineer to give notice to the contractor for the inspection of the records the engineer has prepared.[29]
The Red Book 2017 also includes a new provision for establishing new rates or prices for items where no rates or prices are specified in the contract, or where existing rates or prices are deemed inappropriate because of quantity changes.[30]
In the FIDIC Yellow and Silver Books 2017, the quantity risk remains with the contractor as a lump-sum contractor. [31]
Other contract forms
The IChemE form of contract is a lump-sum contract, meaning much of the pricing risk lies with the contractor, whereas the employer typically gets contract price; therefore, the contractor will need to include contingencies in their price for estimating errors, cost escalation and currency fluctuations, which are risks that could all affect the ultimate price. To assist in deciding which form of contract best suits the allocation of risk on a particular project, the introductory notes to IChemE include a helpful comparison table.[32]
The LOGIC contract is also typically delivered on a lump-sum basis. The employer (referred to as the ‘company’) is not entitled to investigate the makeup of rates and prices of items in the contract when conducting an audit of the works.[33]
As for the NEC4 contract, there are a menu of contract mechanisms, including lump-sum or priced contract, cost reimbursable contract, target contract or management contracts.[34] The option that is chosen will determine how quantities and prices for items are dealt with in the contract and how the risks associated with those prices are allocated between contractor and employer (referred to as the ‘client’). For example, Option B is for a priced contract with a bill of quantities.[35]
Errors or changes in employer requirements
1999 and 2017 FIDIC contracts
Under the Red Book, the employer is responsible for the design of the works and, therefore, also for any errors in the design.[36]
The Yellow Book requires the contractor to design the works in accordance with the contract such that, when completed, the works are fit for purpose; however, it provides that the contractor is not responsible for any error, fault or defect in the employer’s requirements to the extent that ‘an experienced contractor exercising due care’ would not have discovered the error, fault, or defect by the relevant time specified in the contract.[37]
The Silver Book provides that the contractor bears the risks of errors in the employer’s requirements. Under Clause 5.1 of the Silver Book, the contractor shall be deemed to have checked and scrutinised the employer’s requirements 28 days before submission of the tender. The risk is therefore fully transferred to the contractor.[38]
There are no material changes to the allocation of this risk in the 2017 version of these books.
Other contract forms
Clauses 16 and 17 of the IChemE form of contract deal with variations by the project manager and the contractor respectively. The project manager has the final say on all variations to the contract, and Clause 19 establishes the mechanism for price adjustments to the lump-sum price.[39] The contractor is responsible for the design, engineering and construction of the plant; therefore, if there are any errors in the documentation provided by the employer at the outset, the contractor should identify these promptly as the risk of incorporating those errors into the design lies with the contractor.[40] The contractor will be entitled to an increase in the contract price for errors attributed to the employer.[41]
In the LOGIC form contract, the employer is entitled to issue instructions to make changes at any time for the contractor to revise, accelerate, or reprogramme the works.[42] The default position is that the contractor is not responsible for any element of the design.[43] For all items received by the contractor from the employer, the contractor has three days to review them and check for errors.[44] Any errors not notified within that window will be deemed accepted by the contractor and thereafter the contractor’s responsibility.[45] A shift in the allocation of risk is therefore contemplated.
The NEC4 form of contract makes the contractor responsible for the design, and it is for the project manager to review and sign off on the design before proceeding; however, the employer remains liable for errors in the design contained in the scope provided by the employer, or an instruction from the project manager changing the scope of work.[46]
In each of these contract forms, therefore, the allocation of risk varies, often based on who is responsible for design and checking whether errors are carried through from the planning phase.
Unforeseen ground conditions
1999 FIDIC contracts
In the FIDIC Red and Yellow Books, the issue of unforeseen ground conditions is dealt with under the heading ‘Unforeseeable Physical Conditions’,[47] which is not the same as unforeseen ground conditions. The FIDIC term ‘physical conditions’[48] is defined in the subclause as ‘natural physical conditions and manmade and other physical obstructions and pollutants, which the contractor encounters at the Site when executing the Works, including sub-surface and hydrological conditions but excluding climatic conditions’.[49] Although this formulation is broader than just ‘ground conditions’ (e.g., extending beyond geology to hydrology), it is notably limited to conditions that are unforeseeable. Unforeseeability is an objective test defined[50] as ‘not reasonably foreseeable by an experienced contractor by the date for submission of the Tender’.[51]
The unforeseeability test is crucial to the risk allocation for ground conditions and other physical conditions under the FIDIC Red and Yellow Books, and three considerations[52] should be taken into account when applying it:
- First, the test is not what was actually foreseeable, but what would have been reasonably foreseeable.
- Second, the foreseeability is not that of the specific contractor but of any experienced contractor (i.e., an industry standard).
- Third, the point in time to which the test refers is the date for submission of the tender (or the base date for the FIDIC multilateral development banks (MDB) form), which means that it must be assessed together with information available to the contractor (site data)[53] and the ‘correctness and sufficiency of the Accepted Contract Amount’[54] to obtain a full picture.
The issue of reasonable foreseeability by an experienced contractor under Clause 4.12 of the Yellow Book was considered in Obrascon,[55] where the English Technology and Construction Court held that the contractor ‘did not in fact encounter physical conditions in relation to contaminated soil over and above that which an experienced contractor could reasonably have foreseen by the date of submission of its tender’,[56] applying a ‘balance of probabilities’ test. The Court of Appeal of England and Wales upheld that analysis of the issue.[57]
Users of standard form contracts are not bound to accept the risk allocation for unforeseen ground conditions (or anything else). The Building Law Reports commentary on Obrascon[58] warns that, ‘[c]ontractors may want to consider whether or not they would be comfortable assuming the risk . . . or, rather, whether to propose bespoke . . . specificity as to the nature of the ground conditions which are contemplated’. In the Guidance Notes to the Red and Yellow Books, FIDIC has provided an alternative on the basis of risk sharing, by which Clause 4.12(b) is replaced with a percentage allocation of cost between the employer and the contractor, respectively.
A full reallocation of ground risk (as part of physical conditions) is found in the FIDIC Silver Book. Under Clause 4.12, the contractor is ‘deemed to have obtained all necessary information as to risks, contingencies, and other circumstances which may influence or affect the Works’ so that the contractor ‘accepts total responsibility for having foreseen all difficulties and costs of successfully completing the Works’ and the effect is that no addition to the contract price is payable.
It follows that the contractor under the Silver Book bears the risk of unforeseen ground conditions, covered by the expression ‘unforeseen difficulties’; however, two qualifications must be made.
- First, the employer is made responsible for certain data that it provides to the contractor[59] so that extension of time could be claimable for error in certain circumstances,[60] although there is no express entitlement to any additional payment.
- Second, depending on the governing law selected by the parties, the effect of the provisions may be in doubt.[61] For example, strong reservations have been expressed[62] as to whether the transfer of risk to the contractor is enforceable under German law in circumstances where the employer has provided incorrect information on ground conditions.[63]
2017 FIDIC contracts
The definition of ‘unforeseeable physical conditions’ is similar to that in the 1999 editions, with the addition of the words ‘excluding climatic conditions at the Site and the effects of those climatic conditions’.[64] The 2017 editions have followed the MDB version of the Red Book in defining ‘unforeseeable’[65] as ‘not reasonably foreseeable by an experienced contractor by the Base Date’, which means 28 days before the latest date for submission of the tender,[66] instead of not reasonably foreseeable at the date for submission of the tender, as under the 1999 editions.
The 1999 ‘site data’ provision[67] has been replaced by the ‘use of site data’ provision,[68] which no longer contains the requirement that ‘The Employer shall have made available to the Contractor . . . all relevant data in the Employer’s possession’ in relation to the site; that obligation has been relocated to ‘Site Data and Items of Reference’[69] with the addition of ‘topography of the Site’ and ‘climatic conditions’ at the site. The contractor continues to be responsible for interpreting all such data and is still[70] deemed to have satisfied itself of the sufficiency of the ‘accepted contract amount’, the definition of which has been amended by the 2017 forms of contract.[71]
In the Red and Yellow Books 2017, FIDIC has continued to provide a risk-sharing alternative, by which substitute wording is inserted into Clause 4.12 allocating risk in relation to sub-surface conditions on a percentage basis. The guidance[72] now recommends that, to assist the engineer in agreeing or determining delay or cost in the event that the contractor encounters adverse subsurface conditions, the employer ‘may consider including the physical/geological/sub-surface conditions that are known at the Base Date in the Contract—in the form of a “Baseline Report”’.
The reallocation of ground risk in the Silver Book 1999 is preserved with identical wording in the Silver Book 2017[73] on unforeseeable difficulties. As under the Silver Book 1999, any qualifications must be made to the general principle that the contractor bears the risk of unforeseen ground conditions.
Other standard contract forms
The IChemE form also incorporates a robust ‘reasonable foreseeability’ test, which provides that the relevant physical condition has to be such that it: could not reasonably have been foreseen by properly qualified and competent persons engaged in the same or a similar business to that of the contractor, and having all the information which the contractor then had or could have obtained by a visual inspection of the site or by reasonable enquiry.[74]
It also contains detailed requirements in relation to the contents of the notification to be provided by the contractor to the employer, which include specifying the condition encountered, the steps the contractor is taking or proposing to take to overcome the condition encountered, estimates of the effect on the program and the amount of any additional cost, and the contractor’s proposals for minimising the additional time or cost.[75] The contractor is then permitted a reasonable increase in the contract price resulting from the specified conditions.[76]
The NEC4 form uses a slightly different test, which provides that the ‘physical conditions’[77] have to be something that an experienced contractor would have judged at the contract date to have such a small chance of occurring that it would have been unreasonable to have allowed for them.[78]
The meaning of the phrase ‘a small chance’ of an event occurring was considered in Atkins.[79] Atkins’ claim was based on encountering a greater number of potholes than it had anticipated at the time it entered into the contract. Mr Justice Akenhead dismissed Atkins’ claim that a higher number of potholes than was expected constituted a compensation event, either as a matter of the language of the clause itself or as a matter of commercial interpretation. Although it would be very difficult in practical terms to determine how many potholes would constitute an excessive number and such an exercise would be both difficult and artificial, the real question was whether the likelihood of occurrence of potholes had such a small chance of occurrence that it would be unreasonable to allow for them.
Force majeure
1999 FIDIC contracts
The force majeure provisions[80] in the 1999 FIDIC forms of contract are essentially the same for the Red, Yellow and Silver Books.[81] Force majeure is defined[82] as ‘an exceptional event or circumstance’ that must be:
- beyond a party’s control;
- beyond reasonable provision by a party before entering into the contract;
- not reasonably capable of being avoided or overcome; and
- not substantially attributable to either party.
A non-exhaustive list of possible exceptional events or circumstances is given as:
- war, hostilities, invasion and enemy action;
- rebellion, terrorism, insurrection, coup d’état or civil war;
- riots and other civil or industrial disorder;
- munitions, explosives, radiation or contamination (except as attributable to the contractor); and
- natural catastrophes, such as earthquakes, hurricanes, typhoons or volcanic activity.
A party that is prevented from performing its contractual obligations[83] by a force majeure event must give notice to the other party within 14 days of when it became or should have become aware of it.[84] The party is excused from the performance of its obligations while prevented from doing so and, in the case of the contractor, may be entitled to further relief in the form of an extension of time or (in limited circumstances) additional payment.
2017 FIDIC contracts
The 2017 editions of the Red, Yellow and Silver Books have replaced the force majeure provisions in the 1999 editions with a new clause[85] entitled ‘exceptional events; however, this is a less profound change than the replacement of a force majeure clause would suggest, since the 2017 definition of ‘exceptional event’ is similar, but not identical, to the 1999 definition of force majeure. Apart from some redrafting separating ‘riot, commotion and disorder’ from ‘strike or lockout’, the most notable change to the non-exclusive scope of the provision is the addition of ‘tsunami’ to the ‘natural catastrophes’ item.
That aside, the effect of the occurrence of an exceptional event under the 2017 forms resembles the effect of a force majeure event under the 1999 forms; the procedures and consequences are similar, with some amendments to the drafting.
Other standard contract forms
The NEC4 form adopts a different approach. Instead of including a separate force majeure regime, it provides for a compensation event that has a similar effect. Clause 60.1(19) allows the contractor relief in the case of a compensation event if it can demonstrate that it is something neither party could prevent, an experienced contractor would have judged the event to have had such a small chance of occurring that it would have been unreasonable to have allowed for it, and it is not covered under any of the other compensation events under the contract.
The LOGIC contract form sets out a limited set of prescribed events that constitute force majeure at Clause 12.[86] For a party affected by a force majeure event, they must have exercised ‘reasonable diligence’ to guard against the effects of such event and comply with the notification requirements set out in Clause 12.[87] Following such notification, the parties ‘shall meet without delay’ to try and agree a course of action that minimises the effects of the force majeure event.[88]
The IChemE form of contract deals with force majeure under the ‘delays’ section in Clause 14. It makes similar provision for force majeure as the other contract forms, but includes a provision that the ‘mere shortage of labour, materials or utilities shall not constitute force majeure unless caused by circumstances which are themselves force majeure’.[89] It also provides the parties with a right to terminate the contract if the force majeure event has persisted for 120 days.[90]
Each of the contract forms include force majeure events specific to their industry or project, providing the parties with some contractual certainty should that event arise. For contractors seeking to rely on force majeure provisions, they should be cognisant of the requirement to mitigate and use reasonable diligence to avert the impact and limit their exposure.
Change in law
1999 FIDIC contracts
The 1999 FIDIC forms of contract provide that the contract price may, under certain conditions, be adjusted to take account any increase or decrease in cost resulting from a change in laws of the country in which the works are situated, or in the judicial or official interpretation of the laws made after the base date (i.e., the date for the submission of the tender), that affects the contractor’s performance of obligations under the contract. In such a case, the contractor may be entitled to claim for time or cost relief.
2017 FIDIC contracts
The 2017 edition of the FIDIC forms of contract expands the scope of the change in law provision such that any changes in the terms of any permits, permission, licence or approval – or the requirement for a particular permit, permission, licence or approval to be obtained after the base date – may entitle the contractor to relief. Conversely, if there is a decrease in cost because of a change in law, the employer is typically entitled to make a claim under the contract for an adjustment to the contract price.
Other standard contract forms
All other standard forms, other than the LOGIC contract form, generally allow the contractor to claim both time and cost. The LOGIC contract form only allows for an adjustment to the contract price, but not to the time for completion.[91]
NEC4 provides for a change in law provision, but it has only been included as a secondary option clause.[92] If the relevant option provision is incorporated, it provides that any change in law may be a compensation event, shifting much of the risk to the employer. It also provides that, where the effect of a change in law is for the overall costs to decrease, the contract price typically may be reduced to reflect that decrease.[93]
Delay
1999 FIDIC contracts
The 1999 FIDIC forms of contract provide that a failure by the contractor to meet the agreed time for completion generally may entitle the employer to claim liquidated damages for delay. Delay liquidated damages may be the only damages applicable to the contractor’s delay in completing the works by the time for completion, but payment thereof generally does not relieve the contractor from its obligation to complete the works in accordance with the contract.
2017 FIDIC contracts
The 2017 FIDIC forms of contract contain a very similar provision in relation to delay liquidated damages save that they provide that the liquidated damages provisions typically will not limit the contractor’s liability for delay in the event of fraud, gross negligence, deliberate default or reckless misconduct by the contractor; therefore, a contractor must not deliberately delay the works once it has reached the delay damages cap, otherwise it risks uncapped liability.
Other standard contract forms
The IChemE, NEC4 and LOGIC contract forms all provide for liquidated damages for delay in the event of the contractor’s failure of timely completion;[94] however, unlike the other forms, the IChemE and NEC4 forms do not expressly refer to payment of such damages as the sole and exclusive remedy of the employer for the delay. In addition, the NEC4 form expressly provides that if the completion date changes to a later date after the liquidated damages for delay have been paid, the employer is to repay the overpayment of damages with interest.[95]
Similarly, if the employer takes over a part of the works before the completion date, the delay liquidated damages are typically reduced from the date on which the portion of works is taken over. The project manager conducts an assessment of the benefit to the employer of receiving part of the works early, and that benefit is taken into account to reduce the liquidated damages.[96] Whether an employer’s remedies are limited to liquidated damages will impact the contractor’s potential risks when facing delay claims.
Performance
1999 FIDIC contracts
The 1999 FIDIC forms of contract provide for two sets of tests in relation to the performance of the works: tests on completion and tests after completion. The tests on completion are to be carried out in the following sequence: pre-commissioning tests, commissioning tests and trial operation. Following trial operation, performance testing (if any) shall take place to demonstrate whether the works comply with the performance guarantees.
If the works fail the tests on completion (i.e., fail at all or fail to achieve the minimum levels of performance, if specified), the employer will generally be entitled to order further repetition of tests, reject the works if the failure deprives the employer of substantially the whole benefit of the works or issue a taking-over certificate. If the employer decides to take over the works, it is typically entitled to reduce the contract price by such amount as shall be appropriate, taking into account the reduced value of the works as a result of the failure.
In addition, the 1999 FIDIC forms of contract provide for tests after completion (if specified). A failure of tests after completion is typically deemed to constitute a pass where ‘the relevant sum payable as non-performance damages’ stated in the contract is paid by the contractor.
2017 FIDIC contracts
The 2017 FIDIC forms of contract have refined the concept of performance liquidated damages.
In most contracts where performance parameters need to be measured and specific levels achieved for taking over to occur (typically power projects and process plants), these types of provisions are already added to the FIDIC clauses. Participants in such sectors will likely have forms of wording with which they are already comfortable and that are often more intricate than the new drafting proposed in the Silver Book.
Other standard contract forms
Other standard forms also provide for the application of performance liquidated damages.[97]
The IChemE form provides for a performance test period during which the performance tests are to be carried out.[98] If the plant fails to pass any performance tests, or if any performance test is stopped before its completion, the employer may typically permit the contractor to make any adjustment or modification to the plant at the contractor’s cost before the repetition of any performance test (subject to the employer’s prior approval of the same) and may, if the contractor reasonably requires, shut down any relevant part of the plant and restart it following any adjustment or modification.[99]
If, by the end of the performance test period, the plant has failed any performance tests and the results are within any limit for the application of liquidated damages, the contractor will generally be required to pay performance liquidated damages to the employer;[100] however, if the results remain outside the limits by the end of the performance test period, the contractor may be required to compensate the employer for the failure to comply with the relevant guarantees.[101] In the event that any performance test has not been completed by the end of the defects liability period for a reason that is not the responsibility of the contractor, the relevant performance test shall generally be deemed to have passed.[102]
In the LOGIC contract form, there is a general clause that provides for liquidated damages for the events that are specified in Appendix 1 to Section I of the model form agreement.[103] Such damages often are the sole and exclusive remedy for the employer, so it is important to ensure that performance liquidated damages are included in the appendix to the model form agreement if that is the intention of the parties.
Indemnities
1999 FIDIC contracts
Clause 17 of the 1999 FIDIC contracts uses indemnities as the medium for risk allocation on a range of issues. The net effect is relatively complex. Indemnities are given by both the employer and the contractor and some, but not all, are reciprocal. For example, in relation to 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, but not identical, indemnity to the contractor.[104]
More of Clause 17 is devoted to obligations of the contractor, including responsibility for the care of the works,[105] which has no equivalent in the case of the employer. The contractor is liable for loss or damage during the period from the commencement date to the issuance of the taking-over certificate, except where the cause thereof is classified as an employer’s risk;[106] however, it would be an over-simplification to say that the indemnity provisions under the FIDIC forms of contract favour the employer. Wherever loss or damage to the works results from an employer’s risk, the contractor may be able to claim an extension of time for delay and (or) additional cost.[107]
There are also some differences between the various forms of FIDIC contract. Whereas all forms include as an employer’s risk foreign hostilities, civil conflict, riots and disorder, explosions, contaminations and radiation, and sonic damage by aircraft,[108] the Silver Book omits three categories of employer risks found in the Red and Yellow Books,[109] namely use or occupation of the works by the employer, design of any part of the works by personnel for whom the employer is responsible, and ‘unforeseeable’[110] operation of forces of nature.
Moreover, the MDB version of the Red Book adds to the first paragraph of 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”’.[111]
Many of the remaining indemnities and related provisions can be regarded as fairly balanced in terms of risk allocation. The indemnities for infringement of intellectual property rights[112] are essentially reciprocal. The exclusion of liability for ‘any indirect or consequential loss’[113] also 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 an express provision, usually included in the particular conditions following negotiation.
The concept of ‘indirect’ or ‘consequential’ loss in civil law, particularly in contract law, can be complex and varies across jurisdictions. While some jurisdictions, like those influenced by English law, make a distinction between direct loss and indirect or consequential losses, others, such as those in continental Europe, do not have a specific, legally defined category for indirect or consequential losses; instead, they focus on whether the loss was a foreseeable consequence of the breach and whether the loss was a direct result of the breach.
2017 FIDIC contracts
It was assumed by some observers that the 2017 FIDIC forms of contract would follow the approach of the Gold Book in risk allocation, and this expectation was to some extent encouraged by FIDIC in the pre-release editions of the Yellow Book.[114] Under the Gold Book, all risks were allocated between the parties (though design–build period risks and operation service period risks were differentiated), with distinctions made between employer’s commercial risks, employer’s risks of damage,[115] and contractor’s risks.[116]
In the end, the 2017 FIDIC forms of contract did not follow the Gold Book approach; instead, there was substantial reworking in the form of a new care of the works and indemnities clause,[117] which embodies traditional care-of-the-works obligations making the contractor fully responsible for the works, subject to exceptions expressly set out.[118] Employer’s risks are no longer listed as they were in the 1999 FIDIC forms of contract,[119] and the carve-outs from the contractor’s liability for care of the works[120] 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;[121] and
- acts or defaults by the employer’s personnel or other contractors of the employer.
Although some of the distinctions between the respective FIDIC 1999 editions no longer remain, there are still divergences arising from the different procurement models; therefore, the exception to the contractor’s liability for care of the works owing to faults in the 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) that 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).
In particular, the Yellow and Silver Books 2017 now feature what may be considered a strengthening of the contractor’s design obligations and liabilities using 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’.[122] The Red Book 2017 equivalent applies ‘[t]o the extent, if any, that the Contractor is responsible for the design of part of the Permanent Works’[123] and is intended to refer to the situation where a particular condition allocates an element or elements of the design to the contractor.[124]
Although the Yellow and Silver Books 1999, and to a very limited extent, the Red Book 1999, contained fitness-for-purpose obligations in respect of design, none of those obligations 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 contracts may be said to represent a rebalancing of risk allocation in favour of the employer.
Other standard contract forms
Given that the LOGIC forms of contract are drafted mainly to be used for offshore works, the indemnity regime is based on ‘knock-for-knock’ indemnities.[125] In its simplest form, under a knock-for-knock indemnity, each party to a contract agrees to bear responsibility for and indemnify the other in respect of loss of or damage to their and their group’s (which would include their contractors and subcontractors) property and injury to or death of their and their group’s employees regardless of fault. These cross-indemnities are usually intended to be effective even if the losses arise because of negligence, breach of statutory duty or breach of contract.
Given the nature of the works and the potential extent of pollution-related liabilities, the LOGIC form, for example, carves out pollution-related liability from the knock-for-knock indemnities; instead, the employer typically indemnifies the contractor in relation to any pollution emanating from the reservoir or from the property of the employer group, and the contractor indemnifies the employer in relation to any pollution emanating from the premises, property or equipment of the contractor group.[126] The knock-for-knock indemnities also generally do not extend to any third-party liability, which is dealt by way of a fault-based approach.[127]
The NEC4 form takes the approach of replacing indemnities with liabilities for costs and definitively setting out the risks that the contractor and the employer assume.[128] The parties will need to be careful when using these provisions to ensure that all risks clearly fall on either the contractor’s or the employer’s list of risks.
Warranties and defects liability
1999 FIDIC contracts
In the Yellow Book and Red Book, Clause 11 focuses on the contractor’s warranties and their liability for defects during the defects liability period (DLP). This period, typically lasting 12 or 24 months after the taking-over certificate is issued, is when the contractor is obliged to rectify any defects that appear in the completed works. Put simply, the contractor warrants the quality of the works and is responsible for addressing any defects that arise during this specified time.[129]
If the contractor refuses to remedy a defect, the employer may request a reduction of the price, have the defects remedied by another party or, in severe cases, terminate the contract.[130]
2017 FIDIC contracts
The 2017 version of the FIDIC Books introduce slightly more detailed provisions, but do not substantially change the employer’s rights.[131]
Other standard contract forms
Clause 37 of the IChemE form of contract deals with liability for defects. The defects liability period lasts for 365 days from the issuance of a take-over certificate. The usual provisions regarding the contractor’s responsibility to remedy any defects and cover such costs are included, together with a right of the employer to remedy the defect and charge the contractor, if such defect arose from the contractor’s breach of contract.[132]
Likewise, defects that arose from improper operation of the plant by the employer are to be treated as variations chargeable to the employer.[133] Clause 37.12 enables the parties to agree on a particular condition to limit the contractor’s liability for defects arising after acceptance.[134] The parties are encouraged to set a limit, and, if no limit is stated, the contractor’s liability will only be limited by Clause 43.2: ‘limited to the damages, remedies and reimbursements expressly provided in the Contract’.[135]
The LOGIC form of contract provides for similar allocation of risk in respect of liability for defects at Clause 28. Although, the employer has a unilateral right to remedy the defects itself if it believes instructing the contractor to do so would be ‘detrimental to its interests’.[136] In that instance, the employer can recover its reasonable costs from the contractor.[137]
Core Clause 4 of NEC4 governs defects liability. As is typical, the contractor is responsible for correcting defects,[138] or covering the cost of remedying uncorrected defects;[139] however, under NEC4, the contractor must correct a defect regardless of whether it has been notified by the supervisor.[140] The contractor and project manager are also able to agree that a defect should not be remedied, but the scope of works be amended instead.[141]
Insurance
1999 FIDIC contracts
The types of insurance to be effected under the 1999 FIDIC forms of contract are against loss or damage to works and contractor’s equipment,[142] personal injury and damage to property of third parties,[143] and personal injury to the contractor’s personnel.[144]
The coverage that is ultimately obtained depends to some extent on what is available in the market and at what cost; however, 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 coverage needs to be considered in conjunction with the employer’s risk provisions, which ‘shall cover all loss and damage from any cause not listed in Clause 17.3’.[145] Insurance for contractor’s equipment[146] has to be for ‘not less than the full replacement value, including delivery to Site’.
The required scope of the insurance against personal injury and damage to property of third parties is also defined by reference to Clause 17.3, it being permissible to exclude liability to the extent that it arises from ‘a cause listed in Clause 17.3 [Employer’s Risks], except to the extent that cover is available at commercially reasonable terms’.[147]
2017 FIDIC contracts
In the 2017 editions, the general conditions[148] simply provide for insurance to be provided by the contractor (although this could be varied by a ‘particular condition”’). The scope of the coverage contemplated has been expanded as compared with the 1999 editions. There is still the obligation to cover the works[149] and goods[150] against injury to persons and damage to property[151] and injury to employees.[152] To these have been added ‘all other insurances required by the Laws of the countries where (any part of) the Works are being carried out’ and ‘[o]ther insurances required by local practice (if any) shall be detailed in the Contract Data’.[153]
The most important addition, however, is the requirement that the contractor’s indemnity in respect of breach of its fitness for purpose obligation to the employer for design of the works shall be covered by professional indemnity insurance if required by the contract data.[154]
Other standard contract forms
Given the offshore nature of the works covered by the LOGIC forms, there are specific insurances that are required to be taken out by the contractor, including marine hull and machinery insurance in respect of all vessels used by the contractor group in the performance of the works and protection and indemnity insurance, including wreck and debris removal and oil pollution liability in respect of all vessels or floating equipment owned, leased or hired by the contractor group in relation to the performance of the works.[155]‘Construction all risks’ insurance is to be taken out by the employer, but any deductible to be paid under such insurance shall be the contractor’s responsibility.[156]
Under the IChemE form, the employer is responsible for procuring insurance for all risks relating to the plant, site materials and temporary works in joint names of the employer, project manager, contractor and subcontractors.[157] Although the insurance shall cover physical damage by defective design, it shall (in line with typical practice) exclude the cost of rectifying any defect.[158] The contractor is required to procure insurance covering the contractor’s equipment,[159] third-party liability insurance[160] and employer’s liability insurance.[161] The contractor is not specifically required to maintain any professional indemnity insurance.[162]
Under the NEC4 contract, the contractor is required to take out insurance to cover loss or damage to the works, plant, materials, equipment, property, injury to persons and death.[163] The contract sets out the minimum level of cover in the ‘insurance table’.[164]
Termination
1999 FIDIC contracts
In the Yellow and Red Books,[165] termination by the employer can occur owing to the contractor’s default or for the employer’s convenience. Termination for cause requires a 14-day notice, unless the reason is insolvency or bribery, which allows for immediate termination. The employer can terminate for issues like failure to provide security, abandoning the works, failing to comply with notices or engaging in bribery.
The employer can also terminate for convenience in which case specific payment provisions apply to compensate the contractor.
2017 FIDIC contracts
The 2017 editions of the Red and Yellow Book expand on the grounds for termination and describes the grounds in more detail, as well as the procedure for handling the termination.[166] If the contractor subcontracts the whole works, the 14-day notice period no longer applies and the employer may also immediately terminate; otherwise, the allocation of risk remains unchanged when compared with the 1999 versions.
Other standard contract forms
Under the IChemE form of contract, the employer has a contractual right to require the contractor to permanently cease all outstanding works at any time and for any reason, except those set out in Clause 42 ‘Termination for Contractor’s default’.[167] Both parties have a right to terminate the contract under Clause 14.9 in respect of a force majeure event. Where termination occurs in respect of the contractor’s default, the employer will typically require another contractor to remedy or finish the works, with the original contractor being liable for any additional costs associated with completing the works.[168]
Under the LOGIC contract, the employer has a broad power to terminate the works or the contract at any time, to suit its convenience.[169] If the works are terminated, the contract remains in full force and effect, whereas if the contract is terminated, only certain obligations will survive. Consideration should be given to those terms which the parties may want to remain post-termination.
The NEC4 contract sets out a prescribed list of events which entitles the employer or contractor to terminate the contractor’s obligations to deliver the works.[170] The employer does not have a broad, unilateral right to terminate in the core clause; however, Clause X11.1 in the option clauses does provide such a right, if the parties choose to include it.
Conclusion
The allocation of risk in construction contracts is a complex process that requires careful consideration of project-specific factors, procurement methods and the relative ability of parties to manage and bear particular risks. As explored throughout this chapter, standard forms such as FIDIC, IChemE, NEC4 and LOGIC provide a range of approaches to risk distribution, each with its own balance of control, responsibility and protection. Ultimately, clear contract drafting, informed negotiation and a thorough understanding of both legal and practical implications are essential to achieving fair and effective risk allocation – minimising disputes, supporting project delivery and providing greater cost and schedule certainty for all parties involved.
Looking ahead, key trends to watch include the continued evolution of standard contract forms in response to industry feedback, the increasing emphasis on collaborative risk management and the growing impact of technological advances – such as digital project management tools, automation and data-driven construction methods – on how risks are identified, allocated and managed. Recent cases and legislative developments may further influence how risks are allocated and interpreted in practice. Parties are encouraged to remain vigilant, adapt their risk strategies to emerging challenges and seek specialist advice to ensure their contracts remain robust and fit for purpose in an ever-changing construction environment.
Acknowledgements
The authors would like to acknowledge Taylor Wilson and Rachel Hsu for their helpful contributions to this chapter.
Endnotes
[1] Peter Simon, David Hillson and Ken Newland, Project Risk Analysis and Management Guide (2nd edn., Association for Project Management, 1997), p. 17.
[2] See Yilin Yin, Qing Lin, Wanyi Xiao and Hang Yin, ‘Impacts of Risk Allocation on Contractors’ Opportunistic Behavior: The Moderating Effect of Trust and Control’, Sustainability, Vol. 12, Issue 22 (2020).
[3] Simon, Hillson and Newland (see footnote 1), p. 17.
[4] See Catriona Norris, John Perry and Peter Simon, Project Risk Analysis and Management Mini-Guide (Association for Project Management, 2018), p. 4.
[5] Nael Bunni, ‘The Four Criteria of Risk Allocation in Construction Contracts’, The International Construction Law Review, Vol. 26 (2009), p. 6.
[6] See Samuel Laryea and Will Hughes, ‘The Price of Risk in Construction Projects’ (22nd Annual ARCOM Conference, Birmingham, 2006), www.arcom.ac.uk/-docs/proceedings/ar2006-0553-0561_Laryea_and_Hughes.pdf (accessed 15 June 2025), p.553.
[7] Julianne Tolentino, ‘The golden rule of fair risk allocation in construction: An expert’s insights’, Construction Week (1 April 2023), www.constructionweekonline.com/business/insights/golden-rule-of-risk-allocation-in-construction (accessed 15 July 2025).
[8] Y Yin, Lin, Xiao and H Yin (see footnote 2).
[9] Tolentino (see footnote 7).
[10] Bryan S Shapiro KC, ‘Transferring Risks in Construction Contracts’ (Vancouver, 2005), p. 5.
[11] id., p. 17.
[12] In relation to the International Federation of Consulting Engineers (FIDIC), see Ellis Baker, Ben Mellors, Scott Chalmers and Anthony Lavers, FIDIC Contracts: Law and Practice (Informa, 2009), p. 6.6.
[13] See Ramy Zaghloul and Francis T Hartman, ‘Construction contracts and risk allocation’ (Project Management Institute Annual Seminars & Symposium, San Antonio, 2002), www.pmi.org/learning/library/construction-contracts-risk-allocation-1025 (accessed 15 July 2025).
[14] Max W Abrahamson, ‘Risk Management’, The International Construction Law Review (1984), p. 244.
[15] Nael Bunni, ‘Managing Risk’ (FIDIC’s Internation Conditions of Contract: A Two-Day Seminar organised by IBC/FIDIC, December 2005), p. 9.
[16] ibid.
[17] See also the section on the FIDIC Conditions of Contract for Construction for Building and Engineering Works Designed by the Employer (Red Book) in the chapter in this guide titled ‘Introduction to the FIDIC Suite of Contracts’.
[18] See also the section on the FIDIC Conditions of Contract for Plant and Design-Build for Electrical and Mechanical Plant and for Building and Engineering Works Designed by the Contractor (Yellow Book) in the chapter in this guide titled ‘Introduction to the FIDIC Suite of Contracts’.
[19] Document, ‘Construction Contract Types’, Associated Builders and Contractors, www.abc.org/Portals/1/Documents/Membership%20 Docs/MemberDiscountDocs/ContractTypes.pdf (accessed 15 July 2025).
[20] See also the section on the FIDIC Conditions of Contract for EPC/Turnkey Projects (Silver Book) in the chapter in this guide titled ‘Introduction to the FIDIC Suite of Contracts’.
[21] ‘Construction Manager at Risk Pros and Cons: A Guide to Protect You’, American Institute of Constructors (17 June 2024), www.aic-builds.org/construction-manager-at-risk-pros-and-cons (accessed 15 July 2025).
[22] ibid.
[23] Institution of Chemical Engineers (IChemE), International Red Book (1st edn., 2007) (IChemE Red Book).
[24] New Engineering Contract (NEC), Engineering and Construction Contract (4th edn., June 2017) (NEC4).
[25] Leading Oil and Gas Industry Competitiveness (LOGIC), General Conditions of Contract for Construction (3rd edn., November 2018) (LOGIC Contract).
[26] FIDIC Red Book 1999, Clause 14.1 (c).
[27] id., Clause 14.1
[28] FIDIC Red Book 2017, Clause 12.1.
[29] id., Clause 12.1.
[30] id., Clause 12.3 (note that the article name has changed from ‘evaluation of the works’ to ‘valuation of the works’).
[31] id., Clause 14.1.
[32] IChemE Red Book, Introductory Note 3 and Table 1.
[33] LOGIC contract, Clause 30.1.
[34] NEC4, Main Option Clauses A to F.
[35] NEC4, Option Clause B.
[36] FIDIC Red Books 1999 and 2017, Clause 4.1
[37] id., Clause 1.9
[38] id., Clause 5.1
[39] IChemE Red Book, Clause 17.3.
[40] id., Clause 21.12-21.13.
[41] ibid.
[42] LOGIC contract, Clause 13.1.
[43] id., Clause 4.3.
[44] LOGIC contract, Clause 5.2.
[45] ibid.
[46] NEC4, Core Clause 80.1.
[47] FIDIC Red and Yellow Books 1999, Clause 4.12
[48] Significantly, the FIDIC provision begins by defining ‘physical conditions’. This was a problematic omission from the fourth edition of the Red Book, noted by Jeremy Glover and Simon Hughes KC in Understanding the FIDIC Red Book: A Clause-by-Clause Commentary (2nd edn., Sweet & Maxwell, 2011), p. 108.
[49] FIDIC Red and Yellow Books 1999, Clause 4.12.
[50] id., Clause 1.1.6.8.
[51] In the version of the Red Book for multilateral development banks (the Pink Book), ‘base date’ replaces ‘tender’.
[52] Baker, Mellors, Chalmers and Lavers (see footnote 12), p. 88.
[53] FIDIC Red and Yellow Books 1999, Clause 4.10.
[54] id., Clause 1.1.4.1.
[55] Obrascon Huarte Lain SA v. Her Majesty’s Attorney General for Gibraltar [2014] EWHC 1028 (TCC).
[56] id., paragraph 277.
[57] Obrascon Huarte Lain SA v. Her Majesty’s Attorney General for Gibraltar [2015] EWCA Civ 712. A recent discussion of Australian and English cases can be found in Gordon Smith, ‘Latent Conditions and the Experienced Contractor Test’, International Construction Law Review (2016), pp. 390–412.
[58] [2014] BLR 484, pp. 488–89.
[59] FIDIC Silver Book 1999, Clause 5.1.
[60] For commentary, see Baker, Mellors, Chalmers and Lavers (see footnote 12), p. 92.
[61] Peter Fenn, ‘Review of international practice on the allocation of risk of ground conditions’, International Construction Law Review (2000), pp. 439–53.
[62] Dr Alexander Kus, Dr Jochen Markus and Dr Ralf Steding ‘FIDIC’s new Silver Book under the German Standard Form Contract Act’, International Construction Law Review, Vol. 16, Part 4 (1999), pp. 533–50.
[63] Axel-Volkmar Jaeger and Götz-Sebastian Hök, FIDIC – A Guide for Practitioners (Springer, 2010), p. 107, provides a commentary on the German law position in relation to these types of risk allocation.
[64] Red and Yellow Books 2017, Clause 4.12, 2017.
[65] Red Book 2017, Clause 1.1.85; Yellow Book 2017, Clause 1.1.87.
[66] Red and Yellow Books 2017, Clause 1.1.4.
[67] Red and Yellow Books 1999, Clause 4.10.
[68] Red and Yellow Books 2017, Clause 4.10.
[69] id., Clause 2.5.
[70] id., Clause 4.11.
[71] id., Clause 1.1.1.
[72] Red Book 2017, p. 24; Yellow Book 2017, p. 25.
[73] Silver Book 2017, Clause 4.12.
[74] IChemE Red Book, Clause 6.3.
[75] ibid.
[76] ibid.
[77] Although a ‘physical condition’ has not been defined, it is clarified that the contractor cannot claim for a weather condition.
[78] NEC4, Clause 60.1(12).
[79] Atkins Ltd v. Secretary of State for Transport [2013] EWHC 139 (TCC).
[80] Red, Yellow and Silver Books 1999, Clause 19.
[81] Glover and Hughes (see footnote 48).
[82] Red, Yellow and Silver Books 1999, Clause 19.1.
[83] In the Pink Book, ‘substantial obligations’ rather than ‘obligations’.
[84] Red, Yellow and Silver Books 1999, Clause 19.2.
[85] Red, Yellow and Silver Books 2017, Clause 18.
[86] LOGIC contract, Clause 14.
[87] id., Clause 14.1.
[88] id., Clause 14.6.
[89] IChemE Red Book, Clause 14.6.
[90] id., Clause 14.9.
[91] LOGIC contract, Clause 20.3.
[92] NEC4, Option X2.
[93] ibid.
[94] IChemE Red Book, Clause 15; NEC4, Option X7; LOGIC contract, Clause 35.
[95] NEC4, Option X7.2.
[96] id., Option X7.3.
[97] IChemE Red Book, Clause 35.9; NEC4, Option X17; LOGIC contract, Clause 35.
[98] IChemE Red Book, Clause 35.4.
[99] id., Clause 35.7.
[100] id., Clause 35.9.
[101] id., Clause 35.10.
[102] id., Clause 35.14.
[103] LOGIC contract, Clause 35.1.
[104] Red, Yellow and Silver Books 1999, Clause 17.1.
[105] id., Clause 17.2.
[106] id., Clause 17.3.
[107] id., Clause 17.4.
[108] id., Clause 17.3.
[109] See Baker, Mellors, Chalmers and Lavers (see footnote 12), p. 346.
[110] Defined by Clause 1.1.6.8 of the Silver Book 1999 as ‘not reasonably foreseeable by an experienced contractor by the date for submission of the Tender’.
[111] Glover and Hughes (see footnote 48), p. 342.
[112] Red, Yellow and Silver Books 1999, Clause 17.5.
[113] id., Clause 17.6.
[114] Distributed in London December 2016 and in Abu Dhabi in February 2017.
[115] Contract Guide for the FIDIC Conditions of Contract for Design, Build and Operate Projects, Clause 17.1.
[116] id., Clause 17.2.
[117] Red, Yellow and Silver Books 2017, Clause 17.
[118] id., Clause 17.2.
[119] id., Clause 17.3.
[120] id., Clause 17.2.
[121] id., Clause 18.
[122] Yellow and Silver Books 2017, Clause 17.4.
[123] Red Book 2017, Clause 17.4.
[124] Sometimes referred to in the United Kingdom as the contractor’s design portion from the Joint Contracts Tribunal equivalent provision.
[125] LOGIC contract, Clause 21.
[126] id., Clauses 21.3 and 21.4.
[127] id., Clauses 21.1(c) and 21.2(c).
[128] NEC4, Clauses 80.1 and 81.1.
[129] Red, Yellow and Silver Books 1999, Clause 11.1.
[130] id., Clause 11.4.
[131] Red, Yellow and Silver Books 2017, Clause 11.
[132] ibid.
[133] ibid.
[134] id., Clause 37.12.
[135] IChemE Red Book, Guide Note L: Liability for Defects; Clause 43.2.
[136] LOGIC Contract, Clause 28.3.
[137] ibid.
[138] NEC4, Clause 44.
[139] id., Clause 45.2.
[140] id., Clause 44.1.
[141] id., Clause 45.
[142] Red, Yellow and Silver Books 1999, Clause 18.2.
[143] id., Clause 18.3.
[144] id., Clause 18.4.
[145] id., Clause 18.2(c).
[146] Defined in Clause 1.1.5.1 of the Red, Yellow and Silver Books 1999.
[147] Red, Yellow and Silver Books 1999, Clause 18.3(d)(iii).
[148] Red, Yellow and Silver Books 2017, Clause 19.2.
[149] id., Clause 19.2.1.
[150] id., Clause 19.2.2.
[151] id., Clause 19.2.4.
[152] id., Clause 19.2.5.
[153] id., Clause 19.2.6.
[154] id., Clause 19.2.3.
[155] LOGIC contract, Clause 22.2.
[156] id., Clause 23.3.
[157] IChemE Red Book, Clause 31.1.
[158] id., Clause 31.1.
[159] id., Clause 31.2(b).
[160] id., Clause 31.2(c).
[161] id., Clause 31.2(a).
[162] id., Clause 31.2.
[163] NEC4, Clause 83.2; X10.7.
[164] ibid.
[165] Red, Yellow and Silver Books 1999, Clause 15 and 16.
[166] Red, Yellow and Silver Books 2017, Clause 15 and 16.
[167] IChemE Red Book, Clause 41.1.
[168] id., Clause 42.
[169] LOGIC contract, Clause 29.
[170] NEC4, Clause 90.
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