Four of Five – Variations
Over the years, there have been a number of efforts to secure firm prices – phrases like “fixed price, lump sum” and “Guaranteed Maximum Price” or “GMP”, and even target price with painshare/gainshare. None are effective while the owner is able to instruct variations, designs and other construction details are unresolved when the price is fixed and the project remains exposed to unforeseen events. While some contracts endeavour to transfer these risks, they are, in the main, ineffective.
Variations, and corresponding rights to additional payment and time, are a fact of life in construction projects.
The “costs” can be broken down into a number of headings:
(a) direct, or actual net cost, being the contractor’s actual cost incurred in carrying out the additional work – this may be subcontractor/supply cost and the contractor’s own labour and material cost;
(b) overheads – generally these are split into two categories, (i) on-site overhead, being costs allocated specifically to the project, like insurance cost, bonds and project management cost directly attributable to the project; and (2) off-site overhead, being the project’s share of more general head office costs like rent, staff costs etc;
(c) time related costs, usually linked to extensions of time with a day rate; and
Extensions of time are linked to delays caused by the variation or other event, based on the current critical path.
There are two aspects in which NZS3910 needs to be re-examined in this respect:
(1) how variations are classified; and
(2) how variations are costs.
NZS3910 treats most claim events as “Variations” – the formula “shall be treated as a Variation” appears 31 times, covering late issue of drawings and instructions (clause 2.7); breach by Nominated Subcontractors (clause 4.2.6); loss or damage to property arising from the carrying out of the works (clause 5.4.6); assisting Separate Contractors (clause 5.5.2); loss or damage arising from excepted risks (clause 5.6.5(c)); errors in levels (clause 5.8.5); changes to consent conditions (clause 5.11.7); changes in law (clause 5.11.10); utilities miss-located (clause 5.13.4); dealing with treasure (clause 5.14.2); late supply of goods and materials by the owner (clause 5.16); failure by the Engineer (clause 6.2.4); additional testing and sampling (clause 6.4.2); suspension, not arising from a default by the contractor )clause 6.7.3); unforeseen physical conditions (clause 9.5.4); and occupation by the owner (clause 10.7.4). Other events, for example weather delays, give rise to an entitlement to additional time, but not to cost.
When calculating the cost of a variation, clause 9.3 provides for the actual net cost to be assessed, the percentage for on-site overheads to be applied, and the percentage for off-site overheads and profit to be applied to the aggregate of those two. While treating effectively all claims, whether traditional variations or disruption events, as variations and simply applying agreed percentages to quantify the cost is easier, this makes for expensive variations. For example, if a “variation” has minimal disruption effect and time consequences, but high value (for example the substitution of material which may be quicker and easier to instal, but at a high supply cost), the contractor gets to apply both on-site overhead and then off-site overhead and profit for a high cost change which has minimal impact. The converse is also true, where a small but highly disruptive change has a lower valuation.
Variations are also the most fertile ground for dispute.
Other construction contracts, notably FIDIC, requires proof of actual cost and is very specific about which events give rise to entitlements to additional profit. NEC separates entitlement to payment from traditional variations, and provides instead for “compensation events” which may give rise to cost, time and profit.
For most projects, these costs can be separated into three categories:
(i) changes to the permanent work, either arising from an instruction by the owner or unforeseen events which trigger such a change;
(ii) disruption events which need to be dealt with, but which do not entail a change to the permanent works; and
(iii) delay costs, which prevent the contractor from engaging in new projects.
For traditional variations (ie, instructed changes to the permanent works), the justification for additional cost and profit is clear. Where there is a disruptive event, with no impact on time or the permanent works, the justification for paying more than proven cost (which includes actual on-site and off-site overhead costs, but not profit), seems less clear. Stacking the cost with percentage overheads and profit is harder to justify.
Delay, however, is another matter. As NZS3910 currently works, where there is a variation, however incurred, which causes delay the contractor is entitled to all the costs and profit listed in (a) to (d) above, typically calculated on agreed percentages, and day rates for prolongation costs.
A more logical approach is to recognise that where the contractor is delayed, save for its own default, then it is missing out on profit for other projects. In that case, provided there are proper efforts to manage costs and to mitigate delays, the contractor should be paid not just day rate holding costs, but a “fee” or profit on a daily basis for every extension of time granted. This is an approach adopted in recent major projects in NZ and overseas with some success.
For smaller projects, simply applying percentages is probably the easiest and most cost effective means of dealing with costs and delay. However, for major projects, the problems with the NZS3910 approach quickly become apparent, as the number of disputes shows.
The whole variation process under NZS3910 needs reconsideration.