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How to Value Variations - Judicial Guidance

The valuation of variations is a near daily task on large construction contracts. The standard fonn building and civil engineering contracts contain a variety of complex mechanisms for valuing variations, often ~eferring to the use of "reasonable" rates or a "reasonable" basis of valuation. Those responsible for applying such provisions have adopted sometimes diverse approaches, assisted, until recently, by little relevant case law. A barrister, acting as arbitrator, recently applied what he considered to be a fair and reasonable approach to value variations. The Technology and Construction Court in the English case of Henry Boot Construction v Alstom Combined Cycles said his approach was wrong.

At issue in the case was the rate to be applied when valuing the additional work required by a tender addendum and also substantial additional work instructed of a similar nature. The applicable rate was unusually high because a lump sum adjustment post tender had been mistakenly expressed as covering only part of the work for which it was calculated.

The Conditions of Contract (based upon the ICE 6th edition) provided:

"the rates and prices in the Bill of Quantities shall be used as the basis for valuation so far as may be reasonable failing which a fair valuation shall be made."

Alstom first argued that the lump sum adjustment could not be used to extrapolate a rate, as it was not "a rate or price in the Bill of Quantities" or, alternatively, that to do so would require a notional breakdown of the price. The Court held that the post tender agreement had the effect of modifying the Bill of Quantities, even though there was no express agreement to do so, and so the lump sum adjustment was a price in the Bill of Quantities for the purposes of the valuation of a variation. Further, the Conditions of Contract did not oblige the contractor to provide any information as to how a rate or price was arrived at (it is interesting to note that the West Rail Conditions contain an express requirement for the contractor to provide a breakdown).

Alstom's main argument (which found favour with the arbitrator) was that it would not be "reasonable" to use the price as a basis for valuing a variation, because the price was high due to a mistake in the tender. The Court stated that what was reasonable in this context was to be determined by looking at the nature of the work itself and not extraneous economic or financial considerations. That the result of the use of the rate or price might be unreasonable was irrelevant, because the rate or price was already unreasonable before the variation was ordered; the rate or price was not made unreasonable by the execution of the variation. The Court ordered that rates derived from the lump sum adjustment should be used for the valuation of the variations.

The Court acknowledged that:

"It is one of the skills of tendering for a construction contract ... to anticipate where there may be departures from the estimated quantities or item descriptions which might prove to be to the contractor's advantage."

This is a clear statement that it is legitimate to load rates, and the burden is on the employer to scrutinize the tender with care to see that no advantage is taken by such means.

In summary, the Court was keen to provide commercial certainty to construction contracts, whilst acknowledging their approach may lead to rates being applied that resulted in substantial profit or loss for a contractor. The moral of the story for employers is that they should give as much attention to the rates set out in tenders as to prices.

Lovells, Asia Focus
May 1999

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