Index of Content

Is "Guaranteed Maximum Price" The Way To Go?

While both employer and contractor may find a guaranteed maximum price arrangement attractive, Glenn Haley and Geoffrey Shaw draw attention to potential pitfalls that both sides need to be aware of.

Question:

I am a main contractor operating in Hong Kong. One of my friends, who is a property developer, tells me he is interested in having projects carried out on a "guaranteed maximum price" basis in the future. What does this expression mean? Can you please let me have some background information regarding this form of contract?

Answer:

One needs to be cautious when using the expression "'guaranteed maximum price". Why? There are at least two reasons.

  • First, because (as discussed further below) the "maximum" is not necessarily a maximum, beyond which the amount payable cannot go. It is possible - indeed, it usually is probable - that a higher total price will be payable by the employer to the contractor at the end of the day.
  • Secondly, because expressions like this mean different things to different people in different situations. Other examples in the construction industry are "construction management", "project management" and "partnering". In fact, some industry commentators regard a guaranteed maximum price arrangement as being merely one type of construction management arrangement.

So, having started with the mandatory lawyers' caution, we turn' now to your question. For brevity, we will refer to the "guaranteed maximum price" as GMP.

The Usual Eelements of a GMP

In general terms, a GMP contract arrangement tends to be one that seeks to involve the following concepts or elements:
  • The GMP (of course).
  • An agreed scope of works, against which changes to the GMP will be judged.
  • A mechanism by which the GMP may be adjusted (upwards), if the scope of works is varied in a way that adds cost or complexity.
  • A mechanism by which the contractor may suggest cost saving changes to the scope, with the savings to be shared in some way between the employer and the contractor. (Depending on the risks being undertaken by the contractor, and other issues of respective bargaining positions, the cost sharing may even be 100% to the contractor.)

The Seduction

Why would a GMP method of project delivery be attractive to the parties? In theory, the factors include the following.

For the employer, a major factor usually is that the employer is relieved from the worry of the project exceeding the budget. The employer is attracted by the "G" and the "M" aspects of the GMP. This is coupled with the attraction of the scope of works being fixed.

For the contractor, there is the "carrot" of being able to share in cost savings. The contractor is also likely to be encouraged by the scope of work being fixed, rather than being subject to major or continued changes at the hands of the employer's design team.

The Reality

As with all forms of project delivery, a GMP arrangement can work and has produced successful results on various projects However, it is not a panacea for the ills of the industry. Like all forms of project delivery, there are pitfalls and potential problems. Some of the pitfalls and potential problems are discussed below.

For the contractor, the nightmare scenario is being bound to stay within the GMP, but yet being required to build something . considerably more expensive. For the employer, the nightmare scenario is being bound to pay the full GMP (and perhaps rr)ore on top), but to be given a product that is inferior in some way to what he anticipated at the time of signing the contract.

Budget. Let us start by discussing the budget, or the "P" in the GMP. You do not have to be a modern day Sherlock Holmes in order to make the elementary deduction that there is likely to be a basic conflict of interest here between the employer and the contractor. The employer usually wants to set as Iowa "P" as possible, whereas the contractor usually will seek a higher "P".

The scope of works. A connected matter is the scope of the works, which naturally should extend both to the quantity and quality/standard of the works to be undertaken. If the contractor is to be held responsible for delivering the project within the GMP, one school of thought is that it is fair that the contractor also should have the capacity to manage the costs. Equally, however, the employer will want some protection as regards the quality and standard of what is being built. The employer will also want to be protected from claims by the contractor that "variations" have occurred, for which the employer must pay extra.

If the employer is not cautious in how he draws up the scope of works document, he might find that the contractor is "cutting corners" (in a way sanctioned by the contract), leading to what the employer might regard as a drop in quality or standard of the finished project. Such" changes" mayor may not be variations, for which the cost savings provisions apply.

The above two points drive home a further point. There is a school of thought that the dynamics between the GMP on the one hand and the scope of works on the other hand is such that it is preferable for the design to be as advanced as possible before the scope of works and the GMP are fixed. Some readers will tut tut in protest that this is a point that is so obvious that it goes without saying. However, even seemingly obvious points sometimes escape the parties (and the contract drafter). The employer's consultants team. Given the scope of works document and its interplay with the GMP and the costs savings provisions, detailed thought is needed as to what ongoing role the employer's consultants team is to play. Sometimes, the employer's consultants adopt a role similar to that in a designand-build contract arrangement (but this can of course lead to its own problems for the employer and his consultants).

Sub-contractors. The parties also need to address their minds to how they will deal with sub-contractors. In order to lessen the perceived risk of the contractor containing costs by engaging "budget" sub-contractors, some employers seek to insist that the contractor use "domestic" contractors from lists nominated by the employer. This is not necessarily a bad thing, but it can reduce the contractor's capacity to stay within the GMP.

Extensions of time (EoT). Given that a GMP differs in various respects from a traditional contract regime, employers often seek to impose a very limited range of circumstances in which the contractor becomes entitled to extensions of time. This often is coupled with stringent notification procedures. Again, thf' contractor needs to ensure that this risk is priced within the ( .). The contractor also should ensure that his project team is t 'ed on what steps are needed to comply with the contract rMirements if the rights to EoTs are to be preserved. (E loyers need to take care that they do not cut down the EoT e;:mffements to such a degree that might enliven the prevention principle, thus putting at risk the entire enforceability of the liquidated damages provisions. However, this is a topic for another article.)

Delay/disturbance costs. It is not uncommon for employers to insist that the GMP contract provide for very limited circumstances in which delay/disturbance costs may become payable. Again, the contractor needs to ensure that this risk is priced within the GMP; and that his project team is briefed on what steps are needed to comply with the contract requirements if the rights to claim additional payment are to be preserved.

The GMP ‘Form of Contract’

Your question asks about the GMP "form of contract". In fact, the GMP is a method of project delivery, rather than a form of contract. The usual practice is to start with a traditional standard form and to adapt it with amendments to the general conditions of contract (GCCs) and the addition of (often lengthy and detailed) standard conditions of contract.

Regardless of what form of contract is used, the basic position remains the same. Both parties need to ensure that they fully understand what risks they are assuming. The best formula is for there to be open and mature discussion of these points, so that there is clarity and common understanding. That of course is easy to say but much more difficult to implement.

Additionally, the contractor should be careful that he is not lulled into a false sense of security by the fact that a "standard" set of GCCs is being used as the nominal starting point for the contract structure. The many and detailed changes require thorough review and risk analysis.

You asked us to let you have some background information regarding the GMP method of project delivery. We hope that the above discussion provides what you want. Of course, the above discussion is not - and cannot be - a complete review of the GMP method of project delivery. Whilst it does have its fans, it also has its detractors. It is an interesting alternative that will suit some but not all projects and some but not all industry participants.

Glenn Haley and Geoffrey Shaw, Deacons
Published in the 'Hong Kong Engineer'
January 2002

Back to top