How Valuable Is The FIDIC Suite For Construction of Project Financed

Society of Construction Law (Singapore) International Conference, Singapore 16 October 2006
How Valuable is the FIDIC Suite for Construction of Project Financed Projects?
Professor Doug Jones

AM, RFD, BA, LLM, FCIArb, FIAMA
Clayton Utz, Lawyers, No. 1 O'Connell Street, Sydney, Australia

tel +61 (0) 2 9353 4120 fax +61 (0) 2 8220 6700 email djones@claytonutz.com
London Chambers: Atkin Chambers, 1 Atkin Building, Gray's Inn, London, WC1R 5AT, United Kingdom
Tel: +44 (0) 20 7404 0102 Fax: +44 (0) 20 7405 7456 Email: dougjones@atkinchambers.law.co.uk
2006 Doug Jones AM. These materials are subject to copyright. No part may be reproduced, adapted or communicated without written consent of the copyright owner except as permitted under applicable copyright law.
How Valuable is the FIDIC Suite for Construction of Project Financed Projects? 1
Professor Doug Jones AM RFD, BA, LLM, FCIArb, FIAMA Partner, Clayton Utz
1. Introduction Project financiers have three primary concerns when considering whether or not to finance a major project: cost, timely completion, and revenue. To achieve certainty and reduce risk in these three critical areas, financiers and their advisors must pay particular attention to the terms of the construction contract between the project vehicle and the contractor. As the financier is not a party to this contract, its requirements and interests must be channelled and protected via the project vehicle that it funds. This paper will explore whether the financier's requirements and interests are appropriately addressed and protected by the FIDIC suite of contracts, with particular focus on the operation of the FIDIC EPC/Turnkey Projects Contract - the "Silver Book". The Silver Book was specifically created and released in 1999 by FIDIC in response to industry demand for a standard form contract applicable to project financed projects. Although the Silver Book is more favourable to the project vehicle (and consequently the financier 2) than the contractor, as will be discussed in this paper, it still falls short of guaranteeing financiers the certainty and risk protection that they require. These shortcomings are highlighted by the fact that, in practice, the Silver Book is usually the subject of significant amendments by parties or disregarded altogether, thereby rendering the FIDIC suite of lesser value to project financed projects than its drafters presumably intended. 1.1 The nature of project finance Project finance is a form of finance often used in infrastructure projects. There are many different structures that may be employed in projects using this method of finance, limited only by the imagination of the financiers and other parties to the transaction. However, a common factor distinguishes project finance from other forms of financing, which is that the financiers
The author gratefully acknowledges the assistance provided in the preparation of this paper by Julia Hoffmann, Senior Solicitor, and Catherine Mann, Paralegal, Clayton Utz. The terms "financier" and "lender" are used interchangeably throughout this paper.
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rely on the revenues generated by the project itself for the repayment of the debt and there is limited recourse to the sponsors of the project, if any. For this reason, project finance may often be referred to as "non-recourse" financing. The non-recourse basis of project financing places numerous risks on the financiers of such projects. The financiers will generally only have recourse to the cash-flows generated by the project when completed and the assets subsisting in the project. In many cases, the value of those assets will be significantly less than the total obligations of the borrower - the project sponsor. In this context, two factors are of paramount importance. First, the financiers to a project financed on a non-recourse basis must be certain that the cash-flows forecast to be obtained from the completed project will be sufficient to service the debt. Second, financiers must be confident that the project assets will be completed and become operational, and thus are able to generate the revenues from which the borrower's debt service obligations will be discharged. As a consequence, financiers usually require the construction contract to have a fixed price and date of completion, with recourse to the contractor in the event of failure. This increased certainty, however, comes at a premium in terms of a higher contract price to reflect the contractor's greater assumption of risk. 1.2 Classic structure for project financing The variety of financing structures is almost coextensive with the number of projects that proceed on a project finance footing. Numerous approaches may each have advantages
depending on the composition of the sponsors and lenders, the regulatory framework in whic h the project is implemented, and the type of project. The potential for variation means that it is not possible to provide a comprehensive analysis of the different structures in this paper. However, in the context of discussing construction risks, the following generalised structure will be assumed: The sponsors form a project vehicle, which is then used to implement the project. The project vehicle is either an entity separate from the sponsors, or it remains linked to the sponsors but a detailed regime is put in place to protect the assets of the sponsors from the liabilities of the project vehicle; Financiers lend to the project vehicle pursuant to conditions contained in a loan agreement, typically limiting recourse to the assets of the project vehicle and the revenues from the project assets; The project vehicle engages contractors to construct the project assets;
2
The project vehicle receives revenue from the assets and services the debt from those revenues; and
Any profits made by the project vehicle are eventually distributed to the sponsors.
Below is an example of a classic structure of a project financed project. The key players for the purposes of this paper will be the financiers, the project vehicle (the "employer" in FIDIC contracts) and the contractor.
Financiers
Operator Loan agreement Operating agreement Concession agreement
Government
Project vehicle Supply agreement Supplier of project resources e.g. power Construction contract Off-take agreement
Product offtaker
Contractor
As this diagram demonstrates, the construction contract is only one in a number of agreements in the project, although it is one of the most complex because of the competing interests of the contractor, project vehicle and lenders. There is an important interplay between the
construction contract and these other agreements, particularly: the concession agreement between the project vehicle and the government if the project is BOT-style; the loan agreement; and the off-take contract, which establishes the basic terms by which the product will produce revenue, for example, through road tolls or sale of power.
Lenders have an interest in all these agreements, and significant interactions between the construction contract and the other project documents are highlighted in this paper. 1.3 Risk allocation and project delivery methods The method of project delivery has a fundamental bearing upon the risks arising during, and subsequent to, the construction of infrastructure. Different delivery structures have widely differing implications in terms of the risks borne by each of the parties and therefore financiers need to be cognisant of the risk allocation implicit in particular methods of project delivery. Financiers have a real interest in the choice of project delivery structure and need to understand the options available as, generally speaking, the risks borne by the financier in this context are those borne by the project vehicle or owner. A table outlining delivery models with advantages and disadvantages for the financier is included in Appendix 1. The EPC/turnkey model will be the particular focus of this paper as it is the model found in the FIDIC Silver Book and is the most commonly used delivery model in a project finance context. Its attractions to project financiers are the lump-sum pricing and single-point completion responsibility, which provide greater completion certainty - reducing the risk to financiers, who would otherwise rely only on the project assets to recover their loan. 1.4 Risk allocation in drafting the contract While the choice of delivery method sets the scene for the allocation of risk between the parties, the terms of the contract itself will be the ultimate determinant of the rights and obligations of the parties. For this reason, it is necessary for the parties to ensure that the terms of the contract impose rights and obligations that complement the risk allocation desired by the parties and are appropriate to the delivery structure. A clear allocation of risk is vital. In particular, due to the complexity of these projects and the variety of causes of each risks, risk allocation should be linked to causation according to which party can best control the causal event.3 Financiers ought to be concerned with the terms of the construction contract, with a view to controlling their exposure to risk. The diligent financier should ensure that the risk allocation contained in the contractual provisions reflects the basis upon which they are willing to provide finance, and is not watered down by the contract. In addition, financiers should make certain that their interests will be protected. Although to an extent the project vehicle represents the financier in the construction contract, the financier should be involved in the
JG Mauel, "Common Contractual Risk Allocations in International Power Projects" (1996) Columbia Business Law Review 37 at 41.
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contract, both at the drafting stage and in contract administration, in order to safeguard their interests. Also important is that in BOT projects the contractor is usually a shareholder of the project company and a member of the sponsoring organisation, so it should be able to make its views heard at the negotiation and drafting stage. 4 2. Background to the Silver Book In 1999 FIDIC published a suite of four new Standard Forms of Contract: Conditions of Contract for Construction for Building and Engineering Works Designed by the Employer (known as the "Red Book"); Conditions of Contract for Plant and Design-Build for Electrical and Mechanical Plant, and for Building and Engineering Works, Designed by the Contractor (known as the "Yellow Book"); Conditions of Contract for EPC/Turnkey Projects (known as the "Silver Book") NEW; Short form of Contract, a new form designed for minor works (known as the "Green Book") - NEW; The Conditions of Contract for Design-Build and Turnkey (known as the "Orange Book", and first issued in 1995) was not updated. The impetus for this was the need to update the Red and Yellow Books to reflect changes in the construction industry and the increased numbers of larger and more complex projects. The increased use of project financing motivated the addition of the Silver Book to the suite. According to the Introductory Note to the Silver Book, FIDIC perceived that the construction market, in the context of project finance, required a contract where employers were willing to pay more for certainty of price and completion date. Its application, however, is not limited to project financing. The Introductory Note states that it is intended to be suitable "for all the many projects, both large and smaller, particularly E & M (Electrical and Mechanical) and other process plant projects, being carried out around the world by all types of employers, often in a civil law environment, where the government departments or private developers
C Wade, "The Silver Book - The Reality" (2001) 18(3) International Construction Law Review 497 at 509.
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wish to implement their project on a fixed-price turnkey basis and with a strictly two party approach".5 The Silver Book, unusually for a FIDIC contract, has no engineer. According to its Introductory Note, the Silver Book will have to be modified in the context of project financing in order to take account of lenders' requirements. Additionally, in the
Introductory Note, FIDIC recommends a number of circumstances in which the Silver Book is inappropriate and the Yellow Book should be used: If there is insufficient time or information for tenderers to scrutinise and check the Employer's Requirements or for them to carry out their designs, risk assessment studies and estimations; If there will be substantial work underground or work in other areas which tenderers cannot inspect; If the employer intends to supervise closely or control the contractor's work, or to review most of the construction drawings; or If the amount of each interim payment is to be determined by an official or other intermediary. As the contract intended to be used in project financed projects, the Silver Book will be the focus of analysis in this paper. Given that FIDIC recommends falling back on the Yellow Book as an alternative to the Silver Book, the paper will also note where the Yellow Book differs from the Silver Book. 2.1 The rationale for the Silver Book The Silver Book represents a departure from FIDIC's traditional principles of balanced risk sharing by primarily allocating risk to the contractor. At the time of the publication of the Silver Book, FIDIC argued it was responding to demand from the construction market for a form that suits turnkey projects - including, but not limited to, project financed projects where the employer is willing to pay a higher price for increased certainty of completion date and final cost. Placing an increased burden of risk on the contractor is necessary for such a project.6
Introductory Note to First Edition of Silver Book.
C Wade, "FIDIC's Standard Forms of Contract - Principles and Scope of the Four New Books" (2000) 17(1) International Construction Law Review 5 at 11.
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In light of this market demand, FIDIC decided to develop a standard form contract tailored to such projects, rather than leaving employers to "mutilate" the other FIDIC contracts to suit their needs, a practice which disadvantaged contractors and led to poorly drafted contracts. 7 Instead, the open and clear allocation of risk and responsibility in the Silver Book was intended to benefit all parties. Christopher Wade, who as Chairman of FIDIC's committee for International Contract Conditions was responsible for production of the new suite, stated that "FIDIC (bearing in mind its position as exponent and even in some respects guardian of the best modern engineering practice), came - rightly or wrongly - to the conclusion that one has to move with the times, and that it is often better to face up to the market demands, rather tha n deny their obvious existence... one cannot halt progress."8 FIDIC also argued that in BOT projects there is substantial negotiation before signing the contract, and in this context the Silver Book is intended to be a starting point, or a "guide at the outset", rather than a finished product.9 The allocation of greater risk to the contractor meant that the publication of the Silver Book was met, unsurprisingly, with severe criticism from contractors and others. These will be identified throughout this paper. While not all the criticisms are justified, financiers need to be aware of these arguments if there is to be a considered allocation of risk and a successful project. Parties should also note that a number of clauses were amended to be more favourable to the contractor,10 and the financier should therefore consider whether these provisions reflect the risk allocation on which basis they have agreed to finance the project. 2.2 Layout of the Silver Book The Silver Book comprises: General Conditions, consisting of 20 clauses which are themselves divided into subclauses that form the provisions of the contract. The sub-clauses are those which FIDIC considered would be applicable to many contracts, proceeding on the basis that parties would prefer to delete or modify inapplicable provisions rather than draft additional text for the Particular Conditions;11
C Wade, above n 4, at 502. C Wade, above n 4, at 501. C Wade, above n 4, at 502. Sub-Clauses 2.4, 2.5, 13.7, 14.8, 16.1, 17.4, 19.1, 20.1. Foreword to the Silver Book.
7
10
11
Particular Conditions, containing modifications and additions to the General Conditions. These Particular Conditions are referred to in many sub-clauses in the General Conditions. Some sub-clauses in the General Conditions do not operate unless required to by the Particular Conditions, for example, advance payments 12 and performance security.13
FIDIC has contemplated that the Silver Book will be substantially adapted to the parties' situation, and so has published with the Silver Book a "Guidance for the Preparation of Particular Conditions" which suggests text options for the Particular Conditions. It is
necessary to remember that the Silver Book is a standard form contract which should be modified by parties to reflect their needs. They are thus free to amend the terms to achieve the risk allocation appropriate for their project. 3. Project finance requirements and the Silver Book This section will evaluate the Silver Book from the financier's perspective. Examining the main areas of risk for the financier (cost, time and quality) as well as other risks of concern, this section will set out the relevant clauses of the Silver Book and assess them according to project finance requirements. 3.1 Cost risks For obvious reasons, a key concern for financiers will be the provisions of the contract whic h affect the cost of the project, as unbudgeted cost overruns will threaten the viability of the project vehicle and may lead to the financier being required to advance more funds than those initially approved, in order for the project to be completed. The pricing structure for the works has the most significant influence on the allocation of cost risk, as the magnitude of risks borne by the financier will vary significantly depending on whether the contract has, for example, a lump-sum or a cost plus fee pricing structure. The Silver Book is project finance-friendly, and provides for a fixed lump sum price. Using this payment method places the onus on the contractor to correctly price the project and bear the risk of currency fluctuation and changes to the cost of materials and labour, giving the financiers certainty of price.
12
Sub-Clause 14.2. Sub-Clause 4.2.

8
13
"Contract Price" is defined in the Silver Book as "the agreed amount stated in the Contract Agreement for the design, execution and completion of the Works and the remedying of any defects, and includes adjustments (if any) in accordance with the Contract". Further, subclause 4.11 provides that "the Contractor shall be deemed to have satisfied himself as to the correctness and sufficiency of the Contract Price." Set out in the table below are the circumstances that give rise to the "adjustments" referred to in the definition of "Contract Price", as well as extensions of time: 14
SubClause Yes/No 2.1 Right of Access If the contractor is not given access to the site as required under this clause. (Note that access may be denied if the contractor has not yet provided the performance security.) 4.24 Fossils Complying with the employer's instructions in relation to any fossils found on-site 7.4 Testing Contractor is instructed to vary the location or details of specified tests or carry out additional tests 8.9 Consequences of suspension 9.2 10.3 Delayed tests Interference with Tests on Completion 11.8 Contractor to search for the cause of any defect 12.2 Delayed tests Unreasonable delay by the employer to the Tests after Completion no yes yes Contractor is instructed by employer under Sub-Clause 8.8 to suspend part or all of the works. Tests on Completion unduly delayed by the employer Contractor is prevented for more than 14 days from carrying out Tests on Completion by a cause for which the employer is responsible Contractor is instructed to search for a cause of a defect, and the cause of the defect not the fault of contractor. no yes yes yes yes yes yes yes yes yes yes no yes yes yes yes yes no yes Yes/No yes Yes/No yes Heading Sub-Clause content - circumstances entitling adjustment EOT? Cost? Profit?
14
Adjustment by variation is also possible - see section 3.4(a) below.

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SubClause
Heading
Sub-Clause content - circumstances entitling adjustment
EOT? Yes/No
Cost? Yes/No yes
Profit? Yes/No yes
12.4
Failure to pass Tests after Completion
Unreasonable delay by the employer in permitting access to the works or plant, either to investigate the causes of a failure to pass a Test after Completion or to carry out any adjustments or modifications
no
13.7
Adjustment for changes in legislation
Contract price shall be adjusted to taken account of any increase or decrease in cost resulting from a change in the laws of the country, which affect the contractor in the performance of its obligations.
yes
yes
no
13.8
Adjustments for changes in costs
If the contract price is to be adjusted for rises or falls in the cost of labour, goods and other inputs to the works, the adjustments are to be calculated in accordance with the provisions in the Particular Conditions.
n/a
yes
no
14.8
Delayed payment
If the contractor does not receive payment in accordance with sub-clause 14.7 (Timing of Payments), the contractor will be entitled to receive financing charges compounded monthly on the amount unpaid during the period of delay. The clause provides the rate of interest.
n/a
n/a.
n/a
16.1
Contractor's entitlement to suspend work
If the employer fails to comply with sub-clause 2.4 (financial arrangements) and sub-clause 4.7 (timing of payment) the contractor may suspend work. The contractor must give 21 days notice of its intention to do so.
yes
yes
yes
17.4
Consequences of employer's risks

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Rectification of loss or damages to the works, goods or Contractor's Documents caused by employer's risks
yes
yes
no
19.4
Consequences of force
If the contractor is prevented from performing any of its obligations under the contract and suffers delay or incurs cost
yes
yes
for
no
certain
" Employer's Risks" are defined in Sub-Clause 17.3 as "(a) war, hostilities, invasion, act of foreign enemies, (b) rebellion, terrorism, revolution, insurrection, military or usurped power, or civil war, within the Country, (c) riot, commotion or disorder within the Country by persons other than the Contractor's Personnel and other employees of the Contractor and Subcontractors, (d) munitions of war, explosive materials ,ionising radiation or contamination by radio-activity, within the Country, except as may be attributable to the Contractor's use of such munitions explosives, radiation or radio-activity, and (e) pressure waves caused by aircraft or other aerial devices travelling at sonic or supersonic speeds."
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10
SubClause
Heading
Sub-Clause content - circumstances entitling adjustment
EOT? Yes/No
Cost? Yes/No types of force majeure
Profit? Yes/No
majeure16
by reason of a force majeure
Financiers may wish to limit the scope for adjustment of the contract price, by deleting or amending the above provisions, or capping the amount of adjustment. In particular, it would be prudent from the financier and employer's perspective to remove the possibility of adjustment for rises or falls in the costs of labour, goods and other inputs to the works under Sub-Clause 13.8. Note that the Yellow Book as well as allowing this adjustment provides formulae for its calculation.17 (a) Payment
The actual mechanics of payment of the contract price are also relevant to financiers. The Silver Book has a complex payment structure of advance payment, interim payment, and final payment, which is explored below. (i) Advance payment
The Silver Book allows advance payment to be made for design and mobilisation. 18 The advance payment is an interest-free loan. It is up to the parties to agree upon the amount of the advance payment in the Particular Conditions. If no amount is agreed, then the sub-clause is inapplicable - there is no advance payment. If an amount is provided, but the terms of
"Force Majeure" is defined in Sub-Clause 19.1 as "an exceptional event or circumstance: (a) which is beyond a Party's control, (b) which such Party could not reasonably have provided against before entering into the Contract, (c) which, having arisen, such Party could not reasonably have avoided or overcome, and (d) which is not substantially attributable to the other Party." "Force majeure may include but is not limited to, exceptional events or circumstances of the kind listed below, so long as conditions (a) to (d) above are satisfied: (i) war, hostilities (whether war be declared or not), invasion, act of foreign enemies, (ii) rebellion, terrorism, revolution, insurrection, military or usurped power, or civil war, (iii) riot, commotion, disorder, strike or lockout by persons other than the Contractor's Personnel and other employees of the Contractor and Sub-contractors, (iv) munitions of war, explosive materials, ionising radiation or contamination by radio-activity, except as may be attributable to the Contractor's use of such munitions, explosives, radiation or radioactivity, and (v) natural catastrophes such as earthquake, hurricane, typhoon or volcanic activity."
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payment are not otherwise stipulated, then default provisions determine the basis and timing of payment.19 These default provisions require the advance payment to be made once the contractor has provided: an application for interim payments;20 the performance security in accordance with Sub-Clause 4.2; and a guarantee (subject to certain conditions) in amounts and currencies equal to the advance payment. The provision of a guarantee should allay most financiers concerns as to the appropriateness of advance payment. The employer is required to pay the first instalment of the advance payment within 42 days of the date on which the contract came into full force and effect or within 21 days of the employer receiving the performance security and claim for advance payment.21 It has been suggested that it may in fact be in all parties' interests, from a cash flow perspective for the contractor, and from the perspective of the financier and employer in getting the project underway, that the advance payment be made at the commencement of the contract - however, obviously for the financier it would be critical, in the context of security, that the performance security and guarantee were, in any event, in place. The advance payment is repaid in proportional deductions to interim payments, which are discussed below. (ii) Interim payment
The Silver Book sets out an interim payment procedure at Sub-Clause 14.3. The procedure itself is reasonably conventional in requiring the contractor to submit a statement of the amount claimed and any additions/reductions and retention figures, together with supporting documentation of its claim. The timing of the submission of the statement, if not stated, is after the end of each month.
19
Sub-Clause 14.2. Sub-Clause 14.3. Sub-Clause 14.7.

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20
21
The interim payment procedure gives the contractor incentive for early completion.
The
contract may include a schedule of payments as to the instalments in which the contract price will be paid.22 Unless otherwise agreed by the parties, Sub-Clause 14.4 also provides the basis of the calculation of the instalments, and the procedure to be followed in the event that there is no schedule of payments. The procedure could be improved for the financier, however, by requiring the employer to prepare the schedule of payments based on completion of discrete tasks, which must be completed to the satisfaction of the employer's representative (that is, following testing). 23 Then the completion of such construction tasks could be independently verified before allowing payment. 24 This would not only provide an incentive for early
completion but also ensure the construction produces a fit for purpose project asset. The employer may be entitled to withhold payment: 25 if the employer has not received and approved the performance security; if anything supplied or work done by the contractor is not in accordance with the contract, the cost of rectification or replacement may be withheld until rectification or replacement has been completed; if the contractor was or is failing to perform any work or obligation in accordance with the contract, and has been so notified by the employer, in which case the value of this work or obligation may be withheld until the work or obligation has been performed. Further, the Silver Book provides that the employer may, by any payment, set-off "any correction or modification that should properly be made".26 These exceptions to payment provide the employer with considerable discretion, which should therefore appeal to financiers. In addition, the requirement for the contractor to provide security before receiving interim payment for plant and materials 27 should make the payment acceptable to financiers.
22
Sub-Clause 14.4.
23
JA Huse, Understanding and Negotiating Turnkey and EPC Contracts, 2nd ed, London, Sweet & Maxwell, 2002, at 645. JA Huse, above n 23, at 645. Sub-Clause 14.6. Sub-Clause 14.6. Sub-Clause 14.5.
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24
25
26
27
In terms of timing of payment, the Silver Book provides that payment is to be made within 56 days of receiving the statement and supporting documentation.28 This is a considerably longer period than under most contracts. However, if payment is late, the contractor is entitled to financing charges compounded monthly on the unpaid amount.29 Further, if the basis of the calculation has not been provided in the Particular Conditions, then the Silver Book provides by default that these charges are to be calculated at the annual rate of three percentage points above the discount rate of the central bank in the country of the currency of payment, and shall be paid in such currency. 30 This default method of calculation is reasonably generous to contractors. (iii) Final payment
The Silver Book provides a staged process for final payment. The contractor is first required to submit a statement at completion within 84 days of the contractor receiving the taking-over certificate for the works.31 The statement at completion is similar in content to the statements for interim payment, and requires supporting documentation, as well as details of the value of all work done up to the date stated in the taking-over certificate and an estimate of any other amounts which the contractor considers will become due to him under the contract. The notice provisions for the employer and the timing of payment are the same as those for interim payment (that is, 28 days notice of any objections, and payment within 56 days of the employer's receipt of the statement). Once the employer has issued the performance certificate in accordance with Sub-Clause 11.9, to confirm the date on which the contractor completed its obligations under the contract, the contractor must, within 56 days of receiving the performance certificate, submit a draft final statement with supporting documentation showing the value of all work done in accordance with the contract and any further sums which the contractor considers to be due to him under the contract or otherwise. The employer may require additional supporting material and
agreed changes may be made to the draft before it is submitted in final form. The final statement is to be accompanied by a written discharge which confirms that the total of the final statement represents full and final settlement of all moneys due to the contractor under or in
28
Sub-Clause 14.7(b). Sub-Clause 14.8. Sub-Clause 14.8. Sub-Clause 14.10.

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29
30
31
connection with the contract.32 If there is a dispute as to the final amount due, the employer is required to pay whatever amounts are agreed, and the dispute will be submitted to the dispute resolution process set out in Clause 20 of the contract. The final statement will then be issued after the dispute has been resolved. The Silver Book expressly limits the employer's liability to the claims made in the final statement and statement at completion, as it provides that the employer shall not be liable to the contractor for any matter or thing under or in connection with the contract or execution of the works that is not included therein. 33 (iv) Financier involvement in payment?
The Silver Book, as a two-party contract, does not provide for any financier involvement in payment. An alternative to the model presented in the Silver Book would be for the financiers to be responsible for payments. Under such a system, the contractor makes regular claims for progress payments under the contract. These claims are then submitted to the financier, and if they are satisfied that any preconditions to payment have been met they may release the payment. The strength of such an approach is that the financier should be able to satisfy itself as to the work that has been done by requiring their information needs to be met before payment occurs. It is also possible to attach other conditions to payment, such as requiring that payment claims be capped at an amount specified in a pre-agreed drawdown schedule. Financiers should consider whether they wish to gain greater control of the payment process through taking over responsibility from the employer, or alternatively by requiring the employer to consult with the financier prior to making any decisions on payment. (b) Cost risks under the Silver Book: conclusion
The Silver Book goes some way towards addressing project finance requirements for minimal cost risk. The lump sum pricing, guarantee for advance payment and the employer's discretion regarding interim payments provide a cost and payment structure generally favourable to financiers. There are deficiencies, however, and it would be prudent for financiers to insist upon some amendments to the circumstances in which the contract price may be adjusted, as well as to aspects of payment mechanisms such as linking interim payments to completion of discrete tasks. The financiers may also wish to have greater involvement in the payment process.
32

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3.2
Time risks Time is of major concern to the financier because a delay to completion usually results in a delay to the revenue stream. This in turn may detrimentally affect the solvency or profitability of the project. Given that time is so critical in projects which are undertaken on a project finance basis, the construction contract often allocates risk for all delays to the contractor, as does the Silver Book, on the basis that the contractor's control of design and construction means it is most able to avoid late completion. Accordingly, the Silver Books sets out a limited range of grounds for an extension of time for completion, and imposes delay damages on the contractor as penalty for lateness where no extension of time has been granted. Unlike some other contracts, however, the Silver Book does not provide for a bonus for early completion. Such a bonus can be a useful way of lessening time risks as it provides the contractor with an incentive to promptly complete the works, and given the importance of ontime completion to financiers, could be a wise addition to the construction contract. Financiers should also note that in the Silver Book the contractor is entitled to the benefit of the early completion float. Sub-Clause 8.4 refers to entitlement to an extension of time if "completion for the purposes of Sub-Clause 10.1 (Taking Over of the Works and Sections) is or will be delayed" rather than if the deadline of the time for completion will not be met. Similarly, Sub-Clause 8.2 obliges the contractor to complete the works "within the Time for Completion". This probably makes more sense as where the contractor carries out the work, particularly in a design-build context, it is best able to schedule and plan for work.34 In these circumstances, if a contractor has been able to progress ahead of time, it is entitled to the benefit of the float achieved. However, financiers may wish instead for the employer to have the benefit of the float so as to reduce completion risk. (a) Extensions of time
As extensions of time necessarily delay the financier's recovery of the loan, these provisions are of considerable importance to the financier, who will be keen to ensure that only a limited range of circumstances give rise to an entitlement to an extension of time. The Silver Book list of events entitling the contractor to an extension of time is exhaustive, reflecting the importance of on-time completion in project financed projects. Sub-Clause 8.4
JK Hoyle, "The Rainbow Down Under - Part 2: Further Reflections from the Antipodes on Aspects of the New FIDIC Design-Build Contracts" (2002) 19(1) International Construction Law Review 4 at 11.
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provides generally the circumstances in which the contractor is entitled to an extension of time: variations; delays, impediments or prevention caused or attributable to the employer, their personnel or their other contractors; and other entitlements set out in the contract.
Grounds for an extension of time found elsewhere in the contract concern circumstances in which completion is or will be delayed as a result of: the employer's failure to give the contractor access to or possession of all or parts of the site within the time stated in the Particular Conditions;35 the contractor complying with the employer's instructions to the contractor regarding items of archaeological or geological interest found on the site;36 the contractor complying with the employer's instructions to vary the location or details of specified tests, or carry out additional tests, or a delay for which the employer is responsible;37 the contractor diligently following procedures of the public authorities, and the authorities delay or disrupt the contractor's work, if the delay or disruption was not reasonably foreseeable at the date of tender;38 the contractor complying with the employer's instructions to suspend or resume work;39 Tests on Completion being unduly delayed by the employer;40
35
Sub-Clause 2.1. Sub-Clause 4.24. Sub-Clause 7.4. Sub-Clause 8.5. Sub-Clause 8.9. Sub-Clause 9.2.
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36
37
38
39
40
the contractor being prevented for more than 14 days from carrying out the Tests on Completion by a cause for which the employer is responsible;41
changes in the laws or in the judicial or official interpretation of such laws of the host country;42
the contractor's suspension of work for non-payment by the employer, or the employer's failure to provide evidence of his ability to pay;43
an employer's risk;44 a force majeure event.45
Financiers should be relatively content with these grounds. The Silver Book has substantially fewer grounds for extensions of time than the other FIDIC forms, and their scope is comparable with what financiers are accustomed to accepting in practice.46 Financiers should also be satisfied that failure to comply with the procedure for contractor's claims outlined in Sub-Clause 20.1 will defeat the claim for an extension of time. Nonetheless, if financiers are tempted to reduce the list of events entitling an extension of time, they should note that the choice of events is essentially a commercial decision. If the
occurrence of a class of event does not entitle an extension of time, a risk inevitably falls on the contractor, which risk will ultimately be priced into the bid of the contractor, increasing the cost of delivering the project. If the risk of the event occurring lies within the control of the employer, the risk premium it attracts may be exorbitant. For this reason, failure to award an extension of time for preventive acts may have adverse consequences. It may be
uneconomical for the contractor to have no entitlement to an extension of time in the event of a variation initiated by the employer. Alternatively, it may be more productive for the employer to be able to order acceleration (as under Sub-Clause 8.6), so that the employer retains some control over the attendant increase in cost, rather than the contractor pricing the risk into the
41
Sub-Clause 10.3. Sub-Clause 13.7. Sub-Clause 16.1. Sub-Clause 17.4. "Employer's risk" is defined at n 15. Sub-Clause 19.4. "Force majeure" is defined at n 16.
42
43
44
45
B de Cazalet and R Reece, "The New FIDIC EPC BOT Contract" (1999) 180 Project Finance International 50 at 52.
46
18
contract price. The capacity of the employer to control the progress of the works in this way is discussed below.47 In addition to these considerations, it is clear that the financier has an interest in ensuring the extensions of time clause is carefully drafted to avoid the possibility of a preventive act setting time at large, so that the contractor no longer has the obligation to complete by the specified date. Otherwise, if the employer causes a delay and the contractor fails to follow a notice procedure or does not claim an extension of time, the employer will be unable to claim liquidated damages from the contractor for failure to complete on time.48 This means that where the employer commits a preventive act, the contractor can avoid paying liquidated damages by not claiming for an extension of time. Contracts often seek to avoid the operation of the prevention principle by permitting the employer or the employer's representative to unilaterally grant an extension of time, a power which is not granted in the Silver Book. Financiers would be advised to press for the inclusion of such a provision in order to ensure that the employer stays solvent through liquidated damages in the event of late completion. The extension of time sub-clause could also be improved for the employer by specifying that an extension of time will only be granted where there is delay to the critical path and the contractor could not have avoided or reduced it.49 This would help to minimise the risk of late completion by reducing the potential for unnecessary extensions of time. Financiers may also want the concession contract to transfer to the host government the risks of contractor's claims for extensions of time arising out of events within the control of the host government. These may include force majeure events within the control of the host government and delay caused by failure of the authorities to issue permits.50 As discussed below, consistency between the various contracts is important to managing risk across the project as a whole. (b) Calculation of delay damages
A delay in completion will have adverse financial consequences for the employer and hence the financier. The loss suffered by the employer for delayed completion may be recovered as damages for breach of contract. However, as is common in construction contracts, the Silver
47
See section 3.2(c). JK Hoyle, above n 34, at 11-12. JA Huse, above n 23, at 634. JA Huse, above n 23, at 58.
19
48
49
50
Book allows the employer to recover liquidated damages (or delay damages, as they are known in the FIDIC contracts) as a debt due under the contract when completion occurs after the date set down for completion. This has numerous advantages from a practical perspective, as actual loss need not be proven,51 and the contractor's liability may be capped at a manageable level in the Particular Conditions. Delay damages also provide an incentive for the contractor to complete on time and maintain the project company's solvency in case of late completion. The level at which delay damages are set in the Particular Conditions is an important part of risk allocation in major projects. In large infrastructure projects, the losses that may flow as a result of a contractor's late completion may be enormous. In some cases, the potential loss may be so great that no contractor would willingly participate in the project without the benefit of some limitation of their potential liability. The calculation of the per-day rate of liquidated damages is where many decisions about the amount of risk to be retained by the employer manifest themselves, so the financier should be involved in this decision. The Silver Book requires that if the contractor fails to comply with the time for completion it shall pay delay damages for every day until the date stated in the taking-over certificate, for the sum stated in the Particular Conditions.52 Importantly, delay damages are no substitute for performance: the contractor must still complete the works and comply with any other obligations under the contract. There are, however, some limitations to liability for delay damages for failure to complete within time. The only other delay damages for which the contractor may be liable are those connected to termination by the employer for cause under Sub-Clause 15.2.53 Sub-Clause 17.6 also limits liability to the amount of the contract price and prohibits liability for loss of use of any works, loss of profit, loss of any contract or for any indirect or consequential loss or damage which may be suffered other than under Sub-Clause 16.4 (payment on termination) and Sub-Clause 17.1 (indemnities). The Particular Conditions may also set a maximum amount of delay damages. The employer may wish to have the level of delay damages fixed by reference to the financing costs incurred during the period of delay so that it passes through to the contractor its liability for interest payments to the financier consequent on late loan repayment. Parties should also be aware that the interpretation of delay damages clauses will be affected significantly by the applicable law, as they are not recognised in all legal systems, or may be
51
Subject to the applicable law: see below n 57. Sub-Clause 8.7. Discussed below at section 3.4(e)(ii).
20
52
53
reduced if a court finds them to be excessive.54 For example, delay damages under English law are only awarded commensurate with actual loss; in contrast with civil law, they cannot be in the nature of a penalty. 55 The per diem basis of delay damages under the Silver Book should be proof of their compensatory nature but may not be sufficient. 56 Additionally, in some common law jurisdictions liquidated damages are not recoverable without proof of actual loss.57 Nonetheless, these provisions go some way towards keeping the project vehicle solvent in the event of late completion and thus ensuring the financier's loan is repaid, however, given their significance, financiers would be wise to be involved in negotiation of the amount of delay damages and any maximum set. (c) Project management
Reflecting the importance of on-time completion in project finance, the Silver Book contains provisions by which the employer can control the project in order to minimise the risk of late completion. The contractor is required to submit a programme within 28 days of commencement and revise it whenever the employer gives notice, within 21 days, that the programme does not comply with the contract or actual progress of the work, or if the contractor gives notice to the employer of specific probable future events or circumstances which may adversely affect or delay construction. 58 The content requirements of a valid programme are set out in more detail than in previous editions of the FIDIC contracts, including order and timing of the works, periods for review under Sub-Clause 5.2, sequence and timing of inspections and tests, and a supporting report which includes a general description of the methods the contractor intends to adopt and the approximate number of the contractor's personnel and equipment for each major
54
JA Huse, above n 23, at 275, 292. See also A Kus, J Markus and R Steding, "FIDIC's New 'Silver Book' Under the German Standard Form Contracts Act" (1999) 16(4) International Construction Law Review 533 at 543. NDJ Henchie, "FIDIC Conditions of Contract for EPC Turnkey Projects - The Silver Book: Problems in Store?" (2001) 18(1) International Construction Law Review 41 at 54. JA Huse, above n 23, at 292.
55
56
In Malaysia, s 75 of the Contracts Act 1950, has been interpreted to require actual proof of damages incurred unless the amount set in the contract was a true or genuine pre-estimate of the loss (Wearne Brothers (M) Ltd v Jackson [1966] 2 MLJ 155; Selva Kumar a/l Murugiah v Thiagarajah a/l Retnasamy [1955] 1 MLJ 817). In India, s 74 of the Contract Act 1872 also requires the plaintiff to prove actual loss (Bhai Panna Singh v Bhai Arjun Singh AIR (1929) PC 179). See G Xavier, "Global Harmonisation of Contract Laws - Fact, or Fiction" (2004) 20(1) Construction Law Journal 3 at 17.
58
57
Sub-Clause 8.3.
21
stage. This provision should be drafted to be consistent with any obligation to keep the financiers informed through progress updates and regular reports.59 In addition, the employer may require the contractor to submit a revised programme and report on revised methods showing how the contractor plans to expedite progress and complete within the time for completion. 60 This may be ordered if actual progress is too slow to complete within that time and/or progress has fallen or will fall behind the current programme, unless the contractor is entitled to an extension of time. The revised methods may include increased working hours, or amount of goods or number of personnel, and the contractor must bear the costs, as well as any additional costs incurred by the employer and any delay damages. These provisions are important ways in which the employer can monitor the project and be able to respond at an early stage to circumstances that could prevent on-time completion. Given their utility, financiers may wish to have a more official and active role in this process. Suspension provisions are also a powerful method of enabling the employer to control the progress of the project, although as suspension may prevent the project from being completed on time, financiers would be wise to insist that it will not be ordered without their approval. As it stands, the Silver Book permits the employer to order the suspension of progress on all or part of the works at any time for any reason. 61 The contractor must secure the works from loss, deterioration and damage, and upon resumption of the work the contractor must make good any deterioration or defect in or loss of the works, plant or materials which has occurred during the suspension, regardless of the cause of the suspension.62 Financiers and employers should also note that the contractor may be able to claim an extension of time or actual costs if pursuant to suspension or resumption of the work the contractor suffers delay and/or incurs cost.63 However, the contractor may not be compensated for lost profit, and neither an extension of time nor costs are available if the cause of the suspension is the contractor's responsibility. The contractor must notify the employer and
59
JA Huse, above n 23, at 634. Sub-Clause 8.6. Sub-Clause 8.8. Sub-Clause 8.12. Sub-Clause 8.9.
22
60
61
62
63
comply with the procedure for contractors' claims set out in Sub-Clause 20.1, which, as discussed below,64 is generally favourable to the employer. Additionally, if the contractor is not responsible for the suspension, it is entitled to payment of the values of plant and/or materials which have not been delivered to the site if the work on plant or delivery of plant or materials has been suspended for more than 28 days and the contractor has marked the plant or materials as the employer's property in accordance with the employer's instructions.65 Financiers should also note that there are detrimental consequences of suspension lasting more than 84 days, if the cause of the suspension is not the contractor's responsibility. If the contractor requests the employer's permission to proceed, and the employer does not give permission within 28 days of the request, the contractor may give notice to the employer that it is treating it as an omission under Clause 13 (governing variations and adjustments) of the affected part of the works.66 Further, if the suspension affects the whole of the works, the contractor may give notice of termination under Sub-Clause 16.2. As this demonstrates, while suspension provisions give the employer greater control over the project, they are an example of circumstances in which the employer's interests and the financiers' interests may not be completely aligned. For this reason, to minimise the risk of delay to revenue from the project, financiers should ensure they are strongly involved in the use of suspension powers. (d) Time risks under the Silver Book: conclusion
The Silver Book is generally successful, from the project financier's perspective, in allocating time risks to the contractor. However, it is important that financiers are involved in
administration of the provisions which allow for employer control of time risk, in particular where the employer's and financiers' interests diverge. In addition, the extension of time provisions could give the employer/financier greater control in relation to preventive acts and unilateral extensions of time. A bonus for early completion would also be favourable to financiers.
64
See section 3.4(b). Sub-Clause 8.10. Sub-Clause 8.11.

23
65
66
3.3
Quality risks The quality of the project is crucial to the project vehicle, and as a result, the financier. The quality of the completed project will determine its ability to fulfil its intended purpose, as well as having more obvious consequences such as increased repair and maintenance costs. Failure to fulfil the intended purpose will also jeopardise compliance with the other agreements involved in a project financed project. Importantly for the financiers, repayment of the loan depends on the capacity to obtain revenue from a working asset; a project that is deficient may reduce revenue. Quality risks in the Silver Book encompass design obligations, the fitness for purpose standard, responsibility for site data and unforeseeable conditions, the employer's capacity to monitor quality during constructions, and aspects of completion. (a) Design obligations
Under the Silver Book the contractor assumes responsibility for the design of the works. 67 Additionally, the contractor is deemed to have scrutinised the Employer's Requirements, 68 prior to the base date, and is responsible for the design of the works and for the accuracy of the Employer's Requirements. The employer is not responsible for the accuracy of the Employer's Requirements and is deemed not to have given any representation as to their accuracy. The only aspects for which the employer retains responsibility are: portions, data and information which are stated in the contract as being immutable or the responsibility of the employer; definitions of intended purposes of the works or any parts thereof; criteria for the testing and performance of the completed works; and portions, data and information which cannot be verified by the contractor, except as otherwise stated in the contract.69 This last exception in particular has the potential to be a fertile source of disputes and contractors' claims. It is problematic because it does not specify the relevant time at which the information must be unable to be verified by the contractor. Edward Corbett has suggested that the argument that would be most convincing to arbitrators would be that it refers to
67
Sub-Clause 5.1.
The Employer's Requirements are the documents specifying the purpose, scope, design and technical criteria for the works (Sub-Clause 1.1.1.3).
69
68
Sub-Clause 5.1.
24
verification at tender stage.70
It would, however, be in financiers' interests to limit this
exception. This sub-clause also displaces the fitness for purpose standard in respect of these exceptions. A more certain allocation of responsibility by removing the exceptions may be preferable to financiers (for a higher price of course). In addition, in the Australian context it would seem that contractors can argue that an employer's intervention in design demonstrates a lack of reliance on the contractor's design, precluding contractor liability for design defects. 71 This appears to thwart the intention of the Silver Book. Due to this allocation of responsibility, the Introductory Note advises that the Silver Book is inappropriate for projects in which the employer wishes to review most of the construction drawings. If this risk allocation is nevertheless unacceptable to the contractor and the financier/employer is willing to negotiate, then the Yellow Book allocates less risk to the contractor and may be an alternative. In the Yellow Book, while the contractor must still carry out and be responsible for the design of the works, the contractor has a period in which to scrutinise the Employer's Requirements and give notice of any error or other defect found therein. The engineer the n determines whether there should be a variation or adjustment. If, taking account of cost and time, an experienced contractor exercising due care would not have discovered the error or other defect when examining the site and the Employer's Requirements before submitting the tender, then the time for completion and the contract price may be adjusted. This test - the experienced contractor exercising due care - has been criticised for its indeterminacy.72 The Yellow Book also differs from the Silver Book in the inclusion of employer's design as an employer's risk.73 However, to compensate for this, the Yellow Book has a quality assurance scheme: the Yellow Book requires that design be undertaken by qualified designers who comply with any criteria stated in the Employer's Requirements. In addition, the engineer must approve each proposed designer and design subcontractor. 74 The contractor also warrants
70
E Corbett, "FIDIC's New Rainbow 1st Edition - An Advance?" (2000) 17(2) International Construction Law Review 253 at 269.
Cable (1956) Limited v Hucherson Bros Pty Limited (1969) 123 CLR 143, discussed in JK Hoyle, "The Rainbow Down Under - Part 1: Some Reflections from the Antipodes on Aspects of the New FIDIC Design-Build Contracts" (2001) 18(1) International Construction Law Review 5 at 19.
72
71
E Corbett, above n 70, at 268. Sub-Clause 17.3(g). Sub-Clause 5.1.

25
73
74
that the contractor, the designers, and the design subcontractors have the experience and capability necessary for the design. 75 In both the Silver Book and Yellow Book the contractor remains responsible for ensuring that the design, Contractor's Documents,76 execution and the completed works will be in accordance with the law of the country, and the documents forming the contract, that is, including the Employer's Requirements.77 The contractor is also responsible for compliance with local technical standards, building, construction and environmental laws, laws applicable to the product being produced and any other standards specified in the Employer's Requirements.78 If these change after the base date the contractor must give notice to the employer and submit proposals for compliance, if appropriate; the employer shall initiate a variation if it determines that compliance is required and that the proposals for compliance constitute a variation. Financiers may also wish the contract to expressly state that the
contractor is still obliged to design and construct the works in accordance with the fitness for purpose obligation, regardless of reliance on those technical standards.79 Notably for financiers, responsibility for the Contractor's Documents remains with the contractor notwithstanding any approval or consent by the employer: if errors, omissions, ambiguities, inconsistencies, inadequacies or other defects are found in the Contractor's Documents, they and the works must be corrected at the contractor's cost.80 The Silver Book and Yellow Book allow different scope for employer supervision of the design process. In the Silver Book, if the Employer's Requirements so provide, the employer may review the Contractor's Documents, and unless the parties otherwise agree, execution may not commence until the expiry of the review period, which shall not exceed 21 days.81 This review does not relieve the contractor of responsibility. However, the employer's power is limited to advising that the Contractor's Documents fail to comply with the contract, in whic h case the contractor must rectify and resubmit them for review. In contrast, the review
75
Sub-Clause 5.1.
76
"Contractor's Documents" are defined in Sub-Clause 1.1.6.1 as "the calculations, computer programs and other software, drawings, annuals, models and other documents of a technical nature supplied by the Contractor under the Contract". Sub-Clause 5.3. Sub-Clause 5.4. JA Huse, above n 23, at 226-227. Sub-Clause 5.8. Sub-Clause 5.2.
26
77
78
79
80
81
procedure in the Yellow Book permits the Employer's Requirements to specify that the Contractor's Documents be reviewed and/or approved before work commences, although such review and/or approval does not relieve the contractor of any responsibility or obligation. 82 Huse suggests the provision for review only in the Silver Book is to ensure the employer does not bear any responsibility for design,83 but surely the disclaimer at the end of the Sub-Clause that the contractor remains responsible is sufficient for this purpose. Financiers may prefer the Yellow Book model if they wish the employer to have greater supervision of the design process. The potential for the significant control by the employer in using this position is unusual for turnkey contracts, and contractors argue that they should be free to achieve the performance criteria in the manner of their own choosing. A response is that non-compliance with the contract in terms of performance criteria will be unlikely to be established at the design stage. 84 The issue of employer intervention will be explored in greater detail below.85 (b) Fitness for purpose
Consistent with the nature of an EPC/Turnkey project, under the Silver Book the contractor undertakes to design and construct works that are fit for their purpose and to remedy any defects.86 The fitness for purpose standard imposed in the Silver Book has been criticised as placing a heavy burden on contractors due to its interaction with a number of other provisions in the contract. Firstly, although the contractor is liable for design, the employer can require review of design, as discussed above.87 Secondly, the contractor is liable even where the Employer's Requirements are insufficient for the purpose of the works.88 Contractors also make a number of general criticisms of the fitness for purpose standard. Contractors take on extra risks where they employ design consultants, as consultants can only obtain insurance up to a standard of reasonable skill and care. The contractor will therefore bear the cost of work that is less than fit for purpose but where more than reasonable skill and
82
Sub-Clause 5.2. JA Huse, above n 23, at 217. E Corbett, above n 70, at 270. See section 3.4(d)(i). Sub-Clause 4.1. Sub-Clause 5.2. Sub-Clause 5.1.
27
83
84
85
86
87
88
care was used. Related, the contractor is held to a higher standard of care than a professional designer would be, although the employer's response will be that a higher standard is necessary to ensure the contractor does not cut costs and supply an inferior design. Lastly, the contractor will be liable even where the standards and knowledge of the industry are such that no competent contractor would have noticed the flaw in the design.89 However, fitness for purpose is essential for financiers given that revenue from the project is their only recourse to the loan. Financiers will be unwilling to lend where there is no
guarantee that there will be a working, revenue-producing asset. Nonetheless, if particular standards are required in order to produce the necessary revenue, it would be in financiers' interests to ensure they are also specified in the contract. (c) Site data and unforeseeable conditions
The Silver Book allocates to the contractor all responsibility for verifying and interpreting the site data provided by the employer.90 Under this sub-clause, the employer has no liability for the accuracy, sufficiency or completeness of site data, except for data that the contract states is immutable or the responsibility of the employer, and data which cannot be verified by the contractor. Financiers may therefore wish that in order to maximise risk allocation to the contractor, the employer provide no site data, or allow the contractor plenty of time to verify the data and require the contractor to expressly state it had full opportunity and did verify all data provided by the employer. 91 In contrast, in the Yellow Book the employer undertakes the investigation and the contractor is only responsible for interpreting, not verifying, the data.92 Additionally, in the Yellow Book the contractor is only deemed to have obtained all necessary information to "the extent which was practicable (taking account of cost and time)".93 Gaede argues this makes more sense than multiple tenderers all having to investigate, duplicating tests and costs.94 However, financiers may not be happy with the significant potential for the contractor to argue that it was too costly or there was insufficient time to obtain the necessary information.
89
JA Huse, above n 23, at 149-150. Sub-Clause 4.10. JA Huse, above n 23, at 52. Sub-Clause 5.1. Sub-Clause 4.10.
90
91
92
93
28
Except as otherwise stated in the contract, the contractor also bears all risk of unforeseeable ground conditions.95 Under this Sub-Clause, the contractor is deemed to have obtained all necessary information regarding risks, contingencies and other circumstances which may influence or affect the works. The contractor accepts total responsibility for having foreseen all difficulties and costs of successfully completing the works and the contract price is not adjusted to take account of any unforseen difficulties or costs. Where the contractor assumes the risk of unforeseeable ground conditions, the contract price should increase to reflect this. However, in practice, contractors may find such risk to be difficult to quantify, due to its unforeseeable nature, which could lead to higher pricing. 96 Huse suggests that it may be more economical for employers to assume the risk themselves and pay a lower contract price.97 As discussed below, this will be influenced by the market and the parties' bargaining power. 98 The Yellow Book provisions on unforeseeable conditions are more favourable to contractors. Under the Yellow Book the contractor may be entitled to an extension of time or additional costs if it encounters unforeseeable adverse physical conditions.99 Unforeseeable means "not reasonably foreseeable by an experienced contractor by the date for submission of the Tender".100 In determining the claim, the engineer may reduce those additional costs if there were physical conditions in similar parts of the works which were more favourable than could reasonably have been foreseen when the tender was submitted.101 However, the application of a foreseeability standard has been criticised, for example, because the real test is not whether something was foreseeable but whether there should have been allowance for it.102
94
AH Gaede Jr, "The Silver Book: An Unfortunate Shift from FIDIC's Tradition of Being Evenhanded and of Focusing on the Best Interests of the Project" (2000) 17(4) International Construction Law Review 477 at 488. See also JA Huse, above n 23, at 52. Sub-Clause 4.12. JA Huse, above n 23, at 143. JA Huse, above n 23, at 143. See section 5 below. Sub-Clause 4.12. Sub-Clause 1.1.6.8. Sub-Clause 4.12. See for example, E Corbett, above n 70, at 258.
29
95
96
97
98
99
100
101
102
There is some justification for the risk allocation in the Silver Book.
The contractor is
arguably the most qualified person to bear the risk, given it will have conducted site investigations and is in charge of design and construction. 103 In a project financing context, FIDIC reasons, lenders will be willing for the contractor to include the risk of unforeseen ground conditions in the contract price. The Introductory Note advises that the risk allocation should be accompanied by willingness to allow the tenderer time to verify all relevant information and data and make any necessary investigations. Additionally, the Introductory Note recommends that the Silver Book should not be used where there will be insufficient time for this aspect, or where construction will involve substantial work underground or work in areas where tenderers cannot inspect. FIDIC also argues that the risk of unforeseen ground conditions will be negligible in the majority of projects for which the Silver Book will be used, and will be of less significance than other risks turnkey contractors assume. 104 A number of commentators, however, have observed that since most infrastructure projects involve substantial underground work, the Silver Book thus excludes most of the projects for which it intends to cater.105 Contractors may be able to mitigate the risk if they negotiate for the employer to pass on any relief it obtains from the host government for this,106 although financiers may prefer the employer to keep the benefit and be in the best position possible. It would be advisable that where there will be substantial work underground and an increased chance of encountering unforeseen ground conditions, that the parties include a specific risk allocation.107 The provisions concerning site data and unforeseen ground conditions are some of the most severely criticised in the Silver Book; contractors in particular argue that they place an unreasonable burden of risk on contractors. While not all these criticisms are maintainable, financiers and employers need to be aware of this general perception of the Silver Book and be prepared for these arguments at the stage of contract negotiation. One criticism advanced is that these provisions will lead to the contract being awarded to the tenderer with the lowest bid who has included in the price little or no contingency for
103
B de Cazalet and R Reece, above n 46, at 51. C Wade, above n 4, at 514.
104
AH Gaede Jr, "Letter to the editor: FIDIC Conditions" (2001) 18(4) International Construction Law Review 703 at 709; NDJ Henchie, above n 55, at 46.
106
105
B de Cazalet and R Reece, above n 46, at 51. JA Huse, above n 23, at 182.
30
107
unforeseen ground conditions, and who may be the least qualified. 108 Tenderers may be reluctant to price the risk and jeopardise being awarded the contract. In addition, the fact that the contractor has performed site investigation is arguably irrelevant to the issue of who should bear the risk, which by definition is unforeseen. 109 It is also argued that financiers and
employers will not be able to distinguish, as the Introductory Note does, between projects where ground conditions are known or certain and projects where ground conditions are unknown or uncertain and for which the Silver Book is therefore inappropriate.110 Henchie has argued that in relation to site data, the standard of what is able to be verified by the contractor is so imprecise as to lead to disputes.111 A number of commentators also suggest that the contractor will try to recover costs from the employer if unforeseen ground conditions are encountered, and that there are various arguments they can make based on other terms in the contract, for instance, that contractors are not responsible for the correctness of the employer's data which cannot be verified.112 The contractor might also argue that Unforeseeable ground unforeseeable ground conditions are a force majeure event.113
conditions could also be characterised as frustration: an event or circumstance outside the control of the parties making it impossible to fulfil contractual obligations, thus releasing the parties from performance.114 This risk allocation, they argue, is therefore likely to cause disputes, and is thus counter-productive. 115 As Huse notes, however, as this allocation of risk increasingly reflects industry practice in relation to international EPC contracts, criticisms should be directed at the practice rather tha n the Silver Book. 116
AH Gaede Jr, "The Silver Book: An Unfortunate Shift from FIDIC's Tradition of Being Evenhanded and of Focusing on the Best Interests of the Project" (2000) 17(4) International Construction Law Review 477 at 485; JA Huse, above n 23, at 52-53.
109
108
See AH Gaede Jr, above n 108, at 485. See AH Gaede Jr, above n 108, at 488. NDJ Henchie, above n 55, at 45. Sub-Clause 5.1(d). Sub-Clause 19.1. Sub-Clause 19.7. AH Gaede Jr, above n 108, at 489-490; NDJ Henchie, above n 55, at 46. JA Huse, above n 23, at 147.
31
110
111
112
113
114
115
116
(d)
Monitoring quality during construction
Tests and standards are necessary for the employer and the financier to be satisfied that the construction is of the quality desired, particularly where contractors may be endeavouring to cut costs to meet a low contract price. However, an unnecessary level of testing should not be permitted to jeopardise cost and time certainty. The Silver Book contains a number of
provisions which permit the employer to oversee construction and be sure it is getting the quality for which it contracted. The Silver Book requires the contractor to carry out the manufacture of plant, the production and manufacture of materials, and all other execution of the works in the manner specified in the contract, in a proper workmanlike and careful manner in accordance with recognised good practice and with properly equipped and non-hazardous materials, except as otherwise specified in the contract.117 Huse suggests that to resolve the ambiguity in the standard of "good practice", parties specify a relevant professional standard.118 The Silver Book provides for a quality assurance scheme which the contractor must institute to demonstrate its performance of its obligations under the contract, and which the employer is entitled to audit. 119 Before each design and construction stage is commenced the contractor must submit to the employer all procedures and compliance documents for that stage. This is not only of benefit to the employer and financiers in gaining a fit project but for the contractor who will be able to know at an early stage whether it is performing to the standard required. However, financiers might also wish for an amendment requiring the employer to approve the quality assurance programme, not just audit it.120 The contractor must also submit to the employer, at the contractor's cost, samples for review in accordance with the procedures for Contractor's Documents.121 The employer and its
personnel must have full access to the site and are entitled at any time during production, manufacture and construction to examine, inspect measure and test the materials and
117
Sub-Clause 7.1. JA Huse, above n 23, at 253. Sub-Clause 4.9. As suggested by JA Huse, above n 23, at 172. Sub-Clause 7.2.
32
118
119
120
121
workmanship and to check progress.122 Importantly for financiers, these inspections do not relieve the contractor of any responsibility or obligation. The employer is empowered by the variations provisions 123 to vary the location or details of specified tests or instruct the contractor to carry out additional tests, and if these varied or additional tests show that the plant, materials or workmanship is not in accordance with the contract, the cost of carrying out the variation will be borne by the contractor, regardless of other provisions of the contract.124 UNCITRAL recommends adding a provision that failure of the employer or contractor to discover a defect during testing does not relieve the contractor of the responsibility of remedying the defect.125 The power to inspect and test is supplemented by the power to reject the plant, materials, design or workmanship by giving notice to the contractor, with reasons, if they are found to be defective or otherwise not in accordance with the contract.126 The contractor must the n
promptly make good the defect and ensure that the rejected item complies with the contract. The Yellow Book also provides that failure to comply with the employer's notice of rejection within 28 days, without reasonable excuse, entitles the employer to terminate the contract. 127 If this is to be included in the contract, financiers should insist they be involved in the decision.128 The employer may instruct the contractor to remove and replace any plant or materials whic h are not in accordance with the contract, remove and re-execute any other work which is not in accordance with the contract, and execute any work which is urgently required for the safety of the works, whether because of an accident, unforeseeable event or otherwise.129 If the
contractor does not comply, the employer may employ others to carry out the work and the contractor must pay all costs arising from this failure in accordance with employer's claims procedure, except to the extent that the contractor would have been entitled to payment for the work. There is no provision for the contractor to repair the work without removing it. Under
122
Sub-Clause 7.3. Clause 13. Sub-Clause 7.4. JA Huse, above n 23, at 259. Sub-Clause 7.5. Sub-Clause 15.2(c)(ii). The necessity of financier involvement in contract administration is discussed further below, at section 3.4(d)(ii). Sub-Clause 7.6.
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123
124
125
126
127
128
129
the Yellow Book, the contractor must also comply within a reasonable time and the employer is entitled to terminate the contract for failure to comply with the instruction within 28 days, without reasonable cause.130 If parties wish to include this extra sanction in their contract, financiers should ensure they have the power to approve or veto the employer's decision. (e) Completion (i) Tests on completion
Tests on completion occur upon completion of construction of the works and signal the employer's take over and the commencement of the defects notification period in which the contractor is responsible for remedying defects in the works. The tests on completion are critical for the employer to ensure that the works constructed are fit for purpose and for financiers to be certain that the project will produce revenue. Importantly, if the works do not pass the tests, the contractor may still be liable for delay damages. The Silver Book provides for 3 stages of testing by the contractor: pre-commissioning (including that items are safe to operate), commissioning (that the works can operate safely under all operating conditions) and trial operation (that the works perform reliably and in accordance with the contract).131 Trial operation can also include additional tests including to determine whether the works conform with criteria specified in the Employer's Requirements and with the performance guarantees. The contractor must submit to the employer a certified report stating that the tests have been passed. Huse suggests the employer would be able to better monitor the tests if the contract required the contractor to develop and follow a particular testing programme.132 If the works or a section of the works fail to pass the tests, Sub-Clause 7.5 applies, discussed above, and either party may require the tests to be repeated under the same terms and conditions. Under Sub-Clause 9.4, after repetition of the tests, if the works or section still fail to pass, the employer may: order repetition of the tests;
130
Sub-Clauses 7.6, 15.2(c). Sub-Clause 9.1. JA Huse, above n 23, at 313.

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131
132
if the failure deprives the employer of substantially the whole benefit of the works or section, reject the works or section and terminate the contract as a whole or in respect of the major part which cannot be put to the intended use; or
issue a taking-over certificate, signifying the works have been completed in accordance with the contract.
If a taking-over certificate is issued, the contract price will be reduced accordingly and the contractor must still comply with other obligations under the contract. The contract may state the amount of this reduction or its method of calculation, or the employer may require both parties to agree on the amount to be paid before the issue of the certificate, or determined and paid under the procedure for employer's claims (Sub-Clause 2.5) and determinations (SubClause 3.5). This process should be acceptable to financiers, as it ensures that the works are fit for purpose and operational and gives the employer considerable power. However, financiers may wish to remove or amend the ability to reduce the contract price for works that do not perform, as their objective is to attain complete performance. For this reason, Huse suggests that lenders be given the power to review whether the contract price is reduced or the contractor instructed to rectify the works. He also suggests lenders consider the effect of the works not performing on the other agreements, such as the concession agreement. 133 This is another clause in which the financier's involvement is in its interests. Financiers could further ensure the requisite standards are met by providing for bonus payments if performance exceeds certain levels. (ii) Tests after completion
The rationale for tests after completion is to ensure the plant meets performance criteria under normal operating conditions, particularly where part of the works must meet an operational standard. The contract should be explicit about what these standards are, and the tests used. Lenders will be concerned to ensure that the minimum standards of performance are appropriate. Parties should also allocate the risk of impossibility of meeting the minimum or expected performance.134 Performance tests after completion are not mandatory in the Silver Book, but if they are included in the Employer's Requirements, which financiers should ensure they are,135 the following applies.
133
JA Huse, above n 23, at 54. JA Huse, above n 23, at 359. JA Huse, above n 23, at 359.
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134
135
The tests must be carried out as soon as practicable after take-over, with the employer determining the dates, in accordance with a set procedure. The contractor must compile and evaluate the tests in a report. 136 In contrast, in the Yellow Book the employer carries out the tests and both parties compile and evaluate the results.137 While the Yellow Book model gives the employer more control, the Silver Book more clearly allocates responsibility to the contractor; financiers will have to determine which they prefer. The contractor may claim for costs incurred as a result of unreasonable delay by the employer to the Tests after Completion.138 It would be preferable to replace the vague standard of "unreasonable delay" with a specific period of time, in order to reduce the potential for disputes. If the works fail to pass a test, the contractor must remedy the defect and either party may the n require the failed tests and tests on any related work to be repeated under the same terms and conditions.139 If the contractor would be liable for the costs of remedying the defect under Sub-Clause 11.2, and the employer incurs additional costs because of the failure and retesting, the employer may claim for these additional costs. The Yellow Book is substantially the same, except there is a narrower range of grounds of costs of remedying work for which the contractor is responsible.140 The Silver Book also permits "deemed passing of tests". The works are deemed to have passed a test if it cannot be completed during the defects notification period for reasons not attributable to the contractor. 141 The Silver Book also allows the works to be deemed to have passed the tests if the contract provides for (or states a method for calculating) nonperformance damages and the contractor pays this sum to the employer during the defects notification period.142 Additionally, a test is deemed to have been passed if, after a failure to pass, the employer does not give notice to the contractor, before the expiry of the defects notification period, of a convenient time to modify the works.
136
Sub-Clause 12.1. Sub-Clause 12.1. Sub-Clause 12.2. Sub-Clause 12.3. Sub-Clause 12.3. Sub-Clause 12.2. Sub-Clause 12.4.
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137
138
139
140
141
142
Financiers may wish to modify these provisions in a number of ways. Firstly, lenders and the employer may want to ensure they get the standard of performance for which the employer has contracted, by reducing the capacity of the contractor to pay damages in lieu of providing complete performance.143 Secondly, financiers may also wish to abolish or limit the possibility for tests for critical items to be deemed passed, given the importance of the works meeting performance standards in a project financed project. Thirdly, lenders may wish to make provision for circumstances that have rendered it impossible to pass a test. Under the Silver Book, in this situation, the contractor's only obligation is the potentially futile one of having to continue to repeat the tests. If the contractor does not do this, the employer may terminate the contract. An alternative may be to allow the payment of non-performance damages instead of termination where the passing of a test is impossible.144 It may be necessary to ensure that any damages paid are consistent with damages that may be incurred through the other agreements involved in the project.145 (iii) Defects notification period
The defects notification period is intended to ensure quality by requiring the contractor to rectify defects notified during a period after take over. In the Silver Book, the length of the defects notification period is one year, unless otherwise stated in the Particular Conditions, and financiers may wish for this to be longer.146 Subject to the procedure for employer's claims set out in Sub-Clause 2.5, the employer is entitled to an extension of the defects notification period for the works or a section thereof if and to the extent that the works, section, or a major item of plant cannot be used for the purposes for which they were intended because of a defect or damage. 147 The sub-clause limits this extension to no more than 2 years. However, for certain projects, employers and financiers may wish to be able to extend the defects notification period for more than 2 years.148 The Silver Book terminology of "defects notification period" rather than "defects liability period" emphasises that the end of the period does not mean the expiry of the contractor's liability itself, but only of the employer's ability to notify the contractor of a defect in order for
143
JA Huse, above n 23, at 359. JA Huse, above n 23, at 366. JA Huse, above n 23, at 55. Sub-Clause 1.1.3.7. Sub-Clause 11.3. JA Huse, above n 23, at 639.
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144
145
146
147
148
it to be the contractor's responsibility. Parties should ensure they are aware of the effect of the applicable local law on defects liability. So that the works are in the condition required by the contract at the date of the expiry of the defects notification period, the contractor must: complete any work stated to be outstanding in a taking-over certificate within such reasonable time as is instructed by the employer; and execute all work required to remedy defects or damage as is notified by the employer on or before the expiry date of the defects notification period.149 The employer can also require the contractor to search for the cause of any defect.150 The contractor thus may be obliged to remedy defects even after the expiry of the defects notification period, if the employer notifies the contractor of the defect on or before the expiry date. Under the Silver Book the contractor is responsible for rectifying all defects, not just those it has caused. This is in financiers' interests, for if the contract provided that the contractor was only responsible for remedying defects attributable to it, the employer would have to use the variations clauses and thus be liable for additional costs or extensions of time. It may be prudent, however to amend the sub-clause to expressly provide that a defect includes an omission. 151 Additional amendments to make the sub-clause more favourable to employers could include adding a latent defects liability period, and allowing the employer to choose to remedy the defect itself and then recover the costs from the contractor. 152 Under the Silver Book, the contractor may receive costs for any remedial work unless and to the extent that the work is attributable to: the design of the works; plant, materials or workmanship not being in accordance with the contract;
149
150
151
JK Hoyle, "The Rainbow Down Under - Part 1: Some Reflections from the Antipodes on Aspects of the New FIDIC Design-Build Contracts" (2001) 18(1) International Construction Law Review 5 at 31-32. JA Huse, above n 23, at 638.
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152
improper operation or maintenance which was attributable to matters for which the contractor is responsible; or
the contractor's failure to comply with any other obligation. 153
Significantly, by stipulating the circumstances in which the contractor must bear the cost of remedial work, the employer bears the burden of demonstrating that the circumstances fall within the grounds specified. This is arguably inconsistent with the contractor's responsibilities to design and construct to a standard of fitness for purpose.154 Additionally, the sub-clause does not specify the result of the defect being attributable to the defective design of the employer, and parties should clarify the allocation of responsibility for this in the Particular Conditions.155 It is in financiers' interests for contractors to remain responsible for costs of rectifying such defects. The contractor must remedy any defect within a reasonable time; if it fails to do so, the employer may fix a date on or by which the defect must be remedied, provided the contractor receives reasonable notice of this date.156 If the contractor fails to comply with this later date the employer may (provided the contractor would have been responsible for the cost of the rectification): 157 carry out the work himself or by others at the contractor's cost (the contractor shall have no responsibility for this work); agree or determine a reasonable reduction in contract price; or terminate the contract in whole or part if the defect or damage deprives the employer of substantially the whole benefit of the works or any major part of the works. The contractor is then liable, in addition to any other liabilities, to pay back all sums paid for the works, to pay financing costs, and for the cost of dismantling the works, clearing the site and returning plant and materials to the contractor.
153
Sub-Clause 11.2. JK Hoyle, above n 151, at 32.
154
JA Huse, above n 23, at 343. Note that the Yellow Book Sub-Clause 11.2 excludes rectification work attributable to the employer's design from the contractor's risk and cost.
156
155

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157
This last option gives the employer considerable power to effectively undo the work done and oblige the contractor to put the employer back in the position he was at the start, although it is somewhat difficult to imagine this option being used in practice, except reluctantly as a last resort. It may be advisable for the financier to have a contractual role in the administration of this provision, as its interests are liable to be detrimentally affected by the decision. The contractor's obligations under the contract are only complete and the works are only deemed accepted when the employer issues the Performance Certificate, stating the date on which the contractor's obligations were completed.158 This must be issued within 28 days of the latest of the expiry dates of the defects notification periods, or as soon thereafter as the contractor has performed all required obligations, such as remedying defects. If the employer fails to issue the certificate, it is deemed issued on 28 days after the date on which it should have been issued.159 If this occurs, the contractor is not required to clear the site and may claim additional expenses even though the final statement has been submitted. Financiers may wish to press for this provision to be deleted, or require financier involvement in this function to ensure a deemed issue of the Performance Certificate does not occur. Employers and lenders may also wish to amend this sub-clause so that the contractor is still obliged to clear the site where the certificate is deemed to be issued, as the present position seems unnecessary. The employer may also require the provision to expressly state that the issuance of the certificate does not exclude the contractor's continuing liability in contract or at law.160 (f) Quality risk under the Silver Book: conclusion
The Silver Book generally addresses the requirements of project finance in relation to quality risks. All design risk is allocated to the contractor through the use of a fitness for purpose standard and requiring the contractor to bear responsibility for verifying site data and the occurrence of unforeseeable ground conditions. However, there are some minor amendments which financiers may require, including limiting the areas for which the employer retains design responsibility. The Silver Book also provides for reasonable employer monitoring of quality and performance throughout construction and completion. However, financier
involvement in key decisions which could have a negative impact on the long-term performance of the project asset would be beneficial. 3.4 Other risks for the financier
158
Sub-Clause 11.9. Note that the Yellow Book does not allow for the deemed issue of the performance certificate (Sub-Clause 11.9). JA Huse, above n 23, at 640.
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159
160
Within these broad categories of risk are a number of risks which deserve special mention because their consequences may overlap between the various classes, or because their occurrence is commonplace in construction projects. (a) Variations
Variations give rise, or may be a response to, cost, time and quality risks. Quality is an issue because the variation is an attempt to improve the design of the works. However, quality risks may flow into time and cost risks: ordering variations will usually delay completion and may entitle the contractor to remuneration for costs associated with the varied work. Financiers thus have an interest in the contractual terms governing variations and in ensuring a balance between the need for a revenue-producing project and the avoidance of delay to the commencement of the revenue stream. A variation is defined in the Silver Book as "any change to the Employer's Requirements or the Works" which is instructed or approved under Clause 13.161 Sub-Clause 13.1 gives the
employer the power to initiate variations at any time prior to taking over by issuing a n instruction or requesting the contractor to submit a proposal. One restriction on this power is that a variation may not comprise the omission of any work which will then be carried out by others. The contractor is bound by a variation unless it promptly gives notice to the employer with supporting particulars that: it cannot readily obtain the goods required; it will reduce the safety or suitability of the works; or it will have an adverse effect on the achievement of the Performance Guarantees.
The employer must then cancel, confirm or vary the instruction. This sub-clause gives the employer significant power, and it has been suggested that this is inconsistent with the contractor being bound to a fitness for purpose standard.162 Additionally, there is no restriction that the variations instructed be within the scope of the contract.163 These factors make this provision favourable to the employer and thus the financier.
161
Sub-Clause 1.1.6.8. E Corbett, above n 70, at 270. In contrast with some Australian standard form contracts: JK Hoyle, above n 151, at 35.
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162
163
In addition to these employer-initiated variations, the contractor is empowered to make proposals that would accelerate completion, reduce the cost to the employer of executing, maintaining or operating the works, improve the efficiency or value of the completed works or otherwise be of benefit to the employer.164 However, there are no incentives provided in the contract for the contractor to share such information, as the contractor must prepare it at his own cost and it could potentially reduce the contract price. It is in financiers' interests, in obtaining a better product, to provide such incentives to the contractor.165 The procedure for variations is outlined in Sub-Clause 13.3. The employer may request a proposal prior to instructing a variation, in which case the contractor must respond as soon as practicable and give either: reasons why he cannot comply; or submit a description of the proposed design and/or work to be performed; a programme for its execution; proposed modifications to the programme and time for completion; and proposed adjustments to the contract price. The employer, as soon as practicable after receiving this, must respond with approval, disapproval or comments. However, the contractor must not delay work while awaiting this response. The employer must issue to the contractor an instruction to execute a variation and stipulate whether the contractor must record costs incurred, after which the contractor is required to acknowledge receipt of the variation. The employer then agrees or determines adjustments to the contract price and schedule of payments, in accordance with Sub-Clause 3.5 on determinations. These adjustments must include reasonable profit and, if applicable, take account of the contractor's submission of the proposal to accelerate completion under SubClause 13.2. As mentioned above, the contractor is entitled to an extension of time for an employer-initiated variation. 166 However, the procedure for contractor's claims in Sub-Clause 20.1 means that if the contractor fails to give notice of the claim within 28 days, it will lose the entitlement to the extension of time, or additional costs, so the employer may get the benefit of a variation for free.167
164
Sub-Clause 13.2. JA Huse, above n 23, at 377. Sub-Clause 8.4. AH Gaede Jr, above n 108, at 500-501.
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165
166
167
While the variations provisions allow the work to be improved at the employer's instruction, the potential for variations to delay completion means that financiers should be closely involved in the decision to instruct a variation. 168 The Silver Book could also better encourage contractor initiative. (b) Notice provisions and determination of contractors' claims
Notice provisions, by facilitating the timely flow of information, are crucial in project financed projects in which time is critical. In particular, where the contractor wishes to make a claim for extra payment or an extension of time, it is desirable that the employer be in a position to make enquiries as to the cause and extent of any delay or increase in cost, and consider its position. Requiring notice to be given of claims is an effective method of ensuring this. The precise form of provisions requiring notice will be of interest to the financier. Of
particular note is whether a notice requirement operates as a condition precedent to payment or an extension of time, or whether the claim is not barred notwithstanding the failure to comply with the notice requirement. In the Silver Book, compliance with notice provisions is a
condition precedent to consideration of a claim for additional payment or an extension of time 169. That is, the contractor must give notice to the employer, describing the event or circumstance giving rise to the claim, as soon as practicable, and not later than 28 days after the contractor became aware, or should have become aware, of the event or circumstance. Further, the contractor must submit any other notices which are required by the contract, and supporting particulars for the claim as relevant to the event or circumstance. The contractor must keep records that are necessary to substantiate the claim, and the employer may monitor this record-keeping, instruct the contractor to keep further records, inspect the records, and instruct the contractor to submit copies to the employer. Within 42 days after the contractor became aware or should have become aware of the event or circumstance giving rise to the claim, the contractor must give the employer a fully detailed claim with full supporting particulars. This 42 day limit may be varied if approved by the employer. This procedure should be satisfactory to financiers, particularly if there is provision for their involvement in the employer's role. This would ensure that financiers are kept informed of potential claims that could threaten cost or time certainty, and that all information regarding the circumstances of the claim flows from the contractor to the employer to (ideally) the financier.
168
This will be examined more fully below at 3.4(d)(ii). Sub-Clause 20.1.

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169
The determination process for claims is contained in sub-clause 3.5, which provides that the employer shall consult with the contractor in an endeavour to reach agreement regarding the claim, and "if agreement is not achieved the Employer shall make a fair determination in accordance with the Contract, taking due regard of all relevant circumstances". The requirement that the employer's determination be "fair", effectively gives the contractor a n additional ground to challenge the determination. From the financier's perspective it may be preferable for this word to be deleted. The determination process of contractor's claims outlined above should be reasonably attractive to financiers for the following reasons: Time limit: the requirement that unless the contractor submit its claim within 28 days or else it is invalid prevents the employer, and consequently the financier, from being indefinitely liable for valid claims; Discretion in determination: the determination of the claim is ultimately at the employer's discretion if it is unable to agree with the contractor. (c) Security
In project finance, the financiers will take security over the assets of the project. In reality, however, such security is at best "defensive" in many infrastructure projects. By taking
security over those assets, financiers do not expect the value of those assets to cover the debt. Security over the assets may, however, prevent third party interference with the assets and allow the financiers to "pick up the pieces" of a project after insolvency. Under the Silver Book, the financier will have recourse to the assets when legal title, free from liens and other encumbrances, of the plant and materials passes to the employer, being the earlier of when it is delivered to the site, and when the contractor is entitled to payment of the value of the plant and materials.170 However, this is only to the extent consistent with the laws of the country, and it would be advisable to seek advice on the impact of these laws on the financier's interests. Importantly, however, where the asset has not yet been completed, and the financier bears construction risk, the insolvency of the project vehicle poses large problems for the financier. The assets over which they hold security are incomplete, and the cash-flows (from which the debt was to be serviced) cannot be produced. One solution is for the financier to take security over bank guarantees which are provided by the contractor to the employer as security for the performance of the contractor's obligations
170
Sub-Clause 7.7.
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under the construction contract. If the Particular Conditions state an amount, Sub-Clause 4.2 requires the contractor to obtain performance security for proper performance, at the contractor's cost. The contractor must deliver this security to the employer within 28 days of both parties signing the contract and the employer is able to approve the entity and jurisdiction from which the security is issued. The employer also has the power to approve the form in which it may be issued, if the form annexed to the Particular Conditions will not be used. The contractor must ensure that the performance security is valid and enforceable until the contractor has executed and completed the works and remedied any defects, including being able to extend it if necessary. The circumstances in which an employer may make a claim on the performance security are:171 failure by the contractor to extend the validity of the performance security, in which case the employer may claim the full amount of the performance security; failure by the contractor to pay the employer an amount due as either agreed by the contractor or determined under the procedure for employer's claims (Sub-Clause 2.5) or the dispute resolution process, within 42 days; failure by the contractor to remedy a default within 42 days after receiving the employer's notice requiring the default to be remedied; or circumstances which entitle the employer to termination under Sub-Clause 15.2, irrespective of whether notice of termination has been given. 172 However, the employer must indemnify and hold the contractor harmless against any loss, damage or expense arising from a claim to the extent that the employer was not entitled to make the claim. The employer must return the performance security to the contractor within 21 days of the contractor becoming entitled to receive the performance certificate. The ability of the employer to control the nature and form of the security should be acceptable to financiers. In addition, under the sample performance security annexed to the Silver Book the employer does not need evidence that a precondition for a claim against the security has been fulfilled. However, there is a loophole which reduces the ability of the employer to promptly call on the performance security.173 As regards a claim on the performance security
171
Sub-Clause 4.2. Termination is discussed below at 3.4(e). AH Gaede Jr, above n 108, at 496-497.
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172
173
due to the contractor's failure to pay an amount determined under employer's claims procedure, the contractor may refer the question to the dispute resolution process, thus impeding the employer's prompt recovery of security. A financier would wish to call up this performance security in the event of a breach by the contractor under the construction contract. To do this, the financier obviously needs to take security over the employer's rights in respect of the performance security. The security would contain provisions: preventing the employer accepting performance security without first obtaining the financier's approval of the proposed issuer, the terms of the performance security and the terms of the construction contracts (if any) regulating the rights of the owner to make a demand under the performance security; preventing the employer varying the terms of any performance security or the terms on which any performance security is held; preventing the employer, without the financier's consent, releasing the performance security to the contractor except when and to the extent to which it is obliged to do so under the construction contract; obliging the employer to deposit all moneys received by it under the performance security into a nominated bank account; and restricting drawings by the employer from the bank account and entitling the financier, in a default situation, to withdraw from that account any moneys to which the employer is then absolutely entitled. As well as taking security over bank guarantees, the financier may protect its interests through having security over all the construction contracts. In this way, the financiers will be in a position to step in and complete construction, and perhaps produce an asset capable of generating the desired revenue stream. By taking security over the employer's rights under the construction contract, a financier will, in the event of a default, have a contractor already on site who has contracted to complete the works for a specific price and within a specific time frame. This is beneficial not only to the financier itself but also to anyone who then purchases the site from the financier. Some of the provisions which would be expected to be in such a security include:
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an obligation upon the employer to perform its obligations under the construction contract;
the employer to advise the financier of any default by the contractor under the construction contract or of any dispute with the contractor;174
the employer to exercise or refrain from exercising its rights and remedies under the construction contract in accordance with any direction from the financier; and
the employer being prevented, without the consent of the financier, from exercising its right to terminate the construction contract or agreeing to vary the construction contract or the plans and specifications (at least where the variation may cause cost or time blowouts or adversely change the quality or scope of the works).
Additionally, financiers should also consider having a direct contractual recourse to other parties, such as the contractor, in order to safeguard their interests. For this purpose a
collateral contract may be useful. First, collateral contracts can provide the means by whic h project targets can be adhered to in the event of the insolvency of, say, the project vehicle, or the head contractor. It is possible to minimise, through collateral contracts, the need to Second, collateral
completely re-contract the project in order to bring it to completion.
contracts enable a party to recover damages for loss occasioned by the actions of another party with whom that party would not normally be in a contractual relationship. In the absence of a collateral contract the wronged party must rely upon much less certain remedies such as tort or trade practices/fair trading legislation. There are three parties with whom financiers may wish to have a collateral contract: the contractor, subcontractors and consultants. A key provision of a collateral contract with the contractor would be an undertaking by the contractor not to terminate the construction contract as a result of default by the project vehicle without first giving the financier an opportunity to remedy the default. Such "cure" provisions are common to other project finance documents as well. The contractor's side agreement would also contain a provision entitling the financier to assume the employer's rights and obligations, in effect, under the construction contract in the event of a default by the employer under the debt agreement. Alternatively, there could be provision for a third party to
completely take over the project company's rights and obligations under the contract.
174
Such default would hopefully also come to the knowledge of the financier as a consequence of its participation in contract administration.
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The objectives behind this agreement are to secure the funds advanced by the contractor and to ensure the successful completion of the project without the need for the financier to arrange for another contractor to complete the works. If the financier were forced to take this course of action, many attendant delays and additional costs would materialise. From the contractor's point of view, it will usually be secure in the knowledge that if the employer defaults and the financier wishes to complete the project, it has a good chance of being paid for the work carried out to the date at which they became entitled to terminate or suspend the construction contract. Additionally, by completing the project for the financier in the event of the
employer's default or insolvency, the contractor secures its profit for the whole of the project works. The financier may also include other useful provisions in the collateral contract made with the contractor. For instance, it is advisable that it contain a provision obliging the contractor to include in each subcontract a provision that where the contractor is in default under the construction contract the employer, or, where the employer is in default under the debt agreement, the financier, may take an assignment of the subcontract. In relation to assignment of the subcontracts, the financier can go one step further and enter into a collateral agreement directly with the subcontractors. This is preferable from the
financier's point of view particularly in the situation where both the employer and contractor become insolvent. Such agreements should give the financier the right to require the
subcontractors/suppliers to agree to an assignment of their agreement from the contractor to the financier or its nominee. A financier may also wish to enter into a collateral agreement with the design consultants, in order to provide the financier with a contractual remedy against the consultants where loss has been occasioned by defective design. Such a collateral contract provides some measure of protection to a financier where it is necessary to "build out" of the difficulties rather than to dispose of the security in its existing condition. (d) Intervention (i) By the Employer
The Introductory Note states "the Contractor should be given freedom to carry out the work in his chosen manner, provided the end result meets the performance criteria specified by the Employer. Consequently, the Employer should only exercise limited control over and should in general not interfere with the Contractor's work". However, the Silver Book itself allows
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the employer considerable scope for involvement in the execution of the works. While these provisions help ensure the employer gets the project for which he contracted, if too excessively used they can be counter-productive and impede timely progress. Therefore, while the
financier will prefer the balance of power to favour the employer, it would be wise to ensure the financier is involved in the decision to interfere. In addition, from the contractor's
perspective, the provisions are a controversial inclusion in a turnkey contract, so financiers can expect resistance in the negotiation of the contract. The Silver Book gives the employer power to issue "instructions which may be necessary for the Contractor to perform his obligations".175 Such an instruction may constitute a variation, in which case the variations provisions apply.176 This sub-clause has significance, for when used in combination with other provisions it allows the employer to interfere in the manner in whic h the contractor performs its obligations. For example, as already discussed, the Silver Book (in contrast with the Yellow Book) limits the employer's powers to reviewing, not approving, the Contractor's Documents.177 However, the employer could use its power to issue instructions to further control the Contractor's Documents, despite the ostensible design responsibility of the contractor. This power is also problematic for the contractor because of the ambiguity of instructions "which may be necessary"; it seems likely to invite dispute. One author has suggested clarifying the provision and more strictly confining the employer's power to issuing instructions which are necessary and are contractual.178 Another area in which the employer may interfere is to use the variations clauses to nominate a subcontractor.179 The contractor may only refuse if it raises reasonable objection by notice to the employer as soon as practicable, accompanied by supporting particulars. This enables the employer to control the quality and price of subcontracted work, while the contractor retains liability. Gaede argues this is inappropriate for a turnkey project given that the contractor bears the risks and responsibilities of their actions. He also suggests that parties will debate the meanings of "reasonable objection", "as soon as practicable" and "supporting particulars". 180 Also, the rationale of lowering cost is less applicable to a lump sum turnkey contract.
175
Sub-Clause 3.4. Discussed above at section 3.4(a). Sub-Clause 5.2.
176
177
AH Gaede Jr, "Letter to the editor: FIDIC Conditions" (2001) 18(4) International Construction Law Review 703 at 707.
179
178
Sub-Clause 4.5. AH Gaede Jr, above n 108, at 482.

49
180
Otherwise, as the Silver Book contains no requirement that subcontractors be approved by the employer, financiers might wish for the inclusion of some sort of consent procedure, as in the Yellow Book where all subcontractors not named in the contract must be approved by the engineer.181 This would enable greater control over the quality of the work. As discussed above,182 the employer may instruct the contractor to accelerate if the contractor has fallen behind the programme or actual progress is too slow to complete on time. 183 Contractors argue that they should be allowed to be behind as long as they complete on time, which is in their interests after all to avoid liability for delay damages. However, the
importance of certainty of time in project financed projects means this provision is important. Additionally, this is less unreasonable than some have asserted:184 the programme to which the contractor must adhere will not be out-of-date as the contractor has an obligation under SubClause 8.3 to submit revised programmes whenever the previous programme and actual progress are inconsistent. The Silver Book provides that the contractor must submit monthly progress reports to the employer, enabling the employer to monitor progress and the quality of the work. 185 The contents of the progress reports are required to be quite detailed and have been criticised as placing too onerous a burden on contractors, particularly if the employer has an Employer's Representative on site who will be keeping the employer informed as well. 186 Lenders may wish to have access to the progress reports. Other provisions that involve the employer in the execution of the works that have been discussed above include: employer review of the drawings and documents that the Employer's Requirements require to be submitted;187 inspection rights,188 which Gaede believes this is often a method of undue interference by employers.189
181
Sub-Clause 4.4. At section 3.2(c). Sub-Clause 8.6. See for example NDJ Henchie, above n 55, at 48-49. Sub-Clause 4.21. JA Huse, above n 23, at 193.
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182
183
184
185
186
rejection of the plant, materials, design or workmanship and instruction to retest;190 and
instructions to conduct remedial work.191
While financiers and employers will be happy with this ability to control the project, these provisions have been criticised as incompatible with the fitness for purpose standard and the allocation of risk to the contractor in the Silver Book and turnkey contracts generally. 192 However, Christopher Wade, who was Chairman of FIDIC's committee for International Contract Conditions at the time of the drafting of the new suite, has defended the Silver Book model of employer interference. He acknowledges that undue interference by the employer can have time and costs impacts on the contractor, but argues that having no control over the contractor could result in an unfinished project. He believes that the problem of contractors underperforming is equal to the risk of undue interference by the employer. The employer has a right to know that time, cost and quality are being complied with.193 He notes that parties can delete or modify the relevant clauses if they are unhappy with them, or if, as the Introductory Note observes, the employer wants to have greater supervision of the contractor's work or construction drawings.194 Employer control may also be necessary given that
contractors may be concerned only with short-term profitability and minimum standards, rather than the long-term quality requirements of the employer and the financier. (ii) By the lender
For many purposes it is useful to consider the financier's position as more or less equivalent to that of the owner or project vehicle, in that it desires to contain cost, and ensure timely completion and quality.
187
Sub-Clause 5.2. Sub-Clause 7.3. AH Gaede Jr, above n 108, at 483. Sub-Clause 7.5. Sub-Clause 7.6.
188
189
190
191
E Corbett, above n 70, at 269-270; J Delmon and J Scriven, "A Contractor's View of BOT Projects and the FIDIC Silver Book" (2001) 18(2) International Construction Law Review 240 at 243; AH Gaede Jr, above n 108, at 479, 501; JK Hoyle, above n 151, at 17.
193
192
C Wade, above n 108, at 512-513. C Wade, above n 108, at 511-513.

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194
However, the financier is somewhat removed from the administration of the contract, and without adequate provision being made, may not be able to safeguard its interests in the same manner as may the project vehicle. For this reason, it is important that financiers bargain for an opportunity to participate meaningfully in contract administration, in particular the employer's power to intervene in the execution of the works. The financier, if it is to participate fully and constructively in the process of contract administration, must have access to the information it requires to make informed decisions. Mandatory reporting obligations will generally be placed on the project vehicle, as it will typically be in the best position, apart from the contractor, to gauge the progress of the works. In this manner the financier can be kept abreast of developments and potential problems, hopefully for any difficulties to be overcome. The problem will often remain, however, that the lender is reliant on other parties for the raw information that they require. One method of overcoming this problem is for lenders to engage the independent certifier or contract administrator jointly with the project vehicle on some projects. In this manner, the contract administrator/independent certifier will be to some extent required to take into account the interests of the financier when certifying work done under the contract. This helps to ensure that the financier is kept informed and that the financier's interest is taken into account by the independent certifier when important matters are certified, such as completion. Lenders may wish to have direct involvement in contract administration through the appointment of a lender's engineer or technical adviser who could exercise some control over matters of particular concern to lenders, such as extensions of time, variation, and testing. This would also require provisions for access and inspection. However, the amendments should endeavour to minimise the potential for such involvement to be counter-productive and delaying.195 One area in which financiers should take an active role is with regards to variations. As discussed above,196 variations have the ability to impact on all three key areas of risk. While variations are almost bound to occur in any sizeable project, their consequences should not be overlooked. A large number of variations and consequent extensions of time over the life of a project may lead to a cost blow-out, which may place a lender in an invidious position, being forced to lend more funds solely to ensure that the project does not flounder. For this reason a
195
JA Huse, above n 23, at 67. At section 3.4(a).

52
196
lender should have a right to approve all variations before they are ordered. By ensuring that no variation may proceed without the financier's consent, the potential for variations to detrimentally affect the lender's financial position is reduced. It should be noted that many variations may be in the best interests of all parties. Often, a variation will be made which will improve the quality of the project, or reduce long term maintenance costs. In such a case, it may not be productive for the financier to exercise their rights to veto changes in the works. The financier should accordingly ensure that it exercises any rights it has regarding variations only when fully appraised of the circumstances surrounding the variation. Financiers have a legitimate interest in contract administration, and accordingly, they should be willing to participate actively in contract administration issues. (e) Termination of the contract
Though termination of the construction contract for the default of one of the parties is likely to be fatal to the project, adequate provision in the contract for termination may facilitate successful re-tracking. In major projects, the circumstances in which the contract allows
termination ought to be well defined. If one party purports to terminate a contract, and this purported termination is wrongful, the terminating party has repudiated the contract. To avoid the uncertainty associated with the common law position, detailed contractual provisions regarding when a party may terminate for default may be used to great effect. Thus, when a contractor is in default, the contract may be readily terminated and the defaulting contractor replaced before the project is irreparably harmed. However, termination provisions should be drafted to be consistent with other project agreements, such as the concession agreement. (i) Termination by the contractor
The contractor is entitled, after giving notice, to suspend work if the employer is late with payments or fails to give evidence of financial arrangements as required by Sub-Clause 2.4.197 However, the contractor must resume work as soon as is reasonably practicable once the employer subsequently gives the evidence or makes the payment. Under the Silver Book the contractor may terminate the contract after giving 14 days' notice to the employer if: 198
197

53
198
the contractor does not receive reasonable evidence of the financial arrangements of the employer within 42 days of giving notice to suspend under Sub-Clause 16.1;
the contractor does not receive a payment within 42 days of the expiry of the time in which the payment is to be made;
the employer substantially fails to perform its obligations under the contract; or the employer fails to comply with Sub-Clause 1.7, prohibiting assignment without consent of any benefit or interest under the contract.199
This notice provision should be significant when the notice periods of the referred sub-clauses are accumulated. However, financiers could request that the contractors give notice of
intention to terminate to the financiers so step-in rights could be exercised. Financiers should also ensure that for these events there is express provision that if the employer cures the default during the notice period the termination is annulled. 200 The contractor may by notice terminate the contract immediately if: a prolonged suspension affects the whole of the works as described in Sub-Clause 8.11; or the employer becomes bankrupt or insolvent, goes into administration, has a receiving or administration order made against him, compounds with his creditors, or carries on business under a receiver, trustee or manager for the benefit of his creditors, or if any act is done or event occurs which (under applicable laws) has a similar effect to any of these acts or events.201 The Silver Book provision in Sub-Clause 16.4 for compensation to the contractor if the contractor terminates the contract is broader than is usual in project finance; in particular the 5 aspects for which the employer must pay the contractor following termination following a
Sub-Clause 1.7 prohibits either party from assigning the whole or any part of the contract or any benefit or interest under the contract, except with the prior agreement of the other party (at the sole discretion of that party) and assigning its rights to moneys due under the contract as security in favour of any bank or financial institution.
200
199
JA Huse, above n 23, at 474. Sub-Clause 16.2.

54
201
force majeure event do not reflect practice, where the employer and the contractor normally split the risk.202 (ii) Termination by the employer
If the contractor fails to carry out any obligation under the contract, the employer may by notice require the contractor to remedy the failure within a specified reasonable time.203 This is a wide power as it is not limited to failure to carry out a material obligation but covers any obligation. Under the Silver Book, the employer may terminate the contract after giving 14 days' notice to the contractor if the contractor: fails to comply with the notice to correct under Sub-Clause 15.1; fails to comply with Sub-Clause 4.2 on performance security; abandons the works or otherwise plainly demonstrates the intention not to continue performance of his obligations under the contract; without reasonable excuse fails to proceed with the works in accordance with Clause 8 on Commencement, Delays and Suspension; or subcontracts the whole of the works or assigns the contract without the required agreement with the employer. 204 The employer may terminate the contract immediately if the contractor: becomes bankrupt or insolvent, goes into administration, has a receiving or administration order made against him, compounds with his creditors, or carries on business under a receiver, trustee or manager for the benefit of his creditors, or if any act is done or event occurs which (under applicable laws) has a similar effect to any of these acts or events; or
M Wahlgren, "Delivering Infrastructure: International Best Practice - FIDIC Contracts: A Developer's View", August 2002, (paper based on a talk given to the conference "Delivering Infrastructure: International Best Practice" organised by the Society of Construction Law, Centre of Construction Law at King's College, London, European Society for Construction Law and Society of Construction Arbitrators and held in London on 12th July 2002) available at www.scl.org.uk/papers/papers99on.php, at 5-6.
203
202
Sub-Clause 15.1.
55
gives or offers to give (indirectly or directly) to any person any bribe, gift, gratuity, commission or any other thing of value, as an inducement or reward: for doing or forbearing to do any action in relation to the contract; or for showing or forbearing to show favour or disfavour to any person in relation to the contract, or if any of the contractor's personnel, agents or subcontractors does so. Lawful inducements or rewards to contractor's personnel shall not entitle termination. 205
The employer may then complete the works and/or arrange for others to do so, and they may use any goods, contractor's documents or design documents made by or on behalf of the contractor. Upon termination for cause pursuant to Sub-Clause 15.2, the employer may still proceed with any employer's claims he has, withhold payments to the contractor until costs owed to the employer have been established, and/or recover any losses or damages from the contractor. 206 Again, the parties should clarify whether the contractor's cure of the default during the notice period annuls the termination. Given the expense and disruption to the project caused by termination, it may be in the financiers' interest to allow the contractor to cure the default and continue. The employer is also entitled to terminate the contract for the employer's convenience, with effect 28 days from the later of the date of giving notice or returning the performance security.207 However, the employer may not terminate under this provision in order to execute the works himself or arrange for the works to be executed by another contractor. This is a powerful provision, the exercise of which may not necessarily be in the financier's interests. The financiers should ensure that the employer has to gain their consent before terminating the contract.
204
Sub-Clause 15.2. The Yellow Book provides two addition grounds for termination by the employer: failure to comply with a notice within 28 days issued under Sub-Clause 7.5 (Rejection) or Sub-Clause 7.6 (Remedial Work). Huse suggests that the omission of these in the Silver Book is a printing error: JA Huse, above n 23, at 453.. Sub-Clause 16.2. Sub-Clause 15.4. Sub-Clause 15.5.
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205
206
207
4.
Does the Silver Book go far enough for financiers? It has been suggested that, compared with the project finance construction contracts which are normally used, the Silver Book still favours the contractor.208 In addition to those already highlighted, from the financier's perspective, there are a number of inadequacies in the Silver Book, and parties should consider making some amendments in order to better address the financier's requirements. The contract should be drafted to be in harmony with the concession contract. For example, definitions of force majeure and "change in law" should be consistent so that the contractor's entitlements under the construction contract are the same as the employer's entitlements under the concession contract. Similarly, termination and inspection provisions should work together and lenders may wish to make contractors' claims contingent on the employer recovering under the concession contract.209 A number of amendments would more directly protect the financiers' rights and make the Silver Book more acceptable for financiers. Firstly, potential cost overruns could be catered for by sponsors or the contractor (particularly if it is also one of the sponsors), providing a stand-by line of credit.210 Secondly, the financier may oblige the contractor to undertake not to do anything inconsistent with the financier's interests under the loan and security documentation.211 This could include a requirement that payments to the contractor are made subordinate to payments to the financier. Thirdly, the financier could request the inclusion in the construction contract of some of the employer's obligations that would typically be in the lending agreement, including guarantees not to amend or waive rights under the construction contract, or substantially changing the project plans, without the consent of the financier. The Silver Book could also be improved by eliminating some of the vague and ambiguous standards where they are imposed against the employer/financier. For example, where
particular performance standards are required to achieve the level of revenue, these could be specified in the contract. Additionally, the Silver Book's frequent use of a standard of
reasonableness increases the potential for disputes over what is "reasonable" in the circumstances, which is not in the interests of financiers or the project.212
208
M Wahlgren, above n 202, at 6. B de Cazalet and R Reece, above n 46, at 52. JA Huse, above n 23, at 69. B de Cazalet and R Reece, above n 46, at 52.
209
210
211
212
A standard of reasonableness is used in Sub-Clauses 2.1, 2.2, 2.4, 4.5, 4.6, 4.8, 4.15, 4.18, 4.24, 6.7, 6.11, 7.3, 7.4, 8.5, 10.3, 11.1, 11.4, 11.8, 12.2, 12.4, 15.1, 15.2, 16.1, 16.2, 18.2, 18.3, 19.1, 19.3, and 19.6.
57
5.
What is the practical application of the Silver Book? The Silver Book was a response to a perceived bargaining strength of financiers and a need, therefore, to make the Silver Book practical, by reflecting that market climate. Since it was published, however, the market has changed: contractors are in a stronger position. Previously, an excess of contractors forced them to assume significant risks, incur greater costs in bidding, and obtain lower profits, usually less than 2% of the contract value.213 The
decrease in competition among contractors means that contractors now have more power to choose their projects and negotiate terms, which has a significant impact on project finance. 214 The Silver Book model of satisfying lenders' demands for certainty of cost and completion by shifting most risk onto the contractor may not be applicable in the current environment. In the Middle East, for instance, EPC contractors are demanding flexible cost reimbursement contracts where cost increases are shared with the sponsor. 215 Contractors, particularly established contractors, may not be willing to bid on a competitive lump sum turnkey basis.216 Consequently, new strategies have recently developed that replace cost certainty with flexibility: The contractor is retained on the basis of experience and man-hour rates and prepares a lump sum estimate on a reimbursable basis, then under the contract converts the estimate into a fixed price.217 The "target price approach" or "guaranteed maximum price" contract (for the whole project or part thereof). Sponsors share savings with the contractor if the actual cost is less than the guaranteed maximum price, but the contractor bears the risk of actual cost exceeding the guaranteed maximum price. basis.218 This encourages the
contractor to be cost-effective, and contractors have been happy to contract on this
213
J Jenkins, P Leighton and J Staigerwald, "Current Trends in EPC costs", in Rod Morrison (ed), Project Finance International Yearbook 2006, Thomson Financial, London, 2006, at 11. A Campomar, "What Price Chemicals?" (2006) 269 Project Finance 47 at 48; J Jenkins, P Leighton and J Staigerwald, above n 213, at 15. Michael Marray, "Backseat Drivers", (2006) 267 Project Finance 62 at 62. A Campomar, "What Price Chemicals?" (2006) 269 Project Finance 47 at 48. J Jenkins, P Leighton and J Staigerwald, above n 213, at 15-16.
214
215
216
217
218
J Jenkins, P Leighton and J Staigerwald, above n 213, at 15-16; M Lucas, "Old Risks - New Contracts" (2006) 271 Project Finance 32 at 32-33.
58
EPCM (engineering procure and construction management) contracts, in which more efficient pricing is achieved through the sponsor bearing the fundamental process design risk. However, lenders usually require sponsors to expose their balance sheets for the purposes of completion risk.219
Where financiers retain a preference for a lump sum turnkey contract, these alternative models may be coupled with sponsor guarantees or only using contractors with a proven track record of completing on time and to cost.220
These market changes, combined with the unfavourable perception of the Silver Book, work against its use as a standard form contract for project finance. Some authors have suggested that the Silver Book, alone of the new FIDIC contracts, is not used regularly due to its reputation as "draconian".221 Notably, the current World Bank Standard Bidding Document for the supply and installation of plant and equipment, which has been revised since the Silver Book, is based on a contract favourable to the contractor - the Model Form of International Contract for Process Plant Construction published by the Engineering Advancement Association of Japan - rather than the Silver Book. It has been suggested that this may be partly due to the general criticism of the Silver Book by contractors.222 The perception of the Silver Book as unfair and draconian means that it is not accepted as a starting point for negotiation, as it is intended to be, and parties are instead amending the Yellow Book for their purposes.223 Contractors are not agreeing to use an unamended Silver Book unless the Both parties seem to prefer the Yellow Book, or employer has significant influence.224
alternatively, developers' bespoke forms of contract which they are accustomed to using (and which require less amendment than the FIDIC suite).225 In this respect, the Silver Book could be said to have failed, as it was the use of these bespoke contracts and the need for a standard form that prompted the drafting of the Silver Book in the first place. This perhaps highlights
219
M Lucas, "Old Risks - New Contracts" (2006) 271 Project Finance 32 at 33. M Lucas, above n 219, at 33. NDJ Henchie, above n 55, at 42-43.
220
221
222
M Bell, "Will the Silver Book Become the World Bank's New Gold Standard? The Interrelationship Between the World Bank's Infrastructure Procurement Policies and FIDIC's Construction Contracts" (2004) 21(2) International Construction Law Review 164 at 168. NDJ Henchie, above n 55, at 43. M Bell, above n 222, at 171. M Wahlgren, above n 202, at 8.
59
223
224
225
the danger of FIDIC moving away from its traditional balanced risk allocation, even where it aims to reflect changes in construction practice. 6. Conclusion It is necessary to identify the legitimate requirements of financiers and whether the Silver Book provides them, for if contractors are not prepared to address them, lenders will refuse to finance the project. However, financiers need to be aware of contractors' concerns in order to be prepared for contract negotiation. All parties must have a detailed understanding of risk so that the contract can reflect the risk allocation they desire. In general, the use of standard form contracts is beneficial to project finance as it increases certainty in risk allocation through familiarity and awareness of which terms to negotiate. Of course, parties should tailor the contract to suit the project, not vice versa, and should also be aware of where a standard form contract is interpreted differently in different jurisdictions. The Silver Book is favourable towards the employer, which indirectly benefits the project financiers. Although requiring some amendment, it generally addresses project finance
requirements relating to cost, time and quality risks. However, where the Silver Book falls down is in the failure to provide a role for the financier, given that the interests of financiers and employers are not always aligned. In light of the considerable discretion conferred on the employer in aspects of contract administration and intervention in the execution of the works, financiers should have a contractual role in ensuring this discretion is not exercised to the detriment of financiers' interests. Arguably, in attempting to maximise the application of the Silver Book beyond project finance, FIDIC has failed to address the complexity of a project financed project and the interaction of the construction contract itself with other parties and agreements in the project. Ultimately, however, the terms to which financiers and contractors are going to agree will depend on the market. The current contractor's market means contractors are unlikely to even agree to a lump sum contract as provided in the Silver Book. Skewing a contract too much one way means not only that it lends itself to "mutilation" but more detrimentally that it will not be used at all - as is the present case with the Silver Book. It may be that sponsors need to consider exposing their own balance sheets to a limited degree to protect financiers until the project is delivered and then revert to revenue from the completed project as the source of debt repayment. Doug Jones 2006.
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7.
Appendix 1: Delivery models and their approach to risk
Delivery model Traditional lump sum
General features Construct only Contractor bears risk of cost overruns However, lump sum may be subject to: escalation for part or all of contract period adjustment (due to variations, delay latent conditions etc)
Approach to risk Adjustment provisions cause some out-turn cost risk to be shared with owner/financier Contractor has no responsibility for design (and duty of consultants is less onerous "reasonable care" duty)
Design & Construct (D&C)
Single line responsibility for design and construction Appropriate where: Owner's priority is best design for a price; and Concept design and design brief are sufficiently developed to ensure delivery of the required product
Increased contractor liability for design defects (fitness for purpose) Possible to place greater burden for time and site condition risks upon contractor: eg, requirement to "design around" unforeseen conditions Greater control allows risk of neutral events (impacting on time and cost) to be better predicted and managed Buildability studies and value management measures
Design Construct Maintain/Operate Combine delivery and operation/maintenance structures Developed to increase contractor responsibility for the "maintainability" of a facility Limited pool of contractors capable of committing? Difficulty specifying precise O&M requirements at time of tender may lead to uncompetitive tenders Turnkey Lump sum - design, construction and commissioning Contractor hands over operating facility (eg, power station) Commissioning is a critical stage from PF perspective, as it is at this point that facility becomes revenue producing Engineering Procurement Construction Management Engineering firm co-ordinates delivery through design, construction and commissioning stages Usually remunerated on a fee for service basis High degree of owner control: Trade contractors enter into direct contractual relationship with owner once work is let
As for D&C Plus contractor's obligation to carry out corrective maintenance without remuneration: Gives owner greater protection against defective design or construction Allows transfer of neutral risks (eg, force majeure, security) to contractor for a significant period after completion
Contractor bears responsibility for design and construction Employer has less control
Example of project delivery by a low risk manager: Contractor is assigned the role of managing the work of various trade contractors Fee based remuneration transfers most risks away from manager
In return, owner/financier has large degree of control

61
Delivery model
General features
Approach to risk Direct contractual relationship with contractors gives owner direct contractual recourse for defective work
Partnering
Moral, non legal arrangement emphasising trust, mutual objectives, fair dealing, good faith and cooperation
Can be implemented in respect of any contracting strategy Risk that informal undertakings will give rise to equitable duties of good faith or merely "gloss over" what remains an inherently adversarial relationship Lower cost and quality risks than lump sum D&C contractor: Cost - Lump sum + reimbursable remuneration. Costs incurred through MC's default not reimbursed (achieves accountability) Quality - MC not subject to fitness for purpose warranty (separate obligations in respect of design and construction)
Managing contractor
Essentially a D&C contractor responsible for delivery from feasibility through to commissioning Differs from D&C contractor in terms of role and risk: Usually subcontracts all design and construction obligations in close consultation with owner
Captures some benefits of lump sum D&C delivery whilst maintaining a high degree of owner control
Owner/financier's risk exposure far greater than under traditional model (but also greater control to manage risk) Extensive consultation may add to time and cost
Alliance
Project alliances: Project based Applies to a specific scope of works
Aim to create environment where it is in both parties' financial interests to co-operate: Must provide incentives to perform and incentives to co-operate Remuneration structure must not subvert the risk allocation of the parties
Strategic alliances: Long term relationship Performance of routine and ongoing work Series of similar or related projects "Core" workload + evolving scope
Alliances may be a potential trap for financier where there is: Poorly defined risk allocation Unpredictability as to out turn cost
Doug Jones 2006.
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How Valuable Is The FIDIC Suite For Construction of Project Financed

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Society of Construction Law (Singapore) International Conference, Singapore 16 October 2006

Professor Doug Jones

Clayton Utz, Lawyers, No. 1 O'Connell Street, Sydney, Australia

Operator Loan agreement Operating agreement Concession agreement

Introductory Note to First Edition of Silver Book.

Sub-Clause 14.2. Sub-Clause 4.2.

Adjustment by variation is also possible - see section 3.4(a) below.

Sub-Clause content - circumstances entitling adjustment

Cost? Yes/No yes

Profit? Yes/No yes

Failure to pass Tests after Completion

Adjustment for changes in legislation

Adjustments for changes in costs

Contractor's entitlement to suspend work

Consequences of employer's risks

Sub-Clause content - circumstances entitling adjustment

Cost? Yes/No types of force majeure

by reason of a force majeure

Sub-Clause 13.8. Sub-Clause 14.2.

Sub-Clause 14.2. Sub-Clause 14.3. Sub-Clause 14.7.

Sub-Clause 14.7(b). Sub-Clause 14.8. Sub-Clause 14.8. Sub-Clause 14.10.

Sub-Clause 14.12. Sub-Clause 14.14.

an employer's risk;44 a force majeure event.45

See section 3.4(b). Sub-Clause 8.10. Sub-Clause 8.11.

verification at tender stage.70

It would, however, be in financiers' interests to limit this

E Corbett, above n 70, at 268. Sub-Clause 17.3(g). Sub-Clause 5.1.

B de Cazalet and R Reece, above n 46, at 51. C Wade, above n 4, at 514.

Monitoring quality during construction

Sub-Clauses 7.6, 15.2(c). Sub-Clause 9.1. JA Huse, above n 23, at 313.

Sub-Clause 11.1. Sub-Clause 11.8.

the contractor's failure to comply with any other obligation. 153

Sub-Clause 11.2. JK Hoyle, above n 151, at 32.

Sub-Clause 11.4. Sub-Clause 11.4.

This will be examined more fully below at 3.4(d)(ii). Sub-Clause 20.1.

completely re-contract the project in order to bring it to completion.

Sub-Clause 3.4. Discussed above at section 3.4(a). Sub-Clause 5.2.

Sub-Clause 4.5. AH Gaede Jr, above n 108, at 482.

instructions to conduct remedial work.191

C Wade, above n 108, at 512-513. C Wade, above n 108, at 511-513.

JA Huse, above n 23, at 67. At section 3.4(a).

Sub-Clause 16.1. Sub-Clause 16.2.

JA Huse, above n 23, at 474. Sub-Clause 16.2.

contractor to be cost-effective, and contractors have been happy to contract on this

Appendix 1: Delivery models and their approach to risk

Delivery model Traditional lump sum

Design & Construct (D&C)

In return, owner/financier has large degree of control

Project alliances: Project based Applies to a specific scope of works

Doug Jones 2006.

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