Understanding the Generality of Variation Clauses and the Variety of Broad Interpretation that Exists under FIDIC Based Contract Modalities in Gulf

By Dr. Chandana Jayalath

Majority of construction contracts in the Gulf region maintain the principle features of the FIDIC forms of contract, yet there are many subtle changes from the FIDIC forms of contract. These changes will eventually imbalance the even risk allocation between the parties. Many contracts drafted in one sided language biased towards the clients are a result of cut and paste exercise, for instance, sometimes; there is no provision for price escalation and variations exceeding 10 or 15 per cent. The message to contractors entering into contracts on the basis of these forms is to review them very carefully without being fooled into thinking they are simply the FIDIC versions.

Although it is advised by FIDIC not to alter the General Conditions, but use the particular conditions, clients articulate their own requirements using the General Conditions. It is therefore important to understand the salient features of such changes made in the contracts.  This paper is an attempt to understand the ‘four corners’ of the variation clauses and their application.

It is fundamental that the parties are only bound to perform what is stipulated in the contract document they sign. Unless there is an express provision allowing alterations to be made during the course of the contract, the Contractor cannot be compelled, for example, to perform additional works and the Employer cannot, without being in breach of the contract, omit any works that have been agreed. Variation clauses introduce much needed flexibility into somewhat rigid rules that otherwise govern the parties’ obligations arising under building contracts.

Usually, the clause 51 defines a variation as any change in form, character, kind, quality, quantity, line, level, position, alignment, or dimension of existing work or any additional work that the Engineer finds necessary, appropriate or desirable to complete works.

The intent of the clause 51 is to enable the Engineer to vary the works ‘under’ the contract and not ‘in’ the contract. A variation instruction does not automatically entitle the Contractor to additional payment, but once it is validly given, the Contractor is under an obligation to perform it.

A valid Engineer’s variation instruction must therefore meet the basic requirements; it must be in writing or orally and subsequently confirmed in writing; be in respect of the form, quality or quantity of the works or any part of the works; and in the Engineer’s opinion, be necessary or be otherwise appropriate.

A change in the final quantities of work for an item may upset the balance of resources and method of working resulting in the unit price inaccurate. The actual quantity of work for an item may differ from the estimate at tender for a number of reasons. In the case of excavation for instance the removal of unsuitable material or the extent of rock or the extent of tunneling in particular classifications of ground, may only be estimated from ground investigation information and not known until work is carried out. Similarly the length of piles driven to a specified depth may not be known precisely at each pile location.

The most glaring anomaly in lump sum contracts is related to quantities. The risk of errors may be either fallen into the Contractor or the Employer. The chances to alter quantities are remote even in a substantial variance. A clause is that requires the Contractor to consider b/q quantities as actual and correct and any error or omission from the b/q provides no grounds to adjust the contract price (penalizing for someone else’s mistakes). In contrary, another clause is that vests powers to the Engineer allowing room for re-measurement where the Engineer can order increase, decrease or even omit works, thereby determining the amount to be adjusted in the contract price.

Mistakes in the bill descriptions or quantities are unlikely to be remedied as a legal rectification of the terms of the contract to reflect the true intention of the parties. The more likely practice is that the tender price prevails rather than a price revised to account of the error. Generally, the Contractor is entitled to assume that the B/Q has been prepared in accordance with SMM and that the items and quantities found in the Bill of Quantities are reasonably accurate descriptions and estimates of the work shown on the Drawings and described in the Specification. The B/Q may not have been prepared in accordance with the Standard Method of Measurement (SMM). The risk of inaccuracies in bills has fallen on the parties on the level of estimation done by a third party. Any error or omission provides no grounds for adjusting the contract price under lump sum contracts.

Although quantities are ‘actual and correct’, Contractors claim new rates when quantities substantially vary when the B/Q quantities are wrong.  Contracts based on firm quantities are in essence lump sum contracts, where the quantity risk is transferred from the Employer to the Contractor. Although the burden of quantity risk lies entirely with the Contractor in typical lump sum contracts, a question is why the Contractor is held liable for missing items and errors in quantities prepared by an outsider.

The Consultant shall be held liable for quantity errors in case the Employer becomes vicariously liable. A specific remedy would be to cover up this scenario in the insurance policy. There should be a B/Q provision for the tenderer to adjust the quantities when he finds any missing, under measured or over measured item so that he takes the burden before the contract is entered into.

As a matter of business efficacy, a term will be implied (in the absence of express terms) that the cost of the work for a Bill item which has not been priced by the Contractor is included in the prices entered elsewhere in the Bill.

We often find a clause vesting some powers on the Engineer to form an opinion as to suitability and applicability of a new rate and as to the limit of enhancement of an existing bill rate. The Engineer shall determine the suitability of the new rates based on the nature and amount of the subject omission or addition against the nature and amount of whole of works. Broadly speaking, the varied work shall be priced in accordance with the rates and prices in the contract, but if those are not applicable, the Engineer has the power to agree rates and prices with the Contractor. If no agreement is reached, the Engineer shall fix what he considers suitable.  Because the valuation of varied work can be fertile ground for argument, if a Contractor disagrees with the Engineer’s determination on rates or prices, he can still refer the issue to the Engineer once again prior to invoke the dispute resolution procedure. This can be considered as an extra contractual opportunity available for the parties to avoid disputes.

Following the UK case of Henry Boot v Alstom Combined Cycles (2000) considers the issue of when ‘fair valuation’ can be applied and when it cannot. Bills of quantities describe the work that is to be carried out and establish a rate or price for the item of work. The bill therefore allows the final measure of work to be valued by simply multiplying the rate by the quantity of measured work. But in practice matters are not so simple. The original bill of quantities may be inaccurate either in the description of the work or in the estimate of quantities. The question then is how far can the rates be applied in valuing the corrected measure? To what extent do the original rates apply and can they be used to value all variations or does another approach need to be adopted? So how are variations to be valued and when can fair valuation be used?

The rates will apply unaltered if the work is similar in character and executed under similar conditions as work priced in the bill. If either the work is dissimilar in character or executed in dissimilar conditions, then the engineer fixes a ‘star’ rate, by breaking down the quoted rates into the elements of plant, materials, labour and overheads and adjusting each element that is affected by the variation. This kind of adjustment seems sensible.

The engineer must fix the rate even if he does not have the contractor’s build-up. Instead he has to use a notional build-up using any contemporary records submitted by the contractor. It is still not clear when the star rate approach will not be appropriate, but it appears that only in exceptional situations will a fair valuation be made. As to what amounts to a fair valuation, it was held in the Henry Boot case that this meant one that does not give a contractor more than his actual costs, reasonably and necessarily incurred, plus similar allowances for overheads and profit. It was held further that fairness is an objective test which takes into account the position of both parties.

However, it is not clear from the decision how the profit and overheads are to be assessed; whether these are to be based on the contractor’s tender allowances, or whether the contractor has to show some loss of profit or loss of contribution to his overheads. This approach applies not only to the varied work itself, but also to work affected by the variation. It is necessary first to show that the variation caused bill rates for other items of work to be rendered unreasonable or inapplicable. If so, then new rates can be fixed or fair valuation used where appropriate. Importantly, the decision in Henry Boot teach apart the effect of additional varied work on original measured work from the effect on other work. The re-rating appears to apply only to rates and prices in the original bill and not those fixed by the engineer, for varied work for instance. This interpretation leads to the odd situation that star-rated work, which is subsequently affected by further variations, cannot be the subject of a further re-rating. It is legitimate to load rates, and the burden is on the employer to scrutinize the tender with care to see that no advantage is taken by such means. In summary, the Court was keen to provide commercial certainty to construction contracts, whilst acknowledging their approach may lead to rates being applied that resulted in substantial profit or loss for a contractor. The moral of the story for employers is that they should give as much attention to the rates set out in tenders as to prices.

Which of the rules, ie, existing rates, or fair rates, depends largely upon the timing of the variation order, the location of the work, the quantity involved and the circumstances in which the work is executed. If it can be established that these factors preclude the valuation on the basis of bill rates then the valuation will usually be based on fair rates. If the varied work is of a similar character and executed under similar conditions to work priced in the B/Q, such rates and prices shall be used to value the varied work. The factor of profit or otherwise of the rate is immaterial.

The words do not enable the Engineer to open up or disregard the rates on the ground that they were inserted by mistake. It was the use of the rates in the changed circumstances brought about by the variation order that must be reasonable, not the rates themselves.

Absence of contemporary records amounts to a situation where the Engineer shall make his own assessment based on information available to him and as he feels reasonable. Items covered by pricing preamble notes or descriptions in the bill item provide no entitlement. Considerations arising out of specifications, pre-contract addendums, manufacturing instructions and any minor details necessary for completion of work though not specified in specification or not shown in drawings are deemed to be included within the price. Any item duplicated in re-measure and superseded or rescinded by a subsequent instruction shall be ignored. Any work, which exceeded the scope required by the variation order, is considered as overwork. Unless otherwise stated, any discount or correction factor will be applied for the original works as set out in the bill of quantities. Variations valued as per bill rates will also be subject to discount. This factor is proportionately applicable for the measured items under appropriate bills unless any specific mention as to contrary has been made at the tender.

As mentioned earlier, the clause 51 requires variations to be priced as per bill rates presumably for works of similar nature executed under similar conditions. The key question is whether it is reasonable to use bill rates to value changed quantities when the rate contains an admitted error.

The court of appeal in ‘Henry Boot vs Alstom (2000) found in favour of the Contractor and emphasised the fact that bill rates, which contained an error, should not prevent them from being applied to the additional work as well. (In this case, it was an over pricing 7).

If the Contractor put an unrealistically high rate, he is entitled to have the rate used for valuation of subsequent variation. “When the Employer accepted the tender with the unrealistically high rate, it can be said that the Employer accepted also the risk of that being used in valuing additional quantities”. The application of the contract rates can not be avoided simply because one party is dissatisfied with them. The contract rates are immutable, and not subject to correction. There shall be no rectification of any error, omission or wrong estimate in the descriptions, rates and prices inserted by the Contractor. The effect of this principle is that a mistake in a rate is bound by the parties equally. The only situation where a contract rate may be departed from which it is not executed under similar conditions or when there is a substantial increase or decrease in quantities which render the existing rate unsuitable.

The matters to be taken into account when deciding whether conditions are similar are the physical site conditions such as wet compared with dry, confined space compared to ample working space, winter working compared to summer. The matters should be taken up when deciding whether work is of a similar character are the functions of materials, size and shape, vertical, horizontal and sloping, location, to name a few.

However in either of these operations the fact that a rate or price may be too high or too low is completely immaterial. A very high rate or a very low rate is not rendered unreasonable by a variation or a substantial change in quantities but is already unreasonable when the contract is entered into.

Alternatively, the Contractor has included an unrealistically low rate in the bill of quantities; such rate could be applied to the extent of bill quantities. Any excess in quantity over and above bill quantity shall be paid at a fair rate. However the conditions provide no room for the Contractor to demand an enhanced rate even where the actual quantity is of a substantial increase.

The parties are the masters of their own contractual fate. Indeed, the courts are normally slow to interfere in agreements reached between two parties, but they will interfere in agreements procured by the exertion of economic duress by one party on the other. Variations for instance issued from time to time in connection with variations to the contract are the subject matter that the Engineer should take a middle position in interpreting them.

The ingredients of actionable economic duress are that there must be pressure whose practical effect is that there is compulsion on, or a lack of practical choice for, the “victim”; and the pressure must be illegitimate and a significant cause which induces the “victim” to agree to enter into the agreement. As such, the contractor may contest under duress when the Engineer unilaterally fixed a rate for a new work without giving the Contractor a chance to negotiate.

The tender price break-up to be submitted before or after the contract has been let is not, per se, a contract document. It is to be used, wholly or partly, as a guide in pricing variations, and remains subservient to the requirements of the contract. Errors, omissions oversights within the tender price break-up do not prove particular inclusion or exclusion within the contract sum. The nature of the inclusions within individual tender rates and prices are determined by the conditions of contract, not by Contractor’s subsequent break-up. No Contractor can be permitted touse his lack of compliance with tender requirements to maneuver to his own advantage.

Whenever variations are ordered that omit work under clause 51, and particularly if such omitted work is substantial in quantity, Contractors often argue that they should be entitled to claim loss of profit that they would have been earned on such works if carried out. If the variation omitting works is invalid then such is a breach of contract entitling the Contractor to damages, and loss of profit can form part of such a claim for damages. Where the works have been omitted and given to others to carry out, it is clearly established that it is a breach of contract and not a valid variation order.

The existence of a variation clause does not entitle the Engineer to make large scale or significant changes to the nature and scope of work. A variation order that deviates from the fundamental scope, nature, type or complexity of work contemplated by the parties at the tender affects the validity of the contract. The Engineer should not introduce work outside the domain of the original job, which would cause hardship to the Contractor in terms of finance and technical capacity. The criteria to evaluate whether a change is a variation could be the cost of work, scope of work, technical input required, etc. Hence, the Engineer shall make any variation under the contract and not in the contract. All variations shall be considered in ascertaining the contract price. As a principle, no variation to the contract can be made by the Contractor. This does not however restrict the Contractor to submit at any time to the Engineer value Engineering proposals which in the Contractor’s opinion will if adopted accelerate completion, reduce cost to the Employer in executing, maintaining and operating works, improve efficiency, enhance the value of completed work, otherwise be of benefit to the Employer.

It is also seen that the Contractor delays the start of work in connection with variation till he gets the rates agreed and considers the date of formal instruction in writing as the date of issue of instruction when calculating time extensions. This belief is wrong. As per clause 51, the Engineer can give oral instructions and the Contractor should  not await till he gets it formally in writing in order to start work, rather he should confirm the recognition of such instruction in writing to the Engineer, and immediately proceed to carry out such instructions. If such confirmation is not contradicted by the Engineer, such instruction is deemed to be a formal instruction of the Engineer, albeit a deadline is not specified. Hence, the conditions are clear enough establishing the validity of the Engineer’s order to commence work.

The Contractors however feel hesitant to start work without getting prior approval on the cost because of the fear of not getting the full entitlement under payment procedures, which are usually prolonged.

Any instruction that the consultant thinks will take additional cost and/or time should accompany with a tentative budget estimate before issuing the same to the Contractor. The date ever first the Contractor received orally any instruction is the effective date of instruction unless otherwise stated. For planning purposes, it is the date the Contractor is actually supposed to commence the varied work.

There may be circumstances which could lead to changes introduced by the Engineer falling outside the variations clause. Contractors who find themselves with unattractive contract prices would find it arguable that a change introduced by the Engineer fell outside the variation clause thus the payment for the change should be on a quantum meruit basis. In Blue Circle Industries v Holland Dredging Co (1987), the works involved dredging in Larne Lough in Ireland to enable larger vessels to dock. The tender referred to the dredged material being deposited in areas approved by the public authorities, the intention being to discharge the material excavated in suitable areas in the Lough. Larne Harbour Board rejected this proposal later and as a result an alternative plan was agreed to use the excavated material to form an artificial bird island. It was argued by the Contractor that this was not a variation to the works within the confines of the contract but a separate contract in its own right. It was held that if the additional or varied work were so peculiar, so unexpected and so different from what any person reckoned to such an extent that it is not contemplated by the contract then it would constitute a separate contract. Hence, the construction of the bird island was wholly outside the scope of the original dredging contract and therefore constituted a separated contract.

When a large number of changes are instructed though they individually fall within the ambit of the variation clause, they can collectively have the effect of completely changing the scope of the works. This is referred to as either abandonment or cardinal change and deals with the situation where the Employer makes excessive changes to a project beyond what the parties reasonably could have anticipated at the time the contract is entered into. Courts will look at a number of factors in helping to decide whether the changes have been excessive such as the size, nature, complexity, expected duration the number of changes, how many changes were anticipated when the project started, the magnitude of the work involved in the changes and the length of time in which such changes were made etc.

A misunderstanding is that the Engineer can issue any number of variations for any purpose. Even where a contract includes the usual variation clause there may be circumstances which could lead to additions or changes introduced by the Employer which falls outside the variations clause where the payment for the change should be on a quantum meruit or fair valuation basis. It can be argued by the Contractor that this is not a variation to the works within the confines of the contract but a separate contract in its own right, because the additional work were so peculiar, so unexpected and so different from what was contemplated by the contract.

Also, the Engineer is under liability in the issue of variation orders, particularly the concessions granted for the Contractor. Even if the Engineer’s permission for a change is fully authorized, the Engineer is not freed from his general duty to the Employer to exercise reasonable care and skill. If the change does later cause the Employer loss, the Engineer may face reciprocal claim from the Employer.

We also find instructions in some contracts that the Employer has the right to increase or decrease work, upto 20% of the contract sum, but not beyond.  It also does not address what will happen when this limit exceeds.

The employer’s right to issue variations upto the limit of 20% original contract sum is totally different from the variations exceeding 20% for the compensation of unabsorbed overhead due to adjustment of quantities and varied work. The first limit could be during the progress of work while the second only at the practical completion. The first explains the employer’s right while the second deals with the contractor’s entitlement. There is no express provision in the contract for the second purpose, as mentioned at the outset.

The whole idea of ‘Variations exceeding 10% clause’ typically in other contract modalities is to compensate the contractor for any unabsorbed overhead component due to overwhelming decrease or increase of such work where his overhead would have been expended more and his profit would have been exhausted more in proportion to what he had planned and contracted with, and vice versa for the employer. It should not be confused when the quantity of an individual pay item has been found to be exceeded by a certain limit, not necessarily 20%. An individual treatment is allowed in the contract depending on the nature and amount of such varied work so that this is not the subject coverage under variations exceeding 20%.

Under circumstances, it is not reasonably inferable that the contractor has the right to refuse any variations beyond this limit, except of course in two circumstances; where the instructed new work fall out of the contract domain because the additional work were so peculiar, so unexpected and so different from what was contemplated by the contract, and in any additional work found to be unnecessary for completion.

A glaring anomaly of this ruling is the ignorance when some works omitted at the last lap of the project so that the net resultant impact is not necessarily exceeding 20% but still the contractor may have a case validly submitted under the grounds of such instruction. he power to control variations gone into the hands of the contractor is not at all practicable when the employer badly needs some varied work inevitable for the completion of the works.  The clause 51 on the other hand does not specify a limit in the contract for the contractor to stop work or object compliance with the instructions to variations.

A rate revision can be made only on the circumstances that rendered the existing rates unreasonable or inapplicable (due to nature and amount of any omission and addition compared with the nature and amount of whole of the contract work or to any part thereof). A rate would even be reduced perhaps in a typical civil engineering work where the rates could be much more profitable owing to economies of scale whenever the quantities are overwhelmingly increased. A rate revision is possible only when the net resultant impact of variations is in excess of +/- 20% of the effective contract sum which is not the subject of instruction, where the instructed new work found to be unnecessary for completion that does not fall under variation clause and the contract domain because they were so peculiar, so unexpected and so different from what was contemplated by the contract in terms of location, nature, type or technical complexity. This is an exceeding the intended limits or purpose of the original contract, resulting in a separate contract situation, in which the contractor may well be having a legitimate claim for a total rate revision.

Let us consider two recent cases under lump sum contracts. The ducts for underground electrical cables at 600mm level shown in tender drawing No E-00 were not mistakenly measured in the b/q. The revised construction drawing No SD-E00 superseded the scope of work envisaged in the tender drawing No E-00. This paved the way for adjusting the contract sum as a valid variation under the contract as per clause 55, which involved omission and addition of the scope shown the drawing No E-00 and SD-E00 respectively. The Contractor argued that omission from the bill of quantities is not possible in absence of a B/Q item. However, the logic is that the tender shall be comprehensive enough to cover up all the obligations under the contract as prescribed in the contract documents including drawings, irrespective of whether a particular item of work has been included or excluded in the bill of quantities unlike in a typical measure and pay contract. The Contractor shall also be deemed to have satisfied himself before tendering as to correctness and sufficiency of the tender for the works as per clause 12(1). Accordingly, the cost on PVC ducts shown in tender drawing is deemed to be priced within the tender.

Having subsequently altered the subject scope by the above revised drawing constituting a variation to the contract as per clause 51(1), the Engineer ascertained by ad-measurement the net resultant value of the respective work as per clause 51(3). All such works were valued at the rates set out in the contract in order to maintain the tender pricing level. As such, the deduction made for omission for which the price is already catered for was contractual.

Dewatering is an existing b/q item, quoted as a lump sum, but not prevailed at site. Hence, the Contractor was invited to sign the original copy of the site instruction as a formality to omit dewatering from the scope of work. The Contractor regretting signing the site instruction argued that dewatering is an integral part of excavation that cannot be separated from excavation item and hence, the contract sum can not be adjusted. He further added that he did not receive soil report at the time it was priced.

Notwithstanding the extent of availability of information related to tidal movements, type of soil, water table etc or the pricing strategy adopted in the tender, the entire obligation falls on the Contractor to make his own interpretation as to the nature and extent of work involved in both temporary and permanent works. Such a technical judgment is a sole prerogative of the Contractor for which the Employer is not liable under whatsoever circumstances except in cases where the Contractor is able to justify that the Employer is at default, such as failure to provide accurate information timely whenever expressly provided for in the contract.

The Engineer found no such record of request or qualification during the tender. The Contractor has neither made any provision in his clause 14 program nor in the methods statement as to how he intends to deal with the issue of dewatering. The section B for preliminaries in which the tenderer has an opportunity to identify the items not priced elsewhere in the b/q also had a zero value. Nothing has been executed physically later at site with regard to control of ground water such as installation of standpipes and other devices as specified, altogether revealing lack of compliance/emphasis on the subject issue at the time of tender.

Nonetheless, the Contractor shall be deemed to have satisfied himself before tendering as to correctness and adequacy of the tender for the works as per clause 12(1), bearing in mind that pricing risks are inherent in any typical lump sum fixed price contract. As such, the tender sum shall be comprehensive enough to cover up all obligations under the contract as specified in drawings, b/q and specifications etc. Without prejudice to the primary intention of the contract, the Engineer reserves the right to vary the works within the meaning of clause 51 (1). The distinction is made in clause 55, where any error or omission from the bill of quantities shall provide no grounds for adjusting the contract price. In contrary, omission of an existing b/q item is defined as a variation as per clause 51(1) and thereby provides grounds for adjusting the contract price. This deletion is thus contractually valid and the power to do so has been vested in the Engineer as per said clause.

Further, the Contractor’s price against each bill item shall truly reflect the value of the item described as noted in pricing preamble. Any individual b/q item that is itemized and separately measurable or payable, apart from other pay items operationally or otherwise integral, incidental or associated with it can be assessed in full at the existing contract rate/s according to its occurrence. The dewatering in this particular instance is an independent bill item of that category that did not prevail at site at all, so is apparently a subsequent variation under the contract by a complete omission, the benefit of which shall be retained by the Employer. Under circumstances, the Engineer found no strong valid technical or contractual basis to justify why the Employer is liable for payment for dewatering.

‘Variations’ has long been recognized as a major source of conflict in construction projects. A one of reasons is the decisions heavily influenced by subjectivity that differs from one person to another. The author’s view is that even under the label of strict lump sum firm price contracts, the Engineer ultimately sits in a strong position to convert the whole scenario into a traditional form of measure and pay. Variations and measurement clauses are evident enough. Indeed, computing a realistic value for variations is often not an easy task. The parties need a considerable knowledge, skill and exposure in the art of  judgment in order to have a sound appreciation of the methods of construction, estimating practice, contractual implications, construction programming techniques and most importantly the records intact.