The clock is ticking to the launch of new editions of the most widely used forms of contract for international construction projects. Nearly 20 years after the publication by the International Federation of Consulting Engineers (FIDIC) of the first editions of the Red Book (Building and Engineering Works designed by the Employer), Yellow Book (Plant and Design-Build), and Silver Book (EPC Turnkey), second editions will be released at the FIDIC Users Conference in London on 5th / 6th December 2017.
FIDIC gave us a taste of what is to come by issuing a pre-release draft of the new Yellow Book (the "Pre-Release Draft") at its 2016 Conference. It is expected that the changes in the Red and Silver Books will follow a very similar approach, with adjustments and additions appropriate to the differing risk profiles of each.
One of the key questions at the launch of the new forms, therefore, will be the extent to which they differ from the Pre-Release Draft, and how far such changes reflect the comments made on the latter since its release last December.
Foremost among these "friendly reviews" was a letter sent to FIDIC in January this year on behalf of the EIC (European International Contractors), ICAK (International Contractors Association of Korea), OCAJI (Overseas Construction Association of Japan Inc) and CICA (Confederation of International Contractors' Associations). For ease, this is referred to below as the "EIC Letter".
FIDIC responded to this in April (copies of both letters can be found on the EIC website). The exchange provides some clues as to how FIDIC's thinking might have developed since the publication of the Pre-Release Draft, and we expand here on some of the key themes, in preparation for the launch of the new editions.
Risk allocation – a Gold Standard?
The EIC Letter opens with the assertion that, over the years, FIDIC's approach to the preparation of its new forms has gradually come to involve less collaboration with the international contracting community, and that this, in turn, has coincided with a higher degree of risk transfer from Employer to Contractor – both by FIDIC itself (most notably via the turnkey Silver Book), and by clients independently appropriating FIDIC's drafting, in order to "dump" risk indiscriminately on their contractors.
The EIC Letter pulls no punches in alleging that the Pre-Release Draft has continued this trend, saying that: "FIDIC once again aggravates the Contractor's position with respect to the proposed risk allocation and contract administration and, unfortunately, does not live up to the task of reflecting a good industry standard".
It goes on to make specific comments on these two key areas of risk and administration, and this article considers the exchange between EIC and FIDIC on the first of these. A separate article will consider the second area of contract administration.
EIC's comments on risk focused on the new version of Clause 17 (Risk Allocation), and addressed two main changes – the inclusion of a design indemnity, and the distinction drawn between Employer's Risks and Contractor's Risks in allocating responsibility for damage.
Both draw on the approach of FIDIC's earlier Gold Book (Conditions of Contract for Design, Build and Operate), which is something of a surprise, given how little the Gold Book has been used since its publication in 2008.
We consider each of these changes in turn below.
Clause 17.7 of the Pre-Release Draft adds a Gold Book-inspired indemnity from Contractor to Employer in respect of "all errors in the Contractor's design of the Works and other professional services which result in the Works not being fit for the purpose(s) intended in accordance with Sub-Clause 4.1 [i.e. the purpose(s) defined and described in the Employer's Requirements]...or result in any loss and/or damage for the Employer...".
This addition prompted the following complaints in the EIC Letter:
- the indemnified concept of fitness for purpose under Sub-Clause 4.1 is unclear and open to wide interpretation by the Employer;
- the indemnity will allow the Employer to recover all of its losses however unexpected or unforeseen, irrespective of whether the Employer has contributed to the loss by its own failings;
- liability under the indemnity is expressly carved out (in Clause 17.6) from both the overall cap on all liability and the exclusion of indirect loss, and is therefore entirely uncapped as to nature and extent; and
- liability under the indemnity will be uninsurable.
In its April response, FIDIC pointed out that Sub-Clause 4.1 now defines fitness for purpose by reference to what is in the Employer's Requirements, whereas both the old Yellow Book and the Gold Book referred to the broader concept of what is "defined in the Contract". Whilst this is correct, this narrowing of fitness for purpose has not gone as far as the EIC would wish, and the concept remains open to a broad interpretation of the content of the Employer's Requirements - with considerable attendant risk for the Contractor.
FIDIC did not expressly comment on EIC's next two complaints – regarding the scope of the indemnified loss and the lack of any cap as to its nature and extent - save to point out that the new Clause 17.9 (another Gold Book addition) provides for the Contractor's liability to be "reduced proportionately to the extent that the Employer's Risks may have contributed to the said damage, loss or injury". (The Employer's Risks are considered below.)
As for EIC's comment on the uninsurability of the indemnity, FIDIC appears to side step this, by referring to the availability of third party / public liability insurance in the context of property damage. This is not the same, however, as insurability of design liability, and it is unlikely that professional indemnity insurance will be available to cover an indemnity of this width.
In summary, therefore, it's fair to say that FIDIC's responses only partly addressed EIC's concerns as to the design indemnity, and there seems little doubt that this addition from the Gold Book does, in the words of the EIC Letter, impose "a major additional risk upon international contractors".
This conclusion is reinforced when one considers a further aspect of the indemnity that the EIC Letter did not specifically raise – i.e. that, as drafted, it creates an uncapped liability (extending to indirect loss) in respect of all design errors which result in loss and/or damage to the Employer, and not just those which result in the Works not being fit for purpose.
Employer's Risks / Contractor's Risks
The EIC Letter has two concerns over the adoption by the Pre-Release Draft of the Gold Book regime governing Employer's Risks and Contractor's Risks:
Commercial risks / risks of damage
The first is that EIC interprets the definition in Clause 17.1(a) of those Employer's Risks which are described as "commercial" as being limited to those "where insurance is not generally or commercially available", and regards this as inappropriate. In EIC's view, "the question of insurability should be separated from and should not affect the general risk allocation".
EIC has a point here, and it is notable that the FIDIC Response does not address this concern. The wording is ambiguous, to say the least. By comparison, the Gold Book and old Yellow Book contained no such limitation by reference to the availability of insurance. Instead, it was simply acknowledged that the Employer's Risks are matters which may be excluded from the insurances maintained by the Contractor (as would be expected), and this did not operate to limit the scope of the Employer's Risks themselves.
The EIC Letter could also have pointed out that the definition appears to limit the "commercial" Employer's Risks to those which "result in financial and/or time loss for the Employer". This is problematic for two reasons:
- Given that the purpose of the Employer's Risks is to provide relief for the Contractor against the consequences of specified events, the real issue is not whether the Employer has incurred such financial or time loss, but whether the Contractor will be affected by the matters listed in the subparagraphs to the definition.
- It casts doubt as to whether the "commercial" Employer's Risks will cover physical loss or damage caused by the matters identified - especially given that the separate category of Employer's Risks in Clause 17.1(b) (described as "risks of damage") expressly refers to physical loss or damage, but in the context of a quite different list of matters. This is important, because it is Clause 17.1(a) – not Clause 17.1(b) - that refers to the Employer's use or occupation of the Permanent Works, which is the activity most likely to cause physical damage to the Works.
In relation to the "risks of damage" in Clause 17.1(b), the introductory wording describes them as being "those that result in physical loss or damage to the Works or other property belonging to either Party (other than commercial risks)".
Unfortunately, this renders virtually meaningless the "risks of damage" in the first subparagraph of the Clause arising from interference with any right of way, light, air, water or other easement, since such interference is highly unlikely to cause physical damage to the Works.
(On a more helpful note, however, the words – "other than commercial risks" – may indicate that the "commercial" Employer's Risks in Clause 17.1(a) are, indeed, deemed to be capable of causing such physical loss or damage.)
All of this ambiguity begs the question as to why Clause 17 of the Pre-Release Draft (and the Gold Book before it) makes the confusing distinction between "commercial risks" and "risks of damage", given that the two categories are not treated differently in the other operative provisions of the Clause and the division is not reflected elsewhere in the contract.
It may be that it was intended as a helpful confirmation that the Employer's Risks cover purely financial risks as well as physical damage, but any benefit in doing this is undone by the limiting effect of the division between the two categories, and the fact that each is a closed list of specific items, to which the introductory categorisation - as one or the other - appears to act as a further limitation.
Risk and rectification
The second concern in the EIC Letter under this heading lies in its dislike of the introduction of the express statement (at Clause 17.2) that all risks that are not Employer's Risks are Contractor's Risks.
FIDIC's response was to point out that nothing has substantively changed, since the old Yellow Book also made the Contractor responsible for damage caused by anything that was not an Employer's Risk.
This is correct, but further changes in the Pre-Release Draft have caused confusion in implementing this Gold Book regime.
For example, having introduced the express concept of Contractor's Risks, the Pre-Release Draft goes on to adopt the Gold Book requirement that the Contractor notify and rectify damage caused by such a risk (Clause 17.5). Unfortunately, in doing so, FIDIC appears to have forgotten to delete the now redundant Yellow Book obligation (in Clause 17.3) to rectify any damage that is not caused by an Employer's Risk – leaving an unnecessary and confusing duplication.
There is further confusion (carried over from the Gold Book itself) concerning the rectification of damage. In the second paragraph of Clause 17.4, the Contractor is said to be entitled to time and money for such rectification, in the event of "the allocation of the risk not being governed by any other term of the Contract". It is difficult to give meaning to these words, however, since the effect of Clause 17 is that a risk is either an Employer's Risk, if it falls within Clause 17.1, or it is a Contractor's Risk, if it does not. There is no gap in the drafting here – a risk is either one or the other.
FIDIC asserts in its response that the provision is dealing with a situation "where the risk can be traced to both the employer and the contractor, in which case the contractor becomes entitled...to proportionate time and money. An example would be a risk emanating from a combination of defective Employer's Requirements and defective workmanship". Whilst this may have been FIDIC's intent, it is difficult to read this mechanism into the binary words that have been used, and further clarificatory wording will be needed to remove this ambiguity.
Whilst the EIC Letter, and our comments above, highlight a number of issues with the content of the Pre-Release Draft, FIDIC has made a point of welcoming constructive criticism and suggestions for improvement.
Indeed, its response to the EIC Letter confirmed that it would be reviewing and modifying Clause 17, in light of the comments raised therein and elsewhere.
The real test, therefore, will be the extent to which the final version of the Yellow Book (and its Red and Silver siblings) are seen to have addressed these concerns, when they are finally revealed in December, and we look forward to assessing the outcome in subsequent briefings.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.