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Prolongation Claims in Construction Contracts - Cost or Value?

This commentary is provided on the panel debate and discussion held at the Central Conference Centre, Hong Kong on the evening of Wednesday 22nd September 2004, organised by the Society of Construction Law Hong Kong.

The speakers were three well known quantity surveyors, each with many years experience in Hong Kong. They were, in order of speaking, Mr. Michael Charlton, Mr. John Molloy, and Mr. John Battersby. The event was chaired by Mr. Nicholas Seymour, Chairman of the Society of Construction Law Hong Kong.

This commentary is provided by Chris Morgan, also a quantity surveyor with many years experience in Hong Kong, and current Membership Secretary of the Society of Construction Law Hong Kong. The views expressed herein are his and do not necessarily represent the views of the Society of Construction Law Hong Kong. Views provided by him are shown in square brackets [ ] to clearly differentiate these from the remainder of the paper.

Mr. Charlton spoke first. He usefully outlined the background to the traditional approach in building contracts, based on the UK JCT 1963 form of contract, which is the basis for the current Hong Kong HKIS private form of contract. He specifically referred to Clause 11(4)(b), which refers to the pricing of variations where work is not of similar character or executed under similar conditions, Clause 11(6) which allows for payment of “direct loss and / or expense”, and also Clause 24 which also makes provision for recovery of direct loss and / or expense.

He made the point that where delay was caused by variation orders, these variations were almost always priced at BQ rates without any allowance for prolongation costs. He also stated that the reference to “direct loss and / or expense” in Clause 11(6) was thought to include prolongation costs.

Mr. Charlton noted that in building contracts, preliminaries were set out fully in the opening section of the BQ, and that traditionally, prolongation costs had been priced by reference to these preliminaries. This obviously gave the result that the valuation of prolongation costs could be either high or low depending on the pricing of the preliminaries by the Contractor. Mr. Charlton went on to say that some time during the 1980s this traditional basis fell into doubt, and that following various cases, (which are set out in his paper) it started to be accepted that loss and expense should be the actual loss and expense incurred as a consequence of the variation. He stated that this would be claimable as loss and expense under Clause 11(6).

Mr. Charlton comes down in favour of the use of actual cost to price prolongation in building contracts. However, he quotes from the learned QC and author, Duncan Wallace, who he says has pronounced in favour of the use of Clause 11(4)(b) to cover loss and expense, that is to price it into the cost of variation orders.

[Whilst this commentator can see the argument for pricing prolongation costs within variation orders, as apparently suggested by Mr. Wallace, this ignores the practical difficulties which will often arise in attempting to do this, and it may be that it is for these practical reasons that the alternative method of pricing under Clause 11(6) is set out in this contract. A contract may well have many hundreds of variations, and many dozens of these could be critical and contributing to the delay. A further large number could be causing concurrent delay. To attempt to individually price prolongation costs properly and for each variation which causes critical delay is, for many contracts, simply not practical. Further, there seems little point or need to have to go through what could well be a horrendous exercise to attempt to do this. Where we have a situation where there is a period of prolongation which has to be priced then it is much more practical to simply price this period without having to allocate costs to individual variations. This is what Clause 11(6) allows us to do].

Mr. Charlton also spelt out the position as he sees it under engineering contracts, and makes the point that as there is only a short preliminaries bill in the BQ, this was not conducive to the use of the prelims bill for pricing prolongation and that it prompted a further move away from the traditional approach and towards an actual cost basis for prolongation costs. [This commentator notes that he has seen a number of engineering claims where the Contractor has still attempted to price prolongation at alleged rates in the contract by breaking down BQ rates or using percentages for overheads which may have been agreed with the Engineer for the pricing of variations.]

Mr. Charlton concluded that he thinks the industry has accepted that the correct means of evaluating prolongation costs is by reference to actual expenditure, but emphasizes that this depends on the precise terms of the particular contract.

Mr. Charlton also commented on the practice of adjusting for the duplication in recovery of additional overheads where such overheads are recovered in both payment for variations and in the pricing of prolongation costs. He sets out his thoughts on pages 5 and 6 of his paper. Mr. Chartlon’s views are premised on the basis that the overheads in the BQ rate should not be adjusted where the variation may cause a critical delay when it would not be adjusted if the variation has not caused delay. He states that to deduct this allowance in the BQ rate because the Contractor has incurred a delay would place the Contractor in a worse position than it would have been absent any delay. [This commentator would offer a different interpretation on this matter. It is agreed that the overheads in the BQ rates which are used to price variations are not adjusted. However, it is suggested that in pricing prolongation costs the additional recovery of overheads from the variation causing the critical delay should be taken into account by adjusting the prolongation costs to allow for this recovery. i.e. It is the loss and expense which is adjusted, not the BQ rate. Not to do so would mean that the Contractor would be paid twice for some element of his additional overheads, and it seems difficult to believe that the contract intends this to be the case, or that a judge or arbitrator would come to this conclusion.]

Mr. Charlton also touched on the linkage between extension of time and prolongation costs at page 7 of his paper. He also provides a brief review of other forms of contract in general use outside Hong Kong – JCT80, FIDIC 4th Edition, and the ICE Fifth Edition contracts.

Mr. Charlton makes an interesting point in respect of Clause 63 of the Hong Kong Government’s General Conditions of Contract. This clause allows for payment of “Cost” as a result of “Expenditure” which the Contractor has been or is likely to be involved in. Mr. Charlton makes the point that both “Cost” and “Expenditure” appear to exclude opportunity cost which is the basis of many Contractors claims for head office overheads calculated on a formula basis. [Whilst this commentator has seen claims for head office overheads fail, this is generally due to the lack of the necessary proof of cost with a formula calculation, rather than the argument that GCC Clause 63 does not allow for an opportunity cost type of claim. If Mr. Charlton is correct, Hong Kong practitioners may need to review how they are handling claims for head office costs, and Contractors will need to base their claims on costs of running their head office which they can attribute to the delayed contract, rather than relying on a formula type calculation.]

Mr. Molloy considered particularly the situation under the Hong Kong Government General Conditions of Contract. He interestingly set out the historical development of the Government Form of Contract starting from the 1971 form. He noted in particular that the provision in GCC Clause 63 (b) which allows payment of additional costs arising from variations appeared for the first time in the 1985 conditions, whilst the wording of GCC Clause 61, dealing with pricing of variations, continued largely unchanged.

Mr. Molloy set out two options for pricing prolongation costs arising from delay caused by variations. The first is that all prolongation is priced at Cost. The second is that prolongation for late possession, suspension and matters referred to in GCC Clause 63, except variations, should be assessed as Cost, but that prolongation caused by variations should first be assessed using the rates in the BQ and if the Contractor can show that he has incurred more money than is reimbursed by such an assessment, then he would be entitled to top up this assessment to reflect his actual costs. Mr. Molloy clearly sets out on pages 8 and 9 of his paper his “arguments and answers” to these two options. [This commentator agrees with the views put forward by Mr. Molloy at 5.1 of his paper, to which reference may be made.] In summary, this concludes that prolongation should be assessed at Cost in accordance with GCC Clause 63(b).

Mr. Molloy continues at 5.2 of his paper to consider his second option, i.e. that prolongation should be assessed at value for variation orders with a top up under Clause 63 if value is less than Cost. However, Mr. Molloy does not agree with this second school of thought, and his views are clearly set out at 5.2 of his paper. [This commentary does not repeat these arguments which may be readily seen from Mr. Molloy’s paper, and this commentator simply notes that in his view the points put forward by Mr. Molloy appear reasonable and have validity.]

Mr. Molloy briefly touched on the position under the KCRC form of contract, Clause 56.3, which he stated clarifies the position that prolongation caused by variations shall be assessed as Cost.

Mr. Battersby opened by stating that in his view prolongation caused by variations should be valued under the variation provisions, and not paid at Cost. This is a fundamental difference to the other two speakers.

Both Mr. Battersby and Mr. Charlton touched on the matter of extension of time not giving an automatic right to prolongation costs. Mr. Battersby made the point that the Employer cannot profit from liquidated damages during a period of the Contractor’s culpable delay if the Employer has also prevented completion. He also made the point that the Contractor cannot recover damages in respect of an extension of time if he has caused concurrent delay. However, interestingly, he did not apply this to the valuation of prolongation caused by variations which he believes should be valued and not paid as loss and expense or damages. He deals with this at Section 4 of his paper at which he argues that even in the event of a concurrent delay for which the Contractor is responsible, if the Contractor is delayed during that period by a variation then the Contractor should be paid for that prolongation necessitated by the variation.

Mr. Battersby also puts forward the proposition (at 3.10 of his paper) that if a variation causes standing time, then the Contractor may successfully recover the costs of that standing time as a variation even if it could be shown that the Contractor had no alternative work in any event and would suffer no loss from his idle resources. [Whilst this commentator would accept that in practice it would be usual to pay the Contractor for this standing time, it must be equally arguable that if there is no cost, then there is no addition to be made to the valuation of the variation.]

Mr. Battersby also dealt with the matter of the period to be priced for the delay; should it be the period when the delay actually occurred or the extended period at the end of the Contract? Mr. Battersby went on to explain that it is a question of “Cause and Effect”. There is little doubt that what must be priced is the effect of the delay, and it boils down to a clear and careful analysis of the effects of the delay to ascertain the additional overhead resources which are incurred. [I would clarify one point within paragraph 5.2 of Mr. Battersby’s paper when he says that “it is only if, and when, the project as a whole is extended or prolonged beyond its programmed completion period as a result of the delay to the progress of the structure that the Contractor would be involved in the extra employment of resources over and above that allowed in the Contract Price”. I would qualify this to the extent that certain resources could be extended within the original contract period as a result of variations and those extended resources should, of course, be reimbursed to the Contractor.]

Certain further useful points were made during the Question and Answer session.

The question of the impact on the notice provisions was raised if prolongation caused by variations is priced under the variation provisions. Mr. Molloy deals with this matter at 5.1.4 of his paper, and uses it as a further argument for his view that prolongation costs should be valued at Cost, and not under the variation provisions.

The panel were asked about their experience of this matter in arbitrations. Mr. Charlton stated that he had never seen prolongation caused by variations priced under Clause 61 of the Government Form of Contract. He did, however, refer to the case of John Doyle v. Laing where the judge apportioned costs between the causes of delay. Mr. Battersby said that in his experience on projects it was quite common to value prolongation caused by variations, and that in arbitration he had seen awards where delay due to variations were valued with a top up under Clause 63 of the Government Conditions. He stated, however, that he had also seen the opposite view. Mr. Molloy stated that in his experience, for civil engineering works, it was normal to assess prolongation at Cost, but that for building works quantity surveyors tended to extend the detailed preliminaries rates provided in the BQ. Mr. Battersby commented that substantiating costs of prolongation can be quite difficult and that Contractors often would not have the necessary or complete records to properly do this. It was much easier to provide a valuation which did not rely on records. [Commentator’s Note: whilst this is often the case, it does not, in my view, provide a justification in itself for valuing delay due to variations at BQ rates.]

Within the audience was Mr. Peter Berry, an ex-Government quantity surveyor who had been involved in the drafting of the 1985 Government General Conditions of Contract (‘GCC’) and who briefly explained the background and the thinking behind the drafting. He subsequently provided this commentator with a note of his views on the background and application of Clauses 61 and 63 of the GCC, and this note headed ‘Clauses 61 and 63 (1985 Edition)’ is attached hereto as received. [Commentator’s Note : Whatever the views or intent of the drafters of a contract it is, of course, the interpretation of the written word which is relevant in deciding the proper application of the contract].

In conclusion, Mr. Charlton and Mr. Molloy were of the view that prolongation costs arising from delay caused by variations should be assessed at Cost, and Mr. Battersby was of the view that a valuation should be carried out under the valuation provisions of the Contract. However, all speakers appeared to accept that it was possible to argue it either way due to the various provisions of most contracts. [The view of this commentator follows the majority decision of the speakers, but I am also aware of arbitrations in Hong Kong where it has been decided that the assessment of prolongation arising from variations should be assessed under the variation provisions. So, as the speakers have said, it can be argued either way!]

Chris Morgan, FRICS, MCIArb, AAE
Managing Director, Cannonway Consultants Ltd.
September 2004


Clauses 61 and 63 (1985 edition)

Background

The review was driven by a letter of complaint to the Governor in 1980. The complaint targeted the management of civils contracts. Architectural Office (as it was) largely went their own way.

It was decided to use the review to take the opportunity to simplify contract interpretation and make it more consistent, by drafting ofthe Building form and the Civil Engineering form to be the same, as far as possible, given that one was to be "lump sum" and the other "remeasurement".

This was done regardless of the differences in the requirements of the two SMM's particularly so far as PrelimslPreambles were concerned. This basic split has caused the "valuelcost" debate. Despite the intentions of the drafters, it seems that so far as Clauses 61 and 63 are concerned, it has resulted in two different approaches to paying claims for disrupted progress caused by variations (usually referred to as disruption/prolongation claims, even though the words are not used in the Contract).

The sources for the two new versions were to continue to be civil engineering based Le. the ICE 4th and 5th editions, plus a bit of JCT 80, which made it easier for the civils departments to accept (and they did spend most of the money). The civils influence was never overwhelming, because the engineer technical advisers changed a number of times, whereas the building adviser remained unchanged throughout.

It was decided not to follow in the ICE contracts use of "rates and prices". The new versions would only refer to "rates".

As the documents developed, another principle evolved (at least as far as the Building form was concerned). Apart from looking after the interests of the tax payer in the distribution of risk, the Contractor was not to be kept out of pocket for additional expenditure brought by the Employer's changes of mind. The Contractor could take care of changes to the physical work through the rates in the BQ, but could not allow for the unknown "knock-on" effects on progress and on other work.

Clause 61 included familiar words for pricing the physical work and for the adjustment (up or down) of (other) rates, should the varied work impact on them (the proviso). It did not cover any extra expenditure that could not be measured or adjusted - hence Clause 63(b).

Application

The Building contract makes the SMM Preliminaries a mandatory part of the BQ measurement. Anything missed is likely to bring a claim. The SMM must also be followed when measuring variations. It then follows that the Prelims (in so far as they apply) are to be include in the measure and value of any variation. It is the "rates" in the Prelims that are most often adjusted under the proviso, by making allowances for their set-up/removal etc. costs. For this reason alone, the argument that the sums of money included in the Preliminaries Bill are not "rates", but are different, being the (not mentioned) "prices", and therefore do not apply, is unlikely to succeed. If an instruction doubles any Prelim item, Clause 61 applies. It does not differentiate.

If the completed exercise does not reasonably recompense the Contractor for the unforeseen expenditure attributable to any Employer caused delay or disruption, and the Contractor is unhappy, Clause 63(b) is there to put things right - subject to the rules being followed and the supporting evidence.

If the Contractor has included highly beneficial rates in the Prelims, it is no different than a beneficial rate for concrete. The BQ rates apply. There is no power to "claw back" windfall overheads by adjusting other rates under the proviso unless it is the variation work itself that is directly impacting on the other rates, including those in the Prelims by making that work easier or harder.

The civil engineering contract is different in that the relevant SMM refers to very few Preamble items. Generally, the site and office overheads are required to be included in the rates for the physical work. But it has the same clauses with the same wording as the Building version and therefore the same rules apply. Clause 61 and the rates are paramount. Clause 63(b) only applies when all else fails. There is no power to deduct some arbitrary percentage from the rates just because there appears to be an element of over retrieving of overheads i.e. for disruption (not prolongation). There is no specific evidence of how much and where the Contractor has included the overheads.

Notice provisions in Clause 64

Sub-clause (1) only comes into effect following the Engineer/Surveyor's formal notification of the rate(s), usually after Clause 61(2) has been applied. Just sending the completed Bills of Variations to the Contractor is not good enough to start the time bar running.

Sub-clause (2) does not apply to Clause 63. The "written application" referred to in that Clause is sufficient notice and the Clause includes no time bar. It operates in the same way as e.g. Clauses 48(2) and 54(2). This sub-clause refers to Clauses 13,22,28,30,33,34 and 66(1)(b), or anything else the Contractor can dream up.

Peter Berry
September 2004

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