FIDIC: Key risks for the Employer under the Red Book, Yellow Book and Silver Book

Resource type: Practice note Status: Maintained Jurisdictions: England, International, Wales
An overview of key risks and negotiation issues for the parties to a FIDIC Red Book, Yellow Book or Silver Book, focusing on key risks for the Employer. FIDIC contracts are used on international construction and engineering projects. Daniel Tain, Pinsent Masons LLP

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Contents
FIDIC contracts Key risks for the Employer This note Table of key risks

FIDIC contracts
The "Fdration Internationale des Ingnieurs Conseils" or International Federation of Consulting Engineers (FIDIC) publishes a suite of standard forms of contract for international construction projects. For more information, see Practice note, FIDIC Forms of Contract. This note refers to:

The 1999 edition of the "Conditions of Contract for Construction for Building and Engineering Works Designed by the Employer" (Red Book). For more information, see Practice note, FIDIC Red Book (1999).

Top

"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). "Conditions of Contract for EPC/Turnkey Projects" (Silver Book).

Key risks for the Employer

This note
This note highlights some key terms of the three FIDIC contracts (the Red, Yellow and Silver Books) and highlights some key risks, from the Employer's perspective. The note seeks to show the similarities, as well as the differences, between the contracts on some key areas. Each project will be different. This note is an overview of some key high-level issues. This note uses defined terms with capital letters to have the same meaning as they have in the relevant FIDIC contract.

Table of key risks

Key issue Typical use

Red Book Recommended for building and engineering works if most (or all) of the works are to be designed by (or on behalf of) the Employer.

Yellow Book Recommended for the provision of electrical and/or mechanical plant and for building and engineering works if most (or all) of the works are to be designed by (or on behalf of) the Contractor.

Silver Book Suitable for a process or power plant, or an infrastructure project, if: a higher degree of certainty of final price and time is required; and The Contractor takes total responsibility for the design and execution of the project (including responsibility for Employer design). Majority of risks are allocated to the Contractor under the Contract.

General risk profile

The Contract allocates the risks between the parties on a fair and equitable basis, taking account of such matters as insurability, sound principles of project management and each party's ability to foresee, and mitigate the effect of, the circumstances relevant to each risk. Key Employer issues: There are a number of key risks that the Employer retains, for example "Unforeseen" Site risk and elements of "in country" cost risk for Force Majeure. Usually seek to limit Force Majeure claims to time only on a worldwide basis.

Key employer issues: Employer retains influence over performance of the Contract. Limited scope for Contractor claims for additional Note: see below for more on Force Majeure. time/money. The Contractor will: Employer prepares Contract can o price these design. Any defect in only be used risks, leading Employer design may (unamended) to an increase entitle the Contractor to where the in the initial make a time/money Contractor is Contract Sum claim (clauses 1.9 and providing the (clause 14.11); 8.4(e)). design and/or (clause 5.1). o carry out extensive due diligence to mitigate risk, which could

delay contract execution (clause 14.12). Sponsors/funders will typically accept the "turn key" approach, even though there may be a cost premium attached, so they can limit their exposure to additional time/money claims.

Design

The Employer designs the The Contractor carries out the design Works (unless specified to (clause 4.1). the contrary). The Engineer manages design process. (Clause 3.1.) The Contractor executes the works in accordance with the Contract (which includes the Specification and Drawings) and the Engineer's instructions (clause 4.1). Key Employer Issues: Key Employer Key Employer Issue: Issue: Errors in design may Contractor remains entitle the Contractor to Contractor fully responsible claim time/money remains fully for design and (clause 8.4(e)). responsible design for its design coordination Failure of Engineer to (clauses 5.1 (including any manage issue of and 5.8). design of the updated/modified Employer) designs may entitle (clauses 5.1 and Contractor to claim 5.8). time/money (clause 1.9). On project financed deals, it is extremely unusual for the Employer to provide the design.

Payment

Interim and final payments are certified by the Engineer, typically

Fixed price lump sum payment against a schedule of payments (clauses 14.1 and 14.4).

determined by measurement of the actual quantities of the works and applying the rates and prices in the Bill of Quantities or other Schedules (clauses 14.3 and 14.6). Key Employer issue: Payment by measurement of quantities is not appropriate for power projects (save for some elements of the civils works). Key Employer issues: Long payment period, which is beneficial to Employer's cash flow. A fixed price lump sum payment process is a standard sponsor/ funder requirement on a project-financed deal.

Fixed price lump sum payment with various rights for Contractor to claim additional time/ money. Rights to claim additional time/ money include for example, variations, "in county" Force Majeure, "Unforeseen " ground conditions, setting out and discovery of fossils. (Clause 8.4.)

Fixed price lump sum payment with limited rights for Contractor to claim additional time/money (clause 8.4).

Security

Contract allows for Employer to receive an Advance Payment Bond, Performance Bond (expiring on issue of Performance Certificate) and/or Retention from the Contractor to help cover potential risk of events such as delay, breach or insolvency. Key Employer issues: A robust security package will be essential to help ensure that

monies are available in the event that the Contractor is in breach or becomes insolvent. A robust security package is a standard sponsor/ funder requirement on a project-financed deal. Warranty Bond should be considered for period of 24 months after Taking Over (subject to amount of retention held). (Clause 4.2.) Site risk Contractor responsible for ground condition risk except for "Unforeseeable" risks. Key Employer issue: If an "Unforeseeable" ground condition risk occurs, the Contractor may be entitled to make a claim for time and money (clause 4.12). Contractor responsible for ground condition risk. Key Employer issue: Full ground condition risk taken by Contactor so no adjustment to Contract Sum if unforeseen ground risks occur (clause 4.12).

Programme/delay Fixed programme with limited right to an extension of time/ increase in Contract Sum. Key Employer issues: Employer entitled to liquidated damages for delay (clause 8.7). Rate to be agreed before Contract is executed but typically between 10 and 20% (or greater) of the Contract Price. (For more on liquidated damages, see Practice note, Liquidated damages in construction contracts.)

Extension of time (EOT) available for a variation, delay or impediment of the Employer, exceptionally adverse weather conditions, shortages of goods or personnel (clauses 8.4 and 8.5). On a projectfinanced deal, the Employer and Funder/Sponsor usually require the deletion of these EOT rights.

Limited rights for Contractor to claim EOT (clauses 8.4 and 8.5).

Suspension Testing

Employer entitled to suspend Works for any reason, subject to right for Contractor to claim extension of time/ costs (clause 8.8). Detailed testing regime contained in Contract (clauses 7.4 and 9). Testing allows for tests before Taking Over. Key Employer issues: Testing regime is not appropriate for plant and Detailed testing regime contained in Contract (clauses 7.4 and 9). Testing allows for tests before Taking Over and subsequent performance tests (clause 12.1). That is, subsequent tests to ensure that plant is performing to required standards/reliability requirements. Key Employer issues: Testing regime is suitable for

machinery/commissioni ng of a power plant. Testing regime does not allow for performance testing to be carried out.

commissioning of plant and machinery/ a power plant. Employer's technical advisors to set performance/ reliability requirements as part of tender process. Performance liquidated damages will be levied if the Works do not meet specified performance requirements. Performance liquidated damages are typically between 10 and 20% (or greater) of the Contract Price. (Clauses 9.4 and 11.4(c).) Employer's technical advisor must review testing regime and performance guarantee levels.

Defects Liability Period

Key Employer issues: Key Employer issues: To be agreed, but typically a period To be agreed, but between 12 months and 24 months. typically a period between 12 Right to extend Defects Liability Period by months and 24 up to 24 months for defective items (clause months. If not 11.3). agreed, the default period is 12 months (clause 1.1.3.7). Right to extend Defects Liability Period by up to 24 months for defective items (clause 11.3).

Subject to overall security held by Employer, a Warranty Bond may be required (see "security" above).

Variations

Key employer issue: Robust variation procedure incorporated into the Contract (clause 13). Robust termination procedure incorporated into the Contract. Key Employer issues: Employer has the right to terminate for convenience (a funder usually requires this right on, for example, a project-financed power project) (clause 15.5). Contractor's liability is capped at 100% of the Contract Price. While this is a typical provision, experienced Contractors will seek to reduce this cap. Caps may go as low as 40% of the Contract Price, but consider this unusual (clause 17.6). Employer will be responsible for damage/ losses over the cap. A funder will need to be sure that relevant security package mitigates

Termination

this risk. Insurance Key Employer issues: Typically, the parties agree project-specific insurance provisions in advance. Contractor may be best- placed to procure insurances, as it may have better "buying power" than the Employer. Seek advice on pricing from the insurance market. Include drafting to ensure that all insurance monies go into a separate insurance proceeds account, for the benefit of the Employer/ funder. (Clause 18.) Key Employer issues: Contractor's liability is limited to the amount of the Contract Price. As set out above (see "termination"), this reflects the market position, but an experienced Contractor will seek to reduce this cap (clause 17.6). The Employer will require carve-outs from caps for death, personal injury, monies recovered under insurances, fraud and gross negligence, as a minimum. That is, liability for one of those matters would not "count" towards the cap. Key Employer issues: Employer responsible for planning/ environmental permits. Parties generally agree position on permits as part of the technical negotiations at tender stage. Employer/ Contractor permit list will need to be appended to the Contract. (Clause 1.13.) Key Employer issue: Employer retains risk of cost/ time implications of a Change in Law after the Contract has been entered into. This is a major risk to the Employer in the UK (and EU) given current development of UK/ European environmental/ health and safety laws. (Clause 13.7.) Force Majeure clause is incorporated. That is (to paraphrase), an exceptional event beyond the control of the parties, which could not reasonably have been avoided. Examples include war, terrorism, riot, radiation and natural catastrophes. Key Employer issues: Force Majeure events are listed but are not exhaustive (clause 19.1). Ideally, the Employer would amend the list of Force Majeure events so that it is finite and exhaustive. Contractor may be entitled to an extension of time (EOT) if a Force Majeure event occurs worldwide (clause 19.4(a)). For example, consider the shutdown of European air travel in spring 2010, following the volcanic eruption in Iceland. Contractor may be entitled to additional costs if a Force Majeure

Limit on liability

Permits

Change in Law

Force Majeure

event occurs (save for a natural catastrophes) in the country where the site is located (clause 19.4(b)). A funder providing project finance may seek to restrict Force Majeure remedies to an EOT only, but this is unlikely to be acceptable to a Contractor.

Choice of Law

Key Employer Issue: For a UK lender, the chosen law of the contract must almost always be English law. Similar considerations will apply for lenders from other jurisdictions. Dispute Adjudication Board (DAB), followed by ICC arbitration (clauses 20.2 and 20.6). For more on: Dispute boards, see Practice notes, Dispute boards: what are dispute boards? andDispute boards: comparison table of dispute board rules. ICC arbitration, see PLC Arbitration, Practice note, ICC arbitration: a step-by-step guide. Key Employer issues: For a project in the UK, the FIDIC DAB procedure does not comply with Part II of theHousing Grants, Construction and Regeneration Act 1996 (Construction Act 1996). If the contract between the parties is a "construction contract", as defined in the Construction Act 1996, they should agree a contractual adjudication mechanism, else the Scheme for Construction Contracts (England and Wales) Regulations 1998 (SI 1998/649) (Scheme for Construction Contracts 1998) (or its Scottish or Northern Irish equivalent) will imply the statutory adjudication scheme into their contract. For more information, including commentary on whether a contract is a "construction contract", see Practice note, Dispute boards and the Construction Act 1996.

Dispute Resolution

With arbitration, there may be difficulty joining third parties to any dispute unless clear drafting is incorporated into the Contract. An alternative for a project in England would be to adopt the English courts, but an international contractor may feel there is a potential for prejudice in favour of the Employer from a local court. Typically, an international contractor will require a "neutral" seat for arbitration. The seat of the arbitration deals with the procedure of the arbitration, not the law by which the dispute is governed. For a project in the UK, the parties might choose Paris or Geneva. (For a project outside the UK, some parties could choose London.) Despite the additional travel time and costs associated with this, a neutral seat is usually acceptable to the Employer and any funder.