Risk allocation in the FIDIC Conditions of Contract (1999 & 2017) for Construction (Red Book) and the FIDIC Conditions of Contract (1999&2017) for EPC / Turnkey Projects (Silver Book) from the perspective of a German lawyer
By Rechtsanwalt Dr. Götz-Sebastian Hök
In 1999 FIDIC updated its existing standard forms of Conditions of Contract, i.e. the Conditions of Contract for Works of Civil Engineering Construction (the so-called “Red Book”) and the Conditions of Contract for Electrical and Mechanical Works including Erection (“Yellow Book”), as well as the Conditions of Contract for Design-Build and Turnkey (“Orange Book”). In December 2017 the second Edition thereof was launched.
The new FIDIC suite of Contracts (1st Edition 1999 and 2nd Edition 2017) are composed by the Conditions of Contract for Construction that replace the former Red Book (1987), the Conditions of Contract for Plant and Design-Build that replace the former Yellow, 1992, and Orange Books 1995, and finally by the Silver Book (EPC Turnkey).
In 1999 the main motive for publishing new editions of the FIDIC books was to adjust them to significant changes that the construction industry had undergone since the last edition 1987 (1995). Additionally, FIDIC had to take into account that multinational development banks (Worldbank, EBRD etc.) and also bilateral development banks and institutions (JICA, KfW), had included the FIDIC standard forms into their bidding documents. Discussions between the MDB´s and FIDIC had finally led to a harmonized version of the Red Book which has been published in 2005 (compare Hök, The FIDIC Red Book "Harmonised Version" as a Variation of the FIDIC Red Book 1999 and the Standard Bidding Formulas of the World Bank Bidding Documents 2005, ICLR 2006, 405 ff.). The current version is that of June/August 2010.
The 2nd Edition is a modestly revised and improved 1st Edition. There are editorial and substantial changes. The new forms include more words, more definitions and more Clauses. Quality assurance and contract management improvements prevail.
FIDIC standard forms are generally recognised as being well balanced because both parties bear parts of the risks arising from the project. In the eyes of English contractors and lawyers there is nothing too bad in assuming risk (Pickavance, Delay and Disruption in Construction Contracts, 2.28). They are challenged by the tasks to identify the risk retained and to recognize the fact that there is a risk (Pickavance, Delay and Disruption in Construction Contracts, 2.28). To the contrary for German contractors and other civil law contractors risk allocation remains an entirely technical problem and is not yet understood as being a contractual issue because they are not really familiar with using various different standard forms of contract including and providing different risk allocation models. Rather civil law practitioners typically rely upon the rule that the apportioning of risks in standard terms should be in line with the one provided for by statutory provisions and within the limits of these provisions.
Remarks for in depth studies: Civil law countries usually provide for a complete set of concepts and rules as to frequently used types of transactions also referred to as default rules. Hence one will find a particular type of sales contract, a particular type of contract for services and a one for works, each having particular characteristics such as a locatio conductio operis compared with a locatio conductio operarum and each being shaped in a way which has been considered being appropriate.
Hence it can be said that under civil law the parties will make their contract in contemplation of a pre-determined contractual framework which they may shape and modify in order to meet the common intentions. The extent to which a pre-determined type of contract may be modified without switching to another pre-determined type of contract depends on the applicable law. Although contractual freedom is widely recognised being a rule so called innominate contracts, whether bespoke or standardised (such as FIDIC forms of contracts), are rarely accepted as such although being generally admitted. Instead the opinion prevails that contracts may have a mixed nature thus being amended partially by the pre-existing framework of one nominate contract and partially amended by the pre-existing framework of a another nominate contract, as it may the case for a design, build and operate contract if the operation service meets the elements of a simple service contract by which the contractor undertakes to perform services with due skill and care only (best efforts approach) whilst the contractor shall deliver the Works under the regime of a locatio conductio operis.
Under German law the limits, constraints and restrictions as to drafting of standard forms of contract are covered in Section 307 German Civil Code (BGB). This statue provides that standard terms of contract are invalid if they put that party to the contract, which has not drafted these terms, in a position which is unreasonably disadvantageous and this is a result of bad faith of the drafter. If there is doubt, an unreasonable disadvantage is assumed if a standard contract term cannot be reconciled with essential basic principles of the statutory rule from which the contract term deviates. Or: if it restricts essential rights or duties resulting from the nature of the contract in such a way that it endangers the purpose of the contract to an extent that this purpose will not be achieved. Only within these statutory limits the parties of a construction contract are free to assume risks in standard business terms. § 307 BGB has lead to many litigated cases that anybody who drafts standard business terms for the construction industry should be aware of.
Hence, in practice Germans contractors almost always accept the risk allocation model of the so-called “Vergabe- und Vertragsordnung für Bauleistungen” (contract rules for governmental projects), part B, as General Conditions for public works which have to be used for all projects of the German state and the municipalities and which commonly are considered being fair and just for private parties as well. Just recently the German legislator has enacted a privilege that partially makes Part B of the contracting rules for governmental contracts immune against judicial review. However, German courts are allowed to review the Vergabe- und Vertragsordnung part B in the event that a consumer is a party to the contract.
Thus, the main German law books on construction law do not even treat contract based risk assessment and risk allocation as a topic or issue because it does not seem worth to talk about. Instead the German legal risk allocation concept as to a locatio conductio operis contract (Werkvertrag) will be accepted as a given fact. Currently it proves very difficult and to some extent hazardous to deviate from the provisions of the German Civil Code. This does not mean that Germans are not aware of the risks inherent to a construction contract. But it does not spring to their mind that risk assessment and risk allocation provisions should be shaped distinct from those being ruled by law.
Thus there is no doubt that German contractors, consultant engineers and other practitioners have to change their minds when they start to compete on the international market. They have to understand that German law and German standard forms are not necessarily the only possible approach in respect to risk allocation. To the contrary of current German practise they have to take into consideration different risk allocation philosophies and concepts by learning the internationally recognized principles of risk apportionment, such as
(1) risks should be allocated to the party that is in the position to control them and
(2) risks should not be allocated to a party that is unable to bear the consequences of a potential risk becoming reality.
Sub-Clause 4.12 FIDIC 1999 is a typical example for the above approach: The Contractor is usually able to overcome subsoil problems. However, he is not always able to make allowance for all additional expenditure which may become necessary in doing so. Hence Sub-Clause 4.12 allocates the risk of overcoming any problem to the Contractor whilst the Employers assumes the risk to compensate the Contarctor for unforeseeable risk which might occur or eventuate.
On the other hand: Anglo - American contractors should be aware of some more or less substantial particularities of some civil code systems. In German law specific performance is not a discretionary extraordinary remedy but the general rule. Thus, if a defects occurs the employer can demand supplementary performance under Section 635 Germany Civil Code (BGB hereinafter). If the employer claims supplementary performance, the contractor may, at his option either remove the defect or produce an entirely new product (Section 635 BGB). Additionally, the principle of good faith is generally recognized, meaning that the contractor cannot just follow the orders of the employer without regarding possible consequences. Instead there is a general duty to give advice and to cooperate. Contrary to English Law liability for breach of contract means that the party in breach is liable for all losses (including consequential losses) which follow from the breach, provided that there is adequate causation between the breach and the loss. The concept of liquidated damages, well known in common law jurisdictions, is currently either unknown or at least not used in civil law countries. In these countries penalty-clauses are common and valid as well. Finally, under the Civil Codes the contractors retain all risks until not only substantial completion of the project but until formal “acceptance (Abnahme)”, which in principle means approval of the Works. Insofar acceptance should not be confused with the type of acceptance that is required to form a binding contract. This is a completely different issue. Acceptance (Abnahme) in respect to construction contracts under the various civil codes determines the event on which the employer confirms that the works conform to the contract. The contract price becomes due on this event and the burden to prove defects shifts to the employer as does the risk of accidental loss. If the employer is entitled to a claim for the correction of a defect, he may, even after he has accepted the works, retain a reasonable amount of the contract price, namely: two times the estimated costs to correct the defect (see Section 641 para. 3 BGB).
FIDIC forms are generally and worldwide recognised as a fair and balanced standard form for construction works. The best example for an internationally recognised fair and balanced standard form is the new Red Book, 1999 and 2017 edition which are drafted for the use in traditional projects of civil engineering, such as the construction of infrastructure facilities (roads, bridges, dams etc.). The new Silver Book on the contrary is tailored to somehow different types of projects. These “new” types of projects are based on some trends in the international construction industry: during the recent years there is a certain tendency towards larger and more complex projects at considerably higher costs. Along with this tendency the need for private financing for these undertakings has increased. Likewise, there is a trend preferring direct – face to face contracting at an arms length between employers and contractors without of an engineer who is traditionally in charge of administrating and adjudicating the contract. This kinds of projects typically involve private lenders whose interest not only focus on the financing of the project during the actual construction period, but also extent to some type of secured cash flow subsequent to the actual works going on. They take into account that the construction contract usually forms just one part of a complex commercial venture, including other concession and financing agreements.
Consequently, lenders and concessionaires as well as the employer want contract terms that ensure an increased certainty that the agreed contract price will be paid and that time for completion will not be exceeded. Thus, the characteristics of such an agreement are that the contractor – without an engineer – assumes full responsibility for the design and construction of the facility, whereas the employer is not involved in the actual construction as far as possible, but receives the certainty of a fixed final price on a lump sum basis, although on a higher price level, and the certainty of a fixed completion date.
The FIDIC Silver Books 1999 and 2017 have adopted most of the wishes of employers and lenders for the above mentioned types of projects. Most of the risks are borne by the contractor including for example (but not limited to them) the risks of unforeseen ground conditions and the responsibility in respect to design which is completely done by the contractor.
German contractors and lawyers are not yet really familiar with this type of contract terms. They consider them being unevenly balanced or even illegal under Section 307 (BGB). However, this argument is probably of low importance because as a matter of fact German law hardly applies to international construction contracts and even if it does it is still an unsettled issue whether conformity to German law offers legal protection against risks already assumed. Besides, there is no express exemption from the contra proferentem rule in respect to standard terms of contract having been drafted by representative bodies or committees after lobbying efforts of one of the parties; as it is under English law (see in so far Adriaanse, Construction Contract Law, 14).
In the long run even German contractors will have to accept that the Silver Book is highly transparent and that the application of the Silver Book is recommended only if the employer is willing to pay a higher price than for a contract based on the FIDIC Red Book. The issues are how to ensure that employers will not misuse the Silver Book and to identify the risks which are inherent to this contract form and to be aware of the simple fact that to transfer a risk does not reduce it at all. Finally, the issue which party bears a risk is simply a matter of commercial negotiation.
This leads me to the conclusion that employers have to adjust their bidding procedures if they are willing to use the Silver Book. Art. 28 of the directive 2004/18/EC on the coordination of procedures for the award of public works contracts, public supply contracts and public service contracts provides that: “In awarding their public contracts, contracting authorities shall apply the national procedures adjusted for the purposes of the directive. In most cases the bidder who has offered the lowest price will be awarded with the contract”. The Standard Bidding Documents for Works of the World Bank provide that the employer will award the contract to the bidder whose bid has been determined to be substantially responsive to the bidding documents and who has offered the lowest evaluated bid price. This is not acceptable for contracts based on the Silver Book because price competition is not the appropriate approach for such contracts.
Once the appropriate procurement method has been chosen it is up to the bidders to identify the contractual risks and to evaluate the apportionment of risks to be borne by the employer and the contractor. There is no doubt that risks vary in construction contracts depending upon many factors that can effect the progress and the completion of the work, such as (see Adriaanse, Construction Contract Law, 4):
Unforeseen events and circumstances (weather, ground conditions, shortage of material, shortage of labour, accidents, during the construction period it turns out that particular innovative design is impossible to construct etc.), currency risks, interface problems, war, strike etc.
When evaluating risks under the FIDIC Conditions of Contract for Construction and the FIDIC Conditions for EPC / Turnkey Projects, the parties first have to take a look at the scope of either of these forms, since the risks of the employer and the contractor are usually allocated in relation to the true nature of the contract between them. In so far it is evident that the Silver Book imposes most of the risks, especially in respect to price and time for completion on the contractor.
A very important issue are the clauses regulating site data and unforeseeable circumstances. Subclauses 4.10 Silver Book 1999 and Red Book 1999 provide that the employer shall make available to the contractor all relevant site data and the contractor shall be responsible for interpreting this data. Similar wording is used in Sub-Clause 2.5 and 4.10 FIDIC 2017.
The provisions in Silver Book 1999 and 2017 however go much further by stating that that the contractor is not only in charge of the interpretation but also of the verification of this data. Clause 5.1 of the Silver Book 1999 states that the Designer shall be deemed to have scrutinised the employer's requirements, shall be responsible for the design of the works and the accuracy of such requirements and shall not be relieved from his responsibility by data or information received from the Employer. The latter is not responsible for any error, inaccuracy or omission of any kind in his requirements as included in the contract, except for some specific data mentioned in this clause. The problem of a contractor at the time of submission of the tender might be to evaluate the likelihood of encountering such difficulties. In addition to these regulations, Sub-Clause 4.12 FIDIC 1999 deals with unforeseeable conditions.
Under the Red Book 1999 "Unforeseeability" is expressly defined in Sub-Clause 220.127.116.11.
Under the Red Book 2017 “Unforeseeable” means not reasonably foreseeable by an experienced contractor by the Base Date
If an unforeseeable event occurs the contractor shall be entitled to extension of time and extra payment of costs. The corresponding provision in the Silver Book 1999 and 2017 does not protect bidders in a likewise manner. To the opposite the Silver Book makes very clear in sub-paragraph (b) that the Contractor accepts total responsibility for having foreseen all difficulties and costs and in sub-paragraph (c) that the contract price shall not be adjusted to take account of any of these unforeseeable events or circumstances.
On the other hand the burden of risk may vary according to the applicable law. Whereas for example in some jurisdictions the modification of the contract in the event of unforeseen circumstances has been established by law or case law other jurisdictions are particularly strict. In some countries (e.g. Italy, Netherlands) it has been admitted (with different nuances) that a contract, the obligations of which can still be performed, must be modified in so far as performance becomes ruinous (see Rodière/Tallon, Les modifications du contrat au cours de son execution en raison de circonstances nouvelles, 186). In France and in Belgium to the contrary it seems that the parties will be bound to the contract even if the contract is unbalanced (see Rodière/Tallon, Les modifications du contrat au cours de son execution en raison de circonstances nouvelles, 186). In Germany according to Section 313 BGB adaptation of the contract may be claimed if circumstances upon which a contract was based have materially changed after conclusion of the contract and if the parties would not have concluded the contract or would have done so upon different terms if they had foreseen that change, in so far as, having regard to all the circumstances of the specific case, in particular the contractual or statutory allocation of risk, it cannot reasonably be expected that a party should continue to be bound by the contract in its unaltered form.
The contractor who has realized that all these risks are imposed upon him must prepare his bid by evaluating especially the following risks:
Are the expected quantities reasonable?
The Works to be designed must be fit for the purpose
All eventually but currently unforeseeable events (knowing that it is not logical that an event can be eventually unforeseeable, because if it is then it is no longer unforeseeable)
Errors concerning site data
Errors concerning accuracy of employer´s requirements
Since 2005 the World Bank and some other multilateral development banks have published the so-called Red Book harmonised version, which has been made part of the SBDW of the Bank. The World Bank has decided to modify the FIDIC Red Book 1999 for its proper purposes. Some of the changes are of less importance, some seem to have an impact on the allocation of contractual risks (compare Hök, The FIDIC Red Book "Harmonised Version" as a Variation of the FIDIC Red Book 1999 and the Standard Bidding Formulas of the World Bank Bidding Documents 2005, ICLR 2006, 405 ff.). The World Banks has already changed the Red Book twice, first in march 2005 and second in may 2006. The current versions are those of June/August 2010 and 2012.
It becomes obvious that contract assessment is an important thing. It can avoid expensive lessons learnt and disputes. Avoiding disputes is a value as such because handling disputes is expensive and takes a lot of time. FIDIC supports dispute avoidance by providing for permanent Dispute Adjudication Boards or Dispute Avoidance and Adjudication Boards. Permanent DAB´s may help to prevent and avoid disputes. It is beyond doubt that an effective risk management provides a greater understanding of the project objectives and the risks facing the achievement of those objectives. It should also be commonplace that an effective dispute avoidance concept supported by a standing DAB is a helpful means of risk management.
The author has published various articles on the subject matter:
Dr. Hök, Relationship between FIDIC Conditions and Public Procurement Law - Reliability of Tender Documents, (2009) ICLR 23 et seq.
The FIDIC Contracts Committee has decided to publish an updated version of the 1999 edition in 2013. A Task Group was working on the update. The Task Group was inclined to adopt major parts of the FIDIC Gold Book 2008 regarding claim management, disputes and dispute avoidance. Finally the 2017 suite of FIDIC contracts is far away from merely adopting the innovative FIDIC Gold Book language. It has adopted a faar more advanced and a far more sophisticated appaoch regarding claims and disputes.
The author is a fully accredited FIDIC trainer and a member of the German Dispute Adjudicator assessment panel. He is also listed on the FIDIC President´s as an assessed adjudicator. He has experience as an arbitrator, adjudicator and mediator and he has been involved inter alia in dispute adjudication cases in Armenia, Bosnia, England, Germany, Mali, Mexico, Morocco, Poland, Romania, Tansania and Zambia. Finally he has been a friendly reviewer of the FIDIC Gold Book. In 2011 Dr. Hök had been appointed to serve as legal adviser of the FIDIC Task Group on the ODB Contract (TG11) and the FIDIC Design & Build Subcontract (TG9).
Dr. Hök was involved in all the FIDIC Updates as friendly reviewer.
WARNING: the material contained in these notes is a simplified guide to some of the major topics in German construction law. It is not intended as a substitute for legal advice on individual transactions, and does not necessarily stand on its own. Whilst the contents are believed to be correct, the author cannot accept any responsibility for errors or omissions.
LAW OFFICE Dr. Hök, Stieglmeier & Kollegen
Contact: Advocate Dr.Götz-Sebastian Hök
Tel.: 00 49 (0) 30 3000 760-0
Fax: 00 49 (0) 30 513 03 819